“Expect the Unexpected”

Speech of Commissioner Bart Chilton to the Oversight of Derivatives Roundtable, University of Maryland

September 9, 2011


It’s good to be with you today. Thanks for having me. Thanks especially to Susan Ferris Wyderko, the Executive Director of the Mutual Fund Directors Forum for the kind invitation and to both the Forum and the University of Maryland’s Smith School of Business Center for Financial Policy for their sponsorship of this roundtable.

It is fitting that we are having this event in the Ronald Reagan building for two reasons. First, as I think most people know, President Reagan had a great sense of humor. These days in Washington, it seems like we’ve lost our sense of humor. What you may now know is that in this very building on every Friday and Saturday night, there is a performance by a troupe called the Capitol Steps. You don’t need to like politics to enjoy their humor. They are completely bipartisan. They make fun of the President. They make fun of Speaker Boehner. They make fun of Sarah Palin and on and on. So, I encourage you to go to the show. And, if I talk long enough, you can go straight there tonight.

The second reason it is appropriate to be in the Reagan building is that we are going to discuss regulations. I’m not sure if I can add much humor, but I’ll try to make it interesting.

Reagan and Regulation

President Reagan was a big believer that government was too big and that we needed only limited regulation. He said government is not the solution to problems. Government is the problem. What a sound bite: government is the problem.

In 1985, President Reagan visited the New York Stock Exchange. He was the first sitting president to do so. Here is what he said when he was there:

“Trust the people. This is the one irrefutable lesson of the entire post-war period, contradicting the notion that rigid government controls are essential to economic development. The societies that have achieved the most spectacular, broad-based progress are neither the most tightly controlled, nor the biggest in size, nor the wealthiest in natural resources. No, what unites them all is their willingness to believe in the “magic of the marketplace.”

The magic of the marketplace—gosh he had a way with words. Unfortunately, what we have witnessed leading up to the economic meltdown was that government got out of the way and we did see a lot of magic in the marketplace, but not the good kind. What we have seen is a lot of sleight of hand and smoke and mirrors.

Where are We and How Did We Get Here?

People, and particularly politicians, bashing government isn’t anything new. Governments of all sorts are easy targets. Talking about the evil regulations, that is a good (although shallow) applause line too.

By the way, I believe most Americans like a lot of regulations, they just need to be reminded of them. Think food safety, child safety, car and truck and airline safety, and drug testing regulations. I think those are pretty popular regulations that folks would not want to see go away.

But, when people talk about the evils of regulation in the financial sector, the first thing I do is a little remedial history. I try to remind them how we got here. How we got into this financial mess that President Obama spoke about last night. Earlier this year, the Financial Crisis Inquiry Commission (FCIC) issued a report, and in it they ask this question:

“How did it come to pass that in 2008 our nation was forced to choose between two stark and painful alternatives—either risk the collapse of our financial system and economy, or commit trillions of taxpayer dollars to rescue major corporations and our financial markets, as millions of Americans still lost their jobs, their savings and their homes?”

That’s a good question. FCIC concluded that the entire mess never had to take place. They noted widespread failures in financial regulation, excessive risk-taking on Wall Street, policymakers who were ill-prepared for the crisis, and systemic breaches in accountability and ethics at all levels. The bulk of the blame went to regulators and the captains of Wall Street. The high-wire magic of the marketplace deal makers and regulators with a “do not disturb” sign on their door got us into the mess.

The deregulated environment had gutted our system of checks and balances, and as a result, we became a system of just checks. Checks to AIG and many checks totaling hundreds of trillions of dollars to the largest banks in the country. That Gordon Gekko greed is good mentality put us in an economic tailspin that we’re still trying to stop. But then, in my opinion, came the good news.

Along Comes Financial Reform

We now have the most sweeping set of financial reforms in our history—the Dodd-Frank law. It was necessary if we were ever going to protect ourselves again from the kind of financial meltdown that occurred, and now, we regulators are trying to do the right thing as we write all the new rules associated with the law.

Now, there are still the naysayers out there. Some of the folks who aren’t so happy want to defund the regulatory reforms by starving financial regulators’ funding. Others want to repeal Dodd-Frank altogether. Some just want to slow it down in the hopes that if they run the clock out, perhaps there will be a political change in Washington. Pretty constantly we hear from the usual suspects, about the big bad government and the big bad regulations and how they stifle innovation and competition and that the level of the earth in the U.S. is actually rising because of the lifted weight of businesses that are leaving in droves for foreign shores. Everybody’s entitled to their own opinion even if it’s contrary to my own. After all, somebody has to be wrong. I’m just kidding—kind of.

Expect the Unexpected

Oscar Wilde, the flamboyant and quick-witted cultural commenter, had a great quote – “To expect the unexpected shows a thoroughly modern intellect.” (He also said, “I can resist everything but temptation,” but I’m trying to be intellectual here, so let’s go back to the first quote). “To expect the unexpected shows a thoroughly modern intellect.”

He made this statement about the “modern intellect” in the late 1800’s, so perhaps his idea of modernity was a bit different from ours. Back then, people rode around in buggies drawn by horses, houses didn’t have electricity, and heck, their idea of indoor plumbing was a bucket.

On the other hand, some events occurred in the late 1800s that you might not have expected. For example, it might surprise you to learn that the principles behind fiber optics were first presented to the Royal Society in 1854, when John Tyndal, using a curved stream of water, proved that a light signal could be bent. And building on this concept, in 1880 William Wheeler invented a system of what he called “light pipes,” coated with a highly reflective coating, to send indoor lighting throughout homes from a single light source. As early as 1888, medical doctors in Vienna were using similar technology to illuminate body cavities to perform complicated surgeries, and in 1885, the same types of bent glass rods were used to guide light images in the first attempt at an early television.

You all probably know that pasteurization was invented in the 1850s, but did you know that the first plastic was made in 1862? (And we all thought it was relatively new when “The Graduate” came out. Nope—it had been around about 100 years by that time). Typewriters, airbrakes, metal detectors, escalators, contact lenses, radars, dishwashers, washing machines, cash registers, seismographs, rayon and tungsten steel—all invented in the last half of the 19th century. Amazing. Think about what it must have been like to live back then, when the Industrial Revolution was turning the world on its head—and these changes were felt not only by the rich and privileged, but also by average folks. It was just at this time that Wilde made his comment to expect the unexpected—and all of these things were certainly “unexpected”—indicating a modern intellect. I think that must have been an incredibly exciting time and a time when to have a “modern intellect” meant to be open not only to exciting to new inventions, but also—almost by definition—to new ways of thinking. I mean, some of these inventions were probably pretty scary to people. Think about radar, for example, probably considered devilish by some—but to those with a “modern intellect,” with open and inquiring minds that want to know, these new inventions opened up new pathways of thinking and ultimately manifold opportunities for economic growth.

My point is—O ye, those of little faith who thought I didn’t have one—my point is this: we’re at a similarly exciting time right now with regard to financial reform regulations. I’m going to invite you to do something similar—to expect the unexpected. Hear me out on a new way of thinking.

This is what I want to propose to you today—to “expect the unexpected” with regard to the new regulations on financial market regulatory reform. By the way, this fits exactly into what President Obama was talking about last night with regard to doing only regulations that make sense. Here is the thought: rather than producing overly burdensome rules that stifle innovation (the arguments that President Reagan made in the 1980’s and that you still hear today) or constructing weak rules that compromise consumer protections (the argument from the left), I think this new set of rules will do something absolutely unique. I believe these rules will actually create jobs. They will create new sectors within sectors. They will create new opportunities for economic growth on American soil. Let me explain why.

For the first time, we are not writing rules and regulations for an exchange-trading market that is already in existence—like the securities and commodities markets. This new exchange-trading marketplace is being built from the ground up. To be sure, there is a vibrant OTC swaps market in this country, and as I’ve said many times, we don’t want to do anything to hurt legitimate business but at the same time we need to fix what got us into the mess in 2008. We’ve got real, tangible and extremely important reasons to continue to move forward to implement financial reform. Folks who are upside-down on their mortgages will tell you that. But again, let me get back to my original point: why these regulations will be a positive good for the American economy.

As I said, this industry, this exchange-trading of swaps, will be built from the ground up. The Dodd-Frank law instituted clearing requirements for swaps—the fundamental provisions to address transparency and systemic risk issues. Along with those statutory dictates are new requirements for “swaps execution facilities”—platforms on which to trade swaps. In addition, there will be “swaps data repositories,” to warehouse swaps data. All of these entities—and the participants—will be registered with the Commission and will require staff to ensure compliance with federal mandates. As this new industry develops, I am fully confident that “better mousetraps” will be developed. People will devise new and innovative—and better—ways of doing business, and we as regulators are going to need to be nimble and responsive to ensure that we accommodate that growth and at the same time protect markets and consumers. All of this is a Herculean task, and all of it takes putting people—lots of people—to work. I have no doubt that these new regulations—instituting new types of clearing, trading, and reporting platforms—will foster a landslide of hiring in the financial sector.

In addition, there is another factor to consider, equally important as an economic generator. All of this new trading activity with new regulatory oversight requirements will require the development of new technologies, both in the private and public sectors. And I think the competition here has already begun. We have seen high frequency traders abound in recent years, and we are going to see, I believe, new types of technologies that will be needed, both in the marketplace and by regulators, to effectively do business and oversee the conduct of that business. The “language” of algorithmic trading will become the legal definition of how financial market activity is done, and new technologies will be needed to develop the methods with which we speak to each other. The possibilities for economic growth and competition here are mind-boggling. And I have great faith in the ability of American computer scientists, physicists, logicians, statisticians—inventors of all kinds—to come up with the best, the fastest, the most capable, and the best financial market technologies in the world.

On top of all that, Dodd-Frank is kind to the nation’s deficit. The Congressional Budget Office estimates that it will reduce the deficit by $3.2 billion in the next ten years.

Can this all be done? I’ve been involved with government for 25 years. Maybe I’m part of the problem, but I don’t think so. I see how government operates and how it can change. Sure, we need to do better and I can tell you we have already made good progress. That’s why we haven’t done the rules by the date Congress told us to do them—by July. We are taking our time and being thoughtful. We are doing them correctly. We are getting them right, and we have already started what I’m talking about. We did two rules last month that will help create economic activity. It can be done. It is being done.

When President Obama spoke last night about regulation, he said that, while there are some who advocate simply throwing out all regulation and letting everyone write their own rules, “that’s not who we are.” That’s not what it means to be an American. He noted that yes, we’re strong and self-reliant, and yes, we have an economic engine that has been the envy of the world, but he also correctly stated that there are some things “we can only do together” that we are guided by a belief that we are connected. He noted that, while some are already complaining about his proposal for an American Jobs Act and regulatory reform, and some would like to simply wait it out until the next presidential election in 14 months, there are those who don’t have jobs, who are suffering, who don’t have the luxury of waiting 14 months. That’s why instituting sensible, appropriate regulations, to put people to work and create jobs is so incredibly important, right here, right now. That’s why I’d like you to think differently about our regulations, to expect the unexpected.

Just like Wilde’s vision of a modern intellect, in the financial arena I see countless possibilities, innovative horizons, unbounded opportunities that this new and novel marketplace will bring to the American economy and ultimately to the American consumer. And the new regulations framing the market’s existence—and providing needed guidelines and protections—will be the foundation for a new generation of economic growth. So, let’s expect the unexpected.

American Idol

Let’s shift gears now. I don’t have a great transition here, so I’ll use that old line from Monty Python, when the great comic John Cleese would say, “And now, for something completely different.”

American Idol is the most watched television show ever. I told you I didn’t have a good transition—just go with me here. The May 25th American Idol show had 124 million votes, just 5,000 shy of the number of votes cast in the 2008 presidential election. To be fair, for those of you who don’t know about the show, you can vote more than once for the American Idol. Sort of like they joke folks did in Chicago years ago. The point is that whatever American Idol has been doing has worked. You know what hasn’t worked very well recently? Financial ratings agencies. So what’s the difference between rating agencies and American Idol? Let’s contrast and compare a bit, shall we.

As you will recall, on August 5th, Standard and Poor’s (S&P) rating agency unexpectedly downgraded the United States from AAA to AA+. Since the early 1900s when ratings began, this was the first time the U.S. wasn’t rated AAA.

The downgrade was based upon S&P’s view that Washington politics remain unstable and therefore deficit-reduction measures will not be attainable. Washington—unstable, tell me it ain’t so. I mean, gridlock in Washington is hardly a shocker. I guess we will all have to continue to look at the way Capitol Hill responds to the President’s call to action last evening. However, the S&P decision was also fueled by what they called a $2 trillion calculation error—a $2 trillion calculation error. The direct impact of this ratings downgrade on markets was enormous. The Monday following the release of the rating, the Dow dropped 635 points! I have a problem with that, with a ratings agency being so powerful.

Remember, some of these agencies are the ones who got ratings so incredibly wrong in 2008. Not only did they give favorable ratings to firms that ultimately went under during the economic fiasco, they maintained AAA ratings on pools of junk mortgages packaged by Wall Street banks, trading away credible ratings for the bottom line of the ratings agencies. Do we really want to continue to rely upon such agencies?

Now, bring in Steven Tyler, the new Idol judge and the flamboyant Aerosmith front man. He provides insightful commentary based upon his music and performance experience. What he says colors contestant performances with a professional texture viewers might not otherwise notice. What he and the other American Idol judges do not do, however, is render the final judgment. Unlike the ratings agencies, the American Idol judges aren’t that powerful. Final determinations are left up to the viewers.

Maybe ratings agencies need to get a little more like American Idol. We shouldn’t treat the rating agencies as idols themselves. We shouldn’t have to bow down to them and accept that the fate of our markets will hinge upon their every word. Instead, the rating agencies should provide (like American Idol judges) premium and high-quality information. What they should not do is make final judgments that drastically influence markets. They should be more informative and insightful, but not deterministic. They've become excessively powerful and create a self-fulfilling prophesy about what markets will do.

In addition, three agencies comprise 97% of all ratings. Three—talk about too much concentration! There are smaller agencies out there and a little competition would seem to be a very good thing. As a final point, all these agencies should work for consumers, not deal makers. That’s a flawed business model that incentivizes agencies to provide favorable ratings. The American Idol judges don’t get paid by the contestants.

We need to change the way the raters operate. You may say, as Tyler sings, “Dream On,” but we have seen the damage the raters can create. We should not simply accept the status quo.


I want to leave some time for questions, if I haven’t already used all of that. If so, I guess you can go directly to the Capitol Steps. But before I go, I want to reiterate that we need to think more positively about where we are headed. We need to not only look for bad things that could happen, but potentially good things that can happen. Businesses need to be looked at as partners in this effort, and to the extent we can do better in government and do the jobs that we are supposed to be doing, we can make great strides. That’s good for market participants, for business and especially for the consumers who depend on these markets for the price discovery of just about everything they purchase. I know it is a tough challenge, but I am optimistic that we can meet it.

So, maintain your sense of humor, and most importantly, expect the unexpected, it will demonstrate your thoroughly modern intellect.

Last Updated: September 9, 2011