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Geithner: Regulatory Framework Failed to Evolve with Financial System

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Treasury Department secretary Timothy Geithner, speaking before the Financial Crisis Inquiry Commission (FCIC) today, said the current financial crisis can be traced to a regulatory system that failed to keep up with a changing financial environment. The circumstances bred a parallel banking system -- not exactly a "shadow" banking system, Geithner noted, as it was conducted out in the open. The post-Great Depression regulatory system "did not evolve to keep pace with growth and innovations in our financial services industry," Geithner told the the congressionally-appointed panel tasked with investigating the cause of the current financial crisis. "The constraints imposed by banking regulation were significant enough to encourage activity to move away from banks in search of lighter regulation, lower capital requirements, weaker consumer protections, and better tax and accounting treatment," he said. A parallel financial system developed outside the banking regulatory framework. Geithner said a diverse number of financial firms were allowed to operate outside of traditional regulation. "The shift in mortgage lending away from banks, the growth of the relative importance of non bank financial institutions, the increase in the size of investment banks, and the emergence of a range of specialized financing vehicles are all manifestations of this phenomenon," he said. The new financial system failed to attach enough importance to the possibility of a severe crisis, Geithner told the FCIC. The protections over the traditional banking system did not provide sufficient financial cushions or shock absorbers to withstand a severe drop in real estate values and the following recession. He pushed the merit of financial reforms being considered now by the Senate. Key among the reforms are resolution authority to wind-down failing financial firms, greater oversight of derivatives, and comprehensive constraints on risk-taking, according to Geithner's testimony. Write to Diana Golobay.

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