Archive for the ‘bank regulation’ Category

Suppose that a systemically important financial institution (the official designation, now in true DC style the acronym SIFI) actually fails.  Do we get a financial crisis?  Are owners/creditors punished for endangering the economic system or partly/largely bailed out by loans/transfers from taxpayers?  A few days ago here in Chicago, the acting chair of the FDIC, Martin Gruenberg, spoke to the Chicago Fed about how the FDIC would “systemic resolve” a failing SIFI without endangering the financial system while actually placing losses on those who own and are owned by the institution.  Speech here.


I am glad the work is proceeding.  If, . . oops I mean . . . when we end up in the next financial crisis, we will at least have a plan.  And an ex ante plan may help reduce the frequency of crises.  As  Gruenberg said, “developing a credible capacity to place a systemically important financial institution into an orderly resolution process is essential to subjecting these companies to meaningful market discipline. “

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Some of the financial sector is informal – friends or relatives lending to one another.  In recent years, intermediaries have stepped into these markets.  These companies typically match people looking to borrow with people looking to lend.  The individuals set may of the terms, and the intermediary does some monitoring and information revelation about borrowers.  An example is the company Prosper.  What is interesting is that this is like banking light – instead of lending to banks and having banks lend to other people, people lend directly to people, setting their own interest rates and terms with some guidance and information from the intermediary.


Economists have been doing interesting research on this financial market (see Kellogg grad Enrichetta Ravina and Sarah Miller).  This market is largely unregulated, and, with unregulated finance having become a large concern, the GAO just did a report on the industry.  Their report, here, lays out the issues in regulating the market and describes two possibilities: leaving things roughly as they are or putting the market participants under a regulatory authority such as the CFPB.  Interesting issues. If regulation proceeds, this will give a host of interesting information about financial issues from the analysis of the transition from unregulated financial market to regulated financial market.

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According to ProPublica (source) “Magnetar worked with major banks, including Merrill Lynch, Citigroup, and UBS. At least nine banks helped Magnetar hatch deals. Merrill Lynch, Citigroup and UBS all did multiple deals with Magnetar. JPMorgan Chase, often lauded for having avoided the worst of the CDO craze, actually ended up doing one of the riskiest deals with Magnetar, in May 2007, nearly a year after housing prices started to decline. According to marketing material and prospectuses, the banks didn’t disclose to CDO investors the role Magnetar played.” And “Magnetar pressed to include riskier assets in their CDOs that would make the investments more vulnerable to failure. The hedge fund acknowledges it bet against its own deals but says the majority of its short positions, as they are known on Wall Street, involved similar CDOs that it did not own.” What differs from the Goldman-Paulson situation is: “Magnetar says it never selected the assets that went into its CDOs.”  Fine line between “pushing for what is riskier” and “selecting” but it might be the difference between basing selection on broad ratings/public information and private analysis of what assets were more likely to fail.  Also, I should note that

And I just see that this is what Bloomberg thinks the case hinges on: article here.

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I applaud some of the features of the Administrations newly proposed financial regulations. The Administration has proposed reigning in risk taking by banks by limiting insured banking to the more traditional investments of banks and eliminating some serious conflicts of interest. While risk taking is not bad, this step will be good for the American economy because we live in a world where we the taxpayers are on the hook for bank failures. Since we are insuring them, we ought to monitoring them. And we ought to be limiting their investments to what we can monitor. (more…)

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A. Causes

1.  Bank Regulation Broke Down

AIG bailout, too-big-to-fail

© Beth Cravens (cravensworld.wordpress.com)

All firms are bound to make mistakes and those mistakes will be bigger the bigger the firms involved.  When big firms also happen to be financial institutions, especially banks, everyone in the economy will pay for their errors.  That is because financial institutions are intricately connected with every aspect of the economy and they can and will bring an economy to a grinding halt if they cease to function. If banks and other intermediaries suffer badly enough, economic activity freezes and the entire economy suffers also.  This is what economists call a “negative externality” and the Great Depression was a great example of what that means in practical terms. It is why banks have always been more heavily regulated than other firms, and why they should be treated the same today. Big banks present special problems and they require special handling. (more…)

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