The OFR’s first annual report

Here is the first annual report of the Office of Financial Research.  Among other things, the report details what the OFR don’t know and would like to. Interesting reading for those interested in questions like what should be monitored? Why? Are there clever ways to measure it? And if not, how could one structure surveys or regulation to measure it?

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The Volcker Rule Moves Forward

A small army of Federal Agencies — the Treasury, Fed, FDIC, and SEC – have set forth a proposed implementation of the Volcker rule contained in the Dodd-Frank legislation, here.  In short, the Volcker rule is a rule to disallow proprietary trading by banks and non-bank financial companies.  The proposed rule does this and also covers relationships with hedge funds or private equity funds. There are exceptions for running a hedge fund under certain conditions, for example hedging investments or making some international investments.  But in general, the rule limits investments in hedge funds to be small relative to the hedge fund size and to be small relative to the bank’s size.

 

There are potential adverse effects of this rule when combined with the restrictions imposed by the qualified investors rules.   This is all about efficiently getting investment funds to businesses from savers.  It makes sense to provide insured, liquid ways to save and to monitor and restrict the activities of banks that are insured.  But then can people save in illiquid, risky ways?  And how do businesses with illiquid risky investments get funding.  Seems like we are pushing funds into banks and then forcing to make direct loans rather than hire others to make investments for them that are not debt contracts.  Is this the right channel and are these the right contracts for getting fund to businesses from savers?  I tend to think we want more equity-type contracts and less debt type contracts.

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How to Have a Successful Failure

Recommended reading: The upcoming FDIC quarterly contains a fantastic article on how, if Dodd-Frank were law then, Lehman Brothers might have been liquidated in a more orderly  and rapid fashion after its failure. The article is a nice summary of the events leading up to the Lehman failure, the relevant provisions of the Dodd Frank Act, and a description of how these would have been implemented in the case of Lehman.  I learned a number of things about how the financial regulation will look going forward. Something I did not know from Dodd-Frank’s orderly liquidation process is that “The Dodd-Frank Act provides that the FDIC may borrow funds from the Department of the Treasury, among other things, to make loans to, or guarantee obligations of, a covered financial company or a bridge financial company to provide liquidity for the operations of the receivership and the bridge financial company.” At least according to current law, any losses on this mini-bailout are born by the industry, not the taxpayer.

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Appropriately Retentive about Risk Retention

The SEC now has a proposal for how to implement the Dodd-Frank requirement that institutions retain some of the risk of loans when securitizing and selling loans.  The idea of this requirement is to give originators better incentives to originate and sell good loans.  Not sure why the private sector screwed this up – one reasonably hypothesis is that a few large players screwed it up, AIG, Lehman and others — but anyway.  The proposed SEC rules are here for public comment.  To make things interesting, important government officials are now weighing in.  Here is the comptroller of the currency’s response (mostly concerned with fighting exemptions), and here is the press release for Tim Geitner’s (Treasury is supportive of the general rule and accepting of the specifics).  In my opinion, financial institutions need retain no common or systemic risk to be properly incentivized, they just need to hold the risk of the loans they originate relative to similar other loans.  Otherwise, systemic crises damage bank capital.  But I have blogged a fair bit on this before . . .

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Watch the revisions to Dodd-Frank

The Dodd-Frank bill, the large financial regulatory reform bill that finally became law last year after a year of Congressional and Administration work, is being both implemented and changed.  The implementation process is where the legislation will succeed or fail.  For example, nothing in the bill definitively eliminates “too big to fail” for example, but it does allocate enough power that the implementation of the bill could be structured to limit the problem.  Another example, here is a very nice report on how to implement the Volcker rule.

Actual changes in the legislation are more of a concern, because they can represent the success of industry lobbyists at rolling back regulations.  The bill was passed under the spotlight brought by the crisis, and my concern is that useful pieces can be repealed by legislators (in exchange for cash) when the press and voters are paying less attention.  While not as drastic as Congressional attempted revisions (and Judicial actual revisions) to the health care legislation, the revisions are starting to appear.  As an example, the Bureau of Consumer Financial Protection is to be largely funded from revenues from the Federal Reserve, limiting congressional oversight.  The Federal Reserve has a long and successful history of banking regulation (remember they did not have the authority to regulate the investment banks or AIG, they just helped clean up the mess!).  Texas congressman Randy Neugebauer is trying to give Congress complete control of the purse strings (see here).  Maybe this is helpful, in that Congress can respond to the needs of the voter (and democracy has some advantages).  But institutions and institutional culture matters.  The Fed has struck an awe-inspiring balance between responsiveness to industry and protection of the economy.  And it would be great if we could construct some similar institution to regulate consumer finance.

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More Fed Translucency

The Dodd-Frank Act required that the Fed make readily available to the public information that is public.  So we now have a nice web page here that provides easy access to the latest reports on Fed lending authority and activity. It includes reports prepared by the Fed for the Senate Banking Committee and from the Comptroller General for example, as well as transaction data.

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