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Archive for the ‘regulation’ Category

 

Here, in a readable but general document, is the Office of Financial Research’s strategic plan.

A huge amount depends on the talent that it can draw and the culture it can develop.

Did I, an economist, really say that about culture?  Huh. I guess it shows how little we know about what makes for an (in)effective regulatory agency.

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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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While Congressional extremists look to undo what Congress just did on financial reform, Bernanke offers a measured take on the economics and incentives of a few aspects of the regulation of systemic risks in the financial system, here.

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Here is an interesting new paper on how regulation can mitigate systemic risk, put out by the Technical Committee of the International Organization of Securities Commissions. The paper reviews the crisis, its lessons, and then launches into the identification and mitigation of these risks.  While such an aggregation of opinions is necessarily mainstream, the paper is a nice summary of the regulatory view of the crisis and response.  But economists need to weigh in with evidence.

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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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Having been away for a while, the news is a little old, but the Basel Committee has issued more details on “Basel III” – the regulations, endorsed by the G20 in November, that will cover the regulation of bank capital adequacy and liquidity globally.  Documents here.

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The Journal of Consumer Affairs has some interesting reading on the regulation of the consumer market for financial products in a special isues here.  They also published a while back an article (speech) by Elizabeth Warren on applying what is known in product safety regulation to financial products, here. (These may be restricted or require a log in if you are not at an allowed IP address.)

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Just a quick post to flag, here, a candid and well-written overview of some of the policy failures leading up to the crisis and policy responses during the crisis by John Dugan, the outgoing head of the OCC (‘The what?’ you say. The OCC happens to have been a regulator of national banks.) And just so you don’t ignore the piece once you see it is a speech given to the “Exchequer Club,” which sounds like a group of guys that make one happy we rebelled against English rule, he contrasts this financial crisis with earlier financial disruptions, and notes how earlier policy responses were useful in this crisis:

“ . . .the systemic risk authority that Congress provided to the FDIC 19 years ago in FDICIA . . .  allowed the agency to guarantee obligations other than insured deposits in extraordinary circumstances . . .  Of course, this was the provision that we did use when the crisis hit, not only in individual cases involving several large institutions, but also more broadly to temporarily guarantee the obligations of a wide range of financial institutions, just as other governments were doing. As a result, this is the provision that has been widely criticized as the wellspring for the government’s “too-big-to-fail” actions, unfairly allowing bailouts of large firms about to fail, while smaller distressed banks have been forced to close their doors without government help.  . . . But here’s the thing of it: in the middle of the crisis, it worked. That is, in the absence of an orderly resolution mechanism for large financial firms, the provision worked phenomenally well to avoid runs and restore confidence, just as it was intended to do – and it will even end up making money for the taxpayer.”

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Here is the summary from the Senate Banking Committee. Lots and lots to digest here. . .

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Finally, the two parties have agreed on legislation that largely ends “too big to fail.”  The latest amendment to the financial reform legislation, sponsored by Senators Dodd and Shelby, is described by Dodd here.  My view is that this amendment does end too big to fail and dramatically reduces taxpayer exposure to large failing financial firms. The legislation allows large financial institutions to be taken over and run and liquidated in an orderly fashion by the government when they become insolvent. All shareholders and creditors will take losses in proportion to what they would have taken had the firm been allowed to fail.  It limits section 13(c) of the Federal Reserve Act so that the Fed can only use its emergency lending to lend to solvent institutions (My understanding was that this was pretty much the Federal Reserve’s interpretation of their authority during the initial phases of the crisis and that this interpretation is why Lehman was allowed to go under.  However, as the crisis evolved post-Lehman, the Fed relaxed its interpretation because the size of the “emergency” made the strict interpretation of “lending” as opposed to bailing out less relevant – see Maiden Lanes I through III.)

My two concerns? The legislation seems to be a field day for lawyers in the wake of any such failure.  I would prefer legislation that requires such institutions to have covenants in place ex ante that specify relative losses across debt classes when an institution fails. Second, I fear the complete stripping of an institution before it goes under, which would leave all creditors and equity with nothing but potentially leave the government either needing to cover some of those losses which “somehow” appear to be held in systemically important places or having to cover some commitments of the defunct firm to maintain faith in the financial system. This is related to my view that derivatives contracts allow firms to make new debt senior to existing debt and to pledge value out of firms ‘expropriating’ long-term debt holders and now potentially the taxpayer. Your thoughts are welcome . . .

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