What We're Reading: Financial Regulatory Reform, November 21

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Wednesday, November 21, 2012

BPC's Financial Regulatory Reform Initiative will regularly highlight news articles, papers, and other important work which illuminate current and new thinking within financial regulation. We circulate these articles to provide a full view of cutting edge ideas, reactions and positions. The views expressed in these articles do not necessarily represent the views of the initiative, its co-chairs, task force members, or the Bipartisan Policy Center.

Compiled by Aaron Klein and Shaun Kern

Happy Thanksgiving. We thought as you enjoy the holidays and time with your families you may also enjoy a few articles and speeches, current and past, which highlight key issues in the financial services world.

Remarks of Under Secretary Miller at the 15th Annual International Banking Conference Hosted by the Federal Reserve Bank of Chicago

By Mary Miller, Under Secretary for Domestic Finance, Treasury Department

“[F]inalizing the mortgage finance rules, derivatives regulations, and the Basel capital rules as well as protecting short-term funding markets are not just goals unto themselves. Clarity engenders confidence in our financial system, and it is a crucial ingredient for job creation and economic growth. That is why it is so important that we press forward with financial reform.

I recognize that this is not easy. Reform is hard. Memories of the financial crisis fade. And we have some tough assignments ahead that require coordination not just among banking and market regulators, but also with our international counterparts. [The term “level playing field” is often invoked, but is hard to achieve in practice.] While we strive for simplicity in our reform efforts, we must recognize that we have a complex and globally interconnected financial system.

But I think the importance of getting the rules right goes directly to the theme of this conference, and more broadly, the work that we do at the Treasury Department every day. Quite simply, our financial policies matter because of the critical role that financial institutions and markets play in our everyday lives.” Read the full speech here.

Solving the Too Big to Fail Problem

By William Dudley, President, Federal Reserve Bank of New York

“I am going to focus my remarks today on what is popularly known as the “too big to fail” (TBTF) problem. In particular, should society tolerate a financial system in which certain financial institutions are deemed to be too big to fail? And, if not, then what should we do about it?

The answer to the first question is clearly “no.” We cannot tolerate a financial system in which some firms are too big to fail—at least not ones that operate in any form other than that of a very tightly regulated utility.

The second question is the more interesting one. Is the current approach of the official sector to ending TBTF the right one? I’d characterize this approach as reducing the incentives for firms to operate with a large systemic footprint, reducing the likelihood of them failing, and lowering the cost to society when they do fail. Or would it be better to take the more direct, but less nuanced approach advocated by some and simply break up the most systemically important firms into smaller or simpler pieces in the hope that what emerges is no longer systemic and too big to fail?” Read the full speech here.

What Now? Opening Address to the 6th Biennial Conference on Risk Management and Supervision in Basel, Switzerland

By Peter Fisher, former Under Secretary of Domestic Finance, Treasury Department

“What now? In the post‐crisis world, bank supervisors have taken on two challenges: first, you have committed to place effective limits on bank risk taking and, second, you have committed to arrange bank capital structures to reduce the likelihood of taxpayer losses. Can you do this? Yes, I think you can. But to be successful, you will have to change your own behavior, and the behavior of bankers, more than is apparent thus far.

Before you can effectively limit bank risk taking in general, and risk to taxpayers in particular, you will have to take view on how much risk banks should take and, correspondingly, how much reward they should seek. While bank management and bank boards are responsible for this in the first instance, you will not be able to assure yourselves that risk is effectively limited without making hard judgments about risk and return – “hard” both in the sense that these judgments are difficult to make and in the sense that you need to be prepared to make them binding.” Read the full speech here.

Proposed Recommendations Regarding Money Market Mutual Fund Reform

By Financial Stability Oversight Council

“The Council is proposing to use this [Section 120 of Dodd Frank] authority to recommend that the SEC proceed with much needed structural reforms of MMFs. There will be a 60-day public comment period on the proposed recommendations. The Council will then consider the comments and may issue a final recommendation to the SEC, which, pursuant to the Dodd-Frank Act, would be required to impose the recommended standards, or similar standards that the Council deems acceptable, or explain in writing to the Council within 90 days why it has determined not to follow the recommendation.” Read the full recommendations here.

Senate Banking Committee Statement on Basel III: Impact of Proposed Capital Rules

By George French

“The basic purpose of the Basel III framework is to strengthen the long-term quality and quantity of the capital base of the U.S. banking system. In light of the recent financial crisis, that would appear to be an appropriate and important goal. However, that goal should be achieved in a way that is responsive to the concerns expressed by community banks about the potential for unintended consequences.” Read the statement here.

Making Credit Safer

By Senator-elect Elizabeth Warren and Oren Bar-Gill [Written November 2008]

“Physical products, from toasters and lawnmowers, to infant car seats and toys, to meat and drugs, are routinely inspected and regulated for safety. Credit products, like mortgage loans and credit cards, on the other hand, are left largely unregulated, even though they can also be unsafe. Because financial products are analyzed through a contract paradigm rather than a products paradigm, consumers have been left with unsafe credit products. These dangerous products can lead to financial distress, bankruptcy, and foreclosure, and, as evidenced by the recent subprime crisis, they can have devastating effects on communities and on the economy. In this Article, we use the physical products analogy to build a case, supported by both theory and data, for comprehensive safety regulation of consumer credit. We then examine the present state of consumer credit regulation, explaining why the current regulatory regime has systematically failed to provide meaningful safety regulations. We propose a fundamental restructuring of this regime, urging the creation of a new federal regulator that will have both the authority and the incentives to police the safety of consumer credit products.” Read the entire law review article here.

The Financial Crisis: An Inside View

By Phillip Swagel, former Assistant Secretary for Economic Policy, Treasury Department

“This paper reviews the policy response to the 2007–09 financial crisis from the perspective of a senior Treasury official at the time. Government agencies faced severe constraints in addressing the crisis: lack of legal authority for potentially helpful financial stabilization measures, a Congress reluctant to grant such authority, and the need to act quickly in the midst of a market panic.” Read the entire paper here.

Letter from Japanese Financial Markets Council to CFTC on Proposed Cross-Border Swap Regulations

By Jonathan Kindred and Shigesuke Kashiwagi

“We are all aware that participants in the 2009 G20 summit agreed the regulation of the derivatives market should be strengthened, and that a significant effort is underway to set new international standards. Derivatives, and swaps in particular, remain crucial instruments for risk management, hedging and the facilitation of growth. For the swaps market to provide this important function, it is crucial the market remain liquid, price competitive and ultimately driven by market considerations within a harmonized set of global regulatory parameters.

The JFMC would caution against rules that, in pursuing the goals of the G20, inadvertently pose risks associated with a reduction in liquidity. Moreover, any regulatory regime that is significantly out of step with those being developed elsewhere, either in substance or in implementation, will inevitably cause distortions and unintended consequences.

That puts the responsibility on regulators and industry to ensure rules are effective not only domestically but internationally as well. May we therefore suggest the CFTC consider implementing its cross-border swaps regulations, as applied to non-U.S. persons, with the achievement of full coordination with each relevant G20 regulator, through formal and comprehensive intergovernmental agreements.” Read the full letter here.

How Central Banks Can Succeed as Systemic Risk Regulators

By Aaron Klein, Project Director, Bipartisan Policy Center

“There is a reason why central banks have seen their authority grow. Having tamed inflation, central banks around the world have enjoyed increased political independence and respect from elected officials. The initial success of the Euro currency upon its launch in 1999 and the structure put in place granted the ECB power and authority that other supranational European organizations lack. Despite protests against the ECB in Europe and the rise of a prominent U.S. presidential candidate who called for an end to the Fed (the third central bank in U.S. history), these institutions have emerged from the financial crises of the last five years with enhanced legal authority and regulatory responsibility.” Read the full article here.

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