What We're Reading in Financial Regulatory Reform, July 2

Here are the latest and greatest in financial regulation to take with you as you celebrate America’s 239th birthday. When you get back from your long weekend, we hope you can join us on July 9, as BPC and Managed Funds Association celebrate Dodd-Frank’s 5th birthday with: Dodd-Frank at Five: Looking Back and Looking Ahead, featuring keynote remarks from Federal Reserve Board Governor Lael Brainerd.

As always, 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, Justin Schardin and Olivia Weiss.

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What we’re reading on payments:

“Building a Safer Payment System”, Speech at the Federal Reserve Bank of Kansas City Conference, “The Puzzle of Payments Security: Fitting the Pieces Together to Protect the Retail Payments System”, Kansas City, Missouri
By Jerome H. Powell, Governor, Federal Reserve Board

“Earlier this month, the faster payments steering committee met to begin developing timelines, processes, and criteria–including criteria related to security–that will be used to evaluate potential approaches to improving the speed of the payment system. … By the end of next year, the plan is for the faster payments task force, with input from the secure payments task force, to have laid out its detailed thinking on the most effective approaches for implementing faster payments in the United States. Then, it will be up to the industry to implement these approaches.” Read the full speech.

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“Faster Payments in the United States: How Can Private Sector Systems Achieve Public Policy Goals?”, Research Working Paper, The Federal Reserve Bank of Kansas City
By Fumiko Hayashi, Senior Economist in the Payments System Research Department, Federal Reserve Bank of Kansas City

“The Federal Reserve could engage in three key activities in its leadership role to influence the systems’ governance: creating core criteria that reflect desired outcomes, governance, public policy goals, and public interests; ensuring the faster payment task force’s evaluation of alternative approaches aligns with core criteria; and monitoring faster payment systems and strongly encouraging them to build and operate the infrastructure to both meet core criteria and incorporate public interests in its governance. … A leadership role may increase the probability of success of private-sector systems while avoiding public authority intervention as regulator or operator.” Read the full working paper.

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What we’re reading on liquidity:

“Mutual Funds – The Next 75 Years”, Remarks at the Brookings Institution, Washington, D.C.
By Kara M. Stein, Commissioner, Securities and Exchange Commission

“I hope that as the Commission considers action in the area of liquidity, it asks hard questions about new and innovative products, as well as emerging risks. Do the retail investors investing in these funds truly understand and appreciate the liquidity of the fund? Perhaps these investments make sense for a private fund, which has a more sophisticated investor base and is often subject to lockups and gates that can help the fund navigate market stress. But what happens to an open end mutual fund or ETF – which must honor redemptions in seven days – when financial conditions get rocky, redemption requests surge, and the fund is primarily invested in illiquid assets?” Read the full speech.

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“Keynote Speech at the Quadrilateral Meeting at the European Central Bank, Frankfurt, Germany”
By Sharon Y. Bowen, Commissioner, U.S. Commodity Futures Trading Commission

“Many speakers at MRAC had extremely different opinions about what constitutes strong liquidity. Absent agreement on what liquidity actually is, regulators will be hard-pressed to craft and implement policies to improve liquidity. At the very least, people need to be more precise about what they really mean when they say liquidity is down or we need more liquidity. …While the new regulations enacted as part of Dodd-Frank, Basel III, or European Market Infrastructure Regulation (EMIR) may be playing a role in changing liquidity, many participants didn’t focus on regulations as being the prime cause for a drop in liquidity. We need more study of this subject, however, and we should be quick about it.” Read the full speech.

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“Is there a problem with liquidity in the financial markets?”
By Douglas J. Elliott, Fellow, Economic Studies, Initiative on Business and Public Policy, Brookings Institution

“The cumulative effects of a series of regulations have made it substantially more difficult and expensive for banks and large securities dealers to act as market makers. …Smaller dealers, hedge funds, and other asset managers will pick up some of the slack, but there are real limitations on their ability to do so cost-effectively. The markets can also adapt, such as by moving to agency rather than principal models and by embracing electronic markets, but, again, there are some serious limits on how far these moves can go. The net result should logically be decreased liquidity and we have already seen much lower securities inventories held for market-making purposes by dealers along with some other signs of lessened liquidity.” Read the full blog post.

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What we’re reading on insurance:

“The Offshore Reinsurance Tax Fairness Act”
By Senator Ron Wyden (D-OR)

“The PFIC rules provide an exception for income derived from the active conduct of an insurance business. The exception applies to income derived from the active conduct of an insurance business by a corporation which is predominantly engaged in an insurance business and which would be subject to tax under Subchapter L if it were a domestic corporation. Current law does not prescribe how much insurance or reinsurance business the company must do to be considered predominantly engaged in an insurance business. Senate Finance Democratic staff investigative efforts show that some companies that are not legitimate insurance companies are taking advantage of this favorable tax treatment.” Read the overview. Read the bill.

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What we’re reading on consumer protection:

Senate Democrats Urge Government Agencies to Investigate Potential Violation of the Fair Housing Act
By 14 Democratic Senators including Robert Menendez (D-NJ); Sherrod Brown (D-OH); Elizabeth Warren (D-Mass.); and Chuck Schumer (D-NY)

“We have reviewed with great interest and concern a report of the National Fair Housing Alliance (NFHA). … The report found that REO properties in communities of color were much more likely to have a higher number of maintenance and marketing deficiencies, leading to destabilizing outcomes for families and neighborhoods. … According to NFHA’s report, the same communities who were victimized by predatory mortgage lending practices may now be facing additional burdens from unequal and inadequate management of foreclosed homes.” Read the full letter. Read the report.

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“The State of Lending in America & its Impact on U.S. Households: The Cumulative Costs of Predatory Practices”
By Center for Responsible Lending

“Families with annual incomes below $25,000– $35,000 are much more likely to receive an abusive loan product. And in most cases, borrowers of color are two to three times more likely to receive an abusive loan compared with a white counterpart. The discriminatory effects of abusive lending clearly contribute to the widening wealth gap between families of color and white families.” Read the full report.

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What we’re reading on Dodd-Frank:

“Bank Living Wills: Five Years Later, Still in Probate”
By Justin Schardin and Kristofer Readling

“If the plans aren’t up to the standards the FDIC and the Fed are expecting, it may start a countdown for more serious actions. Dodd-Frank grants regulators the power to deal harshly with firms whose wills are deemed “not credible,” but it remains to be seen whether the regulators will go down this route. Specifically, the two agencies can impose extra prudential requirements and possibly even forced divestitures.” Read the full blog post.

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“AIG in Hindsight”
By Robert McDonald, Erwin P. Nemmers Professor of Finance, Kellogg School of Management,
Northwestern University, and Anna Paulson, Vice President and Director of Financial Research, Federal Reserve Bank of Chicago

“AIG’s real estate positions were apparently motivated by the belief that these investments
would not default. The analysis sheds light on a claim often made by AIG executives that their mortgage-related investments might have suffered a decline in their market value in the short-term, but that they would pay off over time. This claim implicitly attributes any price decline in such securities to short-term illiquidity. …However, this stark claim that assets were “money good” is not borne out: a number of AIG’s mortgage-related investments suffered principal write-downs.” Read the full paper.

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“What Do Rating Agencies Think about “Too-Big-to-Fail” Since Dodd-Frank?”
By Gara Afonso, Senior Economist, Financial Intermediation Function and João Santos, Vice President and Function Head, Financial Intermediation Function; Federal Reserve Bank of New York

“Circling back to our original question of whether the Dodd-Frank Act has solved too-big-to-fail in the United States, the answer seems to be yes, according to Fitch; maybe, according to Moody’s; and not yet, according to S&P. While Fitch has removed its expectation of government support to U.S. commercial banks and bank holding companies, Moody’s still expects support for commercial banks, and S&P for commercial banks and bank holding companies. However, S&P has indicated that it expects to revise its ratings of four U.S. G-SIBS this year to reflect the reduced likelihood of government support for these institutions.” Read the full blog post.

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What we’re reading on FSOC and international regulation:

“What to Watch for: Secretary Lew’s Wednesday Testimony on FSOC’s Annual Report”
By Justin Schardin and Kristofer Readling

“Members may also ask about whether FSOC plans to designate any asset management companies as SIFIs. Last year, the council directed its staff to engage in an analysis of activities and products in the asset management industry, possibly indicating a focus on those activities and practices instead of designation of individual asset managers. In March, however, the Financial Stability Board (FSB) and International Organization of Securities Commissions (IOSCO) published a consultation paper that included specific size thresholds for asset managers for use in determining whether they are systemically important.” Read the full blog post.

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“IOSCO and the international reform agenda for financial markets”, Speech at the National Press Club, Washington, D.C.
By Greg Medcraft, Chairman, International Organization of Securities Commissions

“The markets we regulate are built on the idea of risk taking – risk taking which supports
wealth creation and economic growth. We see regulation as being about ensuring markets accurately and fairly price those risks and that market participants act with integrity. It’s all about ensuring trust and confidence in these markets. Regulation should be careful not to stifle risk taking – or make it prohibitively expensive. The tools we develop and use should be tailored to the particular risks we think warrant regulation and supervision. In the markets space, they should be about conduct supervision and enforcement.” Read the full speech.

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What we’re reading on monetary policy:

“Monetary Policy in the United States and in Developing Countries”, Speech at the Crockett Governors’ Roundtable 2015 for African Central Bankers, University of Oxford, Oxford, United Kingdom
By Stanley Fischer, Vice Chairman, Board of Governors of the Federal Reserve System

“Still, one feature of the era after the first increase of the federal funds rate will, in all likelihood, be higher U.S. and global interest rates compared with their extraordinarily low levels of recent years. The increase in global interest rates could cause investors to adjust their portfolios, triggering capital outflows from emerging market and developing economies. …Higher global interest rates could limit the possibilities for governments to finance their projects or budgets on the same favorable terms. The reduced ability of governments to finance their needs will likely increase the challenges faced by central banks in their efforts to assist the economic growth and development agendas of their national governments.” Read the full speech.

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“Inside the Fed: Demystifying Monetary Policy”
By Emily Liner, Policy Advisor, Capital Markets Initiative, Third Way

“Every weekday, the Federal Reserve Bank of New York holds an auction to buy, sell, loan, or borrow government bonds from or to certain large, private banks designated as primary dealers. …
Putting more money into the market lowers interest rates, loosens the money supply, and heats up the economy. Thus, when the Fed purchases government bonds from primary dealers in exchange for cash, money enters the system. Likewise, pulling money out of the market raises interest rates, tightens the money supply, and cools the economy. When the Fed sells bonds to primary dealers in exchange for cash from banks, money leaves the system.” Read the full blog post.

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