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What We're Reading: Financial Regulatory Reform, January 16

BPC’s Financial Regulatory Reform Initiative regularly highlights 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

Financial Regulatory Reform Initiative Letter to Financial Regulators on the Volcker Rule

By Financial Regulatory Reform Initiative, Capital Markets Task Force

“Without regard to the underlying substantive differences among the Agencies, we believe it is very important that the Agencies act in a coordinated manner to adopt final Volcker Rule regulations that are substantively identical and issued at the same time. If the Agencies’ rulemaking efforts are not coordinated, market participants could be faced with different and potentially conflicting requirements that are subject to inconsistent interpretation by different Agencies. This would unnecessarily increase the complexity of an already complex regulatory framework and would result in additional uncertainty for market participants, their customers, and U.S. financial markets overall.” Read the full letter here.

Resolving Globally Active, Systemically Important, Financial Institutions

By the Federal Deposit Insurance Corporation and the Bank of England

“This paper focuses on the application of ‘top-down’ resolution strategies that involve a single resolution authority applying its powers to the top of a financial group, that is, at the parent company level. The paper discusses how such a top-down strategy could be implemented for a

U.S. or a U.K. financial group in a cross-border context.” Read the full paper here.

Industry Structure and Systemic Risk Regulation

By Federal Reserve Governor Daniel Tarullo

“The importance of understanding the costs of various regulatory measures is self-evident. As I will discuss shortly, industrial organization (IO) can help determine the circumstances in which firm size or industry concentration is associated with economies of scope and scale that carry social benefits. Any reduction in such benefits would be an unintended cost of financial stability policies. Conversely, if firm size or industry concentration is found to stem only from market power or from funding advantages associated with too-big-to-fail policies or perceptions, then some policies aimed at diminishing systemic risk would have the added benefit of mitigating market failures.

Less obvious, perhaps, is the potential for IO research to inform financial stability regulation by illuminating industry dynamics that may not be intuitively apparent. For example, unlike firms in most other industries, large financial institutions transact with one another on a nearly continuous basis and regularly maintain contractual relationships carrying substantial future obligations. The daily operations of most firms in the financial industry depend to a much greater extent on the conditions of their competitors than do such operations of firms in other industries. By extending work on patterns of cooperation and competition among firms in other industries to the financial sector, IO might help shape regulatory structures that can reduce the potential for contagion during periods of financial stress.” Read full the speech here.

Final Rule on Ability-to-Repay and Qualified Mortgage Standards under the Truth in Lending Act

By Consumer Financial Protection Bureau

“During the years preceding the mortgage crisis, too many mortgages were made to consumers without regard to the consumer’s ability to repay the loans. Loose underwriting practices by some creditors—including failure to verify the consumer’s income or debts and qualifying consumers for mortgages based on “teaser” interest rates that would cause monthly payments to jump to unaffordable levels after the first few years—contributed to a mortgage crisis that led to the nation’s most serious recession since the Great Depression.

In response to this crisis, in 2008 the Federal Reserve Board (Board) adopted a rule under the Truth in Lending Act which prohibits creditors from making “higher-price mortgage loans” without assessing consumers’ ability to repay the loans. Under the Board’s rule, a creditor is presumed to have complied with the ability-to-repay requirements if the creditor follows certain specified underwriting practices. This rule has been in effect since October 2009. In the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress required that for residential mortgages, creditors must make a reasonable and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan according to its terms. Congress also established a presumption of compliance for a certain category of mortgages, called “qualified mortgages.” These provisions are similar, but not identical to, the Board’s 2008 rule and cover the entire mortgage market rather than simply higher-priced mortgages. The Board proposed a rule to implement the new statutory requirements before authority passed to the Bureau to finalize the rule.” Read the full rule here.

Key Dimensions and Processes in the U.S. Credit Reporting System: A Review of How the Nation’s Largest Credit Bureaus Manage Consumer Data

By Consumer Financial Protection Bureau

“This paper describes the credit reporting infrastructure at the three largest nationwide consumer reporting agencies (NCRAs) – Equifax Information Services LLC (Equifax), TransUnion LLC (TransUnion), and Experian Information Solutions Inc. (Experian) – with a special focus on the infrastructure and processes currently used by the NCRAs to collect, compile, and report information about consumers in the form of credit reports.” Read the full report here.

Report to Congress on Credit Ratings as Required by Section 939F of Dodd Frank

By SEC Division of Trading and Markets

“Under section 939F of Title IX, Subtitle C (“section 939F”), the U.S. Securities and Exchange Commission (“Commission”) must submit to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives, not later than 24 months after the date of enactment of the Dodd-Frank Act, a report containing: (1) the findings of a study on matters related to assigning credit ratings for structured finance products; and (2) any recommendations for regulatory or statutory changes that the Commission

determines should be made to implement the findings of the study.” Read the full study here.

SEC Staff Paper: Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher

By SEC Division of Risk, Strategy, and Financial Innovation

“The Commissioners asked whether money market funds that break the buck outside a period of financial distress would cause a systemic problem. RSFI documents that a number of funds received or requested sponsor support during non-crisis times, an indication that defaults and rating downgrades have led to significant valuation losses for individual funds. With the exception of The Reserve Primary Fund, however, these funds’ distress did not trigger industry wide redemptions. This finding suggests that idiosyncratic portfolio losses may not cause abnormally large redemptions in other money market funds. However, data is limited even on these and other potential events because the instances where sponsor support was provided generally were not publically disclosed to money market fund investors and thus, it is difficult to determine the exact number of funds that might have been affected or the consequences if investors had been aware of sponsor support.” Read the full staff paper here.

An Evaluation of Money Market Fund Reform Proposals

By Samuel Hanson, David Scharfstein, and Adi Sunderam

We analyze the leading reform proposals to address the structural vulnerabilities of money market mutual funds (MMFs). We take the main goal of MMF reform to be safeguarding financial stability. Specifically, MMF reforms should reduce the ex ante incentives for MMFs to take excessive risks and increase the ex post resilience of MMFs to system-wide runs. We argue that requiring MMFs to have capital buffers best accomplishes these goals. Capital provides MMFs with loss absorption capacity, lowering the probability that a MMF suffers losses large enough to trigger a run, and reduces ex ante incentives to take excessive risks. Read the full paper here.

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