What We’re Reading: Financial Regulatory Reform, November 1

The BPC’s Financial Regulatory Reform Initiative regularly highlights news articles, papers, and other important work which illuminates 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, Justin Schardin, and Shaun Kern

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A Better Path Forward on the Volcker Rule and the Lincoln Amendment
By Jim Cox, Jonathan Macey, and Annette Nazareth, co-chairs of the Financial Regulatory Reform Initiative’s Capital Markets Task Force

“The task force’s recommendations avoid a “one-size-fits-most” approach to implementation that focuses on individual transactions and presumes trading to be proprietary and impermissible. Instead, the task force’s recommendations stress the importance of a functional, data-driven model that takes account of the significant differences across asset classes, products, and markets. This approach focuses on tailored, data-driven metrics to help define what constitutes impermissible proprietary trading as well as the use of safe harbors to promote clarity regarding clearly permissible activity. An iterative, phased-in approach with access to a robust set of data maximizes the ability of regulators to fine-tune implementation and to continue to adjust in the future.” Read the white paper here.

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Toward Building a More Effective Resolution Regime: Progress and Challenges
By Federal Reserve Governor Daniel Tarullo

“To be credible, then, a resolution mechanism for large financial firms must be capable of dealing with these characteristics of financial markets. This is the premise underlying Title II of Dodd-Frank, and I think it has also been the premise of thoughtful commentators who have proposed amendments to the Bankruptcy Code for application to large financial firms. There are three key features of Title II and, modified in certain respects, some of these Bankruptcy Code proposals reflect recognition of the peculiarities of financial markets in a way the current Bankruptcy Code does not.” Read the full speech here.

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Lean, Clean, and In-Between
By Federal Reserve Governor Jeremy Stein

“The traditional, pre-crisis framing of the [“lean versus clean” debate] went something like this: Should policymakers rely on ex ante measures to lean against potential financial imbalances as they build up, and thereby lower the probability of a bad event ever happening, or should they do most of their work ex post, focusing on the clean-up? Post-crisis, the emphasis in the debate has shifted. I think it’s safe to assume that nobody in this room would now argue that we should be putting all our eggs in the “clean” basket. Discussion these days tends to focus instead on which ex ante measures are best suited to safeguard financial stability.” Read the full speech here.

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Remarks at the American Bankers Association Annual Convention
By CFPB Director Richard Cordray

“It would have been a classic governmental approach for us to say, once the mortgage rules were published, “Well, that’s your problem now.” We could have said we have plenty of other things to do ? which is true ? and so we will not see you again until our examination teams arrive to gauge whether you are getting it right or we bring an enforcement action contending that you did not get it right. We could have left you entirely on your own. Instead, we have chosen to handle things very differently. All this year, since the rules were first published, we have made it a point to engage directly and intensively with financial institutions on a project that we call regulatory implementation.” Read the full speech here.

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Consumer Regulator to Stop Bringing Lawyers to Firm Exams (The Wall Street Journal)
By The Wall Street Journal’s Alan Zibel

“The Consumer Financial Protection Bureau said it is ending its practice of bringing enforcement lawyers to regular examinations of financial institutions…The CFPB’s policy shift, which becomes effective Nov. 1, comes after intense criticism from banks, industry lawyers and trade groups who said the presence of enforcement attorneys at routine examinations created a hostile regulatory environment… “Any organizational benefits envisioned from that policy are outweighed by the more visible drawback of creating a barrier to forthright communication,” the Bipartisan Policy Center said in a report on the CFPB last month.” Read the full article here.

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Asset Management and Financial Stability
By Office of Financial Research

“Unfortunately, there are limitations to the data currently available to measure, analyze, and monitor asset management firms and their diverse activities, and to evaluate their implications for financial stability. These data gaps are not broadly recognized. Indeed, there is a spectrum of data availability among asset manage¬ment activities. Mutual funds and other investment companies registered under the Investment Company Act of 1940 (1940 Act) publicly report data on their holdings; banks report aggregated data on collective investment funds in regulatory Call Reports; and regulators have recently begun to collect data regarding private funds and parallel accounts on Form PF, under a mandate included in the Dodd-Frank Act. However, data for separate accounts managed by U.S. asset managers are not reported publicly and their activities are less transparent than are those of registered funds.” Read the full report here.

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Key Developments in the Tri-Party Repo Market
By President of the Federal Reserve Bank of New York William Dudley

“The recent financial crisis showed us that the tri-party repo market was inherently unstable due to deficiencies in the settlement infrastructure. Prior to 2008, there was limited recognition of the ways in which adverse developments in this market could quickly transmit risk to other parts of the financial system with unforeseen consequences. We now know, with the benefit of hindsight, that the market was overly reliant on massive extensions of intraday credit by the clearing banks to the broker-dealers, that market participants did not adequately appreciate the magnitude of the risk embedded in the role played by the clearing banks, and, as a result, market participants underpriced risk in ways that undermined the market’s resiliency during periods of stress.” See the full speech here.

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Fire-Sale Spillovers and Systemic Risk
By Federal Reserve Bank of New York Staff

“Using a simple model and detailed balance sheet data for U.S. bank holding companies (BHCs) and broker-dealers, we find that spillover losses from fire-sales have the potential to be economically large. This is true even for moderate shocks during “normal” times, when markets are relatively deep. For example, if the value of assets for one of the largest five BHCs declined by 1 percent in 2013-Q1, we estimate spillover losses equivalent to 1 to 2 percent of total equity held in the commercial banking sector. For broker-dealers, a 0.1 percent decline in the price of all assets financed in the tri-party repo market would lead to spillovers amounting to almost 6 percent of system equity for the same time period.” Read the full paper here.

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Five Years Later: Lessons from the Financial Crisis
By Jeffrey R. Shafer, McGraw Hill Financial Global Institute

“10 lessons learned from the crisis: (1) Financial markets are not inherently stable and not always efficient in making use of information… (3) A collapse of market liquidity is the greatest risk to which a modern financial system is exposed. (4) The Federal Reserve exercised its role as a lender of last resort courageously. Its powers to do so need to be protected, not curbed as Dodd-Frank seeks to do…(7) Problems build up where attention is not focused?shadow banking will always be a challenge.” See the full report here.

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Insurance Needs a Federal Regulator ? But Not the Fed
By Jim Sivon and Greg Wilson

“The problem with the dual regulation by the Fed and individual states is the lack of symmetry between the two distinct regulatory systems. In other words, the systems are designed for entirely different purposes. State insurance regulation is focused on insurance risks, whereas the Fed traditionally has been focused on banking risks and, for the most part, has no real experience or deep expertise in the insurance business. These risks are fundamentally different and demand different approaches to effective regulation. Forcing insurance companies into a bank-centric model of regulation simply will not work.” See the full American Banker piece here.

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Treasury’s Latest Financial Power Grab (The Wall Street Journal)
By Holland & Knight LLP Partner Richard Liskov

“On Friday, Prudential Financial Inc. dropped its fight against being designated as a “systemically important financial institution” by the Treasury Department’s Financial Stability Oversight Council… [s]o instead of focusing federal oversight on the non-insurance operations of major players, the Fed will now displace state insurance officials in overseeing the solvency of SIFI carriers. Unless the Federal Reserve Board’s rules defer to state regulators’ judgment, the insurance-buying public is likely to see the dismaying spectacle of a new set of inexperienced federal regulators disagreeing with state insurance departments with decades of expertise, over a major insurers’ financial condition. And insurers designated as SIFI are likely to be perceived as gaining the mantle of the Fed’s protection to the detriment of fair competition in the insurance marketplace. How those results further public confidence in sound regulation, or promote the consumer’s interest, is anyone’s guess.” Read the full Wall Street Journal opinion here.

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High-Level Expert Group on Reforming the Structure of the EU Banking Sector (The Liikanen Report, October 2012)
Chaired by Erkki Liikanen

“In evaluating the European banking sector, the Group has found that no particular business model fared particularly well, or particularly poorly, in the financial crisis. Rather, the analysis conducted revealed excessive risk-taking- often in trading highly-complex instruments or real estate-related lending ? and excessive reliance on short-term funding in the run-up to the financial crisis. The risk-taking was not matched with adequate capital protection, and strong linkages between financial institutions created high levels of systemic risk.” Read the full report here.