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

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

Three Years Later: Reflections on the Financial Crisis and the OCC, Remarks before the GW’s Fourth Annual Financial Regulatory Reform Symposium

By John Dugan

“Let me begin with some general remarks about the financial crisis, which I think began in March of 2007 with the Bear Stearns transaction; reached its zenith of fear and panic in the fall of 2008 with the implosion of Lehman Brothers and the government take-over of AIG; and subsided only after the massive infusion of private capital into the banking system in the wake of the remarkable, almost magically successful stress tests of 2009.

“People often say that this period was the worst financial crisis since the Great Depression of the 1930s – but they are wrong. That depression was certainly the worst economic collapse the country ever suffered, with a quarter of our people out of work, and one of its fundamental causes was indeed the collapse of thousands of banks across the nation. But as a financial crisis – a period of fear, panic, loss of confidence, and impending failures of major financial institutions both here and around the world – the panic of 2008 was worse. That is certainly the view of the person who has perhaps the best informed perspective on both: Federal Reserve Chairman Ben Bernanke, one of the foremost scholars of the Great Depression and someone who was at the epicenter of the more recent crisis, describes September and October of 2008 as “the worst financial crisis in global history, including the Great Depression” – where 12 of the 13 most important financial institutions in the United States “were at risk of failure within a week or two”– something that had no analog in the 1930s.” Read the full speech here.

Comment Letter on Basel III Regulatory Capital Rules

By Americans for Financial Reform

“The historical failure of risk-based capital metrics calls for a fundamental shift in the structure of bank capital regulation. As many observers have commented, the byzantine complexity of risk adjustments and the excessive reliance on bank internal modeling have been deeply counterproductive. The reliance on complex internal models has undermined what should be the central regulatory goal – limiting excessive leverage. This implies that regulators should place significantly heightened leverage capital requirements at the center of their regulatory response to the financial crisis.

“This proposal does not do that. We appreciate that these rules strengthen the definition of capital and marginally increase Tier 1 common equity requirements. However the required capital levels here still fall well short of what both common sense and bipartisan independent experts conclude would be necessary to protect taxpayers from yet another financial system catastrophe. Furthermore, the maintenance of excessive reliance on risk weighting, complex exposure modeling, and various means of moving exposures off the balance sheet continues to invite banks to game the system and reduce their actual capital ratios even further.” Read the full letter here.

Are U.S. SIFIs Still TBTF?

By Karen Shaw Petrou, Federal Financial Analytics, Inc.

“This paper examines a fundamental premise of financial-industry regulation: whether or not large financial-services firms are too big to fail. Assessing this in light of the new systemic-resolution process created in the Dodd-Frank Act (the “orderly liquidation authority” or OLA), the paper concludes that U.S. bank holding companies and other financial-services firms, regardless of size or the nature of their operations, can no longer be rescued at long-term cost to the federal government or otherwise supported in ways that undermine meaningful market discipline. The paper does not argue that OLA is complete, perfect or proven under stress. It does, however, detail key terms in the law, implementing regulation, government policy and other critical features to demonstrate that a large U.S. financial-services firm would not now be resolved in a fashion in any way comparable to the emergency transactions mustered during the financial crisis to support companies like AIG.” Read the full assessment here.

Letter to Chairmen Bernanke, Gruenberg, and Comptroller Curry regarding Basel III standards as applied to insurance companies

By 24 U.S. Senators led by Senator Sherrod Brown (D-OH) and Senator Mike Johanns (R-NE)

“Applying a bank-centric capital system to insurance-based holding companies raises significant concerns. Any regulatory regime must acknowledge how insurance companies rely upon long term assets to fund long-term liabilities. By contrast, banks have a range of investments and use a variety of bonds, equity, and short-term debt to fund their operations. Asset-liability matching is fundamental to the insurance business, and any regulatory capital regime should recognize that applying a bank-centric capital regime to the insurance industry would fundamentally alter the nature of the business.” Read the letter here.

Betting Big: Value, Caution and Accountability in an Era of Large Banks and Complex Finance

By Professor Lawrence Baxter

“Big banks are controversial. Their supporters maintain that they offer products, services and infrastructure that smaller banks simply cannot match and enjoy unprecedented economies of scale and scope. Detractors worry about the risks generated by big banks, their threats to financial stability, and the way they externalize costs of operation to the public. This article explains why there is no conclusive argument one way or the other and why simple measures for restricting the danger of big banks are neither plausible nor effective.” Read more here.

The Growth of Modern Finance

By Robin Greenwood and David Scharfstein

“The U.S. financial services industry grew from 4.9% of GDP in 1980 to 7.9% of GDP in 2007. A sizeable portion of the growth can be explained by rising asset management fees, which in turn were driven by increases in the valuation of tradable assets, particularly equity. Another important factor was growth in fees associated with an expansion in household credit, particularly fees associated with residential mortgages. This expansion was itself fueled by the development of non-bank credit intermediation (or “shadow banking”). We offer a preliminary assessment of whether the growth of active asset management, household credit, and shadow banking – the main areas of growth in the financial sector – has been socially beneficial.” Read the full article here.

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