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What We're Reading in Financial Regulatory Reform, April 17

Whether you are returning from spring break or enjoying the warmer weather, we hope you enjoy our latest selection of readings from the financial regulatory world. 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.

BPC’s Financial Regulatory Reform Initiative 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.

Compiled by Aaron Klein, Eric Dash, Justin Schardin and Olivia Weiss.

GE to Create Simpler, More Valuable Industrial Company by Selling Most GE Capital Assets; Potential to Return more than $90 Billion to Investors through 2018 in Dividends, Buyback & Synchrony Exchange
By GE Capital

“GE has discussed this plan, aspects of which are subject to regulatory review and approval, with its regulators and staff of the Financial Stability Oversight Council (FSOC). GE will work closely with these bodies to take the actions necessary to de-designate GE Capital as a Systemically Important Financial Institution (SIFI). ‘We have a constructive relationship with our regulators and will continue to work with them as we go through this process,’ [CEO Jeff] Immelt said.” Read the announcement.

A Major Test for Dodd-Frank: Can GE Check Out of the SIFI Hotel (California)?
By Aaron Klein and Justin Schardin

“Friday’s announcement by General Electric Co. (GE) that it plans to sell or divest the majority of GE Capital’s assets is a seminal test for whether the Financial Stability Oversight Council (FSOC) can implement the Dodd-Frank Act as Congress intended. FSOC, which designated GE Capital as one of the first systemically important financial institutions, or SIFIs, will for the first time be faced with deciding whether a firm that drastically changes its business model can shed its SIFI status. How FSOC responds will tell us much about how well Dodd-Frank is working for “de-designating” SIFIs. Put another way, is SIFI designation a Hotel California, where institutions are checked in but then can never leave? Or, is it a two-way street?” Read the blog post.

“The Unfinished Business of Financial Reform”, Remarks at the Levy Institute’s 24th Annual Hyman P. Minsky Conference, National Press Club, Washington, D.C.
By Elizabeth Warren, Senator (D-MA)

“What’s needed are smarter and simpler regulations, the kind of regulations that give smaller institutions a fighting chance to meet their compliance obligations without going bankrupt. The goal is to make markets more competitive, and that means a simple, structural solution: break up the biggest banks so that no bank is too big to fail. That would let us cut the tangle of the regulations that are intended to stop a Too Big to Fail bank from taking on too much risk and bringing down the economy.” Read the speech.

“Remarks on Monetary Policy” at the C. Peter McColough Series on International Economics Council on Foreign Relations, New York
By Jerome Powell, Governor, Federal Reserve Board of Governors

“Overly accommodative monetary policy also poses risks. First, the economy could overheat, and rising inflation could require the Committee to raise rates faster, which–if overdone–could produce a damaging recession. For now, I would be more concerned with a second risk, which is that more-accommodative policy could lead to frothy financial conditions and eventually undermine financial stability. While I do not see a troubling buildup of these risks today, tighter monetary policy might eventually be necessary if such risks do appear.” Read the speech.

“A Conversation about Regulatory Relief and the Community Bank”, Remarks at the 24th Annual Hyman P. Minsky Conference, National Press Club, Washington, D.C.
By Thomas Hoenig, Vice Chairman, Federal Deposit Insurance Corporation

“Defining an approach to regulatory relief by complexity and activity, not strictly size, would provide a beneficial and prudent trade-off for firms protected by the safety net by acknowledging that banks that engage in traditional banking activities are sufficiently supervised and by appropriately bringing riskier activities under greater scrutiny.
For the vast majority of commercial banks that stick to traditional banking activities, and conduct their activities in a safe and sound manner with sufficient capital reserves, the regulatory burden should be eased. For the small handful of firms that have elected to expand their activities beyond commercial banking, supported with the subsidies that arise from the bank’s access to the safety net, the additional regulatory burden is theirs to bear.” Read the speech.

“Student Loan Delinquency: A Big Problem Getting Worse?” Article in Economic Synopses
By Juan M. Sánchez and Lijun Zhu

“Over the past decade, the percent of student loan borrowers who are not making their debt payments on time has increased significantly. This trend has generated a large debate because the government subsidizes a very significant share of that debt. This essay analyzes the evolution of some key statistics relevant to this debate. The conclusion? Student loan delinquency is a big problem, but it is not getting worse.” Read the article.

“Coming of Age in the Great Recession”, Speech at the Economic Mobility: Research and Ideas on Strengthening Families, Communities, and the Economy” Ninth Biennial Federal Reserve System Community Development Research Conference, Washington, D.C.
By Lael Brainard, Governor, Board of Governors of the Federal Reserve System

“Overall, the added educational investments made by the Great Recession generation could be a positive legacy of the crisis over the long term. But for some, the returns may not turn out to be worth the cost. For this group, the burden associated with student debt may constrain their economic opportunities for years to come. Borrowers who struggle to repay student loans face special challenges because student loans cannot be discharged in bankruptcy, unlike other forms of household credit. Fortunately, largely because of significant policy changes, beginning in the 2008-09 school year, the vast majority of student loans have been originated directly by the federal government and have flexible repayment and deferment options. Nonetheless, high levels of student indebtedness appear to be one factor influencing the Great Recession generation’s slow progression into homeownership.” Read the speech.

“Financial Sector Assessment Program: Detailed Assessment of Observance of Insurance Core Principles”
By International Monetary Fund

“There are differences between state insurance regulators and between state and federal regulators, in both regulation and supervision. The regulatory system is complex and there are risks from a lack of consistency, including the creation of opportunities for unhealthy arbitrage (which accounts in part for the growing use of affiliated captive reinsurers, for example); and risks of failure to act on gaps or weaknesses in regulation with sector or system-wide implications. The current regulatory architecture lacks capacity to fully address these issues. The authorities should review the options for change, which include strengthening the capacity of the FIO to bring about convergence on uniform high standards of regulation and supervision as well as comprehensive market oversight.” Read the report.

Discussion of “Systemic Risk and the Solvency-Liquidity Nexus of Banks”, Staff Report by the Federal Reserve Bank of New York
By Tobias Adrian

“Pierret (2015) presents empirical analysis of the solvency-liquidity nexus for the banking system, documenting that a shock to the level of banks’ solvency risk is followed by lower short-term debt. Conversely, higher short-term debt Granger-causes higher solvency risk. These results point toward a tight interaction between solvency and liquidity risk over time. My comments are threefold. First, I suggest improving the identification of shocks in Pierret’s vector autoregressive setup. Second, I caution against using the quantitative results as the basis for setting policy. Third, I recommend using theoretical restrictions from macro-finance theories to improve identification and interpretation.” Read the report.

“Insolvency after the 2005 Bankruptcy Reform”, Staff Report by the Federal Reserve Bank of New York
By Stefania Albanesi and Jaromir Nosal

“We show that insolvency is associated with worse financial outcomes than bankruptcy, as insolvent individuals have less access to new lines of credit and display lower credit scores than individuals who file for bankruptcy. Since bankruptcy filings declined much more for low-income individuals, our findings suggest that, for this group, BAPCPA may have removed an important form of relief from financial distress.” Read the report.

“Bank Regulators at the Gates: The Misguided Quest for Prudential Regulation of Asset Managers” Remarks at the 2015 Virginia Law and Business Review Symposium, University of Virginia School of Law, Charlottesville, VA
By Daniel M. Gallagher, Commissioner, Securities and Exchange Commission

“The decisions made by post-financial crisis star chambers like FSOC and the FSB take place behind closed doors, with no checks or balances. This opacity masks a blatant regulatory creep. It is high time we all acknowledge that the systemic risk designation process itself is far more dangerous to our financial markets than the purported risk factors it was created to address.” Read the speech.

“Macroprudential Policy and Labor Market Dynamics in Emerging Economies”, Working Paper Published by the International Monetary Fund
By Alan Finkelstein Shapiro and Andres Gonzalez

“We show that a countercyclical macroprudential policy that reduces formal credit fluctuations has positive though quantitatively limited effects on consumption and output volatility, but generates larger unemployment fluctuations in response to productivity shocks; the same policy increases labor market and aggregate volatility in response to net worth shocks. The link between input credit and the labor market structure—key for capturing the cyclical dynamics of labor and credit markets in the data—plays a crucial role for these results.” Read the paper.

“Reform the Fed? Get Rid of Groupthink”
By Aaron Klein and Olivia Weiss

“In the past, Fed governors and regional bank presidents regularly disagreed and cast dissenting votes. While some Fed regional bank presidents continue to dissent, Fed governors have ceased publicly disagreeing with the chair. There has not been a single dissenting vote by a Fed governor on monetary policy in almost a decade, the longest streak since the Fed began recording votes in 1957. In fact, there have only been two dissents by Fed governors in almost twenty years, since 1996, according to research by the Federal Reserve Bank of St. Louis.” Read the blog post.

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