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What We're Reading in Financial Regulatory Reform, August 7

Here are some fun beach 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.

Compiled by Aaron Klein, Justin Schardin and Olivia Weiss.

What We’re Reading on Systemic Risk

“Mapping Heat in the U.S. Financial System,” Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs
By David Aikman, Michael T. Kiley, Seung Lee, Michael G. Palumbo, and Missaka N. Warusawitharana, Federal Reserve Board

“Our framework indicates that vulnerabilities in the financial system have remained subdued even five years after the financial crisis. Although risk appetite is currently elevated, our measures of vulnerabilities in the financial sector (and in residential mortgage debt) remain at or near historically low levels.” Read the report.

“Systemic Importance Indicators for 33 U.S. Bank Holding Companies: An Overview of Recent Data,” OFR Brief Series
By Meraj Allahrakha, Paul Glasserman, and H. Peyton Young, Office of Financial Research

“Of the 33 U.S. banks, the eight designated as G-SIBs in 2012 had the highest systemic importance scores in 2013. JPMorgan Chase & Co. had the highest score at 5.05 percent, followed by Citigroup Inc. (4.27 percent), Bank of America Corp. (3.06 percent), Morgan Stanley (2.60 percent), Goldman Sachs Group, Inc. (2.48 percent), and Wells Fargo & Co. (1.72 percent).” Read the report.

What We’re Reading on Insurance Regulation

“How FSOC Undermined, and the Fed May Save, U.S. Case for Insurance Regulatory Equivalence”
By Justin Schardin, Financial Regulatory Reform Initiative, BPC

“Later this year, European Union officials will make several decisions whether to grant U.S. insurance regulation ‘equivalence’ with the EU’s new insurance regulatory and capital regime set to take effect in January. Equivalence would make doing business easier for insurers and regulators on both sides of the Atlantic. A decision against equivalence could complicate economic relations between the United States and the EU, or even upset the Transatlantic Trade and Investment Partnership talks toward freer trade and investment between the two large economic blocs. It is interesting, then, that the Financial Stability Oversight Council may have undermined the U.S. case for equivalence in the supervision of insurance groups as part of its designation of MetLife as a systemically important financial institution.” Read the blog post.

“International Insurance Capital Standards: Collaboration among U.S. Stakeholders Has Improved but Could Be Enhanced,” Report to Congressional Requesters
By United States Government Accountability Office

“This report examines (1) the status of the development and implementation of the international standards; (2) what is known about their potential effects; (3) views on the need for the standards; and (4) the extent to which U.S. regulators are collaborating in developing a U.S. position on the standards. To enhance and sustain U.S. involvement in the development process, FIO, in consultation with the Federal Reserve and NAIC, should take steps to sustain leadership over the long term and publicly report on their collaborative efforts. FIO concurred with the recommendation, stating that it would build on existing collaboration efforts.” Read the report.

“International Developments in the Insurance Sector: The Road to Financial Instability?” Cato Working Paper No. 30/CMFA No. 5
By Therese M. Vaughan, Robb B. Kelley Distinguished Professor of Insurance and Actuarial Science, Drake University and Mark A. Calabria, Director of Financial Regulation Studies, Cato Institute

“The insurance sector was also stressed by the meltdown in financial markets that occurred in 2007–2008, albeit far less than the banking sector. With the exception of AIG, however, insurers played little role in the financial crisis. Nor do traditional insurance activities pose a systemic risk to the financial system. Nonetheless, the insurance sector has also been the target of new regulatory initiatives at the international level. … Attempts to regulate insurance companies like banks are certain to end badly, both for the companies and for purposes of financial stability.” Read the paper.

What We’re Reading on the Dodd-Frank Act

“Dodd-Frank Five Years Later: Accomplishments, Threats, and Next Steps,” Democratic staff report
By Representative Maxine Waters (D-CA), Ranking Member of the House Financial Services Committee

“According to one analysis, as of March 31st, almost five years after enactment, 60 percent of the regulations required by Dodd-Frank have been completed. The most important action regulators can take to strengthen financial reform is to complete all of the outstanding Dodd-Frank regulations. These regulations are an important part of financial reform. … Dodd-Frank provided regulators with tools to prevent another crisis. However, if regulators opt not to use those tools, the financial system won’t be any safer than it was before the crisis. Regulators have to hold financial institutions to a high standard in reviewing their activities.” Read the report.

“How Dodd-Frank Harms Main Street: Ill-Considered Financial Reform Law Thwarts Americans’ Access to Financial System,” On Point, No. 202
By Iain Murray, Vice President for Strategy, Competitive Enterprise Institute

“This delegation of rulemaking has created great uncertainty for the financial industry. While Dodd-Frank provides an outline, the final rule is usually far more detailed, leaving firms to guess what new restrictions may be put in place. … Many of the rules issued under Dodd-Frank have harmed some of the poorest Americans, who have seen their insurance made more expensive, their banking choices reduced, and their bank fees increased. Many have been forced out of the banking system altogether, only to face the alternatives, such as prepaid debit cards and payday loans, more difficult to access. When legal choices are restricted, people turn to illegal ones. Loans sharks and racketeers could soon make a comeback, thanks to Dodd-Frank’s “consumer protection” provisions. Read the article.

“Forecasting the Recovery from the Great Recession: Is this time Different?” National Bureau of Economic Research, Working Paper 18751
By Kathryn M.E. Dominguez, Professor of Public Policy and Economics, University of Michigan (newly nominated to the Federal Reserve Board of Governors) and Matthew D. Shapiro, Lawrence R. Klein Collegiate Professor of Economics,
University of Michigan

“Thus, four years beyond the trough of the Great Recession, there have been a series of growth adjustments that were disappointing even relative to the forecasts of slow growth in 2009. The concomitance of the financial/fiscal shocks in Europe beginning in 2010 and the changes in US economic outlook suggest an important role of the unresolved financial problems in Europe damping the US recovery over several years. … The slow pace of the projected path of GDP from the trough has been a feature of US recoveries since the 1990s, though the depth of the 2009 trough was of course unique in post-Great Depression experience. The halting recovery—coming from the continued unfolding of joint financial/fiscal crises internationally—has made the recovery from the Great Recession even slower than initially expected.” Read the report.

What We’re Reading on the Financial Stability Oversight Council

Testimony before the Senate Subcommittee on Securities, Insurance, and Investment, U.S. Senate Committee on Banking, Housing, and Urban Affairs
By Patrick Pinschmidt, Deputy Assistant Secretary for the Financial Stability Oversight Council, U.S. Department of Treasury

“The supplemental procedures address the areas that stakeholders were most interested in and formalize a number of existing Council practices regarding engagement with companies. Under the new procedures, companies will now know early in the process where they stand, and they will have earlier opportunities to engage with and provide input to the Council. … As Congress contemplates additional changes to the designations process, it is important that such changes do not compromise the Council’s fundamental ability to conduct its work. We are particularly concerned with legislative proposals that would dramatically lengthen an already long and deliberative designation process, impose insurmountable practical hurdles on the Council’s work, and prevent the Council from taking action to address potential threats to financial stability that it has identified.” Read the testimony.

What We’re Reading on Liquidity

“Structure and Liquidity in Treasury Markets,” Remarks at The Brookings Institution
By Jerome H. Powell, Member, Board of Governors of the Federal Reserve System

“The technologies and strategies that people associate with high frequency trading are also regularly employed by broker-dealers, hedge funds, and even individual investors. Compared with the speed of trading 20 years ago, anyone can trade at high frequencies today, and so, to me, this transformation is more about technology than any one particular type of firm. Given all these changes, we need to have a more nuanced discussion as to the state of the markets. Are there important market failures that are not likely to self-correct? If so, what are the causes, and what are the costs and benefits of potential market-led or regulatory responses?” Read the speech.

Remarks at The Brookings Institution
By Antonio Weiss, Counselor to the Treasury Secretary, U.S. Department of the Treasury

“High-speed trading algorithms, which are employed by many bank dealers and hedge funds, as well as by PTFs, appeared to respond to an extraordinarily one-sided trading environment, with far more willing buyers than sellers, by generating a rapid rally in treasuries. And human traders took several minutes to react. … Information about activity in cash Treasury markets is not readily accessible, and authorities have virtually no visibility on dealer-to-customer activity, which by some estimates is well over 40% of the cash market. Moreover, regulatory authority over Treasury cash and futures markets is fragmented, making cooperation essential, but also slowing response times considerably. Put simply, we cannot get the information we need to analyze risk across Treasury markets in anything that approaches real time, and that has to change.” Read the speech.

What We’re Reading on the Federal Reserve

Federal Reserve Dividends Should Not Be a Piggy Bank for Congress
By Aaron Klein, Olivia Weiss, Kristofer Readling, and Andrew Wolff, Financial Regulatory Reform Initiative, BPC

“The Senate is considering new legislation that seeks to change an obscure interest rate paid by the Federal Reserve to its member banks as part of broader legislation to pay for transportation investment. The interest rate determines dividends private banks receive, risk-free, on funds they are required to invest as a condition of becoming a member of the Federal Reserve System. … Tinkering with the Federal Reserve’s system to fund current congressional spending initiatives, without public debate or thought on its ramifications, sets a dangerous precedent and is bad policy.” Read the blog post.

What We’re Reading on Student Loans

“Credit Supply and the Rise in College Tuition: Evidence from the Expansion in Federal Student Aid Programs,” Staff Report No. 733
By David O. Lucca, Taylor Nadauld and Karen Shen, Federal Reserve Bank of New York

“Our identification approach exploits changes in the maximum disbursable amounts of per student federal aid in federal student aid programs (collectively known as “Title IV” programs). We focus on the two largest such Title IV programs: subsidized and unsubsidized loans under the William Ford Federal Direct Loan Program (known as the Federal Family Education Loan Program prior to July 2010) and Pell Grants. … From a welfare perspective, these estimates suggest that, while one would expect a student aid expansion to benefit its recipients, the subsidized loan expansion could have been to their detriment, on net, because of the sizable and offsetting tuition effect. Pell Grants also seem to have driven tuition higher, but the net cost of attendance for a student declined because the pass-through was less than one and grants do not require a repayment of principal.” Read the report.

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