Feliz Ano Nuevo!
In service of my resolution to blog more regularly (and to take a break from grading)…
I recently posted on ssrn a symposium piece I wrote for the Georgia Law Review that examines how securitization formed a coupling rod that joined together real estate and banking crises. Moreover, changes in banking law improved this transmission line.
Here is the abstract:
This essay examines how securitization served as a new coupling rod joining cycles in real estate and banking markets and created a new pathway for financial contagion in the “subprime” financial crisis. Legal changes promoted the growth of securitization and improved this crisis transmission line. The essay examines the history of legislative and regulatory changes that facilitated bank participation in the markets for mortgage-backed securities. The essay then explains how securitization failed to mitigate the credit, liquidity, and interest rate risk associated with real estate when losses in residential markets became correlated nationwide. It then discusses how regulation contributed to this, as the spread of securitization and financial industry consolidation created a nationwide market for mortgages.
The essay telescopes out from securitization to discuss an often overlooked danger of bank investments in real estate: the cyclicality of real estate losses. The essay analyzes the evidence that real estate prices exhibit positive serial correlation. It also summarizes historical evidence of the correlation between banking and real estate crises. The essay then looks at feedback mechanisms between banking and real estate markets, including research on bank leverage cycles.
The essay next provides a very high level outline of various approaches to decoupling bank and real estate crises and the advantages and drawbacks of various approaches. These approaches include curbing bank investments in real estate and mortgage-backed securities, using bank regulations as a more surgical tool to fix problems with securitization, and developing countercyclical approaches to regulations of mortgage markets and bank investments in them. The essay then concludes by discussing the political dynamics that will shape and constrain any of these policy approaches.
This symposium piece continues a line of research that examines securitization in light of the financial crisis. I’ve looked at how:
¶ regulators outsourced responsibility for regulating markets and financial products to risk models (including models that price securitizations);
¶ how securitization provides an example of how contract “patterns” (think “boilerplate” but more conceptual) can modularize contract language and turn contracts into complex transactions and ultimately into new markets for financial instruments; and
A half-dozen or so more pieces and I can write a book: "13 ways of looking at securitization." Or I can go meta - writing about derivatives and being derivative.
The UNIVERSITY OF NEBRASKA COLLEGE OF LAW invites applications for lateral candidates for a tenured faculty position to hold the Clayton K. Yeutter Chair at the College of Law. This chaired faculty position will be one of four faculty members to form the core of the newly-formed, interdisciplinary Clayton K. Yeutter Institute for International Trade and Finance. The Institute also will include the Duane Acklie Chair at the College of Business Associations, the Michael Yanney Chair at the College of Agricultural Sciences, and the Haggart/Works Professorship for International Trade at the College of Law. The Yeutter Chair, along with the other three professors, will be expected to support the work and objectives and ensure the success of the Yeutter Institute. The Yeutter Chair will teach courses at the College of Law, including International Finance. Other courses may include Corporate Finance and/or other related classes pertaining to issues arising in international business and finance. More on the Yeutter Institute can be found at http://news.unl.edu/newsrooms/today/article/giftsestablish-endowed-chairs-for-yeutter-institute/. Minimum Required Qualifications: J.D Degree or Equivalent; Superior Academic Record; Outstanding Record of Scholarship in International Finance and/or other areas related to international business; and Receipt of Tenure at an Accredited Law School.
General information about the Law College is available at http://law.unl.edu/. Please fill out the University application, which can be found at https://employment.unl.edu/postings/51633, and upload a CV, a cover letter, and a list of references. The University of Nebraska-Lincoln is committed to a pluralistic campus community through affirmative action, equal opportunity, work-life balance, and dual careers. See http://www.unl.edu/equity/notice-nondiscrimination. Review of applications will begin on November 5, 2016 and continue until the position is filled. If you have questions, please contact Associate Dean Eric Berger, Chair, Faculty Appointments Committee, University of Nebraska College of Law, Lincoln, NE 68583-0902, or send an email to email@example.com.
I'm not sure whether to call it the power of regulation, the fact that investors like being deluded about the value of assets they hold, or the existence of an implicit government guarantee. But as OFR notes, investors are getting out of funds with gates and floating asset values, and getting into funds with fixed asset values (even if they also have feeds and gates). Not sure what to make of it, but the change is marked, and surely attributable to regulation.
It's not the last word or anything, but I found this survey of entry level classes of City of London banks to be interesting (I'm in the UK for the semester). Less than half Brits, and 14% Italian, more than any European country/ethnicity/whatever, including Germany and France if you like your countries big, Spain if you like your countries poor, and Ireland if you like your countries English speaking. This anonymous banker thinks it is because Italians are desperate and charming. Your mileage may vary!
I've been writing some about international financial regulation this year. Here's my take on what IFR tells us about international law, which it isn't, but which in practice it, in some ways, resembles. It's up at SSRN, and I hope you'll give it a look.
In an era riddled with critiques of the relevance of classic international law, some have loudly given up on the subject, while others have placed their hopes in alternative mechanisms of global governance. One alternative is “soft law,” and nowhere is soft law more successful than in international financial regulation (IFR). Today, almost every bank of any size across the world has to keep similar amounts of money in its emergency reserve, cannot stake its future on complex derivatives or other forbidden trades, and faces oversight that, no matter where the bank is located, will be conducted in roughly similar ways, with roughly similar tools. And yet the promulgators of these rules consistently disavow their status as binding law.
These disavowals are disingenuous, and unpacking the reasons why has useful lessons for how international governance works, whether backed by treaty and custom or not. IFR works like traditional international law in three ways. It, like international law, depends on domestic institutions for implementation, although traditional international law has often sought to ignore the importance of any institution below the level of the state. IFR reminds us that the coordination of international interests comes with winners and losers, and therefore that the “mere coordination exercise” that international governance represents should not be dismissed, though traditional international law occasionally has been critiqued for that reason. And IFR emphasizes the necessarily messy way that fundamental legal principles are arrived at in international governance of any stripe -- something I call the contestation principle. These features of both hard and soft law have been overlooked by both the traditionalists and critics of international law, but process-driven insights like them have much to tell us about both hard and soft law, which may not, in some ways, be so different after all.
Should you be so inclined, you can find the paper here.
Over at DealBook, I try to forecast the most likely prominent challenges to the Consumer Financial Protection Bureau's Payday Lending Rule. Here's the start:
The new payday lending rule, once complete, will force many payday lenders out of business. That means that a legal challenge is certain, and also the courts, which worry about regulations that require bankruptcies, will take it seriously.
That is good news for challengers of the rule. The bad news is that their claims will probably fail.
Payday lenders will challenge the authority of the Consumer Financial Protection Bureau to issue the rule, the cost-benefit analysis behind the rule and the constitutionality of the consumer agency itself.
When they fail, we will know that we have a new and powerful financial regulator, one that can touch not just banks but any source of credit, including credit cards, payday lenders and other informal ways to get money.
Go give it a look!
MetLife successfully appealed its designation as a SIFI to the district court in Washington, which took an awfully searching review of the factors used by the FSOC to make the determination. The court, in the end, concluded that the council's designation was arbitrary and capricious, which means it was illegal. The most interesting part of the opinion is the part requiring the FSOC to do a cost benefit analysis before designating.
FSOC has refused to do a quantified cost benefit analysis, which is a departure for the executive branch. The White House requires agencies to conduct one before they promulgate expensive rules. That a financial regulator, where excel spreadsheets and quantified stress tests are part of the job, would refuse to do one in making a determination about the riskiness of a financial institution is a pretty interesting rebuke to those who believe that cost benefit analyses are essential components of effective regulation. But perhaps the FSOC has been listening to John Coates.
Here's what the court had to do to require a cost benefit analysis - most, um, interestingly it relied on the word "appropriate" while ignoring the word "deems" in Congress's guidance about how to do SIFI designations. Most administrative lawyers would conclude that it was up to the Council to decide whether to take costs into account in designations if the statute provides that the FSOC “shall” consider a number of factors and also “in making a designation, any other risk-related factors that the Council deems appropriate.”
But the court thought differently:
FSOC, too, has made the decision to regulate—by designating MetLife. That decision intentionally refused to consider the cost of regulation, a consideration that is essential to reasoned rulemaking. Cf. [Michigan v. Environmental Protection Agency, 135 S. Ct. 2699 (2015)] at 2707 (“Consideration of cost reflects the understanding that reasonable regulation ordinarily requires paying attention to the advantages and the disadvantages of agency decisions.”) (emphasis in original). In light of Michigan and of Dodd-Frank’s command to consider all “appropriate” risk-related factors, 12 U.S.C. § 5323(a)(2)(K), FSOC’s position is at odds with the law and its designation of MetLife must be rescinded.
I'm pretty unpersuaded by that reasoning. Cost benefit analysis may be a good idea, or it may not be, but I don't see how the courts should go around requiring it on the basis of a catch-all clause awarded discretion to the agency to add factors to an already long list of factors to be considered in SIFI designations.
I trust you all enjoyed our symposium on The Power And Independence of the Federal Reserve. There's another one starting on the (excellent) Notice and Comment blog, so do head over there for more takes on Peter Conti-Brown's book, and on assessing the place of the Fed and how it works.
My thanks to my inimitable friend and colleague David Zaring for hosting this book club and for inviting me to respond. It’s a real pleasure to be back among the Glomerati—my first venture into academic blogging was on these digital pages back in 2011, including a real-time record of my finding the primary source for the “punch bowl” metaphor that figures so prominently in my book. I still love those stories about Stanford’s Erika Wayne, equal parts document sleuth and librarian.
I wanted to write a few responses to the excellent posts from David, Matt, and Usha and in the process write a bit more about what I see as the central intellectual puzzle of Federal Reserve independence, governance, and accountability, which is this: how can such a technical field benefit from democratic processes without corrupting the entire enterprise? As I wrote, I realized I was going to end up droning on and on, so I’ll keep this a bit more limited than the quality of these responses warrant.
This framing gets at the pith of Matt’s first post. He asks, “is it okay to ‘Bork’ a Federal Reserve appointee?” This question can be broken into two—should there be a more searching assessment of Fed appointees subject to the Appointments Clause, and what is the standard at which the senatorial consent should be withheld?
On the first, I think the answer is a resounding yes, with one clarification. The more searching assessment I would hope to see would not necessarily be at the Senate level alone—we’ve had plenty of closed-door politicking on Fed appointments that have led to some extraordinary appointments and also some very regrettable decisions. On the unfortunate side, I’m thinking of Senator Shelby’s decision to block Peter Diamond from a Fed governorship because Diamond was “unqualified,” just as he received the Nobel prize in economics. I’m thinking, too, of the regrettable—and hopefully temporary—decision to “pair” Fed appointments on a partisan basis, such that Jeremy Stein (a Democrat) could only get through the Senate with Jerome Powell (a Republican), despite no partisan balancing requirement in the Federal Reserve Act. We don’t need more Senators trying to play fast and loose with Fed appointments; we need more public attention on these appointments.
An example of this that I find exactly in line with my vision of a successful public engagement on the Fed was in the summer of 2013 when the Obama Administration leaked that the president was considering Janet Yellen and Larry Summers for the Fed Chairmanship, and leaned Summers. The reaction was swift and very public: from every corner of the democracy came searching assessments of these two proto-candidates’ personalities, histories, ideologies, expertise, and more.
At the time, some lamented this attention to the Fed from outside the temple of full-time Fed watchers as corrosive and lamentable. I think they are exactly wrong. There was plenty of frivolity, gossip, and consideration of extraneous factors in the public vetting we saw in Yellen vs. Summers. But the level of public attention was also impressively substantive. My favorite example in this phenomenon was the non-ironically titled “Seventeen academic papers of Janet Yellen’s that you need to read.” (Full disclosure: I used to work indirectly for Summers at Harvard and continue to have enormous respect for him.)
To Matt’s first question, then, I would like to see more of this kind of public attention to these appointments. The authority of the Fed governors is extraordinary. It’s important that the public have a role in selecting them so that their values are as known as they can be.
To the second question—when should Senators reject a candidate?—I’ll confess something that may make my liberal friends cringe. I’m not convinced that Robert Bork himself should have been Borked. I would prefer a model of Senatorial advice and consent that looked much more like a brake on cronyism than on a sustained attack on a candidate’s (or the sponsoring Administration’s) politics. The Senators’ role, then, is to prevent presidents from rewarding their talentless but politically or financially connected friends with jobs that require policy expertise. It’s not to attempt a redo of our most essential of institutions, the quadrennial presidential election.
To take Supreme Court history (not to say the Supreme Court present) as an example, there was simply no question that Bork was qualified to sit on the court, even if his values and judicial philosophy (and beard?) were out of sync with the Democratic and perhaps American majority. But minus the beard, what about Bork was different from Antonin Scalia, who sailed through the nomination process? Not much that could be known at the time. And it’s not clear to me that the kind of judging we see in the jurist who took Bork’s place—Anthony Kennedy—is better for our democratic institutions, even as I have endorsed and celebrated some of the outcomes in cases that make Kennedy so famous.
If I were a Senator in 1987, then, I would’ve voted for Bork and then sought to campaign hard in 1988 to say that while qualified, we needed justices of a different philosophy much more likely to be sponsored by a Democratic president than a Republican one. At the same time, I would’ve felt more comfortable voting against Abe Fortas (given the air of scandal and undue proximity to President Johnson) and felt very comfortable voting against Nixon’s nomination of Harrold Carswell (about whom—in his defense—Senator Roman Hruska said “Even if he is mediocre, there are a lot of mediocre judges and people and lawyers, and they are entitled to a little representation, aren't they?”). Qualifications, not politics.
It’s the same analysis for the Fed. There are a few Governors who I think should not have been nominated given their abundant lack of anything except a connection to the President. And as mentioned, there are others who were dinged because of their perceived politics despite sterling credentials. I would want to see more public attention on the expertise and less of the politics, recognizing with Churchillian sobriety that the democratic process will lead to all kinds of regrettable excesses. It’s just better than anything else we might design to take its place.
On Matt’s other post, his hypothesis that “Fed appointees cannot have the expertise necessary to do their job without also being wed to some of the economic and banking orthodoxies that led to the 2008 financial crisis,” I say that we should have that debate. Not just in the Senate Banking Committee hearing room, but in the blogosphere, editorial pages, academic conferences, and around the water cooler. Let’s inquire about what a potential Fed Governor believes about the world and the Fed’s place in it before we hand over a vote that can influence the development of the global economy. The stakes are just too high to leave it to backroom deals. And this is the overarching point: politics is already happening in and around the Fed. To pretend otherwise is fantasy. The question is whether those politics will be little-d democratic or whether they will be something else.
David highlights the essential importance of looking beyond traditional methodological or institutional paths in trying to get a sense of how agencies work in practice. Like anyone, I’m likely to overemphasize my own methodological approach over others. For example, I am decidedly skeptical that indices of central bank independence coded on the basis of central bank charters tell us much of anything. I think the question of “independence”—to the extent it’s a coherent question at all—is better explored through the methods of narrative history rather than quantitative econometrics. But that’s the point: we need to have multiple approaches in case my view is filled with blind spots and otherwise limited—narrative history isn’t great for doing a 100-nation study, for example.
Finally, I’m delighted Usha brought in her excellent perspective on “fetishization” of independence, an article that has shaped my thinking over the years. I think she’s exactly correct. I’d even go a step further and say that the term itself is devoid of much or any analytical content. Part of my aim in this book is to prompt readerly skepticism anytime anyone—whether in defense of the Fed or in attack—invokes “independence” as the support for their proposition. As I argue at length, and as Usha makes clear in the corporate governance context, Fed independence on the ground is not what those who rely on it have supposed it to be.
Again, my thanks for taking the book seriously and providing a wonderful forum for discussing it.
Peter's book on the Fed represents, among other things, a take on how you figure out what a particular government institution is up to. You could try to do this quantitatively, especially if the part of the Fed you care about sets interest rates. What market conditions predict what the Fed is going to do? You can also do this by going big history, and critical as a matter of policy. That's what Alan Meltzer has done in his two volume history of the Fed, which processes an enormous amount of archival information - minutes, policy papers, etc - to describe what the Fed has done. These days, Meltzer often finds something to criticize. You could also try to understand it purely as a weird culture, which it very much is. Central bankers all talk to one another, only really do central banking throughout the course of their careers, have Ph.D.s in economics, and stay close to the discipline (but not too close! you write a couple of good articles, and then stick to policy with modest empirics.). It's a super insular, almost quintessentially technocratic community. Or you could simply look at its legal authority and examine its rules and orders.
I take Peter to be suggesting that none of these approaches could, if taken alone, provide you with a full picture of how the Fed works. One of the themes that runs through the book is that consideration of the law alone would lead observers to think that members of the Board of Governors are insulated and empowered, when in practice, they cycle through the Fed quickly, and presidents get to appoint many of them. The culture of the Fed, or at least Fed-watching, on the other hand, reifies the Fed chair, and the FOMC, without paying attention to the truly powerful Fed staff, who never leave, even as their leaders revolve away. Finally, Peter rejects the idea that the Fed is a technocratic exercise in the abstruse, but a place where powerful value judgments are made, and so therefore worth some measure of accountability - Matt talks about that. The Fed is much more than a vehicle for monetary policy, as we found out during the financial crisis, and encapsulates a disturbingly large number of bureaucratic actors - Peter is particularly critical of the continued existence of the regional federal reserve banks, and with good reason.
I admit that I prefer these sorts of mixed method accounts, on the assumption that more inputs probably creates a more accurate output. It does complexify things, to be sure. But the Fed is a complex beast, and pretending it is anything but is disengenously reductionist.
And they are doing well. They - implausibly, by my reading - got a judge not to dismiss claims that Anthony Chiasson's business partner had suffered due process violations, based on the taking of his property, on the fact that their hedge fund was searched based on a misstatement in an affidavit that the business partner knew about the alleged insider trading, and that the supervisors of the lawyers and investigators who brought the claim failed to rein in the unconstitutional conduct of their subordinates. The judge wants discovery.
To me, this order looks bound for a quick reversal, and, as it is a qualified immunity claim that is being rejected, it should be immediately appealable. I'm no expert on searches and seizures. But it would be reasonable to assume that the government, with reason to believe that one of the co-founders of a hedge fund was engaging in insider trading, would search the papers of the hedge fund, including those of the hedge fund's other co-founder, and if the government made a mistake in one of the affidavits supporting the search, that mistake would be immaterial. The defendants in the case are all but absolutely immune prosecutors and law enforcement officials, and the court doesn't even address that issue.
I don't think the interesting thing about the decision is the legal analysis. Instead, it's interesting:
- because Manhattan judges and its US Attorney are in a repeat-player relationship. In this order, one of those judges basically instructed the US Attorney to prepare to be deposed, which is apocalyptically out of the ordinary. It suggests that the judges are really angry about prosecutorial overreaching, or at least that one of them is.
- because this is the sort of relief that judges can uniquely order in business law enforcement. I doubt that the government will ever have to pay Level Global's owners a penny for essentially shutting it down because it thought one of its principals was an insider trader. But courts can force the government to worry about that prospect with intrusive injunctive relief like this, and angered scolding. That's a real remedy, even if the usual remedy - money damages - won't work!
Over at DealBook, I've got a column on international insurance regulation and its discontents. A taste:
The globalization of the rules that govern insurance companies has been extremely quick — too quick for the tastes of many American insurers. They are fighting back by asking for process, process and more process.
I think that the protections sought would be unnecessary, and even counterproductive. But they are classics. The insurers are asking for more notice and comment and more trial-type procedures. Administrative process, and how much of it someone should get, lacks a bit of glamour. But it is something that the government and the financial industry will always fight about.
Go give it a look!
Media observers will be a little curious about the timing of an op-ed that isn't really asking for much, even though it sort of serves as a rebuke to one of the themes of the Bernie Sanders campaign. Still, Eisman, the Big Short protagonist, on why breaking up banks is a bad idea:
It’s no longer accurate to say that the large banks pose a systemic danger to the American economy. Some argue that they should be broken up solely because they are too politically powerful. Perhaps so, although that power hasn’t managed to prevent regulators from dismantling bank leverage and risk. Furthermore, no advocate of a breakup has come forward with a plan on how to do it. Large banks are global, complex, integrated institutions. Breaking them apart would be incredibly difficult, long and disruptive, and the banks might have to freeze loan growth during the process, slowing our economy even further.
He thinks that banks were too risky because they were overleveraged, but now that they are not levered up, they are safe. You will note that safety isn't the only reason to break up the banks. Apart from the politics, there's the antitrust problem, and maybe large financial institutions discourage experimentation. Moreover, maybe even low leverage banks are prone to bank runs. I'm not convinced by this, but it's always nice to see another unicausal theory of the financial crisis.
For those who believe that bank regulators are totally captured, I give you MetLife's very grudging decision to maybe break itself up in an effort to get undesignated as a systemically important financial institution, subject to extra capital requirements and Fed supervision. GE hated being a SIFI so much that it got out of of the business of finance. MetLife was so outraged by its designation that it sued. And the enormous asset managers, such as BlackRock, watching this must be terrified that they will be designated next.
The exception? Very large banks, who were already subject to Fed supervision, aren't trying to get smaller, or at least haven't so far. It could be that one of the things that they consider to be part of their skill set is dealing with regulators. For those who grew into prominence with other skills, regulatory management is clearly not worth the candle. But that's what big banks do.
The giant insurer MetLife said on Tuesday that it was exploring spinning off its retail life and annuity business in the United States because of financial pressures it is facing under regulations put in place in the wake of the financial crisis.
The decision was made two years after the Financial Stability Oversight Council, a group created by the 2010 Dodd-Frank regulatory legislation, named MetLife a systemically important nonbank financial institution, or SiFi. That designation carries requirements to set aside more capital as a cushion against a substantial decline in the nation’s financial markets as occurred in 2008, potentially limiting its earnings.
MetLife is considering several options, including an initial public offering to create a company that would, presumably, be better able to compete with smaller life insurance and annuity providers who are not subject to the same regulatory restrictions.