September 11, 2014
Capital Adequacy News
Posted by David Zaring

The Basel Committee is doing a lot of Basel III capital accord implementation this week.  Page 10 of this report makes it look like the largest banks hold slightly less capital than smaller banks, which is the opposite of what you would want (smaller banks hold more variable capital though).  And this report suggests that the effort to have banks deal with a hypothetical effort to adopt the new capital rules was messy.  Not to worry, though!  As is the case with all Basel documents, bland positivity about the success of the regulatory effort is the tone of the day.

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September 09, 2014
The Modest New Super-Global Trend In Bank Regulation
Posted by David Zaring

One of the reason that bank capital regulation became an international affair was to ensure a regulatory "level playing field," which would be paired with market access to the US and UK.  That is, as long as the rest of the world complied with the Anglo-American vision of capital requirements, access to London and New York would be assured.

But as former law professor and current Fed Board member Daniel Tarullo will testify to Congress today, as those global (call them "BCBS") rules have become more elaborate and comprehensive, some countries have elected to depart from them - only upwards, not downwards.  Switzerland is trying to use very, very heightened capital requirements to shrink its universal banks into asset managers.  And now the United States is enacting global rules with its own pluses.  For example, the liquidity coverage ratio, which requires banks to keep a certain percentage of their assets in cash-like instruments,

is based on a liquidity standard agreed to by the BCBS but is more stringent than the BCBS standard in several areas, including the range of assets that qualify as high-quality liquid assets and the assumed rate of outflows for certain kinds of funding. In addition, the rule's transition period is shorter than that in the BCBS standard.

The Fed is also imposing an extra capital requirement on the largest American banks:

This enhanced supplementary leverage ratio, which will be effective in January 2018, requires U.S. GSIBs [very large banks] to maintain a tier 1 capital buffer of at least 2 percent above the minimum Basel III supplementary leverage ratio of 3 percent, for a total of 5 percent, to avoid restrictions on capital distributions and discretionary bonus payments 

And another such requirement based on the amount of risk-based capital

will strengthen the BCBS framework in two important respects. First, the surcharge levels for U.S. GSIBs will be higher than the levels required by the BCBS, noticeably so for some firms. Second, the surcharge formula will directly take into account each U.S. GSIB's reliance on short-term wholesale funding. 

I think of the global efforts in financial regulation as being notable precisely because they created, incredibly informally, some reasonably specific and consistently observed rules that comprise most of the policy action around big bank safety and soundness.  The little new trend towards harmonization plus is a bit comparable to the trade law decision to create the WTO for global rules, but to permit regional compacts like NAFTA and the EU to create even freer trade mini-zones.  Some find this multi-speed approach to be inefficient and, ultimately, costly to the effort to create a consistent global program.  We'll see if the Basel plus approach rachets up bank regulation, or just disunifies it.

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August 20, 2014
Trying To Understand New York State's Regulation Of Business
Posted by David Zaring

You'd think that the state that's home to the center of American business would take a Delaware-style light touch approach to overseeing it.  But instead, the New York paradigm is to take ambitious politiicans, blend with broadly worded supervisory or anti-fraud statutes like the Martin Act, and come up with stuff that, to my ears, sounds almost every time like it is off-base, at least in the details.  So:

  • Eliot Spitzer pursued research analysts for the sin of sending cynical emails even though they issued buy recommendations, despite that fact that analysts never issue negative recommendations, and if cynical emails are a crime, law professors are the most guilty people in the world.
  • I still don't understand what Maurice Greenberg, risk worrier par excellence, did wrong when he was running AIG.  I do know that after he was forced out by Spitzer, the firm went credit default swap crazy.
  • Maybe there's something to the "you didn't tell your investors that you changed the way you did risk management for your mortgage program" prosecutions, but you'll note that it is not exactly the same thing as "you misrepresented the price and/or quality of the mortgage products you sold" prosecutions, which the state has not pursued.
  • Eric Schneiderman's idea that high frequency trading is "insider trading 2.0" is almost self-evidently false, as it is trading done by outsiders.
  • Federal regulators wouldn't touch Ben Lawsky's mighty serious claims that HSBC or BNP Paribas were basically enabling terrorist financing.
  • And now Lawsky is going after consultants for having the temerity to share a report criticizing the bank that hired them to review its own anti-money laundering practices with the bank, who pushed back on some, but not all of the conclusions.

The easiest way to understand this is to assume that AGs don't get to be governor (and bank supervisors don't get to be AGs) unless people wear handcuffs, and this is all a Rudy Giuliani approach to white collar wrongdoing by a few people who would like to have Rudy Giuliani's career arc.

But another way to look at it is through the dictum that the life of the law is experience, not logic.  The details are awfully unconvincing.  But these New York officials have also been arguing:

  • Having analysts recommending IPO purchases working for the banks structuring the IPO is dodgy.
  • HFT is front-running, and that's dodgy.
  • This new vogue for bank consulting is dodgy, particularly if it's just supposed to be a way for former bank regulators to pitch current bank regulators on leniency.
  • If we can't understand securitization gobbledegook, we can at least force you to employ a burdensome risk management process to have some faith that you, yourself, understand it.
  • And I'm not saying I understand the obsession with terrorism financing or what the head of AIG did wrong.

Their approach is the kind of approach that would put a top banker in jail, or at least on the docket, for the fact that banks presided over a securitization bubble in the run-up to the crisis.  It's the "we don't like it, it's fishy, don't overthink it, you're going to pay for it, and you'll do so publicly" approach.  It's kind of reminiscent of the saints and sinners theory of Delaware corporate governance.  And it's my pet theory defending, a little, what otherwise looks like a lot of posturing.

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August 17, 2014
After the Deal: Fannie, Freddie and the Financial Crisis Aftermath, by Davidoff Solomon and Zaring
Posted by David Zaring

Steve Davidoff Solomon and I have put together a paper on the litigation between the government and the preferred shareholders of Fannie Mae and Freddie Mac.  Do give it a look and let us know what you think.  Here's the abstract:

The dramatic events of the financial crisis led the government to respond with a new form of regulation. Regulation by deal bent the rule of law to rescue financial institutions through transactions and forced investments; it may have helped to save the economy, but it failed to observe a laundry list of basic principles of corporate and administrative law. We examine the aftermath of this kind of regulation through the lens of the current litigation between shareholders and the government over the future of Fannie Mae and Freddie Mac. We conclude that while regulation by deal has a place in the government’s financial crisis toolkit, there must come a time when the law again takes firm hold. The shareholders of Fannie Mae and Freddie Mac, who have sought damages from the government because its decision to eliminate dividends paid by the institutions, should be entitled to review of their claims for entire fairness under the Administrative Procedure Act – a solution that blends corporate law and administrative law. Our approach will discipline the government’s use of regulation by deal in future economic crises, and provide some ground rules for its exercise at the end of this one – without providing activist investors, whom we contend are becoming increasingly important players in regulation, with an unwarranted windfall.

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August 05, 2014
The Banco Espirto Santo Bailout
Posted by David Zaring

Portugal took the kind of quick action on its second largest bank that is completely by the book.  What can we learn about the current reality of bank bailouts from it?

  • Even medium sized banks are global: BES was doomed not by its Portuguese operations, but by its Angolan unit.  This sort of thing has driven supervisors to set up global regimes - the idea that their domestically safe and sound bank is in trouble internationally, but they don't know it - or that its foreign counterparties are, and they don't know that.
  • The government created a good bank and a bad bank, meaning that BES stakeholders now have one bank with depositors and branches, and another with dodgy loans in Angola.  This is a way of giving everyone - creditors, shareholders, employees - a haircut, but, since the Portuguese government is loaning BES $4.5 billion, it is hard to say this isn't also a lender of last resort bailout.  Still, a textbook approach.
  • This sort of ring-fencing, on a much larger scale, is one of the ways that some regulators would like to practice bank safety.  A British bank would have its British assets segregated from its overseas ones, and so on.  That obviously creates internal inefficiencies in the bank, but there you go.
  • What Portugal did was to "resolve" BES.  You can perhaps see why some think that one of the failures of the post financial crisis reforms is the failure to, so far, come up with a cross-border resolution scheme.  The British couldn't do this with Barclays, or couldn't without agreement by the Americans, and who knows if, when the chips are down, that would be forthcoming?

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July 18, 2014
The College of Supervisors Considered
Posted by David Zaring

Over at DealBook, I've got something on the financial regulatory reform that Europeans, in particular, love.  Give it a look.  And let me know if you agree with this bit:

Can a supervisory college work in lieu of a vibrant global resolution authority regime? The problem with these colleges is not that they are implausible, but that they have not really been tried in a crisis. The best-known supervisory college outside of the European Union was created in 1987 to monitor the Luxembourg-based, but international, Bank of Credit and Commerce International. Rumors of widespread fraud in the management of the bank were plentiful, but the collegiate approach did not mean that these problems were nipped in the bud. Although coordinated supervision led regulators to close many of bank’s branches at once after the bank’s accountant resigned and its insolvency became obvious, it is not clear whether Bank of Credit and Commerce International is a college success story or cautionary tale.

There are other reasons to worry about relying on colleges. The collegiate approach is meant to encourage communication more than action. Colleges operate as peers, convened by the home banking regulator, without the sort of hierarchy of decision-making and direction that leads to coordinated action.

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June 05, 2014
The Second Circuit Reverses Judge Rakoff On The SEC
Posted by David Zaring

After the SEC settled with Citigroup over misreprsentations made about a toxic security it sold during the financial crisis for a centimillion dollar fine among other things, Judge Rakoff rejected the settlement for failing to contain "cold, hard, solid facts established either by admissions or trials."  I've been pretty critical of the decision, which was always headed for reversal.  Not that Judge Rakoff cares: his familiarity with the agency (he once was in it), his generally respected status as a judge, and rumblings of discontent by other courts asked to approve other settlements once he fired his shot across the SEC's bow has led to a change in approach by the agency; I talked about the new policy here.

The problem with the decision was twofold, according to the Court of Appeals, at least as I interpret it. 

Problem 1: Doctrinally, a settlement decision is an exercise of enforcement discretion, and enforcement discretion is basically unreviewable because the alternative - making it reviewable - would thrust the courts into the heart of what the executive branch does.  Because the SEC wanted continuing court supervision of Citigroup as a consequence of the settlement, Rakoff did, indeed, have something to do.  But if the SEC had simply dismissed its suit in exchange for the payment of a fine, which is less onerous than a fine plus continuing supervision by a court, Rakoff would have had, literally, no role to play in the resolution of the case.  So requiring cold, hard facts to be established as a condition of signing off on a deal was a radical increase in the oversight of the SEC by a court.

No surprise, then, that the Second Circuit said that "there is no basis in the law for the district court to require an adminision of liability as a condition for approving a settlement between the parties.  The decision to require an admission of liability before entering into a consent decree rests squarely with the SEC."

Problem 2: Settlements are not about right and wrong, while admissions of guilt are.  Settlements are about moving on.  We don't expect private parties to establish whether management caused the bankruptcy or someone else did, whether that product really was dangerous, or was misused by consumers, or whatever.  And these can be matters of great public import.  So it was never clear why the government, even though, yes, it is a state actor, should be treated very differently.

No shock, then, that the Second Circuit has said that "consent decrees are primarily about pragmatism" and "normally compromises in which the parties give up something they might have won in litigation and waive their rights to litigation."

According to the appellate court, the right way to review consent decrees is for procedural clarity and, as far as the public interest is concerned, with Chevron deference to reasonable decisions by the agency.  It's not totally clear what that deference means - the court faulted Rakoff for figuring out whether the public interest in the truth was served by the deal when he should have been deciding "whether the public interest would be disserved by entry of the consent decree."  But there you go.

Anyway, I think this stuff is interesting, because it's a tool in the regulatory arsenal, and indeed, my first baby law professor article was on just that.

 

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May 31, 2014
Partnoy's Primer on Financial Crises and Law
Posted by Erik Gerding

Frank Partnoy returns to the subject he wrote about early in his academic career, the role of law and regulation in financial crises, with a new book chapter on Financial Systems, Crises, and Regulation.  I read Frank's earlier 1999 article avidly: this was back before the topic was fashionable.  This new chapter includes a discussion of theories of the roles that information asymmetries and agency costs play in propagating crises. Later, the chapter moves on to talk about mandatory disclosure, anti-fraud enforcement, and corporate governance as crisis prevention tools.  This swims against the tide of conventional wisdom which has focused more on prudential financial regulation (which Partnoy also discusses) as antidote to crisis.  

Here is a critical excerpt from the chapter:

In the aftermath of the 1929 crash, regulators imposed a twin pillar regime of mandatory disclosure and anti-­‐fraud enforcement. Those two pillars were the key architecture features that supported well functioning markets for decades. Both have been eroded in recent years, as disclosures became boilerplate and anti-­‐fraud prosecution more limited and infrequent. The response to the Global Financial Crisis could have included architecture moves to rebuild those pillars. But instead the Dodd-­‐Frank legislation focused on other priorities and architecture changes in the areas of disclosure and anti-­‐fraud enforcement were minimal.

This provocative line of thought raises an important question: If disclosure and corporate governance rules are key for systemic risk too, should these rules be tailored for financial institutions?  After all, Coca Cola's securities disclosure and corporate governance played no role in our latest crisis.  Shouldn't we tailor securities disclosure and corporate governance reforms for banks rather than a blunderbuss approach?  After all, banks (including those by any other name) are special; they play special roles in the economy and pose special risks.

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May 28, 2014
RIP IRB & DIY Cap Reqs
Posted by Erik Gerding

In Governor Tarullo’s closely watched speech on bank regulation (I already blogged on the idea of a sliding scale of regulation based on bank size), he also argued for ending the IRB approach to capital requirements.  How does IRB translate into Plain(er) English: DIY capital requirements for big banks.  Tarullo’s argument is based in part on obsolescence: all the increases to capital in Dodd-Frank and Basel III dwarfed the IRB component.  But it is also based on the fact that DIY capital requirements was a spectacularly bad idea (something I wrote about back when).  Big banks have built in incentives (courtesy of government guarantees, explicit and implicit) to lower their capital and increase their leverage.  Tarullo’s coming to bury not praise this part of Basel II calls for revisiting some of Joe Norton’s prescient work critiquing that accord as a political economy product of lobbying by behemoth banks. If we take New Governance and its experimentalism seriously, it is vital that we look at experiments that failed.

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Tinker, Tailor, Tarullo: Diff’rent Strokes for Diff’rent Banks
Posted by Erik Gerding

A little over a week Governor Tarullo gave a fascinating speech that focused on creating different regulatory approaches for different sized banks.  This is a must read for policymakers and scholars (and further evidence of the value of having at least one lawyer or expert in prudential regulation on the Federal Reserve Board).  Tarullo advocates pushing further the approach in Dodd-Frank of having a sliding scale with different regulatory standards for different tiers of banks. 

Several news outlets picked up on Tarullo’s call to reduce compliance costs for community banks.  Tarullo’s welcome approach recognizes that not all banks pose the same amount or types of risk.  It contrasts sharply with the views of folks like Tim Geithner, who in his Stress Test memoir, discounts reform proposals that targeted the “popular villain” of size (see pages 391-2).  Oddly, Geithner’s memoir also makes the case that the government did not have enough “foam for the runway” when some of the jumboest jetliners started to plummet in the Panic of 2007-2008.

Still Geithner makes a point that serves as a mild corrective addendum for Tarullo’s sliding scale approach: many financial crises started with the risk-taking and failure of smaller institutions.  Indeed, too-big-to-fail is but one problem.  It should not completely overshadow the risks of herd behavior and too-correlated to fail.  The collective actions of stampeding small institutions can generate big doses of systemic risk. 

Tarullo’s speech implies that “macroprudential” regulation should only kick in for medium sized banks and ramp up further still for the behemoths.  But the case for no macroprudential regulations for smaller firms depends on what we mean by “macroprudential.”  One kind of macroprudential regulation focuses on correlated risks across financial institutions (what Claudio Borio labels the “cross-sectional” dimension).  What does this mean concretely?  Regulators need to worry when even small financial institutions collectively have too much risk exposure to the same types of losses (e.g. subprime residential mortgages, the Sunbelt, the energy sector, etc.).  So even community banks need to come under the macroprudential umbrella.

The good news for community banks is that the monitoring cost of looking at correlated risks should (and likely has to) sit with regulators.  No individual community bank would be able to assess the overlap between its risk portfolio and that of hundreds or thousands of competitors.  Regulators, by contrast, are built to serve these information-gathering and coordination (or anti-coordination if you want to get technical) functions. 

Regulators must also carry the burden of looking at how regulations can promote dangerous herd behavior by financial institutions and how this herd behavior can increase during bubble periods (the subject of Chapter 7 of my book).  But that is a topic for another day.

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May 22, 2014
Godzilla versus Collateralized Debt Obligations
Posted by Erik Gerding

 

Godzilla

 

Collateralized Debt Obligations

Definitively

Derivative?

Definitionally

USAF Tests early 1950s

Origin

JPM experiments early 1990s

Radioactive waste

Diet

Toxic Mortgages

Pricey Simulation of Destruction of Tokyo

Computer Special Effects

Destructive Monte Carlo Simulation for Pricing

Heating up in Asia

Foreign Markets

Europe already burned

Laser, Taser, Bomb

Too Big To

Fail

Japan, Hawaii, San Francisco, Las Vegas, in other words, comparatively limited

Scope of Devastation

Arizona, California, Florida, Nevada, European banks, worldwide financial markets

“Mmm … Calamari”

Attitude towards

Giant Squid

BFF

Mothra, MechaGodzilla

Nemesis

Carl Levin, Mecha-Carl Levin

Hollywood too risk averse; recycles old assets

Bottom Line

Wall Street too risk seeking; recycles old assets

 

 

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May 14, 2014
When Insurance is Systemically Risky
Posted by Erik Gerding

Dan and Steven Schwarcz have an insightful new article, Regulating Systemic Risk in Insurance (forthcoming Univ. of Chicagao Law Review).  The potential systemic risk in the insurance industry became front page news after AIG (see here for an essay questioning the AIG bailouts).  It has continued to simmer; the Financial Stability Oversight Council designated both AIG and Prudential as non-bank SIFIs (systemically important financial institutions).  One criticism of this desgination is that it may lead to bank-style regulations being imposed on these firms even though the risks they pose are different in kind from banks (e.g., insurance firms typically don't engage in maturity transformation).

So how might insurance firms pose systemic risk concerns?  Schwarcz fils and per focus less on size and Too-big-to-fail, and more on risk correlations.  This insight is welcome: the Beltway obsession with size has obscured other dangers, such as herd behavior and correlated risk exposures.    

What should be done?  Schwarcz and Schwarcz argue for a greater federal role in regulating insurance.  Yet they chose to focus less on FSOC and more on an expansive role for one of Dodd-Frank's less well-known innovations, the Federal Insurance Office.  Their abstract is after the jump...

Schwarz & Schwarcz abstract:

As exemplified by the dramatic failure of American International Group (AIG), insurance companies and their affiliates played a central role in the 2008 Global Financial Crisis. It is therefore not surprising that the Dodd-Frank Act – the United States’ primary legislative response to the crisis – contained an entire title dedicated to insurance regulation, which has traditionally been the responsibility of individual states. The most important of these insurance-focused reforms in Dodd-Frank empowered the Federal Reserve Bank to impose an additional layer of regulatory scrutiny on top of state insurance regulation for a small number of “systemically important” insurers, such as AIG. But in focusing on the risk that an individual insurer could become too big to fail, this Article argues that Dodd-Frank largely overlooked a second, and equally important, potential source of systemic risk in insurance: the prospect that correlations among individual insurance companies could contribute to or cause widespread financial instability. In fact, the Article argues that there are often substantial correlations among individual insurance companies with respect to both their interconnections with the larger financial system and their vulnerabilities to failure. As a result, the insurance industry as a whole can pose systemic risks that regulation should attempt to identify and manage. Traditional state-based insurance regulation, the Article contends, is poorly adapted at accomplishing this given the mismatch between state boundaries and systemic risks and states’ limited oversight of non-insurance financial markets. As such, the Article suggests enhancing the power of the Federal Insurance Office – a federal entity currently primarily charged with monitoring the insurance industry – to supplement or preempt state law when states have failed to satisfactorily address gaps or deficiencies in insurance regulation that could contribute to systemic risk.

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May 13, 2014
What the Economist Forgets in its History of Five Financial Crises
Posted by Erik Gerding

A few weeks back (I am catching up on my blogging), the Economist featured a terrific essay on “A History of Finance in Five Crises.”  The conclusion of the essay – “successive reforms have tended to insulate investors from risk” and “this pins risk on the public purse … [t]o solve this problem means putting risk back into the private sector” – resonates.  However, the Economist makes a few surprising errors of omission in reaching this point.

First, many financial crises occurred without much of a state bailouts or safety net.  The Economist starts its history with the Panic of 1792 in the United States.  By that point England had already experienced a crisis in the late 1690s and the South Seas Bubble in 1720 and France had suffered through the searing Mississippi Bubble (I discuss all of these in Chapter 2 of my book).  The Economist then hopscotches to the Panic of 1825.  Roughly every ten years after that, Britain experienced another bubble and crash (also detailed in my book).  It is less than clear how government safety nets triggered these crises.

These crises point to a second omission: each of these 19th Century British crises – the Panic of 1825, the Panic of 1837, the Crisis of 1847 (it is a mystery to me what causes some incidents to qualify as a “Panic” and others to be a “Crisis”), the Crisis of 1857, and the Overend Gurney Crisis of 1866 – was preceded by a liberalization of corporate law or an expansion of limited liability for corporate shareholders.  Some scholars wax poetic about the “sine curve” of regulation without tracing that back in history.   Well, British corporate law (see also Chapter 2 of my book) provides the caffeine for that coffee.  This corporate law history has several important implications:

State intervention in financial markets takes other forms than deposit insurance and government bailouts.  This intervention often occurs before crises.  Indeed, I argue that booming markets and bubbles create strong incentives for interest groups to lobby for, and policymakers to provide, legal changes that further stimulate markets.  What I call “regulatory stimulus” goes beyond “deregulation” and includes government subsidies or legal preferences (think bankruptcy exemptions for swaps) for particular markets.  It also includes active government investments in markets (think all those state land and money giveaways to 19th Century railways). 

Regulatory stimulus in the form of changes to corporate law has particularly powerful effects.  The corporate form provides ideal for lobbying for regulatory favors: corporations solve collective action problems by centralizing decision-making and allow managers to lobby with “other people’s money.” 

Moreover, as the Economist hints but doesn’t quite hammer home, limited liability can generate moral hazard, which becomes particularly vicious if risk-taking can be externalized onto financial markets and taxpayers.

The Economist’s third omission is the most amusing (at least to nerds like me).  The magazine notes that after the Overend Gurney Crisis in 1866, “Britain then enjoyed 50 years of financial calm, a fact that some historians reckon was due to the prudence of a banking sector stripped of moral hazard.”  Many economists reckon that these years of calm owe more to the Bank of England finally assuming the mantle of lender of last resort in a banking crisis.  The intellectual godfather of this was none other than Walter Bagehot, the legendary editor of the Economist.  Perhaps this failure to provide credit where it is due owes to some intellectual Oedipal issues at the journal?

The fourth omission in the essay is perhaps the most unforgivable.  The Economist talks about the Great Crash of 1929 without mentioning the critique that the Federal Reserve failed to serve as lender-of-last-resort and pursued a destructive monetary policy at critical junctures.  Indeed, these are state interventions that many economists advocate that central banks take in the face of a banking crisis.  These state interventions also provide a government safety net that can create moral hazard.

 Which leads to the most biting criticism of the Economist piece: letting the economy burn in the wake of a financial crisis is pure but risks being purely destructive.  Rather than focusing on unravelling government safety nets for markets, we should be thinking about how to regulate financial firms given their inevitability.

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May 12, 2014
Summer Reading from Colorado’s Business Law Colloquium
Posted by Erik Gerding

We enjoyed a great lineup of speakers and cutting edge scholarship here in Boulder this past semester as part of CU’s Business Law Colloquium.  The following papers make for excellent start-of-the-summer reading:

Dan Katz (Michigan State): Quantitative Legal Prediction – or – How I Learned to Stop Worrying and Start Preparing for the Data Driven Future of the Legal Services Industry: a provocative look at Big Data will help clients analyze everything from whether to bring or settle a lawsuit to how to hire legal counsel.  Katz examines implications for legal education.

Rob Jackson (Columbia): Toward a Constitutional Review of the Poison Pill (with Lucian Bebchuk): Jackson and Bebchuk kicked a hornet’s nest with their argument that some state antitakeover statutes (and, by extension, poison pills under those statutes) may be preempted by the Williams Act.  See here for the rapid fire response from Martin Lipton.

Brad Bernthal (Colorado): What the Advocate’s Playbook Reveals About FCC Institutional Tendencies in an Innovation Age: my co-teacher interviewed telecom lawyers to map out both their strategies for influencing the Federal Communications Commission and what these strategies mean for stifling innovation in that agency.

Kate Judge (Columbia): Intermediary Influence:  Judge examines the mechanisms by which intermediaries – both financial and otherwise – engage in rent-seeking rather than lowering transaction costs for market participants.  The paper helps explain everything from Tesla’s ongoing fight with the Great State of New Jersey to sell cars without relying on dealers to entrenchment by large financial conglomerates.  

Lynn Stout (Cornell): Killing Conscience: The Unintended Behavioral Consequences of 'Pay For Performance': Stout argues that pay for performance compensation in companies undermines ethical behavior by framing choices in terms of monetary reward.  This adds to the growing literature on compliance which ranges from Tom Tyler’s germinal work to Tung & Henderson, who argue for adapting pay for performance for regulators.

Steven Schwarcz (Duke): The Governance Structure of Shadow Banking: Rethinking Assumptions About Limited Liability: Schwarcz argues for imposing additional liability on the “owner-managers” of some shadow banking entities to dampen the moral hazard and excessive risk taking by these entities, which contributed to the financial crisis.  This paper joins a chorus of other papers arguing to using shareholder  or director & officer liability mechanisms to fight systemic risk.  (See Hill & PainterAdmati, Conti-Brown, & Pfleiderer; and Armour & Gordon).

[I’ll inject myself editorially on this one paper: this is a provocative idea, but one that would make debt even cheaper relative to equity than it already is.  This would encourage firms to ratchet up already high levels of leverage.  I looked at the expansion of limited liability in Britain in the 18th Century in Chapter 2 of my book.  The good news for Schwarcz’s proposal from this history: expansions of limited liability seem to have coincided and contributed to the booms in the cycle of financial crises in that country that occurred every 10 years in that country.  The bad news: unlimited liability for shareholders does not seem to have staved off crises and likely contributed to the contagion in the Panic of 1825.]

The CU Business Law Colloquium also heard from Gordon Smith (BYU), Jim Cox (Duke), Sharon Matusik (Colorado – Business), Afra Afsharipour (UC Davis), Jesse Fried (Harvard), and Brian Broughman (Indiana).  Their papers are not yet up on ssrn.

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May 10, 2014
Breathing Life into Living Wills
Posted by Erik Gerding

For your weekend reading pleasure: Thomas Hoenig, Vice Chair of the Federal Reserve, made a speech this week arguing that the living wills provisions in Title I of Dodd-Frank were critical to ending financial bailouts.  He concludes:

"In theory, Title I provisions to resolve these firms make the system safer.  In practice, it will be the industry and its regulators that make the law work."

Sing It loud!  

But calling on industry and policymakers to make the law work points to the biggest problem with (arguably) the only really novel policy solution in post-crisis financial reform: where are the incentives for financial firms to get their living wills right?  Unfortunately, we might not know if living wills work until firms actually fail.  One fascinating item I learned in Mehrsa Baradaran's great forthcoming article Regulation by Hypothetical: the living wills that the largest Wall Street banks have produced appear to all have been drafted by the same team at Davis Polk.  Judge for yourself how helpful these recipes will be for regulators attempting to untangle a large failed financial colossus.

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