It is a pleasure to be guest-blogging here at The Glom for the next two weeks. My name is Josephine Nelson, and I am an advisor for the Center for Entrepreneurial Studies at Stanford’s business school. Coming from a business school, I focus on practical applications at the intersection of corporate law and criminal law. I am interested in how legal rules affect ethical decisions within business organizations. Many thanks to Dave Zaring, Gordon Smith, and the other members of The Glom for allowing me to share some work that I have been doing. For easy reading, my posts will deliberately be short and cumulative.
In this blogpost, I raise the question of what is broken in our system of rules and enforcement that allows employees within business organizations to escape prosecution for ethical misconduct.
Public frustration with the ability of white-collar criminals to escape prosecution has been boiling over. Judge Rakoff of the S.D.N.Y. penned an unusual public op-ed in which he objected that “not a single high-level executive has been successfully prosecuted in connection with the recent financial crisis.” Professor Garett’s new book documents that, between 2001 and 2012, the U.S. Department of Justice (DOJ) failed to charge any individuals at all for crimes in sixty-five percent of the 255 cases it prosecuted.
Meanwhile, the typical debate over why white-collar criminals are treated so differently than other criminal suspects misses an important dimension to this problem. Yes, the law should provide more support for whistle-blowers. Yes, we should put more resources towards regulation. But also, white-collar defense counsel makes an excellent point that there were no convictions of bankers in the financial crisis for good reason: Prosecutors have been under public pressure to bring cases against executives, but those executives must have individually committed crimes that rise to the level of a triable case.
And why don’t the actions of executives at Bank of America, Citigroup, and J.P. Morgan meet the definition of triable crimes? Let’s look at Alayne Fleischmann’s experience at J.P. Morgan. Fleischmann is the so-called “$9 Billion Witness,” the woman whose testimony was so incriminating that J.P. Morgan paid one of the largest fines in U.S. history to keep her from talking. Fleischmann, a former quality-control officer, describes a process of intimidation to approve poor-quality loans within the bank that included an “edict against e-mails, the sabotaging of the diligence process,… bullying, [and] written warnings that were ignored.” At one point, the pressure from superiors became so ridiculous that a diligence officer caved to a sales executive to approve a batch of loans while shaking his head “no” even while saying yes.
None of those actions in the workplace sounds good, but are they triable crimes??? The selling of mislabeled securities is a crime, but notice how many steps a single person would have to take to reach that standard. Could a prosecutor prove that a single manager had mislabeled those securities, bundled them together, and resold them? Management at the bank delegated onto other people elements of what would have to be proven for a crime to have taken place. So, although cumulatively a crime took place, it may be true that no single executive at the bank committed a triable crime.
How should the incentives have been different? My next blogpost will suggest the return of a traditional solution to penalizing coordinated crimes: conspiracy prosecutions for the financial crisis.
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Credit scoring has greatly reduced the cost of credit to the benefit of industry and borrowers, and has minimized concerns about intentionally discriminatory underwriting. Despite these gains, there remain questions about the integrity of the data used to determine borrowers’ scores and the fairness of the models used by credit reporting agencies (CRAs). These concerns are amplified as credit scores take on increasingly important roles in the society. Indeed, they have become a form of collateral. In this post, we muse about areas in which credit scoring needs further investigation.
Credit scoring unquestionably predicts borrower creditworthiness; however, scores could be more accurate and, thus, more fair. In particular, there is evidence that: (1) there are errors in the inputs on individual consumers; (2) some of the variables and the weights given to them are not predictive; and (3) models omit variables that would help predict borrower creditworthiness. For example, medical debt is often treated the same as credit card debt in scoring models. As a result, borrowers with unexpected, delinquent medical debt will be “dinged” on their credit reports just as people who took on debt buying discretionary consumer goods.
The Consumer Financial Protection Bureau’s bailiwick includes the authority to write rules that would further the purposes of the Fair Credit Reporting Act. The CFPB is already collecting credit report information on 200,000 individuals from each of the three major CRAs for the purpose of analyzing variations between the scores sold to consumers and those sold to creditors (http://www.consumerfinance.gov/wp-content/uploads/2011/07/Report_20110719_CreditScores.pdf). These efforts could expand to include requiring that CRAs and entities, like FICO, that develop scoring models provide the CFPB with their algorithms, including the inputs and the weights given each variable. This would enable the CFPB to test how well the CRAs predict default risk and the accuracy of their inputs.
The three national CRAs are not the only entities that collect and sell data on consumers. Smaller enterprises collect discrete data on individual borrowers that are not necessarily captured in traditional credit scores. Another role of the CFPB should be to identify these providers, evaluate their methods, and subject them to regulatory oversight.
There is a need to understand the market for the provision of accurate credit scores. In a well-functioning market, you would expect that competition among CRAs would lead to ever more accurate credit scoring models. However, if the marginal gains from: (1) including omitted, predictive variables, (2) insuring the accuracy of data with precision, and (3) scrutinizing weights, is small relative to the efficiency of slightly more crude scoring, CRAs and their clients might prefer the latter course. The result would have a potentially adverse impact on borrowers who are at the cusp of creditworthiness, which would implicate fairness concerns.
With lenders increasingly cautious about granting credit to people with less than pristine credit scores, there is a need to survey and evaluate models other than traditional scoring. This should include approaches taken in other countries, with an emphasis on programs that help low-income borrowers build credit and demonstrate creditworthiness.
I am sure there are other areas in which more understanding is needed and hope people will comment on this post so I can expand my catalog.
Stay tuned: Suffolk Law School Law Review will have a special issue on credit scoring and reporting later this year. (http://www.law.suffolk.edu/highlights/stuorgs/lawreview/index.cfm)
Teaching international financial regulation in a business school is no easy task, but I often think it should be. There isn't a good set of readily available opinions to be summarized in a casebook, so the instructor has to look to other methods of imparting the information to students. If you aren't going to lecture, it would seem that the business school case would be an attractive pedagogical alternative. "Cases" in a business school means "scenarios," which usually last for one class, and otherwise proceed in a reasonably similar way that a law school class does (there's cold-calling, c-x, and nicer ways of running the discussion too).
The business school method is attractive in some ways, and as law schools try to do more skills education, I predict that its appeal will only grow. But it isn't an easy way to impart doctrine. It can push critical thinking and strategic management skills quite well. In my view, however, IFR will work best in a business school when someone develops some cases that encourages both doctrinal mastery and situational analysis.
This post comes to us from Lawrence Baxter (Duke University School of Law) as part of our Roundtable on Teaching Banking Law/Financial Institutions. You can read the other posts in the roundtable here.
Thank you, Erik, for setting up this fascinating and very helpful forum. I apologize for coming late to the conversation, situated as I now am in chilly but exuberant and splendid South Africa after languishing for a week in beautiful Croatia. I have had the benefit of being able to read the inspiring contributions to the forum; as a result, I am inspired to revise completely the order of my assigned readings before classes begin—in only four short weeks!
I should note that I come to the teaching of bank regulation with a particular set of biases. In the first place, having spent some of my earlier years consulting with the federal banking agencies and working with the staff of the Senate Banking Committee during passage of FDICIA, I am keenly aware of the importance of understanding the law within the larger framework of financial policy. Secondly, my time working with a financial institution was entirely on the strategic and business side, not within the office of general counsel. So I tend to think of legal practice as serving the long term strategic prosperity of the business, which long term prosperity necessarily involves stability and the addition of value for sharehoders and the communities in which they operate. This is not to say that I believe the role of lawyers is simply to serve the immediate ends of the businesses that are their clients; on the contrary, I take the view that some among the legal profession, whether external or in-house counsel, sometimes submit far too greatly to the will of business executives without asserting independent leadership where the long term interests of the financial institution and its shareholders and customers really demand this independence. Financial lawyers have sometimes allowed themselves to become too much of a service industry and appear to have abandoned their roles as a source of wise counsel.
So my approach is to try to inculcate in students an understanding of the whys more than the whats. My hope is that this will encourage students not only to think strategically but also to recognize and understand both public and long-term private interests. This asks a lot of such future lawyers because impatient executives are seldom willing to listen to a sermon on the virtues of constraints they are trying to avoid. But if we don’t persevere in this effort then attorneys might as well consign themselves to roles not significantly different from those of marketers and human resource personnel.
I teach domestic and international banking regulation in separate courses—the former in the fall and the latter in the spring. During the past academic year I used a diverse collection of material for the domestic course and the superb Schooner/Taylor book plus additional material for the international course. Before I left on my current trip I had worked out the syllabus and reading assignments for the fall 2011 domestic course, almost all of which are based on Lissa Broome’s and Jerry Markham’s new casebook edition.
I never felt comfortable with this approach for two main reasons. First, it is now entirely artificial to separate domestic and international bank regulation, so a good deal of the international course has to find its way into the domestic course anyway. How can one possibly teach domestic regulation without recognizing that the operations of large banks are transnational and, in most cases, global? And, of course, Basel is integral to domestic bank regulation, while the actions and recommendations of the Financial Stability Board, G20 and other international institutions have a great impact, whether acknowledged or not, on the shape of domestic regulation, be it through rules or agency decisions. The Collins Amendment provides one of many illustrations.
Second, although Lissa and Jerry performed a Herculean task in updating their excellent casebook so soon after the passage of Dodd-Frank, I have become increasingly disenchanted with the casebook method as a means of teaching financial regulation, particularly now that the field has become so dynamic when compared to how it was twenty years ago. Of course there are key historical cases (e.g., McCulloch v. Maryland, Tiffany National Bank), and well-crafted judicial opinions, albeit rather scarce, help students to understand essential principles and the way these are applied in formal disputes. Cases such as the Second Circuit’s § 20 decisions form part of the dynamic tableau of financial regulation and they help to illustrate the interaction of public policy, agency positioning, industry advocacy that produces important though evanescent inflection points. But forcing the class to understand the larger picture through the episodic vignettes and procedural contortions of cases that make their way to the federal circuits and Supreme Court seems to me to distort the overall picture in ways that are not ideal when one is trying to lay down a long-lasting framework for future counsel. It is true that future financial lawyers are going to need to know the law with great precision once they engage in practice, but they are never going to acquire such precision within the framework of a three-hour course of passing technical validity. My hope is that the learning in law school that lasts is the bigger picture that frames the continually changing detail.
Perhaps it is also true that the case method, if used too much beyond the first year (where one is teaching basic forensic skills), wrongly encourages young lawyers to the assumption that the most important service they can provide is to defend their clients’ positions at almost all costs. This teaching method might even have contributed to the more general malaise in regulatory Washington, where no sensible result can be reached because adversary gridlock is perpetually generated or encouraged by lawyers terrified of conceding ground on behalf of their clients.
The previous conversations in this blog, in which others have described such imaginative use of diverse material in a fluid environment, leaves my earlier planned approach seeming not only uncomfortable, for the reasons already outlined, but also rather pedestrian. So although the die is cast for course listings for the 2011-12 academic year and my messy domestic/international bifurcation between must continue for the time being, I am nevertheless going to impose my own framework on the class reading sequence for the casebook. Instead of following the general order of the casebook, in making the reassignments of the readings from Broome & Markham I now plan to lay out my syllabus along the outline below (readers will recognize in my terminology my fascination with complexity theory as it applies to financial regulation):
I. The Financial Regulatory Ecology
- Financial systems, agents and stability
- Incl. brief overview of industry structure and demographics
- Central banking and regulatory supervision
- Agency structure overview
- Incl. some comparatives
- Exchanges and FMUs
- Regulatory forms, market failure and regulatory failure
- Why banks are (still) special and often Too Big to Fail
II. Path Dependencies
Like others in this forum, I cannot conceive teaching financial regulation without helping students to gain a basic understanding of how our regulatory framework evolved, what happened at various key moments in US and international economic history, and why legislation such as Dodd-Frank ends up being as complex and convoluted as it is. This history provides crucial elements of the initial states from which our regulatory thickets sprung, and how the financial industry has formed. Besides, the history is one of the most entertaining elements for students and a way to help them integrate their knowledge from other courses, such as constitutional and administrative law, into their understanding of financial regulation in general and banking regulation in particular.
III. “Banking” in its Modern Forms
- “Business of banking,” “incidental business,” and “closely related” financial services
- Balance sheet structure and P&L dynamics
- Basic overview of capital/liability/asset structure
- How banks earn (and lose) money
- Liquidity and funding management and risks
- Incl. securitization, derivatives, etc.
- Accounting and tax trickery
- How other financial segments fit in
- Investment banking
- Public and private funds
- “Shadow banking”
- Rating agencies
- Competition, Scale and Universal banking
- The conflicting ethics and cultures of modern finance
- Fractional reserve banking
- Risk management
- Capital, risk-adjustment, Collins, etc.
- Traditional “walls:” Glass-Steagall, McFadden, BHC Act, McCarran-Ferguson
- M&A & competition
- Affiliation & Anti-tying
- GLB & “Deregulation”
- Dodd-Frank, esp. Volker Rule(s): the attempt to separate, once again, custodial banking from investment banking
- Size and TBTF redux
(Note: Here I lean in the direction of Adam Feibelman rather than Heidi Schooner. But I would go further: not only are consumer protection issues, presented a certain way, of macroprudential importance; they are also directly relevant to the supervision of individual institutions for safety and soundness (i.e. as a microprudential consideration). As an illustration, my own company (after I retired from it, I hasten to add!) entered the realm of adjustable ARMs when it purchased Golden West. This step eventually destroyed the company. I believe the regulators and shareholders should be asking penetrating questions about why financial institutions are making patently stupid, or at the very least imprudent, loans and why such activity will not impact the solvency of the institution. Regulators should be demanding proof that mortgage service outsourcing, for example, has been done responsibly and in a manner that can withstand a crisis like the one we are in. The debate on consumer protection has been cast as one of irresponsible lending versus irresponsible borrowing, but I think this way of framing the issues underplays the important microprudential elements that regulators failed to police. So my presentation of consumer and investor protection issues would be presented, not so much from the point of view of consumers and investors themselves but from the point of view of regulators and shareholders.)
- General consumer and investor protection
- HMDA etc.
- Fed and traditional agencies
- Incl. Durbin (fees), smart cards, etc.
VII. Depositor Protection
- Origins & comparisons
- Including the financial stability and liquidity roles depositor protection plays
- Moral hazards & influence on regulation
- Including whether depositor protection achieves its goals or perhaps makes things even worse
- Supervisory process
- SFI regulation
(This whole section could form the heart of the evaluative discussion with the class on market v. regulatory failure, our inability to take regulation seriously, whether internal constraints such as ethical and moral precepts might offer better alternatives, and whether some of the ambitions of regulatory constraints—such as preventing systemic failures—are achievable.)
- Why banks are handed differently through the receivership rather than the bankruptcy process Traditional FDIC receivership (incl. conservatorship)
- Living Wills
- Incl. GSFIs and cross-border resolution
X. So What Will Happen in the Next Crisis?
- I.e., an evaluation of the reforms and current approach to banking regulation
# # #
In the final result, some large chunks of the casebook will be left out and I will again provide substantial legal and non-legal supplementary material. Basically I need a whole new type of coursebook, but that is another story . . .
Our thanks to our panelists for an insightful roundtable on teaching Banking/Financial Institutions. As they noted it is a particularly challenging and rewarding time to be teaching and rethinking this course. We heard from Adam Feibelman (Tulane), Anna Gelpern (American), Heidi Schooner (Catholic), and Arthur Wilmarth (George Washington). We will hear from Lawrence Baxter (Duke) later in the summer.
This coming Thursday and Friday (June 23-24) we will gather a distinguished group of teachers and scholars to convene a roundtable on teaching Corporate Finance.
First, huge thanks and kudos to Erik and the Glom crew for being visionary. My version of letting no crisis go to waste is to assert that The Crisis is attributable entirely to the formerly niche status of banking and financial institutions in the law curriculum, which misled some of the best minds in the country to things like the Constitution and SOX, when we all should have been thinking about capital adequacy and systemic risk. But I digress. Bye-bye seminar caps, hello first-year lecture halls! Hooray for big screens and Heidi's graphics! And thank Goodness for the giants among us who knew the difference between FDICIA, FIRREA, FIRIRCA and FBSEA as it happened. I am deeply honored and humbled to be in their company.
My quick and dirty take on the course boils down to sequencing, central banks, and movies. The international dimension is a no-brainer, so I get to it last. But really, it is all about the movies. To wit, my only Dodd-Frank thought is on the visuals. I concur with everything DFA that has been said before.
Sequencing. Capital and Systemic Risk have to come super-early in the course, probably immediately after the definition of a bank. It makes no sense to wait until after geographic restrictions, which are weedy and not particularly binding anyway (not to be confused with activities and affiliation restrictions, which are a must). Another reason to start with capital is that it gets the bank balance sheet up on the board soonest. While we are on balance sheets, the Unidentified Financial Institutions exercise in the Jackson-Symonds book (pp. 14-26) is truly genius, though the book is more than a decade out of date. Maybe someone should start a wiki to put together balance sheets and income statements for all kinds of institutions, including shadow banks ...
Central Banks. The role of financial institutions in money creation is important, as is their access to the Lender of Last Resort. This ties in with systemic risk, shadow banking, runs and crises, aka major payoff. (Tradeoff? Chartering rules. Snooze.) The Fed is also a fabulous resource, with this and this just about enough to get you through. Bonus feature: Bernanke's Great Depression writing is remarkably accessible (I assign Nonmonetary Effects, minus the math section), and makes everyone feel very theoretical. Same goes for many Tarullo speeches, which come across as learned yet accessible to the law audience.
Movies. Breaking the Bank is just the right length, and can serve as a nice transition between banks and other financial institutions, or to set up crisis response, as well as affiliation material. My all-time favorite is Trillion Dollar Bet, which is more about systemic risk, hedge funds, derivatives, regulatory perimeter, funky hand gestures, and the perils of being filmed riding a golf cart. But honestly, I would find a way to show it in a physics or interpretive dance class. Don't miss the options pricing game on the website. Do miss Inside Job -- not enough substance, except maybe for an Economics Department consulting ethics module (do they have those?).
In the clips department, FDIC needs to get a real soundtrack for Never Lose a Penny. Davis Polk's Dodd-Frank miniseries must have a cult following, but Mad Men it isn't. On the bright side, Fidelity Fiduciary Bank is the hands-down favorite for content saturation and technical accuracy (safe and sound! compound! propriety! prudently!). Sadly, this YouTube sing-along version cuts off before the bank run, so make yourself a CD and post the lyrics. Below is my mature representation of the difference between banking and securities investing, using Jane and Michael Banks. Wicked popular with the pre-K crew.
International. Another reason to start with Mary Poppins: it frames banking as international and comparative from the start. How can you possibly understand our weird system without either historical (see Art's post) or cross-country context? Northern Rock is the ideal case study for deposit insurance, especially since the scheme that failed was a bright shiny modern one that had thought about moral hazard and tried to do the clever thing. Perfect foil for rusty ole FDIC. Iceland is good for home-host issues, which by the way is the way I deal with geographic restrictions, branching and subsidiaries. Wal-Mart Bank in Mexico is a five-fer: affiliations, activities restrictions, financial inclusion, consolidated supervision, and home/host/international coordination. But don't take my word for it; this Ortiz speech is the perfect length, and divisible in two. Bonus feature: even if you do not teach anything international, read Heidi's book with Michael Taylor, because it is the crispest account of banking of any sort, ever. I cannot wait for the movie version.
By the way, I understand that Basle might be the hipper way to write Basel, but that might reinforce the niche image, so better not. I do worship their statistics.
Many thanks to Erik Gerding for organizing this exchange of views on teaching Banking Law, and for inviting me to participate. Following are some of my thoughts on teaching Banking Law in the context of the financial crisis and the Dodd-Frank Act:
(1) I use a historically-oriented approach in teaching Banking Law. I spend at least two classes on the history of banking regulation before 1980, with a particular emphasis on the 1920's and the New Deal legislation of the 1930s. I believe that the credit boom of the 1920s, the financial and economic crises of 1929-1933, and the New Deal legislation provide a very helpful comparative context for studying the events of the past decade.
(2) I spend several classes reviewing the expansion of powers for national banks and the expansion of permitted financial activities for bank holding companies (BHCs) before I discuss the financial crisis. We also consider the basic safety-and-soundness regulations for banks (including deposit insurance, capital requirements, prompt corrective action (PCA) and affiliate transaction rules) before we discuss the financial crisis. Evaluating the desirability and effectiveness of limitations on bank and BHC activities as a trade-off for government support helps the students to appreciate policy arguments for and against greater regulation. We also discuss Congress' decision to rely on the affiliate transaction rules under Sections 23A and 23B of the Federal Reserve Act as the best way to prevent the spread of safety net subsidies from banks to their nonbank affiliates (especially securities broker-dealers) following the enactment of the Gramm-Leach-Bliley Act in 1999.
(3) We spend 2-3 classes discussing the banking and thrift crises of the 1980s and the legislative responses to those crises in 1989 and 1991. That discussion helps students to appreciate the limited ability of Congress to respond effectively to the causes of financial crises. In 1991, Congress focused on capital regulation as the best antidote to the moral hazard created by deposit insurance, even though there was already significant evidence that capital rules were undermined by (i) the lagging effect of capital levels as indicators of bank problems, and (ii) the vulnerability of capital rules to capital arbitrage. Congress also thought it could force regulators to take timely action against undercapitalized banks by enacting the PCA regime.
Instead, however, regulators agreed to the advanced internal risk-based approach for capital regulation embodied in Basel II, which deferred to internal risk models created by the largest banks and allowed them to conceal significant increases in their effective leverage. In addition, when the financial crisis reached its peak in 2008 and early 2009, U.S. regulators announced they would not apply PCA rules against any of the 19 largest BHCs and, instead, would provide any capital those institutions needed to survive. Similarly, the Fed repeatedly waived the affiliate transaction rules under Sections 23A and 23B so that major banks could support their broker-dealer affiliates during the crisis. Thus (as Saule Omarova has persuasively demonstrated in her forthcoming article), regulators decided not to enforce Sections 23A and 23B against the largest financial holding companies just as they refused to enforce the (purportedly) non-discretionary PCA rules.
(4) We spend 2-3 classes on the basic causes of the financial crisis. There is a huge amount of material on which to draw, but I have used two sources in the past couple of years that I have found to be reasonably comprehensive and accessible to students. The first is testimony that FDIC Chairman Sheila Bair presented to the Financial Crisis Inquiry Commission in January 2010. It provides a good survey of the causes of the crisis as well as several proposals for regulatory reform that were ultimately adopted in Dodd-Frank. That testimony can be found on the FDIC's website at the following weblink:
The second source is an article written by Kenneth Scott entitled "The Financial Crisis: Causes and Lessons." The article is available on SSRN at the following weblink:
There are certainly many other good sources that are available on the causes of the crisis.
(5) After discussing the causes of the crisis, we spend 3-4 classes on the main highlights of Dodd-Frank (especially Titles 1, 2 and 10, with somewhat less attention to Titles 3, 6 and 7). Again, there are many useful summaries of Dodd-Frank. None of them is ideal, but I have found the e-book on Dodd-Frank published by Arnold & Porter to be quite good. The e-book is available at the following weblink:
In our discussions, we try to evaluate whether the provisions of Dodd-Frank (i) represent promising or misguided responses to the causes of the financial crisis, and (ii) were the product of compromises and concessions that indicate the surprising amount of political influence retained by the major financial institutions despite their shared responsibility for the crisis and the extraordinary governmental assistance they received.
(6) We finish the course by looking at the conventional bank receivership rules under the Federal Deposit Insurance Act, and we compare those rules to the orderly liquidation authority created by Title 2 of Dodd-Frank. We also discuss, more generally, whether the Dodd-Frank has essentially separated the regulation of financial institutions into two tiers, one for non-systemic institutions and the other for systemically important financial institutions (SIFIs) that will be subject to Titles 1 and 2 of Dodd-Frank. I point out that numerous PCA orders have been issued against small and midsized banks, and hundreds of those institutions have been placed in receivership during the past three years. In contrast, Lehman Brothers stands alone in the U.S. as a presumptive SIFI that was allowed to fail. We discuss the policy implications of too-big-to-fail (TBTF) for the future of financial regulation in the U.S., and we evaluate whether Dodd-Frank will do much to reduce the explicit and implicit subsidies received by institutions that are perceived to be TBTF.
(7) As the above discussion indicates, I emphasize history and also integrate policy discussions with regulatory analysis. I believe that the current regulatory structure and the most important regulatory statutes cannot be understood by law students and banking lawyers unless they understand the historical background of those statutes and the policy arguments that led to their enactment. To the extent that our students become regulatory lawyers, they will certainly need to use policy arguments in their future interactions with regulators and the courts. The financial crisis has demonstrated that policy considerations count much more than statutory technicalities in determining how Congress and regulators respond to a major crisis.
In the roundtable spirit, I thought I’d respond to one point Heidi makes in her initial post: that consumer protection issues might fall beyond the scope of macro-prudential regulation. Lately I’ve been exploring the opposite possibility, that regulation of consumer financial has important macro-prudential relevance.
Erik and Anna have written about this recently, both emphasizing that the recent global, systemic crisis began with consumer financial transactions that were sped and magnified through the financial system. But the relevance is even broader. There is a growing body of evidence that central bankers and other international institutions are increasingly focused on how the amount and composition of household debt affects macro-economic performance and vulnerability, a surprisingly understudied topic. For one example, consider the 2009 conference, Household Debt: Implications for Monetary Policy and Financial Stability, co-sponsored by the Bank of Korea and the Bank of International Settlements. I’m currently working on a paper, Toward a Macro-prudential Approach to Consumer Financial Regulation. It explores, among other things how the substance of regulation in this area might be influenced by macro-prudential concerns. If anyone out there would like to see a preliminary draft, I’d be more than happy to send it along.
I don’t mean to overstate the macro-economic or systemic importance of consumer finance or household debt, especially in relation to other financial and economic activity. But I am convinced that the recent crisis has drawn this topic within the field of systemic concerns. And at the very least, the topic illustrates how the content and contours of macro-prudential regulation are as yet undefined and up for grabs.
The following post comes to us from Heidi Mandanis Schooner, Professor of Law at the Columbus School of Law of the Catholic University of America.
Teaching Banking Law has always been about systemic risk. Post-Financial Crisis, we see that the microprudential approach to systemic risk was too narrow (i.e., it only focused on deposit-taking banks and too much on their solvency). Yet, the regulatory goal remains the same. In other words, protecting the solvency of a bank (microprudential) was never meant to be about protecting that individual firm. It was about protecting that firm because of the systemic implications if you didn’t. The Financial Crisis highlighted the need to broaden the scope of prudential regulation – and we gave it a new and improved name – macroprudential regulation.
In almost every class, I use variations on two visuals that I find useful in teaching the course. The first is the balance sheet which I use throughout the course to help students understand the nature of the business of banking and the fragility of banks. The second visual (the focus of this post) is a series of organizational charts. Focus on the structure of the organization emphasizes the traditional and persistent institutional focus of prudential regulation. Some examples of various charts are below but, obviously, there are many variations on this theme. The progression below is also roughly chronological in terms of the passage of bank legislation and therefore can be used in developing the history of regulation. Moreover, the statutes themselves are a challenge for students. The institutional focus assists in separating, for example, the National Bank Act from the Bank Holding Company Act, etc.
National Bank. Most traditional prudential rules apply strictly to that entity, i.e., special chartering, lending limits, business of banking (§ 24(seventh)), etc. Other types of prudential rules can also be introduced at this level and circled back to later, e.g., Section 16 of Glass Steagall, capital regulation, administrative enforcement, special insolvency rules.
Bank Holding Company. Coverage at the bank holding company level can include 23A and B, geographic limits, activities restrictions (e.g., commerce, Volcker rule). This type of organization chart is also useful in illustrating the responsibilities of the various bank regulators.
Systemically Important Financial Institutions. This will include large bank holding companies and, most importantly, non-bank financial institutions. The visuals here will be less about adding onto an organizational chart and more about identifying firms that are deemed systemic. Naturally, this is the place in which Dodd-Frank will have the greatest impact on the course. Coverage will include: identification of systemic non-bank institutions, enhanced prudential rules, countercyclical rules, living wills, and the new resolution regime.
International Law. Although Banking Law is a domestic course, I try to introduce as much international and comparative law as possible. In teaching capital, for example, I find that the Basel rules are more accessible to students than U.S. capital regulations. I also try to introduce some comparative perspective as time permits.
Topics Not Covered. If one conceives of the course as macroprudential, then consumer protection issues can be omitted. This does not solve the question of how to deal with market regulation that aims to address systemic risk (e.g., OTC derivatives). I am inclined to conclude that a full treatment of market regulation should be left to securities courses. At very least, some coverage of market regulation in the banking law course is appropriate to emphasize the fact that a purely institutional focus to systemic risk regulation is incomplete.
First of all, thanks to Erik and the folks at the Conglomerate Blog for inviting me to participate in this roundtable, and greetings to the other participants.
Even in economic peacetime, regulation of financial institutions is a challenging and rewarding topic to teach. The subject matter is always important, if usually not very salient to most law students, and it provides an interesting window into a broad range of general issues that societies and policymakers face when they regulate industries and commercial activities.
I found teaching it this year, in the wake of financial crisis and regulatory responses, especially Dodd-Frank, to be an exceptionally challenging and rewarding experience.
I learned with some surprise in late fall that I was going to teach financial institutions this spring. I had taught it a few times previously, but not in many years, and only as a seminar; this spring I was expected to teach it as a course. And although I had followed some of the debate leading up to Dodd-Frank with interest and concern and some bewilderment, I had not followed it carefully, and I had largely ignored large swaths of issues implicated by the proposed bill. I was distracted with other topics, and so once Dodd Frank became law, I moved on and gave its details little thought. I distinctly remember looking at a brief summary of the bill running many pages and thinking, “Thank God I’m not teaching banking law any time soon.”
Given the short notice, I faced a dilemma. The bill made some major changes to the regulatory landscape affecting financial institutions (bye-bye Office of Thrift Supervision, hello Consumer Financial Protection Bureau). But it also provided for a dizzying array of smaller, if not minor, changes to the substance and structure of financial regulation. (“Provided for,” that is, because many of these changes will only emerge in the slow process of rule-making and agency practice.) In the busy period between terms, there was no way that I could comprehend all of these changes and incorporate them all into a syllabus.
Out of necessity, then, I decided to spend most of the term teaching the field as it stood before Dodd-Frank (using Anna Gelpern’s fantastic syllabus to help me convert my seminar into a course) and then to spend the last few weeks of the term exploring the regulatory events of the recent crisis, the bill itself, and the changes it made to the pre-existing landscape.
I was sheepish about this approach at first, but quickly decided that it had some unanticipated merit. Focusing on the regulatory status quo ante made it much easier to draw students into the law- and rule-making process and to get them to consider the range of alternative designs and approaches that policymakers have at their disposal. Again, these are always important background issues in a course on regulated industries, but I felt that withholding the regulatory “reveal” added some elements of drama and uncertainty that brought these issues to life. I noted along the way that particular doctrines or rules we were covering had been altered by Dodd-Frank, and I did not sense that students were made anxious or confused by the approach.
As much as I enjoyed this approach to the course, I doubt I will be able to reconstruct it in the future. Having become familiar with ways in which the new law changed the regulatory landscape, it will be hard to resist explaining the new current framework topic by topic, to integrate the recent changes into the material in the way that legal developments get woven together to create a field of law. And I certainly won’t be able to recreate my own nervous uncertainty and surprise at learning the substance of reforms for the first time mid-course.
As a side note, teaching this material again after Dodd-Frank underscored for me how the essential content of the field has shifted in recent years, especially in light of recent issues and developments. A number of topics that are traditionally part of the course now seem a bit quaint, like geographic restrictions on banking or rules governing branching. Other topics that I previously omitted or under-emphasized now seem central, like resolution, capital requirements, consumer protection, and transnational regulation. And still other topics, like macro-prudential regulation, are altogether new. I wonder what the casebooks for the course will look like a few years from now.
The Conglomerate is pleased to host our second online teaching roundtable of the summer today and tomorrow. We have gathered together some of my favorite scholars and teachers who will be discussing how they approach the course in Banking Law/Financial Institutions during a time of legal upheaval.
As with last week’s engaging roundtable on teaching Contracts, we give our guests free rein to discuss topics of their choice. Here are some of the questions they may examine:
- How has the financial crisis changed the subject matter of the course?
- How much do you focus on non-bank financial institutions? Is “shadow banking” (financial instruments and markets, like asset-backed securities, that perform many of the same economic functions and pose some of the same economic risks as depository banks) a component of the course?
- If non-bank institutions are increasingly emphasized, how do you define the boundaries and central themes of the course, so that it is still coherent and manageable? How much do you focus on financial instruments and markets?
- How do you cover the sheer scope of Dodd-Frank? What topics are most important?
- How much of a historical focus helpful in teaching?
- How much of the economics of banking do you teach? Is it a useful frame for the course, or do you dip into economics as needed?
- How do you incorporate international or transnational subjects into the course?
- How do you balance policy issues with preparing students to be practitioners? How does one incorporate practitioner perspectives/problem solving dimensions into an introductory course when the material is so highly technical and likely to be alien to most students?
- How do you “sell” students (and even colleagues) on what the course is and why it is relevant for students? (I am sure many of us have a “friend” who has had to have this conversation with colleagues).
Let’s get started!