Archive for the ‘Financial Crisis’ Category

A Crisis of Banks as Liquidity Providers

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday December 8, 2014 at 9:01 am
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Editor’s Note: The following post comes to us from Nada Mora, Senior Economist at the Federal Reserve Bank of Kansas City, and Viral Acharya, Professor of Finance at NYU.

In our paper, A Crisis of Banks as Liquidity Providers, forthcoming in the Journal of Finance, we investigate whether the onset of the 2007-09 crisis was, in effect, a crisis of banks as liquidity providers, which may have led to reductions in credit and increased the fragility of the financial system. The starting point of our analysis is the widely accepted notion that banks have a natural advantage in providing liquidity to businesses through credit lines and other commitments established during normal times. By combining deposit taking and commitment lending, banks conserve on liquid asset buffers to meet both liquidity demands, provided deposit withdrawals and commitment drawdowns are not too highly correlated. Evidence from previous crises supports this view. In fact, banks experienced plenty of deposit inflows to meet the higher and synchronized drawdowns that occurred during episodes of market stress (Gatev and Strahan (2006)). The reason is that depositors sought a safe haven due to deposit insurance as well as due to the regular occurrence of crises outside the banking system (e.g., the fall of 1998 following the Russian default and LTCM hedge fund failure; the 2001 Enron accounting crisis).

…continue reading: A Crisis of Banks as Liquidity Providers

How Do Bank Regulators Determine Capital Adequacy Requirements?

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday October 15, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from Eric Posner, Kirkland & Ellis Distinguished Service Professor of Law and Aaron Director Research Scholar at the University of Chicago.

The incentive to take socially costly financial risks is inherent in banking: because of the interconnected nature of banking, one bank’s failure can increase the risk of failure of another bank even if they do not have a contractual relationship. If numerous banks collapse, the sudden withdrawal of credit from the economy hurts third parties who depend on loans to finance consumption and investment. The perverse incentive to take financial risk is further aggravated by underpriced government-supplied insurance and the government’s readiness to play the role of lender of last resort.

…continue reading: How Do Bank Regulators Determine Capital Adequacy Requirements?

Towards a “Rule of Law” Approach to Restructuring Sovereign Debt

Posted by Steven L. Schwarcz, Duke University, on Tuesday October 14, 2014 at 9:08 am
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Editor’s Note: Steven L. Schwarcz is the Stanley A. Star Professor of Law & Business at Duke University School of Law.

In a landmark vote, the United Nations General Assembly overwhelmingly decided on September 9 to begin work on a multilateral legal framework—effectively a treaty or convention—for sovereign debt restructuring, in order to improve the global financial system. The resolution was introduced by Bolivia on behalf of the “Group of 77” developing nations and China. In part, it was sparked by recent litigation in which the U.S. Supreme Court held that, to comply with a pari passu clause (imposing an equal-and-ratable repayment obligation), Argentina could not pay holders of exchanged bonds without also paying holdouts who retained the original bonds. That decision was all the more dramatic because the holdouts included hedge funds—sometimes characterized as “vulture funds”—that purchased the original bonds at a deep discount, yet sued for full payment.

…continue reading: Towards a “Rule of Law” Approach to Restructuring Sovereign Debt

Financial Market Infrastructures

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday October 6, 2014 at 8:56 am
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Editor’s Note: The following post comes to us from Guido A. Ferrarini, Professor of Business Law at University of Genoa, Department of Law, and Paolo Saguato at Law Department, London School of Economics.

In the paper Financial Market Infrastructures, recently made publicly available on SSRN and forthcoming as a chapter of The Oxford Handbook on Financial Regulation, edited by Eilís Ferran, Niamh Moloney, and Jennifer Payne (Oxford University Press), we study the impact of the post-crisis reforms on financial market infrastructures in the securities and derivatives markets.

The 2007-2009 financial crisis led to large-scale reforms to the regulation of securities and derivatives markets. Regulators around the world acknowledged the need for structural reforms to the financial system and to market infrastructures in particular. Due to the global dimension of the crisis and the extent to which financial markets had been revealed to be closely interconnected, national regulators moved the related policy debate to the supranational level. This approach led to the international regulatory guidelines and principles adopted by the G20 and then developed by the Financial Stability Board (FSB). The new global regulatory framework which has followed has institutionalized financial market infrastructures (FMIs) as key supports for financial stability and as cornerstones of the crisis-era regulatory reform agenda for financial markets.

…continue reading: Financial Market Infrastructures

After the Deal: Fannie, Freddie and the Financial Crisis Aftermath

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday September 11, 2014 at 9:09 am
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Editor’s Note: The following post comes to us from Steven Davidoff Solomon, Professor of Law at the University of California, Berkeley School of Law, and David T. Zaring, Associate Professor of Legal Studies and Business Ethics at the Wharton School, University of Pennsylvania.

In After the Deal: Fannie, Freddie and the Financial Crisis Aftermath, we offer a solution to the problem of what to do with the profits being made by Fannie Mae and Freddie Mac, the subject of a dispute between the government, which has declared that it will keep those profits, and the shareholders of common and preferred stock left behind after the firms were quasi-nationalized, who have sought, in court, a share of them.

…continue reading: After the Deal: Fannie, Freddie and the Financial Crisis Aftermath

Rolling Back the Repo Safe Harbors

Posted by Mark Roe, Harvard Law School, on Wednesday September 10, 2014 at 9:02 am
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Editor’s Note: Mark Roe is the David Berg Professor of Law at Harvard Law School, where he teaches bankruptcy and corporate law. This post is based on an article co-authored by Professor Roe, Ed Morrison, Professor of Law at Columbia Law School, and Bankruptcy Judge Christopher Sontchi for the District of Delaware. All three are members of the Advisory Committee on Derivatives, Financial Contracts and Safe Harbors, which is working with the ABI Commission to Study the Reform of Chapter 11. The article was presented at the Federal Reserve’s recent conference on Wholesale Funding Markets.

Ed Morrison, Judge Christopher Sontchi and I recently posted to SSRN our article recommending a major narrowing of the repo safe harbors, after presenting it at the Federal Reserve’s recent conference on Wholesale Funding Markets in which the Boston Fed president warned of the dangers in the repo market. Overall, we conclude that the Bankruptcy Code has aggressively and unwisely sought to regulate market liquidity and systemic risk, with the Code’s “safe harbors” from the normal bankruptcy machinery largely backfiring during the financial crisis. The sounder policy would be to limit the repo safe harbors to U.S. Treasury repos and repos of similarly liquid government securities.

…continue reading: Rolling Back the Repo Safe Harbors

Correcting Some of the Flaws in the ABS Market

Posted by Luis A. Aguilar, Commissioner, U.S. Securities and Exchange Commission, on Tuesday September 9, 2014 at 9:07 am
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Editor’s Note: Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at a recent open meeting of the SEC; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Today [August 27, 2014] the Commission takes an important step to protect investors and promote capital formation, by enhancing the transparency of asset-backed securities (“ABS”) and by increasing the accountability of issuers of these securities. The securitization market is critical to our economy and can provide liquidity to nearly all the major economic sectors, including the automobile industry, the consumer credit industry, the leasing industry, and the commercial lending and credit markets.

Given the importance of this market, let’s also remember why we are here and the magnitude of the crisis in the ABS market. At the end of 2007, the ABS market consisted of more than $7 trillion of mortgage-backed securities and nearly $2.5 trillion of other outstanding ABS. However, by the fall of 2008, the securitization market had completely seized up. For example, in 2006 and 2007, new issuances of private-label residential mortgage-backed securities (“RMBS”) totaled $686 billion and $507 billion, respectively. In 2008, private-label RMBS issuance dropped to $9 billion, and flat-lined in 2009.

…continue reading: Correcting Some of the Flaws in the ABS Market

Statement on Asset-Backed Securities and Credit Rating Agencies

Posted by Mary Jo White, Chair, U.S. Securities and Exchange Commission, on Friday August 29, 2014 at 9:00 am
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Editor’s Note: Mary Jo White is Chair of the U.S. Securities and Exchange Commission. The following post is based on Chair White’s remarks at a recent open meeting of the SEC, available here and here. The views expressed in this post are those of Chair White and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The Commission will today [August 27, 2014] consider recommendations of the staff for adopting two very important final rules in different, but closely related, areas—asset-backed securities and credit rating agencies.

The reforms before us today will add critical protections for investors and strengthen our securities markets by targeting products, activities and practices that were at the center of the financial crisis. With these measures, investors will have powerful new tools for independently evaluating the quality of asset-backed securities and credit ratings. And ABS issuers and rating agencies will be held accountable under significant new rules governing their activities. These reforms will make a real difference to investors and to our financial markets.

We will first consider the recommendation related to asset-backed securities, and then we will consider the rules relating to credit rating agencies.

…continue reading: Statement on Asset-Backed Securities and Credit Rating Agencies

Banks, Government Bonds, and Default

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday August 19, 2014 at 9:15 am
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Editor’s Note: The following post comes to us from Nicola Gennaioli, Professor of Finance at Bocconi University; Alberto Martin, Research Fellow at the International Monetary Fund; and Stefano Rossi of the Finance Area at Purdue University.

Recent events in Europe have illustrated how government defaults can jeopardize domestic bank stability. Growing concerns of public insolvency since 2010 caused great stress in the European banking sector, which was loaded with Euro-area debt (Andritzky (2012)). Problems were particularly severe for banks in troubled countries, which entered the crisis holding a sizable share of their assets in their governments’ bonds: roughly 5% in Portugal and Spain, 7% in Italy and 16% in Greece (2010 EU Stress Test). As sovereign spreads rose, moreover, these banks greatly increased their exposure to the bonds of their financially distressed governments (2011 EU Stress Test), leading to even greater fragility. As The Economist put it, “Europe’s troubled banks and broke governments are in a dangerous embrace.” These events are not unique to Europe: a similar relationship between sovereign defaults and the banking system has been at play also in earlier sovereign crises (IMF (2002)).

…continue reading: Banks, Government Bonds, and Default

Embracing Sponsor Support in Money Market Fund Reform

Editor’s Note: Jill E. Fisch is Perry Golkin Professor of Law and Co-Director of the Institute for Law & Economics at the University of Pennsylvania Law School.

Money market funds (MMFs) have, since the 2008 financial crisis, been deemed part of the nefarious shadow banking industry and targeted for regulatory reform. In my paper, The Broken Buck Stops Here: Embracing Sponsor Support in Money Market Fund Reform, I critically evaluate the logic behind current reform proposals, demonstrating that none of the proposals is likely to be effective in addressing the primary source of MMF stability—redemption demands in times of economic resources that impose pressure on MMF liquidity. In addition, inherent limitations in the mechanisms for calculating the fair value of MMF assets present a practical limitation on the utility of a floating NAV. I then offer an unprecedented alternative approach—mandatory sponsor support. My proposal would require MMF sponsors to commit to supporting their funds as a condition of offering a fund with a fixed $1 NAV.

…continue reading: Embracing Sponsor Support in Money Market Fund Reform

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