Tag: Too big to fail


Enhancing Prudential Standards in Financial Regulations

The following post comes to us from Franklin Allen, Professor of Economics at the University of Pennsylvania and Imperial College London; Itay Goldstein, Professor of Finance at the University of Pennsylvania;
 and Julapa Jagtiani and William Lang, both of the Federal Reserve Bank of Philadelphia.

The following post comes to us from Franklin Allen, Professor of Economics at the University of Pennsylvania and Imperial College London; Itay Goldstein, Professor of Finance at the University of Pennsylvania;
 and Julapa Jagtiani and William Lang, both of the Federal Reserve Bank of Philadelphia.

The recent financial crisis has generated fundamental reforms in the financial regulatory system in the U.S. and internationally. In our paper, Enhancing Prudential Standards in Financial Regulations, which was recently made publicly available on SSRN, we discuss academic research and expert opinions on this vital subject of financial stability and regulatory reforms.

Despite the extensive regulation and supervision of U.S. banking organizations, the U.S. and the world financial systems were shaken by the largest financial crisis since the Great Depression, largely precipitated by events within the U.S. financial system. The new “macroprudential” approach to financial regulations focuses on both the risks arising in financial markets broadly and those risks arising from financial distress at individual financial institutions.

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

Steven L. Schwarcz is the Stanley A. Star Professor of Law & Business at Duke University School of Law.

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.

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Cross-Border Recognition of Resolution Actions

The following post comes to us from Sullivan & Cromwell LLP, and is based on a Sullivan & Cromwell publication authored by Mitchell S. Eitel, Andrew R. Gladin, Rebecca J. Simmons, and Jennifer L. Sutton. The complete publication, including footnotes, is available here.

The following post comes to us from Sullivan & Cromwell LLP, and is based on a Sullivan & Cromwell publication authored by Mitchell S. Eitel, Andrew R. Gladin, Rebecca J. Simmons, and Jennifer L. Sutton. The complete publication, including footnotes, is available here.

On September 29, 2014, the Financial Stability Board (the “FSB”) published a consultative document concerning cross-border recognition of resolution actions and the removal of impediments to the resolution of globally active, systemically important financial institutions (the “Consultative Document”). The Consultative Document encourages jurisdictions to include in their statutory frameworks seven elements that would enable prompt effect to be given to foreign resolution actions. In addition, due to a recognized gap between the various national legal resolution regimes that are currently in place and those recommended by the FSB, the Consultative Document sets forth two “contractual solutions”—that is, resolution-related arrangements to be implemented as a matter of contract among the private parties involved—to address two underlying substantive issues that the FSB considers critical for orderly cross-border resolution, namely:

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US Regulatory Outlook: The Beginning of the End

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication. The complete publication, including appendix and footnotes, is available here.

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication. The complete publication, including appendix and footnotes, is available here.

Regulatory delay is now the established norm, which continues to leave banks unsure about how to prepare for pending rulemakings and execute on strategic initiatives. With the “Too Big To Fail” (TBTF) debate about to hit the headlines again when the Government Accountability Office releases its long-awaited TBTF report, the rhetoric calling for the completion of these outstanding rules will once more sharpen.

This rhetoric should not be confused with reality, however. At about this time last summer, Treasury Secretary Lew stated that TBTF would be addressed by the end of 2013—a goal that resulted in heightened stress testing expectations and a vague final Volcker Rule in December, but little more. Since then, the slow progress has continued, with only two key rulemakings completed so far this year: the finalization of Enhanced Prudential Standards for large bank holding companies (BHCs) and a heightened supplementary leverage ratio for the eight largest BHCs (i.e., US G-SIBs).

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Supersize Them? Large Banks, Taxpayers and the Subsidies

The following post comes to us from Nizan Geslevich Packin of the University of Pennsylvania Law School; Zicklin School of Business, Baruch College, City University of New York.

The following post comes to us from Nizan Geslevich Packin of the University of Pennsylvania Law School; Zicklin School of Business, Baruch College, City University of New York.

In the paper Supersize Them? Large Banks, Taxpayers and the Subsidies that Lay Between, I provide an in-depth study of the substantial, non-transparent governmental subsidies received by the biggest banks. Though some continue to deny the existence of these subsidies, I conclude that the subsidies exist and negatively impact the financial markets. The most significant implicit subsidy stems from market perception that the government will not allow the biggest banks to fail—i.e., that they are “too-big-to-fail” (TBTF)—enabling them to borrow at lower interest rates. I outline the solutions that have been proposed and/or implemented as an attempt to solve the TBTF problem, and I suggest a new user-fees framework that can be used in conjunction with other approaches to mitigate the consequences of the TBTF subsidies.

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What It Takes for the FDIC SPOE Resolution Proposal to Work

The following post comes to us from Karen Petrou, co-founder and managing partner of Federal Financial Analytics, Inc., and is based on a letter and a FedFin white paper submitted to the FDIC by Ms. Petrou; the full texts are available here.

The following post comes to us from Karen Petrou, co-founder and managing partner of Federal Financial Analytics, Inc., and is based on a letter and a FedFin white paper submitted to the FDIC by Ms. Petrou; the full texts are available here.

In a comment letter and supporting paper to the FDIC on its single-point-of-entry (SPOE) resolution concept release, Karen Shaw Petrou, managing partner of Federal Financial Analytics, argues that SPOE is conceptually sound and statutorily robust. However, progress to date on orderly liquidation has been so cautious as to cloud the credibility of assertions that the largest U.S. financial institutions, especially the biggest banks, are no longer too big to fail (“TBTF”). Crafting a new resolution regime is of course a complex undertaking that benefits from as much consensus as possible. However, if definitive action is not quickly taken on a policy construct for single-point-of-entry resolutions resolving high-level questions about its practicality and functionality under stress, markets will revert to TBTF expectations that renew market distortions, place undue competitive pressure on small firms, and stoke systemic risk. Even more dangerous, the FDIC may not be ready when systemic risk strikes again.

Questions addressed in detail in the paper and Ms. Petrou’s answers to them are summarized below:

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Too-Big-To-Fail Banks Not Guilty As Not Charged

The following post comes to us from Nizan Geslevich Packin of the University of Pennsylvania Law School; Zicklin School of Business, Baruch College, City University of New York.

The following post comes to us from Nizan Geslevich Packin of the University of Pennsylvania Law School; Zicklin School of Business, Baruch College, City University of New York.

In the paper, Breaking Bad? Too-Big-To-Fail Banks Not Guilty As Not Charged, forthcoming in the Washington University Law Review, Vol. 91, No. 4, 2014, I focus on the benefits that the largest financial institutions receive because they are too-big-to-fail. Since the 2008 financial crisis, rating agencies, regulators, global organizations, and academics have argued that large banks receive significant competitive advantages because the market still perceives them as likely to be saved in a future financial crisis. The most significant advantage is a government implicit subsidy, which stems from this market perception and enables the largest banks to borrow at lower interest rates. And while government subsidies were the subject of a November 2013 Government Accounting Office report, in the paper I focus on a specific aspect of the benefits the largest banks receive: the economic advantages resulting from exempting the largest financial institutions from criminal statutes. I argue that this exemption—which has been widely discussed in the media over the last few years, following several scandals involving large financial institutions—not only contributes to the subsidies’ economic value, but also creates incentives for unethical and even criminal activity.

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Structural Corporate Degradation Due to Too-Big-To-Fail Finance

Mark Roe is the David Berg Professor of Law at Harvard Law School, where he teaches bankruptcy and corporate law.

Mark Roe is the David Berg Professor of Law at Harvard Law School, where he teaches bankruptcy and corporate law.

Corporate governance incentives at too-big-to-fail financial firms deserve systematic examination. For industrial conglomerates that have grown too large, internal and external corporate structural pressures push to re-size the firm. External activists press it to restructure to raise its stock market value. Inside the firm, boards and managers see that the too-big firm can be more efficient and more profitable if restructured via spin-offs and sales. But for large, too-big-to-fail financial firms (1) if the value captured by being too-big-to-fail lowers the firms’ financing costs enough and (2) if a resized firm or the spun-off entities would lose that funding benefit, then a major constraint on industrial firm over-expansion breaks down for too-big-to-fail finance.

Propositions (1) and (2) have both been true and, consequently, a major retardant to industrial firm over-expansion has been missing in the large financial firm. Debt cost savings from the implicit subsidy can amount to a good fraction of the big firms’ profits. Directors contemplating spin-offs at a too-big-to-fail financial firm accordingly face the problem that the spun-off, smaller firms would lose access to cheaper too-big-to-fail funding. Hence, they will be relatively more reluctant to push for break-up, for spin-offs, or for slowing expansion. They would get a better managed group of financial firms if their restructuring succeeded, but would lose the too-big-to-fail subsidy embedded in any lowered funding costs. Subtly but pervasively, internal corporate counterpressures that resist excessive bulk, size, and growth degrade.

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The Costs of “Too Big To Fail”

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 Professor Roe’s most recent op-ed written for the international association of newspapers Project Syndicate, which can be found here.

The idea that some banks are “too big to fail” has emerged from the obscurity of regulatory and academic debate into the broader public discourse on finance. Bloomberg News started the most recent public discussion, criticizing the benefit that such banks receive — a benefit that a study released by the International Monetary Fund has shown to be quite large.

Bankers’ lobbyists and representatives dismissed the Bloomberg editorial for citing a single study, and for relying on rating agencies’ rankings for the big banks, which showed that several would have to pay more for their long-term funding if financial markets didn’t expect government support in case of trouble.

In fact, though, there are about ten recent studies, not just one, concerning the benefit that too-big-to-fail banks receive from the government. Nearly every study points in the same direction: a large boost in the too-big-to-fail subsidy during and after the financial crisis, making it cheaper for big banks to borrow.

But a recent research report released by Goldman Sachs argues the contrary — and deserves to be taken more seriously than the first dismissive views. The report concludes that, over time, big banks’ advantage in long-term funding costs relative to smaller banks has been one-third of one percentage point; that this advantage is small; that it narrowed recently (and may be reversing); that it comes from the big banks’ efficiency and their bonds’ liquidity; and that historically it has been mostly small banks, not big ones, that have failed.

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Too Early to Tell if Dodd-Frank Ends “Too Big To Fail”

Bradley Sabel is partner and co-head of the Financial Institutions Advisory & Financial Regulatory practice group at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication by Donald N. Lamson and David L. Portilla; the full text, including footnotes, diagram, and chart, is available here.

Bradley Sabel is partner and co-head of the Financial Institutions Advisory & Financial Regulatory practice group at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication by Donald N. Lamson and David L. Portilla; the full text, including footnotes, diagram, and chart, is available here.

The debate regarding “too big to fail” (“TBTF”) has reemerged as a focus of regulators, legislators and the media. We review the regulatory activity since the Dodd-Frank Act was enacted and show that new proposals intended to address TBTF tend to put the policy cart before the regulatory implementation horse.

By our count, regulators have amassed over 1,650 pages in proposed and final rules that seek to address TBTF, which we roughly define as proposals that seek to limit the size of financial institutions, the scope of their activities or otherwise seek to protect the Federal safety net (which we use as a term to refer to any Federal assistance, including deposit insurance). In addition, there are provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“DFA”) which address TBTF that do not require rulemaking.

Despite this volume of regulatory work to implement the DFA’s reforms, which is mostly not yet complete, proposals for new measures are being put forward, including:

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