The Future of Financial Institution Resolution

One of the principal lessons learned from the 2007-2009 financial crisis was the need for new legal regimes to facilitate the rapid and orderly resolution of systemically important financial institutions without a government bailout.  In the final part of a six-part article that has just been published, I trace the development of these new legal regimes.[1]  The United States was itself a first mover in this regard with the enactment in 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).[2]

The Dodd-Frank Act contains two provisions of singular importance to the resolution of … Read more

Emergency Guarantee Authority: The Pros and Cons

Today, we present a debate among preeminent scholars about Columbia Law School Professor Kathryn Judge’s proposal for an emergency guarantee authority that could help contain the fallout from another financial crisis. The first piece is Professor Judge’s summary of her proposal. It is followed by responses from Professor Morgan Ricks at Vanderbilt Law School, Graham Steele at Stanford University’s Graduate School of Business, and Professor Stephen G. Cecchetti at the Brandeis International Business School and Kermit L. Schoenholtz at New York University’s Leonard N. Stern School of Business.… Read more

Guarantor of Last Resort: Is There a Better Alternative?

Larry Summers, who was one of President Obama’s key economic advisors when the Dodd-Frank Act of 2010 was enacted, recently decried what he called “excessive populism” in portions of that legislation. This might seem surprising; Dodd-Frank’s technocracy-on-steroids approach (848 pages! 390 separate rulemaking requirements!) might seem like the antithesis of bust-up-the-banks populism. “My administration is the only thing between you and the pitchforks,” President Obama once famously told the nation’s leading bankers.

But Summers was referring to several specific Dodd-Frank provisions that curtailed the federal government’s financial rescue powers. During the financial crisis of 2007-2008, the Federal Reserve, the … Read more

Emergency Guarantee Authority: A FEMA for Finance

“[I]t is a question of when, not if, a large-scale attack succeeds.” DTCC and Oliver Wyman, Large-scale Cyber-attacks on the Financial System, March 2018.

“The government cannot credibly commit to a no-bailout policy.” Kathryn Judge, “Guarantor of Last Resort,” 97 Texas Law Review, forthcoming.

Modern financial systems are inherently vulnerable. The conversion of savings into investment—a basic function of finance—involves substantial risk. Creditors often demand liquid, short-term, low-risk assets; and borrowers typically wish to finance projects that take time to generate their uncertain returns. Intermediaries that bridge this gap—transforming liquidity, maturity and credit between their

Read more

The Impact of Banking Regulation on Voluntary Disclosures

Firms disclose a variety of information to the public, some because they are required to do so by law or regulations, and others voluntarily because they want, for example, to signal their creditworthiness to potential investors. The level and effectiveness of financial institutions’ regulatory oversight have been widely debated since the onset of the financial crisis of 2007-2009. Financial and banking regulators have responded by increasing regulatory requirements and oversight, and by mandating greater disclosure of information. However, these actions do not necessarily improve the information environment of firms if they discourage voluntary disclosures of other types of information. In Read more

Securities Disclosure As Soundbite: The Case of CEO Pay Ratios

Since 2018, U.S. public companies have had to calculate and report a new, unconventional statistic—a CEO pay ratio—which links CEO pay to the pay of rank-and-file workers. Based on a last-minute addition to the Dodd-Frank Act of 2010, the disclosure requirement generated significant controversy during the lengthy SEC rulemaking process. Companies and their executive compensation consultants spent years and considerable resources preparing to comply with the rule. Once the pay ratio figures started arriving in 2018, they captured public imagination in ways that the typically long and technical corporate disclosure documents never do. The sizeable pay gaps highlighted by the … Read more

Sullivan & Cromwell Discusses Resolution-Planning Guidance for U.S. Global Systemically Important Banks

On December 20, 2018, the Federal Reserve and the Federal Deposit Insurance Corporation (together, the “Agencies”) issued final guidance (the “Final Guidance”)[1] with respect to future resolution plan submissions under Title I of the Dodd-Frank Act by the eight U.S. Global Systemically Important Banks (U.S. G‑SIBs), including the plan submissions that are due July 1, 2019.[2]  The Final Guidance adopts, and addresses comments provided in response to, the proposed resolution planning guidance the Agencies issued for comment on June 29, 2018 (the “Proposed Guidance”).[3]  Like the Proposed Guidance and the foundational guidance issued by the Agencies in … Read more

Why Dismantling Nonbank SIFI Regulation Is a Serious Mistake

The unnerving events of fall 2008 removed all doubt that investment banks and other nonbank financial firms can propagate systemic risk and endanger the world’s financial system.  In response, Congress instituted a robust system for regulating systemic risk posed by nonbanks.  The Dodd-Frank Act created two approaches to nonbank systemic risk regulation.  The first, known as entity-based regulation, authorized the new Financial Stability Oversight Council (FSOC) to designate individual nonbank financial firms as systemically important financial institutions (SIFIs) for heightened regulation and oversight by the Federal Reserve.  The second, dubbed activities-based regulation, gave FSOC the power to make … Read more

Transparency and the (E)valuation of Asset-Backed Securities

In 2011, the commission appointed by Congress to investigate the causes of the financial crisis concluded that “a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis” (The Financial Crisis Inquiry Report, 2011, p. xix).  In particular, the opacity of asset-backed securities (ABS) greatly inhibited the ability of investors and regulators to fully understand the risks held by institutions that owned these products.  As part of the post-financial crisis effort to reform the securitization process, the Dodd-Frank Act directed the SEC to “require issuers of asset-backed securities, … Read more

The Unwise and Illegal Deregulation of Prudential Financial

On October 18, federal regulators released the largest U.S. insurance group, Prudential Financial, Inc., from enhanced government oversight.  Prudential had been the last remaining systemically important financial institution (SIFI)—a designation Congress created in the Dodd-Frank Act for nonbank financial companies that could threaten U.S. financial stability.  Prudential’s deregulation fulfills a years-long effort by Dodd-Frank critics to weaken a crucial post-crisis regulatory reform.

In my new essay, “The Last SIFI: The Unwise and Illegal Deregulation of Prudential Financial, Inc.,” I contend that overturning Prudential’s “systemically important” status was not only misguided, it was also against the law.  By illegally … Read more

The Underappreciated Dilemmas of Overlapping Financial Regulations

Calls to dismantle the legal framework that was developed in response to the financial crisis have begun to multiply and gain momentum. Pursuant to a Trump Administration executive order, the Treasury Department has released a series of reports that undertakes a comprehensive review of existing financial regulations. And in Congress, the proposed Financial CHOICE Act sets forth a roadmap for replacing the Dodd-Frank Act in full. Some of that roadmap was enacted earlier this year with the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act.

The recent wave of reforms is as much about a change in … Read more

The Real but Exaggerated Threat of Financial Institution Mobility to Financial Regulation

Where jurisdictions differ in how they regulate an activity, migration allows private parties to choose between regulatory regimes.  In the context of financial regulation, scholars assert that harmonization of regulation across jurisdictions is necessary to prevent institutions from opting into the laxest regulatory regime through relocation.[1]  This assertion relies on two assumptions: (1) financial institutions indeed move in response to burdensome regulations, and (2) unilateral regulation is insufficient to achieve regulatory objectives with respect to offshore institutions.  My recent project provides the first empirical evidence supporting that financial institutions relocate activities in response to derivatives regulation.  Charges that unilateral … Read more

Did Deregulation End the “Quiet Period” of Low-Risk Banking?

From the New Deal until the 1970s, banks were on a tight leash. Regulators controlled the rate of interest they could pay on deposits. Banks could not underwrite or deal in corporate securities. With some exceptions, they could not expand geographically.

These restrictions were gradually eliminated beginning in the 1970s. Simultaneously, banking grew riskier. From the end of World War II to 1970, bank failures were virtually nonexistent. From that time on, the U.S. experienced waves of bank distress culminating in the financial crisis of 2007-09.

It is tempting to conclude that the deregulation caused the instability. I believe, however, … Read more

Was Glass-Steagall’s Demise Both Inevitable and Unimportant?

The financial crisis of 2007-09 caused the Great Recession, the most severe global economic downturn since the Great Depression.  The financial crisis began with the collapse of the subprime mortgage market in the U.S. and spread to financial markets around the world.  Similarly, the disastrous financial events of the Great Depression began with the Great Crash on Wall Street in October 1929 and spread throughout the U.S. and Europe during the early 1930s.[1]

Congress responded to the Great Depression by passing the Glass-Steagall Banking Act of 1933.  Two of Glass-Steagall’s key provisions – Sections 20 and 32 – separated … Read more

The Deregulation Debate: The Challenge of Using Static Rules to Govern a Dynamic System

In their lively disagreement about the role of deregulation in contributing to the 2007-2009 financial crisis, professors Arthur Wilmarth and Paul Mahoney inadvertently illuminate why the processes through which finance is regulated are so ill-suited to that purpose.  Finance is dynamic.  Today’s financial system bears only a coarse resemblance to the financial system of the 1950s.  Tomorrow, the system will evolve yet further and in ways we may not be able to imagine today.   In contrast, the legal regime is designed to stagnate. Frictions make statutes and regulations difficult to change, even when market changes have already altered the substantive … Read more

How Private Equity Enhances the Market for Corporate Control and Capitalism

In this age of firebrand political rhetoric and sniping from the right and the left, Wall Street has taken more than its fair share of criticism. One of the most significantly misplaced criticisms, however, derives from a gross misunderstanding of how the invisible hand of the market works and how certain mechanisms improve the health of firms and the market overall, delivering value for a broad swath of stakeholders—managers, investors, and employees alike.

In his 1965 “Mergers and the Market for Corporate Control,” Henry Manne describes how market competition helps regulate the behavior of managers. Managers that pursue objectives counter … Read more

Disclosure Regulation in the Commercial Banking Industry: Lessons from the National Banking Era

In the aftermath of the 2007—2009 financial crisis, policymakers around the globe responded to calls for greater transparency in the financial system by adopting new rules and institutions that required more and better information disclosure by financial institutions. For example, the Dodd-Frank Act required the Federal Reserve Board to publish the results of periodic stress tests administered to the largest financial institutions. In spite of the recent flurry of regulations, the jury is still out on whether they enhance the stability and development of the financial system.

The lack of consensus is largely based on conflicting predictions from the theoretical … Read more

Lehman Brothers: How Good Policy Can Make Bad Law

As we approach the 10-year anniversary of the failure of Lehman Brothers, the news is again awash in a debate about whether policymakers could have saved the investment bank.  That the issue remains so deeply contested reflects how fundamentally flawed the current legal regime is.  Although embodying ideas that are sensible in the abstract, the regime makes the authority to act contingent on facts that policy makers cannot readily discern during periods of systemic distress.  Making matters worse, subsequent events, including other actions by those same policy makers, can further skew the critical facts on which legal authority rests.  This … Read more

A Retrospective on the Demise of Long-Term Capital Management

The 10th anniversary of the harrowing financial events of September 2008 is nearly upon us.  The anniversary will undoubtedly be marked by various retrospectives analyzing those events.  For a longer-term perspective, though, it may be helpful to consider another anniversary that will be observed in September 2018:  the near failure of Long-Term Capital Management, L.P. and its fund, Long-Term Capital Portfolio, L.P. (collectively “LTCM”) 20 years ago.  LTCM was the largest hedge fund operating in the United States and its brush with death provided a preview of some of the forces that would contribute to the near collapse of the … Read more

Why Firms Disclose a Supplemental CEO-to-Median Worker Pay Ratio

Pay disparity between executives and employees has been criticized as evidence of corporate greed. It can also create perceptions of unfairness and dissatisfaction among employees, weakening their commitment and performance. To provide more information about pay disparity, the U.S. Congress enacted Section 953 (b) of Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which requires all publicly listed firms to disclose a Pay Ratio comparing annual CEO compensation with median annual employee compensation, excluding the CEO. Proponents of Section 953 (b) assert that the information helps investors understand and evaluate CEO compensation within a specific firm. However, critics … Read more