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

Why We Need a Guarantor of Last Resort

More than a decade has passed since the worst of the 2007-2009 financial crisis.  In that time, we have learned that some of the gravest consequences of the crisis were not the economic fallout, but the political backlash it triggered.  After the panic that followed the failure of Lehman Brothers, the Federal Reserve and other regulators understandably concluded that they needed to do everything in their power to prevent the failure of another systemically important financial institution. The very next day, the Federal Reserve stretched the bounds of its legal authority to provide a record amount of liquidity support to … 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: Not Letting a Crisis Go to Waste

Calming the panic in short-term funding markets was a significant part of the response to the 2008 financial crisis. While the TARP bailout programs received the most attention during the crisis, TARP never exceeded one-fifth of the government’s overall financial stability programs, which peaked at $2.4 trillion. These markets were abstract and esoteric to most Americans, but their preservation, it was argued, was crucial to preserving the financial well-being of workers, homeowners, and small businesses. As Professor Judge notes, however, the “perception that the Fed’s interventions looked out for Wall Street over Main Street has been an ongoing source of … 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

Will Putting Title III of Helms-Burton Into Effect Open the Litigation Floodgates?

On April 17, 2019, U.S. Secretary of State Mike Pompeo announced that President Trump would not suspend for any additional periods of time Title III of the Cuban Liberty and Democratic Solidarity Act – better known as “Helms-Burton.”[1]  Title III of Helms-Burton allows U.S. nationals whose property was expropriated by the Cuban government on or after January 1, 1959, to sue in U.S. courts anyone – regardless of nationality – who knowingly and intentionally “traffics” in that property.  But, in response to strong opposition from many of the United States’ close allies and trading partners and to concerns about … Read more

Regulating the Development of Driverless Finance

Before permitting driverless cars to operate on the open road without a licensed driver, lawmakers and innovators are working to ensure the safety not only of the passengers in those cars, but also of third parties – particularly other drivers and pedestrians.  Safety concerns figure much less prominently, however, in discussions about fintech and the increasing algorithmic automation of finance.  While the use of algorithms in finance is nothing new, the ubiquity, sophistication, and autonomy of financial algorithms has increased significantly in recent years with advances in computing power and data usage techniques.  Increasingly automated financial decision-making (a phenomenon that … Read more

The Myth of Risk Free Markets

Economies and markets operate on the assumption that U.S. debt securities (“Treasuries”) are risk-free. This means that the United States is expected to pay its debts. Also, Treasuries are supposed to trade easily and efficiently in secondary markets. Unsurprisingly, the rate at which the U.S. borrows represents a risk-free rate against which any number of financial contracts (e.g. corporate loans, derivative securities) are priced. After the 2008 financial crisis, regulation requires financial firms to deepen their reserves of Treasuries as protection against another collapse. Perhaps most importantly, this risk-free status has enabled the U.S. to confidently rely on global capital … Read more

Initial Crypto-asset Offerings, Tokenization, and Corporate Governance

Blockchain and other types of distributed ledger technology pose various new legal and economic questions for companies. Are crypto-asset holders a new kind of corporate stakeholder? If so, are they like shareholders or bondholders, and how can they participate in the governance of a company? Are smart contracts useful tools for corporate governance? How can free-rider problems in initial crypto-asset offerings (ICOs) be solved? What is the governance of a decentralized autonomous organization (DAO)? And is there such a thing as algorithmic or distributed governance for firms?

In a new article, “Initial Crypto-asset Offerings (ICOs), tokenization and corporate governance”, … Read more

Debevoise Discusses Federal Reserve Proposal to Clarify and Revise Control Framework

On April 23, the Federal Reserve Board (the “FRB”) proposed a new, comprehensive framework for determining “control” under the Bank Holding Company Act (“BHC Act”) and Home Owners’ Loan Act (“HOLA”). We provide a high-level overview of the proposal below. Comments on the proposal will be due 60 days after its publication in the Federal Register.

The proposal is intended to simplify and clarify the FRB’s standards for determining whether a company exercises a controlling influence over the management or policies of another company and, therefore, “controls” the other company under the BHC Act or HOLA. The proposal would codify … Read more

Davis Polk Discusses France’s New Legal Framework for Digital Assets

After becoming one of the first countries to authorize the registration and transfer of unlisted securities using blockchain technology, France has adopted an innovative legal framework governing initial coin offerings (“ICOs”) and digital assets services providers (“DASPs”) with the aim of being at the forefront of the blockchain revolution in Europe.

After allowing the representation and transmission of unlisted securities through the use of blockchain technology in 2017, the draft “PACTE”[1] bill (the “PACTE Act”) was adopted by the French Parliament on April 11, 2019[2], constituting a new step in France’s economic transformation.

This PACTE … Read more

Cleary Gottlieb Discusses Fed’s Proposed Resolution-Planning Rules Overhaul

On April 8, 2019, the Federal Reserve proposed a broad overhaul of the 2011 regulations governing resolution planning (the “Proposal”)[1], which would significantly reduce the frequency of submissions and simplify requirements for many resolution plans.  The Proposal would modify the existing rule to incorporate the experience gained since the first plans were filed in 2013 to target planning efforts on key resolvability issues, while codifying the focus on the eight U.S. global systemically important banks (“U.S. G‑SIBs”).  Most significantly, the U.S. G-SIBs would only file resolution plans every two years alternating between full resolution … Read more

Opening the Black Box of Companies’ Capital Investment Process

In spite of intensive academic research on capital expenditure efficiency, how firms make investment decisions remains largely a black box. We analyze that process by dividing it into two stages: budgeting of capital expenditures (CapEx) and execution of the budget. We find that these two stages have different effects on investment efficiency, and are in turn affected differently by accounting quality and governance. Further, while opportunistic managers massively exceed investment budgets, managers with high ability strategically find a level of execution errors that optimizes their compensation while remaining undetected by boards. These strategic execution deviations entail significant costs for their … Read more

The Future of Data Driven Finance: Financial Regulation, Data Regulation, and RegTech

Fifty years ago, banking was a relationship business. Bank managers collected information about depositors and borrowers from all sorts of sources, formal and informal. In recent decades, credit decisions have become far more data-driven, with companies like Amazon and the Alibaba-affiliate, Ant Financial, taking the lead in the U.S. and China. This paradigm shift in finance, however, is only just beginning. We are entering a period in which the leaders in finance will have to focus intensely on data and its analysis. Banks and traditional financial institutions around the world are in the process of building ever-more sophisticated IT systems … Read more

Arnold & Porter Discusses Bill on Banking Services for Marijuana-Related Firms

Depository institutions have been understandably reluctant to provide banking services to cannabis-related businesses in light of the significant (and costly) regulatory and compliance expectations that apply under the Bank Secrecy Act (BSA) and other anti-money laundering (AML) laws and regulations.[1] Legislative relief, however, may be on the way. On March 27, 2019, with approval of the Secure and Fair Enforcement Banking Act of 2019, H.R. 1595 (SAFE Banking Act), the US House Financial Services Committee (HFSC) is now seeking to increase access to banking services for cannabis-related businesses and their service providers.[2] The SAFE Banking Act, which was … Read more

The Social Functions of the Stock Market: A Primer

A stock market is a key feature found in any economy with a substantial private sector.  For example, in the United States, we see the New York Stock Exchange and Nasdaq, in the U.K, the London Stock Exchange, and in Brazil, B3.  While some commentators suggest that a stock market is primarily simply a place for useless speculation, a well-functioning stock market does in fact serve a number of important social purposes.  It facilitates firms selling shares to raise funds for new investment by assuring potential purchasers that they can easily resell their shares when they wish to.  The shares … Read more

Debt Overhang, Rollover Risk, and Corporate Investment: Evidence from the European Crisis

Investment expenditure in Europe collapsed in the aftermath of the 2008 global financial crisis. This collapse followed a boom during which the corporate sector borrowed heavily (Gopinath, Kalemli-Ozcan, Karabarbounis, Villegas-Sanchez, 2017). Figures 1 and 2 illustrate the extent of the increase in leverage and the collapse of investment  in Europe as compared with the United States. These developments were particularly pronounced in peripheral European economies.

In a new paper (Kalemli-Özcan, Laeven, Moreno, 2018), we investigate whether the corporate debt accumulated during the boom years held back investment by non-financial corporations after the crisis. Specifically, we consider whether high levels of … Read more

How U.S. Tax Inversions Affect Shareholder Wealth

The United States had one of the world’s highest tax rates – around 35 percent – prior to the Tax Cuts and Jobs Act of 2017 (TCJA 2017, and especially the Global Intangible Low-Taxed Income (GILTI) rules in new tax code Section 951A). It also uses the country-of-residency basis for corporate taxation that subjects, at least in theory, all worldwide income earned by a corporation to U.S. tax. Corporations that receive a significant proportion of foreign income can employ corporate inversions, which lead to the U.S. parent company being treated as a foreign entity.  Those firms relocate their legal domicile … Read more

What Do Mutual Fund Investors Really Care About?

Do investors behave rationally? Many researchers examine actively managed mutual funds to answer this question. The advantage of doing so setting is that we can observe the past performance of fund managers as well as the capital allocation decisions of investors, both at relatively high frequency.

Yet, despite three decades of research on mutual funds, whether investors in mutual funds display rational behavior remains unsettled. The empirical facts are indisputable: While fund managers have a hard time beating their benchmarks and their performance is not consistent over time, investors continue to chase past returns. In a seminal study, Berk and … Read more

How an Issuer’s Multiple Credit Ratings Can Affect Its IPO

While the list of prospective issuers with credit ratings is lengthy, literature is sparse on how ratings from multiple credit rating agencies (CRAs) affect the performance of a company’s initial public offering (IPO). Our research is motivated by the lack of such literature and by Sangiorgi and Spatt (2017), who argue that multiple ratings are socially optimal if the benefit of the additional rating outweighs the cost of information production. This argument aligns with the “shopping hypothesis” and “information production hypothesis” of Bongaerts et al. (2012). Under the former hypothesis, issuers “shop” for an additional rating in hopes of improving … Read more