Tag: financial regulation

Special Favors for IEX Will Not Fix Bad Regulation

It isn’t often that an SEC decision involves the star of a best seller, a “magic shoe box,” and fundamental questions about the meaning of words like “immediate” and “fair.”  The SEC made such a decision on Friday. 

Last fall, the trading system IEX applied for designation as a stock exchange.  IEX, and its CEO Brad Katsuyama, rose to fame several years ago with the publication of Michael Lewis’s popular book Flash Boys.  Lewis, ever the artful storyteller, cast Katsuyama as the likeable underdog, exposing and undermining high-frequency traders (HFTs) through the development of IEX.  IEX, an alternative trading system, or in the more colorful industry jargon, a “dark pool,” has allowed investors to trade away from market scrutiny and the HFTs that populate “lit” exchanges.  But there are advantages to being an exchange, and IEX wants in.

At issue in determining whether to approve the application was the meaning of the word “immediate” in an SEC regulation known as Regulation NMS.  Regulation NMS, approved by the SEC in 2005, was intended to increase competition among trading exchanges, resulting in better execution of trades and better prices for investors.  In furtherance of that goal, a part of the regulation requires that trades be made at the best price listed on any exchange and that exchanges make their quotations “immediately” and automatically available.  In the past “immediate” has been defined as “immediately and automatically executable, without any programmed delay.”  Seems clear enough, right?

Big Win for MetLife and Other SIFIs

MetLife notched an important win this week, securing a ruling from a federal court that it is not a systemically important financial institution (SIFI) under Dodd-Frank. Like much of the Dodd-Frank Act, the SIFI designation has been controversial since its introduction in 2010. The designation is intended to help the Financial Stability Oversight Council (FSOC, another Dodd-Frank creation) to monitor companies whose demise could destabilize the country’s financial system. Putting aside the question of whether a group of regulators in Washington could see and stop a crisis more quickly than those in the trenches at the nation’s financial giants, the designation triggers a host of regulatory requirements that many companies would prefer to avoid. 

One of the most controversial aspects of the SIFI designation is its black box nature. There is no publicly available SIFI check-list. The rationale for following a more principles- than rules-based approach may be that the definition needs to remain flexible. Companies may be motivated to avoid the letter of such a rules-based approach without avoiding the spirit, leaving FSOC without the ability to monitor a company that, despite not triggering the SIFI designation, still poses a risk to the financial system. But this has left companies in a bind. The SIFI designation has real and substantial ramifications for any company that triggers it, but companies have been unable both to avoid designation and to challenge designation once applied.  It’s hard to argue that you don’t fit a certain definition if you don’t know what the definition is.

Of course, not all companies want to avoid SIFI status. Although some have argued that FSOC and other aspects of Dodd-Frank will prevent future bailouts, it seems naïve to think that the government could designate a company as a risk to the entire financial system and then sit idly by as it burns.  SIFI designation is a wink and a nod, all but assuring government support if the designated company founders in rocky times.

Occupy Pennsylvania Avenue: How the Government’s Unconstitutional Actions Hurt the 99%

That’s the title of a new paper that Carl DeNigris and I just published in the Drake Law Review.  Here’s the abstract:

Economic freedom is the best tool man has ever had in the perpetual struggle against poverty. It allows every individual to employ their faculties to a multitude of opportunities, and it has fueled the economic growth that has lifted millions out of poverty in the last century alone. Moreover, it provides a path for individuals and communities to free themselves from coercive government policies that serve political elites and discrete political classes at the expense of the politically weak. Because of their relative political weakness, the poor and lower middle class tend to suffer the most from these inescapable power disparities.

Yet economic freedom — and ultimately, economic growth — is not self-sustaining. This tool of prosperity requires sound principles that provide a framework for cooperation and voluntary exchanges in a free society. Principles equally applied to all and beyond the arbitrary discretion of government actors; principles that provide a degree of certainty and predictability in an otherwise uncertain world. That is, economic freedom requires the rule of law, not men.

In this article, we discuss the corrosive effects that unconstitutional actions have on the rule of law, economic growth and, in turn, on the ability of the poor to improve their economic misfortune. We focus on the institutional dangers and adverse incentives that unconstitutional policies tend to create. These dangers are not just abstract or theoretical; this article shows how specific unconstitutional actions adversely affect the lives of poor Americans. And while Part IV shows that even constitutional violations by local governments can have disastrous effects, our central theme is that the federal government’s disregard for the U.S. Constitution has led to policies that kill jobs, stymie economic growth, and ultimately exacerbate the problems of those living in poverty.

The case studies we use to illustrate our argument are Obamacare, bailouts/crony capitalism, the Sarbanes-Oxley/Dodd-Frank financial regulations, and housing policy.  It’s truly stunning to see how the policies that the government pursues – unconstitutional ones at that – hurt the very people they’re designed to help.  Read the whole thing.

Dimon on NY Fed Board a Distraction, Solution Is to Remove the Fed from Bank Regulation

It is not surprising that the recent losses at JP Morgan have resulted in calls by current and would-be politicians to remove bankers from the boards of the regional Federal Reserve banks, as JP Morgan CEO Jamie Dimon currently sits on the board of the New York Federal Reserve. There’s even a petition for the “public” to demand Dimon’s resignation. Setting aside the irony of having senators call for keeping bankers off the regional Fed boards just days after they voted to place a former investment banker on the Federal Reserve board, the real question we should be debating is: Should the the Federal Reserve even be involved in banking regulation?

As I’ve noted elsewhere, a recent paper by economists Barry Eichengreen and Nergiz Dincer suggests that separating monetary policy from banking supervision would yield superior outcomes, both for banking stability and the economy more generally. While there is a very real conflict-of-interest when bankers sit on the boards of their regulators, there is an even bigger conflict-of-interest when those setting monetary policy are also responsible for bank safety. Rather than let institutions they supervise fail, and face public criticism, there exists a strong incentive for the monetary authority to mask bank insolvency by labeling such a liquidity crisis and then injecting easy and cheap credit. The result is that the rest of us are left paying for the mistakes of both the bank and regulator. A far better alignment of incentives would be to separate the conduct of monetary policy from bank supervision.

Like anything, such a separation would not be without its costs. I am the last to go around claiming a “free lunch” when it comes to banking and monetary policy. The current Boston Fed President made a strong case over a decade ago for keeping the two combined. The Richmond Fed has also offered a useful discussion of the pros and cons of such consolidation, as well as consolidating regulators more generally. These costs aside, I believe having the Fed focus solely on monetary policy would improve both.

Political Uncertainty and Investment: Empirical Results

An oft heard explanation for some of the weakness facing our economy, particularly investment and hiring, is that firms are concerned about policy uncertainty coming from Washington, be it health care, financial regulation, labor regulation, etc.  For the most part, those arguments have been based upon anecdote or theory (see Bernanke’s 1983 QJE piece), with some difficulty finding strong empirical support either way.  A forthcoming paper in the Journal of Finance helps to shed some light on the question, by providing more generalized estimates of the impact of electoral uncertainty on investment decisions.

The authors examine whether elections, particularly those that are close, have an impact on corporate investment.  The logic behind the research: “if an election can potentially result in a bad outcome from a firm’s perspective, the option value of waiting to invest increases and the firm may rationally delay investment until some or all of the policy uncertainty is resolved.”  Their sample is national elections in 48 countries from 1980 to 2005.  These almost all developed, industrialized economies, as the unit of observation is a publicly traded firm.  US companies constitute a large portion of their sample.

The results:  holding all else equal, in terms of the economy and investment opportunities, elections  “reduce investment expenditures by an average of 4.8%.”  That’s a substantial hit to investment.  The results are even larger when the incumbent is viewed as “market-friendly.”  Of course one needs to be cautious in applying these results to non-election year political uncertainty.  There are also reasons, some of which are touched upon by the authors, that political uncertainty in the US may have either larger or smaller effects.  So while we might not know the exact magnitudes, I think its safe to say that the notion that political uncertainty depresses investment has both empirical and theoretical support (as well as a few anecdotes).

Obama Tells It Like It Is

The New York Times reports:

President Obama signed into law on Wednesday a sweeping expansion of federal financial regulation….

A number of the details have been left for regulators to work out, inevitably setting off complicated tangles down the road that could last for years…complex legislation, with its dense pages on derivatives practices….

“If you’ve ever applied for a credit card, a student loan, or a mortgage, you know the feeling of signing your name to pages of barely understandable fine print,” Mr. Obama said.

Public Sees Past Facade of “Financial Reform”

A new AP-Gfk poll reveals that about two-thirds of the American public lack confidence that the financial regulation bill, currently being crafted by House and Senate conferees, will actually help avert future financial crises. 

The public is right to be skeptical, as there is nothing in either the House or Senate bill that ends bailouts or ends “too-big-to-fail.”  In fact parts of the bill, such as the expansion of deposit insurance, will actually increase the likelihood of future crises.  (The IMF has an insightful working paper on the negative impacts of deposit insurance). 

Perhaps the failure of Congressional efforts to end financial crises is the result of Washington’s unwillingness to recognize that government itself was the major driver of the recent crisis.  Fortunately the public seems to get that.  Some 70 percent of the poll respondents believe that government shares blame for the crisis.  Here’s to hoping that Congress will at some point listen to the public, and end many of the distortionary policies that caused the crisis.