Risky Businesses

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by Craig Torres

Congress last year ordered U.S. bank regulators to figure out which financial companies are the riskiest and then turn the list over to the Federal Reserve so they can be supervised more closely. The Fed, the Treasury Dept., and nine other regulators on the Financial Stability Oversight Council this spring will reveal the criteria they plan to use to decide which financial companies to tag as systemically risky; the companies will be named later this year. Economists at New York University's Stern School of Business have derived their own list, based on a model that one of them, Nobel Prize winner Robert Engle, helped develop. The model starts with a financial firm's stock price as a proxy for its capital--the money it has to make loans, buy bonds, or absorb losses. They then subject each company to a stress test, in which the stock market declines 40 percent, to find how much capital a company would need to continue holding the same amount of loans and bonds. One downside to the model: It only works for publicly traded companies, so it won't help regulators decide whether most hedge funds should make the list.

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The Dodd-Frank Act, signed into law in July 2010, represented the most significant and controversial overhaul of the U.S. financial regulatory system since the Great Depression. Forty NYU Stern faculty, including editors Viral V. Acharya, Thomas F. Cooley, Matthew P. Richardson, and Ingo Walter, provide a definitive analysis of the Act, expose key flaws and propose solutions to inform the rules’ adoption by regulators, in a new book, Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance (Wiley, November 2010).

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