Recently in General Analysis of Bill Category

Reforming Wall Street

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Regulating Wall Street Co-Editor Matt Richardson recently presented the webinar "Reforming Wall Street," for the Professional Risk Managers' International Association. The hour-long webinar takes an in-depth look at the Dodd-Frank Act and is sponsored by NYU Stern's Master of Science in Risk Management for Executives.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is widely described as the most ambitious and far-reaching overhaul of financial regulation since the 1930s. Together with other regulatory reforms introduced by the Securities and Exchange Commission (SEC), the Federal Reserve (Fed) and other regulators in the United States and Europe, it is going to alter the structure of financial markets in profound ways. In this presentation (based on the book Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance), Viral Acharya provides an overall assessment of the Act in three different ways: from first principles in terms of how economic theory suggests we should regulate the financial sector; in a comparative manner;€“ relating the proposed reforms to those that were undertaken in the 1930s following the Great Depression; and, finally, how the proposed reforms would have fared in preventing and dealing with the crisis of 2007-2009 had they been in place at the time.

Download the presentation (PDF format)

Dodd-Frank and the Fed

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by Kermit Schoenholtz and Paul Wachtel

The Federal Reserve System was born of a financial crisis, the Panic of 1907, so it is not surprising that the global crisis which began one century later should lead to changes in the authority and responsibilities of the Fed. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 mandates the most important changes at the Fed since the Great Depression. The legislation explicitly expands the goals for the Fed to include financial stability in addition to the traditional goals of price stability and full employment.

Consequently, the central bank will have enhanced responsibility for systemic risk assessment and regulation, and it will house and fund a new Consumer Financial Protection Bureau. Yet, in addition to expanding the powers of the Fed, the Dodd-Frank bill also significantly narrows the Fed's emergency lending authority and subjects this lending to greater scrutiny. 

The actions of the Federal Reserve in the recent financial crisis highlighted the extraordinary powers that many central banks have to intervene in an economy in a crisis. Not surprisingly, the interventions led to a vigorous public debate about the choices the Fed made, the proper role of the Fed in a crisis, and the transparency of its actions.  Although Dodd-Frank expands the Fed's responsibilities regarding financial stability, it also seeks to rein in an independent and powerful financial institution with unelected leadership and limited accountability. 

The role of a central bank in financial crises is a topic with a long history. With the help of Walter Bagehot, the Bank of England learned in the 1860s and 1870s that proper behavior on the part of a lender of last resort is to furnish liquidity to the market by discounting freely when presented with good collateral, at a penalty rate of interest that incentivizes borrowers to repay. In the recent crisis, the Fed developed a range of facilities to deliver liquidity. The Fed intervened to an unprecedented degree, reacting quickly to create vast reserves and shoring up institutions in novel ways to prevent a wholesale collapse of the U.S. financial system.

But the Fed and some other central banks also went well beyond what Bagehot taught a century and a half ago. In addition to lending to the market, they lent to particular institutions in trouble, sometimes on dodgy collateral, thereby attracting great political criticism.  Even in lending to the market, the Fed expanded its traditional role as lender of last resort to become an investor of last resort as well. One could argue that this was an appropriate means to prevent a widespread systemic collapse of the financial system. Yet, it was bound to add to concerns about the range of Fed powers. 

Not surprisingly, Congress has turned its attention to ways to improve financial sector regulation and avert future crises. The changes to the role of the Fed that are introduced by the Dodd-Frank bill arise mostly out of serious thought about the role of central banks and the appropriate scope of their activity. But, there also are lingering reflections of the public anger triggered by the crisis and the Fed's role in it. 

There are three aspects of central bank activities - monetary policy, financial institution regulation and systemic risk oversight.  In our view, the strong linkages among the three functions are sufficiently compelling that, with proper oversight, the central bank should have broad authority in all three of them. The Dodd-Frank bill takes some steps in this direction. It gives the Fed a role in maintaining financial stability and sets the stage for its use of macroprudential tools to tame systemic risks. It does not diminish the Fed's responsibility for monetary policy. Finally, it leaves the Fed explicit responsibility for some aspects of bank regulation and, importantly, creates new supervisory authority over all financial institutions that are deemed officially to be systemically important.

A strong and independent central bank is indispensable for effective monetary policy. However, it also is an anomalous entity in a constitutional democracy that emphasizes accountability and the responsibility of elected officials. Fortunately, the Dodd-Frank bill leaves the independence of the Federal Reserve reasonably intact. Some specific challenges to central bank independence that were introduced in earlier Congressional discussion were misguided and potentially counterproductive expressions of public anger regarding the recent financial crisis. Anger is a poor basis on which to make effective reforms. The Dodd-Frank bill dropped the most egregious attacks on the Fed. 

With regard to regulatory and systemic oversight, the Fed's enhanced powers to use macroprudential tools and the policy focus provided by its new Vice Governor for Supervision may help prepare both the central bank and the government for systemic risks.

However, the Dodd-Frank bill also prohibits or delays the use of selected Fed crisis management tools that played an important role in mitigating the recent crisis. In particular, aside from broad-based programs of liquidity provision, the Fed may no longer lend to individual nonbanks whose solvency is in doubt. Instead, the bill relies heavily on new, complex, and potentially unwieldy regulatory and resolution mechanisms to prevent and tame future crises. 

It is far from clear that this new apparatus will prove effective in countering crises when they occur, and may even increase their likelihood. The Financial Stability Oversight Council is an umbrella group of policymakers with a staff housed in the Treasury that will seek to identify systemic risks and instruct the Fed to respond. This loose structure is untested and far from streamlined. It does not appear well suited to foster the strong leadership, clear chain of command, and timely interventions that have characterized successful policy responses over the long history of financial crisies. In addition, the bill's new resolution mechanism - which aims to protect taxpayers and impose the costs of financial failures on unsecured creditors -- may unintentionally increase the probability of a run by such creditors in response to a shock that weakens the financial system.

Ultimately, the combination of new restrictions on Fed emergency lending and the new structures for responding to systemic risk and financial crises will have to be judged when tested by events.  If the new structures prove ineffective, the Dodd-Frank bill's elimination of emergency authority for some forms of Fed lending could make future crises even more devastating than the recent one.

Why Financial Reform May Just Work

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by Matthew Richardson and Nouriel Roubini

The economy is in ruins. Unemployment is at levels not seen in decades. The public seethes. Congressional hearings call for the heads of bankers. Bankers lobby behind the scenes. Politicians fight over the seeming minutiae of regulatory reform.

The year might sound like 2010, but it was actually 1933.

As President Obama visits the city that was at the core of the crisis - and the city that is key to our revival - history can teach us a valuable lesson. Namely: In the wake of a massive shock to the system, stronger rules of the road for large institutions are a prerequisite for sustained recovery.

Read the full opinion editorial at

by Matthew Richardson and Nouriel Roubini

Between the fall of 2008 and the winter of 2009, the world's economy and financial markets fell off a cliff. Stock markets in the United States, Asia, Europe and Latin America lost between a third and half of their value; international trade declined by a whopping 12 percent; and the size of the global economy contracted for the first time in decades.

When economists and Wall Street types toss around the term "systemic risk," that's pretty much what they're talking about. The particular risks that led to the crisis -- i.e., big institutions with too much leverage, too little capital and too many implicit and explicit government guarantees -- were not impossible to anticipate. (In fact, some of us warned about the financial pandemic that was to come.) Now, the question is: How do we keep this all from happening again?

To create a truly safe financial system, we have to focus on two goals. First, we have to drive a stake through the heart of the "too big to fail" mantra that only fattens our financial beasts. Second, we should stop focusing on the problems of individual banks and look at the broader risk that the largest and most complex financial institutions pose.

For the full opinion editorial in Sunday's April 11th Washington Post, please go to the following link





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).

About Restoring Financial Stability

Previously, many of these faculty developed 18 independent policy papers offering market-focused solutions to the financial crisis, which were published in a book, Restoring Financial Stability: How to Repair a Failed System (Wiley, March 2009).

About the Authors