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July 13, 2011

On The Daily Show, Prof. Matthew Richardson discusses Fannie Mae and Freddie Mac from Guaranteed to Fail, co-authored with Profs Viral Acharya, Stijn Van Nieuwerburgh and Lawrence White.

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Wall St. reform slow going

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One year after the signing of the Dodd-Frank financial regulation reform legislation, regulators and market watchers say there are still a lot of hurdles to overcome to avoid another financial meltdown.

Professor Matthew Richardson says, "I would give like Dodd-Frank like a B because something had to get done and you know it's difficult to get anything done in Washington so the fact that something was actually passed was actually a positive. I think, my concern is when I look at the rules, as they begin to come out, like the rules on capital requirements that came from Basle it was more of the same than what we had before so I'd probably drop the grade a little bit."

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The Pew Financial Reform Project & NYU Stern co-hosted a day-long forum on the implementation and impact of the Dodd-Frank Act on Monday, June 27, 2011.

Reshaping the banks has only just begun

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The US media has been buzzing with reviews and comments about William D Cohan's new 670-page blockbuster Money and Power, How Goldman Sachs Came to Rule the World, his third Wall Street "history" in just three years.

by Roy C. Smith

Charles D Ellis spent 10 years writing The Partnership, his much praised 2008 effort to capture the "culture" of Goldman Sachs, and so Cohan's latest effort seems a rush job to catch the last of the lingering public rage against the big banks that played so rough during the financial crisis.

Cohan interviewed former senior partners, who turned out to be much more loquacious than expected for a firm known for its secretive ways.

The glitzy New York version in Vanity Fair included a lengthy, pre-publication excerpt covering 1989-1999 when the firm had five chief executives. This was truly a messy period in the firm's history, full of juicy bits for gossips to savour.

But the piece never mentioned that these were very difficult times in both Wall Street and the City of London, when firms changed their business models drastically to survive and a great many distinguished names either failed or disappeared into mistaken or unwanted mergers.

Goldman is one firm that sailed through this period, despite its management changes and other tumultuous events, without slowing down much at all. Indeed, it emerged after its initial public offering in 1999 as the unquestioned leader of the global capital markets industry.

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Dinallo Revisits the Financial Crisis

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Eric Dinallo, Debevoise & Plimpton partner, and former New York
superintendent of insurance, discusses how the government handled the
AIG part of the financial crisis.

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Preventing the Next Crisis

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The FDIC says the Dodd-Frank Act would have allowed Lehman Brothers to wind down and sell its assets without government assistance. Would such legislation prevent another financial crisis from happening? Thomas Cooley, NYU Stern School of Business discusses.

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IA-Forum: Your book, Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance, provides a detailed analysis of the Act by you and your economic colleagues. What is your overall assessment of the Bill?

Dr. Acharya: The Dodd-Frank Act is clearly the largest regulatory overhaul of the financial sector in the United States since the Great Depression. What it does for the first time, at least as far as financial regulation in the US is concerned, is to take on the issue of systemic risk, the risk that a large number of financial sectors may collapse at the same time, freezing intermediation to households and the corporate sector. The Act requires that the regulators - in particular, a "Council" of regulators - designate a set of institutions as systemically important financial institutions (SIFIs) and then regulate these institutions with better capital and liquidity requirements. The Act also gives the Council the legislative authority to break them up as last resort. In this sense, given that it shifts the focus away from supervising and managing the risk of an individual institution to thinking about the risk of a system as a whole, I would say the Act is a very important step forward. On this it certainly has its heart in the right place.

But if I could pick one big issue with the Act, it's with its lack of addressing government guarantees. Dodd-Frank believes the primary problem with systemic risk and its creation is the existence of systemically important financial institutions, and their propensity to become too big to fail institutions; but it doesn't pay as much attention to the fact that in many cases this kind of behavior, of institutions to become excessively large or that they are herding, arises in the first place because there are government guarantees in place.

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The Wall Street Leviathan

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by Jeff Madrick

Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance
edited by Viral V. Acharya, Thomas F. Cooley, Matthew P. Richardson, and Ingo Walter Wiley, 573 pp., $49.95

One refreshing sign of hope for constructive change is that economists, some of whose theories had much to do with a light regulatory approach toward derivatives and the housing bubble, are increasingly producing research calling for stricter guidelines than Dodd-Frank or the Obama administration. Regulating Wall Street presents a wide range of new research supporting stronger regulations than Dodd-Frank recommends, such as the tax proposals I mentioned earlier. In Reforming US Financial Markets, Robert Shiller also describes new economic theories that take into account more realistic appraisals of how Wall Street works and demonstrates why more effective regulation is necessary. The old theory of rational markets, which laid the groundwork for light regulation, "is one of the most remarkable errors in the history of thought," Shiller writes. He believes that regulators can and should decide to raise capital requirements during periods of excessive speculation.

In the prologue of Regulating Wall Street, the editors, hardly known as progressives, remind financiers how useful strong regulations were in the past:

Many players on Wall Street and in corporate America in the 1930s hated the new regulatory regime imposed on them.... But in the long run...the new regulatory regime was one of the best things that ever happened for Wall Street and corporate America. Why? Because it created confidence among investors--then and in the decades to follow--that Wall Street finally had become a level playing field.
We would be far better off if the powers on Wall Street would remember this lesson.

Read the full review from the New York Review of Books

No need to fear the shadows

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by Roy C. Smith

With the big banks under the boot of the regulators, tucked up with tougher capital ratios, trading restrictions and deferred incentives to rein in recklessness, some bank chief executives and academics have called for similar restrictions on the "non-bank monsters" of the shadow banking system where dangerous, unregulated risks are said still to reside.

A shadow banker is anyone who participates in the lending of money or its near equivalent. These would include financial intermediaries, off-balance-sheet investment vehicles and hedge funds, as well as institutional asset managers.

Altogether, global institutional investors managed about $150 trillion of securities and derivatives in 2009, compared with about $95 trillion for all banks.

But the idea that the next meltdown will occur in the widely distributed shadow banking sector is nonsense, now that its riskier aspects have been addressed.

The five systemically important US non-bank intermediaries - investment banks - were dissolved by the crisis: Lehman Brothers failed, large banks acquired Bear Stearns and Merrill Lynch, and Morgan Stanley and Goldman Sachs turned themselves into banks. The Federal Reserve now regulates them all.

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by Gregory Meyer and Aline van Duyn in New York

US banks are urging regulators writing new rules for the derivatives markets under 2010's Dodd-Frank Act to keep their hands off the banks' swaps businesses in London and other overseas financial centres.

The lobbying efforts highlight the fact that regulations are being written at different speeds in different countries, allowing for "regulatory arbitrage", which officials have sought to stamp out. The US government had to bail out insurer AIG because of soured swap trades by a London-based division.

Lawyers for Bank of America, Citigroup and JPMorgan Chase have written to US regulators and asked them to keep swap business conducted abroad from having to register in the US, warning of "duplicative regulation", "unnecessary cost" and "damage" to their competitiveness in foreign markets. The Securities Industry and Financial Markets Association, a US banking lobby, has told regulators that rigidly applied rules could prompt US swaps dealers to "move offshore".

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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).

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