ELECTRONICALLY REPRINTED FROM JANUARY 2015

Financial Regulatory Reform: Key Changes That Reduced Systemic Risk

By George W. Madison, Gary J. Cohen, and William A. Shirley

wave of retrospection regarding the Dodd-Frank Historical Perspective A legislation1 rolled through the press late last sum- In September 2008 and for several months thereaf- mer. Although articles and opinion pieces marking the ter, the US economy, the strongest in the world, was occasion of Dodd-Frank’s fourth anniversary looked on the brink of collapse. The most severe financial crisis back with a critical eye, this article is the first in a series in 80 years had idled 26 million US workers, wiped out of three that look forward. We start our series with $11 trillion in household wealth, caused four million the principal success of financial regulatory reform home foreclosures, and placed another four million since the financial crisis of 2007–2009. Dodd-Frank families at serious risk of foreclosure. The crisis also is a touchstone for this discussion, but we also take precipitated the failure of esteemed financial institu- up other important initiatives, such as those related to tions and businesses of all sizes, and required the federal Wall Street’s continued reliance on various forms of government to rescue the global financial system before short-term funding. In our second article, we explore millions more US jobs, homes, and businesses were opportunities for improving the current regulatory destroyed.2 framework—where we believe Dodd-Frank and other regulatory reforms did not get things entirely right— One prevalent partisan narrative laid the blame for and in the third, we share our views of the next frontier the crisis at the feet of governmental housing policy, in regulatory reform. as it told a story of Fannie Mae and Freddie Mac implementing lax mortgage underwriting standards Throughout our narrative, we focus closely on the that led to the housing bubble and, ultimately, soaring role played by nonbanks as well as banks in the finan- default rates.3 However, the congressionally chartered cial crisis. This focus is essential to understanding the Financial Crisis Inquiry Commission determined the regulatory successes, the current regulatory opportuni- causes to have included widespread failures in financial ties, and the next big regulatory thing. We use the term regulation and supervision, faulty corporate governance “shadow banking” even though it can obscure rather and risk management practices at financial institutions, than illuminate the issues at hand. As an alternative, we excessive leverage, risk-taking, speculation in the also talk about “maturity transformation,” that is, the derivatives markets, failures of credit rating agencies, practice of borrowing on a short-term basis to lend or and a breakdown in accountability and ethics.4 There otherwise invest on a longer term basis. This mecha- was plenty of blame to go around as a largely unre- nism is essential in any capital-based economy, and strained financial system reach its “Minsky moment”5 although it was historically the domain of banks, today in September 2008. many nonbanks, operating via the capital markets, serve the same function, and their part in the financial crisis In the wake of the crisis, Congress enacted Dodd- was key. Frank, a comprehensive legislative framework intended to plug holes in the financial regulatory umbrella that were exposed by the crisis. The legislation, which was initiated at the US Treasury Department, was negoti- George W. Madison and Gary J. Cohen are partners and ated over a period of months with Congress, with William A. Shirley is counsel of Sidley Austin LLP. During the regulators of various stripes, and with other interested financial crisis, Mr. Madison served as general counsel of the US parties. It eventually comprised 2,300 pages and con- Treasury Department (2009–2012), Mr. Cohen served as general counsel of the Financial Crisis Inquiry Commission (2010–2011), templated hundreds of interpretative regulations and and Mr. Shirley served as general counsel of AIG Financial studies, many of which are as yet unfinished. The Products Corp. (2007–2011). reaction to financial regulatory reform ranged from some admiration, to grudging respect, to howls of important financial institutions should or should not be hostility peppered with charges of partisan overreach.6 saved. In essence it ignores the need to make it both Notwithstanding the harsh critique (some of it mer- unlikely that such institutions will ever again need to ited), there is little doubt that Dodd-Frank and its prog- be “saved” and yet likely that if one (or more) of them eny have effected lasting and positive cultural change ever does face critical distress, the federal government within financial institutions, have lowered financial will have the right tools to do what is necessary to firm risk profiles, and have strengthened important avoid systemic crisis. regulatory mandates. The history of financial crises, their causes and reme- Criticism of financial regulatory reform is not a diation, is replete with unique, market driven events new phenomenon. The 1929 stock market crash and accented by human frailty. Each crisis has been differ- the Great Depression forced a reluctant Republican- ent, and each legislative response has been tailored to dominated Congress to support the US Senate’s Pecora address not only identifiable causal connections, but hearings7 on market manipulation, insider trading, politically attractive targets. The Dodd Frank legisla- and preferential insider arrangements that plagued tion was intended to stabilize the US financial system the Roaring Twenties. When control of Congress by containing excessive risk-taking and restoring public changed hands with the election of Franklin Delano confidence. But it also set its sights on Wall Street and Roosevelt in 1932, the Pecora inquiry was reinvigo- its institutions in ways that were more politically con- rated, and Congress enacted foundational securities venient than causally relevant. laws, which were met with vociferous condemnation by business leaders and New Dealers alike.8 Despite We will take up our primary criticisms of Dodd- subsequent attempts to weaken this legal framework, Frank in our second installment. For now, suffice it to there is no doubt that the market reform legislation say that we do not believe that Dodd-Frank in its cur- of the 1930s—particularly the Securities Act of 1933, rent form provides a complete box of tools for regula- the Securities Exchange Act of 1934, and the creation tors faced in the future with the potential collapse of a of the Securities and Exchange Commission (SEC)— large, interconnected financial institution whose failure were powerful regulatory tools that restored and have could cause a catastrophic collapse of the US and global maintained worldwide investor confidence in US financial system and impoverish millions of US citizens. financial markets. Dodd-Frank’s tools, however, are not insignificant, The last four years also find significant parallels in and therefore we belatedly join the celebration of its the history of the savings and loan crisis of the 1980s, fourth anniversary by considering a few legislative pro- which led to the enactment of the Financial Institutions visions and related regulatory initiatives that have been Reform, Recovery and Enforcement Act of 1989, as successful in reducing systemic risk and the need to well as the history of the corporate and accounting again face “too big to fail.” scandals in the late 1990s, which led to the Sarbanes- Oxley Act of 2002.9 Liquidity Crisis Leads to Great Recession On the occasion of Dodd Frank’s fourth anniversary, The Great Recession began as a liquidity crisis it became fashionable again for pundits and politicians among interconnected financial institutions, which to criticize the support given to the financial system by was followed by a capital crunch in the traditional the federal government and ask whether Dodd-Frank banking world. Panic of a particular sort ensued; some solved for all time the “too big to fail” issue10—in other dominos fell, and more were propped up by the federal words, whether regulatory reforms initiated by Dodd- government. Frank will prevent US taxpayers from having to rescue financial institutions that threaten US financial stability. A hallmark prophylactic measure of financial regu- This formulation of the question oversimplifies the latory reform under Dodd-Frank is the extension of issues at stake and raises a dangerously false dichotomy capital requirements in enhanced form to the largest by focusing policy arguments on whether systemically BHCs, to certain US operations of non-US banks, and

2 • Banking & Financial Services Policy Report Volume 34 • Number 1 • January 2015 eventually to systemically important nonbank financial system.15 In other words, it has been one of the engines institutions. Like other measures, capital requirements of shadow banking. can be a mixed bag. On the one hand, Dodd-Frank and the international accords constituting the Basel III Its most prevalent component is the “repo” market, framework have increased the quality and quantity of particularly the “tri-party repo” market. Generally, in capital maintained by financial institutions.11 The larger the repo market, broker-dealers, hedge funds, and other a firm’s capital cushion, the more likely the firm will institutional investors borrow cash overnight or on an be to survive a global financial panic, and the safer intraday basis from cash-rich lenders such as mutual and sounder will be the financial system. Not only funds and banks. The borrowers use US Treasury do the regulatory requirements prescribe capital levels bonds or other securities as collateral. In effect they based upon the type, quality, and riskiness of associ- finance portfolios of securities the way a Main Street ated assets, but Dodd-Frank’s simpler but overlapping business might finance inventory or capital equipment, restrictions on basic balance-sheet leverage, together but with the need to renew the “loans” on a daily basis. with its mandated stress-testing regime, effectively impose additional capital requirements.12 All these Although these wholesale funding arrangements requirements are monitored on a more or less constant appeared relatively stable for many years, the regula- basis by regulators assessing the adequacy of each insti- tors viewed short-term funding as inherently volatile.16 tution’s capital. This became abundantly clear during the crisis when lenders with a daily right to require the repayment of On the other hand, the more capital that is required, funds borrowed (or on other short notice) failed to the fewer assets firms can deploy in profitable pursuits, roll-over their extensions of credit. As housing prices both for shareholders and for their borrowers. Financial declined in 2007–2008, the value of many of the secu- institutions today are inevitably more selective when rities that borrowers had financed and used as collateral identifying which activities will receive capital support. for their borrowings experienced severe price volatility. To this point, the aggregate effect of the new capi- Concerned with credit risk because of the uncertainty tal requirements is unclear. It is likely that increasing of collateral values—and the increasingly precarious capital requirements have led to less and more selective financial condition of institutions pledging that collat- lending.13 But the latest read is that US bank profits are eral, such as Lehman Brothers—lenders refused to con- at near-record levels, despite regulatory capital chal- tinue providing liquidity. Unable to fund themselves, lenges.14 The impact that capital requirements have firms started to fail. The seizing up of all short-term had on the economy as a whole, accordingly, is hard funding markets was a principal cause of the panic that to judge. led to the global financial crisis.17

Regulation of Short-Term Funding In this context, lenders found themselves left with A second regulatory reform measure that has made collateral to liquidate, which was impossible in a pan- the financial system safer is new regulation of short- icked, declining market. Investors in money market term funding used by financial firms. Scant attention mutual funds, which were chief among the lenders was paid to this critical subject when Dodd-Frank was to troubled borrowers, were surprised to discover framed four years ago, but regulators are increasingly that their very short-term placements of funds with focused on what remains a true Achilles’ heel. mutual funds were unstable. As mutual fund inves- tors sought to withdraw their cash, some funds were The wholesale funding market serves as a means without sufficient cash and liquid assets to meet all for financial institutions—significantly broker-dealers redemptions, leading to the funds potentially—and and other nonbanks—to borrow funds on a short- in one important case, actually—“breaking the buck” term basis to finance longer term assets. The reliance and not being able to repay at face value all amounts on short-term funds raised in the wholesale markets invested.18 became essential to the growth of securitization in the pre-financial crisis period and increased the mismatch The fragility and rapid decline of liquidity for the between liquidity and maturity risk in the financial wholesale funding market, including the role played

Volume 34 • Number 1 • January 2015 Banking & Financial Services Policy Report • 3 by money market mutual funds, shocked the Federal The Federal Reserve also has announced that it is Reserve and the US SEC. considering proposals to:

The wholesale funding markets were not stabilized (1) incorporate the use of short-term funding expo- until the Federal Reserve created backstop lending sures into a risk-based capital surcharge on large facilities. In doing so, the Federal Reserve was serving US banks, in its traditional role as the lender of last resort, not (2) modify the Basel Committee’s net stable funding only for banks but also for nonbank financial firms. It ratio to strengthen liquidity requirements for banks established several creative lending facilities to provide providing short-term funding, and critical liquidity to several segments of the financial (3) consistent with the Financial Stability Board’s pol- markets, including the funding markets for repos, icy recommendations, impose numerical floors for commercial paper, and certain asset securitizations.19 collateral haircuts (i.e., minimum collateral require- In addition, along with the Treasury and the Federal ments) on non-centrally cleared securities financ- Deposit Insurance Corporation, it sought to stabilize ing transactions to limit the build-up of excessive the economy and restore public confidence in the mar- leverage outside the traditional banking system and kets by broadening its guarantees of bank deposits, by reduce the pro-cyclical effects of that leverage.24 providing guarantees of money market funds, and by injecting low-cost capital to strengthen bank and non- Equally important, though not mandated by Dodd- bank balance sheets.20 It is no exaggeration to state that Frank, was the Federal Reserve Bank of New York’s these actions, however unpopular in some quarters, convening of a task force in 2009 that effectively likely prevented far greater economic disaster. reinvented one key element of the repo market: the tri-party repo settlement process.25 At its height the As noted previously, some systemic risks exposed tri-party repo market provided financing on the order by the events of 2007–2008 were not directly targeted of $2.8 trillion daily. It features two large clearing banks by Dodd-Frank; however, the legislation has allowed that provide collateral custody services, settlement regulators in an indirect fashion to address those risks. services, and intraday credit for daily repo transactions The Financial Stability Oversight Council (FSOC) cre- between borrowers (such as broker-dealers) and lenders ated by Dodd-Frank (discussed later) used its author- (usually money market mutual funds). The settlement ity to recommend “new or heightened standards and process ran smoothly until the two clearing banks safeguards.”21 The SEC exercised authority to reduce became unwilling during the financial crisis to take the fragility of institutional money market mutual funds intraday credit exposure to borrowers, the effect of by requiring floating net asset values and authorizing which was to end the routine by which one day’s bor- restrictions on redemptions.22 Separately, the Federal rowings rolled over into the next. This left the lenders Reserve and other banking regulators have taken sig- with collateral to liquidate, which was impossible in an nificant steps to mitigate risk to the financial system overwrought market. The New York Fed’s interven- from short-term wholesale funding by: tion resulted in a significant reduction in the risk of failed trades and reliance on intraday credit extended (1) the imposition of Basel III risk-based capital by the clearing banks. rules applied to “repo style” securities financing transactions, Shadow Banking (2) the formulation of the liquidity coverage ratio A third, reasonably successful, post-crisis reform was requiring the maintenance by large banks of a suf- aimed directly at the “shadow banking” system. As noted ficient pool of high quality liquid assets to cover net previously, the mechanism of accepting short-term cash outflows over a 30-day stress period, and deposits or other short-term investments of cash and (3) the issuance of a supplementary leverage ratio re-lending or otherwise investing the funds on a longer aligning the treatment of off-balance sheet expo- term basis is no longer the principal province of banks. sures with the Basel III leverage requirement and Other financial market actors—money mutual funds imposing an additional leverage buffer on large US and other institutional investors in particular, together banks.23 with broker-dealers and securitization vehicles—play

4 • Banking & Financial Services Policy Report Volume 34 • Number 1 • January 2015 leading roles when it comes to maturity transformation liquidity needs (the other being the short-term financ- in this new world. At the height of the pre-crisis era, ing of of residential mortgage backed security positions assets created through these market participants were, via securities lending transactions), and they were a by some measures, greater than the assets of the regu- principal means by which financial distress traveled lated banking system. Today, according to an October throughout the markets when Lehman failed.29 Many 2014 study of the International Monetary Fund, shadow statistics can be offered to demonstrate the size of the banking assets in the United States exceed assets in swaps market (e.g., $600 trillion to $700 trillion aggre- the conventional banking system, and constitute one-­ gate notional amount30), but there is little doubt that, as quarter of all financial intermediation worldwide.26 But on the eve of the crisis, the swaps market today repre- these market participants are not regulated in the same sents a pervasive global network of financial intercon- manner as banks, and in some cases they are not regu- nection and thus financial risk. In fact the swaps market lated at all (disclosure requirements aside). has been a source of significant systemic risk since the 1990s, when it played an important role in the failure Dodd-Frank created a new council of regulators of Long-Term Capital Management, which brought called the FSOC. Chaired by the Treasury Secretary, that era’s financial markets to the brink. the FSOC consists of 10 voting members from the supervisory and markets enforcement regulatory agen- Dodd-Frank provides for greater transparency and a cies and the insurance industry, and five nonvoting reduction of systemic risk in the swaps market. Its core members. Its statutory responsibility (and that of each provisions require central clearing of some swap trans- agency) is to identify and monitor risks, gaps in regula- actions and mandatory margining (collateral posting) tion and emerging threats to the financial stability of for others (in both cases reducing counterparty and sys- the United States; promote market discipline, share temic risk).31 They also impose exchange-like trading information, and make recommendations regarding mechanisms on portions of the market (increasing price those risks with its members; and designate systemically transparency), and they create new categories of regu- important, nonbank financial institutions for height- lated market participants—swap dealers in particular— ened prudential oversight by the Federal Reserve.27 that are required to meet requirements to ensure both The FSOC effectively supplanted the body known as solid financial footings and appropriate customer deal- the President’s Working Group—which never seemed ings (thus reducing risk and increasing transparency).32 to “work”—in part because the group and its member regulators were given no systemic mandate. Operating But the regulators’ road to implementing the swap through its deputies’ committees, the FSOC has served reforms mandated by Dodd-Frank has been uneven a coordinating role for its constituent agencies in the at best, and has been traveled more slowly than some rule-writing process, and has vetted the need for many would have liked, though more quickly than others of the rules referred to previously. If the FSOC’s delib- believe appropriate. At root the problem is fragmented erations have not always been entirely harmonious, and jurisdiction over a market that is globally integrated like have been criticized for opacity,28 they have nonethe- no other. Not only must US regulators—the CFTC in less been an important forum for interagency debate chief—contend with non-US regulators who are mov- and action in a time of shadow banking, and they will ing more slowly and on different tracks, but the two likely remain one. principal US market regulators—the CFTC and the SEC—must share domestic responsibilities. In addition, Over-the-Counter Derivatives compared with the stock or bond market, or even the Finally, although there are other contenders for the futures markets, the variety and complexity—not to last discussion topic today, we believe reform measures mention the constant mutability—of the swaps market taken with respect to over-the-counter derivatives is extraordinary. Thus, there should be little wonder merit attention. that, in response to recent reports of new activity in the credit default market, one market observer might sug- Swap transactions and other derivatives contributed gest (hyperbolically, we might add), “We’ve reformed critically to the causes of the financial crisis. They were nothing. We have more leverage and more derivatives one of the two core sources of AIG’s unmanageable risk than we’ve ever had.”33

Volume 34 • Number 1 • January 2015 Banking & Financial Services Policy Report • 5 Despite this, we believe the watchwords for swap available at http://www.businessweek.com/articles/2012-10-18/ reform should be “perseverance” and “patience.” We whos-afraid-of-dodd-frank-not-wall-street; “Reactions to Dodd- believe the direction of swap market reform is largely Frank Law Run A Gamut from Enthusiasm to Disgust,” InformationWeek Bank Systems & Technology, July 16, 2010, avail- correct, but regulators must be given and, importantly, able at http://www.banktech.com/compliance/reactions-to-dodd- must take time to tackle an immensely complex set of frank-run-a-gamut-from-enthusiasm-to-disgust/d/d-id/1293973?, market and regulatory issues. There are recent signs last accessed Dec. 29, 2014; Diane Katz, “Dodd-Frank and reg- that just such an approach is now being taken. ulation gone rogue,” The Washington Times, May 29, 2014, avail- able at http://www.washingtontimes.com/news/2014/may/29/­ * * * katz-­regulation-gone-rogue/, last accessed Dec. 29, 2014; Gina Chon, “Dodd-Frank has Made Banks Safer but Slowed Beauty is in the eye of the beholder; and that is true Economy, Data Show,” Financial Times, July 22, 2014; The of financial regulation following the crisis. We believe Futurist Jeffrey Kutler, “The Unintentional Consequences of that enhanced capital requirements, reduced reliance Dodd-Frank,” Institutional Investor, August 3, 2012, available on short-term funding markets, the existence of a at http://www.­institutionalinvestor.com/­blogarticle/3065070/blog/ reinvigorated council of regulators with real authority, the-­unintentional-consequences-of-dodd-frank.html, last accessed Dec. 29, 2014. and a sounder market footing for swap transactions are worthwhile reforms that have made the financial sys- 7. https://www.senate.gov/artandhistory/history/common/­investigations/ Pecora.htm, last accessed Dec. 29, 2014. tem safer and sounder. 8. Bumgardner, Larry et al., A Brief History of the 1930s Securities Laws in the United States—And the Potential Lesson for Today 4 We will turn to the less beautiful aspects of financial (unpublished manuscript), available at www.jgbm.org/page/5%20 regulation reform in our next installment. Larry%20Bumgardner.pdf, last accessed Dec. 29, 2014. 9. See Robinson, Kenneth, J., Federal Reserve Bank of Dallas, Notes “Savings and Loan Crisis, 1980–1989,” paper November 22, 1. Dodd-Frank Wall Street Reform and Consumer Protection 2013, available at http://www.federalreservehistory.org/Events/ Act, Pub.L. 111-203, 124 STAT. 1376 (2010) (Dodd-Frank Act), DetailView/42, last accessed Dec. 29, 2014; Dotsey Michael,and available at http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/ Kuprianov, Anatoli, “Reforming Deposit Insurance: Lessons html/PLAW-111publ203.htm, last accessed Dec. 29, 2014. from the Savings and Loan Crisis,” Federal Reserve Bank of Richmond, Economic Review, March/April 1990, available 2. The Financial Crisis Inquiry Report: Final Report of the National at https://www.richmondfed.org/publications/research/economic_ Commission on the Causes of the Financial and Economic Crisis in review/1990/pdf/er760201.pdf, last accessed Dec. 29, 2014; the United States. 2011, at xv, 391, available at http://www.gpo.gov/ “The Savings and Loan Crisis and Its Aftermath,” 44–51. fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf, last accessed Dec. Web April 10, 2011, available at http://wps.aw.com/wps/media/ 29, 2014. objects/7529/7710171/­appendixes/ch11apx1.pdf; Peregrine, 3. Wallison, Peter J., The Financial Crisis Inquiry Report, Michael, W., “Another View: Sarbanes-Oxley and the Legacy Dissenting Statement, at 411–538; Wallison, Peter, “Four of Enron,” The New York Times, Dealbook, November 20, 2011, Years of Dodd-Frank Damage”, Wall Street Journal, available at http://dealbook.nytimes.com/2011/11/25/another- July 20, 2014, available at http://www.wsj.com/articles/ view-sarbanes-oxley-and-the-legacy-of-enron/?_r=0, last accessed peter-wallison-four-years-of-dodd-frank-damage-1405893333. Dec. 29, 2014; Fass, Alison, “One Year Later, The Impact Of 4. The Financial Crisis Inquiry Report, supra n.3 at xviii–xxii. Sarbanes-Oxley,” Forbes, July 22, 2003, available at http://www. forbes.com/2003/07/22/cz_af_0722sarbanes.html, last accessed 5. According to Investopedia.com, a Minsky moment is when a Dec. 29, 2014. market fails or falls into crisis after an extended period of mar- ket speculation or unsustainable growth. A Minsky moment is 10. Report, “Failing To End ‘Too Big To Fail’: An Assessment of the based on the idea that periods of speculation, if they last long Dodd-Frank Act Four Years Later,” Committee on Financial enough, will eventually lead to crises; the longer speculation Services, U.S. House of Representatives, Republican Staff occurs the worse the crisis will be. This crisis is named after Report, 113th Congress, Second Session, July 2014, available Hyman Minsky, an economist and professor famous for arguing at http://financialservices.house.gov/uploadedfiles/071814_tbtf_ the inherent instability of markets, especially bull markets. He report_final.pdf, last accessed Dec. 29, 2014; Nocera, Joe, “Did felt that long bull markets only ended in large collapses. http:// Dodd-Frank Work?,” The New York Times, The Opinion Pages, www.investopedia.com/terms/m/minskymoment.asp, last accessed July 21, 2014, available at http://www.nytimes.com/2014/07/22/ Dec. 29, 2014. opinion/Joe-Nocera-Did-Dodd-Frank-Work.html?_r=0; Wallison, 6. See “Dodd-Frank Bill Complete, Bankers React,” Forbes, June 25, Wall Street Journal, July 20, 2014, supra, n.4. 2010, available at http://www.forbes.com/sites/­streettalk/2010/06/ 11. See Tarullo, Daniel, K., Member, Board of Governors of the 25/dodd-frank-bill-complete-bankers-react/; “Who’s Afraid of Dodd- Federal Reserve System, “Dodd-Frank Implementation,” testi- Frank? Not Wall Street,” BloombergBusinessweek, October 18, 2012, mony before the Committee on Banking, Housing, and Urban

6 • Banking & Financial Services Policy Report Volume 34 • Number 1 • January 2015 Affairs, U.S. Senate, Washington, D.C., September 9, 2014 www.federalreserve.gov/newsevents/speech/tarullo20141120a%20. (discussing, inter alia, US implementation of the bank capital htm; Tarullo, supra n.10; Bank for International Settlements, framework approved by the members of the Basel Committee Basel Committee on Banking Supervision, “Basel III: the net on Banking Supervision, which include national banking stable funding ratio,” October 2014, available at http://www.bis. regulators from more than two dozen countries, including org/bcbs/publ/d295.pdf, last accessed Dec. 29, 2014; Financial the United States), available at http://www.federalreserve.gov/­ Stability Board, “Strengthening Oversight and Regulation of newsevents/testimony/tarullo20140909a.htm. Shadow Banking: Regulatory framework for haircuts on non- 12. Id. centrally cleared securities financing transactions”, October 14, 2014, available at http://www.financialstabilityboard.org/wp- 13. Borak, Donna, “Four Years Later, Economic Cost of Dodd- content/uploads/r_141013a.pdf, last accessed Dec. 29, 2014. Frank Remains Elusive,” American Banker, July 18, 2014, available at http://www.americanbanker.com/issues/179_138/four- 25. See Federal Reserve Bank of New York(2010), “Tri-Party years-later-economic-cost-of-dodd-frank-remains-elusive-1068834-1. Repo Infrastructure Reform,” white paper (New York: html, last accessed Dec. 29, 2014. FRBNY, May) at 6, available at http://www.newyorkfed.org/ banking/nyfrb_triparty_whitepaper.pdf, last accessed Dec. 29, 2014; 14. See Chaudhuri, Saabira, “US bank profits near record levels,” Tri-Party Repo Infrastructure Reform Task Force (2012), The Wall Street Journal, August 11, 2014, available at http:// “Tri-Party Repo Infrastructure Reform Task Force Releases online.wsj.com/articles/u-s-banking-industry-profits-racing-to-near- Final Report,” press release, February 15; report is also avail- record-levels-1407773976, last accessed Dec. 29, 2014. able at www.newyorkfed.org/tripartyrepo/pdf/report_120215.pdf, 15. See Dudley, William, C., President and Chief Executive last accessed Dec. 29, 2014; See Eichner, Matthew, J., Deputy Officer, Federal Reserve Bank of New York, “Welcoming Director, Division of Research and Statistics, FRB, “Tri- Remarks at Workshop on the Risks of Wholesale Funding,” party Repo Market,” testimony before the Subcommittee speech delivered at the Workshop on the Risks of Wholesale on Securities, Insurance, and Investment, Committee on Funding, Federal Reserve Bank of New York, New York City, Banking, Housing and Urban Affairs, U.S. Senate, Washington, August 13, 2014, available at http://www.ny.frb.org/newsevents/ D.C., August 2, 2012, available at http://www.federalreserve. speeches/2014/dud140813.html, last accessed Dec. 29, 2014. gov/newsevents/testimony/eichner20120802a.htm­ , last accessed 16. Id. at 2. Dec. 29, 2014. 17. Id. 26. International Monetary Fund, World Economic and Financial 18. Id. at 2–3. Surveys, Global Financial Stability Report: Risk Taking, Liquidity, and Shadow Banking, Curbing Excess While Promoting Growth, 19. Id. at 4. October, 2014, Chapter 2, Shadow Banking around the Globe: 20. See Bernanke, Ben S., Chairman, Board of Governors of the How Large, and How Risky, at 66, available at https://www.imf. Federal Reserve System, “The Federal Reserve: Looking org/external/pubs/ft/gfsr/2014/02/pdf/c2.pdf, last accessed Dec. Forward,” speech delivered at the Annual Meeting of the 29, 2014. American Economic Association, Philadelphia, Pa., January 27. See Dodd-Frank Act § 112(a) at 124 STAT. 1394. 3, 2014, available at http://www.federalreserve.gov/newsevents/ speech/bernanke20140103a.htm. 28. See Clowers, A. Nicole, US Government Accountability Office, “Financial Stability Oversight Council: Status of 21. See Dodd-Frank Act, § 120(a) at 124 STAT. 1408. Efforts to Improve Transparency, Accountability, and 22. See 17 CFR Parts 230, 239, 270, 274, and 279 (Money Market Collaboration,” testimony before the Subcommittee on Fund Reform: Final Rule), available at http://www.sec.gov/ Oversight and Investigations, Committee on Financial rules/final/2014/33-9616.pdf, last accessed Dec. 29, 2014. Services, US House of Representatives, September 17, 2014, 23. See 12 CFR Part 50 (OCC), 12 CFR Part 249 (FRB), 12 available at http://www.gao.gov/assets/670/665851.pdf, last CFR Part 329 (FDIC) (Liquidity Coverage Ratio); 12 CFR accessed Dec. 29, 2014; Report, “Financial Stability Oversight Part 3 (OCC), 12 CFR Part 217 (FRB), 12 CFR Part 324 Council: Further Actions Could Improve the Nonbank (FDIC) (Supplementary Leverage Ratio); 12 CFR Parts 3, 5, 6, Designation Process,” US Government Accountability 165, and 167 (OCC), 12 CFR Parts 208, 217, and 225 (FRB) Office, November 2014, available at http://www.gao.gov/ (Basel III Regulatory Capital Implementation). Gruenberg, assets/670/667096.pdf, last accessed Dec. 29, 2014, Heltman, Martin, J., Chairman, FDIC, “Wall Street Reform: Assessing John, “FSOC Meeting Centers on Transparency in Nonbank and Enhancing The Financial Regulatory System”, testimony ‘Systemic’ Designations,” American Banker, November 13, before the Committee on Banking, Housing, and Urban 2014, available at http://www.americanbanker.com/news/­ Affairs, US Senate, Washington, D.C., September 9, 2014, avail- regulation-reform/fsoc-meeting-centers-on-transparency-in-nonbank- able at https://www.fdic.gov/news/news/speeches/spsep0914.html, systemic-­designations-1071218-1.html, last accessed Dec. 29, last accessed Dec. 29, 2014. 2014. See Lynch, Sarah, N., “SEC Official vows to defend 24. See Tarullo, Daniel, K., Member, Board of Governors of the agency from Fed ‘power grab’,” Reuters US Edition, July 15, Federal Reserve System, “Liquidity Regulation,” November 2014, available at http://www.reuters.com/article/2014/07/15/ 20, 2014, speech delivered at the Clearing House 2014 sec-fed-piowar-idUSL2N0PQ2FR20140715. Annual Conference, New York, N.Y., available at http:// 29. See The Financial Crisis Inquiry Report at 343, 344–345.

Volume 34 • Number 1 • January 2015 Banking & Financial Services Policy Report • 7 30. Estimates of the global derivatives market range from $600 See Sheridan, Barrett, “The $600 Trillion Derivatives Trillion to $1,200 Trillion. See “Financial Implosion: Global Market,” Newsweek, World, October 17, 2008, available at Derivatives Market at $1,200 Trillion Dollars … 20 Times http://www.newsweek.com/600-trillion-derivatives-market- the World Economy,” Center for Research on Globalization, 92275. Global Research Washington blog, May 20, 2012, available at 31. See Dodd-Frank Act § 723 (at 124 STAT. 1675) and § 731 (at http://www.globalresearch.ca/financial-implosion-global-derivatives-­ 124 STAT. 1703). market-at-$1,200–trillion-dollars-20-times-world-economy/30944, last accessed Dec. 29, 2014. See Fitz-Gerald, Keith, 32. See Dodd-Frank Act § 734 (at 124 STAT. 1718) and § 731 (at “Derivatives: The $600 Trillion Time Bomb That’s Set to 124 STAT. 1703). Explode,” Money Map Report, Money Morning, October 12, 33. See Alloway, Tracey and Mackenzie, Michael, “Investors dine on 2011, available at http://www.moneymorning.com/2011/10/12/ fresh menu of credit derivatives,” The Financial Times, August derivatives-the-600-trillion--time-bomb-thats-set-to-explode/. 12, 2014.

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