My latest Macro Musings podcast is with Hester Peirce. Hestor is a Senior Research Fellow and director of the Financial Markets Working Group at the Mercatus Center. She previously served on Senator Richard Shelby’s staff on the Senate Committee on Banking, Housing, and Urban Affairs. In that position, she worked on financial regulatory reform following the financial crisis of 2008 as well as oversight of the regulatory implementation of the Dodd-Frank Act. Hester also served at the Securities and Exchange Commission as a staff attorney and as counsel to Commissioner Paul S. Atkins. Hester was also nominated by President Obama to be an SEC Commisioner.
Hester joined me to discuss a new book she co-edited with Ben Klutsey titled “Reframing Financial Regulation: Enhancing Stability and Protecting Consumers” This book covers a lot of topics on how to better regulate the financial system.
We spent most of our time talking about how to improve the stability of the financial system. The laws and regulations emanating from Dodd-Frank (DF) were supposed to make the financial system safer, but a number of recent papers--Nissim and Calormiris (2014), Sarin and Summers (2016), Chousaks and Gorton (2017)--find the banking system weaker now and not meaningfully safer than pre-2008. Others, like Minneapolis Fed President Neel Kashkari, are worried about financial institution that remain too big to fail (TBTF) since they still fund with too much debt. Moreover, it is not clear if the reforms made in DF, like living wills and the Financial Stability Oversight Council, will actually make much difference should the TBTF institutions get in trouble again. President Kashkari, consequently, has proposed a number of reforms to end TBTF.
Hester and I discussed these concerns as well as the possibility that DF has actually increased the fragility of the financial system. One area, in particular, that is creating new potential problems for financial stability is the new DF central clearinghouse utility for derivatives. These central clearinghouses or CCPs were created as a way to improve transparency about derivatives so that regulators and other observer would know what is happening in this part of the financial system. Ironically, however, they appear to be making the financial system more fragile. This is because the CCPs concentrate all the risk from formerly bilateral relationships into one financial firm, making it another TBTF institution. Put differently, DF has inadvertently created more Lehmans or AIGs.
Now some of the clearinghouse existed before DF, but they have grown and absorbed more risk since DF. In fact, the Financial Stability Oversight Board has designated some of the CCPs as TBTF institutions that need to be monitored. Other reports have come out saying "clearing house push has created unforeseen systemic risk" or "U.S. Treasury warns clearinghouses could spread risk". So it is not clear whether DF on balance has increased the safety of the financial system.
Hester and I do discuss other issues that are covered in the book, but I wanted to highlight here what I see as one of the bigger issues still facing us eight years after the crisis.
If you are interested in the book, you can download it or individual chapters from here. This is a great resource to have as the new President and Congress consider revamping financial regulation.
This was a fascinating conversation throughout. You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more episodes are coming.
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