Dodd-Frank turns four today. Proponents marketed the law as the response to the financial crisis of 2007 to 2009, even though it included many unrelated items and left out many matters central to the crisis. It is not surprising that four years later, Dodd-Frank is still flawed. A recent poll conducted on behalf of Better Markets found that sixty percent of the respondents support "stricter federal regulation on the way banks and other financial institutions conduct their business." Only ten percent of survey respondents think the federal government is doing a good job regulating the financial industry using the powers it has already, so additional authority for the government is not the answer. A more effective approach would be to allow the markets to do what they do best--allocate resources to their most productive use and punish firms that are not delivering products and services that people want and need at prices they are willing to pay. Government regulations often impede these healthy market functions. An intense government regulatory regime, such as the one embodied in Dodd-Frank, comes with deep government relationships with large financial institutions and implicit or explicit guarantees that the government will be there to clean up those firms' meeses. Taxpayers bear the cost of this regulatory regime, but so do the consumers and Main Street companies that financial markets are supposed to serve.
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By Olivia Davidson
Two weeks ago, supposed baseball fan Andrew Rector filed a defamation lawsuit against Major League Baseball, ESPN, commentators Dan Shulman and John Kruk, and the New York Yankees for $10 million. Rector, who was caught sleeping on camera during a Yankees-Red Sox game on April 13th, claims that the commentators "unleashed an avalanche of disparaging words" commenting on his weight and ability to sleep through a home run.
Defamation is not a crime, but a tort, and for a statement to qualify as slander (a defamatory statement that is spoken), the following elements must be proven, writes attorney Emily Doskow:
In Rector's case, the alleged slander is evidently published and unprivileged, though whether or not it was injurious and false remains to be determined by the Court. According to a NY Times article,
Mr. Rector maintains the announcers used words like 'fatty' and 'stupid' to describe him, but neither Mr. Shulman nor Mr. Kruk uttered such insults in the clip [of their commentary]. It is unclear whether they commented later in the game on Mr. Rector's lengthy nap, implying perhaps the falsehood lies in Rectors idiosyncratic and frequently grammatically incorrect complaint.
Undeniably, following the upload of the clip to Youtube by MLB, Rector was subject to public ridicule, being called 'Sleeping Beauty' by one Twitter user. Rector goes as far as to say he has "suffered substantial injury" to his "character and reputation," as well as "mental anguish, loss of future income and loss of earning capacity." Rector's mother supported his claims saying he had missed work because of the public scorn he had experienced and that "everyone made fun of him everywhere he went."'
Rector is also suing for intentional infliction of emotional distress which requires an intentional or reckless act, outrageous conduct, causation and sufferance of emotional distress by the plaintiff.
As Texans for Lawsuit Reform wrote, "Lampooning the lawsuit industry has become an industry unto itself." We'll have to see if Rector has what it takes to make it in this business and win his plea.
The Wall Street Journal reports that the Financial Industry Regulatory Authority is reviewing its penalty guidelines to make sure they are appropriately severe. This review follows a speech by Securities and Exchange Commission member Kara Stein, in which she opined that FINRA penalties are "too often financially insignificant for the wrongdoers" and urged FINRA to make penalties high enough to be "impactful, and provide strong motivation for compliance." It is good that someone at the SEC is paying attention to FINRA, but a blanket suggestion to raise penalties may serve only to exacerbate problems that arise from FINRA's inadequate accountability structure.
Last week, the Public Company Accounting Oversight Board released its staff guidance on economic analysis in PCAOB standard setting. According to PCAOB Chairman James Doty, "[t]he Guidance should give those who are interested in the PCAOB's standard setting a better understanding of the analysis that staff plan to conduct to ensure effective and efficient rulemaking." The PCAOB guidance is an important departure from the historical reluctance of federal financial regulators to conduct economic analysis in connection with their rulemaking. In response to this aversion to pre-regulatory analysis, Abby McCloskey and I released a paper this week exploring the merits of a statutory requirement applicable to all the federal financial regulators.
Rather than something to be feared, economic analysis helps a regulator identify the problem it is trying to solve and think through potential solutions. Yes, it is a difficult, time-consuming, and costly exercise. It is true that there are hard to quantify benefits and costs, uncertainties, data gaps, and indirect effects. Despite these problems, most regulators are required by executive order to conduct economic analysis. Given the far-reaching effects that federal financial regulations have, the benefits of ascertaining what your rule will do before you adopt it outweigh the costs of doing a reasonable analysis. The PCAOB guidance embraces a form of analysis similar to that required under the executive orders. The other federal financial regulators should do the same. A clear, statutory requirement applicable to all of the financial regulators would ensure that thinking about whether and how regulations will work and what their likely consequences will be is not optional.
On Monday, the Financial Stability Oversight Council will hold an asset management conference with industry, academics, regulators, and a handpicked audience. The FSOC, which is made up primarily of the heads of the federal financial regulatory agencies, has the power to designate non-bank financial companies for regulation by the Federal Reserve. Monday's event will be the latest step in the FSOC's consideration of whether to designate one or more asset managers as systemically important. A report by the FSOC's sidekick--the Office of Financial Research--on the asset management industry looked as if it had been written without much consideration of the actual nature, purposes, or risks of the industry.
New York Attorney General Eric Schneiderman took the latest step in his "Insider Trading 2.0" initiative to reshape the securities markets. On Wednesday, the attorney general announced an agreement with PR Newswire, a company that distributes corporate news releases. Pursuant to that agreement, PR Newswire will require direct recipients of its information to certify that they will not use it for high-frequency trading purposes. Attorney General Schneiderman has made similar pacts with other news distributors and entered into an agreement with Thompson Reuters, pursuant to which the company agreed to stop selling early access to the University of Michigan consumer sentiment survey. The attorney general is on a mission to ensure--as he said in a recent speech--that the United States is "a little more equal than the rest of the world." But equality based upon prohibiting people from investing in speed, technology, and legal access to information is a foreign concept in American markets. Freely functioning markets allow people to express the value they place on something. A long-term investor is not willing to pay anything for a short-term trading advantage, but a frequent trader may find a two-second information advantage so useful that she is willing to pay for it. The frequent trader's choice to buy something that the long-term investor does not want or need is not a sign of inequality; it is a reflection of different preferences. It's not the government's job to equalize market participants' preferences.
In an opinion this week, United States District Court Judge Ronnie Abrams dismissed a complaint filed against the Federal Reserve Bank of New York (FRBNY) by a fired employee. The case turned, in part, on whether a Fed advisory letter is "a law or regulation," which would trigger the application of whistleblower protection. The employee--a FRBNY bank examiner--alleged that she lost her job in retaliation for refusing to change an exam report finding of noncompliance with SR-08-08, Fed guidance related to compliance risk management programs. The Fed, citing as authority a paper drafted by international banking regulators, issued SR-08-08 to clarify its views on compliance for large, complex banks. In its defense in this case, the FRBNY pointed out that SR-08-08 was not promulgated through a notice-and-comment process or published in the Code of Federal Regulations, two hallmarks of a binding regulation. The court agreed that "SR-08-08 is an advisory letter that does not carry the force of law."
While the court's view that the document is not legally binding on banks is correct as a matter of administrative law, the former employee also appears to be correct that the Fed acts as if SR-08-08 is binding. As the plaintiff noted, the Fed routinely includes compliance with SR-08-08 as a condition in settled enforcement actions. The settlements refer to SR-08-08 as "guidance," but nevertheless compel compliance with that guidance. SR-08-08 is full of directives to large banks, including some very specific ones, such as a requirement that compliance risk management programs be documented and specific board obligations. What will Fed examiners say when banks, armed with the FRBNY's defense in this case, argue that they do not have to set up compliance programs that conform to a mere guidance document?
Earlier this week, the Court of Appeals for the D.C. Circuit issued its much awaited opinion regarding the Securities and Exchange Commission's conflict minerals rule. The court ruled in the SEC's favor with respect to the challengers' Administrative Procedure Act and economic analysis claims and in the challengers' favor on their constitutional claim. The claim on which the challengers prevailed has attracted the most attention, but other parts of the opinion could also have important effects.
The Federal Deposit Insurance Corporation has produced valuable research on community banks, but more research is needed to address an issue of great concern for small banks--growing regulatory burdens. At the end of 2012, the FDIC released a helpful community banking study that explored the characteristics and practices of community banks. And yesterday, the agency issued a report on community bank charter attrition, which offers valuable insights into the nature and drivers of bank consolidation. The message of the most recent report is clear--despite years of consolidation activity, community banks are here to stay. That is good news, because the diversity of the U.S. financial system--including its large number of community banks--is critical to its ability to serve the nation's diverse financial needs. The study's optimistic assessment of the future, however, largely ignores one key issue--the effects of regulatory burdens on small banks.
The Past, Present and Future of Fannie and Freddie: Government Intransigence on the Current Lawsuits Could Make It Impossible to Reprivatize the Residential Mortgage Market
Today, the momentum is growing for fundamentally restructuring the national residential mortgage market in the wake of the earlier collapse of the Federal National Mortgage Association (FNMA, or "Fannie Mae") and Federal Home Loan Mortgage Corporation (FHLMC, or "Freddie Mac). These two government-sponsored enterprises (GSEs)--so-called in recognition of their hybrid public/private nature--have long written large chunks of the residential home mortgage market, to the tune of trillions of dollars. The current legislative fixes now on the table include a bipartisan proposal from Tim Johnson and Mike Crapo, coupled with an earlier entry by Maxine Waters. The Johnson-Crapo proposal follows on earlier entries from Jeb Hensarling on the House side and Bob Corker on the Senate side. Each of these proposals seeks simultaneously to unwind the past and to redefine the future. To evaluate them requires understanding the historical linkage between past events and future prospects.
To begin, some background. In response to the brewing subprime mortgage crisis in 2008, Congress in late July of that year passed the Housing and Economic Recovery Act (HERA). That legislation, inter alia, created a new Federal Housing Finance Agency (FHFA), which on September 7, 2008 placed into a conservatorship both GSEs. These conservatorships were intended to keep both entities alive in order to facilitate their return to the private market. They were not receiverships whose object is the orderly liquidation of the two businesses. The basic plan called for an infusion of up to $200 billion in fresh cash into Fannie Mae and Freddie Mac under a Senior Preferred Stock Purchase Agreement (SPSPA) that gave the government warrants, exercisable at a nominal price, to acquire a 79.9 percent ownership stake in each enterprise. In exchange for that advance the senior preferred stock carried a 10 percent annual dividend payment, which went up to 12 percent if the GSEs delayed their dividend payments on the senior preferred.
The terms of that deal were radically altered in August 2012, when the United States, acting through the Treasury Department, imposed, through the Third Amendment to the 2008 SPSPA, a "net worth sweep" that entitled the government to 100 percent dividends on future earnings. That one bold stroke effectively made it impossible for the GSEs to repay their loans and rebuild their capital stock. Both the junior preferred stockholders and the common shareholders could under this agreement never receive a dime from either GSE, even after the entities returned to profitability. Assessing this gambit requires understanding two things: first, the relationship between the Third Amendment and the original 2008 SPSPA; and second, the relationship between the Third Amendment and efforts to revitalize the housing market. Both relationships are widely misunderstood today.
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