1 / 25

Focusing More on Outputs and on Markets: What Financial Regulation Can Learn from Progress in Other Policy Areas

Focusing More on Outputs and on Markets: What Financial Regulation Can Learn from Progress in Other Policy Areas. Lawrence J. White Stern School of Business New York University lwhite@stern.nyu.edu Presentation at FDIC, Arlington, VA, November 30, 2007. Overview.

Télécharger la présentation

Focusing More on Outputs and on Markets: What Financial Regulation Can Learn from Progress in Other Policy Areas

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.


Presentation Transcript

  1. Focusing More on Outputs and on Markets: What Financial Regulation Can Learn from Progress in Other Policy Areas Lawrence J. White Stern School of Business New York University lwhite@stern.nyu.edu Presentation at FDIC, Arlington, VA, November 30, 2007

  2. Overview • Background on regulation (in general) • Examples, in other areas of regulation, of “success stories” that focused on outputs and markets • Examples of four proposals for reforms of financial regulation that would have focused on outputs and markets (but have not been adopted), and one area of successful flexibility: bank reserve requirements and the Fed Funds market • Conclusion

  3. Classifying types of regulation • Economic regulation • Health-safety-environment regulation • Information regulation

  4. Economic regulation • Control over prices or profits or entry or exit • The Civil Aeronautics Board’s (CAB) former regulation of the airline industry • Bank regulators’ former ceilings on deposit interest rates, limits on entry, branching • The Securities and Exchange Commission’s (SEC) former restrictions on which bond rating companies can become a “nationally recognized statistical rating organization” (NRSRO)

  5. Health-safety-environment regulation • Control over production processes or inputs or outputs • The Federal Aviation Administration’s (FAA) safety requirements for airlines and pilots • Bank regulators’ safety-and-soundness regulatory requirements for banks • The SEC’s minimum capital requirements for broker-dealers and competency requirements for securities brokers

  6. Information regulation • Control over the types and formats of information • Department of Transportation’s (DOT) regulation of fare announcements by airlines • Bank regulators’ interest rate disclosure requirements • SEC’s disclosure requirements for publicly traded companies

  7. Where does corporate governance regulation fit in? • The goal of corporate governance regulation – assuring investors of a fair outcome – is not all that different from the safety goals of the FAA or the Consumer Product Safety Commission (CPSC)

  8. Classifying regulatory implementation • Command-and-control regulation: Centrally devised (macro) solutions imposed at the micro level; often “one-size-fits all” • Technology standards (inputs oriented) • All firms must adopt a specific technology • Performance standards • All firms must meet a specified level of performance, but can choose their technologies • “Bubble” concept • The firm is judged on its aggregate performance (put a plastic bubble over the entire firm), not on the performance of individual units

  9. Regulation of the auto industry exemplifies all three concepts • Vehicle safety standards embody technology requirements and performance requirements • Vehicle pollution control requirements embody performance requirements • Vehicle fuel mileage requirements (CAFE) embody the bubble concept

  10. Going beyond command-and-control: embracing “outputs and markets” • “Cap-and-trade” system for controlling SO2 emissions • Electromagnetic spectrum auctions • “Dedicated-access-privilege” programs for fisheries

  11. “Cap-and-trade” system for SO2 emissions • Replaces command-and-control with much greater flexibility • National aggregate maximum amount of annual SO2 emissions has been allocated among electric utilities • They can trade SO2 emissions permits among themselves • This encourages greater efficiency and innovation • The SO2 program has been highly successful

  12. Electromagnetic spectrum auctions • Replaces Federal Communication Commission’s (FCC) command-and-control allocation of broadcast licenses • Auctions have allowed greater flexibility in use, greater efficiency • Auctions have generated tens of billions of dollars for the federal treasury • Spectrum auctions are considered highly successful

  13. “Dedicated-access-privilege” (DAP) programs for fisheries • Fisheries are a watery commons and often suffer from “the tragedy of the commons” • Response of the National Marine Fisheries Service (NMFS) has been command-and-control regulation for overfished fisheries • DAP programs are like “cap-and-trade” • Set an annual “total allowable catch” TAC • Allocate TAC among fishermen • Allow trading of the allocations • DAP programs in U.S. and especially abroad have been highly successful

  14. Financial regulation • Financial regulation is not different from other regulation • Financial regulation sometimes encompasses technology standards and sometimes encompasses performance standards; often “one-size-fits-all” • Where are the programs that emphasize “outputs and markets”? • Bank reserve requirements and the Fed Funds market • And some proposals • Benston/Kaufman proposal for mandatory subordinated debt for banks • Klausner’s proposal for CRA reform • Ronen’s proposal for financial statement insurance (FSI) • My proposal for NRSRO reform

  15. Bank reserve requirements and the Fed Funds market • Depository institutions are required to hold funds “in reserve” as vault cash or as deposits at the Federal Reserve, calculated as a fraction (e.g., 10%) of their deposits • The Fed Funds market permits banks to buy and sell “excess reserves” and thus provides flexibility in meeting the requirement • “Floor and trade”

  16. Capital requirements for banks • Depository institutions are required to hold minimum levels of capital (net worth) as a % of assets • Capital is a direct buffer that protects depositors (or the deposit insurer) against reductions in asset values • Capital represents the owners’ stake in the bank; a greater stake reduces the incentive for risk-taking

  17. The Benston/Kaufman 1988 proposal for mandatory subordinated debt • As part of their capital requirement, depository institutions should be required to issue a tranche of subordinated debt • Sub debt would bring a set of stakeholders who would lose from the down side of risk-taking but not gain from the up side • Sub debt holders might restrain risk-taking by owners (or managers on owners’ behalf) • Regulators might use the yields on subordinated debt to help identify problem institutions • The Benston/Kaufman proposal has never been implemented

  18. The Community Reinvestment Act of 1977 • The CRA requires banks to “meet the credit needs of the local communities in which they are chartered consistent with safe and sound operation of such institutions” • The CRA is command-and-control regulation • Technology standards from 1977-1995 • Performance standards since 1995

  19. Michael Klausner’s 1995 reform proposal • A bank’s CRA annual commitment would be specifically defined as a dollar amount of loans originated and/or held • The obligation could be transferred to other lenders; a market could develop • Consciously modeled on the SO2 “cap-and-trade” program • Klausner’s proposal has never been implemented

  20. Current accounting/auditing arrangements: the problem • Investors and creditors rely on financial statements • Auditors are hired (and can be fired) by corporate boards of directors, who are selected by managements • Managements always favor rosy scenarios • Auditors face an inherent conflict of interest • After-the-fact liability suits are an imperfect solution • Sarbanes-Oxley command-and-control regulation is not a satisfactory solution

  21. Joshua Ronen’s 2002 proposal • Companies would purchase “financial statement insurance” (FSI) from a competitive insurance market • The insured amount and the premium would be public information • FSI ends the auditor’s conflict of interest: The FSI insurer would hire the auditor and would be interested in “the truth” • Rosy scenario means premiums that are too low • Pessimistic scenario means that the insurer would be underbid by an insurer with a more accurate auditor • Ronen’s proposal has not been acted upon

  22. NRSRO regulation • The bond rating industry was subject to protective regulation by the SEC, 1975-2006 • In 1975 the SEC created the category “nationally recognized statistical rating organization” (NRSRO) and grandfathered Moody’s, S&P, and Fitch • The NRSRO category created an artificial barrier to entry • The SEC never defined NRSRO • When it proposed a definition (in 1997 and 2005), it focused on inputs • The NRSRO designation process was opaque

  23. My 2002 reform proposal • Plan A: abandon the NRSRO category and allow financial markets to form their own judgments as to reliable bond ratings and rating companies • Plan B: retain the NRSRO category, but the SEC must cease being a barrier to entry and must certify NRSROs on the basis of “outputs” – efficacy in predicting bond defaults – rather than inputs • This proposal was not acted upon; but the new (Sept. 2006) NRSRO law may reduce the barrier to entry – or not

  24. Conclusion (1) • An “outputs and markets” orientation would be worthwhile for financial regulation • There are successful examples in other regulatory areas • Bank reserve requirements and the Fed Funds market are an example of successful application • The mandatory sub debt proposal, Klausner’s CRA proposal, Ronen’s FSI proposal, and my NRSRO proposal show that these ideas are more widely applicable to financial regulation • There are surely more areas of financial regulation where these ideas could be applied

  25. Conclusion (2) • My message to financial regulators and policy makers and to financial sector researchers: Think expansively and creatively! Think “outputs and markets”!

More Related