Financial regulation: changing the rules of the game

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Your accounts at the bank must be closed immediately, despite the fact that your business is thriving and you have done nothing unlawful. When you call another banker to try to open an account, he turns you down, too. The bankers all tell you the same story: bank regulators have told them that they should not serve you, and they must obey or will face significant regulatory penalties.

Alongside a litigation initiative that began in the Justice Department, in , the Federal Deposit Insurance Corporation FDIC and other bank regulators warned banks of heightened risks from doing business with certain merchants.

Process Reform

Gun and ammunition dealers were targeted despite their Second Amendment rights. Firms selling tobacco or lottery tickets were persona non grata, too. Payday lenders also were targeted on the basis of the presumption that they prey on the poor. Some observers may agree with Mr. But now that Mr. Trump has taken office, will they agree with his list? Do we want our regulatory system to be a tool for attacking those our president dislikes?

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Such legislation or formal rule making likely would have been defeated owing to the checks and balances inherent in congressional debate or formal rule making under the Administrative Procedures Act. Instead, regulators relied on guidance — which requires no rule making, solicits no comments, entails no hearings, avoids defining violations, specifies no procedures for ascertaining violations, and defines no penalties that will be applied for failure to heed the guidance.

Regulators avoid public statements explicitly requiring banks to terminate undesirables, but privately threaten banks with an array of instruments of torture that would have made Galileo faint, using secrecy to avoid accountability. As DeMuth , Epstein , Hamburger , and Baude have documented, and as financial regulatory practice illustrates, there has been a dramatic increase in reliance on guidance in recent years.

Financial regulators can find it particularly useful to rely on vaguely worded guidance and the veil of secrecy to maximize discretionary power, although doing so imposes unpredictable and discriminatory costs on banks and their customers. That not only victimized payday lenders, it also imposed significant costs on consumers by reducing competition. Their presence reduces borrowing costs for customers. If the prejudiced views of bureaucrats about payday lending had been held up to scrutiny during public hearings, their jaundiced portrayals of the industry would have been disproven.

Introduction to Monetary Policy and Bank Regulation | OpenStax Macroeconomics 2e

In that lawsuit there is more at stake than the fate of payday lenders or their customers. Operation Choke Point has been discontinued. We share your view that law abiding businesses should not be targeted simply for operating in an industry that a particular administration might disfavor. Enforcement decisions should always be made based on the facts and the applicable law. The FDIC subsequently rescinded its list. The Department of Justice Department strongly agrees with this withdrawal. We reiterate that the Department will not discourage the provision of financial services to lawful industries, including businesses engaged in short-term lending and firearms-related activities [ Boyd ].

Despite that assurance, another administration might very well decide to encourage similar regulatory abuses of power in the future. Congress should prevent that from being possible. Or, if the Department of Justice believes that such actions were already illegal, perhaps it will consider criminal legal action against its own former officials responsible for this disgrace.

The OFR is supposed to identify potential systemic risks, using its unprecedented access to the proprietary data of financial regulators and financial institutions, and inform the FSOC of risks. The FSOC, chaired by the Secretary of the Treasury, has a statutory duty to facilitate information sharing and regulatory coordination by the various financial regulators.

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It is charged to respond to systemic risks by recommending appropriate strengthening in regulatory standards, and designating, as appropriate, certain financial market utilities and nonbank financial institutions or other firms as systemically important and therefore subject to new regulations. Critics of FSOC and OFR have pointed to two primary problems in its structure and operation: procedural shortcomings and politicization. The two problems are closely related. Not only is FSOC unaccountable, it also is composed of the heads of the various financial regulatory agencies, all of whom are appointed by the same political party.

On December 18, , Metlife was notified by FSOC that it had been designated a nonbank systemically important financial institution SIFI , which implied new regulatory burdens and risks. Although an agency can change its statutory interpretation when it explains why, FSOC insists that it changed nothing.

Financial Networks and Banking Policy

But clearly it did so. FSOC also focused exclusively on the presumed benefits of its designation and ignored the attendant costs, which is itself unreasonable under the teachings of Michigan v. Environmental Protection Agency, S. In addition to the potential for abusive actions, there is also reason to be concerned about FSOC inaction.

Indeed, it is not an exaggeration to say that FSOC seems to be uninterested in the only obvious and legitimate systemic risk facing the U. Real estate is central to systemic risk in many countries because of four facts. First, exposures to real estate risk inherently are highly correlated with each other and with the business cycle, which means that downturns in real estate markets can have large and sudden implications for massive amounts of loans and securities backed by real estate.

Second, real estate assets are unique and generally cannot be liquidated quickly at their full long-term value, which can imply large losses to holders who are forced to sell real estate quickly. Those losses can further exacerbate financial losses and magnify systemic risk. Third, over the past 40 years worldwide, and especially in the United States, real estate is increasingly funded by government-protected and government-regulated entities.

That protection encourages the politicization of real estate funding given the strong short-term political incentives to subsidize mortgage risk. As we witnessed during the Subprime Crisis in the United States, real estate losses produced substantial liquidity risk beginning in August in the asset-backed commercial paper market, and continuing through September in the repo and interbank deposits markets , which deepened the losses during the crisis and magnified the general contraction in credit that ensued. But this is not just a problem of large banks. The loan portfolios of small banks in the United States are also highly exposed to residential and commercial real estate risk, which over the past two decades averaged about three-quarters of total lending by small banks.

Many observers see large banks as the only source of systemic risk in the economy, but that mistaken view forgets that the United States has been the most financially unstable developed economy in the world for more than a century, despite the fact that large banks are a recent development in the United States Calomiris and Haber : chaps. The s banking crises were all about real estate losses incurred by small banks — not just in housing, but also in commercial real estate, especially in the southwest and the northeast, and in agricultural real estate throughout the country.

It is not hard to see why FSOC has been silent about the excessive exposure to real estate in the banking system, the increased risk taking by the GSEs and the FHA, the failure to reform the GSEs, and the increasing riskiness of mortgages over the past three years. Any discussion about these important systemic risks would be politically inconvenient. Immediately upon assuming authority, Mr.

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Watt reduced the down payment limit on GSE-eligible mortgages from 5 percent to 3 percent. Japanese banks are trying to diversify into areas such as asset management, as near record-low interest rates and tepid loan demand undermine their traditional lending model. The most promising fintech companies would benefit from being allowed to compete on the same playing field as established financial institutions, according to analyst Tsuneharu Miyake.

Like other nations, Japan has seen a plethora of fintech startups emerge in recent years, ranging from robot investing adviser WealthNavi Inc. The FSA is considering new rules around four key functions: settlements, credit, investing and risk transfer. One issue that has emerged as a key area of debate is how to handle deposits.

Under current law, banks are licensed to take deposits that are guaranteed if they fail. Some panel members have warned that if deposit business is opened up to competition from nonbanks, this could lead to a breakdown of credit creation, according to the documents. I don't think firms will change that much.

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  7. There may be cheaper options out there. Lobbying groups have stated their support of the new regulations, which is to be expected since they were deeply involved in drafting them. Critics say that the investment industry lobbying groups believe the fiduciary standard imposes burdensome, costly and unnecessary requirements that don't have a corresponding investor-protection benefit. We look forward to engaging with the SEC and our members as they work to implement the new standards.

    Unfortunately, this misleadingly titled rule may best serve the marketing interests of large financial corporations to the detriment of individual investors. Consumers need to know whether they are buying a product or buying advice. It should not take thousands of pages of rules to get that concept across. We've seen a shift over the last ten years to greater transparency when it comes to fees charged by online brokers, but there are still some mysteries to be solved.

    How are brokers who offer commission-free trades of exchange-traded funds ETFs compensated, for example? As the disclosures required under Reg BI are put into place, advisory clients will end up clicking through statements describing conflicts and fees. Make sure you understand them, and if they seem opaque, ask for clarification. What would move the bar to provide better information to investing clients? M1's Barnes says, "It's not an easy problem to solve.

    But one of the clearest things that could help is if brokers and advisors had to publish an all-in management cost, or report their revenue as a percentage of the assets under management. Barnes also suggest that an independent agency provides a scorecard that rates firms based on lack of conflict and transparency. New rules like Reg BI are always caught in tug-of-war between established broker dealers who have made their money pretty much the same way for years, and new technology upstarts who claim to level the playing field for investors.