Law Commons^™

Were "It" To Happen: Contract Continuity Under Euro Regime Change, Robert C. Hockett

Cornell Law Faculty Working Papers

One way or another, the European Monetary Union (EMU) is apt to endure. The prospect of continuation under the precise contours of the regime as we presently find it, however, is anything but certain. Hence many investors and other actual or prospective contract parties are likely to remain skittish until matters grow clearer. This skittishness, importantly, can itself hamper the prospect of expeditious European recovery. Addressing particular sources of ongoing uncertainty about EMU prospects can itself therefore aid in the project of recovery.

This Essay accordingly aims to impose structure upon one particular, and indeed particularly complex, source of uncertainty …

Bankers, Bureaucrats, And Guardians: Toward Tripartism In Financial Services Regulation, Saule T. Omarova

Cornell Law Faculty Publications

This Article advocates the statutory creation of a new form of tripartite regulatory regime aimed at the detection and prevention of systemic risk in the financial sector. Although it leaves many significant details blank and many important questions unanswered, this Article offers a radically new vision of the financial services regulation as a process involving three equal participants: bankers, bureaucrats, and guardians of the public interest. Admittedly, this vision is not likely to become reality in the near future. Nor is it meant as a comprehensive plan to solve the problem of effective systemic risk regulation in the financial sector. …

Complexity, Innovation, And The Regulation Of Modern Financial Markets, Dan Awrey

Cornell Law Faculty Publications

The intellectual origins of the global financial crisis (GFC) can be traced back to blind spots emanating from within conventional financial theory. These blind spots are distorted reflections of the perfect market assumptions underpinning the canonical theories of financial economics: modern portfolio theory, the Modigliani and Miller capital structure irrelevancy principle, the capital asset pricing model and, perhaps most importantly, the efficient market hypothesis. In the decades leading up to the GFC, these assumptions were transformed from empirically (con)testable propositions into the central articles of faith of the ideology of modern finance: the foundations of a widely held belief in …

License To Deal: Mandatory Approval Of Complex Financial Products, Saule T. Omarova

Cornell Law Faculty Publications

This Article explores the possibility of creating a system of mandatory pre-approval of complex financial products as an ex ante solution to the problem of systemic risk containment. Building on the concept of regulatory precaution borrowed from environmental and health law, and elements of pre-CFMA regulation of commodity futures, the Article outlines the broad contours of a new licensing scheme that would place the burden of proving social and economic utility of complex financial instruments on the intermediaries that structure and market them. Fundamentally a thought experiment, this proposal seeks to enrich the current policy debate by expanding the range …

That Which We Call A Bank: Revisiting The History Of Bank Holding Company Regulations In The United States, Saule T. Omarova, Tahyar E. Margaret

Cornell Law Faculty Publications

This Article does not purport to present an exhaustive and detailed analysis of the entire political or economic history of bank holding company regulation in the United States. Rather, its goal is to examine one particular aspect of that history-the evolution of the BHCA definition of "bank" and the principal exemptions from that definition. Incomplete as it may be, this story highlights some of the key economic, social and political factors that shaped the current institutional structure of the U.S. financial services market and regulation. Without a thorough understanding of the genesis of that structure, it is difficult to envision …

An Evolving Foreclosure Landscape: The Ibanez Case And Beyond, Peter Pitegoff, Laura S. Underkuffler

Cornell Law Faculty Publications

Mortgage securitization, subprime lending, a persistently weak housing market, and an explosion of residential mortgage defaults – today’s homeowners and banks face a new and challenging landscape. Recently, courts in several states have issued decisions that alter the terrain for mortgage foreclosures. In Massachusetts, New Jersey, and New York, among other states, courts have dismissed foreclosure actions on the basis of what might seem to be highly technical deficiencies in the pleading or proof. The most well-known – and controversial – in this cluster of cases is U.S. Bank National Ass’n v. Ibanez, decided by the Supreme Judicial Court of …

From Gramm-Leach-Bliley To Dodd-Frank: The Unfulfilled Promise Of Section 23a Of The Federal Reserve Act, Saule T. Omarova

Cornell Law Faculty Publications

This Article examines the recent history and implementation of one of the central provisions in U.S. banking law, section 23A of the Federal Reserve Act. Enacted in 1933 in response to one of the perceived causes of the Great Depression, section 23A imposes quantitative limitations on certain extensions of credit and other transactions between a bank and its affiliates that expose a bank to an affiliate's credit or investment risk, prohibits banks from purchasing low-quality assets from their nonbank affiliates, and imposes strict collateral requirements with respect to extensions of credit to affiliates. The key purpose of these restrictions is …

The Volcker Rule And Evolving Financial Markets, Charles K. Whitehead

Cornell Law Faculty Publications

The Volcker Rule prohibits proprietary trading by banking entities - in effect, reintroducing to the financial markets a substantial portion of the Glass-Steagall Act’s static divide between banks and securities firms. This Article argues that the Glass-Steagall model is a fixture of the past - a financial Maginot Line within an evolving financial system. To be effective, new financial regulation must reflect new relationships in the marketplace. For the Volcker Rule, those relationships include a growing reliance by banks on new market participants to conduct traditional banking functions.

Proprietary trading has moved to less-regulated businesses, in many cases, to hedge …

Bubbles, Busts, And Blame, Robert C. Hockett

Cornell Law Faculty Publications

I argue that financial asset price bubbles and busts, such as those we have recently experienced in the mortgage and securities markets, are compatible with market efficiency, individual rationality, and even ethically unobjectionable behavior. The reason is that they constitute classic recursively self-amplifying collective action problems, the hallmark of which is the efficient aggregation of individually rational behaviors into collectively calamitous outcomes. In the present case, individuals rationally "legged the spread" between cheap borrowing costs and credit-fueled capital gains rates, neither of which market actors could affect in their individual capacities even when knowing that credit would have eventually to …

Regulating Financial Innovation: A More Principles-Based Proposal?, Dan Awrey

Cornell Law Faculty Publications

Modem financial markets are characterized by complexity, seemingly perpetual innovation, chronic asymmetries of information and expertise, and pervasive agency costs. Perhaps nowhere are these characteristics-or their attendant regulatory challenges-more pronounced than within OTC derivatives markets. Mounting effective responses to these challenges must be considered amongst the most difficult and important tasks confronting financial regulators. Prescriptive, rules-based approaches toward financial regulation have thus far proven inadequate to this task. Through the utilization of outcome-oriented principles, enhanced dialogic relationships, intensive supervision, and targeted and proportional (yet vigorous) enforcement, "more principles-based" financial regulation (MPBR) manifests the potential to overcome these challenges and, in …

Derivatives And The Legal Origin Of The 2008 Credit Crisis, Lynn A. Stout

Cornell Law Faculty Publications

Experts still debate what caused the credit crisis of 2008. This Article argues that dubious honor belongs, first and foremost, to a little-known statute called the Commodities Futures Modernization Act of 2000 (CFMA). Put simply, the credit crisis was not primarily due to changes in the markets; it was due to changes in the law. In particular, the crisis was the direct and foreseeable (and in fact foreseen by the author and others) consequence of the CFMA’s sudden and wholesale removal of centuries-old legal constraints on speculative trading in over-the-counter (OTC) derivatives.

Derivative contracts are probabilistic bets on future events. …

Extending The European Debt Discussion To Broader International Governance, Odette Lienau

Cornell Law Faculty Publications

Although Europe is no stranger to sovereign debt troubles, the focus of international debt governance for several decades has been on the developing world. Discussions surrounding the efficacy and appropriateness of crisis mechanisms have been shaped by this political reality. But the current focus on Europe itself may generate changes in how public and private actors view international debt governance and the legitimacy of crisis mechanisms. In these remarks, I will focus on two ways in which Europe might serve as a test case for broader governance practices. First, I will discuss the ramifications of the European Union’s potential adoption …

The Dodd-Frank Act: A New Deal For A New Age?, Saule T. Omarova

Cornell Law Faculty Publications

This short essay is an attempt to present a few early "big picture" observations on the broad regulatory philosophy underlying the Dodd-Frank Act. The question raised here is whether the Dodd-Frank Act, in fact, provides a blueprint for the twenty-first-century version of the New Deal - a qualitatively new approach to resolving the regulatory challenges posed by today's financial markets. Answering this complex question in full is hardly possible at this stage in the process, when many critical details of the new legal and regulatory regime are yet to be determined. Nevertheless, it is worthwhile to reflect upon some of …

The Limits Of Eu Hedge Fund Regulation, Dan Awrey

Cornell Law Faculty Publications

This article examines the mechanics of the recently adopted EU Alternative Investment Fund Managers Directive. On balance, the results of this examination are not encouraging. The EU has failed to mount a persuasive case for why the Directive represents an improvement over existing national regulatory regimes or prevailing market practices in several key areas. Furthermore, by attempting to shoehorn an economically, strategically and operationally diverse population of financial institutions into a single, artificial class of regulated actors, the EU has established what is in many respects a conceptually muddled regulatory regime. Most importantly, however, the Directive's approach toward the amelioration …

Creditors And Debt Governance, Charles K. Whitehead

Cornell Law Faculty Working Papers

This chapter from the book Research Handbook on the Economics of Corporate Law (Claire Hill & Brett McDonnell, eds.), provides an introduction to the law and economic theory relating to creditors and debt governance.

The chapter begins with a look at the traditional role of debt, focusing on the impact of debt on corporate governance and, in particular, the effect of an illiquid credit market on creditors’ reliance on covenants and monitoring. It then turns to changes in the private credit market and their effect on lending structure. Greater liquidity raises its own set of agency costs. In response, loans …

Wall Street As Community Of Fate: Toward Financial Industry Self-Regulation, Saule T. Omarova

Cornell Law Faculty Publications

This Article proposes an approach to regulatory design that aims to create structural incentives for the emergence of a new model of embedded self-regulation in the financial industry. Without a doubt, the ideas laid out in this Article are more of a thought experiment than a polished set of fully developed regulatory proposals. These ideas and suggestions need a great deal of additional thought and a deeper, more granular and rigorous analysis of their potential consequences, benefits, and costs. Moreover, this Article explores only how to create conditions conducive to the emergence of comprehensive industry self-regulation that is embedded in …

Risk, Speculation, And Otc Derivatives: An Inaugural Essay For Convivium, Lynn A. Stout

Cornell Law Faculty Publications

Speculative trading, including speculative trading in derivatives, is often claimed to provide social benefits by decreasing risk and improving the accuracy of market prices. This assumption overlooks the possibility that speculation can be driven not just by differences in traders' risk aversion and information investments, but also by differences in traders' subjective expectations. Disagreement-based speculation erodes traders' returns, increases traders' risks, and can distort market prices. There is reason to believe that by 2008, the market for OTC derivatives may have been dominated by disagreement-based speculation that contributed to the Fall 2008 credit crisis.

Destructive Coordination, Charles K. Whitehead

Cornell Law Faculty Publications

An important goal of financial risk regulation is promoting coordination. Law's coordinating function minimizes costly conflict and encourages greater uniformity among market participants. Likewise, privately developed market standards, such as standard-form contracts and rules incorporated into widely-used vendor technology systems, help to lower transaction costs partly by increasing coordination.

By contrast, much of financial economics is premised on a world without coordination. Basic tools used to manage financial risk presume that changes in asset prices follow a random walk and individuals buy and sell assets independently. Thus, a bedrock premise of traditional risk management is that a portfolio manager’s actions …

The Fsa, Integrated Regulation, And The Curious Case Of Otc Derivatives, Dan Awrey

Cornell Law Faculty Publications

With a view to better understanding the optimal structure of financial regulation, this paper tests prevailing theoretical hypotheses respecting the efficiency and overall desirability of integrated financial regulation relative to competing institutional models. This test is conducted through the lens of a comparative case study examining the approaches adopted by (fragmented) U.S financial regulators and the (integrated) UK Financial Services Authority (FSA) toward the myriad of regulatory challenges posed by the emergence, growth, and systemic importance of over-the-counter (OTC) derivatives markets. More specifically, this paper examines why, despite the numerous theoretical advantages of integrated regulation, the FSA adopted a non-interventionist …

Rethinking The Future Of Self-Regulation In The Financial Industry, Saule T. Omarova

Cornell Law Faculty Publications

In today's post-crisis world, arguing in favor of self-regulation in the financial services industry is sure to raise many eyebrows and invite significant disagreement. Much of the skepticism in this respect may be fully justified: the lack of truly effective incentives or political obstacles may ultimately foreclose the possibility of creating a new regime of embedded self-regulation aimed at detection and prevention of systemic financial risks. Nevertheless, as this Article sought to demonstrate, the realities of today's financial marketplace make it critically important that we give the idea of industry self-regulation a full consideration.

The main goal of this Article …

A Fixer-Upper For Finance, Robert C. Hockett

Cornell Law Faculty Publications

Three facts bear notice in connection with our current financial troubles. The first is that the First World War, before the Second began, was known as "the Great War." The second is that the global Depression that struck between those two wars, which for now we can still label "Great," commenced with the burst of a multiyear real estate price bubble prior to the 1929 stock market crash. The third is that the U.S. accordingly addressed that depression through mutually reinforcing new regimes not only of financial regulation, but also of home mortgage finance - the very reforms that brought …

Regulate Otc Derivatives By Deregulating Them, Lynn A. Stout

Cornell Law Faculty Publications

When credit markets froze up in the fall of 2008, many economists pronounced the crisis inexplicable and unforeseeable. Lawyers who specialize in financial regulation, and especially the small cadre who specialize in derivatives regulation, knew better.That's because the roots of the catastrophe lay not in changes in the markets, but changes in the law. In particular, the credit crisis can be traced to Congress's 2000 passage of the Commodity Futures Modernization Act, which radically altered the traditional legal approach to financial derivatives.

This shift in the legal treatment of financial derivatives has brought the banking system to its knees. The …

Regulate Otc Derivatives By Deregulating Them: Response To Comments, Lynn A. Stout

Cornell Law Faculty Publications

Response to comments by Jean Helwege, Peter Wallison, and Craig Pirrong on the author's article, "Regulate OTC Derivatives By Deregulating Them." Article predates the author's affiliation with Cornell Law School.

Risks, Rules, And Institutions: A Process For Reforming Financial Regulation, Saule T. Omarova, Adam Feibelman

Cornell Law Faculty Publications

It is fair to say that reforming the regulation of the financial sector is currently one of the most hotly debated issues on the policymaking agenda. Proposals for such reform are proliferating, and the official sector appears committed to adopting at least some meaningful reforms in the near-term. Broadly speaking, this movement toward regulatory reform emphasizes the need for structural reforms, outlines specific rules and regulations targeting primarily the perceived causes of the current crisis, and is carried along by a strong sense of the moment. Rather than add to the body of institutional and substantive proposals, this Article articulates …

The Quiet Metamorphosis: How Derivatives Changed The "Business Of Banking", Saule T. Omarova

Cornell Law Faculty Publications

In the wake of an unprecedented global financial crisis, one of the fundamental questions preoccupying policymakers and students of financial regulation worldwide is "How did we get here?" This Article uncovers and analyzes an important part of our recent regulatory history, which provides a key to understanding some of the deeper, hidden causes of the crisis but whose significance legal scholars have so far failed to appreciate.

The Article examines interpretive letters issued by the Office of the Comptroller of the Currency (OCC), the primary regulator of federally chartered U.S. banks, interpreting the National Bank Act of 1863 to allow …

Banking Supervision And Its Regulations — Comparative Study Between U.S. And China, Han Deng

Cornell Law School Inter-University Graduate Student Conference Papers

The health of the economy and the effectiveness of monetary policy depend on a sound financial system. A smoothly functioning banking supervision regime is one of the cornerstones of any financial system. Only a stable financial system, which is one of the key aims of state regulation and oversight, can optimally fulfill its macroeconomic function of efficient and low-cost transformation and provision of financial resources. A global financial meltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world. The primary goals of supervision and regulations include protecting depositors' funds, maintaining a stable monetary system, promoting an efficient …

The Evolution Of Debt: Covenants, The Credit Market, And Corporate Governance, Charles K. Whitehead

Cornell Law Faculty Publications

No abstract provided.

The New Crisis For The New Century: Some Observations On The "Big-Picture" Lessons Of The Global Financial Crisis Of 2008, Saule T. Omarova

Cornell Law Faculty Publications

The unprecedented scale and complex contagion effects of the current financial crisis, which rapidly spread across geographic borders and market segmentation lines, forcefully underscored the urgent need for policy-makers, financial regulators, and market participants around the world to develop a deeper substantive understanding of the fundamental changes in the dynamics of modern financial markets. Although, in a historical perspective, all financial crises tend to display certain basic commonalities, two key factors make the crisis of 2008 qualitatively different from the panics and crashes of the past centuries. First, this is the world's first truly global financial crisis. Second, this is …

Macro-Prudential Financial Regulation: Panacea Or Placebo?, Dan Awrey

Cornell Law Faculty Publications

No abstract provided.

How Deregulating Derivatives Led To Disaster, And Why Re-Regulating Them Can Prevent Another, Lynn A. Stout

Cornell Law Faculty Publications

When credit markets froze up in the fall of 2008, many economists pronounced the crisis both inexplicable and unforeseeable. That’s because they were economists, not lawyers.

Lawyers who specialize in financial regulation, and especially the small cadre who specialize in derivatives regulation, understood what went wrong. (Some even predicted it.) That’s because the roots of the catastrophe lay not in changes in the markets, but changes in the law. Perhaps the most important of those changes was the U.S. Congress’s decision to deregulate financial derivatives with the Commodity Futures Modernization Act (CFMA) of 2000.

Prior to 2000, off-exchange derivatives contracts …