Law Commons^™

Lessons Learned: William Nelson, Sandra Ward

Journal of Financial Crises

William Nelson was deputy director, Division of Monetary Affairs, at the Federal Reserve Board during the Global Financial Crisis of 2007–09 (GFC). As the nation’s central bank, chief financial regulator, and lender of last resort, the Federal Reserve Board took the lead in setting monetary policy and stabilizing the financial system during the crisis.

Nelson’s responsibilities at the Fed during the crisis included analysis of monetary policy and discount window policy as well as financial institution supervision, and he regularly briefed the board and the Federal Open Market Committee. He developed special expertise in designing liquidity facilities and was a …

The Rescue Of Fannie Mae And Freddie Mac–Module F: Federal Reserve’S Large-Scale Asset Purchase (Lsap) Program, Daniel Thompson, Adam Kulam

Journal of Financial Crises

By late 2008, the secondary mortgage markets were suffering high default rates, causing mortgage lending to slow and the value of mortgage securities to plummet. The Federal Reserve lowered the federal funds rate, and the government placed Fannie Mae and Freddie Mac into conservatorship, yet credit in housing and other financial markets remained tight. On November 25, the Fed announced its intent to purchase up to $500 billion in agency mortgage-backed securities (MBS) and $100 billion in agency debt to reduce the cost and increase the availability of mortgage credit, which would support housing markets and improve conditions in financial …

The Rescue Of Fannie Mae And Freddie Mac-Module B: Senior Preferred Stock Purchase Agreements, Daniel Thompson

Journal of Financial Crises

On September 6, 2008, as part of a four-part government intervention, the Federal Housing Finance Agency (FHFA) took into conservatorship the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), two government-sponsored enterprises (GSEs) that dominated the US secondary mortgage market. Concurrently, the FHFA, as conservator, entered into Senior Preferred Stock Purchase Agreements (SPSPAs) with Treasury, under which Treasury committed to provide funding to ensure the GSEs’ positive net worth. In return, Treasury received senior preferred stock and a warrant to purchase 79.9% of the GSEs’ common stock. The SPSPAs have been amended three …

The Rescue Of Fannie Mae And Freddie Mac – Module A: The Conservatorships, Daniel Thompson, Rosalind Z. Wiggins

Journal of Financial Crises

Two government-sponsored enterprises (GSEs), the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), dominated the secondary mortgage market during the US housing crisis, collectively holding or guaranteeing $5.3 trillion in mortgage assets by late 2007. As the crisis escalated, the two GSEs began to report substantial losses and their survival became uncertain. On September 6, 2008, the GSEs’ new regulator, the Federal Housing Finance Agency (FHFA), placed the firms into indefinite conservatorships, one step of a four-part government intervention to stabilize the enterprises. This case study evaluates the purpose and efficacy of the …

The Rescue Of American International Group Module F: The Aig Credit Facility Trust, Alec Buchholtz, Aidan Lawson

Journal of Financial Crises

In September 2008, American International Group, Inc. (AIG) experienced a liquidity crisis. To avoid the insurance giant’s bankruptcy, the Federal Reserve Bank of New York (FRBNY) extended an $85 billion emergency secured credit facility to AIG. In connection with the credit facility, AIG issued 100,000 shares of preferred stock, with voting rights equal to and convertible into 79.9% of the outstanding shares of AIG common stock, to an independent trust (the Trust) set up by the FRBNY. Three trustees held the stock for the sole benefit of the US Treasury, exercised the rights, powers, authorities, discretions, and duties of the …

The Rescue Of American International Group Module A: The Revolving Credit Facility, Alec Buchholtz, Aidan Lawson

Journal of Financial Crises

On September 15, 2008, the big three rating agencies downgraded AIG’s credit ratings multiple levels, exacerbating liquidity strains that the company was experiencing due to increasing cash demands by securities borrowers and collateral calls by credit default swap (CDS) customers. To prevent AIG from filing for bankruptcy, the Federal Reserve (the Fed) announced on the following day that, pursuant to its emergency powers, it would provide the company with an $85 billion Revolving Credit Facility (RCF). The RCF was secured by AIG assets and interests in its subsidiaries and required AIG to grant the US Department of the Treasury a …

The United Kingdom's Secured Commercial Paper Facility (U.K. Gfc), Claire Simon

Journal of Financial Crises

In mid-2009, the Bank of England (Bank) opened the Secured Commercial Paper Facility (SCPF) as part of its larger Asset Purchase Facility (APF). Through the facility, the Bank offered to purchase secured commercial paper (SCP), a form of asset backed commercial paper, issued by approved programs from both dealers acting as principal in the primary market and after issue from secondary market holders. The facility was designed to establish the Bank as a ready buyer of SCP in the primary market and as a backstop purchaser in the secondary market. In extending the APF to include purchases of SCP, the …

The European Central Bank's Securities Markets Programme (Ecb Gfc), Ariel Smith

Journal of Financial Crises

The Eurozone struggled during the escalation of the sovereign debt crisis in 2010. In order to aid malfunctioning securities markets, restore liquidity, and enable proper functioning of the monetary policy transmission mechanism, the European Central Bank (ECB) instituted the Securities Markets Programme (SMP) on May 9, 2010. This program enabled Eurosystem central banks to purchase securities from entities in Greece, Ireland, Portugal, Italy, and Spain. The program ended on September 6, 2012, and evaluations of its effectiveness are mixed.

The Commercial Paper Funding Facility (U.S. Gfc), Rosalind Z. Wiggins

Journal of Financial Crises

In mid-September 2008, prime money market mutual funds (MMMFs) began experiencing run-like redemption requests sparked by one fund that had “broken the buck” because of large exposure to Lehman Brothers commercial paper (CP). As a result, MMMFs, which are significant investors in CP, became reluctant to hold CP. Within a week, outstanding CP had been reduced by roughly $300 billion. The CP market experienced severe shortening of maturities and increased rates, making it difficult for issuers to place new paper. When government efforts to assist the MMMFs did not resolve the stresses in the CP market, the Federal Reserve announced, …

Solvency As A Fundamental Constraint On Lolr Policy For Independent Central Banks: Principles, History, Law, Sir Paul M. W. Tucker

Journal of Financial Crises

This paper follows up earlier work advocating a principled modernization of doctrines for central bank lender-of-last-resort policies and operations. It argues for a new Fundamental Constraint on such authorities: namely, “the principle that central banks should not lend to firms that they know (or should know) to be fundamentally bust or broken.” Tucker supports this with commentary from various peers, a review of principles underlying bankruptcy law and resolution schemes, and by deconstructing other common counterarguments. Centrally, he argues that when central banks breach the Fundamental Constraint, they distribute resources to short-term creditors at the expense of longer-term creditors, …

Restructuring And Forgiveness In Financial Crises D: The Japanese Financial Crisis Of The 1990s, Christian M. Mcnamara, Andrew Metrick

Journal of Financial Crises

In November 1997 the Japanese government confronted a problem of enormous proportions when the turmoil that had been roiling the financial markets since the collapse of a real estate and stock market asset bubble in 1990 reached a crescendo with the failure of four major financial institutions in quick succession in the space of a month. Prior to these failures, the damage done by the collapsing bubble had seemed to be limited to certain segments of the financial landscape, and the government’s response consisted largely of targeted intervention when necessary for clearly insolvent financial institutions, with a more comprehensive approach …

Restructuring And Forgiveness In Financial Crises C: The Swedish Banking Crisis Of 1990-94, Christian M. Mcnamara, Dr. Lars Thunell, Andrew Metrick

Journal of Financial Crises

In the Spring of 1992, the Swedish government faced a dilemma. The country was in the midst of an economic downturn stemming from the collapse of asset prices (especially in real estate) that had spiked as a result of a credit boom that followed the deregulation of the Swedish banking system in the mid-1980s. Initially the impact of the downturn on the country’s banks had seemed to be limited to a small number of specific firms that the government moved to assist on an ad hoc basis in 1991. However, evidence was mounting that the banking crisis was reaching a …

Restructuring And Forgiveness In Financial Crises B: The Asian Crisis Of 1997, June Rhee, Andrew Metrick

Journal of Financial Crises

Asia’s economy, Thailand in particular, was booming when the financial crises hit in the 1990s. However, troubles were brewing underneath the seemingly buoyant economy. With a fragile financial system and ineffective domestic government responses to these troubles, an exchange rate crisis took over Thailand, and this crisis started a financial contagion in the neighboring countries. This case reviews the background and domestic government responses to contain the crisis, and the international intervention provided by the International Monetary Fund including the assistance and the required reforms accompanying the support.

Guarantees And Capital Infusions In Response To Financial Crises B: U.S. Guarantees During The Global Financial Crisis, June Rhee, Andrew Metrick

Journal of Financial Crises

During 2008-09, the federal government extended multiple guarantee programs in an effort to restore the financial market and contain the panic and crisis in the market. For example, the Treasury provided a temporary guarantee program for the money market funds, the FDIC decided to stand behind certain debts and non-interest-bearing transaction accounts, and the Treasury, the FDIC, and the Federal Reserve agreed to share losses in certain assets belonging to Citigroup. This case reviews these guarantee programs implemented during the global financial crisis by the government and explores the different rationale that shaped certain design features of each program.

Guarantees And Capital Infusions In Response To Financial Crises A: Haircuts And Resolutions, June Rhee, Andrew Metrick

Journal of Financial Crises

After the mortgage market meltdown in mid-2007 and during the financial crisis in 2008, major financial institutions around the world were on the verge of collapsing one after another. Faced with these troubles, the government had to respond quickly to contain the crisis as efficiently as possible. It was, however, limited in resources, time, and experience. To make matters worse, the complexity and opaqueness of the financial market and these institutions greatly affected the government’s ability to design an efficient and consistent method to contain the crisis. Shortly after Lehman Brothers filed for bankruptcy on September 15, 2008, American International …

The Legal Authorities Framing The Government’S Response To The Global Financial Crisis, Scott G. Alvarez Esq., Thomas C. Baxter Jr., Esq., Robert F. Hoyt Esq.

Journal of Financial Crises

The 2007–09 global financial crisis required that the Federal Reserve, Treasury Department and Federal Deposit Insurance Corporation survey their various legal authorities and consider how they might be used to mitigate the meltdown of the United States financial system. This essay explores the range of legal authorities and procedural issues presented by key facilities implemented during the crisis, many of which were new and creative. This essay also provides valuable examples of how such authorities were used and describes how, in some instances, agencies worked together to design innovative interventions that no separate agency could have achieved alone.

Basel Iii G: Shadow Banking And Project Finance, Christian M. Mcnamara, Andrew Metrick

Journal of Financial Crises

The Net Stable Funding Ratio (NSFR), a liquidity standard introduced by Basel III, seeks to promote a better match between the liquidity of a bank’s assets and the manner in which the bank funds those assets. The NSFR requires banks to maintain a minimum amount of funding deemed “stable” by the Basel framework based on the liquidity of the banks’ assets and activities over a one-year timeframe. One of the areas seen as most affected by this development may be bank participation in project finance for infrastructure development. Since the global demand for infrastructure development remains robust, the shadow banking …

Basel Iii F: Callable Commercial Paper, Christian M. Mcnamara, Rosalind Bennett, Andrew Metrick

Journal of Financial Crises

One of the Basel Committee on Banking Supervision’s responses to the global financial crisis of 2007-09 was to introduce the Liquidity Coverage Ratio (LCR), a short-term measure that evaluates whether a bank has enough liquidity to meet expected cash outflows during a 30-day stress scenario. One area in which this incentive has already resulted in changed practices is in the market for commercial paper. Banks often provide backup liquidity facilities to the issuers of commercial paper that the issuers can draw upon to repay a maturing issue of commercial paper if they are unable to sell a new issue to …

Basel Iii E: Synthetic Financing By Prime Brokers, Christian M. Mcnamara, Andrew Metrick

Journal of Financial Crises

Hedge funds rely on “prime brokerage” units within banks to provide leverage. With the enhanced capital requirements and new liquidity standards introduced by Basel III driving up the cost to banks of engaging in such financing, prime brokers have begun to offer an alternative means of providing hedge fund clients with leveraged exposure to securities. Known as synthetic financing, this alternative requires the prime broker to enter into derivatives contracts with the clients. Under the Basel III framework, the ability of banks to hedge and net such derivative positions results in capital and liquidity costs for synthetic financing that are …

Basel Iii D: Swiss Finish To Basel Iii, Christian M. Mcnamara, Natalia Tente, Andrew Metrick

Journal of Financial Crises

After the Basel Committee on Banking Supervision (BCBS) introduced the Basel III framework in 2010, individual countries confronted the question of how best to implement the framework given their unique circumstances. Switzerland, with a banking industry that is both heavily concentrated and very large relative to the size of its overall economy, faced a special challenge. It ultimately adopted what is sometimes referred to as the “Swiss Finish” to Basel III—enhanced requirements applicable to Switzerland’s “too-big-to-fail” banks Credit Suisse and UBS that go beyond the base requirements established by the BCBS. Yet the prominent role played by relatively new contingent …

Basel Iii B: Basel Iii Overview, Christian M. Mcnamara, Michael Wedow, Andrew Metrick

Journal of Financial Crises

In the wake of the financial crisis of 2007-09, the Basel Committee on Banking Supervision (BCBS) faced the critical task of diagnosing what went wrong and then updating regulatory standards aimed at preventing it from occurring again. In seeking to strengthen the microprudential regulation associated with the earlier Basel Accords while also adding a macroprudential overlay, Basel III consists of proposals in three main areas intended to address 1) capital reform, 2) liquidity standards, and 3) systemic risk and interconnectedness. This case considers the causes of the 2007-09 financial crisis and what they suggest about weaknesses in the Basel regime …

Basel Iii A: Regulatory History, Christian M. Mcnamara, Thomas Piontek, Andrew Metrick

Journal of Financial Crises

From the earliest efforts to mandate the amount of capital banks must maintain, regulators have grappled with how best to accomplish this task. Until the 1980s, regulation had been based largely on discretion and judgment. In the wake of two bank failures, the central bank governors of the G10 countries established the Basel Committee on Banking Supervision (BCBS) and in 1988, the BCBS introduced a capital measurement system, Basel I. The system represented a triumph of the fixed numerical approach, however, critics worried that it was too blunt an instrument. In 1999, the BCBS issued Basel II, a proposal to …

Jpmorgan Chase London Whale Z: Background & Overview, Arwin G. Zeissler, Rosalind Bennett, Andrew Metrick

Journal of Financial Crises

In December 2011, the Chief Executive Officer and Chief Financial Officer of JPMorgan Chase (JPM) instructed the bank’s Chief Investment Office to reduce the size of its Synthetic Credit Portfolio (SCP) during 2012, so that JPM could decrease its Risk-Weighted Assets as the bank prepared to adopt the impending Basel III bank capital regulations. However, the SCP traders were also told to minimize the trading costs incurred to reduce Risk-Weighted Assets, while still maintaining the opportunity to profit from unexpected corporate bankruptcies. In an attempt to balance these competing objectives, head SCP derivatives trader Bruno Iksil suggested in January 2012 …

Incorporating Macroprudential Financial Regulation Into Monetary Policy, Aaron Klein

Journal of Financial Crises

This paper proposes two insights into financial regulation and monetary policy. The first enhances understanding the relationship between them, building on the automobile metaphor that describes monetary policy: when to accelerate or brake for curves miles ahead. Enhancing the metaphor, financial markets are the transmission. In a financial crisis, markets cease to function, equivalent to a transmission shifting into neutral. This explains both monetary policy’s diminished effectiveness in stimulating the economy and why the financial crisis shock to real economic output greatly exceeded central bank forecasts.

The second insight is that both excess leverage and fundamental mispricing of asset values …

European Banking Union D: Cross-Border Resolution—Dexia Group, Rosalind Z. Wiggins, Natalia Tente, Andrew Metrick

Journal of Financial Crises

In September 2008, Dexia Group, SA, the world’s largest provider of public finance, experienced a sudden liquidity crisis. In response, the governments of Belgium, France, and Luxembourg provided the company a capital infusion and credit support. In February 2010, the company adopted a European Union (EU)-approved restructuring plan that required it to scale back its businesses and cease proprietary trading. In June 2011, Dexia withdrew from the government-sponsored credit support program before its expiration date, and in July, the company announced that it had passed an EU stress test. However, just three months later, Dexia wrote down its substantial position …

European Banking Union C: Cross-Border Resolution–Fortis Group, Rosalind Z. Wiggins, Natalia Tente, Andrew Metrick

Journal of Financial Crises

In August 2007, Fortis Group, Belgium’s largest bank, acquired the Dutch operations of ABN AMRO, becoming the fifth largest bank in Europe. Despite its size and its significant operations in the Benelux countries, Fortis struggled to integrate ABN AMRO. Fortis’s situation worsened with the crash of the US subprime market, which impacted its subprime mortgage portfolio. By July 2008, Fortis’s CEO had stepped down, its stock had lost 70% of its value, and it was on the verge of collapse due to a severe liquidity crisis. The governments of Belgium, Luxembourg, and the Netherlands quickly came together and agreed to …

European Banking Union B: The Single Resolution Mechanism, Rosalind Z. Wiggins, Michael Wedow, Andrew Metrick

Journal of Financial Crises

The options available to European governments to respond to a multinational bank in financial trouble have been severely limited since each country has its own unique laws and authority applicable to banks operating within its borders. The Bank Recovery & Resolution Directive (BRRD), which was adopted in 2013 and scheduled to go into effect January 2015, harmonizes rules across EU countries for how to restructure and resolve failing banks. However, the directive would maintain the existing system of individual national resolution authorities and resolution funds. To better secure the Eurozone banks and to compliment the Single Supervisory Mechanism, which was …

European Banking Union A: The Single Supervisory Mechanism, Rosalind Z. Wiggins, Michael Wedow, Andrew Metrick

Journal of Financial Crises

At the peak of the Global Financial Crisis in fall 2008, each of the 27 member states in the European Union (EU) set many of its own banking rules and had its own bank regulators and supervisors. The crisis made the shortcomings of this decentralized approach obvious, and since its formation in January 2011, the European Banking Authority (EBA) has been developing a “Single Rulebook” that will harmonize banking rules across the EU countries. In June 2012, European leaders went even further, committing to a banking union that would better coordinate supervision of banks in the then 18-country Eurozone. A …

European Central Bank Tools And Policy Actions B: Asset Purchase Programs, Chase P. Ross, Rosalind Z. Wiggins, Andrew Metrick

Journal of Financial Crises

Beginning in August 2007, the European Central Bank (ECB) used standard and non-standard monetary policies as the global financial markets progressed from initial turmoil to a widespread sovereign debt crisis. This case describes the key features of the ECB’s asset purchase programs throughout the Global Financial Crisis and subsequent European sovereign debt crisis. These programs include the Covered Bond Purchase Programs (CBPP1, CBPP2, CBPP3), Securities Markets Program (SMP), Outright Monetary Transactions (OMT), Asset-backed Securities Purchase Program (ABSPP) and the Public Sector Purchase Program (PSPP).

In combating the crises, the ECB designed various innovative programs which it successively employed as the …

Ireland And Iceland In Crisis C: Iceland’S Landsbanki Icesave, Arwin G. Zeissler, Thomas Piontek, Andrew Metrick

Journal of Financial Crises

At year-end 2005, almost all of the total assets of Iceland’s banking system were concentrated in just three banks (Glitnir, Kaupthing, and Landsbanki). These banks were criticized by certain financial analysts in early 2006 for being overly dependent on wholesale funding, much of it short-term, that could easily disappear if creditors’ confidence in these banks faltered for any reason. Landsbanki, followed later by Kaupthing and then Glitnir, responded to this criticism and replaced part of their wholesale funding by using online accounts to gather deposits from individuals across Europe. In Landsbanki’s case, these new deposits were marketed under the name …