Law Commons^™

Sometimes Too Great A Notional: Measuring The “Systemic Significance” Of Otc Credit Derivatives, Erik F. Gerding, Margaret M. Blair

Erik F. Gerding

This article proposes several simple financial market reforms that can help regulators both identify systemically risky institutions and mitigate the systemic risk associated with derivative trading, especially trading in credit derivatives such as credit default swaps.

The Federal Reserve (or other systemic risk regulator) should require that financial institutions publicly disclose detailed information on all credit derivatives in their portfolio – including counterparties and notional value – on a frequent basis. The notional value of credit derivatives provides a gauge of the maximum amount the derivative seller must pay the buyer if the underlying credit instrument defaults. Although the notional …

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 …

Financial Crisis Containment, Anna Gelpern

Articles in Law Reviews & Other Academic Journals

This Article maps financial crisis containment - extraordinary measures to stop the spread of financial distress - as a category of legal and policy choice. I make three claims.

First, containment is distinct from financial regulation, crisis prevention and resolution. Containment is brief; it targets the immediate term. It involves claims of emergency, rule-breaking, time inconsistency and moral hazard. In contrast, regulation, prevention and resolution seek to establish sound incentives for the long term. Second, containment decisions deviate from non-crisis norms in predictable ways, and are consistent across diverse countries and crises. Containment invariably entails three kinds of choices: choices …

The Shadow Bankruptcy System, Jonathan C. Lipson

Jonathan C. Lipson

This article exposes and explores a puzzle at the heart of the current economic crisis: The surprising under-use, and increasing misuse, of Chapter 11 of the United States Bankruptcy Code, the principal legal system for salvaging troubled businesses.

The answer offered here: The rise of the shadow bankruptcy system. “Shadow bankruptcy” describes the severely under-regulated non-bank financial institutions (e.g., hedge funds, private equity funds and investment banks) that increasingly dominate and manipulate Chapter 11 reorganizations.

Like the “shadow banking” system for which it is named, shadow bankruptcy thrives on and promotes opacity and undisclosed, possibly perverse, incentives. Shadow bankruptcy players …

The Subprime Crisis And The Link Between Consumer Financial Protection And Systemic Risk, Erik F. Gerding

Erik F. Gerding

This Article argues that the current global financial crisis, which was first called the “subprime crisis,” demonstrates the need to revisit the division between financial regulations designed to protect consumers from excessively risky loans and safety-and-soundness regulations intended to protect financial markets from the collapse of financial institutions. Consumer financial protection can, and must, serve a role not only in protecting individuals from excessive risk, but also in protecting markets from systemic risk. Economic studies indicate it is not merely high rates of defaults on consumer loans, but also unpredictable and highly correlated defaults that create risks for both lenders …

Code, Crash, And Open Source: The Outsourcing Of Financial Regulation To Risk Models And The Global Financial Crisis, Erik F. Gerding

Erik F. Gerding

The widespread use computer-based risk models in the financial industry in the last two decades enabled the marketing of more complex financial products to consumers, the growth of securitization and derivatives, and the development of sophisticated risk management strategies by financial institutions. Over this same period, regulators increasingly delegated or outsourced vast responsibility for regulating risk in both consumer finance and financial markets to these private industry models. The proprietary risk models of financial institutions thus came to serve as a “new financial code” that regulated transfers of risk among consumers, financial institutions, and investors.

The spectacular failure of financial …

The Subprime Crisis And The Link Between Consumer Financial Protection And Systemic Risk, Erik F. Gerding

Publications

This Article will appear in a May 2009 symposium issue of the Florida International University Law Review on the global financial crisis. This Article argues that the current global financial crisis, which was first called the “subprime crisis,” demonstrates the need to revisit the division between financial regulations designed to protect consumers from excessively risky loans and safety-and-soundness regulations intended to protect financial markets from the collapse of financial institutions. Consumer financial protection can, and must, serve a role not only in protecting individuals from excessive risk, but also in protecting markets from systemic risk. Economic studies indicate it is …

Faith-Based Financial Regulation: A Primer On Oversight Of Credit Rating Organizations, Christopher L. Sagers, Thomas J. Fitzpatrick

Law Faculty Articles and Essays

In light of the present economic crisis and their role in it, the world seems suddenly keen to know more about the handful of private corporations--variously known as bond rating agencies, credit rating agencies, credit rating organizations (CROs), or the like--that rate the creditworthiness of corporate and government debt securities. By most accounts, these companies hold extensive sway in public capital markets, and for about thirty years, a few of them have enjoyed literally de jure delegation of federal regulatory oversight over much of the U.S. financial sector. With that power their ratings have value regardless of their accuracy, and …

Code, Crash, And Open Source: The Outsourcing Of Financial Regulation To Risk Models And The Global Financial Crisis, Erik F. Gerding

Publications

The widespread use of computer-based risk models in the financial industry during the last two decades enabled the marketing of more complex financial products to consumers, the growth of securitization and derivatives, and the development of sophisticated risk-management strategies by financial institutions. Over this same period, regulators increasingly delegated or outsourced vast responsibility for regulating risk in both consumer finance and financial markets to these privately owned industry models. Proprietary risk models of financial institutions thus came to serve as a "new financial code" that regulated transfers of risk among consumers, financial institutions, and investors.

The spectacular failure of financial-industry …

Financial Crisis Containment, Anna Gelpern

Georgetown Law Faculty Publications and Other Works

This Article maps financial crisis containment - extraordinary measures to stop the spread of financial distress - as a category of legal and policy choice. I make three claims.

First, containment is distinct from financial regulation, crisis prevention and resolution. Containment is brief; it targets the immediate term. It involves claims of emergency, rule-breaking, time inconsistency and moral hazard. In contrast, regulation, prevention and resolution seek to establish sound incentives for the long term. Second, containment decisions deviate from non-crisis norms in predictable ways, and are consistent across diverse countries and crises. Containment invariably entails three kinds of choices: choices …

Deeply Persistently Conflicted: Credit Rating Agencies In The Current Regulatory Environment, Timothy E. Lynch

Faculty Works

Credit rating agencies have a pervasive and potentially devastating influence on the financial well-being of the public. Yet, despite the recent passage of the Credit Rating Agency Reform Act, credit rating agencies enjoy a relative lack of regulatory oversight. One explanation for this lack of oversight has been the appeal of a self-regulating approach to credit rating agencies that claim to rely deeply on their reputational standing within the financial world. There are strong arguments for doubting this approach, including the conflicting self-interest of credit rating agencies whose profits are gained or lost depending on their ability to lure the …

Those Who Forget The Regulatory Successes Of The Past Are Condemned To Failure, William K. Black

Faculty Works

This paper shows that the reregulation of the savings & loan (S&L) industry was successful because the regulators correctly identified the primary cause of the second phase of the debacle as an epidemic of “accounting control fraud” and took effective measures to contain such frauds. Control frauds occur when the persons controlling a seemingly legitimate organization use it as a “weapon” to defraud. In the financial sector, accounting control fraud is the “weapon of choice.” The regulators’ primary insights were (1) that lenders optimize accounting fraud by engaging in a distinctive operational pattern that would be irrational for any honest …

The Three Or Four Approaches To Financial Regulation: A Cautionary Analysis Against Exuberance In Crisis Response, Lawrence A. Cunningham, David T. Zaring

GW Law Faculty Publications & Other Works

Unprecedented interest in financial regulation reform accompanies the nearly-unprecedented scale of financial calamity facing the world. Dozens of elaborate reform proposals are in circulation, most determined to revolutionize financial regulation. No doubt, the crisis makes reevaluation essential, but we contribute a cautionary analysis amid the exuberant atmosphere. Reforms should not discount the value of traditional financial regulation, overlook the functional regulatory reform that has already occurred, or overstate ultimate differences between contending reform proposals. Despite proliferation of dozens of reform proposals, our analysis leads us to conclude that there are ultimately only three or four principal alternatives: (1) the traditional …

Legal And Policy Choices In The Aftermath Of The Subprime And Mortgage Financing Crisis, Gerald Korngold

Articles & Chapters

This essay, delivered at a symposium at the University of South Carolina in October 2008 and forthcoming in South Carolina Law Review, sets out initial thoughts about to the legal and policy choices that decision makers must address in the aftermath of the subprime crisis that has since triggered a global financing crunch. After tracing a narrative of how subprime lending grew into a mortgage financing crisis and then a broader financial dislocation, the essay addresses two issues. First, while it is commonly stated that increased regulation will be required in secondary mortgage markets going forward, the essay explores competing …

The Subprime Crisis And The Link Between Consumer Financial Protection And Systemic Risk, Erik F. Gerding

Publications

This Article argues that the current global financial crisis, which was first called the “subprime crisis,” demonstrates the need to revisit the division between financial regulations designed to protect consumers from excessively risky loans and safety-and-soundness regulations intended to protect financial markets from the collapse of financial institutions. Consumer financial protection can, and must, serve a role not only in protecting individuals from excessive risk, but also in protecting markets from systemic risk. Economic studies indicate it is not merely high rates of defaults on consumer loans, but also unpredictable and highly correlated defaults that create risks for both lenders …

Redesigning The Sec: Does The Treasury Have A Better Idea?, John C. Coffee Jr., Hillary A. Sale

Faculty Scholarship

Symposiums supply a snapshot in time. By observing the common assumptions and shared frameworks of a collection of scholars writing contemporaneously, one gains both insight into the intellectual world of a past era and the ability to measure its distance from our own. Twenty-five years ago the Virginia Law Review organized a noted symposium (the "1984 Symposium") to celebrate the 50th anniversary of the SEC. A number of prominent scholars participated, and its articles have been much cited.

Leverage In The Board Room: The Unsung Influence Of Private Lenders In Corporate Governance, Frederick Tung

Faculty Scholarship

The influence of banks and other private lenders pervades public companies. From the first day of a lending arrangement, loan covenants and built-in contingency provisions affect managerial decision making. Conventional corporate governance analysis has been slow to notice or account for this lender influence. Corporate governance discourse has traditionally focused only on corporate law arrangements. The few existing accounts of creditors' influence over firm managers emphasize the drastic actions creditors take in extreme cases - when a firm is in serious trouble - but in fact, private lender influence is a routine feature of corporate governance even absent financial distress. …