Law Commons^™

Hazardous Hedging: The (Unacknowledged) Risks Of Hedging With Credit Derivatives, Gina-Gail S. Fletcher

Faculty Scholarship

Is hedging with credit derivatives always beneficial? The benefit of hedging with credit derivatives, such as credit default swaps, is presumed by the Dodd-Frank Act, which excludes hedge transactions from much of the new financial regulation. Yet, significant new risks can arise when credit derivatives are used to manage risks. Hedging, therefore, should be defined not only in relation to whether a transaction offsets risks, but also whether, on balance, the risks that are mitigated—as well as any new risks that arise—are outweighed by the potential benefits.

Regulators of the derivatives markets must consider the risks of hedging with credit …

A People’S History Of Collective Action Clauses, Mark C. Weidemaier, Mitu Gulati

Faculty Scholarship

For two decades, collective action clauses (CACs) have been part of the official-sector response to sovereign debt crisis, justified by claims that these clauses can help prevent bailouts and shift the burden of restructuring onto the private sector. Reform efforts in the 1990s and 2000s focused on CACs. So do efforts in the Eurozone today. CACs have even been suggested as the cure for the US municipal bond market. But bonds without CACs are still issued in major markets, so reformers feel obliged to explain why they know better. Over time, a narrative has emerged to justify pro-CAC reforms. It …

From Pigs To Hogs, Stephen J. Choi, Mitu Gulati

Faculty Scholarship

The question of whether, and to what extent, markets price contract terms in government bond issues has been one of considerable debate in the literature. We use a natural experiment thrown up by the Euro area sovereign debt crisis of 2010-2013 to test whether a particular set of contract terms – ones that gave an advantage to sovereign guaranteed bonds over garden variety sovereign bonds – was priced. These contract terms turned out to be important for the holders of guaranteed bonds during the Greek debt restructuring of 2012, where they helped the holders of guaranteed bonds escape the haircut …

Putting The Securities Laws To The Test: The Long-Standing Approach To Federal Securities Regulation Is Not Working, Elisabeth De Fontenay

Faculty Scholarship

No abstract provided.

The Governance Structure Of Shadow Banking, Steven L. Schwarcz

Faculty Scholarship

No abstract provided.

The Impact Of Income Disparity On Financial Regulation, Steven L. Schwarcz

Faculty Scholarship

No abstract provided.

Rollover Risk: Ideating A U.S. Debt Default, Steven L. Schwarcz

Faculty Scholarship

This article examines how a U.S. debt default might occur, how it could be avoided, its potential consequences if not avoided, and how those consequences could be mitigated. To that end, the article differentiates defaults caused by insolvency from defaults caused by illiquidity. The latter, which are potentiated by rollover risk (the risk that the government will be temporarily unable to borrow sufficient funds to repay its maturing debt), are not only plausible but have occurred in the past. Moreover, the ongoing controversy over the federal debt ceiling and the rise of the shadow-banking system make these types of defaults …

The Bankruptcy-Law Safe Harbor For Derivatives: A Path-Dependence Analysis, Steven L. Schwarcz, Ori Sharon

Faculty Scholarship

U.S. bankruptcy law grants special rights and immunities to creditors in derivatives transactions, including virtually unlimited enforcement rights. This article argues that these rights and immunities result from a form of path dependence, a sequence of industry-lobbied legislative steps, each incremental and in turn serving as apparent justification for the next step, without a rigorous and systematic vetting of the consequences. Because the resulting “safe harbor” has not been fully vetted, its significance and utility should not be taken for granted; and thus regulators, legislators, and other policymakers—whether in the United States or abroad—should not automatically assume, based on its …

The Governance Structure Of Shadow Banking: Rethinking Assumptions About Limited Liability, Steven L. Schwarcz

Faculty Scholarship

In an earlier article, I argued that shadow banking — the provision of financial services and products outside of the traditional banking system, and thus without the need for bank intermediation between capital markets and the users of funds — is so radically transforming finance that regulatory scholars need to rethink their basic assumptions. This article attempts to rethink the corporate governance assumption that owners of firms should always have their liability limited to the capital they have invested. In the relatively small and decentralized firms that dominate shadow banking, equity investors tend to be active managers. Limited liability gives …

Lawyers: Gatekeepers Of The Sovereign Debt Market?, Michael Bradley, Irving De Lira Salvatierra, Mitu Gulati

Faculty Scholarship

The claim that lawyers act as gatekeepers or certifiers in financial transactions is widely discussed in the legal literature. There has, however, been little empirical examination of the claim. We test the hypothesis that law firms have replaced investment banks as the gatekeepers of the market for sovereign debt. Our results suggest that hiring outside law firms sends a negative signal to the market regarding the pending issuance; a finding that is inconsistent with the thesis that outside law firms primarily play a certification role in the sovereign debt market.

Derivatives And Collateral: Balancing Remedies And Systemic Risk, Steven L. Schwarcz

Faculty Scholarship

No abstract provided.

The Functional Regulation Of Finance, Steven L. Schwarcz

Faculty Scholarship

No abstract provided.

Regulating Systemic Risk In Insurance, Daniel Schwarcz, Steven L. Schwarcz

Faculty Scholarship

As exemplified by the dramatic failure of AIG, insurance companies and their affiliates played a central role in the 2008 global financial crisis. It is therefore not surprising that the Dodd-Frank Act—the United States’ primary legislative re-sponse to the crisis—contained an entire title dedicated to insurance regulation, which has traditionally been the responsibility of individual states. The most important insurance-focused reforms in Dodd-Frank empower the Federal Reserve Bank to impose an additional layer of regulatory scrutiny on top of state insurance regulation for a small number of “systemically important” nonbank financial companies, such as AIG. This Article argues, however, that …

“Robbing Peter To Pay Paul”: Economic And Cultural Explanations For How Lower-Income Families Manage Debt, Laura M. Tach, Sara Sternberg Greene

Faculty Scholarship

This article builds upon classic economic perspectives of financial behavior by applying the narrative identity perspective of cultural sociology to explain how lower-income families respond to indebtedness. Drawing on in-depth qualitative interviews with 194 lower-income household heads, we show that debt management strategies are influenced by a desire to promote a financially responsible, self-sufficient social identity. Families are reluctant to ask for assistance when faced with economic hardship because it undermines this identity. Because the need to pay on debts is less acute than the need to pay for regular monthly expenses like rent or groceries, debts receive a lower …

Extraterritorial Impacts Of Recent Financial Regulation Reforms: A Complex World Of Global Finance, Lawrence G. Baxter

Faculty Scholarship

No abstract provided.

Towards More Sustainable And Less Crisis-Driven Financial Regulation, Steven L. Schwarcz

Faculty Scholarship

No abstract provided.

The Gathering Storm: Restructuring Sovereign Contingent Liabilities, Lee C. Buchheit, Mitu Gulati

Faculty Scholarship

The contingent liabilities of a sovereign, such as guarantees of the debts of third parties, can normally be kept off the balance sheet of the sovereign guarantor. That is their charm. As the debt to GDP ratios of many developed countries approach red-zone levels, contingent liabilities are increasingly being favored over direct, on-the-balance-sheet, borrowings.

But what happens if a country carrying large contingent liabilities needs to restructure its debt? The borrower dare not leave its contingent claims out of the restructuring. To do so would risk undermining the financial predicates of the sovereign’s economic recovery program should the beneficiaries of …

Götterdämmerung, Lawrence G. Baxter

Faculty Scholarship

In his panel remarks on the future direction of financial regulation after the 2012 elections, Professor Lawrence Baxter argues that the age of large banks and “too big to fail” is destined to come to an end, but not through the traditional avenue of governmental oversight. Baxter starts by detailing the warning signs that illuminate the unsustainable nature of the current financial model and moves to a discussion on the deficiencies of modern banking regulations. Some hope for an end to giant banking behemoths, Baxter finally posits, lies in stricter market discipline and a realization that smaller, less-complex banks provide …

Bypassing Congress On Federal Debt: Executive Branch Options To Avoid Default, Steven L. Schwarcz

Faculty Scholarship

Even a “technical” default by the United States on its debt, such as a delay in paying principal or interest due to Congress’s failure to raise the federal debt ceiling, could have serious systemic consequences, destroying financial markets and undermining job creation, consumer spending, and economic growth. The ongoing political gamesmanship between Congress and the Executive Branch has been threatening — and even if temporarily resolved, almost certainly will continue to threaten — such a default. The various options discussed in the media for averting a default have not been legally and pragmatically viable. This article proposes new options for …

Santa Anna And His Black Eagle: The Origins Of Pari Passu?, Benjamin Chabot, Mitu Gulati

Faculty Scholarship

One of the most debated issues in international finance is the meaning of the pari passu clause in sovereign bonds. The clause is ubiquitous; it is in almost every single foreign-law sovereign bond out there. Yet, almost no one seems to agree on its meaning. One way to cut the Gordian knot is to track down the origins of the clause. Modern lawyers may have simply copied the clause from the documents of their predecessors without understanding its meaning. But surely the people who first drafted the clause knew what it meant. Four enterprising students at Duke Law School may …

Do The Securities Laws Matter? The Rise Of The Leveraged Loan Market, Elisabeth De Fontenay

Faculty Scholarship

One of the enduring principles of federal securities regulation is the mantra that bonds are securities, while commercial loans are not. Yet the corporate bond and loan markets in the U.S. are rapidly converging, putting significant pressure on the disparity in their regulatory treatment. As securities, corporate bonds are subject to onerous public disclosure obligations and liability regimes, which corporate loans avoid entirely. This longstanding regulatory distinction between loans and bonds is based on the traditional conception of a commercial loan as a long-term relationship between the borrowing company and a single bank, in contrast to bonds, which may be …

Comments On The September 29, 2014 Fsb Consultative Document, ‘Cross-Border Recognition Of Resolution Action’, Steven L. Schwarcz, Mark Jewett, Bruce Leonard, Catherine Walsh, David Kempthorne

Faculty Scholarship

This CIGI Paper No. 51 was released on December 3, 2014 by the Centre for International Governance Innovation (CIGI) as a response to the Financial Stability Board’s (FSB) Consultative Document, “Cross-Border Recognition of Resolution Action.” Principally authored by CIGI Senior Fellow Steven L. Schwarcz (who works with the think tank’s International Law Research Program), the Paper comments on the policy measures proposed by the FSB, an international body that monitors and makes recommendations about the global financial system, to address the cross-border legal uncertainties of troubled systemically important financial firms. In that context, the Paper explains why a statutory approach …

Towards A “Rule Of Law” Approach To Restructuring Sovereign Debt, Steven L. Schwarcz

Faculty Scholarship

No abstract provided.