New York International Law Review Symposium St. John’s Law School, Jamaica, New York March 6, 2009...
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New York InternationalLaw Review Symposium St. John’s Law School, Jamaica, New York
March 6, 2009
New World Order: Can a global economy continue to be regulated on a non-global basis?
Presented by: A. JOYCE FURFERO, PH.D, J.D.
Tobin College of BusinessSt. John’s [email protected]
718.990.7350
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Epithets
Ignorance
Carelessness
Apathy
Indifference
Mismanagement
Greed
Incompetence
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The CULPRITS
SubprimeMortgages
Credit Default Swaps
CMORatings
Capital Adequacy
Requirements
FAS 157
No Capital Controls
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Domestic Banks
FAS157
FNMA/FHLMC
Insurance Cos &
Pension Plans
Hedge Funds& Private
Financial Cos
Foreign Banks
Individuals
creditdefault swaps
CMOs
Commercial Banks
-------------------Investment
Banks
Mortgagesjumbo
subprimeAlt-A
CommercialBanks
MortgageBankers
FederalRegulatorsFR, FDIC,
OCC
StateBanking
Depts
SECState
InsuranceDepts
RatingAgencies
FASB
Insurance Cos
Financial Regulatory Scheme
bondinsurance
OriginatorsPackagersEnd UsersPublic regulatorsPrivate companiesFinancial instrumentsInsurance products
Investment Banks & Dealers
OFHEO
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The HOLESMortgage Origination• unqualified borrowers• inadequate documentation• mismatch of borrower to mortgage instrument• unregulated securitization
Credit Ratings - improper AAA designations for CMOs
Credit Default Swaps - NO reserves
FAS 157 • Level 1, Level 2, Level 3 Assets• mark-to-market/mark-to-model
Capital Adequacy Requirements - too rigid enforcement
No Capital Controls - inflow/outflow of money/securities
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Mortgage OriginationBad loans versus loans that go bad
A “no brainer” for banks: • Establish credible lending standards• Qualify borrowers• Demand documentation• Tailor mortgages to borrowers ability to repay
A “no brainer” for regulators:• Hire more bank examiners• Inspect loans with great scrutiny• Raise required performance standards• Verify quality of collateral• Demand 100% compliance or close down
A “no brainer” for Congress: Review/revise CRA
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Credit RatingsReassess risk evaluation methods
• Diversification - How does it apply to pools of homogeneous assets like mortgage loans, auto loans, and credit card loans?
Reclassify derivatives, re: underlying asset
• Treated as securities rather than loans• Decouple look at underlying asset • Ask: can it be traded in the market - If yes, regulate it as a security (SEC) - If not, regulate it as a loan (FR, FDIC, OCC)
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Credit Default SwapsCall a spade a spade• If it looks like a duck and it quacks like a duck, it must be a duck. • Reclassify CDSs as insurance --- establish reserve requirements --- enforce minimum reserve ratios
Establish clearinghouse to keep track of CDSs• public (FR)/private (NYACH)• domestic (FR, NYACH)/international (BIS)
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FAS 157Problems• Artificially devalues assets • Forces unnecessary write-offs• Reduces shareholder wealth• Artificially reduces capital adequacy ratios
Solutions• Eliminate rigid enforcement of mark-to-market• Eliminate Level 1, Level 2, and Level 3 assets• Identify which assets can be marked to market and which cannot be marked to market • Eliminate mark-to-model • Require mark to-market ONLY when possible• Suspend minimum capital requirements
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The 10 Largest U.S. Banksas of December 31, 2008
Bank Name Total Assets Net IncomeJPMorgan Chase Bank, NA $1,746,242,000 $10,419,000 Bank of America, NA $1,471,631,047 $5,894,592Citibank, NA $1,231,154,000 ($2,101,000)Wachovia Bank, NA $635,476,000 ($511,000)Wells Fargo Bank, NA $538,958,000 $3,636,000 Wells Fargo Bank, NA* $1,174,434,000 $3,125,000U.S. Bank NA $261,775,591 $3,356,107Bank of New York Mellon $195,164,000 $1,235,000 SunTrust Bank $185,098,787 $975,730HSBC Bank USA, NA $181,604,079 ($1,589,714)State Street Bank & Tr. Co. $171,227,778 $1,814,088National City Bank $146,057,789 ($318,912)
*As of January 1, Wachovia was merged into Wells Fargo.
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Capital Adequacy Ratiosas of December 31, 2008
Bank Name Tier 1 Tier 2___ JPMorgan Chase Bank, NA 8.73 12.48Bank of America, NA 8.47 11.63Citibank, NA 9.94 15.18Wachovia Bank, NA 6.45 10.89Wells Fargo Bank, NA 7.26 10.79Wells Fargo Bank, NA* U.S. Bank NA 6.56 10.51Bank of New York Mellon 11.26 14.75SunTrust Bank 7.88 10.87HSBC Bank USA, NA 7.49 12.04 State Street Bank & Tr. Co. 19.76 21.28National City Bank 9.73 13.81Peer Group 10.58 12.54Required CA ratios 4.00 8.00
*As of January 1, Wachovia was merged into Wells Fargo.
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International Money Flows
Problem• NO capital controls• International contagion• Unidirectional transmission:
U.S. ROW
Solutions• Global organization• Global agreement• Domestic containment• Alternative solution
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Global Organization/Agreement
A Global Constitution???
• Detail powers of member countries• Achieve appropriate balance of powers -- between organization and member countries -- among member countries or -- otherwise, the countries will not comply • Tendency to cheat - self-interest • Needs common interest or effective enforcement mechanism to force compliance
キキ European airline cartel キキ OPEC
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Problems of Global Organization/Cooperation
Sovereignty versus global cooperation• Paul Volker – Plaza Accord (G-5), Louvre Accord (G-7)• Effectiveness of the World Court? WTO? IMF? IBRD?• European Monetary Union• Beggar thy neighbor policies
Lack of 100% cooperation• Grand Cayman Islands• Switzerland
Participants are not countries or national banks • Private, publicly-owned shareholder corps• A U.S. corp’s first obligation is to its shareholders
– to maximize shareholder wealth
Co-ordinator? The U.S., again??? Wolf by sheep’s door!!!
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Domestic Containment
Unidirectional transmission
• Much of the blame belongs to the U.S.
Back to basics - U.S. domestic regulation
• Mortgage origination and securitization • Credit ratings• Credit default swaps• FAS 157• Capital adequacy standards• Government-mandated capital controls ???
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Alternative Solution
Insurance for deposits and other liabilities• Current deposit guarantees must be honored in full• Other assets should be classified into one of three categories (Level 1, Level 2, Level 3): キ Fully insure (100% of value) for a
10% premiumキ Partially insure for 2/3 of valueキ Partially insure for 1/3 of value
Anti-contagion prevention • Insurance facility for other countries
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Conclusion
The global economy is probably
too large, too heterogeneous, too fluid, too self-interested, too nationalistic, too politically sovereign, and, currently, too fragile
for even the most sophisticated governments to cooperate effectively for any extended period of time.