1. Class 6- The Failure of Regulation? November 6, 2010
The Financial Crisis
Class 6- The Failure of Regulation?
November 6, 2010

2. Last Week We talked about the economic side of things
Macro: The housing bubble, the stock market crash, and gov’t response
Micro: What derivatives are and the role they played in the crisis.

3. This week
Regulation
Or more, precisely, lack of
What role did deregulation of the financial system play in the crisis?
What are the new regulations that have been put in place to stop another crisis from occurring?

4. Before the Great Depression
Not much regulation to begin with
Laissez-faire
If you wanted to leverage, you could do so easily
Not much government intervention

5. Glass-Steagall Act
There are technically two Glass- Steagall Acts, one of 1932 and of 1933
1933 one is what we most normally cite as THE “Glass-Steagall Act”
The latter one is more about regulation

6. Glass-Steagall Act 1933
Established the Federal Deposit Insurance Corporation
Stop bank runs and protect consumers
Enacted a separation of commercial and investment banking

7. Glass Steagall Act 1933 Investment Banking Commercial Banking
Issue securities
Proprietary trading: use the bank’s own money to invest and make money
Commercial Banking
What you normally consider “banking”
Take deposits, give out loans

8. Why the Glass-Steagall Act?
The FDIC part is obvious
You want to protect the consumers!
Separation of investment and commercial banking
Banks took on too much risk with depositor’s money
When they lost money, so did the depositors
Also, conflict of interest

9. Repeal of Glass-Steagall
Gramm-Leach-Bliley Act 1999
Repealed the separation of investment and commercial banking
Of course, FDIC is still in place
The “Chinese wall” is taken down

10. Arguments against the Repeal
It leads to conflict of interest that spurred the Act in the first place
Depository institutions are very important to the soundness of the financial system
If these were to go down as a result of securities losses, the effect would be dramatic.

11. Arguments for the Repeal
Tightly regulated US financial institutions are losing the fight against less regulated foreign counterparts
The investments that these banks go into are not very high risk

12. The Aftermath
The repeal of Glass-Steagall allowed bank holding companies to issue loans and trade securities based on those loans
Some believe that this repeal contributed to the crisis

13. Net Capital Rule
Rule created by the SEC (Securities and Exchange Commission) that limited the leverage ratio
They required brokerage firms to keep a certain amount of capital

14. 2004
In response to requests from major investment banks, SEC releases large i-banks from the Net Capital Rule
This allowed these banks to drastically increase their leverage

15. Basel III Accords
International framework for banking supervision and regulation
Tighter definition of common equity
More stringent capital requirement
Introduction of counter-cyclical capital buffers

16. Dodd-Frank Bill Created the Consumer Financial Protection Bureau
Ending too big to fail
Make banks come up with living wills
Volcker Rule
Separate proprietary trading from other parts of an investment bank