Eight more states have joined a lawsuit challenging the constitutionality of various provisions of the Dodd-Frank financial reform law. The states are Alabama, Georgia, Kansas, Montana, Nebraska, Ohio, Texas and West Virginia. As three states (Oklahoma, Michigan, and South Carolina) had already brought suit, this brings the total number of states involved in the suit to eleven.
UPenn’s David Zaring comments in Dealbook:
Courts are supposed to put the policies of presidents and Congress to the test of judicial review, to evaluate decisions by the executive to sanction someone for wrongdoing and to resolve disputes between private parties. But the really sweeping programs that Congress and the president put in place during the financial crisis will not receive much courtroom attention at all, even as the executive’s individual enforcement decisions receive scrutiny. It is only in private disputes that the facts of the financial crisis will get a judicial airing – and even then, all signs point to the airing being a modest one.
The courts have played such a low-key role for three reasons: the government has rarely been challenged for its own crisis-related conduct; at the same time, the Justice Department and other federal agencies have hesitated to prosecute the financial executives in place during the crisis; finally, private litigation over losses sustained during the crisis has been slow to develop, and quick to settle. In all, it is likely to be a disappointment to those who believe that the blame for the financial crisis can only really be apportioned through verdicts and judgments. . . .
In many ways, this modest turn to the courts is underwhelming. Practicing finance during a recession should not necessarily be a criminal offense, but holding no executives responsible for the actions that led to the housing market collapse, after hundreds were imprisoned during earlier downturns, suggests arbitrariness. Even worse, it sets a different standard for Wall Street financiers of today and the bankers who went to jail in the wake of the 1980s bailout of the thrifts.
And while the government has been criticized for not holding individuals accountable for the crisis, the really huge decisions it made
“Yes, it did,” is the conclusion of a new NBER study of bank lending behavior, “Did the Community Reinvestment Act (CRA) Lead to Risky Lending?” by Sumit Agarwal, Efraim Benmelech, Nittai Bergman, Amit Seru, Here’s the abstract, which begins uncharacteristically with direct answer to the question in the paper’s title:
Yes, it did. We use exogenous variation in banks’ incentives to conform to the standards of the Community Reinvestment Act (CRA) around regulatory exam dates to trace out the effect of the CRA on lending activity. Our empirical strategy compares lending behavior of banks undergoing CRA exams within a given census tract in a given month to the behavior of banks operating in the same census tract-month that do not face these exams. We find that adherence to the act led to riskier lending by banks: in the six quarters surrounding the CRA exams lending is elevated on average by about 5 percent every quarter and loans in these quarters default by about 15 percent more often. These patterns are accentuated in CRA-eligible census tracts and are concentrated among large banks. The effects are strongest during the time period when the market for private securitization was booming.
UPDATE: There’s a discussion about the paper at Marginal Revolution. Note that the paper does not claim that the CRA was the cause of the financial crisis. As Tyler Cowen notes, the claim is that the CRA was an “amplifying mechanism” — a contributing factor to the severity of the crisis, but hardly the only contributing (or causal) factor. [...]
Former White House counsel Boyden Gray and Adama White explain how Dodd-Frank effectively subsidizes large financial institutions at the expense of smaller institutions and “Main Street.” Gray and White are also representing some of the plaintiffs who are challenging Dodd-Frank’s constitutionality (see here and here). [...]
A news release from the Competitive Enterprise Institute notes that the attorneys general of Michigan, Oklahoma, and South Carolina have joined their lawsuit challenging the constitutionality of portions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The original suit challenged several Dodd-Frank provisions, including creation of the Consumer Financial Protection Board. The states’ challenge focuses on Title II’s “orderly liquidation authority,” which allows the federal government to seize allegedly troubled financial institutions with minimal notice or recourse. According to the states, these provisions lack adequate due process and could threaten state pension funds. Here’s the amended complaint. [...]
“I was an advocate of the deregulation movement and I made — along with a lot of other smart people — a fundamental mistake, which is that deregulation works fine in industries which do not pervade the economy,” he said in the appearance on Spitzer’s viewpoint.” “The financial industry undergirded the entire economy and if it is made riskier by deregulation and collapses in widespread bankruptcies as what happened in 2008, the entire economy freezes because it runs on credit.”
Michael Greve [my GMU colleague]:
The mea culpa—hedged with a supercilious “I may have started it but conservatism got out of hand” aside—fails to satisfy minimum standards of intellectual coherence and empirical evidence.
The suggestion that the markets that produced the 2008 financial crisis were “free”—in the sense of unregulated—is charitably described as contrary to fact. The money that juiced the markets wasn’t supplied by some reckless profiteer; it was supplied by the Fed. The GSE’s that by everyone’s admission contributed (and on many accounts caused) the disaster operated (and are still operating) with government guarantees.
Similarly, but more broadly: the financial system operated and continues to operate against the rule that depositors—unlike shareholders, bondholders, vendors, employees, or anybody else—will in the event of failure get 100 cents on the dollar. That arrangement encourages banks to play with somebody else’s money. It is not a “free market” rule. It is a law and a regulation, and the source of a convoluted system that desperately tries to cope with the risks of its own creation by piling layer upon regulatory layer.
It’s true that if you “deregulate” one piece of a market that’s already shot through with government regulation, subsidies, guarantees, and warped incentives, you can increase risk further and get very bad results. Maybe that’s what happen in the
The New York Times Room for Debate Blog, where various Conspirators have served as discussants one time or another, has a very interesting discussion on whether and in what respects the financial crisis might have been avoided. It’s a good short read. From the introduction:
Last week, the Financial Crisis Inquiry Commission, after reviewing thousands of documents, issued a report, which explained the causes of the financial unraveling, the role of government and the banks, and the aftershocks of the crisis. The 10-member commission, however, split along party lines, with the six Democrats voting to adopt the report and its findings, and the four Republican members issuing two dissenting reports. On NPR, Keith Hennessey, one of the Republican commissioners, said that the disagreement could perhaps be boiled down to one statement in the majority report: “We conclude this financial crisis was avoidable.”
The report, majority and dissents, is well worth reading as well. I agree with some of the criticisms that it is too much narrative history and too little analysis, but there’s still value in creating a record of what happened for its own sake.
What are the books specifically about the financial crisis 2007-2009 that that you would put on the genuinely short list for reading? [...]
(Update. Megan McArdle has a number of interesting comments and posts on foreclosure, modification, the effect of securitization, and the processes for recording title and other things. This blog post has very interesting comments as well.)
Adam Levitin writes at the ForeclosureBlues blog about the Ibanez decision in the Supreme Judicial Court of Massachusetts (pdf via Creditslips blog), handed down last Friday. (Actually, I think Adam’s post originated at CreditSlips.) This is an important decision in addressing the exceedingly vexed and, as Megan McArdle notes, highly technical legal questions surrounding the property issues – chain of title, etc. – in foreclosures on mortgages that have been securitized. Levitin offers this assessment of the holding in Ibanez (I recommend also his article with Anna Gelpern, Rewriting Frankenstein Contracts):
The Ibanez case itself is actually very simple. The issue before the court was whether the two securitization trusts could prove a chain of title for the mortgages they were attempting to foreclose on.
There’s broad agreement that absent such a chain of title, they don’t have the right to foreclose–they’d have as much standing as I do relative to the homeowners. The trusts claimed three alternative bases for chain of title:
(1) that the mortgages were transferred via the pooling and servicing agreement (PSA)–basically a contract of sale of the mortgages
(2) that the mortgages were transferred via assignments in blank.
(3) that the mortgages follow the note and transferred via the transfers of the notes.
The Supreme Judicial Court (SJC) held that arguments #2 and #3 simply don’t work in Massachusetts. The reasoning here was heavily derived from Massachusetts being a title theory state, but I think a court in a lien theory state could easily reach the same result. It’s hard to predict if other states will
(Note: I was writing this on the plane without quite being able to see the computer screen, so I’ve gone back and corrected some grammar and spelling, and tried to make a couple of things clearer. I’ll post separately as well on the topic of national security and the financial crisis, and the role of executive discretion in responding. But I also wanted to note that over at The Conglomerate, the compadres there are also having a discussion of Professor Skeel’s book, including my friend David Zaring, who, along with the redoubtable Steven Davidoff, was responsible for a seminal article and concept in this question of discretionary regulation, “Regulation by Deal.”)
Flying to and from meetings this week at the Hoover Institution, I re-read David Skeel’s brand-new book, The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences (Wiley 2011), for a second time. I am even more impressed with this book the second time around, and I believe that it is one of the short list of essential books on the financial crisis and the regulatory aftermath. If you have any interest at all in these topics, this is a book to give serious consideration to reading.
The New Financial Deal is very far from being a dense, specialist book readable only by a lawyer, or law professor, or bankruptcy or finance expert. You might guess from the title that the book is a technically useful, but, for the general reader, impenetrable commentary on the Dodd-Frank bill. After all, the bill itself runs several thousand pages of impenetrable legislative language and Skeel himself one of the country’s leading bankruptcy scholars. It might seem from the title that it is simply an unpacking – at the technical level – of what Dodd-Frank says. Technical experts [...]
I am curious as to whether any law school offers a (seminar?) course on the law and regulation of central banking, either specifically on the Fed in US domestic law or else something like “comparative central banking” in the transnational law curriculum. I’d be interested in responses as to courses, syllabi, reading, and course topics. Serious responses please; no rants or off topic responses. (Let me add that I don’t mean exactly what typically features in the banking course, which is, in my experience, less about the law governing central banking than the legal mechanisms by which the central bank interacts with the rest of the banking and financial services sector. They are not quite the same thing.)
The legal powers of the Fed – and their limits, regulatory, statutory, and Constitutional – are obviously a question of importance today. The financial crisis, the response, and the continuing unemployment rate make the question of the Fed’s mandate, independence, and limits germane in a way that has only rarely been true in the economic history of the US since creation of the Federal Reserve. Consider one of the latest arguments – will the Fed move to monetize the fisc, meaning the fiscal deficits of states and municipalities, as a source of – not liquidity of last resort – but instead as a provider of solvency? A George Will column expressed the concern, set against public pension issues, this way:
People seeking backdoor bailouts hope that the fourth branch of government, a.k.a. Ben Bernanke, will declare an emergency power for the Federal Reserve to buy municipal bonds to lower localities’ borrowing costs. This political act might mitigate one crisis by creating a larger one – the Fed’s forfeiture of its independence.
Will obviously has a side in this debate, but that [...]
Over at the business law professor blog, The Conglomerate, the book club has been reading Bethany McLean and Joe Nocera’s book on the run-up to the financial crisis, All the Devils Are Here: The Hidden History of the Financial Crisis. David Zaring introduces the book, his brief take, and the book club discussion here - then scroll up for the other mini-reviews and comments. The Conglomerators think the book is worth reading, and I’ve just ordered it. (For my own part, I have just finished a second, closer read of David Skeel’s The New Financial Deal, which is outstanding, and on which I’ll post a short review later.) [...]
Although I have a few reservations about the tone of the article being just slightly conspiratorial, Louise Story’s front page NYT story today on the evolution of derivatives clearinghouses is highly informative and very well done. The graphics showing how the bilateral trades would turn into centralized clearing are quite good and would be useful with a class. On balance, I think the overall shift to centralized clearing is a good move. But I also have a bad, bad feeling about this in the context of Dodd-Frank and future expectations. As I have said in past posts, in a future of financial regulation in which the central question of systemic risk and moral hazard has not been addressed, the result of what is otherwise a sensible move (yes, yes I’m skipping over all the concerns about end-users and Main Street, etc.) could turn out to create not so much a central clearing house but instead … a central address for depositing unwanted risk.
After all, why should any of these leading market participants believe at this point that the government would allow the central clearinghouse to burn down in a crisis? And if they don’t believe that, then what is their incentive to set terms that will adequately address the risk as a matter of private ordering of fees, margin, whatever form of insurance the central risk-clearer needs? Having a central clearing counterparty is a great idea – if it and the actors that run and control it have the private incentives to make sure it is not a mechanism for accumulating and compounding risks.
Presumably the answer is that government regulators will set those requirements and solve the problem. But the general theory of financial regulation used to be that systems would be monitored for risk-taking, after private parties [...]
The Wall Street Journal and New York Times each have good, comprehensible explanations of the eurozone sovereign debt crisis on the front pages today. (The Journal has a particularly useful graphic that breaks out each country.) [...]
While I wait for David Skeel and William Cowan’s new book on the Dodd-Frank financial reform bill to appear next month (The New Financial Deal), I have tried to make my own assessment of what the bill means in the aggregate. In order to do this, I have read the bill in its entirety twice. The first time was when the bill was first passed, and this was in order to see if anything in it took me by total surprise. That amounts to a search for particular nuggets that jump out at you, not the “totality” of the bill. I’ll add that he experience of reading the entire thing as a “thing” made clear to me why “reading” bills before you pass them, if it is a good idea, needs to mean “reading” in a really different way. You have to read the bill with all the cross references to other legislation being amended to hand in advance, and a staff of experienced people to make sure that you know the context into which this change or that fits. One hopes, of course, that this was also part of the drafting of the bill … but let’s pass over that detail. (Update: I just ordered Skeel-Cowan from Amazon.)
The second time around reading it was not for nuggets, but instead to try and understand the whole thing, as a comprehensive thing. I realize that this makes little sense given that it is not a “thing” but an agglomeration of many things, some of which fit together and some of which don’t. But this second time, I read it with some research help, and more importantly with the several hundred page bill summary to hand. This was partly to understand the bill, but partly to get a reality check, [...]
UPenn law professor and corporate finance and bankruptcy specialist David Skeel has an important article in this week’s Weekly Standard talking about the possibility and utility of bankruptcy for states. The article argues first that a new chapter for states in the Federal bankruptcy statute would be constitutional, and then turns to argue, second, that the benefits to the public would be considerable:
When taxpayer-funded bailouts are inserted into the equation, the case for a new bankruptcy chapter becomes overwhelming. And it’s a case for Congress to move now on the creation of a state bankruptcy law.
With the presidential election just two years away, the pressure to bail out California, Illinois, and perhaps other states is about to become irresistible. As we learned in 2008 and 2009, it is impossible to stop a bailout once the government decides to go this route. The rescue of Bear -Stearns in 2008 was achieved through a “lockup” of its sale to JPMorgan Chase that flagrantly violated corporate merger law. To bail out Chrysler and General Motors, the government used funds that were only authorized for “financial institutions,” and illegally commandeered the bankruptcy process to give the car companies a helping hand. There is, in short, no law that will stop the federal government from bailing out profligate state governments like those in California or Illinois if it chooses to do so.
The appeal of bankruptcy-for-states is that it would give the federal government a compelling reason to resist the bailout urge.
This is an important piece of public advocacy by a leading scholar, agree or disagree with its two main contentions, and repays close reading. (The illustration above is a thumbnail from the WS.)