12.      US BANKING AND FINANCIAL REFORM

 

 

The course also examines the background and basic structure of the banking and financial system in the US and the responses adopted following the global financial crisis and the emerging shape of the new US regulatory environment. The US regulatory system was principally constructed during the early 1930s as part of the New Deal (‘100 Days’) programme under President F D Roosevelt after the Stock Market Crash in 1929. The Supreme Court had earlier restricted state and federal regulation as being contrary to the ‘Free Commerce’ Clause under the Constitution although this had been relaxed through a number of individual decisions during the 1920s. The volume of federal utility regulation expanded substantially after World War II until a more deregulatory approach was followed during the late 1970s and 1980s. This culminated with the Financial Competitiveness (Gramm Leach Bliley) Act 1999 and the Commodity Futures Modernisation Act (CFMA) in 2000 which deregulated the banking and financial and derivatives markets. A substantial programme of re-regulation has since been adopted, or proposed, following the more recent financial crisis in the US and elsewhere. The implications of all of these initiatives are reviewed as part of the course.

 

(1)       US Banking and Financial Regulation

 

The US system essentially adopts a functional approach to financial regulation with separate agencies being maintained for each principal type of financial activity, including banking, securities and insurance, at both the federal and state levels. This includes the Federal Reserve Board, the Federal Deposit Insurance Corporation (FDIC), the, the Office of the Comptroller of the Currency (OCC), National Credit Union Administration (NCUA), the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), the Financial Industry Regulatory Authority (FINRA) as well as state banking super-intendancies, insurance authorities and Attorneys General, which enforce local ‘blue sky’ securities laws. Even with deregulatory policies under the Gramm Leach Bliley Act, which allowed the establishment of Financial Holding Companies (FHCs), an essential sector separation policy has been adopted with agencies encouraged to oversee and compete with each other to ensure high standards.

A number of the main statutes were adopted during the 1930s, including the Securities Act 1933 and Securities and Exchange Act 1934 as well as the Banking Act 1935. The Securities Act provided for the establishment of the SEC and principally regulated the market for initial issuance of securities while the 1934 Act governed secondary trading. The Banking Act included the Glass Steagall restrictions on commercial banking and securities activities and provided for the establishment of the Federal Deposit Insurance Corporation (FDIC). A number of other statues were adopted subsequently, including the Federal Deposit Insurance Act of 1950 and the Bank Holding Company Act 1956, as well as a series of re-regulatory and consumer protection measures during the 1970s and 1980s. These were followed by a series of deregulatory statutes in the 1990s, including Gramm Leach Bliley and the CFMA. All of this has since been substantially reformed and strengthened under the most recent Dodd Frank Wall Street and Consumer Protection Act 2010.  

 

(2)       US Banking and Financial Reform

 

The US government published two main reports on agency restructuring following the crisis. Treasury Secretary Hank Paulson published a reform paper under the Bush Administration in 2008 with his Blueprint for a Modernized Financial Regulatory Structure which was followed by the report by Timothy Geithner under the Obama Administration on Financial Regulatory Reform in June 2009. The 2009 paper accepts that the crisis had many causes and went back decades with five principal sets of recommendations being issued on improved oversight and control of financial firms and markets, consumer protection, financial crisis management and international co-operation with a new Financial Services Oversight Council (FSOC) and Consumer Financial Protection Agency (CFPA) to be established.

 

The Troubled Asset Relief Program (TARP), which provided for the creation of a US$700bn facility to purchase distressed mortgage backed securities and preferred stock from banks, was set up under the Emergency Economic Stabilisation Act (EESA) 2008. A US$787bn package of measures to promote jobs and investment and consumer spending was also provided under the American Recovery and Reinvestment Act (ARRA) 2009.

 

 

 

(3)       US Financial Crisis Inquiry Commission (FCIC)

 

The independent Financial Crisis Inquiry Commission (FCIC) produced its report on the Causes of the Financial and Economic Crisis in the United States in January 2011. This examines the circumstances behind the collapse and losses suffered by the key financial institutions involved as well as the policies adopted by each of the key regulatory authorities. The Report divides the events behind the crisis up into a number of separate stages and summaries its key findings in terms of avoidability, supervisory and regulatory failure, risk management and corporate governance defect, leverage, official fall and ethical failure.

 

 

(4)       US Senate (Carl Levin) and Valukas Examination Reports

 

The Permanent Subcommittee on Investigations (PSI) of the US Senate, under Chairman Karl Levin and Ranking Minority Member Tom Coburn, produced its report on Wall Street and the Financial Crisis: Anatomy of a Financial Collapse in April 2011. This followed two years of investigations beginning in November 2008 into the causes of the crisis. The Report concluded that the crisis was not a natural disaster but the result of high risk complex financial products, credit rating agency error, regulatory failure and undisclosed conflicts of interest within investment firms. After examining the development of US financial markets over the 15 years prior to the crisis and the emergence of large ‘too big to fail’ (TBTF) institutions, the Report conducted four case studies into the collapse of Washington Mutual Bank (WaMu), the failure of the Office of Thrift Supervision (OTS), the inflated ratings produced by Moody’s and Standard & Poor’s and perceived failures and conflicts of interest within Deutsche Bank and Goldman Sachs.

 

A separate report was published by independent Examiner, Anton R Valukas, into the collapse Lehman Brothers Holdings Inc in 11 March 2010. This includes an ‘Executive Summary and Procedural Background’ (Volume 1) and examination of business and risk management. It also examines issues surrounding valuation and survival (Volume 2), the disputed ‘Repo 105’ transaction (Volume 3), potential claims against Lehman’s secured lenders (including specifically JP Morgan Chase, Citibank and HSBC and others) with Government involvement (Volume 4) and preferences or voidable transfers (Volume 5). The legal issues involved are reviewed in Volume 6 with other ancillary matters in Volume 7 and additional factual information in Volumes 8 and 9.

 

(5)       US Dodd Frank Act Wall Street and Consumer Protection Act 2010

 

The principal legislative reform enacted in the US was the Dodd Frank Wall Street Reform and Consumer Protection Act which was signed into law by the President on 21 July 2010. This followed a Congressional Conference Report with discussions having been led by Congressman Barney Frank and Christopher Dodd. The Act contains 1,601 sections and 16 separate laws (titles) and extends to over 2,300 pages. It was expected to require 243 new federal rules, 67 studies and 22 periodic reports. The stated objectives of the Act were to promote financial stability, end ‘TBTF’ and avoid ‘bailouts’. The Act provided for the establishment of the FSOC and independent Consumer Financial Protection Bureau (CFPB) (Titles II and X) with the OTS being merged with the OCC and a new Federal Insurance Office (FIO) created (Titles III and V). Large hedge funds would become subject to SEC oversight with restrictions imposed on proprietary trading under the ‘Volcker Rule’ named after former Federal Reserve Chairman Paul Volker (Titles IV and VII). The Federal Reserve would be able to impose on standards on payment, clearing and settlement systems with a number of amendments being adopted to improve investor protection (Titles VIII and IX).

 

 

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