Regulation typically results in effects opposite to those intended, causing social harms (Peláez and Peláez, Globalization and the State: I, 143-7). The Banking Act of 1933 (12 U.S.C. § 371a) prohibited payment of interest on demand deposits and imposed limits on interest rates paid on time deposits issued by commercial banks implemented by Regulation Q (12 C.F.R. 217) (Peláez and Peláez, Financial Regulation after the Global Recession, 57). This depression rush to regulation was motivated by the erroneous belief that banks provided high-rate risky loans to pay high competitive market interest rates on deposits, which allegedly caused banking panics in the 1930s. An added motivation was the allocation of savings to housing by maintaining low interest rate ceilings benefitting savings banks and savings and loan associations that complained of unfair competition from higher deposit rates of commercial banks. Milton Friedman analyzed in 1970 that the rise of inflation above Regulation Q interest rate ceilings caused halving of issuance of certificates of deposit (CD), which was the banking innovation created to finance rising loan volumes. Banks accounted higher-rate CDs in their European offices as "due from head office" while the head office changed the liability to "due to foreign branches" instead of "due on CDs." Friedman predicted the future as revealing as his forecast of 1970's stagflation: "the banks have been forced into costly structural readjustments, the European banking system has been given an unnecessary competitive advantage, and London has been artificially strengthened as a financial center at the expense of New York." People of modest means with lower income and wealth having no alternatives other than bankbook accounts received rates on their savings below those that would prevail in freer markets. Regulation transferred income from poorer depositors to endow banks with market power. The financial system was forced into costly readjustments while highly-paid financial jobs and economic activity were exported to foreign countries. The interest rate is the main compass of allocating savings and capital in a market economy but it was distorted by ill-conceived Great Depression regulation that is still emulated currently. The approach of official prudential supervision and regulation (OPSR) blames the irresponsibility of banks for the current financial crisis/global recession. OPSR proposes intrusive new regulation with powers to control business decisions at banks in executive remuneration, capital, liquidity, transactions, portfolio choice and others as if regulators are superior business executives (Pelaez and Peláez, Financial Regulation after the Global Recession, Regulation of Banks and Finance). The effects of laws are reversed by preemptive decisions as proved again by the Credit Card Accountability, Responsibility and Disclosure Act (CARD). By anticipated increasing costs and risks of credit card issuers resulting from CARD before going in effect in February 2010 nine months after its enactment in May 2009, CARD is causing higher fees and tighter credit conditions irrespective of creditworthiness. This will likely be the unintended potential consequence of proposed stiff regulation of consumer credit when consumers are reducing expenditures required for recovery. Frustrating securitization and structured products would have consequences similar to Regulation Q: higher costs to banks partly passed on to all but especially low-income consumers in the form of higher rates, lower financing volume, tighter credit conditions and flight of finance and high-pay jobs away from the United States. New York could decay to the perilous condition during the 1960s. Excessive regulation could create major social losses. Sound weights for prosperity and stability should be used in regulation, avoiding frustration of financial innovation that could restrict future growth and prosperity.


http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10#postPMCA14VSEK76VRCYUat1255311958

In the current issue of the BIS Quarterly Review, Tarashev, Borio and Tsatsaronis define a systemic event as one generating losses sufficiently large that could disrupt the functioning of the system. The three drivers of systemic risk are (1) the individual riskiness of firms; (2) the concentration of the system in relatively large institutions; and (3) the exposure of firms to common risks or to interconnectedness of transactions. There is significant emphasis on technical research and practical policy proposals in creating a regulatory architecture for prevention of systemic risk and its control when it occurs. There are specific proposals of a consolidated supervisor of systemic risk. A risk council composed of all supervisors of financial institutions would conduct oversight by monitoring and identifying systemic risk throughout institutions supervised by the Fed, FDIC, OCC, OTS and everything under the SEC. All institutions posing systemic risk such as investment banks, insurance companies, finance companies (GMAC) and capital companies (GE) would be subject to systemic risk supervision. There are four hurdles to systemic risk architecture. First, an effective oversight council would require consolidation of all supervisors and regulators, which may be unfeasible in practice because of the division of oversight functions in Congress and agencies. Second, winding down the balance sheet of Lehman with worldwide exposures illustrates the technical challenge of creating a global regulatory model for measurement and simulation of systemic risk that could provide analysis, prediction and policy solutions. Third, the credit/dollar crisis originated in nonprime mortgages encouraged by the near zero interest rate in 2003-4, the $220 billion yearly housing subsidy and the purchase or guarantee of $1.6 trillion nonprime mortgages by Fannie and Freddie as analyzed in the previous post. Fourth, the alleged systemic event originating in Lehman and AIG has been disproved by Cochrane and Zingales who have shown that the confidence shock in the financial system originated after Lehman by the proposal of TARP as required in avoiding devastating financial crisis. The key function of transforming illiquid assets such as mortgages in immediate liquidity by means of sales and repurchase agreements was fractured by confidence uncertainty caused by policy. The systemic event originated, widened and deepened by the effects of policy impulses. Regulatory architecture of systemic risk should be based on clear analysis of the origins and propagation of the credit/dollar crisis to avoid future regulatory confidence shocks. Policy with imperfect knowledge and tools may accentuate instability and frustrate financial innovation and economic growth.

http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10#postPMCA14VSEK76VRCYUat1255311958

1:50 AM PDT, October 5, 2009, updated at 6:46 PM PDT, October 11, 2009
In the current issue of the BIS Quarterly Review, Tarashev, Borio and Tsatsaronis define a systemic event as one generating losses sufficiently large that could disrupt the functioning of the system. The three drivers of systemic risk are (1) the individual riskiness of firms; (2) the concentration of the system in relatively large institutions; and (3) the exposure of firms to common risks or to interconnectedness of transactions. There is significant emphasis on technical research and practical policy proposals in creating a regulatory architecture for prevention of systemic risk and its control when it occurs. There are specific proposals of a consolidated supervisor of systemic risk. A risk council composed of all supervisors of financial institutions would conduct oversight by monitoring and identifying systemic risk throughout institutions supervised by the Fed, FDIC, OCC, OTS and everything under the SEC. All institutions posing systemic risk such as investment banks, insurance companies, finance companies (GMAC) and capital companies (GE) would be subject to systemic risk supervision. There are four hurdles to systemic risk architecture. First, an effective oversight council would require consolidation of all supervisors and regulators, which may be unfeasible in practice because of the division of oversight functions in Congress and agencies. Second, winding down the balance sheet of Lehman with worldwide exposures illustrates the technical challenge of creating a global regulatory model for measurement and simulation of systemic risk that could provide analysis, prediction and policy solutions. Third, the credit/dollar crisis originated in nonprime mortgages encouraged by the near zero interest rate in 2003-4, the $220 billion yearly housing subsidy and the purchase or guarantee of $1.6 trillion nonprime mortgages by Fannie and Freddie as analyzed in the previous post. Fourth, the alleged systemic event originating in Lehman and AIG has been disproved by Cochrane and Zingales who have shown that the confidence shock in the financial system originated after Lehman by the proposal of TARP as required in avoiding devastating financial crisis. The key function of transforming illiquid assets such as mortgages in immediate liquidity by means of sales and repurchase agreements was fractured by confidence uncertainty caused by policy. The systemic event originated, widened and deepened by the effects of policy impulses. Regulatory architecture of systemic risk should be based on clear analysis of the origins and propagation of the credit/dollar crisis to avoid future regulatory confidence shocks. Policy with imperfect knowledge and tools may accentuate instability and frustrate financial innovation and economic growth.
http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10

The origin of the credit crisis and global recession is explained in the Pittsburgh G20 statement by an “era of irresponsibility” in the form of excesses in risks and leverage in banks motivated by bankers’ compensation. The alternative view in growing professional literature and also in our seven books published by Palgrave Macmillan is that the crisis could have been caused by regulatory errors: the lowering of the Fed funds rate to nearly zero in 2003-4, collapse of mortgage rates by the elimination of the 30-year Treasury bond, the prolonged housing subsidy of $220 billion per year and the purchase or guarantee of $1.6 trillion of nonprime mortgages by Fannie and Freddie. These policies distorted risk/return decisions not only in finance but also by families, business and government. Interest rates near zero caused high leverage, low levels of liquidity and bad loans. The credit/dollar crisis manifested primarily in nonprime mortgages bundled in derivatives because the central bank created the impression of writing a put or providing insurance against falling real estate prices. House prices would increase but never fall below the level in the mortgage contract. Elementary economics concludes that subsidies cause overproduction of housing. The lowest interest rates in five decades created the impression that house prices would increase forever. Borrowers and lenders believed that the downside would be early repayment of the mortgage or sale at principal value in foreclosure. The sober approach is that of Functional Structural Finance (FSF) developed by Robert C. Merton and Zvi Bodie, which is ideology-free because the financial functions can be provided by the private-sector, government and family institutions. FSF posits that spirals of financial innovation, including structured products, academic landmarks such as Black-Scholes-Merton option pricing and risk-management techniques as by RiskMetrics®, improve the functions of finance required for economic growth. Excessive regulation can distort risk/returns decisions, preventing efficient financial functions, flattening the expansion path of the economy and preventing full employment. Carlos Manuel Peláez, 9/28/09 http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10