Regulatory responses to the subprime crisis
Encyclopedia
Regulatory responses to the subprime crisis addresses various actions taken by governments around the world to address the effects of the subprime mortgage crisis
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Regulators and legislators are considering action regarding lending practices, bankruptcy protection, tax policies, affordable housing, credit counseling, education, and the licensing and qualifications of lenders. Regulations or guidelines can also influence the nature, transparency and regulatory reporting required for the complex legal entities and securities involved in these transactions. Congress also is conducting hearings to help identify solutions and apply pressure to the various parties involved.
U.S. President Barack Obama
and key advisers introduced a series of regulatory proposals in June 2009. The proposals address consumer protection, executive pay, bank financial cushions or capital requirements, expanded regulation of the shadow banking system
and derivatives
, and enhanced authority for the Federal Reserve to safely wind-down systemically important institutions, among others.
U.S. Treasury Secretary Timothy Geithner testified before Congress on October 29, 2009. His testimony included five elements he stated as critical to effective reform:
’s VIP program, ethics experts and key senators recommend that members of congress should be required to disclose information about their mortgages.
and key advisers introduced a series of regulatory proposals in June 2009. The proposals address consumer protection, executive pay, bank financial cushions or capital requirements, expanded regulation of the shadow banking system
and derivatives
, and enhanced authority for the Federal Reserve to safely wind-down systemically important institutions, among others.
Legislation has cleared the house and is progressing in the senate.
A variety of regulatory changes have been proposed by economists, politicians, journalists, and business leaders to minimize the impact of the current crisis and prevent recurrence. However, as of April 2009, many of the proposed solutions have not yet been implemented. These include:
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
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Regulators and legislators are considering action regarding lending practices, bankruptcy protection, tax policies, affordable housing, credit counseling, education, and the licensing and qualifications of lenders. Regulations or guidelines can also influence the nature, transparency and regulatory reporting required for the complex legal entities and securities involved in these transactions. Congress also is conducting hearings to help identify solutions and apply pressure to the various parties involved.
U.S. President Barack Obama
Barack Obama
Barack Hussein Obama II is the 44th and current President of the United States. He is the first African American to hold the office. Obama previously served as a United States Senator from Illinois, from January 2005 until he resigned following his victory in the 2008 presidential election.Born in...
and key advisers introduced a series of regulatory proposals in June 2009. The proposals address consumer protection, executive pay, bank financial cushions or capital requirements, expanded regulation of the shadow banking system
Shadow banking system
The shadow banking system is the infrastructure and practices which support financial transactions that occur beyond the reach of existing state sanctioned monitoring and regulation. It includes entities such as hedge funds, money market funds and Structured investment vehicles...
and derivatives
Derivative (finance)
A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...
, and enhanced authority for the Federal Reserve to safely wind-down systemically important institutions, among others.
U.S. Treasury Secretary Timothy Geithner testified before Congress on October 29, 2009. His testimony included five elements he stated as critical to effective reform:
- Expand the Federal Deposit Insurance CorporationFederal Deposit Insurance CorporationThe Federal Deposit Insurance Corporation is a United States government corporation created by the Glass–Steagall Act of 1933. It provides deposit insurance, which guarantees the safety of deposits in member banks, currently up to $250,000 per depositor per bank. , the FDIC insures deposits at...
(FDIC) bank resolution mechanism to include non-bank financial institutionsShadow banking systemThe shadow banking system is the infrastructure and practices which support financial transactions that occur beyond the reach of existing state sanctioned monitoring and regulation. It includes entities such as hedge funds, money market funds and Structured investment vehicles...
; - Ensure that a firm is allowed to fail in an orderly way and not be "rescued";
- Ensure taxpayers are not on the hook for any losses, by applying losses first to the firm's investors and including the creation of a pool funded by the largest financial institutions;
- Apply appropriate checks and balances to the FDIC and Federal Reserve in this resolution process;
- Require stronger capital and liquidity positions for financial firms and related regulatory authority. The Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into law by President Obama in July 2010, addressing each of these topics to varying degrees.
Housing and Economic Recovery Act of 2008
The Housing and Economic Recovery Act of 2008 in the United States included six separate major acts designed to restore confidence in the domestic mortgage industry. The Act included:- Providing insurance for $300 billion in mortgages estimated to assist 400,000 homeowners.
- Establishing a new regulator, the Federal Housing Finance AgencyFederal Housing Finance AgencyThe Federal Housing Finance Agency is an independent federal agency created as the successor regulatory agency resulting from the statutory merger of the Federal Housing Finance Board , the Office of Federal Housing Enterprise Oversight , and the U.S...
via the merger of two existing authorities, The Office of Federal Housing Enterprise OversightOffice of Federal Housing Enterprise OversightThe Office of Federal Housing Enterprise Oversight was an agency within the Department of Housing and Urban Development. It was charged with ensuring the capital adequacy and financial safety and soundness of two government sponsored enterprises—the Federal National Mortgage Association and the...
(OFHEO), and the Federal Housing Finance BoardFederal Housing Finance BoardThe Federal Housing Finance Board was an independent agency of the United States government established in 1989 in the aftermath of the savings and loan crisis to take over oversight of the Federal Home Loan Banks , and was superseded by the Federal Housing Finance Agency in 2008.The FHFB...
(FHFB), endowed with expanded powers and authority greater than the sum of its predecessors, to supervise operation of the 14 housing government sponsored enterprises (GSEs): (Fannie Mae and Freddie Mac) and the 12 Federal Home Loan Banks. - Raises the dollar limit of the mortgages the GSEs can purchase.
- Provides loans for the refinancing of mortgages to owner-occupants at risk of foreclosure. The original lender or investor reduces the amount of the original mortgage (typically taking a significant loss) and the homeowner shares any future appreciation with the Federal Housing AdministrationFederal Housing AdministrationThe Federal Housing Administration is a United States government agency created as part of the National Housing Act of 1934. It insured loans made by banks and other private lenders for home building and home buying...
. The new loans must be 30-year fixed loans. - Enhancements to mortgage disclosures.
- Community assistance to help local governments buy and renovate foreclosed properties.
- An increase in the national debt ceiling by US$800 billion, to give the Treasury the flexibility to support the secondary housing markets and the 14 GSEs, if necessary.
Federal reserve powers
A sweeping proposal was presented 31 March 2008 regarding the regulatory powers of the U.S. Federal Reserve, expanding its jurisdiction over other types of financial institutions and authority to intervene in market crises.Expansion of government agency authority
The U.S House passed a bill in early April, 2008 that would offer government insurance on $300 billion in new mortgages to refinance loans for an estimated 500,000 borrowers facing foreclosure and an additional 15 billion to affected states to buy and fix foreclosed homes.Lending practices
In response to a concern that lending was not properly regulated, the House and Senate are both considering bills to regulate lending practices.U.S. Congressional ethics reform
In the wake of a subprime mortgage crisis and questions about Countrywide FinancialCountrywide Financial
Bank of America Home Loans is the mortgage unit of Bank of America. Bank of America Home Loans is composed of:*Mortgage Banking, which originates purchases, securitizes, and services mortgages. In 2008, Bank of America purchased the failing Countrywide Financial for $4.1 billion...
’s VIP program, ethics experts and key senators recommend that members of congress should be required to disclose information about their mortgages.
Capital reserve requirements
Non-depository banks (e.g., investment banks and mortgage companies) are not subject to the same capital reserve requirements as depository banks. Many of the investment banks had limited capital reserves to address declines in mortgage-backed securities or support their side of credit default derivative insurance contracts. Nobel prize winner Joseph Stiglitz recommends that regulations be established to limit the extent of leverage permitted and not allow companies to become "too big to fail", by breaking them up into smaller entities. He has also recommended reforming executive compensation, to make it less short-term focused; enhance consumer protection; and establish a regulatory review mechanism for new exotic types of financial instruments.Short-selling restrictions
UK regulators announced a temporary ban on short-selling of financial stocks on September 18, 2008. Short-selling is a method of profiting when a stock declines in value. When large, speculative short-sale bets accumulate against a stock or other financial asset, the price can be driven down. Short sales were among the causes blamed for rapid price declines in Lehman Brother's stock price prior to its bankruptcy. On September 19 the U.S. Securities and Exchange Commission (SEC) followed by placing a temporary ban of short-selling stocks of financial institutions. In addition, the SEC made it easier for institutions to buy back shares of their institutions. The halt of short-selling in the US was set to expire on October 2, but was extended until it expired at 11:59PM EDT on October 8. The action was based on the view that short selling in a crisis market undermines confidence in financial institutions and erodes their stability.Proposed solutions
President Barack ObamaBarack Obama
Barack Hussein Obama II is the 44th and current President of the United States. He is the first African American to hold the office. Obama previously served as a United States Senator from Illinois, from January 2005 until he resigned following his victory in the 2008 presidential election.Born in...
and key advisers introduced a series of regulatory proposals in June 2009. The proposals address consumer protection, executive pay, bank financial cushions or capital requirements, expanded regulation of the shadow banking system
Shadow banking system
The shadow banking system is the infrastructure and practices which support financial transactions that occur beyond the reach of existing state sanctioned monitoring and regulation. It includes entities such as hedge funds, money market funds and Structured investment vehicles...
and derivatives
Derivative (finance)
A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...
, and enhanced authority for the Federal Reserve to safely wind-down systemically important institutions, among others.
Legislation has cleared the house and is progressing in the senate.
A variety of regulatory changes have been proposed by economists, politicians, journalists, and business leaders to minimize the impact of the current crisis and prevent recurrence. However, as of April 2009, many of the proposed solutions have not yet been implemented. These include:
- Ben BernankeBen BernankeBen Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....
: Establish resolution procedures for closing troubled financial institutions in the shadow banking systemShadow banking systemThe shadow banking system is the infrastructure and practices which support financial transactions that occur beyond the reach of existing state sanctioned monitoring and regulation. It includes entities such as hedge funds, money market funds and Structured investment vehicles...
, such as investment banks and hedge funds. - Joseph Stiglitz: Restrict the leverage that financial institutions can assume. Require executive compensation to be more related to long-term performance. Re-instate the separation of commercial (depository) and investment banking established by the Glass–Steagall Act in 1933 and repealed in 1999 by the Gramm-Leach-Bliley ActGramm-Leach-Bliley ActThe Gramm–Leach–Bliley Act , also known as the Financial Services Modernization Act of 1999, is an act of the 106th United States Congress...
. - Simon JohnsonSimon Johnson (economist)Simon Johnson is a British American economist. He is the 'Ronald A. Kurtz Professor of Entrepreneurship at the MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. He has held a wide variety of academic and policy-related positions, including...
: Break-up institutions that are "too big to fail" to limit systemic riskSystemic riskIn finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system. It can be defined as "financial system instability, potentially catastrophic, caused or exacerbated by...
. - Paul KrugmanPaul KrugmanPaul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...
: Regulate institutions that "act like banks " similarly to banks. - Alan GreenspanAlan GreenspanAlan Greenspan is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC...
: Banks should have a stronger capital cushion, with graduated regulatory capital requirements (i.e., capital ratios that increase with bank size), to "discourage them from becoming too big and to offset their competitive advantage." - Warren BuffettWarren BuffettWarren Edward Buffett is an American business magnate, investor, and philanthropist. He is widely regarded as one of the most successful investors in the world. Often introduced as "legendary investor, Warren Buffett", he is the primary shareholder, chairman and CEO of Berkshire Hathaway. He is...
: Require minimum down payments for home mortgages of at least 10% and income verification. - Eric Dinallo: Ensure any financial institution has the necessary capital to support its financial commitments. Regulate credit derivatives and ensure they are traded on well-capitalized exchanges to limit counterparty risk.
- Raghuram RajanRaghuram RajanRaghuram Govind Rajan is currently the Eric J. Gleacher Distinguished Service Professor of Finance at the Booth School of Business at the University of Chicago. He is also an honorary economic adviser to Prime Minister of India Manmohan Singh and the current President of the American Finance...
: Require financial institutions to maintain sufficient "contingent capital" (i.e., pay insurance premiums to the government during boom periods, in exchange for payments during a downturn.) - A. Michael Spence and Gordon BrownGordon BrownJames Gordon Brown is a British Labour Party politician who was the Prime Minister of the United Kingdom and Leader of the Labour Party from 2007 until 2010. He previously served as Chancellor of the Exchequer in the Labour Government from 1997 to 2007...
: Establish an early-warning system to help detect systemic riskSystemic riskIn finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system. It can be defined as "financial system instability, potentially catastrophic, caused or exacerbated by...
. - Niall FergusonNiall FergusonNiall Campbell Douglas Ferguson is a British historian. His specialty is financial and economic history, particularly hyperinflation and the bond markets, as well as the history of colonialism.....
and Jeffrey SachsJeffrey SachsJeffrey David Sachs is an American economist and Director of The Earth Institute at Columbia University. One of the youngest economics professors in the history of Harvard University, Sachs became known for his role as an adviser to Eastern European and developing country governments in the...
: Impose haircuts on bondholders and counterparties prior to using taxpayer money in bailouts. - Nouriel RoubiniNouriel RoubiniNouriel Roubini is an American economist. He claims to have predicted both the collapse of the United States housing market and the worldwide recession which started in 2008. He teaches at New York University's Stern School of Business and is the chairman of Roubini Global Economics, an economic...
: Nationalize insolvent banks.