Prioritization and Mutualization: Clearinghouses and the Redundancy of the Bankruptcy Safe Harbors
This Essay argues for the repeal of the bankruptcy safe harbors for financial contracts because they are redundant systemic risk safeguards. Most systemically important types of financial contracts now clear through clearinghouses. Clearinghouses are a superior method to the safe harbors for protecting the liquidity of systemically important money substitutes and do not subordinate bankruptcy policy concerns to systemic risk concerns. Clearinghouses are a better guaranty against systemic disruption than the safe harbors because they can absorb the losses caused by insolvencies and fire sales due to their deep capital and lack of leverage. Moreover, clearinghouses reduce systemic risk by forcing internalization of systemic externalities on the finance industry through loss mutualization. This reduces the industries incentive to engage in excessively risky transactions. And, in the event that losses overwhelm clearinghouses, they are technically and politically easier to bail out than individual firm when the safe harbors prove inadequate. Accordingly, this Essay argues for the safe harbors to be replaced with a clearing mandate only for those types of highly liquid financial contracts that serve as money substitutes.
Too Big and Unable to Fail
Financial regulation after the Dodd-Frank Act has produced a blizzard of acronyms, many of which revolve around the “too big to fail” (TBTF) problem. OLA, OLF, SPOE, and TLAC are new regulatory tools that seek to build a new regime for resolving failures of systemically important financial institutions (SIFIs). The explicit goal of this new regime is to enable a SIFI to fail, just like United Airlines or Blockbuster Video, without requiring a government bailout. In this article, we express significant doubts about the new regime’s ability to work as advertised. The “single point of entry” (SPOE) resolution strategy, which focuses all resolution efforts on a SIFI’s parent holding company, is a strategy devised for a very stylized, even hypothetical sort of failure that does not threaten the stability of the financial system. SPOE is unlikely to work as intended during a future global crisis that involves multiple failing SIFIs operating thousands of subsidiaries across dozens of national boundaries. The Federal Reserve’s “total loss-absorbing capacity” (TLAC) proposal is closely tied to SPOE. It would require parent holding companies of SIFIs to issue large amounts of debt securities that can be written off or converted into equity in a resolution proceeding. In our view, TLAC debt will create a new, more opaque way to impose the costs of financial distress in SIFIs on ordinary citizens, because most TLAC debtholders are likely to be retail investors in brokerage accounts, mutual funds, and pension funds.The most fundamental shortcoming of SPOE and TLAC, as currently proposed, is that both policies would entrench our perverse system for regulating SIFIs. Our current regulatory system enables SIFIs and their Wall Street creditors to reap massive benefits from the TBTF subsidy while imposing the costs of that subsidy on ordinary citizens. We recognize that a new and improved version of Dodd-Frank is not likely to emerge from Congress in the near term. However, regulators should use their existing powers to shrink the TBTF subsidy by forcing SIFIs and their Wall Street creditors to internalize at least some of the costs of the enormous risks they create. The final part of our article proposes reforms that would help to achieve that goal.
Fiscal Transparency in EU Accession Countries Progress and Future Challenges
This paper discusses the findings of fiscal transparency reports on standards and codes (ROSCs) for most EU accession candidate countries. Emphasis is given to the need to establish effective and accountable medium-term budget frameworks to establish policy credibility and anchor adjustment programs to meet EU fiscal goals. Adoption of budgeting and accounting standards consistent with the IMF Government Finance Statistics Manual 2001 framework will also help link budget decisions to EU standards of fiscal reporting. More consistent and comprehensive coverage of off-budget activities is needed for assessing fiscal risk and sustainability. Finally, local government issues need to be addressed by many of these countries since EU fiscal goals are set with reference to general government. Progress in all of these areas can be monitored by keeping fiscal ROSC assessments up to date.