Summaries, Papers, and Videos

Policy Sessions

Policy session 1–Will the Devil Hide in the New Shadow Banking System?
Paul McCulley, chairman of the Society of Fellows of the Global Interdependence Center and the session moderator, used a dollar bill for an object lesson on shadow banking. A dollar bill is a "zero perpetual" that is accepted as legal tender, hence it is special and in high demand. Only the government has the legal right to issue such zero perpetual notes. The next best thing to issuing such notes directly is to be a bank offering Federal Deposit Insurance Corporation (FDIC) insured deposit accounts, which will issue a zero perpetual note in the event of failure. This one-step-removed ability to issue zero perpetual notes, however, comes with government supervision, regulation, and capital requirements. Shadow banking is ultimately the desire to issue such one-step-removed notes without any government strings attached. Edward Kane, professor of finance at Boston College, then presented his paper "The Inevitability of Shadowy Banking." According to Kane, shadowy banking might be more accurately called safety-net arbitrage. It consists of any institution that issues a large amount of financial products while either actually or potentially being outside the purview of those agencies responsible for monitoring and managing the financial safety net. Paul Kupiec, the director of the FDIC's Center of Financial Research, commented on this safety-net arbitrage by humorously contrasting regulatory dialectics—the deductive process where regulators write new rules, bankers then design ways to avoid these new rules, to which the regulators write even more new rules—with the arrested evolution of "Homo tempora," the species that regulates.

"The Inevitability of Shadowy Banking" pdf
Presenter: Edward J. Kane, Professor of Finance, Boston College [Presentation] pdf

Moderator: Paul McCulley, Chairman, Global Interdependence Center
Discussants: Paul Kupiec, Director, Center of Financial Research, Federal Deposit Insurance Corporation
Zoltan Pozsar, Visiting Scholar, International Monetary Fund

video icon Paul McCulley interview

Policy session 2–Is Maturity Transformation the Devil's Work?
Is creation of liquidity by banks surplus liquidity in the economy or does it serve a useful economic purpose? If the loss of liquidity was a major problem in the financial crisis, was it only a problem given that agents came to expect more liquidity than they needed and organized their affairs in a way that required too much liquidity? Or is it a more fundamental problem in that high levels of liquidity are important for an efficient economy? Philip Dybvig, Boatmen's Bancshares Professor of Banking and Finance at Washington University in St. Louis and chair of this session, opened with these fundamental questions. It was understood that these questions are central to understanding the effects that new regulations will have on the financial system and the economy more broadly. David Aikman, senior manager at the Bank of England, provided a concise history of liquidity regulation, including new macroprudential approaches, and provided estimates of the potential loss in gross domestic product from regulation. Kevin Brown, global head of transaction service products at the Royal Bank of Scotland, considered the important role that liquidity and maturity transformation plays in providing a comprehensive array of financial services to corporate customers, providing a look inside the "black box" of banking. Finally, Cliff Rossi, executive-in-residence of finance at the Robert H. Smith School of Business at the University of Maryland, linked all these topics via the perspective of a chief risk officer. Rossi highlighted the importance of testing liquidity risk exposures under stress rather than relying on regulatory fixes.

Panelists: Philip Dybvig (chair), Boatmens Bancshares Professor of Banking and Finance, Washington University in St. Louis [Presentation] pdf
Kevin Brown, Managing Director, Royal Bank of Scotland [Presentation] pdf
David Aikman, Senior Manager,Bank of England [Presentation] pdf
Cliff Rossi, Executive-in-Residence of Finance, Robert H. Smith School of Business, University of Maryland [Presentation] pdf

 video icon Philip Dybvig interview

Policy session 3–The Devil's in the Tail: Home Mortgage Finance and the U.S. Treasury
Luci Ellis, head of the financial stability department at the Reserve Bank of Australia, opened the discussion by noting that the U.S. mortgage finance system discourages borrowers from prepaying mortgages and leads to much higher debt to housing value ratios than in Australia. Scott Frame, an Atlanta Fed financial economist and senior policy adviser, presented a paper that summarizes the last several decades of residential mortgage markets. He noted that since 2008 these markets have been heavily dependent upon direct support of the U.S. Treasury for Fannie Mae and Freddie Mac. Frame then summarized proposed reforms that would reduce Treasury's role, though most proposals would have the Treasury retain the risk of extremely bad outcomes (or the tail risk). Mark Calabria, director of financial regulation studies at the Cato Institute, noted that the gains in home ownership preceded both the growth in government-sponsored enterprises' market share and the increase in debt to housing values ratio. Calabria concluded by noting that having the Treasury absorb the tail risk is "as likely to create a crisis as to help resolve or avoid one." The final panelist, Andrew Davidson, president, Andrew Davidson & Co. Inc., stated that the Treasury should continue to absorb a part of the tail risk to ensure a stable flow of funds to residential mortgages. However, he argued that this risk can and should be reduced to manageable levels with appropriate underwriting and with procedures that shift more of the credit risk to the private suppliers of capital.

"The Devil's in the Tail: Residential Mortgage Finance and the U.S. Treasury" pdf
Presenter: Scott Frame, Financial Economist and Policy Adviser, Federal Reserve Bank of Atlanta [Presentation] pdf

Moderator: Luci Ellis, Head of the Financial Stability Department, Reserve Bank of Australia [Presentation] pdf
Discussants: Mark Calabria, Director, Financial Regulation Studies, Cato Institute [Presentation] pdf
Andrew Davidson, President, Andrew Davidson & Co. Inc. [Presentation] pdf

Policy session 4–Money Market Mutual Funds: Past Devils? Reformed into Future Angels?
The run on money market mutual funds was central to the unfolding of the financial crisis in 2008, and proposed changes in regulation have been contentious. Eric Rosengren, president of the Boston Fed and chair of this session, opened the session on a strong note. He made it clear he believes financial stability is not consistent with firms offering investors a fixed redemption value on demand when the firms have no capital and take credit risk. He argued this strategy characterizes money market funds today. Barry Barbash, a partner with Willkie Farr & Gallagher, who served at the Securities and Exchange Commission (SEC) in the 1990s, summarized how the SEC arrived at the current arrangements for money market funds and how litigation risk may impact the future of money fund reforms. Zoltan Pozsar, a visiting scholar at the International Monetary Fund, described the international long-term rise of "institutional cash pools" and their demand for insured deposits or substitutes like money market fund shares. Karen Dunn Kelley, senior managing director and chief executive officer at Invesco Fixed Income, detailed money market funds' operations and the already evident implications of the ongoing regulatory changes since the financial crisis, a characterization rather different from the one given by Rosengren. While there was no consensus reached—or expected—the discussion clearly laid out the issues in an important part of the financial markets.

Panelists: Eric Rosengren (chair), President and CEO, Federal Reserve Bank of Boston [Presentation] pdf
Barry Barbash, Partner, Head of Asset Management Group, Willkie Farr & Gallagher
Karen Dunn Kelley, Senior Managing Director and Chief Executive Officer, Invesco Fixed Income [Presentation] pdf
Zoltan Pozsar, Visiting Scholar, International Monetary Fund

video icon Karen Dunn Kelley interview


Fostering Financial Stability off-site image
Ben Bernanke, Chairman, Board of Governors of the Federal Reserve System

video icon Ben Bernanke keynote

Sheila Bair, Senior Adviser, Pew Charitable Trusts and former Chairman, FDIC

video icon Sheila Bair interview

Research Papers

Research paper 1 "Sturm und Drang in Money Market Funds" pdf
Presenter: Michael Wedow, Expert, Directorate General Financial Stability, European Central Bank [Presentation] pdf

Moderator: Gerald Dwyer, Director, Center for Financial Innovation and Stability, Federal Reserve Bank of Atlanta
Discussant: Sean Collins, Senior Director, Industry and Financial Analysis, Investment Company Institute [Presentation] pdf

Research paper 2 "A Bird's Eye View of OECD Housing Markets" pdf
Presenter: Christophe André, Economist, Organisation for Economic Cooperation and Development [Presentation] pdf

Moderator: Larry Wall, Financial Economist and Senior Policy Adviser, Federal Reserve Bank of Atlanta
Discussant: Michael Lea, Director, Corky McMillin Center for Real Estate, San Diego State University [Presentation] pdf