Center for the Study of Financial Market Evolution

After the collapse of Bear Stearns and Lehman Brothers, investors were shocked to learn that even senior executives failed to appreciate how vulnerable their firms were when denied access to short-term funding markets. Similar funding denials preceded the de facto collapses, shotgun mergers, or bailouts of other large investment banks, as well as AIG, Citigroup, Fannie Mae, and Freddie Mac. (full article)

Historically, analysts have disagreed sharply on whether short sellers helped or hurt investors’ portfolio values. Today, those differences are even more contentious -- while the evidence has become much more complex. For certain markets and timeframes, academic researchers have found short sales to be linked more often with overpriced securities. They have also found that more normal prices followed a rise in short interest in those securities. In this, academics and critics seem to agree that short sales drive down stock prices, albeit for good purpose in the former view. This paper presents a third view. (full article)

In August 1998, scenes reminiscent of the pre-Depression failures of U.S. banks showed long lines of Muscovites waiting anxiously to pull their devalued rubles from failing Russian banks. In March 2008, just like the Russian bank runs of 10 years earlier, legions of broker/repo counterparties moved to the sidelines of the market after each new report of staggering bank losses in asset-backed securities and waited anxiously for their own investors to draw down cash, leading to a chain-reaction run on the U.S. and global capital markets. (full article)

The imposing beaux-arts façade of the United States Custom House in New York City braces and prepares petitioners for the complexities they can expect in dealing with its primary tenant, the U.S. Bankruptcy Court. Yet nothing could have prepared creditors for the complexities of the Enron bankruptcy when they arrived in court last December. (full article)

Since 1980, the cash-based securities lending program has evolved to become the prevalent form of collateral management model in the United States. By 2005, U.S.-domiciled insurers, pension funds, mutual funds and corporate treasurers had securities valued at more than $1.25 trillion on loan. This evolution has not come without difficulties. In the 1990s, securities lenders found that a rising interest rate environment suddenly depressed the value of their cash collateral investments, in some cases to the point of loss when lenders were unexpectedly required to return cash deposits to borrowers. A few lenders sustained losses that exceeded the income they had earned over the course of several years, although in several cases agent lenders absorbed the damages in order to protect their franchises. (full article)

Financial modernization has been compared to the fall of the Berlin Wall in American finance. If so, then bank capital reform is equivalent to reconstruction of the Soviet bloc. It is the next step in the evolution of universal banking, American Style. And, like the revolution in eastern Europe, the outcome of the reform negotiations will likely determine how historians grade the revolution in American finance. If convergence is to be successful, it must learn from the experiences of European reformers. (full article)

As of early September, the Federal Reserve Board reported that 396 domestic institutions had declared for Financial Holding Company (FHC) status under the terms of last year’s Gramm-Leach-Bliley Financial Modernization Act (GLB). A bit surprisingly, most of these were not large banks. In fact, three of every four new FHCs had under $500 million in total assets. (full article)

As the final shape of Basel II, the new capital solvency regime for large, complex banks, continues to emerge from the mist of negotiation and experimentation, it is becoming clear that there are many more parties-in-interest to the reform process than had been seen at first. (full article)

Under this rippling banner, on Thursday, Feb. 27, 2003, a complex set of proposed changes in bank solvency rules, known as Basel II, were subjected to tense hearings before a subcommittee of the U.S. House Committee on Financial Services. (full article)

On April 29th, after nearly two and one-half years of debate, bank supervisors presented their third consultative paper on capital reform to the international banking community. Observers agreed that supervisors had made major changes based on bankers’ comments on the original proposal. Supervisors, in turn, expressed their appreciation for bankers’ comments on the earlier drafts and invited further comments by July 31st. Despite the apparently cooperative nature of the consultative process, however, these new rules, if adopted by national legislatures as currently encoded by the multinational Basel Committee on Banking Supervision, will still represent the most sweeping changes in solvency standards to be imposed on bankers since the original Capital Accord was formed in 1988.

After two attempts at consensus among bankers and supervisors, the Basel Committee on Banking Supervision earlier this year issued the third draft of proposed revisions to the Basel Capital Standard of 1988. Unless plans change again, the main focus of the committee will be on implementation of the new accord, which is due to take effect at year end 2006 as of this writing. In the United States, the Federal Reserve has said that only ten of the largest, most complex banking organizations, and another ten that ‘opt in,’ will be subject to the new rules, and specifically to the most advanced level of the rules. In Europe, however, the EU Commission has decided to apply the Capital Adequacy Directive to all financial institutions. CAD 3, as it’s called, is very similar to the new Basel Accord. As a result, virtually all EU banks, brokerages, and broker-dealers will be operating under the new rules. (full article)

Americans are used to influencing standards in ways that conform to our own interests. Success has made our language the lingua franca of global commerce. (full article)

“I always maintain that the payment function is the first function of banking. The creation of paper currency, to replace the commodity currency, caused the need to license someone with an exclusive right to print the currency. That payment function—not the monetary function or supervision of banks—led to the creation of central banking itself,” muses Dr. Tommaso Padoa-Schioppa. Speaking from his office in the European Central Bank’s Frankfurt headquarters. Padoa-Schioppa, a member of the ECB’s Executive Board, described the significance of the payment function in the larger debate over new capital rules for a visiting American researcher. (full article)