 groups, community-based organizations, small business organizations, individual experts, seniors, working together to make sure that there's a public interest voice in debates around the shape of the financial system, and working together to advocate for a financial system that is less dangerous and better at serving a productive real economy. In terms of our plans for the day, very briefly, most of us are used to talking in everyday language about banks or big banks when we think about the central bank actors in the financial system, but in fact, of course, many other actors, broker dealers, money market funds, insurance companies, hedge funds, and more are now absolutely key actors. They do complex and interconnected things and have complex and interconnected relationships with more traditional banks, and the financial crisis under the sharper gaze on them since then has made it very clear that they can be sources of systemic risk. Questions for the day include how we should understand what's really out there, and what we need to do to make sure we're not busy trying to regulate or even transform banks alone, or banks mostly, when more and more credit intermediation is happening somewhere else. Dodd-Frank provides regulators with some tools for dealing with this, but relatively little has been done so far, so we're very, very pleased to have a distinguished set of speakers to explore questions about what exactly shadow banking is and what needs to be done about it to make the system safer and better at meeting real economy needs. Two logistical notes before I introduce our first speaker. First, you can follow on Twitter and join the conversation at the hashtag shadow banking, and second, for people who are trying to get online, the Wi-Fi password is designer with the S as a money sign as an S. Capital D, thank you. All right, so Sheila Baer is now a senior advisor to the Pew Charitable Trusts and chair of the Systemic Risk Council formed by the CFA Institute on Pew to monitor and encourage regulatory reform of U.S. capital markets. Before that, she was the 19th chair of the FDIC, and before that a professor of financial regulatory policy, as well as assistant secretary for financial institutions at the Treasury, senior vice president for government relations at the New York Stock Exchange, a CFTC commissioner, and senior staff for Senate Majority Leader Bob Dole. Chairman Baer has been a principled, prescient and effective leader in work to make the financial system safer, including among other things as a crucial and early proponent of higher capital requirements and sensible leverage ratios, and is one of the first regulators to see the dangers and the high risk of subprime mortgages, and the dangers they pose both for individual borrowers and for the financial system as a whole. She's also the author of perhaps my favorite opening line of a column on financial reform, which following up on a presentation she did at the IMF, where she first posed the question and then answered it, does anybody have a clear vision of the desirable financial system of the future? Yes, me. It should be smaller, simpler, less leveraged, and more focused on meeting the credit needs of the real economy. And also, we should be on speculative use of credit default swaps from the face of the planet. That was a remarkable summary, and I look forward to her elaboration today. Thank you. I really appreciate being here. You know, I think in Kudos to AFR for flagging problems in the shadow sector, because I do think we are, you know, not the banks, so don't deserve it, but they really become quite the target of populist outrage, as well as some of the reform efforts here. And again, a lot of that is justified, but it's not, you know, it's one of the lessons of the crisis is you can't just focus on institutions that are subject to some type of regulatory penumbra and think that you are effectively dealing with systemic risk. The 2008 financial crisis has been called, you know, a run on the shadow banking system. And that's really pretty much what it was. In big investment banks took on a lot of leverage, started funding very, very short term. Bear and Lehman failed, obviously. Meryl did as well, but Meryl had to be acquired, or they certainly would have gone down and Morgan Stanley and Goldman Sachs were highly distressed, and received a lot of government assistance to stabilize their balance sheet. The short term lending markets were a disaster. The report markets froze up. Many market funds suffered a terrible run after the reserve fund broke the buck, which again, the Treasury Department had to get creative and concoct a temporary guarantee program for them to staunch the runs. And you know, by the way, I love the fact I was testifying recently on many market fund reform in Congress. And one of the industry representatives was there. And I want to know he assured me that only one fund broke the buck. And why was anybody worried about this? And oh, by the way, they didn't ask for the bailouts, just Hank just insisted that they get it. So, you know, it's really amazing, the revisionist history. Many bank holding companies obviously took a lot of risks. So there's plenty of blame for the banks too. But a lot of that was done outside of their insured bank where we had a harder focus on regulation and supervision than their non bank affiliates. And of course, the legendary problems with securitization, civs, MBS, all this risk that we thought theoretical is being moved off balance sheet off, you know, off the off the the balance sheets of the regulated institutions. And they were just floating around in the private in the shadow sector and came back quite quickly to to bite us. And then those infamous CDS and CDOs and boy, weren't those lovely things. And I would be in speculative use of CDS from the face of the earth. I think they're insurance. I think there should be an insurable interest requirement. Unfortunately, I think I'm in a minority, at least among the regulators about taking that step. But I do I think they are still quite a significant source of system instability. And then of course, those who wrote them, a lot of them, the AIGs, the financial guarantors, the monolines, those were not regulated banks, but nonetheless, approved to have present, profound systemic risk to our financial system. The regulatory structure hadn't kept pace either. Again, the focus is primarily on FDIC insured banks. And that was a good focus because there's a lot of government exposure there. But the existing resolution regimes were not adequate to deal with the shadow banking entities failing. And this was one of the reasons why we didn't have the right tools. And so we did have to provide some massive government support. And we need to do something. I've never questioned that. I think what we did was far too, far too generous. And then also we had siloed regulators. So the regulators weren't really playing as nice as they should. And you could see this particularly with the market regulators and the bank regulators. And so that I think also created some problems, particularly lack of coordination between the SEC and the bank regulators and Treasury. So where are we now? So I think, you know, the good news is we've made some good progress. Most of the big investment banks are now holding companies. They do have prudential supervision. They are subject to tougher capital requirements. The Fed does have powers. They are subject to the resolution authority, as well, which we have under Dodd-Frank, which we didn't have before him. So those are all good things. I think these large institutions are being forced now to develop living wills to show that they can be resolved in a bankruptcy without hurting the rest of us. And if they can't show that, actually, I think that the regulators have plenty of tools, whether they want to use them or not, as another question, plenty of tools to make and break up or downsize and shed assets until they can get to the point where they can be resolved into bankruptcy, because that's pretty much what the law says right now. Thanks a lot. And in large share to Gary Gensler, most of the, a lot of the derivatives are most of the interest rate swaps and the broad-based CDS have been moving into centralized clearing and decentralized execution. And that's a good thing. I think we need to worry a little bit more about who's regulating the clearinghouses. And we have a very underfunded SCFTC. It's got the lead authority on that. So that is something we need to worry about. But nonetheless, that is very good progress. We've also have an FSOC now. So it's kind of forcing, you know, the FSOC has probably got a mixed record, but at least it's forcing the regulators to get together and talk to each other, which believe me, is helpful in and of itself. And then finally, we have a new consumer bureau, because we also learned that bad consumer protections can also lead to systemic risk. And importantly, we now have mortgage lending standards, which we didn't have prior to the crisis that apply both to banks and non-banks and to shadow banks, which is incredibly helpful. But so much more needs to be done. Obviously, the Volcker rule, why in the world? Is the Volcker rule taking this long? It was disappointing when it's originally proposed. It was, it was, my view, too weak, too complex. And why it's continued to be bogged down like this, I don't know. The good news, I guess, is that at least the leaked press report suggests that one of the delays now is that with a new vote count at the SCC, there's an effort to strengthen it, not weaken it. So that's a good sign. But nonetheless, this really needs to get done. It's five years after the crisis and it's just, you know, regulators need to get in a room and make a decision and write a rule that protects the public. Money fund reform is still very much a work in progress. The SCC has put out a new proposal. I think it's, it's, it's not a strong proposal. It goes in the right direction, but I think it really leaves the system still at risk. I'm particularly concerned that there are weaker protections for retail investors than there are for so-called institutional investors. This idea of gates and fees that, you know, you can, the way to deal with runs is to deny investors access to the money or make them pay to get their money out. As a former chairman of the FDIC, I mean, that just, you know, that raises here on the back of my neck is to deal with runs that way. I think you deal with runs by forcing them to hold more capital to absorb losses or make them float their nav. And so we've strongly, the Systemacris Council, which I chair, has strongly advocated for a floating nav, as have I. Ironically, that's what they're doing in Europe. It's going to be 3% capital or a floating nav. And we are, we are very, very far behind in our thinking on money fund reform, even after this terrible problem we had in 2008. And again, though, the derivatives are finally subject to oversight by the CFTC and SEC. And they're being put through clearing houses. We haven't done enough to address the risk with clearing houses. One of the bad things I think Dodd-Faring did was to open up the access to the discount window or federal, excuse me, Fed lending facilities to clearing houses. They never had that before. I think that creates a lot of moral hazard. And again, we need robust, prudential standards for clearing houses that are going to be able to access that safety net. And we just don't have them now. And we've got a very underfunded CFTC trying to buy, provide oversight. And while the, you know, the FDIC, my former agency, I think they made tremendous, tremendous progress on resolution authority. There are additional rules that need to be put in place to make that work as well as it should, including much stronger capital requirements to prevent them from failing to begin with. But also if they do fail, plenty of long-term debt that would be readily, readily convertible to equity to absorb losses, put the losses of the failure on the shareholders and bondholders, and be able to recapitalize a new institution coming out of receivership. So the Fed has been promising that rule as long as a number of others. Again, they propose some. They haven't, haven't finished them though. And so that's the long-term debt requirement. I think they need to get that out. They've been talking about it good. I know they're committed to it, but it needs to get out. And then a lot of the proposed rules, again, these are all too big to fail related issues, enhanced potential standards for 165 has been pending for a couple of years, leverage ratio, really good rule. I'd like to see it higher, but it would be significantly more capital into the large financial institutions. It's been proposed. It hasn't been finalized yet. The SIFI surcharge, which we agreed in 2010 in the Basel Committee to put substantially higher risk-based ratio capital requirements on the very largest institutions, up to nine and a half percent that hasn't even been proposed yet. They're form banking operations rule to basically require foreign entities to subsidize their operations here to have our, you know, so they're subject to our own capital and liquidity standards, which are significantly stronger than they are in Europe in particular. Great rule still has not been finalized. So it's really, the Fed's got a lot of good things in progress, but they need to get these rules done and they've done great work with the stress test. I know they point to that proudly and they should, but that's not a substitute for, for good strong rules. And hopefully this is another grouping of regulations that really need to be finalized. And it is moral, you know, moral hazard too big to fail remains serious concerns. We, you know, outcome of the veil out. We had moral hazard prior to the crisis. We had even more when all the markets so suspicious that the government would be and not let these big guys go down. We're proven and for the most part to be a valid. So we need to be relentless on this. But we can't just focus on the very largest banks, regulated banks. Again, they need a lot of scrutiny. But you know what, leverage, liquidity and duration mismatches, the lack of transparency, lack of investor understanding about risk. Those are problems, whether you're a bank or a shadow bank and they can lead to broader systemic issues, if not appropriately addressed. And we should also remember that the bailouts, yes, the bailouts help the banks, they help the bank managers, but they also help the bondholders. They help the derivatives counterparties. A lot of those entities were shadow banks that they had taken risks they didn't understand. And when the those risks turned out to go bad, and they started suffering losses, they couldn't absorb the losses without freezing up the system. So you can't say just because it's a bank, we're going to regulate you if it's not a bank, we're not going to worry about you. Because these kinds of activities can be can be highly destabilizing. And again, I really commend this group for putting a laser like focus on this problem, because we probably haven't done with it enough. We do finally have some title one CIFI designations. You know, I think I have only taken a position on AIG and GE capital for being designated to CIFIs. The rest of them I'm agnostic. I don't have the information that the regulators have to know whether they've been, should be designated or not. I can only assume some of them need to be. But, you know, it just was out of the top to me that we would tell the public that AIG and GE capital were systemic for purposes of getting taxpayer system, but they weren't systemic for getting more regulations. So that made no sense to me. So my view is they should have been designated a long time ago or who should have explained to the public why they were no longer systemic and good they have been final. But what did it take a long time to do? So all right, I have to have to tweak people on a few of these things. You know, you got to keep them honest, right? But, you know, overall, I do remain consciously optimistic that progress has been slower than I'd like. Oh, my gosh. In some cases weaker than I like. But we are moving forward and we do know and fairness to the regulators, this group, will knows more than any because you're on the front lines trying to fight back that there's just been relentless on the slot of lobbying and, you know, is biblical the way the lobbyists and everybody has have descended on Washington like locust. So good for you. We want to keep working with you. We want to make this system work right for the real public. We want it in the real economy. And so keep keep your work up. Don't get discouraged. There is progress. I know Dan's going to be speaking later today and he's really been quite courageous on this and make, you know, tell him, get it over the finish line, Dan, you know, and let him know that you're behind him. So thanks. You know, great being here. And I'll be happy to take some questions now. Fresh air and candor and assurance doing the crisis. However, we're concerned that the Justice Department and the FDIC reported that the matter was settled with JP Morgan going against the FDIC insurance regarding WAMU. Jamie Diamond says, in spite of the Justice Department and FDIC's assurances, it's not over yet. Knowing that they have hundreds of millions of dollars prepared for litigation, what is your perspective on this? Yeah. So I think you need to distinguish between the receiver ship and the FDIC. I don't think Chase has ever said they would sue the FDIC and the deposit insurance fund, which would be somewhat bad for them because they, you know, their premiums account for a lot of the deposit insurance funds. They kind of be charging themselves. I don't think they've ever said that what they're talking about is suing the receivership where there's still a few billion of assets sitting in the receivership that have not been distributed yet. So and I think what they're saying is there's still some private litigation against them regarding the mortgage backed securities that WAMU issued that if they have liability there, they're going to take those back to the receivership. So again, you know, I'm not going to comment beyond that because it's an ongoing litigation and but you know, it's there's typically this is not unusual. When you have a failure and maybe when things start costing you more money than you think, there's a little buyer's remorse. I know we didn't agree to that after all. And so, you know, this is common. It's common in bankruptcy processes. It's common in the FDIC resolution process. So actually on that one, I can't get to get to worked up about it, but it is important to understand this against the FDIC receivership. It's not against the FDIC. Hi, thank you. My name is Ken Parris. I'm chief economist with the communications workers of America. You mentioned a whole list of reforms that you would recommend and that are being worked on now. And a lot of people in this room are working on reforms very hard. But there's negotiations going on away from this by trade representatives in the Trans-Pacific partnership, which is covers 12 nations, including the U.S., that represents 38% of world GDP that are basically would thwart and undermine all these efforts. So that in the investment chapter and what we know of financial services chapter, the TPP, basically a deregulation of financial services would prohibit countries from impinging on the ability of the free to the free and undelayed movement of capital, the Volcker rule to be challenged in courts, and Canadian Industry Association has already raised that specter. The TPP would expand all that. So two questions. How do you see the intersection between what you're attempting to do and people in this room are attempting to do to increase regulation, prudential, and what's happening in the trade arena where that's being undermined and directly attacked and would give private corporations the ability to sue countries for imposing those kind of regulations, capital controls. That's one. And two, if you recognize that as a problem, would you write a letter to the editor New York Times or some newspaper stating it because negotiations are at a critical point? Right. Chief negotiators are meeting right now in Salt Lake City. Early next month is a ministerial meeting. The administration is trying to conclude negotiations as quickly as possible. And that would, again, thwart all the efforts that you are trying to do now. Right. Well, I hope that's not that bleak. It may be. You may well be closer to it than I do. It's funny how these things, these little sayings get embedded in everybody's thinking and then they're not questioned like, oh, we don't want to impede capital flows. Right. So that's a bad thing. We don't want to impede capital flows. I absolutely want to impede capital flows. I mean, I think that's subsidization, which is what, you know, a piece of this, which is basically requiring countries that have foreign, excuse me, non-U.S. entities and should go the other way, too, for our banks doing business overseas. They have significant operations here. They should organize under our laws. And they should have capital in accordance with their laws. They should have good liquidity in accordance with their laws because we want them to be stable here in the U.S. And, you know, they don't like that. They want the free flow of capital because they can have less capital. Right. So if they can pull it around anywhere they need it, then that's much cheaper for them. A liquidity, too, as opposed to keeping it in each national jurisdiction where they do significant business. The problem is, of course, you get into a global times of economic stress. You need it everywhere and you don't have enough. So this idea that somehow this free flow is a good thing is not. It makes the system quite volatile. And I would hope that the trade negotiators would challenge some of these conventional wisdoms that just are simply not in the interest of their individual countries. And I don't know why every time we start talking about national standards, it always has to go down. It doesn't have to go up. I said that back to money fund reform. People are, we need national standards. OK, let's raise it to what the Europeans are doing, right? So we need national standards on capital. The Europeans should raise it to what we're doing. Why does it always have to go down? I don't understand that bias. So I think each individual country should do what's necessary to protect themselves and their system. And I think you start a race up, not down when you do that. Do those trade negotiators want the European banking system? That's what we'd have. I mean, we were hearing this prior to the crisis. So we were getting the way of global competition and making our institutions less competitive because we blocked the Basel II advanced approaches, which would have allowed our banks to take on a lot more leverage. They did it in Europe. That's one of the reasons their economy still struggles. Their banks levered up to unbelievable levels. We stopped it here. So as overlevered as our banks where it wasn't anywhere near the problem, it was. Our traditional banks, the investment banks, did lever up the way the European banks did. And that's been a terrible impediment to their economy. So, but you know, if we had gone international standards, free flow of capital, don't make us adhere to tougher laws than what we have in our own jurisdiction. We would have, I don't even want to think what would have happened. So I just wish, you know, that's not a universal ideal one. But I'll say it public. I'm happy to write a letter to the editor of trade negotiations to worry about systems stability to and protecting their own citizens. Yeah, absolutely. Yeah, OK, very good. Very good. Sure. Hi, Chairman Baer. Andy Green with Center Merkley's office. Good to see you as always. I wondered if you would comment on some of the research and data collection and monitoring that you've seen develop over your time at the FDSE. And then now are we making sufficient progress? Are there sufficient research going into this at the reserve banks and academia? Is data and information being appropriately shared between regulatory agencies? Were there challenges during that period? And sort of where are we going? Are there sort of occasionally we hear noise about conflicts of interest between reserve bank research departments and sort of other things going on? And so curious, is there sufficient data research coordination going on? So my sense is no. I mean, there may be stuff going on internally. I don't know about. But no, I was hoping the OFR, the Office of Financial Research, would be a decentralized place to get all the data that all the different regulators sit in and homogenize and make it consistent, put it in searchable formats. And my sense is that really hasn't happened yet. It would be nice to see. And all the individual agencies get proprietary about their own data. But you really, to see what's going on in the system as a whole, you need to put it all together collectively and have a group, which was supposed to be the OFR, analyzing it. So my sense is no. Separately, the System of Gris Council, which I'd share, is going to be soon releasing a couple of letters to the regulators more on a micro than a macro scale. But we're calling for much better disclosure of living wills, more meaningful disclosure of large complex institutions, financial statements, their legal organizations, how those organizations line up with their businesses, the cross guarantees, which are completely opaque, the derivatives exposure, not good disclosures. So I think regulators need better, more centralized data, but the market itself needs better data to, if we want to end bailouts and tell bond holders and shareholders, you're on the hook now. We need to give them data, too. So they can make informed decisions about the risks that are going on. And that will help as well. But no, I don't think there's been enough progress at all. Hi, Chairman Baer. Marcus Stanley from Americans for Financial Reform. I just wanted to quickly ask you about one other element of the safety net you didn't mention, which is the Federal Reserves 13-3 Lending Authority. And Dodd-Frank constructed the Federal Reserve to put out policies and procedures as soon as practicable to ensure that 13-3 lending was limited to solvent institutions on a generally available basis and did not serve to bail out a single institution. Your book was great on the Citibank issue and what was done there. How important do you think it is that the Federal Reserve move forward on this? And what guidance would you give them on how to do it? I think it's pretty important. And that's why I think that kind of my list of rules they've got in progress, they need to get those check. Because there's a lot. There's still a lot more to do. I do think it's important. I think an impediment to convincing the market that too big to fail is there is a little wiggle room in 13-3. And they're assuming that the Fed, I don't think this is right. I don't think Janet Yellen likes bailouts or wants to do them. But I think they're perceiving an institutional bias of the Fed to do bailouts that they're going to trouble again. So they'll do something that they say is broadly available, maybe just to help one institution. So I don't think the Fed's going to do that. But getting some rules out that are pretty tough about how they're going to define generally available, how they're going to define solvency would be helpful to tease this lingering perception of the market that they're still going to be back to our bailouts through 13-3. Absolutely. Hi, Chairman Behr. Nico Valks, IMF. Just a question on the, how do you see the future of the financial system? It was said in the beginning. We need a smaller, simpler, less complex, more transparent system. But if you put all those rules in place on regulated tendencies on shadow banks, isn't there also a risk that things will disappear into a new shadow system? Well, I don't think you can ever, there will always be a challenge with regulation is that the risk will try to go into, you know, they'll try to arbitrage it. And so I think the regulators need to be vigilant on that. I also think some of the, we shouldn't look at Title I, like the SIFI designation authority under Dodd-Frank, is the only way to deal with problems when they emerge in non-banking institutions. A lot of this is really more about activities than specific institutions. And there's plenty of authority. For instance, asset managers, there's been some OFR came out with a report. There's been some, a lot of discussion on that. But a lot of the issues raised there could be done through activity regulation by the SEC, and which may be more targeted and for some of these issues may be a better approach. So, no, I mean, I think, you know, if we just throw up our hands and say, you know, well, we can't, it's always going in the shadow sector, then why bother? Why regulate it all? You know? But you've got to, I think you can change. Good regulation that is simpler, the regulations themselves, should be less complex and are meaningfully enforced and that you have a fluid regulatory process to this idea that, you know, once every 10 years, we're going to do a big rewrite of regs. You can't, you can't do that. It's got to be nimble. And so I think there are ways to deal with it. And just, you know, I hear that a lot, well, it's going to go in the shadow sector, so why bother? And I just don't buy it. But it's a legitimate issue to discuss. Thanks. Hi, Neil Rowland. Neil Rowland. Emlex News. How are you? How are you? I'm going to get greedy and ask two questions, if I can. First, with regard to money market, money fund reform, as you point out, the Europeans are considering far more stringent rules, particularly with regard to capital requirements. How do you see that playing out, particularly with regard to the industry, the fund companies? Will there be a migration, you know, in terms of regulatory arbitrage to the US? Right. And second, Tim Massad, heir apparent to Gary Gensler. A little bit of a mystery. How do you see his tenure playing out, particularly with regard to cross-border derivative regulation? Right. So that's a good question about how many market fund investors will react and money market issuers will react with tougher standards in Europe. But nonetheless, I think Europe should do what's right for it. And I think they're doing a lot better job than we are. And so I would hope that the lesson from that is that the US needs to get the standards up to bring that kind of arbitrage. And with Tim Massad, you know, I wish him well. I think he's got big shoes to fill. Gary did an amazing job. He had a singular focus on getting those rules done. And I think he serves an example of what you can do when you really put your mind to it. And he, you know, he made enemies. He took on a lot of fierce opposition. But he got it done. And that's what you really need to do. So I hope my guess is, once he leaves, there's going to be some relentless pressure to try to undo some of the things he did, to water down some of the things he did. And I hope Tim Massad will follow in his tradition. But you know, I don't know. I wish him well. I'm going to hope for the best there. Hi, I'm Chris Leonard with the New America Foundation. And I guess since the seal's been broken, I'll ask two questions because they're both very short. Firstly, on derivatives, as you mentioned, a lot of the plain vanilla swaps are in central exchanges now and cleared. Do you, how do you, how much of the market do you still feel is in the shadows in terms of over-the-counter swaps or things like that and how much of a risk do you think that still poses today? And then secondly, how do you feel about the will for reform now in Washington that were many years removed from the crisis? Do you feel that it's dissipating or it's still strong? Right. Well, I think for the interest rate, the plain vanilla stuff is pretty much moved. I mean, there's still more customized esoteric instruments. Ironically, the higher risk ones stay on the bank balance sheet or off balance sheet under gap because the clearinghouses don't want to take them, right? They can't, like the London Whales Rates. They wouldn't take that. They wouldn't clear that because it was too hard to figure out what the risk was. So that's kind of upside down. And I think the bank regulators, the regulators of the big derivatives dealers need to focus on that. What's left that the clearinghouses won't take? Why won't they take it? How risky are those trades? And obviously, the non-financial end users are not, I think, most erupting out. And I think the banks are... Here's another problem with regulatory arbitrage. If they're going to have tougher margin requirements, more collateral demands by going to centralize higher upfront fees, by going to centralize clearing versus dealing with their friendly banker on a bilateral basis, then that's what they're going to do. So making consistent margining of capital requirements and looking at what potential impediments there may be for non-financial end users and disincentives to go to centralize clearing is probably something else that the regulators should look at. But the good news and the bad news is that the real economy use of derivatives is a pretty small percentage. And that's one of the problems of derivatives. Most of it is just financial institutions trading with each other. So I'm sorry. Was there a second part of the question? The will for reform is... Well, I'm not giving up. How about you? I do think there's been a calculated effort to delay, delay, delay, hoping that eventually it'll go away and that we'll just do a little few changes on the margin and congratulate ourselves and I'll go home. So I do think that's been a strategy and that's why I support my former colleagues. I know how difficult it is, but this stuff does not get better with time. I mean, look at the Fed. They've got some really good rules proposed that need to be finalized. They've got potentially three or four more governors. The vote count could change there. They're going to have to re-educate people. Fortunately with Janet, you've got somebody who's already been there, voted for it, understands the pending proposals. The same with the SEC on money fund reform. The vote count changed. That slowed things down. So it doesn't get better with time and you just give people more openings to create mischief. The longer you leave these rules out there and the longer it takes you to go final with them. My name is Wynne Brown. I'm with the Johns Hopkins School of Advanced International Studies. I've been asked to say that I have the honor of asking the last question. Okay, good. Oh, make it a good one. I'm struck by the number of commentators and indeed senior regulators who continue to say that Dodd-Frank and all of the regulatory reform efforts since have failed to end too big to fail. And the question for you is if all of the regulations that you've talked about including the 13-3 matter and so forth were in place and you were reasonably happy with them, could you then say as the former chair of the FDIC that too big to fail has been solved? I think it would be great to be able to do that. I do too. And I would like to be able to say that. And I do, you know, the disheartening thing about all of this is that it's not, well, and I know people disagree with my name. Some people think you know you need to restore a Glass-Steagall or put dramatic size caps on these institutions and that's how you do it. But I think with much tougher capital, a leverage ratio, the risk-based rules are too easy to game right now. I've said a minimum of 8%. You need a long-term debt requirement on top of that. So the capital structure, you need to get market discipline back into these banks. And I think that's going to be, I've said that the 30% of their capital stack should be some combination of long-term debt inequity. That's all clearly available for loss absorption if they fail. If you do that, make it clear to the market with your 13-3 rules that they're not going to do back to our bailouts with 13-3, I think, and they need to simplify their legal structures over time. You can end too big to fail without doing that, but it will be a really messy, expensive resolution. And so ironically too, I think, if they can get them to simplify their legal structures and get that information out to the market, the shareholders are going to create pressure to downsize. If you really increase capital requirements, you're going to have to retain more earnings. If you force them to issue a lot more long-term debt that they can't sell to each other, it's going to be very expensive to do. Shareholders are going to get frustrated with that, and they're going to look to the smaller, simpler-to-manage institutions to get better returns, frankly they already do now. And so I think you will get the market working for you as well. So I do think it's doable. I think it, and it's not that far within reach, but they've got to get these rules done and implement them. Okay, so we're honored to have a very distinguished first panel with us today. If any of you have looked at the in-depth academic research on shadow banking, you know that two entities have been in the forefront of it, the New York Fed and the IMF, and we have some very distinguished people from both of those institutions with us today. And if you've thought about shadow banking and all, you also know that the Financial Stability Oversight Committee, the EFSOC, has an absolutely central role, both in coordinating the regulatory response to it and in designating shadow non-bank institutions for oversight. And we also have Amaya Scarity, the deputy assistant secretary for the EFSOC with us today. So in terms of the specific individuals, we have Nicola Cettarelli, who is the, I believe, assistant vice president at the New York Federal Reserve and the author, co-author of many of these academic studies I'm referring to. Adam Ashcraft, the senior vice president at the New York Federal Reserve and someone who is also the author of a lot of pathbreaking research. Laura Kodres, who was until recently the division chief for global financial stability at the International Monetary Fund. We can all agree that global financial stability is extremely important. And I've told that she has moved to the Institute for Capacity Development at the IMF. And as I said, we also have Amaya Scarity, the deputy assistant secretary for the EFSOC. So without further ado, I'll turn it over to Nicola. All right, Marcus, where are you? Thanks so much for having me here and organizing this event today. So we don't have much time for presentations. So what I'm going to say draws from a number of works that I have conducted recently with a number of co-authors. Some are present here in the room. So I'm listing the sources here for reference. So there is a lot to talk about shadow banking, but my presentation today is going to focus on the monitoring aspect of shadow banking. And I think the reason why I wanted to do that is that for the last three years, I've been a member of the working groups for the Shadow Banking Initiative that the Financial Stability Board launched about three years ago on scoping the issue of shadow banking and rethinking regulation and monitoring on a cross-border basis. And so from that vantage point, I can perhaps say, I can state that there has been lots of progress done to understand what the problems are, the definition of the boundaries of the issue of shadow banking. But the remaining challenge, the very large challenge is about monitoring and specifically trying to understand what will be the future evolution of the system of financial intermediation. So how do we do that? And so that's basically what I wanted to focus today with my remarks. And the point is that we can recognize what went wrong, we can apply fixes, but then essentially the system will naturally evolve around the new regulatory environment than whatever new financial innovation that is presented in the marketplace. And so I'm going to just points for discussion on potential principles for forward-looking monitoring. And in order to do that, actually I wanted to start from a very basic description of what traditional financial intermediation is. That will be a useful starting point to obtain a natural definition of shadow banking. And once the two are on the table, I am going to actually focus on the role of banks, regulated bank entities, what the role of banks has been in the evolution of shadow banking. And there are some, again, conclusions for forward-looking monitoring from these observations. So let me start. So it's Friday and the holiday season approaches quickly. So I wanted to start on a whimsical note. Everybody is familiar with this movie, I'm sure. And if you're not familiar in a month, you will definitely have an opportunity to watch it on NBC. So it is, as it says, a gloriously life-affirming film, but it is actually, and I'm sure many of you have seen it and agree on that, it's probably the best depiction of banking in Hollywood cinematic history. If you, again, if you watch it closely, you have all the basic ingredients of banking, of financial intermediation. There is deposit-taking, there is loan-making, there is a very erudite discussion on liability structure. You have a bank run, you have ways to solve bank runs. There is really everything. It's really, really instructive. Good material for a class. There is even a bank examiner. It's kind of a sad description of bank examining, but it is there. So there is really every piece needed to describe a traditional financial intermediation. The problem with that picture is that it would be very hard to do a remake in modern times. And the point is that, you know, that movie is based on what I described, the traditional model of banking, which maybe is a little outdated. Without the maybe, otherwise, I suppose, we would not be here having this conversation today. So in the traditional model, really, the bank is the main broker in the process of intermediation. This is the standard picture that we've all seen on any textbook of money and banking. The banking is in the middle between supply and demand. Deposit taking and loanmaking really defines pretty much completely what a bank is, what financial intermediation is. The intermediation activity is on the bank balance sheet. That is where you want to look, in particular, if you want to highlight what might be the systemic externalities associated with financial intermediation. It may be useful also, and this is useful for me in the next couple of slides, to also simply remind ourselves what are the roles that are played inside this traditional bank, essentially what goes in the black box representation there. And in order for the bank to provide that role of central broker, there has to be a number of services that the bank provides. And so there has to be specialized lending, obviously, that the bank performs. There has to be a component of fact management, deposits and the way how the assets are structured. There is also a very important role of guaranteeing asset liabilities. This is a recognized function of a bank, of an intermediary. And so forth and so on. That is implicitly the bank is an underwriter. It is a broker dealer, if you allow me to stretch a little bit the concept. The problem with all this is that, again, the model of intermediation has evolved into something more complex. The picture now, everybody is talking about, the shadow system as something that has developed somewhat parallel to the traditional model. In this model, essentially, there are many reasons why the system has evolved. But there has been a big component of changing the technology of intermediation. And the asset securitization has been, in my opinion, the major innovation that has essentially broken the bond between deposit taking and loan making, which really defines what the bank is. And so remember the roles that I was mentioning before, the specialized lender, the fund management activity, the guaranteeing, all that. In the traditional model of bank, all those services are glued together, really, and they can only operate within the boundaries of a traditional banking firm. And what really makes the bank special is this unique capability of accessing a stable source of funding, the deposits. With asset securitization, again, that bond is broken. You don't need to hold loans on your books any longer with asset securitization. You don't even need really to rely on deposits any longer as a source of funding to perform financial intermediation because securitization secures, in and of itself, alternative sources of funding. So in this model, in this new model of intermediation, now all those services that I was mentioning before can be provided independently along a much longer chain of intermediation that we have all become too familiar with in the last few years. And so all those services now can be provided really by specialized providers, specialized entity that can emerge in the market. And their interaction that previously was coordinated within, literally, the walls of the traditional bank, now these interactions can be mediated through markets. So I have described what traditional intermediation is. I have described the evolution into the new model, and this is really giving me the opportunity to then define what shadow banking is. And so the definition is very simple. It is credit intermediation activity that is done outside regulated banks with a focus on what are really the essential services that traditional banking does, which can be summarized with maturity transformation, liquidity transformation, and credit transformation. So that simple setting allows us to come up with the definition, which is, by the way, very much consistent with the Financial Stability Board definition, if any one of you has read the many reports that have been issued in the last few years. So that's basically the first part of my presentation. And now I wanted to, again, try to go into the forward-looking approach. And I wanted, however, you can do many things, right? When you look at this picture, you can do many things. You can look at the shadow system. You can focus on particular pieces of the credit intermediation chain. You can study the vulnerabilities. You can try to understand how to make the system stronger and more solid. What I want to do, in particular, one of the things that I think is very useful is to actually recognize what the role of the banks, the regulated intermediaries, have been in the process of shadow banking. And so the role of banks, it turns out, it has been actually quite widespread. It was actually mentioned originally in the introduction of the event. In some of the work that I listed earlier on, we were actually able to document empirically that the banks have been all over the place directly involved in the intermediation chain. When they were not involved directly in the intermediation chain, they were, in fact, the guarantors to shadow bank entities. Again, financial intermediation, in order to be stable, has to rely on solid guarantees, both liquidity and credit guarantees. In the traditional system, the banks have access to the lender of last resort, and some of their liabilities are guaranteed, deposit insurance. A system that performs maturity transformation, liquidity transformation, and credit transformation outside of the system still requires the guarantees. And the banks are actually the natural providers, not the exclusive provider, but they are the natural providers of these guarantees. In part, I would argue, exactly because they have ultimately the backstop of the taxpayer that gives credibility to those guarantees. So in a way, throughout the development of the shadow banking system, they actually have been, I would say, like private central bankers to the system. And then another way to recognize the role of banks, I will go deeper in a couple of slides on that, is what I call the organizational channel. As I just briefly, as I mentioned before, you have all these specialized entities that emerge to cater to the process of modern intermediation, while a way in which the bank can remain central in the process is to acquire all the pieces. And so I'll get back on that in a second. So I wanted to, again, focus very, very briefly on what, right now, currently, the way in which banks are involved in modern intermediation, let's call it the shadow financial intermediation. With a couple of examples, I may just go on one. And there is another one that I don't know that I have the time to cover in details. This is an example of the leverage loan markets, that it is right now one of the hot topic, if you will, in terms of market monitoring as one potential source of risk and, again, associated with shadow banking activity. This is describing, essentially, the intermediation chain associated with institutional leverage loan markets. You have the issuers right there on the left hand side, the facilitator of the process, where banks already play an important role. And then this is the plain valine la part, where the loans are sold in the market. So these are the, I hope you can see, the list of investors. They can be insurance companies, hedge funds, mutual funds, ETFs, are all direct investors, buyer of these loans. But at the same time, banks also play a very important role in the structuring of the CLOs, which is actually quite a large component, currently, of the current outstanding. I think more than $400 billion of CLOs are there. And the existence of this particular derived market really depends on the role of banks. They provide the funding to the loan warehouses. They buy the residual pieces of the CLOs. They are also buying the more high quality tranches. It's even more complex than that. They provide lots of guarantees here to ETFs. They are, in some cases, the largest banks, the sponsors on some of these ETFs. So they provide guarantees there. They provide lines of credit to mutual funds for the purpose of these type of operations. Many of these operations here in the CLO side will also expand bilateral and triparty repo transactions. So the banks are players there with their dealer subsidiaries. So the discussion can go on into details. But that's basically the point that I wanted to make. The banks are really very much present in many, many ways in the process. This is another example. This is the municipal market, also quite fashionable among the, I guess, the nerdy regulators among us. It is not an inconsequential market, about $4 trillion right now. And again, banks have been very instrumental in the development of this market. In particular, the one where you can perhaps identify the so-called shadow banking risks through this particular evolution of these issuance with the VRDOs and TOBs where banks provide and any form of guarantee that you can think of and play so many other roles in that. So that's a way to, again, give you a flavor of the way in which regulated banks play a direct or indirect role in the shadow banking system today. And this is the organizational challenge. This is something that is work in progress that I'm doing right now with my co-authors, Jamie McAndrews and Jane Treina. And the point that I was trying to make, again, the system evolves. You have all these new intermediaries that evolve. Along the chain, you have new frictions that emerge. My colleague Adam actually has pointed out very clearly what the new frictions along the credit intermediation chains can be. And so from an organizational study standpoint, actually, one can make the argument that, in fact, it is efficient to fold all these specialists under common ownership and control to internalize these market-generated frictions. And so what that means is that you actually have a natural tendency for banks to evolve, to change their organizational form into much more complex bank holding company. And so just quickly on facts on that, there has been widespread expansion into non-bank industries of banks over the last 30 years. I can go in example, but we don't have time. And really, banks have become conglomerated specialists. And I'm done with that. So I just wanted to make the point about the relevance for forward-looking monitoring. Again, when you look closely, the system seems actually less shadowy to me than we thought originally. There is a lot that we can learn observing the system. And the regulated banks are right there in the middle of the process. And let me just use this sentence. This is actually not my sentence. My colleague and friend, Virala Chayda, from NYU, used it a week ago at a conference of shadow banking. I asked for permission. It is quite obvious, right? The shadow begins at your own feet. And in a way, this is really the message of my presentation. If you want to understand what the process of the evolution of shadow banking is, you may perhaps learn a lot by starting looking at your own feet, in this case, at what you are already regulating, the banks. And so a functional monitoring of the banks can really offer a very good window into what may be the new evolution in the system. And so that's basically the main message of my presentation. Thank you very much. Again, let me thank the organizers for inviting me today. I think it's always a great opportunity when we can talk about a subject like shadow banking and attempt to the best of our abilities to bring it out of the shadows and to have a transparent discussion of what the issues actually are. Before I start, let me remind you that these views represent my own. They do not represent the views of the IMF executive board nor its staff. Since I'm kind of notorious for not being able to finish my presentations, I've now routinely decided to put all of the takeaways in the first slide. So let me just make sure that I get to those. Essentially, the idea here is that what I'm going to demonstrate is that measuring shadow banking is hard. But we are making some progress. Mainly, we're making progress on the issues of size and the locations. And by locations, I mean both geographic locations and locations in terms of the institutions and the markets. What we need to do next, and I think this reiterates some of the points that Sheila Baer made this morning, is we need to step up our efforts in some very specific areas. We need to measure risk, especially leverage and interconnectedness better. We need to be able to catch the buildups of vulnerabilities earlier by being flexible about what we're monitoring and using what I would call market intelligence. And lastly, and this is sort of the holy grail of this area, is to try to figure out how to use the measures that we are developing to actually give mitigants, to actually put those into the policy design so that we actually are aiming for the right thing. OK, so going back to the basic, basic goal of what it is that we're attempting to accomplish here, what we're trying to accomplish is we're trying to see where in the shadow banking area there are or could become systemic risks that could harm the real economy. And that is really the underlying purpose here. Not all shadow banks are bad and not all shadow banking is bad. But what we are trying to find is the systemic components of it. So how are we attempting to do this? I sort of would like to think about it in terms of measurement into four areas. The location of risks and where they reside. So that's kind of our first slash at this problem, looking at institutions and markets, trying to get some sort of sense of what the size of the risks are. And I'll talk a little bit about how to size the issue in a few minutes. And the nature of risks and how they transmit. Without understanding that, we're not going to be able to really get a grasp on what it is that we need to get as the underlying issue. And lastly, it would be nice, but attempting to find out what the likelihood of the risks materializing would also be a goal that we could have. The first two are easier to accomplish. These last two bullets are actually very difficult. So what are the systemic risks that we're concerned about here? There's a lot of discussion about systemic risk, and not everybody agrees about how to think about it. But let me put the ones on here that I think are very specific for shadow banking. Excessive leverage. And that includes prosyclicality of margin or collateral valuation within, say, a repo contract or a securities lending contract. Overly large maturity mismatches between assets and liabilities. Maturity mismatches are not necessarily a bad thing. Banking relies on them in order to be a productive element in credit intermediation. But it's a matter of degree. And it's especially dangerous when you have illiquid assets financed by short-term wholesale liabilities. Lastly, the potential liquidity runs and associated knock-on effects. So we're also afraid of the money market run. We're afraid of the wholesale repo run. And we're afraid of that not just because it's a dislocation in the money markets, but we're afraid that that will bring down institutions at some point, either through chains of intermediation or through interaction between the funding and the liquidity characteristics and the fire sales that might have to result in order to gain the liquidity to pay off the individuals that are asking for their funds back. So where are we in terms of the status of measurement? It's important to note that we have some very well-known entities that we've been monitoring for some time, broker-dealers, money market funds, civs and conduits, which are on the downswing insurance. And of course, it's not all components of the insurance industry, but there are some activities. We have some other institutions that are now kind of in the gray area. I would characterize those as hedge funds, asset managers, finance companies, and a huge classification of other, which we don't even know necessarily what they do. But let me note that not all hedge funds are doing credit, liquidity, or maturity transformation. In fact, probably very few of them are doing those activities. Many asset managers just take investor money and buy publicly traded equities or bonds with them, again, with little or no leverage and often very little liquidity risk. Finance companies are institutions that make sound credit decisions, often providing retail customers with things like installment loans. So not all of these institutions are taking on bad decisions. In the markets, we know about repo markets, securities lending, ABCP, again, ABCP is kind of on the downswing too, particularly those that used as the underlying AB, the asset backed part, was subprime credit of some type, either a structured credit product or loans themselves. But we have some other questionable markets that are arising, private lending, going on with private equity funds, lending directly to firms, and of course, the leverage loan market, which Nicola discussed and I think Adam will discuss also. So what about sizes of risk? In order to size this, we often use plain old data. National flow funds data is the sort of most popular at the moment for how to size these various types of institutions and what they represent. There's BIS Bank data, which gives us some notion of the cross-border and I'd like to emphasize that we can't ignore the bank data when we're thinking about shadow banks for exactly the reasons that Nicola mentioned. At the IMF, we have something called the Coordinated Portfolio Survey, which looks at cross-border securities holdings. And there are myriad other data sources. Normally, what you do is you piecemeal these things together to get a picture and you use your market intelligence about what's popular now to get a feel for where to uncover the rock, so to speak, and look underneath the rock. So I just wanted to make a sort of a handout to those of you that have internet access, which is everybody. You should go to the FSB website and download the latest monitoring report. This picture is of last year's monitoring report and I wanted to note three things about this year compared to last year. One, the variety of institutions can be very broad and very specialized. We even have something called Dutch Special Financing Institutions in the global financial system. Two, there's an other category. It's the red component here on the left. It last year was 18% of the total of other financial institutions that were the big picture, broad characterization of shadow banking. And lastly, we have more clues about these other investment funds and we can at least eliminate the ones that are mostly equity. They tend to have very little leverage, but the ones that are in bonds do have leverage and we might want to think about what those are. Okay, in this year's report, I wanted to just notice two items. One is that this other category has shrunk from 18% to 9%. Okay, and why is that? Because the FSB asked countries to be more specific in terms of the types of institutions and so they were able to basically back out more types of institutions than they had before. It's a little misleading because not all 25 jurisdictions for which this data was collected have some of those criteria or collect information about those specific subcategories, but at least we're getting a good start and we're eliminating that other category. A little bit more worrying is that the proportion that's moving into bonds has increased and that might not be too surprising to you but in some cases that is ongoing and that will present maybe some areas where we need to look a little closer. In terms of the nature of the risks and the transmission mechanisms, how are we doing in terms of being able to measure these things? We're getting better. We're combining BIS banking data with supervisory data. We're using trade repositories. And we are now in the process at the IMF of developing a global flow of funds framework and we're starting to implement that. So here we're able to get sort of the cross-border and the transmission. Let me just second Sheila's comment about the sharing issue. We still need to do more sharing of this information. It's not shared broadly. It's not even shared broadly in the United States across the various regulators and it's certainly not shared broadly across jurisdictions at the global level. There's some good efforts going on in the senior supervisors group so I don't want to completely dis this idea but it's still not anywhere where it needs to be. On the likelihood that risks materialize, really fundamental, we're really not there yet on this criteria. We cannot predict when a crisis is gonna erupt. It's seemingly very random where these tipping points are. We have some rules of thumb about thresholds where you should be worried. We have some issues about, we have some vulnerability measures about systemic liquidity and systemic solvency issues. And mostly we use options type data to think about what's happening in the tails and that's where these tipping points tend to happen. So what about the future? And I want to also emphasize the way that Nicola is presenting things too is we need to look forward. We need to be flexible. So in particular, we need to stop focusing on institutions or activities. There seems to be this tendency like it's an either or. It's not an either or. It's they're the same. Who do you think produces activities? Institutions. Okay, some of those institutions are banks. Some of them are non banks. Those things happen through institutions often called exchanges or CCPs or clearing houses or trade repositories. All those are institutions. We tend to sort of put these guys in one category and the other. It's a continuum and we need to be more careful about that. In particular, two examples, right? We know that asset managers, some of them are probably not taking leverage but some of them are in the securities lending business where there can be risk. Or an insurance company is now very prominent in the leverage loan business. Again, an area, an activity of shadow banking being used by a specific institution. So you can start to see where these crossover points are. About size, big is not necessarily bad. It's size often combined with growth that we're worried about. Things that are big but stable tend not to be of issue. Sometimes they are in terms of solvency so we want to be careful about that. But generally we're interested in size combined with growth, which is a problem. And we want to think about what are we measuring size with and what are we comparing it to? And that depends on the question that we really want to ask. So what do we need to be able to do? We need to be able to collect the information to begin with. That sounds very sort of fundamental but there are countries in the world that are not allowed to collect information except from regulated entities. And they can't figure out whether they should be within the regulatory perimeter until they can find out any information about them. And so they're in this catch 22 situation where they can't even figure out which one should be within the regulatory perimeter. Fortunately the OFR has legal authority to go and ask any information it wants. So I mean it's a big stick and you might not want to use it very often but nonetheless at least they have the legal authority to start to look underneath the rocks. We need to be flexible and adaptable. So at the same time we need to have this basic information we need to and we need to regularly collect some of it from some types of institutions that we know are performing these shadow activities. We also need to have insight into what is the next thing that we need to collect the information on. Private label securitization is no longer the large issue. So here's private label securitization. I don't know that we need to spend a lot of resources looking at that at the moment. We've re-regulated it and it's gone, okay? Maybe because of re-regulation, maybe because of demand conditions I'm not sure but it's definitely not happening. On the other hand, as Nicola pointed out, these US REITs, these real estate trusts are growing rapidly. This is not a size picture. I think probably Adam has a size picture. This is the proportion of short-term repo funding that they're using as a proportion. It's up to 40% of their own thing. So we have a lot of issues there. But if you measure size a different way, so if the question was not how much runability do they have or what might happen to their wholesale funding but if you looked at it, well, what would happen if Fannie and Freddie couldn't distribute their agency debt which underlies these REITs? Well, they're only 5% of all the outstanding GSE debt so from that perspective they're not big. So you have to think about what it is that you're estimating. One more example. This is not the Chinese wealth management things that you've been hearing about. This is even newer than these wealth management products which are the latest sort of shadow banking entity in China. This is a sweep account from an electronic, essentially a PayPal account that sweeps it into a money market fund. They opened this ability, this alababa which is the third largest one to a money market fund and since June, they have 13 million customers and $9.2 billion in six months. So here's what I'm talking about. Well, it's small, relatively speaking, it's growing astronomically fast. There are six million, sorry, there are 800 million customers of this PayPal kind of thing. So you can see what the potential is for this. It's a money market mutual fund. It's not clear to me that the investors know what they've got. They can redeem at any time and move it back into their checking accounts. So it's something to think about. Okay, so where are we? We need to have better data. We need to have a degree, we need to have better measure leverage in non-banks. Measuring leverage in an insurance company is even non-trillion. You would think that that might be easy. It's not so easy. Measuring the leverage involved in securitization chains. Okay, it's tough. Okay, anybody here at this table will tell you that it's not an easy process. Even measuring the degree of maturity mismatch, often we don't have the data to do that. The degree of interconnectedness. We need obviously more models on how to think about the probability that the risks transpire. We need to have some idea about what the run risk really is and what triggers really are. So let me just mention what the IMF is doing to help. We're working on this global flow of funds. We're upgrading our coordinated portfolio investment survey to have more sectoral, especially in the non-banking area, trying to get more sectoral granularity in what the cross-border exposures are. We're revising the financial soundness indicators. In particular, we will have something on the maturity distribution and the sectoral distribution of assets for money market mutual funds. Let me just mention one last, this is the last slide. I just wanted to mention that what we need to do next is connect these measures to our measures of policy. So we need to directly say the proportion of this firm's added value or added component to systemic risk needs to have an equivalent of proportional cost to having that risk. Right now we're using capital. Capital is kind of a blunt instrument for this. We could do a better job. The G-SIFI charges a move in the right direction, but it's not calibrated to actual measures. We just have a bunch of these that we've said are the right guys and we have a scale. It goes from I think half a percent to 3% or something. But we need to think about that. We need to think about a tax. We need to think about liquidity premium. Whatever the mechanism is to incentivize, particularly incentivize the reduction of systemic risks at their source. And that's my, that's it. Thanks. Good morning. My name is Adam Ashcroft. I'm also at the New York Fed. The views expressed here are my own and not those of my employer as with Nicola, who didn't mention that. But he has a nice disclaimer on his slides and I don't mind. I am the head of credit risk management at the New York Fed. I've been at the New York Fed for a long time and spent a lot of the last five years being actively involved in the design implementation and risk management of the 13 three liquidity facilities that have been talked a little bit about here today. But since the closing of those activities we've been really focused a lot on trying to understand what happens and obviously how to prevent having to do what we did ever again. So while I think that the Federal Reserve has gotten a lot of criticism for the activities of the crisis and you can be on either side of whether or not what was done was make sense or not, I certainly want to at least point out that the Federal Reserve has been at the center of a lot of the efforts both in the academic field and on the policy front to try to really understand what went wrong and trying to put together intelligent policies to be sure that none of this ever happens again. So what I want to talk to you about today is academic work that I've done with Nicola and with some colleagues that tries to put some of those things together and maybe we can talk about what lessons we think we still haven't learned yet from the crisis and what are the things that still frighten us around the corner. So I want to talk a little bit about why shadow intermediation exists, why we should be concerned about it, what we've possibly learned from what happened and what should you be scared about when you go to bed tonight. So to start, this is a chart from our recent paper that wants to give you a historical perspective on shadow credit intermediation using flow of funds data. What this basically does is it breaks out the liabilities of financial business which includes everything from banks to insurance companies to money market mutual funds but does so all the way back as far back as the data go to 1945. And what you see in this blue line here, this is what we call traditional maturity transformation. This is largely short-term deposits issued by banks. What you see in the red is going to be maturity transformation done by shadow entities. So this is a repo and money market mutual funds. Traditional credit information, traditional credit transformation, you're referring here to traditional bond markets and insurance companies and banks using long-term funding and shadow credit transformation is going to include things like mutual funds and then securitization. So I put this chart together and I really like it a lot. There are a couple important things that I want you to draw from it to put the shadow banking system in perspective. A lot of discussion has really focused on what happened in 2008, 2009. But as you can see that these are really just now growth and developments that have been going on for a very long period of time. You'll see that the amount of maturity transformation in the economy generally has been declining since the 1940s. You might think that doesn't make any sense. We've been talking about maturity transformation the entire day. How can it be the case that there's less maturity transformation now than there used to be? A lot of this is really just banks are involved in maturity transformation and banks are just a smaller part over the overall funding of credit than they used to be. The difference though is that when you look at the difference between the blue bars which is maturity transformation by banks and the red bars which is maturity transformation outside of the banking system and to think about the ratio of those two things. Some of those you can think of in some sense as the aggregate supply of money that's in the economy. And what's happened since the 1940s is that non-banks have become a much more important part of the money supply. And as you know, money is very important. It's a medium of exchange, it's a store of value. It is at the heart of the confidence of the financial system. And so what you saw over time was very slowly that banks became just a lot less important in the overall money supply. At least until 2008, 2009 and at that point in time they started to become a lot more important again as people lost confidence in the form of money that was not issued by banks. This pattern for those of you that have studied history is not particularly different from what we saw if you go back to the 1800s and think about the crisis that existed in money and bank panics from then. Originally when money was backed by a specie and people lost confidence in that and there were runs on banks that ultimately were ended with establishment of a national currency. But then with the advent of fractional reserves you again saw bank panics again until you saw the establishment of the Federal Reserve and Federal Deposit Insurance. So this is an interesting cycle. It's something that's happened over a long period of time but it's also interesting to think about how is it similar and how is it different to the historical innovations that we've seen in the supply of money before? And the way that those previous problems with non-bank money were solved were largely around the additional government guarantees. I don't think you shouldn't take that observation as an advocacy for there being government guarantees around this form of the money supply but certainly to understand how it's evolved before and it's not really that different from what we've experienced before. So why do we care about shadow banking? The first of which is a lot of shadow banking has to do with regulatory arbitrage. It's not just capital, capital arbitrage is a big part of it but as you know in order to have good through the cycle intermediation you need to have an adequate amount of capital underneath it and to the extent that the system is able to find ways of circumventing regulatory capital ratios. Sure, I'm sorry. To the extent that the financial system is able to circumvent regulatory capital ratios that's going to make their leverage a lot more prosyclical. It's gonna amplify the underlying fundamentals and create a lot more volatility than what otherwise exists. With respect to neglected risks I think when we think about what shadow banking does is it basically transforms very opaque long-term risky assets into things that are very short-term money-like instruments. And what that process basically does is it basically transforms risk to basically the person who's willing to pay the highest price for it. People in the money market are basically going to be funding those complicated assets at the highest price. The challenge with that is that there are a lot of neglected risks in that process. The complexity of the intermediation chain and the complexity of those instruments and the illusion that they have very short-term maturity permits people to ignore a lot of the risks that exist in that intermediation chain. And that creates distortions throughout the financial system. The funding fragilities you know are well-known to the extent that you have money that doesn't have a backstop. There are runs. And when that happens it scares the heck out of everyone. Leverage cycles we just talked about and agency problems to the extent that you have very long intermediation chains. A problem is that if you want to resolve agency problems you need to invest into mechanisms at every stage of that intermediation chain to eliminate those frictions. Otherwise it's very straightforward for example a local government investment fund in Florida as happened in November of 2008 to be holding subprime mortgages that were backing Asabak commercial paper. So the challenge is that as the intermediation chain becomes very long and very complex you need to make lots of investments in lots of different places in order to be sure that credit is still mediated in a sound way through the cycle. So just to highlight some of the places where it went really wrong. The first place is the Asabak commercial paper market. This was a market that historically was really just used to finance receivables for consumers and finance companies. However there was a change in capital rules and both here in the U.S. as well as in Europe where there was extraordinary growth in this market by Londas banks who were setting up securities arbitrage conduits to buy things like subprime mortgages and this didn't end very well because what happened in August of 2008 was that Asabak commercial paper investors who were viewing their investments as a close substitute to cash realized that they have subprime mortgages underneath them and they all ran for the exits. And so some of the first programs that the Fed built in response to the crisis was one of them was the term auction facility. That was largely about trying to induce banks to come show up and borrow from the discount window many of whom were foreign entities who had set up securities arbitrage conduits and were bidding up the price of dollars in international markets. That was having an adverse effect on financial conditions. Money Market Mutual Funds we've talked a lot about today. I liked Sheila Vera's remarks on the revisionist history. If you look at this chart, you'll see there was a 25% contraction almost in prime money market funds in fall of 2008. I think it's probably the scariest thing that anyone saw throughout this crisis was people running for the exits in the prime money funds. And yes, it is the case that losses were not there but the reason for that was because the extraordinary actions taken by the public sector, by the central bank, by the U.S. Treasury to be sure that there weren't massive fire sales of assets that were in those entities. And so while there have been some changes to improve disclosure and to change the amount of maturity mismatch that money funds can have, I think everyone understands that the most meaningful reform is still on the table and we haven't been there yet. I don't think anyone wants the central bank to go back and do the things again that we had to do in order to prevent a collapse of the money market fund industry but we really need meaningful rules in place to prevent that from happening because the changes that need to happen haven't occurred yet. And the memories of what happened are obviously not as fresh as they used to be. Tri-party repo, so I think at the heart of the failures of Bear Stearns and Lehman Brothers and even if you broaden repo to think about securities lending, it would include AIG. You see massive increases in leverage throughout the 1990s and 2000s and then what happened was that the leverage came to a stop. A lot of this is funded by the money market fund industry. The Fed has been working extremely hard to use the leverage that it has over the clearing banks to facilitate reform of the tri-party repo market, getting people to reduce the amount of intraday credit that they extend to broker-dealers and they've done about as much as far as they can go, the real solution that hasn't been put in the lease yet is how is the market gonna deal with the failure of a large broker-dealer. It still is the case that if a money market mutual fund had to deal with receiving the assets of a failed broker-dealer, it would be receiving assets that it probably wouldn't be able to hold onto and would have to immediately legally sell. So what that means is that even in the tri-party repo market, there's a threat of fire sales because we haven't put in place a meaningful mechanism to deal with the resolution of a large broker-deal yet. With respect to securitization, I show you two charts here, one that probably looks familiar from the recent period. At the bottom is one you probably haven't seen before. It's an excellent paper written by me and a co-author looking at one of the first securitization markets in the US. This is the commercial real estate bond market from the 1920s. There were these commercial real estate bond houses that realized that once the US Treasury started selling Liberty bonds to households in small denominations because households were just starting to figure out how to look at alternative savings mechanisms. The commercial real estate bond houses thought, wow, we could sell complicated financial products in exactly the same way. So what they did was they financed the construction of office buildings in New York and Chicago, many of which are still there, but not as fully stabilized properties but as construction loans that converted into those. And so you can imagine what happened. You had this flood of liquidity from households that had no idea what they were buying. They're buying bonds in small denominations. Of course it wasn't resensitive at all. There was no market discipline on the standards for those loans that were underwritten. And obviously going into the Depression when the economy turned, they turned out horribly. So you can look at the top chart and some people will tell you, this was a one time event. It's never happened before. But you can look at all of the other times in history and there's one right down there in the 1930s where exactly the same thing happened again. We're not learning the lessons that we need to learn in order to prevent this from happening again. We haven't done anything meaningful to prevent the securization market from doing exactly what it just did. And we need to do more for that. In terms of government sponsored agencies, I figured most of you knew the story about Fannie and Freddie, so I wouldn't talk about them. A little below the radar is the Federal Home Loan Bank System. They were a very important part of the story of liquidity in 2007 and 2008. The size of their balance sheets basically doubled from about $500 billion to $1 trillion. We referred to them in a paper as the shadow discount window. Banks didn't really wanna come borrow from the Federal Reserve because of the stigma associated with borrowing, but they were able to borrow massive amounts of money at term and at very cheap interest rates through the Federal Home Loan Bank System, through the crisis until there became concern about the GSEs generally then at that point in time, it became advantageous for them to come turn to the Fed. And Sheila's talked about credit derivatives and we don't need to go much into that. So let me just wrap up with remarks about what to worry about in the future. I think you've seen some remarks on REITs and you've seen some remarks on the Chinese banking system. Just wanna talk very briefly about leverage lending. This is a topic close to my heart because we've been working really hard to put rules in place for risk retention and securitization. And this is a topic where there's been a lot of back and forth with the industry. Leverage loans, as you might know, these are balloon loans. They're largely used to finance leverage buyouts, basically taking companies out of the market and trying to reorganize them in order to sell them later on at a premium, largely done by private equity firms. These are floating rate loans and they take obviously a long time to do. A challenge with this asset class is that first of all, you've got a systemic risk factor which is the equity market. And the second is that you've got balloon loans. And anytime you have asset classes making lots of balloon loans, you have this hidden systemic risk here. It exists also in the commercial real estate market but this is a place where it's potentially a big problem. And so when markets closed in 2008, 2009, all of the people that were holding these loans were frightened to death because there wasn't going to be any refinancing liquidity to take them out. And so as part of the actions that the central bank and everyone took to lower interest rates which made the floating rate loans perform a lot better and improve equity prices which means that the refinancing liquidity to take them out ultimately came back. And these loans didn't perform as horribly as you might have expected if you looked at how badly they were underwritten going into the crisis. The challenge now is in discussions about what to do about the leveraged loan market. People on the other side of the aisle will suggest that these loans actually didn't perform very bad in part because of all the support they got from lower interest rates and from support of the equity market. So there's not really a need to reform this market despite the fact that as you see from the chart here on the right underwriting standards are deteriorating in the same way that they were going into the crisis. So we are not suggesting that the leveraged loan market is as bad as it was in 2006 or 2007 but the point is that the willingness to engage in reform is just not there in part because people didn't take the losses that they might should have taken and that the hope and expectation is that we can do the right thing and protect the economy from harm when it needs to but then after the fact that we can sit down and look at what happened and make the right decisions in order to put meaningful reforms going forward. So that's all I have to say for now. Thanks for your help. Thanks for being here. My name is Amaya Scarida. I work at the Treasury Department where I'm the Deputy Assistant Secretary for the Financial Stability Oversight Council. So it's not in my slide but I don't have slides so we'll leave it up there. I think the key thing that I want to highlight and a lot of what has been said today I think is really on point in terms of having a clear definition and really focusing on this notion of transformation and the transformation between a short-term, safe instrument on the one hand and a long-term risk instrument on the other hand. I think it's the combination of those two that has been highlighted today as the area where people think there's risk when they're talking about shadow banking. That's not the only area there's risk but it's an important element of the definition. And so one of the things that I want to highlight in my remarks today is talk a little bit on the conditions. And Nicola talked about this, about the notion of guarantees, what's the role of banks. So I really want to focus on the conditions for this transformation happening in the shadow banking sector and also talk about the changes in those conditions because I think when we look at mapping we have to recognize not only what happened in the crisis but also what's changed since, what changes are coming and how that will affect our ability to monitor and also the types of activities that we'll need to look closely at in the future. So I think we've already talked a little bit today about the critical role that banks played and then also the critical role that markets played in providing the conditions for shadow banking in the intersection between those two. So I'll just organize my comments in talking a little bit about some of the changes in the way banks interact with shadow banking activities and then some of the changes that have happened in the way that markets interact with shadow banking activities. So the role of banks already, I think Nicola talked a lot about, they played the role of providing liquidity guarantees, they played the role of being sponsors, they played the role of being warehouses of assets. And this role was critical to support the investor assumption that short-term liabilities were in fact very safe and could be treated essentially as money. And that's a really critical point, Nicola already made this, but I just wanna highlight it. So now we have to look at what's changed. Well, let's start with accounting rules. As of 2009, accounting rules have been tightened dramatically so that financial institutions that have significant control over an entity or an obligation to absorb loss must consolidate that entity on their balance sheet. And this has a compounding effect through the capital rules so that if an asset is on your balance sheet, now there's an obligation to hold capital against these assets. But on top of that, the capital rules have changed not just because of accounting rules, but also they've made it more expensive for banks and bank holding companies to provide the sorts of guarantees and other services that link them so tightly to shadow banking activities. And there's also adjustments to better reflect some of the risk and securitizations. So these are direct changes to the treatment of certain sort of traditional shadow banking assets that compound the changes in accounting rules and change the dynamic a bit. So for instance, there were rules changed in the capital rules that have been removed that really gave banks incentives to provide 364-day guarantees on a rolling basis. And those rules have been tightened. Now, whether that's efficient or not, I think is not the point that I'm trying to make, but merely to say that we have to look at the way the role for banks has changed. And I think also to recognize that in order to generate panic-like behavior that we observed in our crisis, there need to be conditions that deeply supported what sort of fundamentally were incorrect views on the value of assets held in shadow banking activities and therefore very brittle views on the safety of the money-like liabilities. And that's why I think the focus on the role that banks played and the contribution they had in creating these fundamentally brittle perceptions of safety. I think we also have to look at on the asset side. And so we have to recognize the role of credit rating agencies and the change is there. Credit rating agencies provided opinions whose errors are now painfully clear. Investors and regulators too can share the blame for relying on rating agency judgments. And this reliance helped create cliff effects. But this landscape is now changing. The SEC is working to finalize proposed rules on rating agency reforms. Regulators have already taken steps to remove references to ratings in their rules. And while regulators can take these steps, we also have to recognize that it's still up to investors to make credit assessments without mechanical reliance on rating agency opinions. We also have to recognize the role of limited disclosure. So compounding the problems of reliance on rating agencies, the lack of detailed disclosure requirements, particularly for asset-backed securities, meant that when market valuations changed, when perceptions changed, there was not enough information available to quickly or efficiently make assessments of the fundamental value of the asset. And without that information to make that assessment, there's no ability for the market to clear. And that again helps explain part of the dynamics that my colleagues have talked about this morning. And here, too, there is change required under the Dodd-Frank Act. Even before Dodd-Frank, the SEC finalized new disclosure requirements for asset-backed securities, and they've proposed additional rules that now conform without law. The proposed rules for rating agencies also have detailed disclosure requirements. And market participants report that they now have data and systems that provide much more visibility and analytical capability for the risk management investment decision. So these are changes that are happening now, and I think we really need to look at these changes and how they will play out as we monitor the financial system. And I think we also have to recognize the role of risk appetite in market discipline. Over the past five years, I think there are very clear signs, and we've seen the number of the charts today, of a very different approach to market discipline and risk appetite, at least for those shadow banking activities that demonstrated the most instability during the crisis. But the message that I think the conversation today really needs to focus on is that that role of market discipline may or may not be a permanent change. It may be a cyclical change. And so I think we have to recognize going forward how much information gets processed through. What is the role of risk appetite in market discipline as we monitor markets going forward? And so when we review the question of shadow banking in today's financial system, we have to recognize we're mapping a very different landscape than the one we faced in 2008. So generally speaking, you've seen lots of charts that show lower risk, much smaller shadow banking activities. You've seen wholesale disappearance of certain activities. And you also see, I think, continued emphasis on efforts to continue to reform. So I'll just give some examples with the Financial Stability Oversight Council. The FSOC members have direct regulatory authority to address risks, but the FSOC has been very publicly active in identifying and working with its members to support key reforms such as supporting the SEC in reforms of money market funds or working with the Federal Reserve to support reforms to the tri-party repo market. And the activities themselves are conducted with lower risk today. For example, the repo market has a much higher proportion of safer assets such as treasuries and agency mortgage-backed securities. That said, at the FSOC, our charge is to monitor markets for signs of excessive risk. And though we know that no financial crisis exactly like the last one, we need to therefore spend significant time and effort identifying the ways in which the financial system is changing in response to the crisis, changing in response to the reforms that have already been implemented or on their way to implementation, and to identify new products and areas of rapid growth that may indicate new risks that are emerging or are imperfectly understood. So I think with that, I'll just close to emphasize the changes that are coming when we think about mapping shadow banking activities. We really want to map it in the context of an understanding of the way the landscape has changed and will continue to change. Okay, so we have about 10 minutes. Maybe a little more. We can go a little past noon, but until our scheduled break, so people who want to ask questions should line up at the mic in the back. I think I will take the moderator's prerogative to ask the first question. I'm glad that Amias worked his way around to mentioning credit rating agencies. AFR is on record as saying that the SEC credit rating rules are completely inadequate. In fact, we think they should be reproposed and that they won't bring real deep change to the credit rating agencies. Just for whoever would like to take this on, first of all, how much do you think could be done in this? And I guess Amias already expressed his view, so maybe Adam and Nicola might speak to this. How far do you think we could get through reform of the credit rating agencies in addressing some of these questions and what would we have to do to really make that work? Sure, so it's an important question. Rating agencies are and probably always will be an important part of financial markets. I think the challenge, we learned a lot about rating agencies when we did the TALF program because we had a part of the TALF program where we wanted to do our own work and not rely on the rating agencies. So what we did is we asked the issuers to give us the same information that they gave to the rating agencies so that we could come to our own judgments of whether or not we thought the securities were good for lending or not. And so I mean, we learned a lot through that, but one of the things we learned was just that there's rating shopping on every transaction. It's just part of the businesses and people's blood. You can talk about market discipline all you want, but the objective of the issuer is to get the least amount of market discipline as possible by choosing the rating agency that's going to give it the best rating and selling it to investors that are going to give it at the highest least sensitive, resensitive price. So I certainly would encourage people to use the authority that they have to try to strengthen the rating agency. I don't think without a wholesale change in the business model, you're going to get a better product. In my view, rating agencies need to have risk retention. They need to basically hold on to a piece of the transactions that they're rating in order for them to kind of give into the rating shopping. Okay, so questions in the back? Neil Rowland with Emlex News for Amias. How will EFSOC go about assessing whether asset managers like BlackRock and Fidelity should be regarded as SIFIs? There seems to be a big absence of data. There also seems to be significant disagreement as to whether they actually should be even assessed at all. What were the procedure that EFSOC will be following here? So let me start by saying that the EFSOC has a stated policy and I'm not going to change that. We do not talk about specific companies that are either being considered or maybe considered for designation so I think it's worth stating that first. That being said, I think it's a good question and the EFSOC spent a lot of time. We put out both an advance notice of proposed rulemaking. We put out two proposals before finalizing on rulemaking and guidance to try and give the public a better understanding of the assessment of any company for consideration as potential designation. And in each of these, the fundamental characteristic is that this is a firm by firm analysis. It is not materially limited by data because the council has the authority to request data from any financial company under consideration. And it's also not fundamentally industry driven because it is firm by firm, the council will consider the particular risks across all of the business lines, all of the activities of any given company. And I think one of the things that is most important to the council in this is not only that it does a thorough review of each company but that it engages directly with any company under consideration before a proposed designation is made. So there's very significant opportunity for the council to have data and to understand the business and activities of any company before that proposed designation or proposed decision is made. And I think that's really the most important thing to understand with the council is that it is engaged on a firm by firm analysis with plenty of opportunity both for data collection analysis and the opportunity for the company to make sure that the council understands its business and its risks. I'll just follow up. I'm sorry. I can go now. Can you say what the FSOC is actually doing in this regard? So I think I just did, but I'll say it again. The council is analyzing each company that it considers for potential designation on a firm specific basis using both public, regulatory, and information requested directly from those companies. And the considerations are laid out in the statute and further elaborated in our rule and public guidance. Nicola. I just wanted to add to the topic of asset management analysis. You raised the question about the SIFI designation of asset managers, which is a legitimate question. And I think that sometimes there is confusion between the SIFI argument and the shadow banking argument. So you could designate a firm for reasons that are not necessarily related to their contribution to shadow banking risk. It's a systemic issue that could be related to size and the way in which they may affect the market. But it may not necessarily be the case that that particular firm is especially engaged in the shadow banking world. So I just wanted to, you know, from an academic perspective at least to raise the distinction. And then just for completeness, I think it may be worth also to pay attention to what the Financial Stability Board is doing right now in parallel to what the United States is currently undertaking. There is a similar initiative on the international scale to complete the task of coming up with methodologies for the designation of globally systemic financial institutions. And so there has been already methodologies and designation of the global banks, most recently of the global insurance companies. And so the remaining piece now is, you know, as actually Laura was mentioning before, it's the other, right? Everything else. And so that is work that is currently, you know, undertaken by the Financial Stability Board. And there is a report that is going to be made public very soon, I think in December. I'm not sure whether the public will see it in December or in January. That will in fact have something to say about, you know, the asset management world as well. So that could be something useful to take a look at. Eventually, you know, one wishes that there might be some cross-border coordination and cooperation in the way in which we tackle these problems. So we're reaching our break point, but let's try to see what we can do with the three questions in back. I don't think we're going to be able to take any more. Otto Burr with the National Association of Neighborhoods. I'm just wondering if I'm the only one in this room that finds this extraordinarily frightening. Is the shadow banking system creating a system of shadow wealth? Is there no there there? Is this all system of hocus pocus that could collapse at any time? Adam seemed most frightened about that possibility in his presentation. So I think when you look at history and you look at the monetary history, you know, until you fix, you know, fiat money until you fix money back by species, you continue to have crises. And so, I mean, you can only extrapolate so far, but you would be concerned that until you fix these problems, you would expect that we will only have, you know, more destabilizing problems in the future. We should be worried. Let me speak to that point. I'm sorry. Go ahead. Sorry about that. Go ahead. I was just going to note that, you know, even though we are concerned about these issues and they are, you know, coming to the fore again, I think, you know, the basic notion of having deposits that can be given back to you in some form is really a very fundamental issue that, you know, in terms of the actual activities, a lot of these activities are financing real activities that you would like to be able to do. You would like to be able to go to the local, you know, Macy's and get your financing done or the Toyota dealer. And so we shouldn't paint all of the activities in this area as institutions, as being, you know, bad or risky. What we really need to do is focus in on where do we think the risks are, why do we think that they're developing, and I second this notion of conditions, looking at the conditions under which things occur, when things are very uncertain, those risks are more likely to come to the fore. So information is critical to getting information out about what it is that you're holding, why it is that you're holding, and how risky it is as a consumer, not only as a retail customer, but also in the institutional realm too. So that's really, I think we need to make sure we don't get too, that we're not a deer in the headlights, that we actually take a good look at where the risks are and take a good stab at trying to figure out what we would do about them. So I take some hope on that. I'm in Sheila's camp as we don't give up yet. Thank you. So even with regard to the gentleman's question and your concerns about the transition into more fixed income, my question is, with economic integration, because you have NAFTA and you have all the other free trade, you know, these regional trade compacts that tend to, given, especially in this hemisphere, have asymmetric economies. So the U.S. is integrating with asymmetric economies and in Europe where we see the problems that are happening, Germany's been able to set up the EU to advantage its national champions. So its people stay employed because you have the nature of a free trade zone over there that can export its goods and its people working at those companies have jobs. So here, however, with the exposure that we have to people who ordinarily had been employed here in the United States, so with economic integration you're having jobs leave a developed economy and go into less developed economies We have to make this fairly quick. I'm going to ask them to speak to this concern about the exposure to these fixed income instruments, the economic deterioration that's going to happen to all the people in the enterprises that ordinarily would have been able to service their debt. So now come economic integration, you have an erosion of the economies where people had worked, been employed, able to service their debt, they're not going to be able to do that going into the future, or the risk is they're not going to be able to do that. What happened in the financial institutions and is this also why you're not only concerned about being able to measure the health and quality of banking because they're not in safe and sound banking, safe and sound banking. Can we just move to the question? So the shadow banking system, which has exposure to all of these, you're not going to be able to go to Macy's anymore if your credit is. You can't even pay your loan anymore. You can't do any of that. So what now are you going to, what's going to be your interaction with these policymakers, what's going on, everything blowing up? Let me try to unpack this a little bit and see if I can't make a little forward progress for you. I think one of the features of many crises is that there are end up being debt overhangs and that individuals in some cases lose their jobs, companies have difficulties, et cetera. And so one of the features of being an economist and one of the features of trying to cope with that kind of issue is to take a very close look at where the vulnerabilities are building up. And even though today we've talked about a very narrow area of vulnerability and that is the shadow banking area, we would take a broad breast view of where the vulnerabilities are building up and that includes the household sector, that includes the corporate sector, that includes the government and the sovereign sector. And so when we do a vulnerability exercise of say an individual country or the global financial system, we're going to look at all of those components, all of those sectors, and we would provide, I would hope, public policy advice about how it is that we could make sure that households are not unduly hit or corporations are not unduly hit or small and medium-sized enterprises are not unduly hit. So I think the aim is not to be so narrow and to criticize one aspect of the economy but to look holistically about where those vulnerabilities are and to attack the underlying causes of those to start with. Okay. I'm going to be fast. Yeah, this has got to be the last question. All right, real fast. Stuart Rosenblatt, I work with EIR, especially for Adam Ashcraft. Your charts are really good, especially when you didn't go into on the total number of banking subsidiaries with the repeal of Glass-Steagall in 1999. Heck of a lot of this stuff really sprung up. There are two bills in the Congress, one in the House with almost 80 sponsors, one in the Senate, Elizabeth Warren, calling for the reinstatement of Glass-Steagall, 11 co-sponsors. I think that's the first place to begin. My question, Adam begged the question, there's nothing being really done yet. And for everybody else, what do you think on the reinstatement of Glass-Steagall and the legislation in the Congress? All right, that's... Oh, sure. So that's actually a topic that is somewhat dear to me because I am actually working on the evolution of bank holding companies, and so I've been following exactly those kind of developments, and you're absolutely right. With the repeal of Glass-Steagall, you have had this proliferation of acquisition in the known bank sector. I am a little bit, again, I'm taking the academic stance here, not the regulatory stance, and yes, I forgot to mention that my views are only my views and not the one of my employer here. But the point that I wanted to make is that I don't know that Glass-Steagall was a random exogenous event that occurred in 1999. The process of deregulation, quite likely, is the result of endogenous changes in the system, in this particular case, in the financial industry. So if you actually look at the history of changes in the Bank Holding Company Act, Glass-Steagall begins way before 1999, right? You're correct. And so the point that I'm trying to make is that the regulatory process or deregulatory process, in a way, is really somehow an adaptation, in this case, to natural forces, which are the ones that I was trying to explain in my presentation. So to go back to your question, I'm going to just, again, my personal views. If you were to reinstate Glass-Steagall and introduce the walls, sure, you would be preventing that particular class of entities, the banks, from having that particular organizational structure. I am not particularly sure that you would be solving the fundamental problem, which is the migration of the risks somewhere else in the system. And I would argue that, in fact, we might be worse off, because right now, more or less, we have good monitoring tools over the regulated bank-holding companies. And I'm not sure that we have equally valid monitoring tools for the other sectors of the economy. So I don't know if that helped. Anybody else want to say anything on this? Okay, well, we've got sandwiches outside, and we've also got Governor Turula speaking in ten minutes. So grab your sandwich. Hi. Certainly didn't mean to suggest that everything they should have banking systems. I know. I know. That's good. That's usual, right, in our jobs. But it's hard. Hi. Hi. Oh, okay. Thank you. No, I'm just saying that insurance companies that do various other activities besides, say, some of those activities are in the shadow banking area. That's fine. I understand. So I'm just concluding this notion of doing leverages and giving a lot of, not just private loans, a very common way of adding value to the bottom line when, you know, so it's just one activity. I didn't mean to say that. There's even one insurance company in doing leverages. They're not the passengers company as part of their... Oh, no, sorry. They do other things at the same time. They have a little main job and... I'm a reporter for Reuters. I found this very extremely interesting presentation. Okay. That's where our desk is. Okay. No, sorry. God, I'm glad I was here. I'll give you another ride. Thank you. We charge this for no reason. Have you? Is it nine? Okay, then. Then we're good? Thank you. Thank you. Thank you. Okay. I don't know. I flooded it out. It's got a scrim on it, so... I think it's only like a 420. It's spotted. I definitely feel that. Here, I got it. I got it. Okay. Oh, well. It just turned off. I don't know if it tripped or... Flip the switch. Someone may have kicked the cord out. Let's try... Okay. Yep, I have just my name in there. I know. Did I not agree with that? Yeah, why do you call this? Thank you. Oh, got that. Yeah. What's your number, guys? Thanks so much. Okay. Is he my height, this guy? You want to raise it up? Yeah. One, two, one, two, one, two. Chip, you want a white? I'd probably just leave it in preset, but that's fine. One, two. I got a wide angle on, so I got to drop it in extender. I'm not going to be able to get that close. One, two, one, two. Do you want to see if you hear? There should be a little. One, two, one, two. One, one, two, one. I can see it hitting there. One, two, one, two, one, two. One, two, one, two. One, two, one, two. You may need to crank it up. You may need to crank channel one up. One, two, three, four, five, four, three, two, one. One, two, three, four, five, four, three, two, one. Are you getting a hum? Unplug my power. Just from down below. One, two, one, two, one, two, one, two. One, two, one, two, one, two. I can go on battery. I can go on battery. Still there? One, two, one, two, three, four, five, four, three, two, one. One, two, three, four, five. Unplug my... One, two, three, four, five, six, seven, eight. Huh? That's fine. I got a fresh batter. Okay, gentlemen, how is this? How is this, gentlemen? This fine for you guys? Doing okay? Okay. Welcome to the Economic Policy Institute. You don't have to talk to me. Oh, okay. Yeah. I don't know. Okay. Yeah. Break it through. Break it through. No, you can spy. You can spy. Watch it. Watch it. Yeah. Yeah. Yeah. Yeah. Okay. All right. All right. Good afternoon. Is this on? All right, it's not on. Hold on. No, now it's on. Good afternoon, everyone. You can chew, but you can't talk now. Good afternoon. I'm Damon Silvers. I'm the policy director of the AFL-CIO, and I've been asked by Americans for financial reform to accept the great honor of introducing our luncheon speaker, Dan Tarulo. Dan, as I think everyone knows, has been a member of the Board of Governors of the Federal Reserve since 2009. And before that, he has had a long and distinguished career both in public service and in the legal academy. Dan and I were talking a moment or two ago, and Dan said that he's been around here long enough to even have remembered a time when people got things done in Washington. And that's now a while ago. I first knew of Dan Tarulo as when he was a law professor at Harvard, where he was really a beloved figure of many law students that I knew when I was an undergraduate. And it is particularly fitting today that Dan speak to us because of Dan's role both as an analyst of the pre-Dodd-Frank financial system and as one of the most important people in American government working on the heroic task of implementing the Dodd-Frank Act. And I say heroic both because of the size and complexity of the problems the Act was designed to address and the power and persistence of those in us through regulatory ledger domain to the unregulated world of 2008. Dan understood before the crisis and told us in his book, Banking on Basel how self-regulation of bank capital requirements would prove catastrophic. Since his appointment to the Fed, Dan has brought an integrated understanding of financial regulation to the job of implementing Dodd-Frank, an understanding that issues such as the Volcker Rule, Resolution Authority and the regulation or lack thereof today are profoundly interconnected. And I suspect we will hear much more about that in a moment. So please join me in giving a warm welcome to our honored guest, Dan Trurullo. Thanks, Damon. It's nice to be back here on H Street. I spent a fair amount of time upstairs, of course, at the Center for American Progress when I was a non-resident senior fellow there. I am as the conference and the title of my paper indicate going to talk about shadow banking today, but as you'll see in a moment, I'm going to zero in on some particular parts of the shadow banking system. As illustrated quite literally by a chart that staff from the New York Fed produced a few years ago, the term shadow banking encompasses a wide variety of institutions that engage in credit intermediation and maturity transformation outside the insured depository system. And as I said, I want to concentrate on one slice of that today but a particularly important part which is short-term wholesale funding and especially the pre-crisis explosion in the creation of assets that were thought to be cash equivalents. Assets were held by a range of highly risk-averse investors who are in many cases not fully aware that the cash equivalents in their portfolios were liabilities of shadow banks, the institutions depicted in their memorable graphic. In some cases, the perception of claims on shadow banks as cash equivalents was based on explicit or implicit promises by regulated institutions to provide liquidity and credit support to such entities. In other cases, the perception came about because market participants viewed the instruments held on the balance sheets of shadow banking entities, notably highly rated asset-backed securities, liquid, and safe. While reliance on private mechanisms to create seemingly riskless assets was sustainable in relatively calm years, the stress that marked the onset of the financial crisis reminded investors that claims on the shadow banking system could pose far more risk than deposits insured by the FDIC. Once reminded of their potential exposure, investors engaged in broad-based and sometimes disorderly flight from the shadow banking system. This experience of the run on the shadow banking system that occurred in 2007 and 2008 reminds us that similarly disordered flights of uninsured deposits from banks lay at the heart of the financial panics that afflicted the nation in the late 19th and early 20th centuries. The most dramatic of these episodes were the bank runs of the early 1930s that culminated in the bank holiday in 1933. Just as it was necessary, though not sufficient, to alter the environment that led to those successive deposit runs by introducing deposit insurance in order to create a stable financial system for the early 20th century. So today, it is necessary, though not sufficient, to alter the environment that can lead to short-term wholesale funding runs in order to create a stable financial system for the early 21st century. As I'll describe in a moment, the Federal Reserve has taken some steps toward this end over the past few years. However, as I will also contend, completion of this task will require a more comprehensive set of measures, at least some of which must cover financial actors not subject to prudential regulatory oversight. Before turning to those points, I want to develop briefly the comparison between deposit runs of the pre-FDIC period and contemporary short-term wholesale funding runs in order better to explain the nature of the regulatory challenge. Each of those runs had a cascading, self-reinforcing quality fueled by questions concerning the solvency of borrowing entities, whether deposit-taking banks or dealers seeking credit in repo markets. And in each case, the opaqueness of the balance sheets of the borrowing entities led lenders to fear that an institution holding assets similar to those held by another troubled institution might itself be in trouble. Significantly, though, in each case, at least some of those actors who were lending to these institutions were interested not just in eventually recovering the full amount of the funds they had extended, but in having access to those funds more or less immediately. That's the whole idea of a cash equivalent. Thus, the issue was not just a matter of solvency whether the firm would ultimately be able to pay all the claims even after the run, but also a matter of the short-term liquidity of the bank or, in latter days, broker. The dynamic unleashed by short-term wholesale funding runs in 2007 and 2008 directly exacerbated financial stress. Many assets funded through the shadow banking system were traded assets, which could be liquidated rapidly, though often at distressed prices, to reduce the funding needs of the borrowing firms. These fire sales created adverse feedback loops of mark-to-market losses, margin calls, and further liquidations. The unwinding of the risk illusion, that is, the assumption that lending to shadow banks was essentially risk-free, helped transform a dramatic correction in real estate valuations into a crisis that engulfed the entire economy. But for a few idiosyncratic instances since the introduction of deposit insurance in 1933, bank runs have been rendered a thing of the past. Of course, the explicit and de facto extension of financial guarantees created moral hazard problems, which the safety and soundness regulation of insured depository institutions was strengthened to address. The similarities between deposit runs and short-term wholesale funding runs have suggested to some that the policy responses should also be similar. Those taking this position argue for providing discount window access to broker dealers, guaranteeing certain kinds of wholesale funding or both. Others, myself included, are wary of any such extension of the government's safety net and would prefer a regulatory approach that requires market actors using or extending short-term wholesale funding to internalize the social costs of those forms of funding. Unlike deposit insurance, the savings of most U.S. households are generally not directly at risk in short-term wholesale funding arrangements. And also, unlike insured deposits, there is an argument in the short-term wholesale funding context that counterparties should be capable of providing some market discipline in at least some of the contexts in which such funding is provided. In thinking about how to regulate shadow banking, we must be mindful that it is not really a single system. And even with the reduction in activity following the crisis, the scale of shadow banking activity remains very large. Banks and broker dealers currently borrow about $1.6 trillion, much of this from money market funds and securities lenders, leaving aside additional funds sourced from asset managers and other investors through channels other than triparty repo. The banks and broker dealers, in turn, use reverse repos to provide more than a trillion dollars in financing to prime brokerage and other clients. While the volume of this activity has fallen considerably since the crisis, and the haircuts and other conditions associated with current securities financing transactions are considerably more conservative than during the pre-crisis period, there is every reason to believe that the amount of this activity could increase and the conservatism of the terms of the lending could be eroded as economic conditions improve. Let me turn now to some of the specific vulnerabilities, steps that have been taken thus far to address these vulnerabilities, and the work that remains. While the term shadow banking implies activity outside the purview of regulatory oversight, regulated institutions, including prudentially regulated institutions, are in fact heavily involved in these activities, both in funding their own operations and in extending liquidity and credit support to shadow banks beyond the regulatory perimeter. In some cases, there are explicit contractual provisions for credit enhancements and liquidity support. In other cases, the support is implicit based on a bank's historical pattern of providing support or a belief among investors that a bank will provide support to maintain the value of its franchise. In the lead-up to the crisis, explicit and implicit commitments by regulated banking firms to shadow banks often combined to create the assumption that the liabilities of such entities were risk-free. This perception led to an underpricing of the risks embedded in these money-like instruments, making them an artificially cheap source of funding and creating an oversupply of these instruments that contributed to systemic risk. Contractually committed liquidity and credit support lends itself more readily to regulation than does implicit support. Basel III reforms have strengthened the regulatory requirements for situations in which there is contractual support for shadow banking activities by imposing capital and liquidity requirements on undrawn amounts of credit and liquidity facilities extended by banks to a special-purpose entity. Implicit support presents more of a regulatory challenge. Identifying implicit forms of support requires a supervisory judgment that, despite some stern warnings in offering documents, a banking organization does bear some of the risk associated with that investment. Regulators must decide how much of the risk the banking organization retains and make context-sensitive judgments about the financial stability implications of various remedies. These challenges notwithstanding, regulators have made some progress in addressing instances of implicit support that played a major role in the last crisis. Let me mention two examples. The first involves the implicit support associated with the provision of intraday credit by clearing banks in the tri-party repo market. In a repurchase agreement or repo, the cash borrower agrees to sell a security to a cash lender and to repurchase the security from the cash lender at a later date. In a tri-party repo transaction, a clearing bank handles settlements through accounts held at that financial institution by the two parties to the transaction. To allow broker-dealers who borrow in the tri-party repo market to have access to their securities for routine trading purposes, the market developed an operational feature known as the Daily Unwind, which essentially involves the extension of intraday credit by the clearing banks. Cash lenders grew comfortable in the belief that they held a cash-equivalent asset that was perfectly safe and liquid. But as the crisis deepened, cash lenders became aware of the fact that the clearing banks were not contractually obligated to unwind repo trades and that the dealers that were the primary borrowers in the tri-party repo market could fail, leaving lenders with collateral that they had little or no capacity to manage at a juncture when its value and liquidity might be open to doubt. This resulted in several distinct episodes during the crisis when cash lenders, despite holding collateral, quickly withdrew financing from dealers perceived to be facing potential financial distress. Since the crisis, the Federal Reserve has led an effort to reduce reliance on intraday credit in the tri-party repo market. Work to date has reduced the amount of intraday credit provided by the clearing banks from 100% of the tri-party repo market to approximately 30%, and commitments by market participants suggest that this amount will fall to 10% by the end of next year. This operational change, in addition to enhancing the resiliency of the settlement process, should help limit the likelihood that tri-party repo lenders revert to believing that lending in the tri-party market is a risk-free proposition. The second example involves the implicit support provided by bank sponsors of certain securitization special-purpose entities. Before the crisis, the interplay between bank capital requirements and accounting rules created a significant incentive for banks to shift assets off-balance sheet through the use of various SPEs. Under the capital requirements that applied at the time, a bank that sold assets to a conduit or other SPE it sponsored was required to hold capital only against its contractual exposure to the SPE. Yet because a bank that failed to support its SPEs might irreparably damage the value of the franchise, banks often, in fact, did provide credit and liquidity support in excess of contractually obligated amounts. Post-crisis reforms have reduced the opportunity for banks to exploit this regulatory arbitrage. In 2009, the Financial Accounting Standards Board modified the accounting treatment for structured finance transactions involving SPEs. Under the new accounting guidance, a company is required to consolidate those SPEs for which the company has the power to direct matters that most significantly impact the entity, as well as the obligation to absorb losses or the right to receive benefits. Following publication of those new accounting standards, the federal banking agencies adopted new rules requiring banking organizations to build risk-based and leveraged capital against assets of the newly consolidated SPEs. Turning now to financial stability concerns raised by short-term wholesale funding more generally, I want to concentrate on collateralized borrowing arrangements. These consist largely of securities financing transactions, or SFTs, a term that generally refers in turn to repo and reverse repo, securities lending and borrowing, and securities margin lending. Lenders are willing to extend credit on a secured basis because these transactions are usually short-term, over-collateralized, backed by reasonably liquid securities, subject to daily mark-to-market and re-margining requirements, and exempt from the automatic stay and insolvency proceedings. The financial stability risk associated with the dealer's use of short-term SFT funding to finance its inventory are relatively straightforward. If a broker-dealer loses access to financing and is forced to sell securities at a depressed price, fire sale externalities may result because other market participants may be less able to borrow against the same securities. And if the broker-dealer fails due to runs by short-term SFT lenders, post-default fire sales by the firm's creditors makes runs on other financial intermediaries may ensue. Because broker-dealers generally do not internalize these externalities, they may use more than the economically efficient level of short-term funding. The financial stability risks associated with SFT matched books are somewhat less obvious. Even if the outflows and inflows associated with a dealer's SFT positions are perfectly maturity matched, though, reputational considerations may inhibit a dealer from reducing the amount of SFT credit that it provides to its customers, thereby exposing the dealer to considerable liquidity stress. And if the dealer does reduce the amount of credit that it provides to its customers, those customers may be forced to engage in asset fire sales of their own. Particularly in situations when most of the customers are highly-leveraged, maturity-transforming entities that lack access to a liquidity provider of last resort, i.e. shadow banks, they may pose a significant risk of contagion. Post-crisis regulatory reform has taken some steps to address the financial stability risks associated with the dealer's use of short-term SFT funding to finance inventory. For example, the liquidity coverage ratio, LCR, requires firms to hold a buffer of high-quality liquid assets when they use SFT liabilities that mature in less than 30 days. New risk-based capital rules have substantially increased the amount of capital that dealers are required to hold against assets in the trading book. But, although important, these reforms are limited. The LCR does not require firms to hold any liquidity buffer against SFT liabilities that mature in more than 30 days or that are backed by very liquid assets. And there continues to be a need for standardized capital requirements for market risk to back up model-derived risk weights. Moreover, neither capital nor liquidity rule changes have to date imposed any meaningful regulatory change on the financial stability risks associated with matched books which are assumed to pose little risk at a micro-prudential level. Again, this may be a reasonable position from a micro-prudential perspective geared toward more or less normal times. But here is where we need an explicitly macro-prudential perspective that forces firms to internalize the tail event financial stability risks associated with SFT matched books. So now for the policy options. There are two kinds of policy options that can be considered individually or together in responding to the financial stability vulnerabilities inherent in firms with large amounts of short-term wholesale funding whether loaned, borrowed, or both. The first would impose a regulatory charge calculated by reference to reliance on SFTs and other forms of short-term wholesale funding. Whether the firm uses that funding to finance regulatory or an SFT matched book. The second would directly increase the very low charges under current and pending regulatory standards attached to SFT matched books. Among the first set of options, the idea that seems most promising is to tie capital and liquidity standards together by requiring higher levels of capital for large firms that substantially rely on short-term wholesale funding. The additional capital requirement would be calculated by reference to a definition of short-term wholesale funding such as total liabilities minus regulatory capital and short deposits and obligations with a remaining maturity of greater than a specified term. There might be a kind of waiting system to take account of the specific risk characteristics of different forms of funding. The capital requirement would then be added to the Tier 1 common equity requirement already mandated by the minimum capital capital conservation buffer and global systemic bank surcharge standards. Moreover, this component of the Tier 1 common equity requirement would be calculated by I'm sorry, not moreover, but however the component of the Tier 1 common equity requirement would be calculated by reference to the liability side rather than the asset side of the balance sheet and that's really the change here so you'd build up the amount of total required capital but much of it of course remaining to be calculated by reference to the asset side of the balance sheet what would distinguish this component would be calculated by reference to the liability side of the balance sheet. The rationale behind this policy option is that while solid requirements are needed for both capital and liquidity the relationship between the two also matters. For example, a firm with little reliance on short-term funding is less susceptible to runs and thus to the need for engaging in fire sales that can depress capital levels. A capital surcharge based on short-term wholesale funding usage would add an incentive to use more stable funding and where a firm concluded that higher levels of such funding were nonetheless economically sensible the surcharge would increase the loss absorbency of the firm. Such a requirement would be consistent with though distinct from the long-term debt requirement that the Federal Reserve Board will be proposing to enhance prospects for resolving large firms without taxpayer assistance. The second kind of policy option is to address head-on the macro-prudential concerns arising from large matchbooks of securities financing transactions. A capital surcharge is in some respects an indirect response to the problem of short-term wholesale funding runs and as earlier noted current versions of capital and liquidity standards do not deal with matchbook issues. One might choose either to increase capital charges applicable to SFT assets or to modify liquidity standards so as to require firms with large amounts of these assets to hold larger liquidity buffers or to maintain more stable funding structures. It is not clear how much appetite there may be internationally for revisiting agreements that have been completed such as the LCR and the Basel III capital rules. However, with the net stable funding ratio still under discussion and with the Basel committee in the process of reconsidering the standardized banking book risk weights and capital regulations associated with related assets, there are opportunities to pursue these options. Requirements building on any of the foregoing options would by definition be directly applicable only to firms already within the perimeter of prudential regulation. The obvious questions are whether these firms at present occupy enough of the market that standards applicable only to them would be reasonably effective for economic risk. And even if that question is answered affirmatively, whether the imposition of such standards would lead to a significant arbitrage through increased participation by those outside the regulatory perimeter. It does not seem far-fetched to think that with time and sufficient economic incentive, the financial, technological, and regulatory barriers to the disintermediation of prudentially regulated dealers indeed, there have already been reports of some hedge funds exploring the possibility of disintermediating dealers by lending cash against securities collateral to other market participants. For this reason, there is a need to supplement prudential bank regulation with a third set of policy options in the form of regulatory tools that can be applied on a market-wide basis. That is, regulation would focus on particular kinds of transactions rather than just the firm engaging in the transaction. To date, over-the-counter derivatives reform is the primary example of a post-crisis effort at market-wide regulation. But given that the 2007-2008 crisis was driven more by disruptions in the SFT markets than by disruptions in over-the-counter derivatives markets, comparable attention to SFT markets is surely needed. Over the past two years, the Financial Stability Board has been evaluating proposals for a system of haircuts and margin requirements for SFTs. In its broadest form, a system of numerical floors for SFT haircuts would require any entity that wants to borrow against any security to post a minimum amount of excess margin that would vary depending on the asset class of the collateral. Like minimum margin requirements for SFT derivatives, numerical floors for SFT haircuts would be intended to serve as a mechanism for limiting the build-up of leverage at the security level and would mitigate the risk of pro-cyclical margin calls. In August, the Financial Stability Board released a proposal that would represent a first step in the direction of such a framework. However, the FSB's proposal has some significant limitations. First, with respect to party scope, the FSB's proposal would apply only to securities financing transactions in which regulated entities provided financing to unregulated entities. It would not cover SFTs between a regulated lender and a regulated borrower, between an unregulated lender and a regulated borrower, or between an unregulated lender and an unregulated borrower. So that's three out of the four. Second, the proposal would apply only to lending against collateral other than sovereign obligations. And finally, with respect to calibration, the FSB's proposed numerical floors are set at relatively low levels. Levels that are, for example, significantly below the haircuts that currently prevail in the triparty repo market. An alternative to the FSB's proposal would be to apply a system of numerical floors to SFTs regardless of the identity of the parties to the transaction. Such an approach would at least partially offset the incentive that will otherwise exist to move more securities financing activity completely into the shadows. Regarding calibration, there are at least three conceptually plausible bases for setting the level of the numerical floors above the rather low backstop levels contemplated in the current FSB proposals. One would be to base the calibration of the numerical floors on current repo market haircuts. As I mentioned earlier, those haircuts have increased significantly compared to pre-crisis levels. And this would basically hold in place the conservatism that's come in the wake of the crisis, even as markets start to change. A second approach would be to set haircuts for a given asset class based on asset price volatility or haircut levels observed during times of stress or long-term periods that include times of stress. While minimum haircut levels would obviously not be set as high as the haircuts lenders demanded of the depths of the crisis, setting numerical floors in proportion to those levels might be reasonable. A third alternative would be to set numerical floors for SFT haircuts at levels that are commensurate with the amount of capital a banking organization would need to hold against the security if it held the security in inventory. Such an approach could be viewed as an indirect way of extending bank capital requirements to the shadow banking system and would reduce the current bank regulatory incentive to lend against the security rather than hold it directly. Finally, it is worth noting that while a framework of universal margin requirements for SFTs could not be evaded through the disintermediation of regulated entities, it might be evaded through the use of alternative transactional structures. If margin requirements for cash SFT transactions are significantly higher than those for creating the same economic exposures using synthetic SFT transactions, a framework of minimum margins for SFTs could push market participants to rely more heavily on derivatives that are the functional equivalent of cash SFTs. Moreover, market participants might attempt to arbitrage margin scores through arrangements whereby the lender effectively lends the SFT borrower the minimum excess margin amount. These and similar issues will need to be addressed as options for minimum margins are further developed. So let me say in concluding that if we think back to the rapid growth of the shadow banking system in the pre-crisis period, we're reminded of a number of glaring vulnerabilities. Large firms that could themselves be considered shadow banks and that relied on the shadow banking system for a significant proportion of their funding, a group that included the so-called freestanding investment banks, were outside the perimeter of prudential regulation. And then the breaking of the buck by the Reserve Primary Fund following Lehman's collapse triggered a run on the shadow banking system that required unprecedented support by the Treasury and the Federal Reserve. The process established by Dodd-Frank for designation of systemically important non-bank firms has provided a means of for ensuring that the perimeter of prudential regulation can be extended as appropriate to cover large shadow banking institutions. The proposals of the SEC on money market fund regulation are a response to continuing vulnerabilities as well as to the run on money market funds in the fall of 2008. These are important initiatives that will contribute to a safer system of funding throughout the financial system. Yet the run excuse me, the risk of contagious runs would persist even in the absence of individually systemic institutions. And with less vulnerable money market funds, other cash-rich entities could emerge as a source of inexpensive funding for the shadow banking system. Finally, as I've noted, the systemic risks associated with short-term wholesale funding in prudentially regulated institutions have not been fully countered by the important capital and liquidity standards adopted since the crisis. My purpose today has been to reinforce the point that a sounder, more stable financial system requires a more comprehensive reform agenda. Thanks very much. You want to monitor their questions? Sure. I know. It's a good question. Obviously with respect to systemically important institutions, either bank holding companies or those designated non-bank SIFIs designated by the FSOC, the Fed does have broad supervisory authority. So the kind of match book things I was talking about, supervisory authority, there would exist. The question would arise in the context of universal margining requirements, particularly depending on how universal that margining is. I think it's probably the case, but this is a tentative observation, that collectively regulatory agencies, including the market regulators, would have authority to do this. Whether the Fed alone would have authority to do it is more of a question. As you know, we do have margin setting authority under the Securities Exchange Act of 1934, but that is not a plenary authority. It's not an untrammeled one. It's one that's got some limits. So that's obviously one of the questions that would have to, well, I'll have to address going forward as we develop these options. A cash flow that Performing Loans Productions, thanks for examining it for safety and soundness. Performing Loans generates cash flows through a lot of new quarter and that kind of thing. So wouldn't there be an interest on the part of the Fed to diminish the permissibility of writing the information? Again, a lot of the SFT is to provide the liquidity that you're not getting from the balance sheets anymore and then look on the ratio that a lot of people do. Do you think it's simple? Oh, you mean the public comment? Yes, yes, yes. That's right. That's right. The leverage ratio, the appeal of the leverage ratio and in the main it is simple in that you can say we just want all the assets in the denominator rather than just the risk-weighted assets in the denominator. The difficulty comes of course because you don't want to capture only the assets that are actually on balance sheet, only the things that actually show up on the balance sheet. You want to capture off balance sheet activities because obviously there's risk to the firm there and thus credit exposure and you also want to capture things like derivatives where it's not an asset in the sense of the nominal value of it but again there's an exposure. Just as with the very first leverage ratio that the U.S. had where there were conversion factors for off-balance sheet assets, there were rough ones but they still had them. There needs to be an answer to how to get those two kinds of exposures into the denominator and you know it's sort of a classic regulatory challenge, right? There is always an argument to be more granular and to say well you've got to take this, this, this and this into account but particularly in the case of a leverage ratio the more of that you do the further you migrate away from the core concept of a leverage ratio which is an admittedly blunt and not particularly risk sensitive measure. So I think with as it's always the case and will certainly be the case with the reaction to the comments on that consultative paper and the position that we'll be taking in Basel I think we go in hoping to minimize the number of complexities and come up instead with a reasonably straightforward way to get a sensible and meaningful denominator in there. On the other party a question because I don't want to take too much time to stop others from answering. I will say there's not a detailed response but I'd say that generally with respect to the use of derivatives or the use of different kinds of assets the aim of prudential regulators and supervisors ought to be to ensure that similar credit or trading risks no matter what form they manifest themselves in have similar capital liquidity charges associated with them. I gave you an example earlier of how that relationship was arbitraged there are always going to be opportunities for it and it needs to inform as I say both regulation and supervision on an ongoing basis. Some of us are concerned about hedging informed by the pathology of the London Whale. Are we going to be those of us who are concerned that hedging is some sort of for trading that somehow banks are able to make a lot more money hedging than they are to make the position. Will we find in the final Volcker rule that the permissions you allow for hedging will not provide a London Whale scenario or that there's an understanding that the upside cannot be greater with the hedged position than with an unhedged position. So I'd say that I not only would but have made the case that even our proposed reg would have cut short the ability of the London Whale strategy to be perpetuated if only because of the documentation and justification requirements. That is what the need to justify why something is a hedge to explain how it is hedging rather than being just a disguised proprietary trading position both within the risk management structure of the firm and also available to the supervisors. In light of the London Whale which of course came to light between the time of the proposed reg now. One of the key mandates to the staff from all the five agencies working on the final rule has been to ensure that London Whale in substantive and procedural terms couldn't happen again. So I think that it's been sometimes you go from preliminary to final rule proposed to final rule without having to abstract or hypothesize what some of the issues may be this was a real world case that evolves in the ability very tangibly to back test if you will to measure so how would the rule if in place have changed treatment along the way. You mentioned the bankruptcy of SFT. There are many who think that when the bankruptcy act of 2005 greatly expanded that category at that point that incurred heavy reliance on the board. Well, Peter, do you mind going on if the mice not all under the sign? If not, if it doesn't work I'll give a little summary of the question. Right, but there are many who think that that sort of removed market discipline and greatly exaggerated the repo problem with 40 billion assets. What do you think that you could accomplish some of your goals by rolling back the bankruptcy without a collateral that would qualify for those super priorities? Or should the super priorities not exist? There are two different questions there. The question is basically about the super priority of some of these transactions that was as art points out expanded in 2005. And I guess at some level art I think the approach where take even there is no doubt about that there are different kinds of alternatives that would achieve some of the same ends. I think one of the earlier question is pointed out that leverage ratio and short term wholesale funding regulation overlap in some respects. And dealing with the bankruptcy exemption could obviously be a different route to some of the ends we're trying to achieve. I think, I will say straightforwardly, I think we are proceeding not on the assumption of statutory change in the law. If someone were interested in doing that and it began to happen I think we would obviously take it into account. But what you heard today were set of options that we're thinking about which we hope in the aggregate could provide the necessary cost internalization even without any changes in current statutory law. Yeah. So, I was very glad to hear you say that a lot of people know you but not of it. Oh, I'm sorry. He's Marcus. He's from Americans for financial reform. A lot of people know small world of the mavens of this stuff. But I was very glad to hear you say that you didn't believe at least preliminarily in a public backstop for shadow banking collateral and so on and something Bill Dudley worked with at times. But I think that the Dott-Frank Act requires the Federal Reserve to put out policies and procedures for 13 free emergency lending that would limit it to solid institutions generally available. I think that those policies and procedures would provide an excellent opportunity to signal that there will not be a public backstop for shadow banking collateral and as long as those policies and procedures are not there we assume that there will be. So I'm just wondering what you thought of the vets of progress in putting those procedures. Right, so the first important point is the law applies regardless of whether we have published an elaboration of them. So the limitations in 13.3 on lending to putting together a facility for a particular institution, the need for collateral, all of those things are fully applicable even in the absence of a developed policy. And I think that my understanding and we always know what to do when someone prefaces their answer with that, but my understanding is that this is something we will be getting out next year I think in all honesty Marcus as you know from other contexts there is with the heavy number of regs that needed to be done there was just inevitably going to be some prioritization some of which we said this is the priority some of which was driven by our colleagues in other parts of the government some of which is sort of driven by circumstances. There's no there's no signaling here in the absence of that statement other than the signaling of we can't get it done as quickly as was we can't get it all done as quickly as was contemplated in Dodd Frank. Have a good rest of the day. So we're going to go right into the next panel Yeah we're going to go right to the next panel So because we have a panelist Yes Thank you We're giving people one second to Daman's on the measure So just introduce him Alright Any place you want to go Do you care about the order? We'll just do it Alright we have Daman's permission to begin with the introductions without him so that we can keep up our record of enormously interesting and engaging substantive presentations while staying more or less on time So let me introduce very quickly the panelists on the next panel not in the order in which they'll speak Simon Johnson So on the end is the Ronald Kurtz Professor of Entrepreneurship at the MIT Sloan School of Management a senior fellow at the Peterson Institute for International Economics excuse me a widely read author columnist and blogger a member of the Congressional Budget Office's Panel of Economic Advisors and the FDIC's Systemic Resolution Advisory Committee He's also a former chief economist at the International Monetary Fund and always a clear and compelling voice underlining the dangers of too big to fail financial institutions and arguing which is including more capital and smaller banks that we need clearly and persuasively Randall Ray is a professor of economics at the University of Missouri, Kansas City and senior scholar at the Levy Economics Institute of Bard College a student of Hyman Minsky Randall is focused on monetary theory and policy macroeconomics, financial instability and employment policy he's widely published and his books include understanding modern money the key to full employment and price stability and money and credit in capitalist economies very much look forward to hearing from him Damon Silvers as he introduced himself already is the director of policy and special counsel for the AFL-CIO also a member of the SEC's Investor Advisory Committee the Treasury's Financial Research Advisory Committee the PCAOB's Standing Advisory Group and its Investor Advisory Group and a pro bono Special Assistant Attorney General for the State of New York he was the Deputy Chair of the Congressional Oversight Panel for TARP from 2008 to 2011 and we're extremely lucky also to have him as a member of AFR's Executive Committee Marcus Stanley is AFR's Policy Director and very much the organizer of this conference for which we thank him before this he worked as an Economic Policy Advisor to Senator Boxer and as a senior economist at the Congressional Joint Economic Committee and was an Assistant Professor of Economics at Case Western Reserve University and Marcus is going to start us off thank you and I remind speakers when they're standing to be relatively close to the mic alright I have this thread of feedback hanging over my head now I want to continue what I think happened with Governor Trullo's speech which is the movement from sort of generalized discussion of what shadow banking is to getting specific about how we can deal with it and my title is regulating shadow banking challenges and solutions and the word solutions is extremely optimistic there because I think we're ways from getting our arms around this problem but just to review what we're talking about which I think was amply covered in the morning sessions shadow banking takes maturity, liquidity and risk transformation traditionally performed by commercial banks through long complex credit intermediation chains and the links in those chains are generally market trades in traded markets or frequently not certainly not always and that transformation relies on supposed safety that's created either by confusion because people can't look through that long credit intermediation chain or implicit guarantees from institutions collateralization or subordination in securitization so I think that the challenges created to regulation by this system are well they're many fold but I want to highlight four of them now in this presentation one is the challenge to defining the bounds of the safety net because as I'll say shadow banking works in many ways by expanding the implicit safety net the second is the integration of markets and institutions that has occurred at a very deep level because of shadow banking Nicola talked about that a lot and our regulatory system is just not well set up to handle that I'm going to argue the third is the sheer complexity of these market based intermediation chains and the fact that they're narrowly volatile and finally just the ease of risk transfer and activity migration throughout the system the financial system today's financial system can respond very very quickly to regulation by moving risk and activities outside of a regulatory perimeter and all four of these I think create really profound challenges to our ability to regulate this system I want to start out talking about shadow banking and the safety net shadow banking relies on private guarantees but people know I think people in the market do understand that private guarantees are systemically unreliable in normal times a private guarantee may come through for you but private actors are exposed to systemic risk that simply cannot be diversified away and in fact it's become more and more difficult to diversify away systemic risk as financial as different markets have become more interconnected and people move between those markets more rapidly and attempt to hedge themselves in different markets I think it's actually become more difficult to diversify away systemic risk so when a true systemic event hits this private safety net is simply not reliable and that systemic event creates pressure on the government to step in for those private guarantees and in fact the more risk has been built up through the reliance on private guarantees the more pressure there is going to be for government to step in when a systemic event happens and it's very easy to say well government just shouldn't step in but that really you know that's like the 1929 solution you know liquidationism when you've let that amount of risk and that amount of dependence build up the dependence of ordinary people for their wages for their houses people who didn't play a role in the creation of this risk then you know you may very well be in a situation where you really are forced to step in to prevent contagion to the real economy and the very real suffering of ordinary people that can result so what happens is that through retailing these private guarantees and allowing more and more risk to build up behind them the shadow banking through shadow banking the private sector kind of expands the implicit safety net and I say the implicit safety net because it's not necessarily the explicit promise that's made but you get to a certain size and you get to a certain dependence you've got a gun to the head of the government when things start to turn south and then you can add to that that even the 2008 where I think there was exactly this process where governments stepped in with all these backstop facilities for for shadow banking collateral and rescued all these institutions that were not supposed to be inside the explicit safety net so and I think also did it in a way that that violated the basic principles of lender of last resort so the question is in the face of this uncertainty about the safety net can market discipline really work and I think this morning there were a lot of questions raised about whether market discipline can work period you know safety net or no simply for informational reasons so how has this been addressed in Dodd-Frank I sort of picked on Governor Twop's push out to agree with the if you think the source of strength changes in Dodd-Frank are going to actually be carried through with maybe the bounds of deposit insurance have been limited somewhat I think a lot depends on how swaps push out is implemented for that the Federal Reserve 13-3 authority it's nominally more limited but I think in practice there are very serious questions about how these limitations in the statute are going to be cashed out the solvency is in the eye of the beholder the Federal Reserve would have a lot of freedom to say hey somebody's solvent and therefore I'm going to do emergency lending to them and that's really I think the main barrier that was created there and we have just to highlight one thing the liquidity support for clearing houses that Sheila Baer talked about the access to the deposit window sorry to the discount window privately run clearing houses can be seen as an expansion of the safety net to the derivatives market potentially depending on how it's handled so I think there are new limitations on the safety net post Dodd-Frank you know we have this this resolution authority that's been clarified and put within like a legal framework we have supposed limitations on 13-3 we have potential new limitations on deposit insurance there's now a requirement that when the FDIC does loan guarantees they have to get approval from Congress but there's still tremendous uncertainty I think about the bounds of our safety net now the second issue the integration of markets and institutions there's no reason why regulators couldn't potentially handle this but our regulatory system is not really shaped to handle this in a lot of ways we have a Glass-Steagall regulatory system we're a financial world that's not Glass-Steagall I mean we have these assumptions that the bank regulator is over here and the market regulator is over there whereas in fact as Nicola talked about the bank and the market are in the same building now and they're run by the same people so we're already starting to see these frictions you know the idea is the FSOC is going to handle this we're already seeing these frictions round one in this fight was the money market funds and money market funds could not have been more central to the crisis I mean they really were right there in the headlines on the crisis and they were bailed out on a massive scale so if you can't agree on money market funds what are you going to be able to agree on and I think there's still some widespread dissatisfaction around the SEC's rule that it really did not execute on what the prudential regulators were asking for and then is round two now going to be asset managers we're already seeing political friction there and Governor Tarullo talked about these new controls on wholesale funding markets is that going to be round three is the SEC going to stand up and say hey well these are markets and if you don't regulate the institutions in them where's your legal authority to put all these restrictions on securities haircuts so I think this is really kind of a continuing issue and you've got is the FSOC going to be able to get its arms around it or will the Federal Reserve just by virtue of being the Federal Reserve be able to kind of assert its authority and just kind of steamroll some of the other agencies I think it's an important question because you've clearly as Governor Tarullo has said you've got to get at the markets as well as the institutions and one little note on that I think the ability of the Fed to regulate designate and regulate systemically important utilities not just private institutions but utilities could actually be really important here because the utilities would be the market exchanges so the third challenge was complex market based intermediation and the sheer complexity of these chains as we heard this morning just multiplies opportunities for deceiving regulators and deceiving counterparties raises serious questions about whether market discipline can be effective and about whether regulators can really fully monitor where these risks are I mean we've seen really limited progress at the Office of Financial Research after three years with a 90 million dollar a year guaranteed funding stream and I think a couple hundred employees I'm not sure how many employees they have but it's a lot so you know this is it's fine to say that you should monitor the stuff but it's much easier said than done and these intermediation chains allow leverage to hide in a lot of ways there was a mention in the first panel of how difficult it is to figure out even whether a regulated insurance company how much leverage they're taking on let alone how much leverage is embedded in a securitization you know there's embedded leverage in derivatives and in securitizations and a lot of times you've got to you know read the contract or read the trust agreement to really understand where that is where that leverage is and we've also got collateral chains which is something that Mount Oman Singh at the IMF has really done a lot of work on you can re-hypothecate your collateral moving on and it can be borrowed collateral that's serving as security for yet another transaction somewhere in the market these are very hard to trace and all these linkages to market prices really increase systemic fragility so I think a central question here that Nicola raised is bank centered regulation going to work I mean that's really where you've really got the biggest hook in where the regulators have the clearest authority and power is at the bank level and I think where they understand the most of what's going on the problem with this Nicola pointed out several people have pointed out the centrality of banks to the shadow banking system but it wasn't just banks it was AIG it was monoline insurers it was there were plenty of non-bank guarantors and remember the investment banks themselves were not commercial banks so they weren't necessarily their access to the safety net was unclear and you've also got the ease of risk transfer outside of regulated banks Basel still permits risk transfer from banks to non-banks through this idea of eligible risk guarantors but there's not a lot of flesh on how that eligibility is going to be determined and then you've just got the sheer competition for market mediated banking everything for money market funds to securitization so these last two slides I suspect I'm going to run out of time but I like these last two slides so I'm just going to plow through with them because they're the solutions I promise that so I want to talk about two sets of solutions one is the set of solutions that I think is on the table it's clearly contemplated in Dodd-Frank that somebody within the regulatory system is out there working on and I would put those in three broad classes the first one is leverage and risk management at the banks and the designated SIFIs themselves goes back to that question are the banks going to be enough the second is leverage and risk management in the markets and the funding and risk transfer markets that kind of glue together shadow banking and that's margin collateral haircuts you know Governor Tarullo's whole speech well the whole last part of his speech was about that it's clearing much more advanced in derivatives than repo markets you know people for some reason the repo markets were held out of Dodd-Frank and I think that was a mistake and the third solution is activity limitations we've got one of the authors of the Volcker rule in the room with us here but these activity limitations whether it's Volcker or Vickers in England maintain connections between banks and traded markets in important ways and you know so how are you going to police that connection is an important question I think there's sort of two really broad issues here first are these these solutions are going to lead to risk migration I don't think there's any question and I think some of that could be healthy if you got you know niche dealing in customized sort of boutique instruments moving out to hedge funds from banks because of the Volcker rule that might not be bad if those hedge funds are subject to market discipline and in some cases if migration gets big enough you know you can designate some of these systemically significant non-banks but is market discipline really going to work to address migration and ensure that wherever these activities migrate to they don't become systemically significant and the people who engage in those activities are there to take losses and can take losses and just the second issue is whether you're going to be able to keep ahead of the banks in the ways that they hide their leverage one of the questions before was about derivatives contracts or actually Governor Terulo mentioned this how derivatives contracts can sort of be rejiggered to simulate any new risk exposure that you any risk exposure that you might try to regulate are we going to be able to keep ahead of that hidden leverage I'm actually somewhat skeptical in terms of the answers to that question so I just got the zero but it's my last slide and most important slide these I think are some solutions that are not on the table but need to be and by not on the table I mean that they're not being seriously discussed within the regulatory community or they're not in law I mean some of them are contemplated in things like Warren's Glass-Steagall and so on I think the first thing we've got to address the complexity bias in our regulation I mean basically the regulators and you could almost hear this in Governor Terulo's speech as well the regulators are very very leery about simply banning an activity or standardizing a contract type or restricting any form of quote unquote financial innovation in order to simplify the system because they have this faith that basically if you have two private participants in a market who want to sign a contract it must be socially beneficial and what this leads to is a situation where they let the risk transfers happen they let the credit intermediation chains get more and more complex but they try and chase the risk around and measure it and staple capital to it or attach something to it and I just think how to simplify this system somehow through some kind of top down activity whether it's standardization whether it's limitation on how many times you can transfer a risk or you're just not going to be able to control the systemic risk part of it the second is that I think we need a clearer and more strategic safety net and by strategic I mean that when a systemic event happens there are certain financial activities that are critical and that we really want to continue and we've got a plan in advance for how those things are going to be continued and we need to protect them as activities rather than protecting the institutions that do them and then just bailing out everything that institution does whether it's critical or not and you know the whole safety net debate has been caught up in this situation where there's there's a lot of rhetoric about bailouts which I think in some cases is quite appropriate and I myself have engaged in it but then on the other hand it's clearly the case nobody wants to get rid of deposit insurance people want to maintain a government role in the housing market you know these are the it's clear so I think that there are a lot of ways we can make our safety net clear and more strategic around the definition of guaranteed collateral as well as support for institutions the third is I think we need to think about a greater public role in the financial system and that includes public infrastructure like critical infrastructure being public or non-profit like clearing houses I think you know if you have a private for profit clearing house with access to the discount window you know that gets you in competitive clearing houses all with access to the discount window can be problematic or key services other countries have things like postal deposits you know so you can run certain kinds of basic liquidity and payment functions through the government I'm not going to be able to get through all this this is a presentation in itself but just to really quickly run through we need to think about restoring a favored role for banking versus trading and I think that's where the glass steel comes in but there are lots of ways you can do this short of glass steel and say to banks if you hold risk on to maturity for a long period of time and you assume that risk as an underwriter then you know we're going to benefit you in terms of capital treatment and other things we have to change the culture of risk transfer so it's not about taking advantage of your counterparty and it's more about servicing a client and I think the reason these things are not on the table is that we've been reluctant to have a political discussion about what is finance or what are the critical roles of finance that we want to protect and favor in some degree and what are the parts of finance that really just don't deserve that public backstop and should be pushed outside of it so thanks very much I think it's safe to approach the microphone now so good afternoon I think we've I'm going to not inflict a power point on you I hope you'll forgive me a couple of about a month or so ago some of you may remember that we faced this question of whether the United States was going to pay its debts and at the moment at which that question was at its greatest degree of tension there was a I'm talking about the debt ceiling showdown one of the strangest panels that I've ever had the privilege to serve on convened at the house financial services committee by the minority where the representatives of the lobby groups for the financial services sector were all arrayed around a big circle with me and the question was posed to us so would it be a bad thing if the United States and just how bad would it be and if you think about it for a moment the sort of whole culture of finance and of the notion of paying your debts and all that this was an extremely strange thing conversation to have and at some point in the conversation the question was posed so what would the contagion effects look like if the United States government defaulted on one or more short term treasury instruments which would probably be the first things to go if we had not raised the debt ceiling and we'd run out of cash and the the people on the panel with me had been very carefully briefed by their lawyers and being very careful about predicting the end of the world and I don't have that kind of oversight at the AFL-CIO and it's not if I say the world's going to end it's not quite the same thing as S&P saying it and so I was sitting at this table and I was thinking what has changed what has changed between 2008 and now and what would the consequence be of the United States government what would the financial markets consequence be not the question of the cost of capital cost of borrowing for the US treasury or various other things but what would the immediate financial markets consequence be of that event and it became clear to me that as I was sitting there thinking that while we've done a number of things to ensure that the full panoply of what happened in 2008 doesn't repeat itself that we still our financial system continues to remain vulnerable to a systemically disruptive event and to contagion from a systemically disruptive event and that the reason why this is true is fundamental there are many reasons and my fellow panellists may address them but the fundamental reason at least in my mind why that particular problem continues to be true and that continues that threat continues to be there and why if the United States had not made good short-term obligations that in my opinion there would have been dramatic financial market consequences and uncontainable financial market consequences is because of what you've heard about today which is the the size and the scale of the shadow banking system as laid out by the very impressive people from New York Fed whom you heard from this morning remains more or less the size and scale that it was before the crash in 2008 and because and because despite the beliefs of a lot of people that something ought to be done about this that the set of issues that Governor Tarullo laid out in his lunch speech are ideas for doing something not things that have already been done and so that specifically we have a financial system still largely dependent on extremely short-term funding and systemically significant financial institutions dependent on short-term funding we continue to have elaborate structures of special purpose entities tied to those systems that in theory are bankruptcy remote that in theory are remote from the parent company in terms of their in terms of the parent company's backing but which we all know are not and finally we have those we have on the one hand significant financial institutions dependent on money market mutual funds for funding and on the other hand we have a large group of investors in money market mutual funds who believe that those funds are risk-free and are certain to act accordingly if they are surprised now let's think for a moment if the failure of the a willful political failure on the part of the United States to pay its debts is one thing what if we had against the system simply the failure of a systemically significant financial institution one of the big six banks I think everyone knows who the big six banks are I won't go through which they are but say one of them failed how would this same set of circumstances play out and the answer is is that as far as I can see all of these banks are dependent on exactly this set of financial structures and the and the consequent failure of one of those banks would set off this more or less the same sequence of events that we saw in 2008 and it would probably begin with money market mutual funds and and a run on those institutions as a result of breaking the buck now the solution that we have heard to this is the Governor Tarullo laid out now there are some people who argue for no solution they say this is all fine and that's this more or less the same argumentation we heard I think before 2008 and I think we know where that leads I'm not so interested in trying to argue that we ought to do something Dan the Governor Tarullo did that I think admirably I want to interrogate the solution that he's offered because what he's essentially said is what we need to do is we need to increase participants based on their sources of funding based on the liability side of their balance sheet and bring fully non-bank institutions meaning institutions that are not touched by the potential system of potential regulation at all into the web of potential regulation to the extent that they participate in these markets now in order to interrogate whether that is the right approach or a sufficient approach I want to be clear that I'm very admiring the Governor Tarullo's general direction and I don't want to be critical of that whatsoever but in order to ask the question of is this sufficient and are we asking the deep enough questions about this we have to ask the question which is and I think if you listen closely to Governor Tarullo you heard the answer but you have to ask the question and Marcus did the same and addressed this a bit as well but some things are worth repeating what is the actual activity what is the actual economic activity that you are talking about today it sounds very complicated it sounds like almost despairingly complicated and it's full of acronyms and so forth it's almost like the military but what is the actual activity and why and why should it be treated any differently than conventional banking this seems to me to be the root question and when you listen and when you parse it all out the actual activity that is going on here behind all of these entities and acronyms and so forth is largely something very simple and very old and it is the provision of credit to secondary capital market participants that's all that's happening here and if that's too complicated let me make it into ordinary language it's lending money to people who want to trade stocks and bonds and things that act like stocks and bonds but aren't called stocks and bonds derivatives and other structured products even now I'm starting to drift off into complexity but that's what it is that's what this activity is it's been going on for a long time at least since the Italian Renaissance and there will be people who will want to do it long after all of us are dead but it's not new and it's not terribly exotic and once we understand this we also need to understand as the New York Fed staff has taught us that this activity is inextricably connected with the credit and the brand of regulated banking institutions it is not the lending of money to secondary capital market participants by some people outside of our system it's not that there's a shadow system and a non-shadow system that no way in shall meet they're actually faces of the same system now why is this developed and note it developed after the repeal of Glass-Steagall and full and the passage of Grand-Leach-Bliley this is not about the purposes of the creation of this system the purposes of institutions and individuals acting in it rather than the conventional banking system is not about getting the authority to the secondary market participants as one might have been tempted to try to do say in 1960 it's not about that it's being able to engage in the activity of lending money to secondary market participants with the indirect backing and support of the Federal Reserve and the FDIC it's about doing that without prudential oversight we're past Glass-Steagall and the Volcker rule we're talking about the question of essentially infinite leverage that begs the question going at that point why should we allow people to engage in this activity with infinite leverage and no prudential oversight begs the real question why are we allowing this activity at all at all outside the conventional bank regulatory system but in a deeper sense and this is the Glass-Steagall point why are we allowing the bank the regulated banking system to be used to finance the secondary capital market activity what economic purpose is served by that and why should we put and why should we put the government-supported banking system in the business of doing so what economic purpose is served as a quite conservative bank regulator said to me recently if we're going to subsidize the banking system and we are through deposit insurance and through the Fed why should we're now outside this realm of you can do anything you want because markets will discipline you and the question has to be asked what purpose, what public purpose is served by doing this because remember the point of the financial system and this is Marcus's point and I'll repeat it again because it's worth repeating the point of the financial system isn't to keep the music playing as somebody once said so we can all dance that's not what it's about the point of the financial system is to officially allocate resources to productive activities how does any of what Governor Tarullo has discussed contribute to that purpose the only answer to be fair the only answer that I can think of is that you have to believe that putting liquidity into secondary markets massive amounts of liquidity into secondary markets encourages a pricing environment that encourages capital to flow into secondary markets into primary markets before that argument for a generation it seems to be the less plausible argument than the argument that this system allows several trillion dollars in investment capital to be diverted to unproductive gambling and away from productive activity that would create jobs incomes and prosperity and so perhaps the question ought to be why are we not simply saying to these institutions and I'm open to the question I'm open to an answer I'm not closed to the idea that I'm not offering this as dogma but I think that the first issue that has to be addressed in the public policy debate here is why are we not treating institutions that essentially take deposits and make implicit promises that turn out to be backended by the government that they are risk free deposits which is what a money market mutual fund is why are we not regulating them like a deposit taking institution and why are we not saying to the people lending money here you are a lender why are we not holding them responsible for the capital requirements we hold other lenders that have indirect and direct access to the Fed responsible to and why are we allowing the system as a whole given its government subsidy to the markets and finally I would tell you this because the entire history of the implementation of Dodd-Frank is a lesson in this final point which comes from what happens when you don't answer the questions I've posed and that is when you start seeing complexity multiplying in a financial regulatory system the financial regulatory scheme is bigger and bigger and bigger I just came from the SEC investor advisory group which met this morning rather than when it was supposed to meet because of the government shutdown and so it got scheduled on top of this and I think about Rule 10B5 securities fraud and Marcus has heard this many times he's laughing I think about Rule 10B5 which is the piece of regulation that covers the entire regulation of proper conduct in the securities markets it's about two and a half pages long of course the case law and it would fill this building but the actual rules very very short so what is going on when you see complexity metastasizing through a regulatory system as we've seen in the vocal rule in the draft and as we are quite likely to see I fear in anything that's tried to be done about shadow banking it means you're ducking it means that the regulators are ducking the issues I don't think that Governor Tarullo has any intention of wanting to duck the issue but he has to live in a political world of intensity and complexity it's hard to imagine being outside of it and I would just conclude by saying that when you look and when you watch and see what happens here if it gets more and more and more complicated it means we're ducking and we can't afford to duck because you got to remember where I started which is that if tomorrow morning a systemically significant financial institution failed or if we got back into the debt ceiling battle again and we didn't act rationally and we went over the cliff there would be a there would almost certainly be in my opinion as a result in significant ways of the subject matter of today's meeting would almost certainly be a similar episode of extremely destructive contagion as we saw in 2008 thank you well thank you for inviting me there was a Xerox of a long presentation I'm not actually going to give that that was supposed to provide the framework last night I talked with Marcus about what I ought to try to narrow down to and I have narrowed quite a bit and found that most of what I was going to say has actually been covered a lot of it this morning actually and I'm very happy to see that the New York Fed came to many of the same conclusions that I was going to present here anyway as you heard I'm a macroeconomist monetary theorist but I guess there is one I was living grace I was a student of Hyman Minsky and as you know he was the father of this crisis called the Minsky crisis or the Minsky moment as soon as it hit I said no no no it's not the Minsky moment which was Paul McCully it's the Minsky half-century this is the final culmination of what he started writing about in the 1950s so when I looked at this crisis I look at it from the point of view of his writings especially in the early 1990s when he talked about the long-term evolution of the capitalist economy toward what he called money manager capitalism and I until fairly recently thought that when he and I were talking about money manager capitalism we were talking about shadow banking finally I came to the realization that actually they're not quite the same thing and I'll come to why I believe that that is that they are different things so anyway I am part of a number of Ford Foundation projects that are looking at the crisis what caused the crisis my own personal project is on looking at the crisis response mostly of the Fed and others are doing the financial reform part and I guess the theme was stated this morning we don't want this ever to happen again that is the theme of all of these foundation projects but on the other hand I'm a student of Minsky and we know stability is destabilizing so to the extent that we do all of this right we're going to create stability which will ensure that it's going to happen again so anyway to understand what do we need to do we need to understand the nature of the financial system the nature of the crisis the nature of the crisis response we need to understand what a financial system ought to do and how we can reform the system so that it serves a public purpose it can be managed and it can be rescued when things go bad as they inevitably will do so anyway very quickly here is the way that we were looking at this there's been a decreasing weight of the banking sector as you've heard many times today and a rise of shadow banking or what we were calling money manager capitalism money under management and at the same time we have a huge increase in financial liability so we have financial assets under management of course the other side of the coin is there must have been a tremendous growth of financial liabilities we all know the story about the household sector rising on trend with a kink with the real estate boom and if you look the other thing that really grew is private finance so this is the term had been used for quite a while financialization or the shadow banking part the layering of debt on debt on debt on debt this is financial institutions owing other financial institutions another picture that shows a piece of that I'm going to go through these things quickly because most of this has been covered this morning in other ways so we had the repeal of the Glass-Steagall Act and one of the justifications was that we needed to facilitate competition as if finance is a scarce resource and fundamentally this is a flawed view finance is key strokes you can't run out of it you run out of good borrowers so what financial institutions are supposed to do is find the good borrowers too much competition was precisely the reason for enacting Glass-Steagall in the first place so that unless new business was created then the entry of new firms meant less profit for the existing firms and the competition was just going to lead to a demise of underwriting and a rise of securitization I'm going to show some pictures of the shadow banking system very similar to what was presented earlier so we see that shadow banking takes a much bigger share of the financial system okay when the crisis occurred though who had to be rescued part of my project was to look at the total number of loan originations by the Fed it turned out is 29 trillion where did that originate those loans originated go to 14 institutions and if you look at the names of these you will recognize them they are for the most part banks so the rescue had to be of the banks not of the shadow banks why is that because the biggest banks do the same stuff they're involved in the non-banking stuff here's the top four they look very different from the rest of the banking system and in terms of what are they getting their non-interest profits from advising and brokerage and so on here is JP Morgan it gets as much from the trading activity as it does from the interest income the largest commercial banks are also the largest investment banks so here's the share of the business that is taken up by the biggest banks so we have multi-functional banking and shadow banking that are currently linked they're doing this the same business and the banks are backing up the shadow banking system has been discussed on this panel and previously so banks are the only entities with access to the Fed at least in normal times they provide the direct finance and then the market based entities provide indirect finance the manage money then invests in paper and so on the role of the commercial banks in running out of time so I'm going to skip to well but the big things are at the end okay, credit enhancements this is what the biggest banks are doing derivatives commitments underwriting I'll skip over this Minsky had argued that this transformation toward money manager capitalism is necessarily as a potential run from these funds will lower asset values let me remind you he died in 1996 he's writing well before the crisis and the recognition the shadow banking system had become really dominant shadow banks are not banks after all we discovered in the crisis and Minsky was already arguing this in 91 through 93 their ability to create liquidity and their access to the market and to commercial banks the degree of layering of financial institutions and the asset liability mix of these institutions is a parameter of the robustness or fragility of a financial system so layering is one of the ingredients of fragility of a financial system so Minsky actually began a project at the leaving institute around 1990 he called reconstituting finance to promote the capital development of the economy which was our previous presentation right we need to direct finance to promoting capital development which Minsky defined very broadly he didn't just mean privately owned physical capital he also included public capital human capital education all this stuff in his capital development economy he argued that we have to have a proper framework in order to provide the analysis that will allow us to direct the financial system to doing this I won't go through these points I wanted to get to this what should a financial system do Minsky already there are five basic functions we need a safe and sound payment system we need short term loans to households firms possibly to local governments a safe and sound housing finance system a range of financial services and long term funding of positions and assets last eagle segregated these functions into basically two different financial systems there's no reason why these things need to be provided within one big box financial institution there's no reason why these need to be provided by private financial institutions and we always argue that private financial institutions actually is a misnomer there's no such thing because you have Uncle Sam backing them up their public private partnerships which is why there is a public interest in the financial system and ensuring that the financial system serves a public interest is essential can we just go back to Glass-Steagall Minsky was wondering about this in 1991 and he argued already that so this is before we actually officially got rid of it I think I'll make it he said really it's going to be extremely difficult to do it and one of the main barriers is how can you make this separated part of the system which is going to be by design safer profitable the fundamental problem is how are they going to be profitable the reason why we eroded Glass-Steagall is because they weren't profitable we had to continually allow them to expand their activities because there was sort of cream skimming taking away their business by money market mutual funds for example so you have to ensure profitability of the system it's going to be hard to re-segment I like the proposal of Morgan Ricks I won't go through that but that is part of the answer you can't let anybody issue anything that looks like a deposit so here is a modest proposal I suppose bankers will think this is an immodest proposal or maybe an eat your young proposal the lines of Swift which is actually not what I had in mind when I titled it this what I had in mind was no this is a Jimmy Stewart bank which we already heard before so what would a Jimmy Stewart bank look like banks lend directly to borrowers and then service and hold the loans there's no further public progress served by selling loans or other assets to third parties but there are substantial costs to the government that backs them up banks should not be allowed to contract in LIBOR we were saying this long before the scandal so the scandal just adds to the argument for the prohibition but an interest rate set externally with large subjective components subject to manipulation as we now know if not for indexing to LIBOR the Fed would have been able to push down interest rates in the United States but to the extent that you had I guess they say trillions of dollars that's written in LIBOR the Fed is not able to implement monetary policy banks cannot have subsidiaries of any kind there's no public purpose served by allowing banks to hold assets off their balance sheets banks should not be allowed to accept financial assets as collateral for loans there's no public purpose served by financial leveraging US banks cannot lend offshore there's no national public purpose served in allowing US banks to hold in for foreign purposes we want to promote capital development of the US economy banks cannot buy or sell credit default insurance the public purpose of banking as a public private partnership is to underwrite and price risk if a bank relies on credit default insurance it's transferring the pricing of risk to a third party which is counter to the public purpose of banking banks cannot engage in proprietary trading or any profit making ventures of public lending if the public sector that Uncle Sam wants to venture out of banking for some presumed public purpose that can be done through other outlets and finally use FDIC approved credit models for evaluation of bank assets don't allow mark to market of bank assets if there's a valid argument for marking a bank asset to market prices the asset should not be a bank asset the public purpose of banking is to facilitate loans based on credit analysis rather than market valuation thanks thanks very much to Marcus for organizing such a really informative day and to Americans for financial reform for all the work they've done over the past five years or perhaps it's longer on these issues I'd just like to say three things the first is about Walter Badger the second is about the New York Fed the third is about Sheila Bear so when you're done here I recommend you spend the rest of the afternoon reading or re-reading Walter Badger's Lombard Street written in 1873 if you don't have time this afternoon it's a perfect escape on Thanksgiving Day from your relatives I have to go read chapter one is what you should say to them I'm quite serious about this chapter one is written in it's a fascinating chapter almost 150 years ago he talks about exactly the issues we're talking about today but in a pre-regulated pre-modern central bank system which I'll come to in a moment he also completely misunderstands risk and return on equity and those of you who have a subscription to economists like myself can reflect on whether or not the economist has changed Badger was their first editor you can reflect on whether or not the economist has got it right after 150 years but anyway so what's interesting and I was thinking about this very much as Nicola and Adam were presenting this morning he talks about what banks do and what banks don't do how much is on the banks balance sheet what's not on the banks balance sheet and he puts great emphasis I think correctly in the importance the strategic value to the economy to the non-financial economy of the development for example of bill brokers and the broader money market in the UK in which banks are lending to the bill brokers I think is at least somewhat more matched in terms of short term liabilities and short term assets than the real maturity transformation going on there and I thought also when you were presenting Nicola and I think Adam's left I was thinking about for example Thai finance houses and the way or Thai banks the way people thought they had a matched book in terms of dollar borrowing and dollar exposure in 1997 but they were lending to corporates and since there was a transformation there it wasn't it was an exposure to the banks as well we didn't book it on the banks balance sheet and I think that one reason to go back to Badger is precisely to understand that these incentives and this misperception of risk that underlies the problems here and underlies exactly what my three fellow panelists have been talking about this is very old and it's perpetual it's a perpetual desire on the part of the private sector to minimize the amount of capital they have in the business because they think that if they have a bigger return on equity that's better because they're not thinking about the risk and pricing the risk either in a market transaction or in how they're promoted and rewarded within the organization so this is profound it will always be with us which leads me to the New York Fed now well I should say also that this issue has been with us not just intellectually it's been with us institutionally and politically for as long as we've had this discussion in the United States particularly and there was reference today to the Christ of 1907 which is the first humongous modern banking crisis obviously we had many many antecedents and it was the the origin not just of our of the Federal Reserve system but also of the political debate that led to a system in which there was a great deal of power placed in the hands of the New York Fed relative to other ways you could have structured a central bank and that power is not well certainly after the reforms of the 1930s it's not directly in the decision making the levers before that the Benjamin Strong and his colleagues had some levers that other people didn't have that power was taken away it was shifted to the Board of Governors but the power of perception of understanding of analysis and the deference within the Federal Reserve system among officials to the New York Fed in the 1980s it was profound for nearly 100 years up to the run up of 2007-2008 the analytical predominance of the New York Fed was really very profound and I should say seeing as Laura just looked at me that the IMF shares responsibility for everything but not Laura not Laura I just take that on myself I'm sure it's all gotten better since I left the IMF in the summer of 2008 so just to focus on what happened around the Lehman collapse which has rightly been mentioned but I just want to emphasize a couple of points about that the first point is the Reserve Primary Fund which experienced the big run the big collapse on the Friday Thursday Friday before Lehman collapsed had about $60 billion in that fund it was understood correctly by the market to have some significant exposure to Lehman commercial paper it actually had about 2.5% of its portfolio in Lehman paper the run on Reserve Primary was so big that by the end of Tuesday they had about 20 billion little bit more than 20 billion left this was almost entirely a wholesale run it was not a retail run very little retail run out of money market funds in this entire episode now Reserve Primary did eventually pay out to its investors about 98 close to 99 cents to the dollar I believe so the amount of capital loss there was ultimately small but the degree of panic out the door was enormous the speed of that run was surely far faster than anything was experienced except perhaps in some very few brief moments in the 1930s second point that I would emphasize came up a little bit this morning in discussions but I think you have to and it was in Randall's very good presentation just now but in passing the foreigners the foreign banks were absolutely central to this process and I think somebody maybe Adam said made some offhand remark about German landers banks he was standing back here away from the microphone it may have been intentional I've been an official I understand what that's about look every crisis that you can remember anywhere in the world had German landers banks making some daft loans that's a technical term banking term to somebody or other not going to go away this is another part of the perpetual cycle and you cannot have you absolutely cannot have a sensible discussion with any German regulator or politician about those I've tried it they say no no no the politicians when you mention public banking everything else I like that makes me very nervous because the profound failure of that level of German banking is awful and it's global and the third point that I would pick up on is about the role of the banks and so I like all your slides Nicole except the one where you drew the picture of shadow banking being separate from and bypassing the banks balance sheets now you then adjusted that and corrected it and you gave us this wonderful depiction of the complexity of the system and the central role of the banks and I would lay forward before you as a theorem you can refer to it from now on as Johnson's theorem that any reasonably accurate depiction of the modern financial system on a single power point is too small to be read that was certainly the case for your slide and Adam's slide I couldn't read that and I think it was through Randall's slides actually and these were all simplifications if you want to go see in fact the I think it's the Ashcraft fantastic picture if you want to go see in a form that's readable you have to go to the offices of better markets because they had it blown up to a size to the size of that white wall there and you can spend a good hour or so loitering in front of that picture of the complexity and so the question I have for the New York Fed the analytical question is to completely reinforce and echo what the three previous speakers said which is we understand there are these externalities we understand they're profound and they're here to some degree always in any version of the financial system you're going to get them but we have allowed to develop an extremely complex agile system in which we absolutely perhaps this would be a controversial statement at the Cato Institute but it's not controversial surely at EPI we will stand behind part of that financial system come what may to the end of the earth or the failure of US government credit which as Damon said maybe it was slightly earlier than the end of the earth unfortunately but that is that you must stand behind now the question is and the question that arose from Badger the question that was between 1907 and 1913 the question that Dantorulo nailed to my opinion in my opinion at lunchtime was we stand behind part of the financial system but not all of it and I am also concerned I mean I think Bill Dudley did not say he wants to expand the safety net to everyone but I agree with Marcus he moved he floated some balloons further in that direction and given that the short time lapse between an incomprehensible throwaway remark in the FOMC minutes and actually becoming policy or anything else makes me very nervous so I second and reinforce the idea that we are not extending the safety net to everyone some things are in and some things are out but I completely agree with the previous speakers the presumption should not be well if the market created it's got to be good and you have to prove to me otherwise if you want to reform it the presumption should be no no no we want a vanilla version of Randall's proposal or Damon or Marcus's proposal something very vanilla and simple unless you can demonstrate to us that the additional complexity and fragility of the modifications you are suggesting confers benefit not please not on the financial sector the financial sector executives the best paid people in the world it must confer benefit on the non financial sector that is the purpose of finance that is why they get the backstop that is why we do not walk away in the crisis that is why the New York Fed has this role a trust that we do not place in anyone else to determine at the moment of crisis whether this or that financial institution is so critical to the future of the country that it must be provided with an unlimited government backstop in 1907 mandated by J.P. Morgan a private authority that was widely recognized to be unsustainable in a modern democracy we rightly created a central bank we have grappled with this issue ever since and I would say to the New York Fed that if you cannot convince us that you are serious about this task not specifically to you Nicola I say the same thing to Bill Dudley whenever he's willing to talk to me don't worry if you cannot convince us you can do this task we will give the job to someone else and there are a number of plausible candidates including the Board of Governors of the New York Fed that is building up its own analytical capacity the US Treasury has interviewed for the job but I think they demonstrated a lack of seriousness particularly in some of their steps but I am encouraged by what they are saying under current management and there are a number of other reserve banks around the world in fact we are not short of reserve banks thanks to the politics of 1913 we have other contenders and I am struck repeatedly by the number of smart people I meet from Kansas just to mention one one state that happens to have two reserve banks that would be willing to take on this job so Badger identified the problem the New York Fed has grappled with it for 100 years and it has struggled in recent years and that leads me to Sheila Baer I agree with some of these general proposals I am asking the question but we are practical people we have to act today do what Sheila Baer told you to do implement the Volcker rule and do it now and do the Kaira Stein version of it okay money market funds clearly have to be reformed and the Federal Reserve has been on the right side for that we need more capital in the system I fully endorse what Mr. Terulo said at lunchtime I think there are steps in the right direction but these are only steps Jack Lew the Treasury Secretary said we should implement Dodd-Frank by the end of this year and then evaluate what else we need to do that's the right approach that's exactly what we should do not drag our feet for another year or two and remember this to be more specific the Europeans are not going to fix their financial system actually the fact that Europeans are slightly ahead of us on money market reform is a profound embarrassment anytime the Europeans are ahead of you on dealing with these issues you've really fallen behind there are going to be destabilizing cross-border flows if you allow them there are going to be crazy German landers banks making irresponsible poorly considered decisions there are, that's just the reality and again the Fed has taken some sensible steps to consider to limit the damage that foreign banks can do next time they go crazy in the United States we need to do more and we need to have more of these discussions and I actually completely agree that they need to be funded with more equity less debt the amount of damage that you can allow any one of those institutions to do is currently excessive but that's just part of the portfolio of changes that we need to implement Sheila Baer showed you the right way I hope that the New York Fed and the rest of the Federal Reserve System converges on the same message I think Dam Trule absolutely did at lunchtime we will not end this the Badger problem the Minsky problem the pronest instability we must recognize that will not go away if next time somebody says to you the world crisis are over you should disregard that completely there will always be crisis there will always be these difficult moments but we can and should and must make the system more stable and safer for all of us thank you very much Superintendent Laski in the back of the room and we have promised him he can speak around 2.30 so I think where we're not going to be able to have a break clearly and I think we can probably take what do you think, 2 questions I think we can take 2 questions we have a tiny bit of wiggle room Andy we would be great if we could have an ask questions we would start with those who have an ask questions yeah, people have an ask questions I think there was a lot of talk about money market funds but could someone explain that as much as these are excess deposits which don't have a home in the banking system and more recently a temporary facility called the Fed's Reverse Repo can someone explain as much as this should not have a backstop you have the best counterparty right now I mean, before this facility we had to go at least the money market funds had to work hard to get a return positive or negative but that was part of the plumbing the dealers, the hedge funds, the collateral but with the reverse repo as much as the same week the Fed writes letters that we need a variable nav the next week they have a reverse repo system which is told to be temporary but clearly is not temporary okay, one question I think I'm the one who said that there should be can we just turn them on for for law spaces I'm the one who said that there should be a very financial system that's one way of doing it but I think in the money market fund sector you see a reach for yield like a race for yield I don't think there's a problem when you have government money market funds that are basically investing in the lowest risk asset out there although unfortunately the actions of the US Congress make it look riskier than it should be but when you have people promising deposits and advertising that I'm going to give you a higher rate than the next guy you're looking at a dangerous situation because if you're giving higher than a risk free rate it's not a deposit so I think the Treasury could run its own Treasury money market fund and I'm glad that people can plug into a reliable counterpart in the money market fund sector but I don't think that's the problem the problem is this perception that it's as good as a bank deposit they're investing in risky assets if the value of those goes up and down in your statement, if they plug the NAD then there's no misperception there's no belief that it's just as good as a bank deposit, that's the origin of the problem and as for this full allotment reverse repo that the Fed is offering I believe that's not a backstop I believe that it's a way to encourage them to deposit with the Fed that's what the Fed says it's not supposed to be an unlimited amount of money that's being provided by the Fed so they're money markets the Fed absolutely categorically denies that that's what's going on with this because that would be a backstop insurance which they're not paying I have a question on strategy and I think that I don't think there's any amount of fiscal reform that's going to save the transatlantic right now I think there has to be the impression that money the primary markets as Mr. Silver said made the distinction is real money and the secondary players secondary markets are in inferior form of capital inferior form of wealth real money is bettering between improvements in terms of development etc that being said I do a lot of work in the Congress on black media the big log gym right now and I can see reform as government now what I want to know my question is how do we create a political will in the Congress to recognize that the last evil is we're cleaning up the banking sector we can clean up our commercial banks to create a medium through which we can funnel credit for physical development physical development is really the ultimate aim of what we need to do in the country for recovery and that we can talk about reform all day but what we really want is development of the country that's clear it's a question on strategy how do we recruit these more serve as members to recognize that it isn't their best interest that we cast them in the last evil or the development of some of these states in the country that aren't even really developed yet so I think the key message to many people on the left and on the right is that the current system is a highly subsidized system that the two big to fail banks are still too big to fail and there's an implicit government guarantee in terms of backs off which they're not paid and I don't know anyone on the Republican side of the Democratic side is possible with such an arrangement so it's substantive what we're looking at right now is a subsidized system and proposals along lines of last evil or other proposals that we've talked about are designed I think the most part or entirely to reduce those subsidies move away from a subsidized system move towards a market system this is what the independent community bank of America say move towards a market system in which everyone can succeed and everyone can fail but now they can't fail so I just wanted to say one thing not disagreeing with David but kind of complexifying a little bit there's no question the shadow bank from funds physical development all you have to do is visit some suburbs in California and you can see lots of physical development that was funded by the securitization markets and the shadow banking system the issue is actually it misallocated funding in a lot of ways for physical development so it's almost worse than if it hadn't funded any in a certain way but I think that people they get people coming to them claiming that these secondary market things are important for transferring money into physical development and so on and you just have to make clear the inefficiencies that are involved compared to and the diversions that are happening compared to if we had a more direct channel of credit I chose to characterize my views especially in physical development I think there was a role to do secondary markets secondary markets are not a bad thing how much do you want to subset on it oh I'm sorry it's really hard to do that so quiet so I'm going to show so secondary markets better secondary markets are not a bad thing and it's they're a good thing they're helpful in a variety of ways in encouraging the financial system to do what it's supposed to do in terms of allocating capital or productive use as I said a moment or two ago I did not use the term physical development because I think the question is that it doesn't really capture primary and secondary financial market activity that Marcus's point is of course correct that shadow banking institutions and shadow banking markets were quite important in the housing bubble and in the rise of the subprime market for 2008 think about them though and I think Marcus pointed to it in his remark the thing about shadow banking institutions as ways to move credit into the real economy to the extent they do that and I think if you listen you listen to what Governor Taruba was talking about primarily primarily focused on the use of shadow banking institutions and secondary markets and today unless you want to characterize the GSEs as shadow banking I would not the shadow banking is not a significant contributor to the financing of any real economy activity I know of but the problem with it as the my friends in the Fed they can be heard they know more about this than I do the problem with shadow banking institutions in my opinion what happened before 2008 what's generally going on now is that they tend to be highly dependent on forms of underwriting that are automated and that are very poorly suited to the investment needs of our society and I've always been struck in looking at the events between 2003 and 2008 not just by the sort of the protest loss that was involved in so much that was built in terms of housing and ultimately nobody wanted to live or pay for it but the opportunity the enormous amount of capital that we very badly needed to do other things to upgrade our economy's competitiveness that was diverted into essentially ways not entirely wasteful activity I mean people that paid to build those houses lived on the but activity that predominantly did not do long-term economy yes I want to thank the panelists all very very much thank you sir thank you thank you thank you thank you thank you thank you thank you thank you thank you thank you thank you good luck there we go we're still there all right we're going to get started again in a moment ask people to take their seats and so we can begin it's a good sign Then people are dying to continue the conversation after the panel that people are asking important questions and then trying to figure out what to do about them. Right. Thanks very much. And thanks for your patience. Our next speaker is Benjamin Lasky, who is the New York State Superintendent of Financial Services. And since that's a job that we in Washington don't necessarily know the job description of. He is the supervisor of banks and non-banks, including all insurance companies in the state, New York State Chartered Depository Institutions, and the majority of United States-based branches and agencies of foreign banking institutions. He also regulates New York State's mortgage brokers, mortgage bankers, check cashers, money transmitters, budget planners, and other similar providers of financial services, a significant portfolio. And he's distinguished himself in his two years or so on the job as a regulator who's ready and willing to look beneath the surface at what's really going on at the institutions that he supervises, ask hard questions, and to take on powerful financial industry interests when it's necessary to defend the public interest or protect consumers. And the examples of that are too many for me to go into before these remarks, but a couple that it's worth highlighting. To name just a few, he has settled major actions over money laundering and violations of international sanctions, and led the way in finding new strategies to take on online lenders and others who violate New York State's prohibition on payday lending and who were absent this kind of action, increasingly undermining all state anti-payday lending laws actions that have really helped shape the national debate and conversation on those and move that in an incredibly useful direction. And he has uncovered many billions of dollars of opaque transactions that insurance companies have been using to make themselves look more solvent and better capitalized than they are, potentially putting taxpayers and policy holders at risk getting at the kinds of questions that are important to our debate today. So we thank and congratulate him for his work in New York and very much appreciate his joining us today. Thank you. It's great to be with all of you today. I want to first thank Marcus Stanley for putting this great conference together. Thank you to Americans for Financial Reform and the Economic Policy Institute for hosting us. And most of all, thank you to Lisa for that kind introduction. I'm very focused on introductions as of late. My six-year-old daughter recently took a dance class, and they learned how to introduce each other. And I was recently, I get up early and I was having breakfast, and she snuck up behind me and unbeknownst to me, I hear, introducing mommy. And my wife walks out, and my wife says to her, your father would love it if you'd introduce him. So she's been well-trained. She puts me in a whole room in the hallway of our apartment. And she lines up my son and my wife and my dog on the couch. And she then gives me, she's about to give me the sign to come in, but I hear my wife whisper to her, we've got this crazy title, superintendent, you should say introducing a superintendent. He would love that. And it's now 7 in the morning. The sun is coming up, and I'm feeling very good. This is a great way to start your day, introduce by your daughter. How cool is this? And she gives me the wave, and I come out. And she says, introducing Mr. Stupid Head. And that's how I started my day. So I've ever since been very focused on the introduction, so thank you for that. Look, the topic of this conference, regulating shadow banking, is one that is vitally important. A stronger oversight of the shadow banking system is just critical to protecting jobs and the savings of everyday Americans from really the reckless risk taking we've seen in the past. The recent financial crisis has made it abundantly clear that we cannot simply focus exclusively on the banking sector when considering the issue of systemic risk. And there are many other diverse sources of capital that are vulnerable to damaging runs and panics. And it is essential that we take steps to help reduce those risks. Today, I want to focus, as Lisa mentioned, the majority of my remarks on one particular area of the shadow banking system that we regulate where I work at the New York Department of Financial Services, and that's the insurance industry. As you likely know, we have a primarily state-based system of insurance regulation. You may not know, actually, because a lot of people don't pay attention to it. But that means that there are more than 50 different regulators across the many US states and territories who are responsible for overseeing the safety and soundness of insurance companies, that their solvency, and ensuring that policy holders are protected. Each of those different state regulators is generally responsible for their own jurisdiction and that insurance companies operating there. However, Dodd-Frank did make some important changes to that system, particularly, Dodd-Frank gives the FSOC the power to designate systemically important financial institutions, CIFIs, for heightened regulatory scrutiny. Some have questioned, of course, whether it is appropriate for FSOC to designate insurers as CIFIs. There have also been similar questions raised about asset managers, as well as other broad categories of investment firms and funds on Wall Street. Now, I don't think it should be terribly controversial to say that companies involved in the insurance business, asset managers, and other parts of the shadow banking system can potentially pose systemic risks to the global economy and should therefore be carefully considered for heightened oversight through the CIFI process. In the wake of a devastating financial crisis, we should not be writing off entire multi-trillion dollar industries from the potential for enhanced scrutiny. Nevertheless, regulators should also take great care to make sure that CIFI determinations and CIFI regulations are tailored to the unique nature of each type of business that the FSOC seeks to designate right and supervision. Just take the insurance industry, for example. As we saw with AIG during the financial crisis, it is certainly quite possible for firms involved in the insurance business to pose a systemic risk. Companies involved in the insurance business can be very large. They can be interconnected. And they're often a critical source of cash and collateral for other big financial institutions in and out of the shadow banking system. And as we saw with AIG, an insurer can stray into exotic financial products beyond the traditional insurance business, far beyond traditional insurance business, which can potentially strain their liquidity position and put them at risk of a catastrophic failure that could threaten our entire economy. Now by the same token, however, the asset and liability structure of traditional insurance business is very different from that of banks. And regulators typically have not seen the type of mass policy holder surrenders at insurance companies that are analogous to depositor runs at banks. And moreover, traditional insurers are typically less interconnected than banks. As Senator Brown and other meaningful commentators have pointed out, a one-size-fits-all approach to CIFI regulation at the federal level, including regarding capital and liquidity rules for insurers, is not necessarily optimal. Applying bank-like capital regimes to insurance companies could be akin to fitting a square peg or trying to fit a square peg into a round hole. Now the primary expertise of many members of the FSOC, let's just admit it, is banking regulation. As such, the Federal Insurance Office, which was created by Dodd-Frank as well, led by Mike McGrath, has and will continue to serve as a valuable resource on the FSOC, as will Roy Woodall and Director John Huff. Moreover, state insurance regulators stand ready to provide assistance. And my staff has been down several times already to meet with FSOC to try and help work through what makes insurance companies unique and different and not necessarily always like banks. I'm not saying the FSOC shouldn't have a role in scrutinizing and regulating insurance companies. I'm just saying, that's fine, but let's not treat them as banks. They are what they are, and let's tailor our regulation and make it smart. Now, I don't want to focus too much on the SIFI issue because I think, frankly, everything I just said is fairly obvious, and insurance companies, our largest insurance companies, are being scrutinized and regulated by the FSOC. But I do want to mention a couple of other areas within the insurance business that don't just apply to the very biggest insurance companies in the world who are subject to the FSOC process, but there are some other developments going on in the insurance world. And I want to take this opportunity to speak to this crowd about it because I think a lot of people are focused more on bank regulation, focus more on Dodd-Frank implementation, and just generally the insurance business gets a little less attention than the banking business or a lot less attention. So I want to tell you about two different areas. One is called captive reinsurance. In July 2012, the DFS, Department of Financial Services, where I work, initiated a pretty serious investigation into this somewhat obscure area called captive reinsurance. And captive reinsurance is sometimes used by large insurance companies to mask, risk, and leverage. Insurance companies use these captives to shift blocks of insurance policies to special, offshore, or out-of-state entities, often places like the Cayman Islands, in order to take advantage of looser reserve requirements and looser oversight requirements. Now reserves, as you probably know, for insurance companies are funds that insurers are supposed to set aside to pay policyholder claims. Now in a typical transaction, an insurance company creates a captive insurance subsidiary in another state with looser requirements, and that's essentially a shell company. It usually doesn't even have a single employee. The company then reinsures the risk they have on their books in the state they're moving the risk out of, and they divert or they take down the reserves they were holding for that risk. You would expect them then to post those reserves, or at least some portion of those reserves, in the state where they've moved the risk to. However, what they do a lot of times is they provide a parental guarantee from the state where they're moving the risk out of. So they lower the reserves there, they divert it to use whatever they want to use more capital for, and they don't post any more reserves in the state where the captive is. So they really hasn't been a risk transfer, but they lower the reserves. And they do this because we have a state-based system, it's very hard for regulators to kind of see into these transactions. And we decided in the summer of 2012 to start investigating, it took a year to really dig down just into the New York-based insurers to understand how much risk. Our first question was how much of this is happening. And ultimately we determined it took about a year with a whole team working on it. So that will tell you something about how opaque this market is. We found that in New York alone, those insurers had moved about 48 billion dollars of risk off their books through these transactions. There have been studies since, other regulators haven't been looking at this as closely, but studies since have estimated that more broadly it's at least 300 billion industry wide that's been moved around through these vehicles. And if these vehicles sound like something familiar to you, like when we all live through Enron, you're not crazy. Now it's important to note, not all captive insurance is bad. In some cases it can be a useful tool for businesses and insurers that are looking to effectively manage their risk profile. But when captive insurance is being used simply to juice a firm's balance sheet without any genuine risk transfer, that's a problem. And if insurance commissioners, the 50 of us around the country, turn a blind eye to this issue, it could call into question our very system of state-based insurance regulation. Now I wanna be clear, I believe our state-based insurance regulation system is quite good and I fear though that if we don't do more about issues like shadow insurance and something goes wrong as it has before and it always does, people will blame the state-based system. Shifting risk around so it can't be seen in order to artificially boost financial performance. We have learned time and again is almost always a recipe for disaster. The use of these shadow transactions has boomed in ways that pervert our system of careful oversight and as high time we put the regulatory brakes on these types of deals. Second area I wanna tell you about is something called principles-based reserving that you've probably never heard of. And this is a, believe it or not, while we are ramping up like crazy in terms of heightened regulation in the world of banking, there is actually a movement afoot in the insurance industry to deregulate. Principles-based reserving basically, right now we have a state-based very formulaic approach to how much reserves an insurance company must hold for any block of business. And it's a pretty conservative approach and it explains why after the financial crisis banks really struggled but insurance companies actually did fine because we had them holding a lot of reserves. But since that time and even before the crisis but it's continued after, there's been a movement to move to a principles-based reserving system which is a system that is based, believe it or not, on internal black box models by the insurance companies where they figure out on their own what their reserves should be. For those of you who live through Basel too it might sound a little familiar. It is, it's the exact same stuff that Sheila Barrier, first speaker this morning fought against in the run-up to the financial crisis but the insurance industry has its claws very much into a lot of the regulators around the country and we had a vote recently at the National Association of Insurance Commissioners to try to see whether we would move to a self-modeling system. And we got killed, we got creamed and I think it was something like 40 votes in favor of deregulating in this fashion. Luckily there's another rule that says you will not move to this system because you have to move to a nationwide or not, it won't work unless I think it states representing 75% of the premium written in the country vote in favor of it and New York is against it and California is against it. So we are barely holding on to preventing the advent of principles-based reserving but it's something I wanted to put on all of your radar screens. If it happens I think we will rue the day and believe it or not in one area we actually try to pilot of the principles-based reserving system to see how it worked and New York agreed with this and it was in a particular area I don't wanna get too far afield but it's called universal life with certain types of guarantees and ULSG products and we moved to a hybrid of not even a full PBR mode to see how the reserving would go and all the modeling we saw at the time indicated that about $10 billion in additional capital at the time would be posted to reserve for these products. So we waited a year to see what would happen and then we actually went back and took a look and 600 million of the 10 billion actually got posted and of the major firms only one actually posted any additional reserves. We therefore in New York pulled out of the compromise that had been put together to allow this type of reserving just on this one product but I think it was a real canary in the coal mine. I mean it really shed light on what principles-based reserving would lead to. I mean the fact is especially now that most insurance companies are stock companies there was just incredible pressure especially in the long-term low interest rate environment we're in to bring down reserves and get loosened up that cash and use it for other things and I very much hope that other regulators are starting to see the light on this issue and I wanted to alert all of you to it because I think we need to have a broader debate about whether this makes any sense. In our system. Now, I also wanted to talk more generally today not just about insurance but about a separate problem I think we as regulators face. While we need to move to a stronger, more robust and more holistic regime of oversight for our insurers, I don't think that's enough. We also need to be grappling with much deeper questions about whether we as regulators have the tools and capacity to truly protect everyday Americans from reckless risk-taking by large financial institutions in the shadow banking industry and elsewhere. Now, usually we talk about this issue as a too big to fail problem some people talk about it as after the London Whale as a too big to manage problem. I think there's a related but distinct issue we need to confront and that is whether some of our nation's largest and most complex financial institutions are just too big to effectively regulate. Now, that's not something that a lot of financial regulators want to discuss, at least publicly but I think it's something that needs to be said. Indeed, rather than forthrightly acknowledge our limitations it sometimes appears that regulators are more likely instead to display a false sense of confidence about our ability to assess and manage risk at the institutions we oversee. And that pretentive knowledge can ultimately prove very damaging. Recent financial crisis is perhaps the clearest example of this phenomenon. In the years leading up to the crash regulators repeatedly and vastly underestimated the impact that the mortgage crisis would have on the health of our nation's institutions and the broader economy. And even now with all that's been done to reform the financial system since the crisis, the new rules, the new regulations, the new tools it is not clear with respect to the very biggest and most complex firms that we are keeping up as regulators. At some point, in my personal opinion, we need to soberly assess our own limitations. Think about this, our nation's six largest bank holding companies have more than one million employees and nearly $10 trillion in assets. I can tell you that the largest insurer we regulate at DFS has more than 1,500 subsidiaries around the globe. And as a regulator, that keeps me up at night. We live in a financial world where a few keystrokes on a computer screen at a small office and ocean away can severely harm or even cripple a major U.S. company. And where the failure of that company can do serious damage to the jobs and savings of everyday Americans. With that in mind, we need to really stare in that mirror, as I do many mornings, as regulators and ask ourselves whether we can adequately regulate such institutions. My view is that the very act of acknowledging our limitations and grappling with the true difficulties of regulating behemoth firms will itself make us better regulators, where we are more aware of what we should be looking for and more aware of what we may be missing. By the same token, regulators often deal with these limitations by doing what? By engaging consultants and monitors to provide the regulator with additional assistance given the finite resources that we as regulators have. Now these consultants are installed at banks and other companies, usually after an institution has committed a serious regulatory violation or broken the law. The intent is that the monitor assists companies in improving controls and ensuring that violations do not reoccur. They're supposed to be independent of the bank and they're supposed to work on behalf of the regulator. All too often, however, we found that the outcome of these monitorships is very disappointing, as we recently saw in the context of the independent foreclosure review. And you could blame that on a number of factors, but it is worth considering that certain structural issues and impediments really can significantly undermine the independence of the monitors. Think about it, the monitors are hired by the banks, they're embedded at the banks, they are paid by the banks, and they depend on the banks for future business. Now at DFS, we're in the middle of a pretty extensive review of the consulting industry. Earlier this year, we took some actions related to Deloitte. They've been banned in New York. An arm of their work has been banned in New York for a year based on the lack of autonomy they displayed in their work, doing anti-money laundering work at a bank called Standard Chartered, you may have heard of. Deloitte also agreed to a set of reforms to strengthen our ability to have oversight of the consultants and really to ensure their independence. And we've decided that in New York, we're not gonna use any monitors or any consultants and hire them unless they agree to those reforms. And I'm happy to say that many of those reforms have now been adopted, I think just last week or maybe the week before, by the OCC. And I think that will be a very positive development. Our investigation into bank consulting is still ongoing, but I will say that the problems of improper influence and lack of independence are not at all limited to Deloitte. They appear to run very deep throughout the consulting industry and we have a heck of a lot more work to do there. My view is if we can soberly reflect on our own limitations as regulators and at the same time, more robustly ensure the independence of the consultants we hire to help us, we may significantly improve the quality of our regulatory work and we may improve upon the protections that our work is supposed to be providing to our citizens and our system. Now, you might wonder why does any of this matter? It's obvious to some of us, but I think it's fair to say that too big to regulate does not resonate necessarily with everyday Americans. After all, I think there's a natural distrust among the public about financial regulators and government officials in general, particularly in the wake of the financial crisis and other shenanigans we've had here in Washington recently. So I think it's worth pausing for a moment outlining why working to address the too big to regulate problem is vital to protecting everyday Americans and our economy. First, if these firms are just too big to regulate, that means regulators and law enforcement officials face much greater challenges in uncovering dangerous misconduct at those companies and that can do serious damage. In recent years, we've seen egregious violations of the law and ethics at a number of our nation's largest firms. We've seen money laundering for terrorists, drug lords, and enemy nations that puts our national security at risk and we've seen mortgage misconduct that has severely damaged many families and neighborhoods perhaps irreparably. The list unfortunately goes on and on and those are just things we know about. Of course, no regulator or law enforcement official has an all-seeing eye but the larger and more diffuse these firms are the greater the risk that misconduct goes undetected and that means less deterrence and that in turn means more everyday Americans will get hurt by the misconduct at financial institutions in the future. Second, if these firms are too big to regulate they are more likely to take on too much risk which puts them in danger of failing. In some ways, financial firms rely on regulators to save them from themselves. The lure of potential profits and bonuses is so great that many executives are willing to take on those outside risks if they can. It's the regulator's job to hold up a stop sign before a large financial institution crosses the line and slips past the point of no return. But if a regulator does not know where the line is or if a firm is close to crossing it that's a recipe again for disaster and it could put our economy at risk. Now to be clear, I think we all acknowledge that making our nation's financial institutions smaller and simpler will not necessarily by itself eliminate systemic risk. Financial crisis that accompanied the Great Depression for example was propelled in great part by a cascading set of small bank failures. Financial markets by their very nature will always be vulnerable to panics, manias and destabilizing runs. But if we as regulators simply accept the risky status quo, a status quo where we may not have the ability to effectively regulate the mammoth institutions we oversee, aren't we being negligent? I do not necessarily know that I or anyone else has a fully satisfying solution to these problems. Some suggest making our institutions smaller and simpler is the answer. Others suggest much, much higher capital levels and those are all important issues to debate. But as everyone acknowledges those types of fundamental change take a long, long time to occur. There are areas however where we can make immediate positive changes as regulators. And one of them I believe is attitudinal. In my opinion, regulators can and should be much, much, much more proactive. We need to focus on the here and now and the new new products and services emerging in the markets. And we need to spend more time focused not only on what we are seeing as regulators today but also what might be around the next corner or lurking in the shadows. Regulators should also where appropriate be more aggressive. They need to ask tougher questions to help lift the veil that shrouds these mammoth financial institutions. They need to probe deeper. They need to engage in tough but fair enforcement that provides real deterrence to bad conduct by individuals inside these massive firms. More proactive work in this fashion will not solve the whole problem, but it's a start. I don't mean to imply that the art of financial regulation is as some may suggest a futile endeavor. I actually believe in it very much. We shouldn't simply resign ourselves to a financial system that forever careens from crisis to crisis, far from it. But at the very least, I know that turning a blind eye to this issue certainly will not solve the problem. And that's one of the reasons why it's so great to be speaking with all of you today, and I'd be happy to take any questions you might have. Neil Rowland with M. Lex News. Two questions. Nice to see you. Nice to see you again. And my compliments to your daughter. Thank you. She's a pistol. First, with regard to captive reinsurance, what are you and other states doing in that regard? And second, with regard to credit card reward programs, is there anything you're doing, particularly in light of the CFPB being pulled up a bit short by a federal court in South Dakota? So first question on the captives. We obviously are not allowing those sorts of transactions to go on in New York anymore, the captive transactions with the parental guarantees. So we're largely solve that problem in New York. The bigger question is what's happening in all the other states and nationwide. I think there is a very robust debate going on at the NAIC right now, National Association of Insurance Commissioners, over this issue. We had called when we put the report out last summer, this past summer, we had called for a moratorium nationwide on these transactions. Although we've stopped them in New York, that hasn't happened, the moratorium. But I think the issue has been raised to a significant degree where you're seeing other regulators thinking long and hard about this. Guy like Joe Torti in Rhode Island, several other regulators are very focused on it now, Dave Jones in California, et cetera. So I think there's now going to be, we have a meeting here in Washington coming up in mid-December with all the regulators. And I think it will be discussed quite a bit. And I can't predict yet where it's going to all go. But I think the more people get focused on the issue, the more they will realize that while captive transactions sometimes make sense, captive transactions just used as a form of financial alchemy or financial engineering are very unwise. And we're going to rue the day if we don't do something about it. On credit card, what was the issue again? Credit card rewards programs. We have a financial frauds group that's looking at many issues around credit card issues. I think you correctly identified, I think, the CFPB and Richard Cordray, who by the way is a bright shining light of the Obama administration, in my opinion, are first and foremost on that issue. We don't regulate, typically, national banks as in their credit card work. So we have to be, we run a little behind the CFPB, let's say, on those issues, but we're certainly scrutinizing. Mr. Lasky, my name is Bart Neyler. I'm with Public Citizen. I praise you for setting what to date is the high watermark for law enforcement with bank fraud when you asked a very simple question, a standard charter. Why should they be chartered in your state if they're committing crimes? On December 12th of 2013, that's what of 360 days ago, HSBC admitted to criminal money laundering of $200 trillion. I'm pausing because it's a T trillion. And yet no human being was charged in that, leading to the infamous series of interchanges with Senator Grassley that it's too big to jail, et cetera. But it actually happens to be incorporated in the state of Maryland, where the Maryland state law says that an enterprise can't engage in aiding and abetting illegal drug trafficking, which HSBC admitted to doing to the tune of $800 million worth of the Sinaloa cartel. We have petitioned the Maryland Attorney General to look into this, if you will. Do you have any advice for the Maryland Attorney General in looking at this? So I try not to give advice to other law enforcement offices and regulators. But look, I will say this, without commenting on any particular case, what really struck me in the statement you just made was your noting that no individual was held accountable inside the firm. And it is a little mystifying, some of the deals we've seen in recent years. It's almost as if the firm itself did something wrong or acted. But of course, a corporation is largely, it is. It's a fiction. It's just a group of people. And if the corporation does wrong, or we think a corporation has done wrong, there are people within that corporation who must have done wrong. That just doesn't happen any other way. And one thing I like to focus on a lot in the work we do at DFS is deterrence. I'm a former federal prosecutor on the criminal side of Manhattan. And if you're not deterring bad conduct, you're really making no headway for the future and improving our system. And if you think about what deters bad conduct, it's usually, one, holding individuals accountable in some way. And two, really exposing the related, exposing the conduct those individuals have engaged in. And it's something we're very focused on in DFS on a going forward basis now. How do you do that? And I think my fear is we're spending a lot of time focused on what happened in the past. And the way to balance focus on the past with preparing for the future and making our system better is to focus in our enforcement efforts on deterrence and holding individuals accountable and exposing the conduct in great detail that took place. So I think you raise very fair points in that regard. Hi, my name is Andy Green. I am a counsel to Senator Merkley on the banking committee. And it's great to see you here. And so glad that you could join this conversation this afternoon. I wanted to ask if I could, two questions. And they're not exactly what I think, but maybe they could be. One is the intersection of insurance and banking. The conversation today has been a lot about how the 2008 crisis has looked a lot like the 1907 panic, where there were feedback runs between borrowers pulling out of markets because of questions about solvency. And what are the tools going to be used, boosting liquidity, boosting solvency, reducing the intersection between banks and trading markets. And I think it's interesting to note that the 1907 banking crisis, in many ways, was started by the payout of the insurance industry two after the 1906 earthquake in San Francisco. And so I'm curious, given that we've seen liquidity swaps between insurers and banks, particularly in Europe, become more prevalent, what types of intersections you're seeing, if any, between the insurance sector and the shadow markets, the shadow banking, the ordinary banking sector? And any thing that you can help enlighten thinking on that front, if I could make the second question real quick on sort of back on that one. Your point about principle-based reserves, I'm glad you raised it, very, very important. I'd be curious if you could add any color about what's going on with solvency, too. If we go back to the banking world, the effort to lower bank capital, which Governor Tarullo talked about in his book, was driven by the Basel process in Basel II. Obviously, that was stopped, and we're still trying to reverse that in the banking world of Basel III. And beyond that, with leverage, et cetera, the Europeans have pulled back on solvency, too, but questions about there hasn't been a lot of attention on whether that's going to fix the problems that solvency, too, might be comparable to Basel, too. Yeah, so let me start with the second question first, because I just don't know the answer. I don't know. I mean, so many of the big international issues, and we didn't even get into the GCI process today, which sort of mimics the SIFI process domestically. So much of the international action has been moving at a snail's pace for a long time. And we often hear, OK, it's really going to happen now. Things are coming. Things are really speeding up. I don't know. I think these are very, very difficult issues. And what will happen with solvency, too? And will it really happen? And when will it happen? Very hard to say. On your first question about the intersections between banking and insurance, I mean, we think about that every day. Governor Cuomo, who I work for, we created this new department back in 2011, combining the state's banking department with the state's insurance department into a holistic financial regulator. And the governor did that because he had been Attorney General during the financial crisis. And I was with him at the time, and we were witnessing sort of our big worry were the gaps. And where firms, whether it's the shadow banking industry or other areas, were really not getting sufficient attention from any other regulator. And that was the impetus behind putting the two together. What I didn't realize, now that I'm in the job, I do realize, by combining the departments, I found we learn a lot from the banking side that we bring to the insurance regulation. And we also learn a fair amount from insurance regulation that colors our view sometimes on the banking side. And I think that's been very positive. And like I was saying before, if you are a bank regulator and you know anything about what happened with Basel 2, you have a much different reaction to principles based reserving when you see it. Same thing with the captive transactions if you've lived through some of the problems created by transactions involving special purpose vehicles in the past. So I think we learn a lot from both sides of the house. I think it sounds like you know a little more history than I do and I could go on and on about this. But I think having a holistic overall state financial regulator has been very positive for us. So thank you. Marcus Stanley from Americans for Financial Reform. You have the nice issue here of having so many proactive initiatives that you're doing that you actually didn't have time to get to one of my favorite ones. Can I guess? Bitcoin? No, no. Hey there, Lending. They just go on and on. Private equity buying. Private equity buying. Neuity companies. I got it. But I just wanted to ask about that from two perspectives. One is the kind of annuity products that are sold under life insurance and appear to offer guaranteed return to people when they purchase them, but actually can have significant concealed risks, especially when they're managed by people who want to kind of milk them for money. And also, your thoughts on a general related problem that AFR is doing a lot on, which is fiduciary duty to retail investors on the products they buy, like equity linked annuities, like products in retail investment products that may contain embedded derivatives and securities securitization connections. Sure. So I think I know less about the second part of the question. But in terms of private equity moving into the annuities market, both fixed and variable, for those of you who don't know, we saw a huge spike over the last year in private equity firms buying up annuity firms. And it was something, it went from, first it was 5% and 7%, and then all of a sudden it was 30%. So about nine months ago, we took some steps to put the brakes on some of those transactions, because we oversee those transactions and have to often sign off on them, at least in part. And the worry really is, look, a life insurance company, its whole business model is premised on its reputation for safety. And so normally, when you're buying an annuities product from a traditional life insurer, you can be pretty confident they're going to be very conservatively invested. They're matching their assets and liabilities very carefully and they're in it for the long tail. So when it does come time and you retire on a fixed income, you know that annuity is going to pay off. When we started to see private equity firms buying up these companies, it was startling and worrisome, because of course, they have an entirely different business model, not predicated on that same type of reputation that life insurers have. And instead, a private equity firm often, they'll get involved in 10 deals for the year. They've had a banner year, four of them fail. No one even cares. The problem is, if one of those four failing is an annuities company that's supposed to pay retirees out living on fixed incomes, we saw that as a big problem, as a regulator. So we were two deals going on, one with Apollo, one with Guggenheim. And we raised our concerns. We actually sat down with them. We were ultimately able to do deals, which was good. We're not sort of preventing deals from happening. But we put in very robust safeguards, including a big, big reserve cushion just devoted to the annuities products so that we'd have a lot of comfort that there would be money there for the retirees someday when they wanted these annuities. But it's something we're continuing to watch closely, especially in a low interest rate environment like we have. The annuities companies are under enormous pressure and they're being bought up by private equity firms that want the premium stream. So we'll continue to watch it. I think what we'll end up doing is issuing a regulation that will govern these sorts of transactions, at least in New York. I hope it would be a model for other regulators. And that regulation will enshrine the kind of concessions we got when we approved the Guggenheim and Apollo deals. So that'll be our focus. Thank you. Thank you all very much. Have a great day. And thank you for the question. Please send us a note with all of the questions and thoughts. This was meant to be the middle of a conversation, not the end of it, so we can look forward to people as you have any thoughts. What else do we need to talk about and what we should be focused on? No, no. I resist going to the bathroom. We'll wait. We'll wait. We'll wait. We'll wait.