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Chapter 10 Regulation.docx

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FIN 800
Lorne Zeiler

FIN800 Ethics in Finance CHAPTER 10 Regulation INTRODUCTION  Two general claims of are defended: 1. Defective risk management practices were to blame for the spate of firm failures 2. Regulators with ample authority to constrain financial institutions from taking excessive risks did not do so  Blamed regulatory framework applicable to financial service industry rather than the performance of regulatory agencies THE REGULATORY FRAMEWORK  Three government agencies have primary responsibility for the safety and soundness of national chartered banks and thrifts: 1. Board of Governors of Federal Reserve System (Fed) 2. Office of Thrift Supervision (OTS) 3. Office of the Comptroller of the Currency (OCC)  Securities and Exchange Commission (SEC) responsible for financial integrity of broker-dealers and delineate enabling legislation and is bounded by the purposes and limitations specified therein or in subsequent legislation  Agencies have two means of bringing law to bear on FIs: regulation and supervision o Regulation includes issuance of regulations, rules, and guidelines and interpretations; supervision includes monitoring, assessing, and enforcing compliance with the rules and regulations  Assiduous supervision can compensate for ambiguous or incomplete regulations, but most comprehensive and explicit rules cannot make up for superficial oversight or feckless enforcement  From the point of view of most industry participants, there are two more oversights: state laws and commissions of banking securities, and regulatory schemes of other nations  Failures of banks and thrifts stemmed primarily from residential and commercial real estate, quintessentially traditional banking business ADEQUACY OF REGULATORY AUTHORITY  Objective is consistent with legislative mandate of agencies with responsibility of financial integrity of U.S. banks and broker-dealers  Regulatory agencies failed to use their authority to constrain risk-taking activities of some major banks and broker-dealers o Two lines of defence against hazards that can imperil FI: 1. Internal risk management systems and strategies 2. Agency supervision of that effect  The claim being made is that regulators failed to intervene in deficient risk management practices o Interpretation is based on beliefs that risks were identifiable, that the agencies had adequacy authority to constrain the, and that there were no impediment to its use  Despite inherent risk of underlying collateral debt obligations (CDO), the industry and regulators were lulled into false sense of security by triple-A ratings given to super-senior tranches of these securities o This comment warrants unpacking: 1. The industry was not lulled into a false sense of security by flawed credit ratings 2. Major banks were naive buyers of non-traditional mortgages; after all, they were sponsors of CDOs
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