In our view, the CHOICE Act correctly views stronger capital requirements as a substitute for other forms of regulation. Indeed, all three recent efforts would dial back one of the three Dodd-Frank levers: the regulation of scope. As indicated, the CHOICE Act, the recent sequence of US Treasury reports on financial regulation, and the enacted EGRRCP Act aim to reduce the burden of financial regulation. With respect to such regulation, the regulator can pull on one or more of three levers: capital (i.e., equity funding) requirements liquidity requirements and regulation of scope (such as restrictions on activities or asset holdings).ĭodd-Frank employs all three of these levers. This negative externality suggests the need for prudential regulation. A financial firm might rationally have high leverage or engage in risk-taking activities that are optimal on an individual basis but that-aggregated with all other financial firms-lead either to too much leverage or to greater risk emanating from the financial sector. It follows, therefore, that the systemic risk of individual firms relates to how these firms contribute to this aggregate capital shortfall. When investors or depositors question the extent to which a class of financial institutions or the financial system as a whole can absorb losses, access to short-term funding and liquidity dries up, which prevents even solvent institutions from taking over the financial intermediation activities of failed firms. Systemic risk arises when there is a breakdown in aggregate financial intermediation, which in turn results from aggregate capital shortfalls and liquidity shortfalls in the financial system. Not unlike the aforementioned Annual Review of Financial Economics piece, the current article summarizes our main findings on the possible deregulation of Wall Street. That 2017 NYU faculty book, Regulating Wall Street: CHOICE Act Versus Dodd-Frank, provides a topic-by-topic analysis of Dodd-Frank and the CHOICE Act’s two approaches to regulation. 2155)-enacted May 24, 2018-embodies some of the ideas from the CHOICE Act. Indeed, the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCP Act, S. While the CHOICE Act did not become law, it represents one possible approach to repealing parts of Dodd-Frank and streamlining regulation, and it continues to represent an important strain of thought on these topics. Given the passage of time, and with the change in power in Washington, DC, the NYU faculty in 2017 reinvestigated Dodd-Frank and for illustrative purposes compared it to legislation, the Financial CHOICE Act, passed by the US House of Representatives. Drawing on this book, in a 2012 piece in the Annual Review of Financial Economics, Acharya & Richardson offered an economic assessment of Dodd-Frank in terms of the likely efficacy of the proposed financial sector regulation, with some emphasis on the act’s unintended consequences. In the United States, this recognition led to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.įaculty at the NYU Stern School of Business and the NYU School of Law provided a detailed analysis of the strengths and weaknesses of Dodd-Frank in Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance (2011). The existing regulatory framework was wholly unsuited to dealing with systemic risk: the widespread failure of financial institutions and freeze-up of capital markets that impair financial intermediation. In the aftermath of this disaster, governments and regulators cast about for ways to prevent-or render less likely-its recurrence. In this period of extraordinary financial strain, the economy and financial markets tumbled in the United States, Europe, and elsewhere. Such disruptions became particularly intense in the fall and winter of 2008–2009, following the collapse (or near collapse) of some of the largest financial institutions. When a large part of the financial sector is funded with fragile, short-term debt and is hit by a common shock to its long-term assets, there can be en masse failures of financial firms and disruption of intermediation to households and firms.
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