Lessons Not Learned: 10 Steps to Stable Financial Markets

289 Pages·2015·4.594 MB·English

by  Susanne Trimbath

LESSONS NOT LEARNED LESSONS NOT
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10 Steps to Stable Financial Markets 0
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The purpose of this book is to demonstrate that the theoretical and intellectual S
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frameworks for regulating financial systems that had been available since at eS LEARNED
least 2001 could have prevented the systemic failure in the United States that p
led to the collapse of global credit markets in 2007-2009. Step by step the book sO

will guide you through what we can do right now and what could have been t
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done before 2008 or Dodd-Frank. The book concludes with a key idea for

how to make your financial services business stand out from the crowd and be S
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successful in the coming decades. t
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The list of 10 Steps is quite straight-forward and simple. bN
• Have private, independent rating agencies. l
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• Provide some government safety net but not so much that banks are not O

held accountable (“Too Big to Fail”) F
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• Allow very little government ownership and control of national financial
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assets. a
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• Allow banks to reduce the volatility of returns by offering a wide-range of n
services. cE
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• Require financial market players to register and be authorized. a
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• Provide information, including setting standards, to enhance market l

transparency. MR
• Routinely examine financial institutions to ensure that the regulatory code a
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is obeyed. r
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• Enforce the code and discipline transgressors.
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• Develop policies that keep the regulatory code up to date.
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• Encourage the creation of specialized financial institutions. s

For each step the reader will find:
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Legislative/regulatory background on the existing rules plus what academic u
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work is available on the theory. a
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The facts and data showing where it was not implemented/enforced in the US n
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(with examples of countries that did get it right), where applicable.

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The facts and data supporting the connection between this step and the events r
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of 2008.
10 Steps to Stable
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ISBN 9781910151235
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Spiramus Press Ltd 90000 >
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102 Blandford Street h Financial Markets

London W1U 8AG
United Kingdom
Tel: [phone]
Susanne Trimbath
9 781910 151235
Email: [email protected]
UK£24.95/US$39.95
LESSONS
NOT
LEARNED
10 Steps to Stable Financial Markets

Dr.Susanne Trimbath
Published October 2015 by
Spiramus Press Ltd
102 Blandford Street
London W1U 8AG
United Kingdom
www.spiramus.com
© Spiramus Press Ltd

Paperback ISBN 9781910151255
Hardback ISBN 9781910151242
Ebook ISBN 9781910151259

The right of the Susanne Trimbath to be identified as the author of this
work has been asserted by her in accordance with the Copyright, Designs
and Patents Act, 1988.
All rights reserved. No part of this publication may be reproduced in any
material form (including photocopying or storing it in any medium by
electronic means and whether or not transiently or incidental to some other
use of this publication) without the prior written permission of the
copyright owner except in accordance with the provisions of the
Copyright, Designs and Patents Act 1988 or under the terms of a licence
issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road,
London W1P 4LP.

Printed and bound in Great Britain by
Grosvenor Group (Print Services) Ltd
Acknowledgements
I started writing about the 2008 financial crisis at the insistence of my editor
at NewGeography.com, Joel Kotkin. Joel’s patient editing of my articles
over the years has made me a better writer. Some of the material in this
book is drawn from the research I did for those online articles. Other
material comes from research reports completed for private clients on the
shortcomings in the operations of stock and bond markets, where I worked
in post-trade processing beginning in the late 1980s. In a sense, this book is
the culmination of 30 years of industry experience and 15 years of
professional economic research.
With every career accomplishment in the field of finance and economics, I
must thank those who inspired my professional life. Joseph Fuhrig (1947-
2003) believed I could do things that I did not even know were things. John
Judd and Roman Frydman were instrumental and supportive in my
development as an economist. Hilton Root and Glen Whitman encouraged
me to keep trying in the face of discouraging comments from reviewers
who found my research contradictory to their own results.
I am grateful to those who read early drafts and provided helpful
comments and criticisms, including Bonnie Brown, Al Hodges, Jerry
Applebaum, C. Austin Burrell and especially PJ Buchanan who gave me
the idea of organizing the list into 10 lessons (‘people like lists to have 10
things’). Rose Kaufman inspires me every day to remain involved in
political life even when the issues seem intractable.
A special thank you to Carl Upsall at Spiramus Press for understanding my
trials and tribulations with technology during the production process.
About the author
Susanne Trimbath holds a Ph.D. in Economics from New York University
and received her MBA in Management from Golden Gate University. Prior
to forming STP Advisory Services, Dr. Trimbath was Senior Research
Economist in Capital Studies at Milken Institute (Santa Monica, CA) and
Senior Adviser on the Russian Capital Markets Project (USAID-funded)
with KPMG in Moscow and St. Petersburg. She previously served as a
manager in operations at Depository Trust Company in New York and the
Pacific Clearing Corporation in San Francisco; she started her career in
financial services operations at the Federal Reserve Bank of San Francisco.
Since 1989, Dr. Trimbath has taught economics and finance in university
graduate and undergraduate programs as adjunct, associate and full-time
professor. In 2009, she was certified to teach in the distance-learning
environment by both Bellevue University (Nebraska) and University of
Liverpool (UK, by Laureate International, Amsterdam). Dr. Trimbath
helped create the Transportation Performance Index for the U.S. Chamber
of Commerce (Washington, D.C.) which she used to demonstrate the real
economic payoff of investments in infrastructure.
Dr. Trimbath authored, edited and contributed chapters to five books,
including Mergers and Efficiency (2002), Beyond Junk Bonds (2003), and
Methodological Issues in Accounting Research (2006). Her media credits
include appearances on national television and radio programs (CNBC’s
Power Lunch and NPR’s Marketplace) and the Emmy® Award-nominated
Bloomberg report Phantom Shares. She appeared in several documentaries
on capital market corruption and the financial crisis including Radio Wars:
The Secret History of Sirius-XM Satellite Radio (2012), nominated for Best
Documentary by the New York City International Film Festival. Dr.
Trimbath’s articles appear in the national publications US Banker, The
International Economy, and The American Enterprise in addition to academic,
peer-reviewed journals. Dr. Trimbath is a contributing editor at
NewGeography.com.
Contents
Acknowledgements ............................................................................................. iii
About the author ................................................................................................. iv
Contents ............................................................................................................... v
Abbreviations ..................................................................................................... viii
Tables of authorities ............................................................................................ xi
Foreword .......................................................................................................... xiii
Introduction ........................................................................................................ 1
1. Updated Regulations ................................................................................... 9
1.1. Lesson ....................................................................................................... 9
1.2. Purpose ................................................................................................... 10
1.3. Theory ..................................................................................................... 16
1.4. Practice ................................................................................................... 22
1.5. Connection .............................................................................................. 31
1.6. Conclusion .............................................................................................. 37
2. Registration and Authorisation .................................................................. 41
2.1. Lesson ..................................................................................................... 41
2.2. Purpose ................................................................................................... 41
2.3. Theory ..................................................................................................... 43
2.4. Practice ................................................................................................... 44
2.5. Connection .............................................................................................. 48
2.6. Conclusion .............................................................................................. 57
3. Surveillance and Examinations .................................................................. 61
3.1. Lesson ..................................................................................................... 61
3.2. Purpose ................................................................................................... 62
3.3. Theory ..................................................................................................... 63
3.4. Practice ................................................................................................... 69
3.5. Connection .............................................................................................. 73
3.6. Conclusion .............................................................................................. 74
4. Allowable Diversification ........................................................................... 79
4.1. Lesson ..................................................................................................... 79
4.2. Purpose ................................................................................................... 79
4.3. Theory ..................................................................................................... 80
4.4. Practice ................................................................................................... 82
4.5. Connection .............................................................................................. 83
4.6. Conclusion .............................................................................................. 89
5. Independent Monitors ............................................................................... 93
5.1. Lesson ..................................................................................................... 93
5.2. Purpose ................................................................................................... 93
5.3. Theory ..................................................................................................... 93
5.4. Practice ................................................................................................... 96
5.5. Connection ............................................................................................ 100
5.6. Conclusion ............................................................................................ 103

LESSONS NOT LEARNED v
CONTENTS
6. Information and Standards ......................................................................107
6.1. Lesson ................................................................................................... 107
6.2. Purpose ................................................................................................ 107
6.3. Theory .................................................................................................. 110
6.4. Practice ................................................................................................. 115
6.5. Connection ........................................................................................... 119
6.6. Conclusion ............................................................................................ 122
7. Enforcement and Discipline......................................................................125
7.1. Lesson ................................................................................................... 125
7.2. Purpose ................................................................................................ 125
7.3. Theory .................................................................................................. 127
7.4. Practice ................................................................................................. 137
7.5. Connection ........................................................................................... 142
7.6. Conclusion ............................................................................................ 146
8. Safety with Accountability .......................................................................150
8.1. Lesson ................................................................................................... 150
8.2. Purpose ................................................................................................ 150
8.3. Theory .................................................................................................. 151
8.4. Practice ................................................................................................. 156
8.5. Connection ........................................................................................... 160
8.6. Conclusion ............................................................................................ 163
9. Private Ownership ...................................................................................166
9.1. Lesson ................................................................................................... 166
9.2. Purpose ................................................................................................ 167
9.3. Theory .................................................................................................. 167
9.4. Practice ................................................................................................. 170
9.5. Connection ........................................................................................... 171
9.6. Conclusion ............................................................................................ 172
10. Specialization .......................................................................................175
10.1. Lesson ............................................................................................... 175
10.2. Purpose ............................................................................................ 176
10.3. Theory .............................................................................................. 176
10.4. Practice ............................................................................................. 181
10.5. Connection ....................................................................................... 184
10.6. Conclusion ........................................................................................ 188
11. Conclusion ............................................................................................193
11.1. Finance is Everywhere ...................................................................... 193
11.2. No single cause, no single solution .................................................. 195
11.3. Moving Beyond Finance and Economics .......................................... 198
11.4. Where We Are Now ......................................................................... 198
11.5. Where we could be .......................................................................... 204
11.6. Epilogue to Individual Investors ....................................................... 205

vi LESSONS NOT LEARNED
CONTENTS
Appendices ...................................................................................................... 207
Appendix 1: Note on the Mathematics of Derivatives ..................................... 209
Appendix 2: SROs, Born of the Paperwork Crisis .............................................. 213
Appendix 3: Structured Finance ....................................................................... 216
Appendix 4: Who Regulates Banks ................................................................... 220
Appendix 5: DFA Cross-Reference and Implementation Trackers .................... 221
Appendix 6: A Collection of Lessons ................................................................. 233
References....................................................................................................... 243
Index ............................................................................................................... 256

LESSONS NOT LEARNED vii
Abbreviations
A&V Acemoglu and Verdier (2000)
AIG American International Group, Inc.
ARM Adjustable Rate Mortgage
ASV Avrham, Selvaggi and Vichery (2012)
ATM Automated Teller Machine
BCL Barth, Caprio and Levine (2001a)
BHCA Bank Holding Company Act of 1956
BIS Bank for International Settlements
CalPERS California Public Employees' Retirement System
CBOE Chicago Board Options Exchange
CDO Collateralized Debt Obligation
CDS Credit Default Swap
CEO Chief Executive Officer
CFPB Consumer Financial Protection Bureau
CFTC Commodities Futures Trading Commission
CLO Collateralized Loan Obligation
CMO Collateralize Mortgage Obligation
CPP Capital Purchase Program
DFA Dodd-Frank Act (The Wall Street Reform and Consumer
Protection Act)
DFI Deposit Insurance Fund
DTC Depository Trust Company
DTCC Depository Trust and Clearing Corporation
ECAI External Credit Assessment Institution (European Union)
ERISA Employee Retirement Income Security Act of 1974
EU European Union
FCIC Financial Crisis Inquiry Commission
FCM Futures Commission Merchant
FDIC Federal Deposit Insurance Corporation
FIPS Fixed Income Pricing System
FOIA Freedom of Information Act
FRB Federal Reserve Board of Governors
FRB-NY Federal Reserve Bank of New York
LESSONS NOT LEARNED viii
ABBREVIATIONS
FSOC Financial Stability Oversight Council
FTD Fail to Deliver
G8 Group of Eight Industrialized Nations
GAO Government Accountability Office
GDP Gross Domestic Product
GLBA Gramm-Leach Bliley Act of 1999
GNMAE Government National Mortgage Association or Ginnie Mae
IMF International Monetary Fund
ISCC International Securities Clearing Corporation
LIBOR London Interbank Offered Rate
MBS Mortgage-Backed Security
MERS Mortgage Electronic Registration Systems, Inc.
MSRB Municipal Securities Rulemaking Board
MTTB Moore, Tetlock, Tanlu and Bazerman (2006)
NAACP National Association for the Advancement of Colored
People
NASD National Association of Securities Dealers
NASDAQ NASD (National Association of Securities Dealers) Stock
Market
NFA National Futures Association
NRSRO Nationally Recognized Statistical Rating Organization
NSCC National Securities Clearing Corporation
NSS Naked short sale
NYSE New York Stock Exchange
OCC Office of the Comptroller of the Currency
OECD Organization for Economic Co-operation and Development
OPEC Organization of Petroleum Exporting Countries
PwC PricewaterhouseCoopers LLP
QIB Qualified Institutional Buyer
REMIC Real Estate Mortgage Investment Conduit
RRA Revenue Reconciliation Act
S&L Savings and Loan
SEC Securities and Exchange Commission
SEC-OCIE Securities and Exchange Commission’s Office of Compliance
Inspections and Examinations
LESSONS NOT LEARNED ix