New York International Law Review Symposium St. John’s Law School, Jamaica, New York March 6, 2009 New World Order: Can a global economy continue to be.

New York InternationalLaw Review Symposium St. John’s Law School, Jamaica, New York

March 6, 2009

New World Order: Can a global economy continue to be regulated on a non-global basis?

Presented by: A. JOYCE FURFERO, PH.D, J.D.

Tobin College of BusinessSt. John’s [email protected]

718.990.7350

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Epithets

Ignorance

Carelessness

Apathy

Indifference

Mismanagement

Greed

Incompetence

The CULPRITS

SubprimeMortgages

Credit Default Swaps

CMORatings

Capital Adequacy

Requirements

FAS 157

No Capital Controls

Domestic Banks

FAS157

FNMA/FHLMC

Insurance Cos &

Pension Plans

Hedge Funds& Private

Financial Cos

Foreign Banks

Individuals

creditdefault swaps

CMOs

Commercial Banks

-------------------Investment

Banks

Mortgagesjumbo

subprimeAlt-A

CommercialBanks

MortgageBankers

FederalRegulatorsFR, FDIC,

OCC

StateBanking

Depts

SECState

InsuranceDepts

RatingAgencies

FASB

Insurance Cos

Financial Regulatory Scheme

bondinsurance

OriginatorsPackagersEnd UsersPublic regulatorsPrivate companiesFinancial instrumentsInsurance products

Investment Banks & Dealers

OFHEO

The HOLESMortgage Origination• unqualified borrowers• inadequate documentation• mismatch of borrower to mortgage instrument• unregulated securitization

Credit Ratings - improper AAA designations for CMOs

Credit Default Swaps - NO reserves

FAS 157 • Level 1, Level 2, Level 3 Assets• mark-to-market/mark-to-model

Capital Adequacy Requirements - too rigid enforcement

No Capital Controls - inflow/outflow of money/securities

Mortgage OriginationBad loans versus loans that go bad

A “no brainer” for banks: • Establish credible lending standards• Qualify borrowers• Demand documentation• Tailor mortgages to borrowers ability to repay

A “no brainer” for regulators:• Hire more bank examiners• Inspect loans with great scrutiny• Raise required performance standards• Verify quality of collateral• Demand 100% compliance or close down

A “no brainer” for Congress: Review/revise CRA

Credit RatingsReassess risk evaluation methods

• Diversification - How does it apply to pools of homogeneous assets like mortgage loans, auto loans, and credit card loans?

Reclassify derivatives, re: underlying asset

• Treated as securities rather than loans• Decouple look at underlying asset • Ask: can it be traded in the market - If yes, regulate it as a security (SEC) - If not, regulate it as a loan (FR, FDIC, OCC)

Credit Default SwapsCall a spade a spade• If it looks like a duck and it quacks like a duck, it must be a duck. • Reclassify CDSs as insurance --- establish reserve requirements --- enforce minimum reserve ratios

Establish clearinghouse to keep track of CDSs• public (FR)/private (NYACH)• domestic (FR, NYACH)/international (BIS)

FAS 157Problems• Artificially devalues assets • Forces unnecessary write-offs• Reduces shareholder wealth• Artificially reduces capital adequacy ratios

Solutions• Eliminate rigid enforcement of mark-to-market• Eliminate Level 1, Level 2, and Level 3 assets• Identify which assets can be marked to market and which cannot be marked to market • Eliminate mark-to-model • Require mark to-market ONLY when possible• Suspend minimum capital requirements

The 10 Largest U.S. Banksas of December 31, 2008

Bank Name Total Assets Net IncomeJPMorgan Chase Bank, NA $1,746,242,000 $10,419,000 Bank of America, NA $1,471,631,047 $5,894,592Citibank, NA $1,231,154,000 ($2,101,000)Wachovia Bank, NA $635,476,000 ($511,000)Wells Fargo Bank, NA $538,958,000 $3,636,000 Wells Fargo Bank, NA* $1,174,434,000 $3,125,000U.S. Bank NA $261,775,591 $3,356,107Bank of New York Mellon $195,164,000 $1,235,000 SunTrust Bank $185,098,787 $975,730HSBC Bank USA, NA $181,604,079 ($1,589,714)State Street Bank & Tr. Co. $171,227,778 $1,814,088National City Bank $146,057,789 ($318,912)

*As of January 1, Wachovia was merged into Wells Fargo.

Capital Adequacy Ratiosas of December 31, 2008

Bank Name Tier 1 Tier 2___ JPMorgan Chase Bank, NA 8.73 12.48Bank of America, NA 8.47 11.63Citibank, NA 9.94 15.18Wachovia Bank, NA 6.45 10.89Wells Fargo Bank, NA 7.26 10.79Wells Fargo Bank, NA* U.S. Bank NA 6.56 10.51Bank of New York Mellon 11.26 14.75SunTrust Bank 7.88 10.87HSBC Bank USA, NA 7.49 12.04 State Street Bank & Tr. Co. 19.76 21.28National City Bank 9.73 13.81Peer Group 10.58 12.54Required CA ratios 4.00 8.00

*As of January 1, Wachovia was merged into Wells Fargo.

International Money Flows

Problem• NO capital controls• International contagion• Unidirectional transmission:

U.S. ROW

Solutions• Global organization• Global agreement• Domestic containment• Alternative solution

Global Organization/Agreement

A Global Constitution???

• Detail powers of member countries• Achieve appropriate balance of powers -- between organization and member countries -- among member countries or -- otherwise, the countries will not comply • Tendency to cheat - self-interest • Needs common interest or effective enforcement mechanism to force compliance

ｷｷ European airline cartel ｷｷ OPEC

Problems of Global Organization/Cooperation

Sovereignty versus global cooperation• Paul Volker – Plaza Accord (G-5), Louvre Accord (G-7)• Effectiveness of the World Court? WTO? IMF? IBRD?• European Monetary Union• Beggar thy neighbor policies

Lack of 100% cooperation• Grand Cayman Islands• Switzerland

Participants are not countries or national banks • Private, publicly-owned shareholder corps• A U.S. corp’s first obligation is to its shareholders

– to maximize shareholder wealth

Co-ordinator? The U.S., again??? Wolf by sheep’s door!!!

Domestic Containment

Unidirectional transmission

• Much of the blame belongs to the U.S.

Back to basics - U.S. domestic regulation

• Mortgage origination and securitization • Credit ratings• Credit default swaps• FAS 157• Capital adequacy standards• Government-mandated capital controls ???

Alternative Solution

Insurance for deposits and other liabilities• Current deposit guarantees must be honored in full• Other assets should be classified into one of three categories (Level 1, Level 2, Level 3): ｷ Fully insure (100% of value) for a

10% premiumｷ Partially insure for 2/3 of valueｷ Partially insure for 1/3 of value

Anti-contagion prevention • Insurance facility for other countries

Conclusion

The global economy is probably

too large, too heterogeneous, too fluid, too self-interested, too nationalistic, too politically sovereign, and, currently, too fragile

for even the most sophisticated governments to cooperate effectively for any extended period of time.