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effects

Policy Changes

inherent

to

the

aforementioned

originate-to-distribute model

structural reforms, there is also an

of securitization. Originate-

overriding need for a renewed policy

to-distribute presents a slew

response to the problem of systemic

of incentive issues by allowing

risk, including measures to address the

originators to book fees up

core problems of too big to fail and the

front and then transfer the

originate-to-distribute model.

risks of their loans to third

In

addition

to

the

challenge

parties. This is made worse

establishing

by CDOs and CDO2s, which

adequate capital standards for financial

push credit risk further down

institutions. Capital standards, at the

the line. Because the original

most basic level, serve as a buffer against

issuers do not have to retain

losses during a crisis. There are also

the credit risk of the loans

some discussions about using capital

they sell, they have little incentive to

a new Financial Stability Oversight

standards to lessen the procyclicality of

monitor this risk in the first place. In

Council and extends federal regulation

the financial system and to discourage

the

to cover credit rating agencies. The

the formation of large, complex financial

services industry, with myriad firms

most

institutions. Regardless, it is clear that

fighting for market share by increasing

is an enhanced resolution authority,

reforms to Basel II must take place,

volume,

will

which could liquidate banks as they

as both Bear Stearns and Lehman

inevitably deteriorate over time, thus

near insolvency, thereby avoiding the

Brothers were well above the threshold

increasing systemic risk. Thus, it seems

messy

for a “well-capitalized” bank in the days

necessary—but likely not sufficient—to

esque

before they fell.

implement some form of risk retention

while unlikely to solve the enormous

To start, regulators will need to

policy, under which originators are

problems facing the financial industry,

precisely define what is to be counted

required to have some “skin in the

nevertheless represent a worthwhile

as

Arguably

facing

the

biggest

regulators

is

incredibly

competitive

lending

financial

standards

promising

proposal,

consequences collapse.

Lehmanmeasures,

capital

game.” Such a policy, in addition to

first

potential reforms to compensation policy

regulatory framework.

Tier 1 capital, Tier 1 capital, Tier 2

and accounting standards, could help to

capital, or potentially new forms yet to

mitigate the perverse incentives created

financial crisis was in many ways the

be defined. Then, it is clear that capital

by the originate-to-distribute model.

result of profound changes in financial

when

evaluating

in

a

These

requirements. This could include core

capital

step

of

however,

reforming

America’s

As previously discussed, the recent

markets over the past forty years, and

standards will be raised across the board, as existing standards are simply

How Congress Has Responded

thus our regulatory structure must also

not sufficient to absorb losses during

Senator Dodd’s recent proposal at least

respond to those same changes. Still, no

true financial crises. Finally, regulators

begins address many of the principles

one can possibly predict what financial

will have to decide whether and how to

outlined above. Of course, the bill was

innovations and legislative proposals

increase capital standards over the cycle

weakened considerably as it moved

will occur over the next decade—much

and for larger, systemically important

through

sausage

less the next forty years. As a result, the

banks. The devil is always in the details,

mill, but it still helps to fill certain

actual nature of financial regulation in

but it seems clear that some adjustments

gaps in the regulatory structure. The

the future really is unknown at this

to capital standards for larger institutions

bill calls for the establishment of

point. What is known, however, is that

and during boom times would help to

a

Protection

the current structure cannot and will

mitigate the too-big-to-fail problem and

Bureau, to be housed in the Federal

not remain. The 21st Century demands

shore up systemic stability.

Reserve, which will write much needed

a

consumer protection laws for mortgage

accountable system, and we owe it to

regulators to establish a regulatory

originators,

ourselves to at least begin to meet that

framework that controls the negative

and other lenders. It also establishes

Finally,

it

is

important

for

the

congressional

Consumer

Financial

credit

card

companies,

more

f lexible,

streamlined,

and

demand. iBR

i n t e r n at i o n a l bus i n ess r e v i e w

19

International Business Review - Spring 2010  

The Spring 2010 edition of the IBR.

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