Preventing the Fire Next Time: Too Big to Fail

H. Rodgin Cohen
90 Texas L. Rev. 1717

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In Preventing the Fire Next Time: Too Big To Fail, H. Rodgin Cohen, Senior Chairman of Sullivan & Cromwell LLP, New York, New York, argues that “the financial crisis of 2007-2009 threatened the very fabric of the financial system.” Cohen argues that while the great financial crisis requires a regulatory response, such a response “requires thoughtful and comprehensive analysis as opposed to simplistic answers.” Moreover, Cohen points out that any response will impact not only the banking system, but also the overall economy.

Governments as Shadow Banks: The Looming Threat to Financial Stability

Viral V. Acharya
90 Texas L. Rev. 1745

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Governments often have short-term horizons and are focused excessively on the level of current economic activity, disregarding whether financial-sector regulation designed to achieve it leads to long-term instability. Their short-term objective can be well served through policies governing competition and risk taking in the financial sector. By allowing excessive competition, providing downside guarantees, and encouraging risky lending for populist schemes, governments can create periods of intense economic activity fueled by credit booms. This way, governments effectively operate as “shadow banks” in the financial sector, a moral hazard that can have even more adverse consequences than risk-taking incentives of the financial sector. This government role appears to have been at the center of recent boom and bust cycles, especially in the housing sector in the United States through the presence of government-sponsored enterprises (Fannie Mae and Freddie Mac), and continues to pose a threat to financial stability.

Do Labrynthine Legal Limits on Leverage Lessen the Likelihood of Losses? An Analytical Framework

Andrew W. Lo & Thomas J. Brennan
90 Texas L. Rev. 1775

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A common theme in the regulation of financial institutions and transactions is leverage constraints. Although such constraints are implemented in various ways—from minimum net capital rules to margin requirements to credit limits—the basic motivation is the same: to limit the potential losses of certain counterparties. However, the emergence of dynamic trading strategies, derivative securities, and other financial innovations poses new challenges to these constraints. We propose a simple analytical framework for specifying leverage constraints that addresses this challenge by explicitly linking the likelihood of financial loss to the behavior of the financial entity under supervision and prevailing market conditions. An immediate implication of this framework is that not all leverage is created equal, and any fixed numerical limit can lead to dramatically different loss probabilities over time and across assets and investment styles. This framework can also be used to investigate the macroprudential policy implications of microprudential regulations through the general-equilibrium impact of leverage constraints on market parameters such as volatility and tail probabilities.

The Emperor Has No Clothes: Confronting the D.C. Circuit’s Usurpation of SEC Rulemaking Authority

James D. Cox & Benjamin J.C. Baucom
90 Texas L. Rev. 1811

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In The Emperor Has No Clothes: Confronting the D.C. Circuit’s Usurpation of SEC Rulemaking Authority, Professor James D. Cox of Duke University School of Law & Benjamin J.C. Baucom, recent law clerk to Justice Don R. Willett of the Supreme Court of Texas, argue “that the level of review invoked by the D.C. Circuit in Business Roundtable and its earlier decisions is dramatically inconsistent with the standard enacted by Congress.” They conclude “that the D.C. Circuit has assumed for itself a role opposed to the one Congress prescribed for courts reviewing SEC rules.”

What More Can Be Done to Deter Violations of the Federal Securities Laws?

David M. Becker
90 Texas L. Rev. 1849

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In What More Can Be Done to Deter Violations of the Federal Securities Laws?, David Becker of Cleary Gottlieb Steen & Hamilton LLP and former General Counsel and Senior Policy Director of the U.S SEC discusses recent criticism of the SEC that focuses “on the severity of sanctions the SEC obtains in its settlements with wrongdoers.”  Becker argues that “severity does not guarantee efficacy.”  Becker “suggests that there is probably little to be gained from increasing sanctions and that the SEC probably would be better served by focusing its efforts on increasing the likelihood that certain violations are punished and by redoubling its efforts to move more quickly.”