NYU Alumni Magazine Spring 2008

White Paper Briefs

Here’s a peek at a few key recommendations:

  • Regulating individual banks is no longer enough to ensure the safety and soundness of today’s globally interlinked system of behemoth financial institutions. Authors argue that it’s time for what they call a special, dedicated regulator, under the auspices of the Federal Reserve, to constantly monitor the soundness of these behemoths. That new regulator should be able to continually measure risk system-wide and should not only gauge it with the single, most commonly used ratio of capital to risk-weighted assets, but a far more well-rounded approach that takes into account an institution’s loans to deposits, insured deposits to assets, liquid bonds to assets, etc.
  • Now that U.S. taxpayers are out $7 trillion in guarantees to financial firms, the public will demand that banks stop rewarding irresponsible behavior and short-term thinking with outsized salaries and bonuses. The book suggests long-term compensation contracts (rather than a salary cap, as President Obama announced in February) and other financial incentives to reward long-term thinking.
  • About one in 10 U.S. mortgages are delinquent or in foreclosure. To prevent this statistic from ballooning even further, the authors call for modifying more mortgages, but in a new and improved way—before foreclosure and bankruptcy sets in. The snag here is that about 80 percent of troubled home loans have been sliced and diced thanks to securitization. To untangle them, the laws that protect lenders from modification must be repealed. And lenders need better incentives to modify loans, such as in exchange for restructuring loan terms, they would receive a share of any future appreciation in the property’s value.
  • Another concern is the $50-trillion-plus over-the-counter derivatives market, where no one knows precisely what the exposure is, where the danger is concentrated, or the values of the contracts. For the most widely traded derivatives, the authors advocate a centralized clearinghouse—as there is now for futures and options—to impose volume and pricing transparency.
  • The United States has long guaranteed, implicitly, that it would rescue failing government-sponsored enterprises, such as Fannie Mae and Freddie Mac, as well as troubled banks. But these guarantees actually became part of the problem. The comfort level they created led to a low cost of borrowing and little “market discipline” to punish these institutions when they took on increasing risk. In the future, the authors oppose such “ill-designed and mispriced guarantees” for both private and quasi-public banking institutions.

  • For a complete list of the authors and to read from the white papers, go to http://whitepapers.stern.nyu.edu/home