Regulatory Structure in Futures Markets: Jurisdictional Competition Among the SEC, the CFTC, and Other Agencies

This paper studies competition among alternative regulatory bodies for authority over innovative financial contracts. In the United States, this rivalry embraces not only the Commodity Futures Trading Commission and the Securities and Exchange Commission, but state and federal deposit-institution regulators and various private regulatory cooperatives. From a political perspective, multipleregulators develop as a way of formally providing ongoing protection for the interests of diverse political constituencies. But from an economic perspective,competition resulting from overlaps in regulatory responsibility establishes an evolutionary mechanism for adapting regulatory structures to technological and regulation-induced innovation. Using both perspectives, this paper explains how interaction between governmental regulatory agencies and self-regulatory cooperatives produces more-efficient regulatory structures over time.The study also seeks to catalog the particular costs and benefits that may be associated with the regulatory tools used to control futures and securities markets(e.g., broker and trader registration, disclosure requirements, margin requirements,and contract-approval processes) and with changes in the distribution of jurisdiction over these tools. The analysis seeks to clarify the tradeoff between the perceived probability of various problems of market performance (e.g., contract nonperformance, widespread financial instability, and activities such as price manipulation by which corrupt or sophisticated operators separate naive investors from their wealth) and the implicit and explicit cost of reducing this probability.

Nested Tests of Alternative Term-Structure Theories

Controversies in term-structure theory center around the existence and variability of term premia in securities yields. In this paper, the term premium on a default-free n-period bond is defined as the difference between its observable yield to maturity and the average expected per-annum rate of return on an n-period strip of rollover investments in one-period bonds. To test alternative term-structure theories without introducing ex post proxies for expectational variables, this paper uses a set of cross-section interest-rate forecasts collected jointly with Burton Malkiel of Princeton University from a population of large institutional lenders at four different phases of a single interest-rate cycle. Statistical tests strongly confirm the existence of nonzero term premia at each survey date, thereby rejecting the pure-expectations theory of the term structure. Additional tests are unable to reject restrictions implied by the liquidity-premium hypothesis that term premia should be positive and increase with maturity. Finally, contrary to the martingale hypothesis, ex ante term-premium data vary significantly overtime and show a positive association with the level of interest rates.

Stopping Information Asymmetries in Government from Promoting Risk Shifting by Banks

Bank managers are said to shift risks when the downside of the profit opportunities that the bank pursues is absorbed in nontransparent fashion by the bank's creditors and guarantors. Risk shifting is facilitated by information asymmetries that tempt government officials to show creditors and taxpayers about how effectively government bureaus are controlling bank risk. The growing sophistication of financial products and financial institutions' net risk-taking positions demands a regulatory regime that—like Pinocchio's nose—can create and enforce incentives for transparency and truth-telling about the nature and value of taxpayers' implicit stake in regulated financial institutions. This paper was presented at the Financial Institutions Center's October 1996 conference on "

Deregulation, Savings and Loan Diversification, and the Flow of Housing Finance

This paper assesses the probable impact on S&Ls' profitability and participation in mortgage markets of The Depository Institutions Deregulation and Monetary Control Act of 1980. It tracks inflation-induced secular declines in the value of S&L mortgage holdings between 1965 and 1979 and argues(contrary to conventional wisdom) that deposit-rate ceilings proved no more than a minor and temporary source of help to S&Ls. Analysis presented shows that Federal Savings and Loan Insurance Corporation guarantees, not deposit-rate ceilings, kept the industry afloat in recent years. Further analysis centers on federal and state restrictions on S&L loan opportunities and on mortgage lenders' ability to design and to price mortgage instruments for an environment marked by accelerating inflation and increasing inflation uncertainty. Since S&Ls were free to raise whatever amount of funds they wished through large certificates of deposit, restrictions on S&L lending opportunities had to lie responsible for the much-publicized bouts of disintermediation these institutions suffered near post-1965 business-cycle peaks.

Charles Kindleberger

Minimalist economists stubbornly resist Charles Kindleberger's characterization of investor expectations in a financial bubble as "irrational." This paper seeks to resolve the controversy by imbedding Kindleberger's well-researched, impressionistic theory of financial crises into an expanded, but still-minimalist model of rational expectations. Introducing the concepts of malicious disinformation and rational overpromotion creates an informational environment in which it is time-consuming and costly to distinguish fact from fiction. Rationality still requires that expectations and market fundamentals move together over long periods of time, but dishonorable overpromoters can earn substantial profits in the interim.

Accelerating Inflation and the Distribution of Household Savings Incentives

This study describes how accelerating inflation has led households indifferent economic and demographic classes to reallocate their "transactable savings." Cross-section data from the 1962 and 1970 Surveys of Consumer Finances are used to estimate both the composition of accumulated households having and prospective rates of return on this saving. The paper shows that accelerating inflation has, in thee presence of comprehensive ceilings on deposit interest rates, altered the savings incentives of different types of households. The effect has been to bias small savers toward leveraged investments in tangible assets (especially real estate) and large savers toward certificates of deposit and marketable bonds. Small savers with disadvantaged access to credit are simply victimized. Our analysis helps to explain a number of anomalous features of the 1975-1979 macroeconomic recovery, particularly the dominant role of consumer spending, the unprecedented expansion of household debt, the boom in housing, and declining flows of household savings into deposit institutions. These data underscore the unintended consequences of trying to reconcile deposit-rate. ceilings with accelerating inflation. This combination of policies unpleasantly distorts the sectoral composition of spending and risk-bearing (crowding out some productive business investment) and aggravates inequities in the distribution of income and opportunity.

Change and Progress in Contemporary Mortgage Markets

Changes in political attitudes toward subsidizing mortgage loans and in technologies for transacting mortgage loans and for pooling and refinancing individual mortgage contracts threaten to remake the face of U.S. mortgage markets. This paper focuses on economic-efficiency benefits embodied in narrowed interest-rate spreads and on distributional effects for different market participants created by three categories of change: changing strategies for controlling implicit federal guarantees; continuing evolution in the character of mortgage-backed securities; and expanding electronic mortgage-application networks. It proves instructive to classify these effects further according to whether they are transitional or permanent in nature and whether they are technologically driven or filtered through the political process.The analysis emphasizes that technological change is reducing the controllability of aggregate subsidies associated with long standing patterns of providing implicit and explicit federal guarantees for the liabilities of important mortgage-market participants and discusses several proposals for bringing the market value of these guarantees back under administrative control.

Who Should Learn What From the Failure and Delayed Bailout of the ODGF?

In March 1985, the failure of the Ohio Deposit Guarantee Fund (the ODGF) sent shock waves reverberating through the financial world. This episode is popularly interpreted as evidence of the dangers of both private deposit insurance and continuing financial deregulation. This paper argues that policies of financial deregulation played little role in the ODGF insolvency. The failure of the ODGF was instead a failure of government regulation, rooted in inadequacies in the OGDF information and enforcement systems. The ODGF may be conceived as the Federal Savings and Loan Insurance Corporation writ small. Both agencies share many of the same structural imbalances: large unresolved losses, explicitly mispriced and underreserved services, inadequate information and monitoring systems, insufficient disciplinary powers, and a susceptibility to political pressures to forbear. Doctors perform autopsies on dead patients to improve their ability to protect living ones. This paper's autopsy of the institutional corpse of the ODGF focuses on identifying the kinds of disturbances that transform structural imbalances into a full-fledged crisis. Our research underscores the way that deceptive accounting and underfinanced insurance funds contain crisis pressures in the short run by setting the stage for more severe problems down the line. As financial markets approach more and more closely the perfect and complete markets beloved by finance theorists, the amount of time that can be bought by policies that merely defer crisis pressures is shrinking and becoming hard to use productively.

Inadequacy of Nation-Based and VaR-Based Safety Nets in the European Union

Considered as a social contract, a financial safety net imposes duties and confers rights on different sectors of the economy. Within a nation, elements of incompleteness inherent in this contract generate principal-agent conflicts that are mitigated by formal agreements, norms, laws, and the principle of democratic accountability. Across nations, additional gaps emerge that are hard to bridge. This paper shows that nationalistic biases and leeway in principles used to measure value-at-risk and bank capital make it unlikely that the crisis-prevention and crisis-resolution schemes incorporated in Basel II and EU Directives could allocate losses imbedded in troubled institutions efficiently or fairly across member nations.

Capital Movements, Banking Insolvency, and Silent Runs in the Asian Financial Crisis

This paper supplies an agency-cost and contestable-markets perspective on the financial policies that triggered the Asian financial crisis. The agency-cost analysis hypothesizes that individual-country regulators knew that politically directed loans had made their banks insolvent, but purposefully gambled that deregulation could allow the insolvent banks to grow their way out of trouble. The contestable-markets paradigm sets this gamble in the context of offshore innovations in financial technology and regulatory systems that made it progressively easier for worried Asian citizens to move funds to foreign institutions. These perspectives portray the simultaneous breakdown of repressive financial systems as a technology-led victory of market forces over longstanding government efforts to wall out foreign financial competition.