Size Matters: Commercial Banks and the Capital Markets

The conventional story is that the Gramm-Leach-Bliley Act broke down the Glass-Steagall Act’s wall separating commercial and investment banking in 1999, increasing risky business activities by commercial banks and precipitating the 2007 financial crisis. But the conventional story is only one-half complete. What it omits is the effect of change in commercial bank regulation on financial firms other than the commercial banks. After all, it was the failure of Lehman Brothers — an investment bank, not a commercial bank — that sparked the meltdown. This Article provides the rest of the story. The basic premise is straightforward: By 1999, the Glass-Steagall Act’s original purpose — to protect commercial banks from the capital markets — had reversed. Instead, its main function had become protecting the capital markets from new competition by commercial banks. Once the wall came down, commercial banks gained a sizeable share of the investment banking business. To offset lost revenues, investment banks pursued riskier businesses, growing their principal investments and increasing the amounts they borrowed to finance them. In effect, they assumed the features of commercial banks — a reliance on short-term borrowing to finance longer-term (and riskier) investments. For the investment banks, combining the two was lethal and eventually triggered the financial meltdown. The divide between two sets of regulators, those regulating commercial banks and those regulating investment banks, enabled the change. The need for greater regulatory coordination has grown with convergence in the financial markets. Although new regulation has addressed some of the concern, the gap between regulators continues today — raising the risk of repeating mistakes from the past. Acknowledging the role of bank regulation (and de-regulation) in reshaping the capital markets is a key step in the right direction

Moving foward by doing analysis

In this article, I address some of the issues for the analysis of categorial features of talk and texts raised by Stokoe’s ‘Moving forward with membership categorization analysis: Methods for systematic analysis’. I begin by discussing a number of points raised by Stokoe, relating to previous conversation analytic work that has addressed categorial matters; the implicit distinction in her article between ‘natural’ and ‘contrived’ data; and ambiguity with respect to the (possible) relevance of categories, in particular practices or utterances. I then discuss how my own previous work could be located in light of Stokoe’s discussion of debates and divergences between conversation analysis (CA) and membership categorization analysis (MCA), and argue that being bound by the integrity of the data on which an analysis is based (Schegloff, 2005) should take precedence over attempting to characterize the analysis as exemplifying either a CA- or MCA-based approach. I conclude by calling for a commitment to doing analysis, and pointing to the value of the resources Stokoe offers in this regard

Sandbagging: Default Rules and Acquisition Agreements

In the M&A world, a buyer sandbags a seller when, knowing the seller has materially breached a warranty, it closes the deal and then asserts a post-closing claim. Traditionally, the buyer must have relied on the warranty, without knowledge of the breach, in order to prevail. The modern trend, with some exceptions, permits the buyer to sue without regard to knowledge. Parties, in both cases, can contract around the default rule--so that the default rule should affect how acquisition agreements are structured. Yet, a survey of publicly available deals, from July 2007 to June 2011, reveals that--regardless of default rule--roughly forty-five to fifty-five percent of contracts contain a pro-sandbagging provision,and roughly forty to fifty percent are silent. Why the similarity in contract provisions? First, the law around sandbagging is unsettled Buyers who particularly value a sandbagging right may develop standard solutions, relying on the certainty of express contractual language rather than the default rule. Second, under a pro-sandbagging standard, sellers have limited incentive to request an anti-sandbagging provision and buyers have limited incentive to agree to it. The compromise is often silence--with the right to sandbag set by the default rule rather than agreement. Thus, the claim that a buyer\u27s \u27purchase of warranties includes a sandbagging right, often used to justify a pro-sandbagging default rule, is open to question. In neither case does a pro-sandbagging default rule reflect a buyer\u27s interest in sandbagging. Rather, bargaining is more likely under an anti-sandbagging default rule, in which case those who particularly value a sandbagging right must expressly negotiate for it

Destructive Coordination

An important goal of financial risk regulation is promoting coordination. Law\u27s coordinating function minimizes costly conflict and encourages greater uniformity among market participants. Likewise, privately developed market standards, such as standard-form contracts and rules incorporated into widely-used vendor technology systems, help to lower transaction costs partly by increasing coordination. By contrast, much of financial economics is premised on a world without coordination. Basic tools used to manage financial risk presume that changes in asset prices follow a random walk and individuals buy and sell assets independently. Thus, a bedrock premise of traditional risk management is that a portfolio manager’s actions affect neither the marketplace nor the trading decisions of others. The result is a paradox: regulations and standards that benefit financial firms and markets can also impose unintended and significant costs - what I label “destructive coordination” - by inducing portfolio managers to act in unison and, in turn, affecting asset prices and eroding the core presumptions underlying much of financial risk management. Greater uniformity can increase the magnitude of a drop in the financial markets, a result that can have systemic effects. Going forward, coordination’s benefits must be weighed against its costs, which are often less well understood. Expanding the scope of regulation beyond individual firms - taking into account the collective impact of coordination on the financial markets and the expectation of market participants - can help fill gaps in today’s regulatory framework. Financial regulators must also consider the role of market standards in promoting coordination, as individual firms are unlikely to have sufficient incentives (or information) to police them themselves

Sandbagging: Default Rules and Acquisition Agreements

In the M&A world, a buyer sandbags a seller when, knowing the seller has materially breached a warranty, it closes the deal and then asserts a post-closing claim. Traditionally, the buyer must have relied on the warranty, without knowledge of the breach, in order to prevail. The modern trend, with some exceptions, permits the buyer to sue without regard to knowledge. Parties, in both cases, can contract around the default rule--so that the default rule should affect how acquisition agreements are structured. Yet, a survey of publicly available deals, from July 2007 to June 2011, reveals that--regardless of default rule--roughly forty-five to fifty-five percent of contracts contain a pro-sandbagging provision,and roughly forty to fifty percent are silent. Why the similarity in contract provisions? First, the law around sandbagging is unsettled Buyers who particularly value a sandbagging right may develop standard solutions, relying on the certainty of express contractual language rather than the default rule. Second, under a pro-sandbagging standard, sellers have limited incentive to request an anti-sandbagging provision and buyers have limited incentive to agree to it. The compromise is often silence--with the right to sandbag set by the default rule rather than agreement. Thus, the claim that a buyer\u27s \u27purchase of warranties includes a sandbagging right, often used to justify a pro-sandbagging default rule, is open to question. In neither case does a pro-sandbagging default rule reflect a buyer\u27s interest in sandbagging. Rather, bargaining is more likely under an anti-sandbagging default rule, in which case those who particularly value a sandbagging right must expressly negotiate for it

Reframing Financial Regulation

Financial regulation today is largely framed by traditional business categories. The financial markets, however, have begun to bypass those categories, principally over the last thirty years. Chief among the changes has been convergence in the products and services offered by traditional intermediaries and new market entrants, as well as a shift in capital-raising and risk-bearing from traditional intermediation to the capital markets. The result has been the reintroduction of old problems addressed by (but now beyond the reach of) current regulation, and the rise of new problems that reflect change in how capital and financial risk can now be managed and transferred. In this Article, I begin to assess the current U.S. approach to financial regulation, in light of recent changes in the financial system, and offer a tentative way forward to address gaps in proposals for regulatory reform. Regulators must focus on the principal problems that financial regulation is intended to address – relating to financial stability and risk-taking – without regard to fixed categories, intermediaries, business models, or functions. Doing so, however, requires a prospective assessment of the markets, a different approach from the reactive process that characterizes much of financial regulation today