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cryptoquicknews-blog · 6 years ago

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How Security Tokens Can Prevent an Impending Financial Crisis

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Many economists argue that the root causes of the 2008 global financial crisis have yet to be addressed comprehensively, or that measures taken have been exhausted, such as the extent to which quantitative easing was used, which has been put forward by the deputy director of the International Monetary Fund (IMF).

Some argue that the efforts to address the causes of the crisis have actually made the system more — rather than less — susceptible to a catastrophic collapse. On the heels of the recent yield curve inversion, finding new solutions that address the causes of the 2008 crisis are more important than ever. The yield curve inversion, an 18-month leading indicator of looming liquidity challenges, has proceeded every major recession since the 1970s, including the global financial crisis of 2008.

The time to pursue new approaches to mitigate liquidity events is now. An investigation of the systemic weaknesses that led to the crisis points to the promise of a new financial instrument that has entered the market — tokenized securities. The liquidity benefits of these instruments derived from the strengths of blockchain and distributed ledger technology suggest that a new approach is possible to aid in preventing and addressing a repeat (or worse) of the 2008 downturn.

While the driving forces that produced the toxic instruments that were at the center of crisis remain a fiercely debated issue, there is consensus on the structural weaknesses that led to the systemic spread of their collapse. Regarding the forces that produced the toxic instruments, some claim that deregulation caused the rise of flawed residential mortgage-backed security (RMBS) portfolios, while others point to overreaching government policies that drove lenders to issue subprime mortgages.

Even with these differences, all sides agree the crisis was, at its core, an issue of transparency in the performance of the RMBS portfolios and the lack of liquidity of interests in these massive issuances.

Political and regulatory solutions of various sorts have been proposed and tried, but the time has come for another approach, one that recognizes the powerful advances in distributed ledger technology to help address these issues of transparency and liquidity. There is one technology that truly enables both: security tokens.

Security tokens

Security tokens serve as digital representations of any other tradable financial asset, including equity shares of companies, interests in funds, contracts entitled to a specific slice of future revenue streams, ownership of intellectual property, fractional ownership of real estate and other physical assets, and derivatives themselves. Security tokens can be regulated and effectively managed, making it easy to form capital and setting the stage for a reformed financial service infrastructure. After the experiment with initial coin offerings (ICOs) and utility tokens, the security token offering (STO), private placement offerings and how they are traded on exchanges is being done in a legal way, complying with existing regulations by the authorities in each jurisdiction in which they operate — including existing United States regulations from the 1930s.

With the yield curve inversion coupled with recent downturns and corrections in the stock market, fears of a building crisis are mounting. Many armchair economists predict an economic downturn is a certainty every seven to 10 years. As we reflect on the 10-year anniversary of the 2008 crisis and try to understand the disruption to global supply chains in a new environment of trade wars, it is important to analyze the fundamental problems that led us down this path of economic turmoil and why security tokens can help stave off future financial disasters.

The beginning of the end

By September 2008, the $2 trillion RMBS market collapsed and sent a ripple through the balance sheets of most major financial institutions in the U.S. and abroad. This resulted in a global crisis of liquidity, as both debt and equity markets froze. At the eye of the storm was the bankruptcy of Lehman Brothers, which delivered subprime residential mortgages with seemingly reckless abandon. As loan default rates rose, RMBS portfolios were under increased pressure. This led to the U.S. government issuing the Troubled Asset Relief Program (TARP) — a $700 billion bailout to purchase distressed assets that yielded limited results — and the United Kingdom government’s $850 billion bank rescue package.

While the catalyst for this prevalence of bad loans is still up for debate, many agree that a potent cocktail of inefficiencies turned what should have been a salvageable market correction into a full-scale crisis. For one, credit rating agencies lacked effective models to rate risk after issuance and lacked objectivity in establishing ratings. Investors relied on these misguided ratings and continued to pump money into portfolios despite their eroding fundamentals. Lack of transparency and inefficient secondary markets made it difficult to price and expensive to sell these assets on the market. As a result, institutions were stuck with these assets and eventually collapsed under their own weight.

Another fundamental issue that led to the crisis — and has yet to be addressed by regulatory reform such as the G-20 coordinated reduction in interest rates and a $5 trillion expansion in April 2009, as well as developing concepts like the Volcker rule in the U.S. and ring-fencing in Europe — is the “too big to fail” nature of the offerings and players themselves.

The barriers of entry to securitization markets drove the centralization of issuances to astronomical heights, as a few participants came to dominate the market. The combination of closed circles and high costs of issuance ran securitized portfolios into the billions and caused a domino effect upon failure. In addition, a lack of liquidity in private securities markets made it difficult to rebalance or break up portfolios by selling smaller positions to a wider pool of potential buyers — or even by selling individual assets.

Coupling this with the significant leverage financial institutions were taking on, they reduced their ability to absorb loss, sending ripples globally. Sometimes, the unintended consequences of regulation are more damaging than the value proposition of that legislation.

Unfortunately, the issues behind this crisis remain in play and require a solution that addresses these deeply ingrained inefficiencies. If this goes unresolved, a complete financial collapse is no longer a matter of if, but when.

The next phase

To combat the issues that led to the 2008 global financial crisis, the adoption of security tokens becomes mission-critical. Many analysts predict that the majority of financial products will one day be traded on the blockchain as security tokens, with programmable smart contracts — and for good reason: Only security tokens can bring greater transparency, oversight, access and liquidity to the market.

This begs the question: Why are security tokens not more prevalent in institutional markets? In short, it’s a matter of skepticism born of misunderstanding and a lack of education. The cryptocurrency market most recognizable to the general public is one that consists of assets like bitcoin, which are exchanged principally for their speculative market value and lack tangible underlying value.

The historical volatility and current state of the cryptocurrencies market certainly does not help the situation: 2018 is considered the worst year yet for cryptocurrencies by market cap, as the market plummeted from $800 billion in January 2018 to approximately $121 billion in December.

Complicating matters is the mistaken conflation of ICOs with true security tokens. After a barrage of ICOs left investors reeling from poor performance, data leaks and stolen funds, the public has rightfully grown skeptical of nondilutive assets sold to retail buyers and traded mainly by speculators. Another misleading factor is that many in the cryptocurrency space are wrongfully promoting security token offerings as ICOs with a veneer of compliance. Areas such as custody, insurance, risk and especially governance become center stage.

The reality is that security tokens provide the benefits of liquidity and transparency while resolving the challenges of their blockchain-based predecessors by embracing compliance, protecting privacy while shunning anonymity and automating regulatory reporting. Even more profoundly, tokenized securities can provide the basis for a reformed financial service infrastructure that addresses each of the structural weaknesses that led to the global financial crisis. Here are the chief benefits of security tokens and the issues they help modify:

Portfolio transparency: Unlike the 2008 RMBS portfolios, security token offerings provide investors with direct, real-time software driven access to portfolios and underlying financial assets. Investors can make their own assessments regarding portfolio performance, allowing the market to play out naturally as conditions change. Furthermore, these securities exist on blockchain and provide a transparent, immutable record of transactions, preventing issuers from “cooking the books.” Token holders are given the ability to manage their portfolios via direct access to transaction records that cannot be altered. Transparent record-keeping of transactions, investments, portfolio performance and origin of the assets every step of the way (you can look inside that cleverly structured security). Clarity around how more complex instruments have been pooled, broken up into tranches, rated — and by whom and when — directly for both the investor and the regulator, who are able to track the lifecycle of the asset, security or financial instrument.

Decentralized ratings: As a result of the transparency of security tokens, many entities are emerging with competing technologies to rate the value and viability of offerings in the security token industry. This trend combats the massive trust issues created from the easy manipulation of ratings in the traditional financial sector. This “decentralized analysis” also provides the basis for innovative new models to rate offerings in real time and employ advanced techniques, such as machine learning.

Efficient, objective pricing: As the STO market matures and institutional adoption broadens, stronger security token offerings backed by high grade investment offerings will enter the market. STO platforms will provide convenient models for access, trading and monetization. Market makers and other tools offered by these platforms will improve buying and selling opportunities, even with minimal market participants. This, in turn, provides efficient, market-based pricing for almost all tokenized assets.

Elimination of “too big to fail” offerings: Security token platforms provide streamlined compliance models and easy access to secondary markets. These capabilities promise to substantially reduce the costs of capital formation, creates a lower barrier to entry for all securities offerings and encourages innovation — leading to more investment choices and opportunities for diversification.

Liquidity at all market levels: Security token platforms provide seamless market access and dramatically reduce the cost of compliance and reporting. Accordingly, assets of any size can be brought to market and, in some cases, can be made available to the masses in a more scalable and inclusive way. Both institutional and retail investors will soon have the ability to efficiently monetize their investment interests, rebalance their portfolios and access opportunities that were previously only available to narrow circles. Furthermore, streamlining cross-border liquidity through global interconnected secondary exchanges that leverage instant settlement and atomic swaps allow for enhanced operational utility and access to broader liquidity pools. Previously, there was a total lack of liquidity and the unequitable secondary market that has emerged with retail investors being completely locked out of owning stock in Facebook, Uber, Palantir and other trophy assets prior to their IPOs, but only after achieving $70 billion+ valuations. One could argue the same about commercial real estate, which STOs will open up as an asset class to the public of single property REITs without diversified REITs. At a $120 billion valuation, Uber would be valued at more than double the average of companies in the Nasdaq 100 Index on a price-to-2018 sales basis. It gives the ride-hailing company a multiple of about 12 times, compared with an average of 4.8 times for the index. This is an illustration of the total failure of the current bulge bracket Wall Street IPO system. STOs could be the best answer to address this while complying with legislation written in the 1930s.

Control: Retail and institutional investors have greater control over the management of their assets through transparency, direct access and further empowerment to control the parameters of their investment portfolio. This, coupled with streamlined compliance frameworks and interconnected secondary markets, allows for more effective market making that promotes cross-border liquidity at a range of levels.

Access: Many more readily accessible investment opportunities at primary issuance and in secondary markets on both the issuance, investment and trading sides, reduce costs of both primary issuances, the barrier to entry for boutique investment banks, cross-border offerings and their trading through globally connected secondary market exchanges and to realize untapped liquidity pools from the private securities markets, which provides for more novel opportunities to both diversify and hedge risk related to portfolios and avoid correlated pooled investments. The cost of completing an IPO in the U.S. is simply prohibitive and ongoing compliance does not make economic sense for a world of Mittelstand companies ignored by today’s financial systems.

Compliance: Real-time regulatory reporting on cash flow, allows discrepancies and risks to be identified well ahead of time so that measures are taken by central bankers, policy makers and regulators to counteract any stresses to the financial system through monetary policy. Albeit this is more an application of DLT, broadly speaking, the use of security tokens better enables the process. Moreover, from a compliance standpoint, the underlying independently audited code of the security tokens can reflect the regulatory structures and regimes, and, in that way, are smart. They are coded to autonomously comply with the relevant regulations and laws, can be recalled, tracked and traced, all the while with compliance built directly into the security token itself.

New assets: The emergence of new financial instrument vehicles such as contingent capital in token form, which are essentially IOUs that imitate bonds and generate a return until maturity — when the principal is repaid and can convert into loss-absorbing equity — will reduce the lag time in needing to quickly and effectively pivot to absorb market shocks. Such derivative and creative securities should only be executed in a programmed software and immutable manner.

Adoption of security tokens is more vital now than ever. In recent weeks, part of the U.S. Treasury’s yield curve inverted, strongly indicating that a recession is on the way. The last time this occurred was June 2007 and served as a precursor to the crisis of 2008.

Luckily, the Nasdaq predicts that 2019 will be the year of the STO, as regulators in global markets are setting the stage for adoption and working toward creating stable regulatory environments. Hopefully, these measures serve as a positive harbinger of things to come and provide a vital tool as the U.S. and other jurisdictions try to navigate toward safer financial waters in 2019 and beyond.

In short, this is an important turning point where we have to decide if we want to seize the opportunity to rewrite the rules of the financial system with new DLT-based and DLT-compatible infrastructure for the creation of security tokens to make it more resilient, sustainable and safe in order to make sure history does not repeat itself.

The article is co-written by Dan Doney, Andrew Romans and Hazem Danny Al Nakib.

Dan Doney is a technologist and futurist, the CEO of Securrency Inc., a financial technology provider and former Chief Innovation Officer of the US Defense Intelligence Agency.

Andrew Romans is a Silicon Valley-based venture capitalist at 7BC.VC and Rubicon Venture Capital as well as an author of two top-10 books on Venture Capital on Amazon and Masters of Blockchain.

Hazem Danny Al Nakib is a financial and regulatory technology expert, a Partner at 7BC, and Managing Partner at Sentinel Capital Group where he works with corporates, governments, and startups leveraging digital emerging technologies.

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flipfundingstuff · 5 years ago

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Lessons to Learn From the Last Recession

While there’s still a great deal of debate surrounding the actual cause of the Great Recession of 2008, the United States and parts of Western Europe have pointed their fingers at the subprime mortgage crisis as a significant contributor. Regardless of the official cause, the economic downturn brutalized the real estate industry, banks, and other related branches of the global economy. Yet even as we’ve tried to recover and distance ourselves from the struggles we all faced 12 years ago, thanks to the coronavirus (COVID-19) pandemic, we’re in similar situations now.

But can we learn from past mistakes to overcome our current and future challenges? Of course. We simply need to understand what happened in the past, note the similarities, and build a plan from there. Should be a piece of cake, right?

The Recession: Then vs. Now

Unemployment

Global and statewide unemployment was a major issue in the last recession. However, as the coronavirus pandemic rages on, we’re facing very similar situations in this day and age. After the Great Recession, the Bureau of Labor Statistics tallied up the job loss numbers from across the United States, and it spat out a net total near 8.8 million, but 39.5 million unemployment claims (from December 2007 to June 2009). Of those lost jobs, 60% of them were jobs paying between $14 and $21 per hour.

In the throes of our current economic downturn, we saw more than 22 million people out of jobs and applying for unemployment in just a few weeks. 65% of the jobs lost in March were in the leisure and hospitality industries. With numbers like those, the St. Louis Fed estimates as many as 47 million jobs lost by the time this is all over.

Income

The previous economic and financial crisis hit the wallets of many an American in ways other than job loss. According to research, the US lost $650 billion in Gross Domestic Product (GDP) between 2008 and 2009 as a direct result of the Great Recession. Taking that into account, each household lost an approximate average of $5,800 in income.

In a recent and ongoing survey, 36% of participants claim they lost between 10–25% of their income as a result of the coronavirus (COVID-19) pandemic. Additionally, 10% claimed to have lost income amounts of 10% or lower, 18% lost between 25–50%, 19% lost greater than 50%, and 17% have reported complete loss of income.

As the pandemic continues, we’ll start seeing more of the true, individual costs of our current recession.

Real Estate

As mentioned earlier, a significant contributor to the Great Recession was the subprime mortgage crisis. A subprime mortgage is a mortgage for homebuyers who don’t have the best credit scores and often struggle with debt. In the early 2000s, interest rates for mortgages were in a sweet spot, and many people with not-so-great credit were jumping on the opportunity and getting approved. As a result, the real estate industry boomed, so it was sunshine and rainbows for a few years before the bubble burst.

When everything fell apart, it hit the ground hard. Final reports put the real estate impact at wealth losses of $3.4 trillion. When broken up across the population, that cost roughly $30,300 per US household.

Ouch.

The impact of the coronavirus pandemic also reached the real estate industry. As reported by Forbes, realtors are letting us know they’re feeling the strain. While houses remain on the market without much issue, roughly half of the agents working to sell them note a decline in buyer interest. When we switch to commercial real estate, the economic strain continues.

47% of agents selling commercial property feel the virus has negatively affected the industry, with businesses slowing down and buyer interest dropping. Despite the low-interest rates available, more than half of the surveyed agents feel they are doing little to rekindle the drive to buy.

International Impacts

Despite the mostly local nature of the Great Recession, several other countries still felt the shockwaves. Through events like currency devaluation and the like, we’re able to track the global economic devastation caused by something that happened in our country. While it took a few more years to manifest, a significant number of foreign nations felt the consequences of the 2008 recession. Several European countries ended up defaulting on national debts, and the European Union had to offer “bailout” loans and other cash investments to help them out.

On the other hand, it’s really easy to see the profound impact of COVID-19 on the world. Not even counting the health impact of the virus, this pandemic is ravaging international industries like travel. Early on, American and foreign airlines cut back on both domestic and international flights as the demand plummeted and travel bans emerged. From there, we saw the closure of international tourist attractions and theme parks. The Florida-based Walt Disney World, which has only closed 7 times in its history, is currently closed until further notice.

There’s almost no way to tell the actual global economic cost of the coronavirus (COVID-19) pandemic—especially while it still rages—but it’s changing the world on a massive scale.

The Environment

Speaking of changing the world, some solid evidence indicates that the planet benefits a bit from our suffering.

During the Great Recession, the International Energy Agency (IEA) predicted a 3% decrease in human-made greenhouse gas emissions—the most significant drop at the time since the 1970s. Since the onset of the coronavirus pandemic, both China and Italy have seen a 35% drop in their NO2 levels, and researchers at Columbia University say carbon monoxide levels from cars in New York are down by as much as 50%. They also claim a 5–10% drop in CO2. Aside from the nasty gasses we produce as we bustle about, our quarantine-induced absence allows the world to recover in other ways.

Recently, people around the world report sightings of animals venturing into civilization and reclaiming the lands they once called their own. Fish are once more visible in Venician canals, mountain goats are exploring Welsh cities, and deer are roaming the streets of Japan.

It’s probably safe to say the natural world is doing a little better while the rest of us keep hiding in our homes as we wait for the coronavirus pandemic to end.

What Can We Learn?

After looking at history and reading through these examples, we can assume our economic situation is likely going to get worse before it gets better. However, as we move forward, there are lessons to learn and preparations to make so you and your business can come out of this crisis intact and shore up against any downturns that may arise in the future.

Hope for the Best, Prepare for the Worst

Not to be a downer, but it’s always a good idea to have a backup plan for when things go wrong. No matter how good things may appear to be, the Great Recession and the subprime mortgage crisis are great examples of what happens when we get too big for our britches. Take it slow, plan ahead, and make sure you’ve built up a safety net. Just because it’s sunny today doesn’t mean a storm’s not on its way.

Innovate and Reimagine

Many companies impacted by COVID-19 are reinventing themselves during the pandemic. Gyms and yoga studios are hosting online workout videos and classes, while more service-based businesses are doing some improvising of their own. Don’t be afraid to adapt. No matter how bleak the future may seem, you can always do something to overcome the challenge. Stay calm, clear your head, and go back to the drawing board. A solution may be nearer than you think.

Take Advantage of Government Aid

The government has several options available to help small businesses keep their doors open. Economic Injury Disaster Loans (EIDL), the Emergency Economic Injury Grant (EEIG), and Paycheck Protection Program (PPP) loans are all great resources to ensure your employees stay paid and your business keeps its head above water. Now—more than ever—is the best time to turn to your friends at Lendio. Whether you’re looking for the most up-to-date information on our blog or trying to secure the funding you need during this economic downturn, we’re here to help.

The post Lessons to Learn From the Last Recession appeared first on Lendio.

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gillespialfredoe01806ld · 7 years ago

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A Fight Over the Credit Score Lenders Use for Your Mortgage

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Banks and rival lenders are butting heads over the credit scores used to decide millions of mortgage requests by U.S. home buyers.

Now, a federal agency is weighing whether to step into the fight, which revolves around a longtime requirement for lenders who sell mortgages to Fannie Mae and Freddie Mac to gauge most borrowers using FICO scores. The Federal Housing Finance Agency’s ultimate decision could have wide-reaching ramifications for the mortgage market and home buyers across the U.S.

Many nonbank lenders, which in some recent quarters have accounted for more than half of the mortgage dollars issued in the U.S., want the ability to use a credit score provided by a company owned by credit-reporting firms Equifax Inc., Experian PLC and TransUnion. These lenders argue the alternative score would open the mortgage market to a greater number of people and lead to more mortgage approvals, helping to boost home sales and the economy.

Banks generally want to stick with the current system that uses FICO scores, which have been around for decades and are created by Fair Isaac Corp. Ditching the status quo, they say, could lead to an increase in consumers with riskier credit profiles getting mortgages and a subsequent rise in defaults.

The FHFA, which oversees Fannie and Freddie, is weighing whether to change the requirement to allow for the use of another credit-scoring system. In late December, the agency asked lenders and others for formal input on the issue.

In doing so, the FHFA acknowledged concerns about a “race to the bottom” where credit-scoring systems would compete to offer metrics that make the most loans rather than aspire to be the most reliable.

Credit scores help determine who gets a mortgage and on what terms. They played a role in the last housing boom and bust as lenders lowered credit-score requirements, extending hundreds of billions of dollars of mortgages to subprime borrowers.

After the financial crisis, lenders tightened requirements for potential home buyers. As part of this, they required higher credit scores, making it more difficult for borrowers with spotty credit histories to qualify for a mortgage.

That is why some lenders, mostly nonbank firms, want a change in the kind of scores that can be used. They would like to increase mortgage volume by expanding the pool of borrowers.

These lenders view FICO scores as an impediment since they tend to be more conservative than alternatives.

Nearly half of mortgage dollars made in the U.S. go through Fannie and Freddie, according to Inside Mortgage Finance, so their requirements have huge sway over the mortgage market.

Nonbank lenders argue the current system shuts out borrowers who don’t use credit either out of personal choice or because they went through a bankruptcy or foreclosure. That is where VantageScore Solutions LLC, the scoring firm that Experian, Equifax and TransUnion launched in 2006, says it can step in.

The company says it can assign a credit score to about 30 million more consumers than FICO. Roughly 7.6 million of those consumers would potentially be eligible for a Fannie or Freddie mortgage, VantageScore says.

VantageScore, for instance, says it will assign credit scores to consumers if they have a credit card or a loan for as little as one month. FICO requires six months. Separately, FICO creates scores for consumers as long as lenders or other entities update information on their credit reports within the last six months. VantageScore says it will go further back than that.

Banks aren’t convinced, even if some big ones have begun to experiment with VantageScore for small pools of applicants whose FICO scores aren’t high enough for a mortgage approval. “We’ve got so much experience using the system we’re using now,” said Gerard Cuddy, CEO of Beneficial Bancorp Inc., a Philadelphia community bank.

The banks’ trade group, the American Bankers Association, says the current system allows for strong underwriting standards. Introducing a new scoring model could put that at risk, said Joe Pigg, senior vice president of mortgage finance at the ABA.

It also could open up mortgage lenders to legal liability, the group says. One feared scenario: If one scoring model is found to approve some borrowers, banks could be accused by regulators of discriminating if they use the other model, Mr. Pigg added.

Nonbank lenders counter that the current system is too rigid and unfairly excludes deserving borrowers. Sanjiv Das, CEO of a major nonbank lender, Caliber Home Loans Inc., said VantageScore could open up homeownership to customers including millennials who don’t have a credit history because of their age.

“I strongly believe that a large number of customers are being excluded because of the slavish reliance on FICO,” Mr. Das said.

Mat Ishbia, CEO of another major nonbank lender, United Wholesale Mortgage, said he was enthusiastic about a possible change. “Doing something just because you’ve always done it that way isn’t a good enough reason,” Mr. Ishbia said.

Both sides agree that Fannie and Freddie’s credit-score requirements need an update, partly because lenders using credit scores must employ an old version of the FICO score.

But the FHFA appears to have doubts about adding a new credit score into the mix. When asked during a congressional hearing in October about new credit-scoring models that can assign scores to people with limited credit histories, FHFA’s Director Mel Watt said, “The notion that there would be substantially more people credit scored and that would increase access if we had competition is probably exaggerated.”

The FHFA has several options as it weighs the debate, including: requiring lenders to check credit scores either from FICO or VantageScore; requiring lenders to check both; or allowing lenders to choose between the two scores.

Not all nonbank lenders are urging change. Stanley Middleman, CEO of the large nonbank lender Freedom Mortgage Corp., supports the continued use of FICO, partly because he doesn’t see the point of adapting a whole new system.

“I don’t think people are getting boxed out of homeownership,” Mr. Middleman said. “And I don’t feel like we’re guilty of something by asking people to have a credit history.”

The post A Fight Over the Credit Score Lenders Use for Your Mortgage appeared first on Real Estate News & Insights | realtor.com®.

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libertariantaoist · 8 years ago

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The ways of the regulatory state go like this: when a crisis erupts, don’t ask how earlier government interventions may have made the crisis possible or worse than it would have been. Rather, denounce private greed, declare good intentions, pile new regulations atop old, and hope for the best.

Unsurprisingly, this does not work. If you misunderstand a crisis you are sure to misunderstand how to end it and prevent its recurrence.

We are living with a clear example of the regulatory state’s perverse dynamic: the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Passed in the Obama administration during the Great Recession, Dodd-Frank declared the government’s intention to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”

As we’ve come to expect, the legislation did not specify how the financial industry would now be governed. Rather, it ordered the government’s financial regulatory agencies -- along with some new ones created by the legislation -- to write 243 new rules for the industry. In other words, as Democratic House leader Nancy Pelosi said when the Affordable Care Act, which also was filled with rule-writing mandates, was being debated, “But we have to pass the bill so that you can find out what is in it, away from the fog of the controversy.” (Pelosi may not have intended to refer to the indeterminate nature of the legislation, but she may as well have been.)

Since the authors of the legislation and the president who signed it misunderstood the causes of the Great Recession, they of course came up with the wrong “solution.” Instead, Dodd-Frank did little more than decree financial instability a thing of the past and told the bureaucrats to figure out how to accomplish this.

The Great Recession was triggered by a collapse of government-boosted housing prices, which in turn made many high-risk (aka subprime) mortgages unpayable, which in turn dramatically reduced the value of mortgage-backed securities and various “exotic” derivatives that were ultimately linked to those mortgages. This along a slew of financial regulations put large private institutions and government-sponsored enterprises (GSEs) -- Fannie Mae and Freddie Mac -- at risk, some of which were then bailed out (via TARP), or in the case of the GSEs, nationalized, by the federal government or the Federal Reserve under the unwritten “too big to fail” doctrine. Or as President George W. Bush said at the time, “I’ve abandoned free market principles to save the free market system.”

Horror over the collapse and public distaste for the “too big to fail” doctrine begat Dodd-Frank.

The problems are, first, that it was based on a misdiagnosis of the crash (it’s silent about the GSEs); second, that it failed to undo earlier interventions that induced and aggravated the crash; and so third, that it won’t do what its advocates promised it would do.

The Great Recession did not result, as popularly believed, from either Wall Street greed or under-regulation. We may assume that greed (however defined) is a constant, so any such explanation would have to show why it had such consequences in 2007-08 rather than another time.

Similarly, to attribute the crash to under-regulation is to overlook all the ways the government encouraged and in some cases even mandated behavior that sowed the ground for the housing market collapse. It is no secret that the national government for years pushed -- and in some ways compelled -- banks and other lenders to make mortgage loans to people with no, weak, or poor credit histories and then encouraged the GSEs to buy those shaky loans from the originating financial institutions. This may have been a well-intended policy to increase home ownership, but it nonetheless created a boom in subprime lending to uncreditworthy applicants who, for example, did not have to document their incomes, that is, their ability to repay their loans. These loans were then pooled to create securities and derivatives that leveraged financial institutions both held and sold to clients. The policy-driven boom also helped to create a price escalation that encouraged riskier loans featuring initial teaser but adjustable interest rates. People who feared they would be overextended were assured they could refinance when the price of their homes went up.

Wall Street of course understood the risks. So why did banks and other institutions become involved in high-risk loans? One answer is that high-risk investments come with the potential for high payoffs. Those who bought and sold these investments knew what they were doing and usually took appropriate precautions, such as purchasing credit-default swaps and other forms of insurance against loss. Despite the impression left by the popular news media and progressives, the insurance mechanism in the financial markets worked as intended, as Edward Peter Stringham documents in “It's Not Me, It's You: The Functioning of Wall Street During the 2008 Economic Downturn.” Risk was efficiently “allocated” from risk-avoiders to risk-seekers, with profits and losses reflecting this arrangement.

But another answer to why people were willing to deal in high-risk loans is that the national government, besides pushing lenders to make the loans, was understood to be ready to bail out big institutions that got in trouble. Indeed, that is just what it did.

In light of all this, Dodd-Frank is exposed as a futile, although costly gesture. Considering that government guarantees were at the root of the crisis, it is strange that Dodd-Frank does not abolish the government’s power to bail out financial institutions. “Too big to fail” lives, despite the bill’s declaration. For example, federal deposit insurance continues. This is usually thought of as a guarantee to bank depositors, not banks. But if depositors need not worry about the safety of their deposits, the banks need not compete with one another in terms of prudence. All are equal because the FDIC sticker is on all doors. This weakens the market’s check on imprudent banks. Indeed, Franklin Roosevelt, after his election but before his inauguration, agreed with President Herbert Hoover that federal deposit insurance was a bad idea. “The general underlying thought behind the use of the word ‘guarantee’ with respect to bank deposits,” Roosevelt said, “is that you guarantee bad banks as well as good banks. The minute the Government starts to do that the Government runs into a probable loss.… We do not wish to make the United States Government liable for the mistakes and errors of individual banks, and put a premium on unsound banking in the future.” Unfortunately he signed deposit insurance into law along with many new banking regulations.

What about “too big to fail”? Dodd-Frank declares the doctrine null and void, but Mark Calabria of the Cato Institute says it’s not so:

“There is, of course, language about ‘eliminating expectations … that the Government will shield’ parties from losses ‘in the event of a failure.’ But vague purposes do not constrain explicit authorities. And Dodd-Frank is quite explicit. Section 204, for instance, is quite clear that the Federal Deposit Insurance Corporation (FDIC) can purchase any debt obligation at par (or even above) of a failing institution. If rescuing a creditor at par is not the very definition of TBTF [too big to fail], I’m not sure what is. Section 201 goes even further by allowing the FDIC to pay ‘any obligations…’ it believes are ‘necessary and appropriate.’ Yes Dodd-Frank does offer a path for ending TBTF without cost to the taxpayer or the rest of the financial industry. But that path is clearly an optional one.”

So Dodd-Frank fails to address the key means by which the government encourages recklessness: relief from the fear of losses. Meanwhile, it imposes huge costs on financial institutions through collateral and complex reporting requirements. Those costs function as barriers to entry into the industry, adding even more protection for large incumbent firms. Moreover, the costs present new obstacles to smaller community banks.

Thus Dodd-Frank strengthens the sheltered financial oligopoly and thereby endangers us all.

#sheldon richman #american institute for economic research

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organisemybiz · 8 years ago

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Wharton’s Benjamin Keys and Columbia’s Christopher Mayer discuss the privatization of Fannie Mae and Freddie Mac. Debate has resumed over the future of Fannie Mae and Freddie Mac after recent comments by U.S. Treasury secretary nominee Steve Mnuchin that they should be privatized. The two government-sponsored enterprises buy home mortgages, pool them and sell them as mortgage-backed securities in the secondary market, with a share of more than 45% of that market. Fannie Mae and Freddie Mac have been in government conservatorship since 2008 after a government bailout of $187.5 billion rescued them from the 2007 subprime mortgage finance crisis. Fannie Mae Freddie Mac Fannie Mae And Freddie Mac Mnuchin’s plan has lifted the share prices of both companies amid hopes of windfall payments for private shareholders. But it also faces challenges such as providing a safety net for the two entities in the event of a housing market crisis; ensuring adequate underwriting standards, and retaining programs for affordable housing and for the elderly, and to promote home ownership, say experts at Wharton and Columbia University. Benjamin Keys, Wharton professor of real estate and Christopher J. Mayer, Columbia University professor of real estate, discussed the ideal roadmap for privatization of Fannie Mae and Freddie Mac on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.) Here are five takeaways from their discussion: Privatize, But with a Safety Net: When the housing market is healthy, it can manage well on its own without government support, said Keys. “The challenge is: What do you do when things go wrong?” he added. “Right now the housing market is looking relatively good and [hence] the push to privatize them. The real question is whether there will be support for that market when things go bad.” Fannie Mae and Freddie Mac issued mortgage-backed securities totaling $974 billion in 2016, up 18% over that in 2015, according to Inside Mortgage Finance. Mayer agreed. “Privatization, absent a plan for what goes wrong when things are bad is not a solution,” he said. “It’s a nice theory to say, ‘We’ll let them fail and go down,’ but every government has discovered in every financial crisis that it is not going to stand by and watch the housing mortgage market completely collapse.” Finding the Right Model If Fannie Mae and Freddie Mac go private, there will be concerns about the risks tax payers are exposed to, said Mayer. He noted that the two entities along with the Federal Housing Administration originate about 90% of all housing mortgages. “The problem is what happens when you have an implicit or explicit government guarantee and private shareholders,” he asked. “Private shareholders will take lots of risk and say, ‘Heads we win, tails taxpayers lose.’ So we need to find a system that is better than that.” According to Mayer, without sufficient capital requirements and other controls, “tax payers eventually will end up on the hook for large bailouts.” He noted that private shareholders like hedge funds and mutual funds that own about 10% of the two companies have been lobbying in Congress over the payouts they could get when Fannie and Freddie are taken out of conservatorship and fully privatized. “The best case scenario is we accurately price the catastrophe insurance and find new and hopefully explicit ways to support low-income and multifamily housing.”–Benjamin Keys Phasing in the Private Sector Keys suggested a phased plan for taking the two companies private. Under that plan, the government would reduce its role in the companies by tightening restrictions in underwriting mortgages. At the same time, hopes would be for the private market to begin to fill the spaces that the government vacates. “The most straightforward proposal I’ve seen is to convert Fannie Mae and Freddie Mac into a form of catastrophe insurance with a larger footprint than say, a flood insurance program, but something that would reinsure the securities that are being issued,” he said. In that plan, the insurance could be priced “as accurately as possible to reflect the underlying risk,” he added. Protecting Affordable Housing Programs According to Keys, many people are relying on low down payment programs, and in many cases are putting down less than 5% of the price of the homes they buy. Any plan to privatize Fannie Mae and Freddie Mac must ensure protection for such affordable programs, and others for multifamily housing and rental properties. “The best case scenario is we accurately price the catastrophe insurance and find new and hopefully explicit ways to support low-income and multifamily housing,” he said. Mayer agreed, and said, “The government needs to find responsible ways to help people in home ownership, because it’s a predominant way of building wealth and for the elderly to be able to manage their lives towards retirement.” Mayer clarified that the bulk of low down payment lending is through the Federal Housing Administration and not through Fannie Mae and Freddie Mac. “The average down payment today is not much different from what it has been historically, especially since around 2000,” he said. “The narrative that the government is pushing low down payment programs and inviting a crisis again is false, based on the data.” What has changed since the subprime crisis is borrowers need to have much higher credit scores than they were required to have in the last two decades, he noted. Moves Afoot for Broader Changes The debate over the future of Fannie Mae and Freddie Mac is occurring amid calls for fiscal changes, such as on tax reform and revisions to deductibility of interest payments on mortgages, Mayer noted. He expected pressure on some of the “implicit subsidies that are occurring through the tax code on housing.” Much of those subsidies go to those at the top end, to high-income borrowers buying homes with high tax rates, he said. Housing policy goals also need to be revisited, especially as many younger people are putting off home ownership since they are marrying and forming households later, he added. “Privatization, absent a plan for what goes wrong when things are bad is not a solution.”–Christopher J. Mayer Adding to those are student debt burdens, the challenges facing middle-income workers and income volatility, noted Mayer. “We need to have a stable housing finance system that has a path to home ownership where people can save and become responsible home owners,” he said, hastening to add that he is not arguing for subsidies. Keys agreed. “People aren’t getting a 30-year job at the factory anymore; they are bouncing from job to job,” he said. “That makes it challenging to save for a down payment and making mortgage payments regularly.” Article by Knowledge@Wharton The post Privatizing Fannie Mae And Freddie Mac: How It Can Be Done Effectively appeared first on ValueWalk.

#IFTTT #Flickr #business #bizfeed #valuewalk

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cryptoquicknews-blog · 6 years ago

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New Post has been published here https://is.gd/qEllY9

How Security Tokens Can Prevent an Impending Financial Crisis

This post was originally published here

Security tokens

The beginning of the end

The next phase

The article is co-written by Dan Doney, Andrew Romans and Hazem Danny Al Nakib.

Dan Doney is a technologist and futurist, the CEO of Securrency Inc., a financial technology provider and former Chief Innovation Officer of the US Defense Intelligence Agency.

Andrew Romans is a Silicon Valley-based venture capitalist at 7BC.VC and Rubicon Venture Capital as well as an author of two top-10 books on Venture Capital on Amazon and Masters of Blockchain.

#crypto #cryptocurrency #btc #xrp #litecoin #altcoin #money #currency #finance #news #alts #hodl #coindesk #cointelegraph #dollar #bitcoin View the website

New Post has been published here https://is.gd/qEllY9

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