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Worried About ‘Too Big To Fail’ Banks? Ignore Romney’s Attacks In The Debate

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Worried About ‘Too Big To Fail’ Banks? Ignore Romney’s Attacks In The Debate

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So how is the market reacting? Jennie Bai, Christian Cabanilla, and Menno Middeldorp of the Federal Reserve Bank of New York wrote a great paper recently that used “Moody’s KMV credit default swap (CDS) implied probability of default to gauge changes in the market perception of the risk that senior bondholders will not be completely repaid.” (Disclosure: In the past, I worked at Moody’s KMV, a well-regarded credit risk firm founded as KMV by three old-school quants, as a financial engineer. As a result, I’m biased towards their probability of default methodologies as a metric.)

What did they find?

Using the results from this regression and the shift in Bloomberg resolution news over our sample, we estimate that the anticipated and actual changes in resolution regime have increased the CDS market’s expectations of default by approximately 20 basis points, which is around a fifth of the average CDS-implied default probability for G-SIFIs in March 2012. While this doesn’t necessarily mean that markets are no longer pricing in any possibility of government support, it does suggest that the new laws have resulted in the CDS market taking into account the view that senior bondholders run a higher risk that they’ll need to share in the costs of bank resolution.

The market is starting to price in the risk that senior bondholders at risky, major financial firms will take hits, and those risks are priced in alongside movements in the resolution authority law. Given that the rules aren’t completed yet and that there are additional ways to bolster them, this is a good sign. Mitt Romney’s attack on the overall plan embodied in Dodd-Frank isn’t the right approach for people serious about tackling Too Big To Fail. The problems we should be worried about are whether there is a good implementation of the law and if it is sufficient for taking down a major firm.

QM

In addition to Adam Levitin’s piece, you should read John Griffith and Julia Gordon of Center for American Progress, writing over at ThinkProgress, who have a piece on the QM issue.

We’re thrilled to hear Romney give such a full-throated defense of the ability-to-repay rule. It’s a welcomed about-face from his recent calls to repeal Dodd-Frank and dismantle the Consumer Financial Protection Bureau, the federal agency that’s responsible for enforcing the rule. That said, Romney has a few key facts wrong.

As Romney points out, the ability-to-repay rule has not yet taken effect as regulators are still defining the “Qualified Mortgage” exemption. But the Republican candidate neglected to mention that the final rule isn’t due until January 2013 — a deadline regulators appear to be on pace to meet. The Consumer Financial Protection Bureau submitted its proposed rule back in April and is currently hashing through public comments.

Romney seems to imply some sort of negligence or malfeasance from the Obama administration that is preventing the rule from being completed. Alas, no scandal here. The Dodd-Frank law is actually quite clear about what type of loan should be considered a “Qualified Mortgage.” The loan must be well-underwritten with verified income, employment, and debt information. Loan payments can’t exceed a certain percentage of the borrower’s net monthly income. The loan can’t contain risky features like negative amortization, interest-only payments, or balloon payments. The list goes on.

It’s a shame the debates didn’t include anything on foreclosures or the housing market more generally, but the Dodd-Frank discussion was a pleasant surprise.

Cross-posted from Rortybomb

7 Comments

  1. Dominick Vila October 8, 2012

    We need strong and effective regulation to minimize the risk of a sequel to what happened brought us to our knees during the S&L debacle when Reagan was in office and to the financial institutions disaster when W was in office. Most importantly, we need to expand the authority of regulators to ensure they have the ability and access they need to do their job effectively.
    I think it is important to remember, however, that what happened to our financial institutions was the result of unadultered greed. Nobody forced banks to lend to people who could not afford the houses they were purchasing, and nobody forced them to engage in the smoke and mirrors scam known as the sub-prime or derivatives. They gambled with assets they did not have and we, the taxpayers, were left holding the bag.

    Reply
  2. Fran October 8, 2012

    I have siad over and over again…when Mitt was talking about his math skills they were so fuzzy non of it added up…I loved the way Mike Konczal describe everything..it was to the tee. thanks…Mike…Mitt is a con-artist and an actor to a tee…that is with the narcissistic personality he possesses…believe me…he wants to pull the wool over everyone’s eyes…and he is convincing to a lot of people..but, not to people like Mike Konczal…Mitt’s math added up wrong in everyway.

    Reply
  3. Lorraine October 8, 2012

    I wish I could take credit, but this was written by another and posted on another site, a number of us said we were going to repost:

    “Snow White, Superman and Pinocchio are walking along. They see a sign: “Contest for World’s Most Beautiful Woman.” Snow White goes in, later comes out smiling, wearing a crown. They walk along and see another sign: “Contest for World’s Strongest Man.” Superman goes in, later comes out smiling, wearing the belt. They walk along and see a sign: “Contest for World’s Greatest Liar.” Pinocchio goes in, later comes out with his head down crying. “Who the hell is Mitt Romney?” Pinocchio sobs.”

    Reply
    1. Ed October 9, 2012

      spot on, I would expect Paul Ryan was a close second!

      Reply
  4. howa4x October 8, 2012

    We’ve already seen a bank loose 7 billion on a risky bet in Europe outside of regulatory oversight. they could cover that one but what if it was a 700 billion bet lost? Would the banking industry expect to be bailed out again? I think a major part of Dodd-Frank that the banks are fighting is not only the capital requirements, but the living will that they have to submit. In that will the board of directors and all the upper management must be removed, if the bank fails, so no golden parachuttes this time. I think if I was a manager of a public pension I would avoid the major bank stocks. There is too much risk in the world and major banks can deal in that risk outside of our boarders. The republicans are playing a dangerous game here. Say they win, repeal Doo/Frank and greed once again takes over in the form of a bubble, like the tech or housing ones. The banks will once again over extend themselves, and if they crash again and pull the economy down, do you think anyone with any sanity will ever vote for a republican again?

    Reply
    1. S-3 October 8, 2012

      America needs more sane people in it to ojoin with Earth itself and move forward, sir… And I WILL aim to be one of them…

      Reply
      1. howa4x October 8, 2012

        I agree that’s why my wife and I recycle and compost so much that we put out 1/2 a bag of gargage a week We are committed to lowering our carbon footprint

        Reply

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