How has market regulation changed since 2008 Financial Crisis?

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Fat-Tailed Contagion
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How has market regulation changed since 2008 Financial Crisis?

Post by Fat-Tailed Contagion » Thu Feb 25, 2016 5:12 pm

Hi Bogleheads,

First, please refrain from political commentary.

After re-watching 'The Big Short' and "Inside Job', my question is how have regulations changed since then?

1. In the derivatives markets ?

2. In the leverage ratios of banks ?

3. Other safeguards ?

This is a very actionable question for me and I believe every investor needs to be educated on these issues in evaluating risk management in the overall context of portfolio construction and strategy.

Thanks for the help!

Fatty
“The intelligent investor is a realist who sells to optimists and buys from pessimists.” | ― Benjamin Graham, The Intelligent Investor

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by livesoft » Thu Feb 25, 2016 5:14 pm

Wiki This signature message sponsored by sscritic: Learn to fish.


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Fat-Tailed Contagion
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Re: How has market regulation changed since 2008 Financial Crisis?

Post by Fat-Tailed Contagion » Thu Feb 25, 2016 5:42 pm

Thank you, now I need an interpreter to figure out what all the jargon means and assess its effects :sharebeer
Last edited by Fat-Tailed Contagion on Thu Feb 25, 2016 5:43 pm, edited 1 time in total.
“The intelligent investor is a realist who sells to optimists and buys from pessimists.” | ― Benjamin Graham, The Intelligent Investor

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Fat-Tailed Contagion
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Re: How has market regulation changed since 2008 Financial Crisis?

Post by Fat-Tailed Contagion » Thu Feb 25, 2016 5:43 pm

FillorKill wrote:Basel III.

US implementation: http://www.federalreserve.gov/bankinfor ... tation.htm
Thank you :beer
“The intelligent investor is a realist who sells to optimists and buys from pessimists.” | ― Benjamin Graham, The Intelligent Investor

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by FillorKill » Thu Feb 25, 2016 5:50 pm

Fat-Tailed Contagion wrote: Thank you :beer
No problem. You may find the publications created by the committee on the global financial system (CGFS) of interest. Their reports are posted here: http://www.bis.org/list/cgfs/index.htm?m=3%7C15%7C569

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by alex_686 » Thu Feb 25, 2016 6:03 pm

Some notes.

I am not overall impressed with the reforms so far.

Frank-Dodd is more about box ticking than actually reduction in risk, in my opinion. The complexity of the regulations entrenches the current big banks. I think better of Basel III. Regulations both in and outside of the US is trying to make sure that individual compartments are better funded so the failure of a single compartment does not take down the entire bank. However, this now means that individual compartments are more likely to fail because it is now harder to transfer capital.

The leverage ratios have fallen. The US has been better about this than others. However, low long term interest rates have a tendency to create asset bubbles. Also, now the US government is guaranteeing more new home loans today then during the crash, so all of those risks are off the books.

The amount of new derivatives on CDOs and the like have dropped. Otherwise the reforms have been fair to middling with low impact to the market. I personally think derivatives have a worse reputation than what they deserve.

FYI, I have read the book but I have not seen the movie.

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by alex_686 » Thu Feb 25, 2016 6:15 pm

Fat-Tailed Contagion wrote:Thank you, now I need an interpreter to figure out what all the jargon means and assess its effects :sharebeer
Basically, Basel is a small town in Switzerland where bankers, international, central, etc., get together and write the rules on how banks should run, covering issues such as risk. i.e., leverage, derivatives, etc. Then everybody is supposed to implement the rules. The rules are supposed to be state of the art and hard to game. And since everybody aggress to the same broad standards companies can not arbitrage the rules by having one subsidiary in county A and another in country B.

Under Basel II, leverage was determined by how risky an asset was. Government bonds/loans had low risk so you could have a high amount of leverage / low bad loan reserve fund. Junk bonds / sub-prime mortgages required a low leverage / high bad loan reserve fund. So far so good.

However there was a flaw. Junk Bonds / Sub prime loans that were insured with a credit default swap could be treated as AAA safe assets. I think the logic works here. The margins were thick in the space so everybody jumped in. This lead to an asset bubble and 2008. This is where things fell apart.

Basel III is supposed to fix that flaw.

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Fat-Tailed Contagion
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Re: How has market regulation changed since 2008 Financial Crisis?

Post by Fat-Tailed Contagion » Thu Feb 25, 2016 6:23 pm

Thank you, Alex for the clarification and insights.

Much appreciated.

Reading wikipedia entries has almost no value for me.
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Re: How has market regulation changed since 2008 Financial Crisis?

Post by alex_686 » Thu Feb 25, 2016 6:57 pm

Fat-Tailed Contagion wrote:Thank you, Alex for the clarification and insights.
One more thought. There is a "heads I win, tails you lose" proposition at the heart of most financial institutions. All things being equal, the company that has the most leverage will have the highest return on investment for the investors. Unless the bank goes bust, where the diversified stockholder will barely notice the blip and the banker now needs to find a new job. So as the regulators try to tighten the screws on the bankers, the bankers are going to look for ways to maximize their leverage. Or maybe "game the system" is better. There are more bankers than regulators and the bankers are better paid.

I am not as pessimistic about regulations as I sound. However, as low long term rates tend to create asset bubbles, which is where I think the next crisis will come. Even strong effective regulations would only have a modest effect in my opinion.

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by dmcmahon » Fri Feb 26, 2016 12:23 am

alex_686 wrote:
One more thought. There is a "heads I win, tails you lose" proposition at the heart of most financial institutions. All things being equal, the company that has the most leverage will have the highest return on investment for the investors. Unless the bank goes bust, where the diversified stockholder will barely notice the blip and the banker now needs to find a new job.
The board of directors would in theory care, as would diversified stockholders if they looked at the banks in aggregate. So would the unemployed banker, if his or her resume of failed speculations followed him/her around. All else being equal, fear of catastrophe is needed to keep leverage in check, IMO.

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by itstoomuch » Fri Feb 26, 2016 12:55 am

From what I get from older bro, his TBTF bank and its executives have become more accountable to their actions. Among the actions are clawbacks to executives, stricter adherence to risk parameters, and better personnel/leadership with more analytics skills rather than personnel with salesmanship and secondary analytics skills. IOW, Morals and Ethics. :oops:

disclaimer: This is not truth or fact, but hearsay to you. :mrgreen:
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

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Fat-Tailed Contagion
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Re: How has market regulation changed since 2008 Financial Crisis?

Post by Fat-Tailed Contagion » Fri Feb 26, 2016 3:11 am

alex_686 wrote:
Fat-Tailed Contagion wrote:Thank you, Alex for the clarification and insights.
One more thought. There is a "heads I win, tails you lose" proposition at the heart of most financial institutions. All things being equal, the company that has the most leverage will have the highest return on investment for the investors. Unless the bank goes bust, where the diversified stockholder will barely notice the blip and the banker now needs to find a new job. So as the regulators try to tighten the screws on the bankers, the bankers are going to look for ways to maximize their leverage. Or maybe "game the system" is better. There are more bankers than regulators and the bankers are better paid.

I am not as pessimistic about regulations as I sound. However, as low long term rates tend to create asset bubbles, which is where I think the next crisis will come. Even strong effective regulations would only have a modest effect in my opinion.
Where do you see asset bubbles beginning to manifest ?

Or if not yet, which do you foresee as a potential risk ?
“The intelligent investor is a realist who sells to optimists and buys from pessimists.” | ― Benjamin Graham, The Intelligent Investor

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by Quark » Fri Feb 26, 2016 6:08 am

dmcmahon wrote:
alex_686 wrote:
One more thought. There is a "heads I win, tails you lose" proposition at the heart of most financial institutions. All things being equal, the company that has the most leverage will have the highest return on investment for the investors. Unless the bank goes bust, where the diversified stockholder will barely notice the blip and the banker now needs to find a new job.
The board of directors would in theory care, as would diversified stockholders if they looked at the banks in aggregate. So would the unemployed banker, if his or her resume of failed speculations followed him/her around. All else being equal, fear of catastrophe is needed to keep leverage in check, IMO.
You might consider how well that theory worked in 2007 and 2008. As Alan Greenspan said on the subject, "I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms". http://www.theguardian.com/business/200 ... -greenspan

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by Valuethinker » Fri Feb 26, 2016 7:15 am

Fat-Tailed Contagion wrote:Hi Bogleheads,

First, please refrain from political commentary.

After re-watching 'The Big Short' and "Inside Job', my question is how have regulations changed since then?

1. In the derivatives markets ?

2. In the leverage ratios of banks ?

3. Other safeguards ?

This is a very actionable question for me and I believe every investor needs to be educated on these issues in evaluating risk management in the overall context of portfolio construction and strategy.

Thanks for the help!

Fatty
One reasonable test is are the banks screaming? And the answer is yes, everyone is trying to avoid becoming a SIFI (Systemically Important Financial Institution). So the regulation is working to a point. Deutsche is in trouble for not having 12% equity capital- -before the crisis none of the investment banks did, and few of the commercial banks.

AT1s (convertible bonds, cocos, convertible in a crisis to equity) are untested-- but that's a European problem. The US banks issued *equity*.

The real problem is the shadow banking industry has resumed its growth and is huge. THAT is the global threat.

2 areas of likely bubble in USA right now:

- car finance. Loans and terms that look pretty much like sub prime mortgages. Exploitation of vulnerable consumers. Passing the risk parcel via securitization Etc.etc.

- commercial real estate. Prices back above 2007 levels. A lot of secondary and tertiary properties have been bid up to unrealistic levels (and prime is off the scale) as investors have sought income

Otherwise we already know: sub investment grade debt to energy and raw materials cos (20% of the market). Energy is a bubble that has "popped" but most companies cannot make money at $30/ barrel on current configurations-- lots of pain to go.

VC Unicorns. Another bubble just blowing up as we speak although it's been on the cards for over a year.

International bubbles

- EM we know. But Brazil could get a lot worse. A LOT worse. And the Saudis run out of money in c. 4.5 years. They keep that place buttoned down with a huge welfare and military spend, if they have to cut that-- Saudi Arabia has one of the youngest populations on the planet, and high unemployment (as did Syria and Libya).

- not a bubble but anything to do with Vladimir Putin's Russia-- he is both ruthless, opportunistic and buoyed by success in Ukraine and Syria. Very dangerous situation.

- EU and the refugee crisis and the impact on domestic EU politics. Marine Le Pen etc. 'nuff said

- Turkey for all the reasons we all know: war on its frontiers, internal war, autocratic politics, vulnerable economy etc.

- the Eurozone is not a "bubble" but apocalypse is still possible. Greece gets cut off from Schengen (free border rights) does Greece then default?

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by alex_686 » Fri Feb 26, 2016 7:59 am

dmcmahon wrote:
alex_686 wrote:
One more thought. There is a "heads I win, tails you lose" proposition at the heart of most financial institutions. All things being equal, the company that has the most leverage will have the highest return on investment for the investors. Unless the bank goes bust, where the diversified stockholder will barely notice the blip and the banker now needs to find a new job.
The board of directors would in theory care, as would diversified stockholders if they looked at the banks in aggregate. So would the unemployed banker, if his or her resume of failed speculations followed him/her around. All else being equal, fear of catastrophe is needed to keep leverage in check, IMO.
We can have a long, nauseated debate on this point. Part of the problem is that the risks are not the same on both sides.

If you take higher risks, you as a investor in a diversified portfolio come out as a winner even after accounting for a few busts . If you a CEO, the odds are you will be able to bank a big payout before things go bust.

In society, we want lots of risk takes stretching for that home run. A big, more dynamic economy for all. What we don't want is everybody making the same bet, which is what happened in 2008.

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by alex_686 » Fri Feb 26, 2016 8:02 am

Fat-Tailed Contagion wrote:Where do you see asset bubbles beginning to manifest ?

Or if not yet, which do you foresee as a potential risk ?
I am not smart enough to figure out exactly where the next bubble is going to be. Most asset classes are priced very high. i.e. low expected yield for the risk required. I kind of suspect we are going to have a Japaneses decade ahead of us. The bubble never pops, but nor does the economy pop upwards.

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Re: How has market regulation changed since 2008 Financial Crisis?

Post by Fat-Tailed Contagion » Fri Feb 26, 2016 12:51 pm

Thank you value and Alex for your thoughts :)
“The intelligent investor is a realist who sells to optimists and buys from pessimists.” | ― Benjamin Graham, The Intelligent Investor

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