The recourse rule, regulatory arbitrage, and the financial crisis
- 236 Downloads
In November 2001, regulators finalized the “Recourse Rule.” The rule lowered risk weights, and therefore commercial bank holding company capital requirements, to 0.2 for holdings of AAA- and AA-rated “private label” securitization tranches, created by investment banks and securitizing commercial bank holding company subsidiaries; risk weights for A-rated holdings equaled 0.5. The rule’s aim was to encourage securitization, but not risk-taking. Regulators indicated that the rule would apply to larger holding companies, without identifying them. Using bank holding companies with subsidiaries that commented on the proposed rule-makings as a treatment variable, average treatment effects from a fully flexible difference-in-differences model indicate that treated banks increased their holdings of the highly rated tranches relative to total assets, while other holding companies, on average, did not. Holding companies with greater highly rated tranche holdings also experienced greater increases in risk after Q1 2008, which suggests that poor performance may have been unanticipated.
KeywordsDifference-in-differences Financial crisis Regulatory capital requirements Securitization Unintended consequences
JEL ClassificationE02 F33 G01 G18 G28
I thank Hester Peirce, Chris Koch, Jeffrey Friedman, Darryl Getter, Thomas Hogan, Ricardo Mora, Lourdes Hilbers at the Federal Reserve’s Freedom of Information Office, Kevin Satterfield at the Office of the Comptroller of the Currency’s Communications Division, Natasha Smith at the Federal Deposit Insurance Corporation’s FOIA/Privacy Act Group, Jerry Ellig, Kristine Johnson, Susan Dudley, Brian Mannix, Sofie Miller, Chad Reese, Ben Klutsey, Youjin Hahn, Hee-Seung Yang, Joe Reid, Tyler Cowen, Thomas Stratmann, participants at the 2015 Western Economic Association Meetings, especially Jin-Ping Lee, participants at the 2017 Southern Economic Association Meetings, especially Weici Yuan, participants at the 2018 Public Choice Conference, especially Julia Norgaard and participants at the research seminar series at Auburn University, especially Jim Barth, for helpful discussions. I also thank an anonymous reviewer and the Editor, Menahem Spiegel, for valuable suggestions.
Compliance with ethical standards
Conflict of interest
The author declares that they have no conflicts of interest.
- Admati, A., DeMarzo, P., Hellwig, M., & Pfleiderer, P. (2014). Fallacies and irrelevant facts in the debate on capital regulation. In C. Goodhart, D. Gabor, J. Vestegaard, & I. Erturk (Eds.), Central banks at a crossroads: Europe and beyond (pp. 33–50). London: Anthem Press.Google Scholar
- Admati, A., & Hellwig, M. (2013). The Bankers’ new clothes. Princeton, NJ: Princeton University Press.Google Scholar
- Cordell, L., Huang, Y., & Williams, M. (2012). Collateral damage: Sizing and assessing the subprime CDO crisis. Federal Reserve Bank of Philadelphia Working Paper No. 11-30.Google Scholar
- Friedman, J., & Kraus, W. (2011). Engineering the financial crisis: Systemic risk and the failure of regulation. Philadelphia: University of Pennsylvania Press.Google Scholar
- Haldane, A. (2012). “The Dog and the Frisbee” (speech by Andrew Haldane, executive director, financial stability, Bank of England, and Vasileios Madouros, economist, Bank of England, at the Federal Reserve Bank of Kansas City’s Economic Policy Symposium, “The Changing Policy Landscape,” Jackson Hole, Wyoming, August 31, 2012).Google Scholar
- Kapstein, E. (1991). Supervising international banks: Origins and implications of the Basle Accord. Essays in international finance, No. 185. International Finance Section, Princeton University.Google Scholar
- Kapstein, E. (1994). Governing the global economy. Cambridge, MA: Harvard University Press.Google Scholar
- Mabel, C. (2001). Bank capital requirements for retained interests in securitizations. North Carolina Banking Institute, 5, 233–264.Google Scholar
- Merrill, C. B., Nadauld, T. D., & Strahan, P. E. (Forthcoming). Final demand for structured finance securities. Management Science, https://doi.org/10.1287/mnsc.2017.2827.