New Regulatory Framework of Financial

New Regulatory Framework of Financial Institutions in the Aftermath of the Global Financial Crisis Over the last several years, the total amounts of regulation in the financial sector have been increasingly brought to the forefront. This is because of the elimination of key guidelines (i.e. The Glass Steagall Act) allowed firms to engage in tremendous amounts of speculation. What was happening is a number of banks had combined their operations with different brokerage firms. The basic idea was to offer consumers with greater amounts of products and services.

(Rottman, 2008) The newest and most popular was the adjustable rate loan (a.k.a. subprime mortgage). This is a home loan that was underwritten by U.S. government backed agencies (such as Fannie Mae and Freddie Mac). They would encourage banks to offer mortgages to consumers with low income or less than perfect credit. What they did not tell borrowers is that interest rates were sitting at multi-decade lows. When they start to increase, their mortgage payments will rise. This is problematic because it will force borrowers to default simultaneously.

(Rottman, 2008) To make matters worse, many of these banks worked with their retail brokerage units and began marketing these investments around the globe. These were called collateralized mortgage obligations (i.e. CMOs). Since the 1980s, this was used as way to purchase many different mortgages and bundle them together (in what is known as a tranche). The idea is that this would reduce default risk and help to increase the total return for investors.

In the early 2000s, these kinds of investment schemes became more complex with many tranches established (which had nothing but subprime mortgages). These assets were sold to investors with the belief that the U.S. government was guaranteeing these loans (from their involvement in the underwriting process). This meant that investors could realize higher returns with reduced amounts of risk (which increased their popularity). (Rottman, 2008) These conditions set off a wave of foreclosures that would lead to the worst housing crisis since the Great Depression.

To make matters worse, the reduced trade barriers created the near collapse of the financial system with a number of large banks holding subprime mortgages. The problem is they could not be sold, as the credit markets were frozen and they needed access to fresh working capital. The results were that a number of firms became "too big to fail" and were provided with assistance from the federal government. This is the only way they were able to avoid bankruptcy.

The purpose of this study is to focus on the causes of crisis and what steps can be taken to prevent these situations in the future. (Rottman, 2008) The working hypothesis that we created is: The past and current challenges have transformed the financial system. This is has resulted in greater amounts of regulation and oversight. These changes are leading to a shift in the regulatory framework that is focused on protecting the interests of the general public.

Over the next 20 to 30 years, this will create a series of standards that will provide the system with long-term stability. This theory will help to focus the research and concentrate on specific areas of this problem. It is at this point that the findings will be more precise. (Rottman, 2008) The methodology that will be utilized is the qualitative approach. This is when an analysis of different sources and their findings are conducted on the underlying causes of the crisis / how it can be prevented.

This will help actuaries to identify key trends and the impact of current initiatives. To achieve these objectives a number of areas will be examined to include: conducting a literature review, providing a model for core analysis and offering empirical evidence. Together, these elements will highlight the way these problems are being addressed and what the regulatory framework will look like in the future.

("What is Qualitative Research," 2012) Literature Overview The Causes of the Financial Crisis The different sources of literature are showing how there are many causes of global financial crisis. For example, in a study that was conducted by the University of Virginia. They determined that the financial crisis was worse in select firms (i.e. those with large institutional ownership and independent boards). According to Erkens (2012) (the lead author of the study) a total of 296 firms in 30 different countries were examined which exhibited these characteristics.

(Erkens, 2012) Commenting about their findings he observed, "Using a unique dataset of 296 financial firms from 30 countries that were at the center of the crisis, we find that firms with more independent boards and higher institutional ownership experienced worse stock returns during the crisis period.

This is because (1) the organizations with higher institutional ownership took more risk prior to the crisis, which resulted in larger shareholder losses during the crisis period and (2) companies with more independent boards raised more equity capital during the crisis, which led to a wealth transfer from existing shareholders to debt holders." These insights are showing how despite an independent board of directors, any excessive capital was used to satisfy bondholders.

This is because the firm had taken on so much debt and risky assets that they needed to use all liquidity to address these concerns. When this happened, all working capital was utilized to satisfy these obligations vs. helping the company adapt with new challenges. (Erkens, 2012) The information from this source is useful, in showing how the primary causes of the financial crisis were from excessive amounts of risk taking. This is because large institutions were placing pressure on executives to meet the Wall Street consensus.

The only way that this could be achieved was to target subprime borrowers and begin aggressively underwriting these securities. In the short-term, the earnings for the firm increased. However, over longer periods of time is when the debt and total number of risky assets rose exponentially. This is the point that the firm needed to restructure its balance sheet. Any kind of working capital that was received only paid off some of the bondholders.

As a result, a large number of institutions were hurt by their inability to reduce risks over the long-term. (Erkens, 2012) Moreover, Crawford (2011) found that the repeal of the Glass Steagall Act played a major part in determining the amounts of risk financial firms were taking. This is a Depression Era law that was enacted in 1933 as a part of the New Deal. When it was first ratified, many banks vowed to repeal it. This is because it gave the government too much oversight into the activities of private firms.

This made it difficult for American banks to compete against international conglomerates. (Crawford, 2011) However, the law prevented abuses by making it illegal for banks, brokerage firms and insurance companies to become involved in each other's activities. This prevents large institutions from developing that could be taking excessive abuses with the working capital they are receiving from investors and shareholders. (Crawford, 2011) Until the late 1990s, the Glass Steagall Act was accepted as an economic reality for 65 years. Then, the banks began to complain how they cannot compete against international organizations.

This would limit their ability to offer a variety of products to customers in numerous regions of the world. At the same time, this will lower the total amounts of fees consumers are paying for these products. (Crawford, 2011) To monitor the sector the self-regulatory approach was utilized. This is when firms will have the industry establish an organization to ensure that everyone is following different standards. These changes, led to abuses with these entities not carefully examining the financial records of these firms.

(Crawford, 2011) To make matters worse, subprime mortgages were created after many of the different securities regulations were first enacted. This meant that they did not qualify as bond, because this asset class did not fall into one of the defined categories. Over the course of time, these areas were unregulated and traded on a market that was only available to financial institutions. When the crisis began, this set the stage for most regulators and executives not to understand their exposure to these risks.

This is the point that bankruptcies could be announced overnight for some of the strongest firms on Wall Street (i.e. Lehman Brothers). (Crawford, 2011) The combination of these events occurred because the Glass Steagall Act was not in place to limit the activities of firms. This created a situation where executives focused on increasing their profit margins at all costs.

Evidence of this can be seen with a plea from Senator Paul Wellstone (who was opposed to repealing the law) with him saying, "The repeal of Glass-Steagall would enable the creation of financial conglomerates which would be too big to fail. Furthermore, the regulatory structure would not be able to monitor the activities of these financial conglomerates and they would eventually fail due to engaging in excessively risky financial transactions.

Ultimately, the taxpayers will be forced to bail out these too-big-to-fail financial institutions." (Crawford, 2011) These comments are showing how Wellstone understood the risk that this would pose to the financial system. In eight years after making this speech, the federal government would be directly bailing out firms that were too big to fail. This is indicating how the repeal of the Glass Steagall Act allowed financial institutions to engage in excessive amounts of risk taking.

It is at this point that they took on large amounts of debt and had no accountability. (Crawford, 2011) The information from this source is useful in showing how the repeal of certain laws helped to create situations which allowed for an atmosphere of deregulation. This set the stage for excessive amounts of risk taking with the liquid assets of the firm. When this happened, many institutions began to engage in activities that were believed to be safe.

However, they were considered to be speculative and increased the company's risk position exponentially. This shows what the regulatory environment was like prior to the financial crisis and those factors allowed it to occur. (Crawford, 2011) The lack of regulation has led to a concentrated push in having the federal government increasing the underlying guidelines inside the sector. This occurred with a focus on the size of these firms and how they were able to become so vulnerable.

The results were that the organizations did not have any kind of responsible lending activities. Instead, they were basically approving loans without analyzing the borrower's ability to pay back the money or their income / credit history. Once interest rates increased, is when many of them could simply walk away from having very little invested in the house. (Crawford, 2011) Solutions and New Regulatory Approach in the Global Financial Aftermath In response to these challenges, the federal government has enacted the Dodd Frank Wall Street Reform and Consumer Protection Act.

This law is reversing the deregulation from the late 1980s and 1990s. Under the new guidelines, a Consumer Protection Agency will have the authority to monitor the transactions of financial firms. Those organizations that are becoming a threat to the economy will be reduced in size from this entity.

(Steiner, 2012) Evidence of this can be seen with observations from Steiner (2012) who said, "Recent bad corporate behavior compelled legislators to step in and tweak corporate governance by giving shareholders proxy access and allowing them to vote on executive pay and golden parachutes. Small investors may also get more protection when it comes to their investment advisers. Retail investors are rarely aware that it's perfectly legal for brokers to overcharge customers -- as long as suitability standards are met.

With the new legislation, investors will get the assurance of knowing that brokers have to put their customers' best interests first. Finally, people with money in the bank can rest easier knowing that FDIC insurance will permanently cover more of their funds." (Steiner, 2012) These insights are showing how Dodd Frank is increasing the overall protections that are available. For all classes of investors, this is resulting in more honest practices when it comes to commissions and the kinds of products that are recommended.

This will provide the industry with a set of morals and guidelines that will automatically reduce risks for these firms. (Holzer, 2012) (Steiner, 2012) The results of the Dodd Frank Act are that the new Consumer Protection Agency is directly going after areas that are creating potential problems for the financial system. For example, in the last year the SEC has wanted to impose new rules on money market funds. This is because they determined that they were engaging in risky practices by investing in areas that are considered to be safe.

Yet, they offer a higher return and greater amounts of income. Historically, these assets have always traded at $1.00. This is because it was believed that the practices of money managers were focused on meeting FDIC guidelines. (Holzer, 2012) (Steiner, 2012) However, once the financial crisis began is when they were exposed for making purchases of subprime mortgages and other areas that were thought to be safe. To address these issues, the SEC wants to have prices trade similar to mutual funds.

This will force the markets to accurately evaluate these areas and they are increasing disclosure requirements. Recently, one of the commissioners on the SEC was blocking any attempts to impose these guidelines.

Then, when the Consumer Protection Agency stepped in, is the point that this person reversed their position (allowing for the implementation of these new guidelines) (Holzer, 2012) Commenting about what is happening is Holzer (2012) who said, "Money funds typically invest in short-term debt instruments and, similar to investors, they pay back the amount that they put in (exactly $1 per share on top of any interest). In 2008, the collapse of Lehman Brothers led to a fund that held Lehman debt to 'break the buck' or fall below $1.00 peg (a rare event).

The government intervened to prevent panic from spreading to other parts of the financial system, and the aim of any regulatory overhaul is to prevent a similar kind of situation." This is illustrating how the markets can provide investors with more accurate information about the risks in these assets. The ability to float against the $1.00 mark will help them to determine this and conduct more precise analysis. These provisions might not have been implemented, if the Consumer Protection Agency wasn't there to play an important role.

(Holzer, 2012) Moreover, the introduction of these provisions will require money market funds to register with the SEC under the Investment Company Act of 1940. This mandates that all mutual funds and other investment related companies must provide disclosures about their investing activities and risks. The fact that money market funds will be forced to follow these standards makes them list any assets that are more risky. In the future, this will assist investors by having better information surrounding specific areas.

(Holzer, 2012) The information from these sources is showing how the regulatory environment has changed after the financial crisis. What is occurring is the federal government has begun to take a more active role in regulating the size of financial institutions and the activities they are involved in. The results are that the entire industry will face increased amounts of scrutiny surrounding their activities. (Holzer, 2012) For a number of years, this will help to promote the long-term stability of the sector.

However, everything will change once financial institutions are able to remove the various protections that are in place. If history is any guide, there will always be attempts to remove these restrictions as the economy changes and adjusts. The key is creating an environment that promotes healthy competition and has effective regulations that will limit abuses. This is the challenge that the global financial markets will face for many decades to come. (Crawford, 2011) Furthermore, Dodd Frank is directly targeting hedge funds and the activities of medium sized investment advisors.

Under the new law, both are required to register with SEC and disclose their investing activities. For hedge funds, this is designed to prevent speculation and ensure that there is increased transparency. This prevents these firms from taking excessive amounts of risk. Prior to the implementation of these laws, any kind of regulation was considered to be voluntary and only 10% of hedge funds participated. ("More than 1,500 Private Fund Advisors," 2012) While medium sized investment advisors were regulated by the state.

However, the concerns about Ponzi schemes and the potential for others developing, resulted in these firms registering with the SEC vs. The state. This is supposed to improve the reporting and monitoring of how client assets are stored / protected. ("More than 1,500 Private Fund Advisors," 2012) Commenting on these changes is SEC Chairperson Mary Shapiro who said, "Prior to the Dodd-Frank Act, regulators only saw a slice of the pie but didn't know how big the pie even was.

The law enables regulators to better protect investors by providing a more comprehensive view of who's out there and what they're doing." This is illustrating how the law will have long-term positive effects on consumers. As firms will be forced to provide them with more information and there will be greater amounts of scrutiny over their activities. ("More than 1,500 Private Fund Advisors," 2012) The information from this source is illustrating how there will be an aggressive focus from regulators.

This is because they want to prevent any kinds of situations from becoming out of control early. The new found authority that they are receiving from the laws such as Dodd Frank will set the tone in the way rules are enforced. In the future, this means that these guidelines will create a set of acceptable practices for everyone to follow. This is the point that the financial system will have greater amounts of stability.

("More than 1,500 Private Fund Advisors," 2012) The Model or Core Analysis Like what was stated previously, the basic model that will be used to conduct the research is the qualitative approach. This is when there will be a focus on the findings of different studies and.