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Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance

Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance (0470768770) cover image
Experts from NYU Stern School of Business analyze new financial regulations and what they mean for the economy

The NYU Stern School of Business is one of the top business schools in the world thanks to the leading academics, researchers, and provocative thinkers who call it home. In Regulating Wall Street: The New Architecture of Global Finance, an impressive group of the Stern school’s top authorities on finance combine their expertise in capital markets, risk management, banking, and derivatives to assess the strengths and weaknesses of new regulations in response to the recent global financial crisis.

  • Summarizes key issues that regulatory reform should address
  • Evaluates the key components of regulatory reform
  • Provides analysis of how the reforms will affect financial firms and markets, as well as the real economy

The U.S. Congress is on track to complete the most significant changes in financial regulation since the 1930s. Regulating Wall Street: The New Architecture of Global Finance discusses the impact these news laws will have on the U.S. and global financial architecture.

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Foreword.

Preface.

PROLOGUE: A BIRD'S-EYE VIEW.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Viral V. Acharya, Thomas Cooley, Matthew Richardson, Richard Sylla, and Ingo Walter).

PART ONE: Financial Architecture.

CHAPTER 1: The Architecture of Financial Regulation (Thomas Cooley and Ingo Walter).

CHAPTER 2: The Power of Central Banks and the Future of the Federal Reserve System (Thomas Cooley, Kermit Schoenholtz, George David Smith, Richard Sylla, and Paul Wachtel).

CHAPTER 3: Consumer Finance Protection (Thomas Cooley, Xavier Gabaix, Samuel Lee, Thomas Mertens, Vicki Morwitz, Shelle Santana, Anjolein Schmeits, Stijn Van Nieuwerburgh, and Robert Whitelaw).

PART TWO: Systemic Risk.

CHAPTER 4: Measuring Systemic Risk (Viral V. Acharya, Christian Brownlees, Robert Engle, Farhang Farazmand, and Matthew Richardson).

CHAPTER 5: Taxing Systemic Risk (Viral V. Acharya, Lasse Pedersen, Thomas Philippon, and Matthew Richardson).

CHAPTER 6: Capital, Contingent Capital, and Liquidity Requirements (Viral V. Acharya, Nirupama Kulkarni, and Matthew Richardson).

CHAPTER 7: Large Banks and the Volcker Rule (Matthew Richardson, Roy C. Smith, and Ingo Walter).

CHAPTER 8: Resolution Authority (Viral V. Acharya, Barry Adler, Matthew Richardson, and Nouriel Roubini).

CHAPTER 9: Systemic Risk and the Regulation of Insurance Companies (Viral V. Acharya, John Biggs, Hanh Le, Matthew Richardson, and Stephen Ryan).

PART THREE: Shadow Banking.

CHAPTER 10: Money Market Funds: How to Avoid Breaking the Buck (Marcin Kacperczyk and Philipp Schnabl).

CHAPTER 11: The Repurchase Agreement (Repo) Market (Viral V. Acharya and T. Sabri Oncu).

CHAPTER 12: Hedge Funds, Mutual Funds, and ETFs (Stephen Brown, Anthony Lynch, and Antti Petajisto).

CHAPTER 13: Regulating OTC Derivatives (Viral V. Acharya, Or Shachar, and Marti Subrahmanyam0.

PART FOUR: Credit Markets.

CHAPTER 14: The Government-Sponsored Enterprises (Viral V. Acharya, T. Sabri Oncu, Matthew Richardson, Stijn Van Nieuwerburgh, and Lawrence J. White).

CHAPTER 15: Regulation of Rating Agencies (Edward I. Altman, T. Sabri Oncu, Matthew Richardson, Anjolein Schmeits, and Lawrence J. White).

CHAPTER 16: Securitization Reform (Matthew Richardson, Joshua Ronen, and Marti Subrahmanyam).

PART FIVE: Corporate Control.

CHAPTER 17: Reforming Compensation and Corporate Governance (Jennifer Carpenter, Thomas Cooley, and Ingo Walter).

CHAPTER 18: Accounting and Financial Reform (Joshua Ronen and Stephen Ryan).

Epilogue.

About the Authors.

About the Blog.

Index.

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Viral V. Acharya is Professor of Finance at New York University Stern School of Business.

Thomas F. Cooley is Dean Emeritus and the Paganelli-Bull Professor of Economics at New York University Stern School of Business, as well as a Professor of Economics in the NYU Faculty of Arts and Science.

Matthew P. Richardson is the Charles E. Simon Professor of Applied Financial Economics at New York University Stern School of Business.

Ingo Walter is the Seymour Milstein Professor of Finance, Corporate Governance and Ethics and Vice Dean of Faculty at New York University Stern School of Business.

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"A fascinating, lively, and thoroughly readable guide to the Dodd-Frank Act that pierces the cloud of confusion that hangs over so much of the financial reform debate. It is extremely timely and valuable, and should be required reading for all policymakers, investors, and students of finance. What makes the book so valuable is that it not only analyzes the scope of the Act, in a punchy, lively style, but it also discusses its potential impact. More important, the book analyzes what is not covered in the Act—and where the potential challenges to the financial system still lie."
Gillian Tett, U.S. Managing Editor, Financial Times

"The crisis of 2008 confronted even well-educated Americans with a flood of incomprehensible financial vocabulary, describing novel financial institutions and practices most of us had never heard of before. Now we have the 2,300-page Dodd-Frank Act, designed to provide the needed repair. Will it do so? What else will it do? How can we even start to think about these basic questions? Regulating Wall Street addresses these questions in a clear, direct style, taking us through the many parts of the Act one at a time, and providing informed, cogent economic analysis of each. A valuable standard source for future discussion."
Robert E. Lucas, University of Chicago, 1995 Nobel Laureate

"Take the faculty of one of the best finance departments in the world. Ask them to analyze the new U.S. legislation on financial regulation, and to think about what the new law gets right, what it gets wrong, and how it is likely to shape the future of the financial system. With a bit of luck, you get this very impressive book. An absolute must-read."
Olivier Blanchard, Chief Economist, International Monetary Fund

"Regulating Wall Street goes a long way toward clarifying the intent of the various provisions of the Dodd-Frank Act and evaluating both its effectiveness and limitations. The need for effective implementation by agencies is appropriately emphasized. Not a quick read, a useful reference work on an enormously complex piece of legislation, dealing with an even more complex financial reality."
Paul Volcker, Chairman of the Economic Recovery Advisory Board and former Chairman of the Federal Reserve (1979–1987)

“There are many villains in the story of the recent crisis and much written to name them, describe them and even curse them. . .  If you want to know how to fix the problem, I highly recommend ‘Regulating Wall Street,’ from New York University’s Stern School of Business. . .  In the excellent book, ‘Regulating Wall Street,’ several of the studies indicate that there are few synergies among financial activities that could lead to economies of scope. The studies also demonstrate that multiple functions in large, complex firms can actually increase systemic risk. Moreover, they suggest that the spun-off activities could thrive without explicit or implied government support.  The conclusion in this book is that separating activities in this manner, together with stronger resolution processes and better capital standards, would do much to strengthen our financial system, making it more accountable and stronger.”
Thomas M. Hoenig, President, Federal Reserve Bank of Kansas City

"Readers should read Regulating Wall Street to understand why, in the face of market failures and copious evidence that Wall Street is unproductive, Congress and regulators labored mightily to resurrect the financial intermediation racket just as it existed on September 12, 2008." (Tax Notes)

“If you want to know how to fix the problem, I highly recommend Regulating Wall Street, from New York University’s Stern School of Business.”
Karl Denninger, Seeking Alpha

“One refreshing sign of hope for constructive change is that economists, some of whose theories had much to do with a light regulatory approach toward derivatives and the housing bubble, are increasingly producing research calling for stricter guidelines then Dodd-Frank or the Obama administration. Regulating Wall Street presents a wide range of new research supporting stronger regulations than Dodd-Frank recommends, such as . . . tax proposals. . . In the prologue of Regulating Wall Street, the editors, hardly known as progressives, remind financiers how useful strong regulations were in the past. . . We would be better off if the powers on Wall Street would remember. . . “
(New York Review)

 

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February 08, 2012
Regulating Wall Street

In December 2008, a working group of faculty from NYU Stern School of Business developed 18 independent policy papers on the causes of the financial crisis and proposals for market-based solutions, which captured the attention of policymakers in Washington and were published in a book, Restoring Financial Stability (Wiley, March 2009). In reaction to the passage of the Dodd-Frank Act, the most significant U.S. financial regulation since the 1930s, they return with a strong call-to-action to regulators in their current book, REGULATING WALL STREET (Wiley; November 2010; $49.95; 978-0-470-76877-8).

More than 40 NYU Stern finance, economics, and accounting professors stress key flaws in the bill, and how these failures could set the next global financial crisis in motion. As 11 different regulatory agencies now begin the process of adopting the Act’s 243 new formal rules, the faculty offer key proposals to integrate into this critical legislation whose outcomes, due by December 2011, will shape the future of global financial architecture for years to come.

Major Criticisms of the Act

 Flaw #1: Government guarantees remain mispriced in the financial system, leading to moral hazard. 

  • Problem: The Dodd-Frank Act needs to address the fact that financial institutions can still finance their activities at below-market rates, effectively a subsidy, and take on excessive riskIt is unlikely that the Act’s proposed orderly liquidation authority will be a sufficient remedy.
  • Recommendation: Dodd-Frank should recognize and charge financial firms for these guarantees where they exist. Furthermore, the book describes more credible resolution plans to deal with failures of every type of institution, so that market discipline can be restored to financial markets. 

Flaw #2: The Act does not sufficiently discourage individual firms from putting the system at risk. 

  • Problem: Firms need to be held accountable not just for their own losses, but also for the cost that their failure would impose on the system. While the Act tries to achieve this goal, it is poorly designed in that surviving banks pay the cost of the failed firms who contribute to systemic risk. If and when another crisis evolves, banks, already struggling for survival, should not have to bear the financial burden of failing institutions.
  • Recommendation: The authors develop a new measure of systemic risk and then show how firms can optimally be made to internalize systemic risk costs whether through an upfront systemic risk tax, through higher capital requirements, or through some limits on systemically risky activities.

Flaw #3: The Act falls into the familiar trap of regulating by form rather than function.

  • Problem: By solely addressing the failures of banking institutions, regulators are excluding the systemically important shadow banking system that serves similar functions, such as clearing houses or money market funds. Excluding these groups of institutions makes the system vulnerable, prohibits access to emergency funding, and creates an unlevel playing field. 
  • Recommendation: The book suggests that it is imperative the Act address the shadow banking system and its resulting systemic risk and treat many shadow institutions in the same way it treats banks. Doing so will better account for the prevalent systemic risk and limit the amount of shadow activity that is dangerous and unregulated.

Flaw #4: Regulatory arbitrage is not adequately addressed, so large parts of the shadow banking sector remain in their current form.

  • Problem: The tale of this crisis was that large, complex financial institutions exploited capital regulatory requirements to take a concentrated one-sided bet, and other parts of the financial system managed to avoid requirements all together by operating in the “shadows.” Many of the problems can be sourced to the Basel Accords and its approach to regulation.
  • Recommendation: The authors recommend and provide suggestions for a consistent framework so that financial innovation arises from efficiency considerations and not regulatory loopholes. Special attention is given to OTC derivatives, repo, and money markets.
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