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Law Office of Ronald David Greenberg

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Securitization, Eurodollars,Mortgage-backed Securities

Outline of contents

• Focus
• Basic comparison: borrower in eurodollar market and in securitization
Creditworthiness and identity of borrower
Disclosure regime
• Securitization implications
Securitization in the eurodollar market
Accounting for securitization of bank assets in eurodollar market
History of mortgage-backed securities and Glass-Steagall
Securitization in the mortgage-backed-securities market
Was Glass-Steagall law root cause of financial crisis?
Glass-Steagall Act repealed; universal banking
Glass-Steagall regime v. universal banking
Covered bonds (on-balance sheet); mortgage-backed securities (off-balance sheet)
Tax issues
• Congressional and other reports
Financial Crisis Inquiry Commission Report
Senate Report on Financial Crisis
• Congressional legislation and regulation
Dodd-Frank Wall Street Reform and Consumer Protection Act
Effectiveness of Dodd-Frank
Dodd-Frank on accountability and executive compensation
Credit rating agencies
Dodd-Frank regulations forthcoming; possible repeal (in whole or in part) of Dodd-Frank
• Financial system structure
Criticism of, and action/inaction against, Wall Street
Consequences beyond financial industry
Financial crisis impact on states
Financial crisis impact on world economy
Securitization impact on expansion of credit and effectiveness of reserve requirements

Concentration of banking industry

Possible alternative future models
Other alternative models
• Goal
s of banking regulatory regime
Enhance virtues of capitalism/free markets
Overcome difficulty of reaching a consensus
Recognize banking's special role and responsibility


Focus

The focus
here is on both
the eurodollar market discussed inThe Eurodollar Market: The Case for Disclosure, 71 Calif. L. Rev. 1492, at 1503-1515 (1983) [The Eurodollar Market: The Case for Disclosure] and the mortgage-backed securities (MBS) market.See belowSecuritization implications. Click herefor more information on article. Click also "publications (with links) at Articles" on Navigation Bar. Click also "curriculum vitae at Research & Publications (Articles)" on Navigation Bar at: The Eurodollar Market: The Case for Disclosure, translated into Japanese, H. Murata, 2 Matsusaka J. Pol. Sci. Econ. (1983). For other expressions of interest, see "Selected Requests for Permission to Reprint and Other Expression of Interest" in "curriculum vitae" on Navigation Bar.For more information on translation, click here.

The Eurodollar Market: The Case for Disclosure analyzes the desirability of regulation, feasibility of regulation, disclosure as a mode of regulation, subject to scrutiny of a supranational bank or supranational agency such as the International Monetary Fund (I.M.F.) or Bank for International Settlements (B.I.S.); the article also discusses macroeconomic regulation (e.g., a government's entering world capital markets) and microeconomic regulation (e.g., restrictions on lending; restrictions on investment activity). It suggests a possible regulatory approach a reasonable disclosure regimen with participation of international organizations (e.g., I.M.F. or B.I.S.) and national monetary authorities, agreeing to formulate disclosure guidelines; disclosure does not directly limit market participants' actions and is an indirect regulatory approach (thereby recognizing the difficulties of reaching a multinational accord on more stringent/substantive regulation).


Cf., e.g., Paul M. McBride, The Dodd-Frank Act and OTC Derivatives: The Impact of Mandatory Central Clearing on the Global OTC Derivatives Market, 44 The International Lawyer, 1077 (Winter 2010) [mandatory central clearing under Dodd-Frank [see belowCongressional legislation and regulation at "Dodd-Frank Wall Street Reform and Consumer Protection Act"] increases systemic risk and does guarantee their stability or transparency; voluntary, not compulsory, clearing market participants strike optimal balance between costs and benefits of clearing; sustained cooperation with gentle regulatory pressure will perhaps result in financial stability and reduced systemic risk; some jurisdictions seem to feel that this type of market evolution is better suited to incentives rather than prescriptive rules (emphasis added) (quoting Jill Sommers, Comm'r., U.S.CFTC, Address at Georgetown University: Financial Reform, What's Next? A U.S. and Global Perspective Examining the Opportunities and Challenges Ahead (Oct. 26, 2010) available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opasommers-11.html or click here.].


The commentary below touches on these and other issues relevant to -- though not fully congruent with -- current aspects of both the MBS and eurodollar markets. These issues have political, economic, and other implications that are important internationally. The commentary here does not purport to be exhaustive or definitive; it attempts to limit its analysis to problem solving -- to recount alternative suggestions (both desirable and feasible ) as has been published in the literature. See also below:Financial system structure at "Possible alternative future models", at "Other alternative models", and at "Goal of banking regulatory regime".


Basic comparison: borrower in eurodollar market and in securitization

Creditworthiness and identity of borrower:In the eurodollar market the lending banks usually do not know the identity or creditworthiness of the finalborrower. In securitizations of mortgage-backed securities (MBS), the investors may be unknown to the originating institution, though its borrower's identity is known. But the borrower's creditworthiness frequently has been questionable and has weakened the pool of mortgages that is securitized. Both markets have involved the lack of financial information on the relevant borrower--whether at the end of the chain of lending (eurodollar market lending) or at the beginning of the chain of distribution of MBS (housing market lending).


With the trend in the eurodollar market away from lending to securitization, the underwriting bank will or should know the identity of the borrowers, as does the loan originator in the MBS market. In both the eurodollar market and MBS market, a note receivable (loan on the bank's balance sheet) that is packaged with others notes is sold to investors and traded by them on the secondary market.In both the eurodollar market and MBS market, thesale of note receivable results in decrease in the institution's notes receivable account and an increase in cash account on institution's balance sheet.For securitization in the eurodollar market, e.g., click here to view an excerpt of 11 N.C.J. Int'l L. & Com. Reg. 539 (1986) [discusses (at 574-582) FRNs, NIFs, and other instruments as of 1986 (pre-repeal of Glass-Steagall Act)] and here. See also, infra, Securitization implicationsat "Securitization in the eurodollar market".


Disclosure regime:A possible, but partial, regulatory solution for both markets might be a reasonable disclosure regime that would measure certain market activities while maintaining the participants' privacy with presumably appropriate protections. The market for mortgage-backed securities, like the eurodollar market, has international dimensions. Both markets might benefit from a reasonable disclosure model providing oversight and guidance by a supranational body or international treaty.Click here for more information on I.M.F. as supranational bank or here as supranational agency. Click here for more information on B.I.S. as supranational bank or here as supranational agency. For a recent recognition of new prominence for I.M.F. by,e.g., Sewell Chan, Debt Crisis Highlights I.M.F.’s Renewed Role, New York Times at B1 (Nov. 27, 2010), click here.For a suggestion by China on reforming global financial system and more influence in International Monetary Fund and the World Bank by, e.g., Dinny McMahon, China Seeks Global Finance Pact, Wall Street J. at c3 (Oct. 11, 2010), click here.


Securitization implications


Securitization in the eurodollar market: Securitization in the eurodollar market has occurred as the result of the trend from bank lending to marketable securities. Insofar as securitization occurs in the eurodollar market, the above discussion on MBS's has relevance also to the eurodollar market. See supraBasic comparison: creditworthiness of borrower in eurodollar market and in securitization.

Examples of securitization are (1) floating-rate notes (FRNs) borrowings by banks in eurobond market (interest payment varies with general level of interest rates (say, U.S. Treasury bill rate or LIBOR)) and (2) note issuance facilities (NIFs (a line of credit permitting borrower from bank to issue a series of short-term (
5 to 10 year) euronotes)). See, e.g., Richard A. Brealey and Stewart C. Myers, Principles of Corporate Finance at 807 (4th ed. 1991) [ now in 9th ed. 2008]. See also, e.g., Federal Reserve Bank of Richmond, Richmond, Virginia, 1998, Chapter 5, Eurodollars, by Marvin Goodfriend [Eurodollar FRNs have been issued primarily by banks and sovereign governments in maturities from 4 to 20 years, majority of issues concentrated in five- to seven-year range; NIFs have a medium-term, usually five- to seven-year arrangement between a borrower and an underwriting bank under which the borrower can issue short-term, usually three- to six-month, paper known as Euro-notes in its own name, and under such an arrangement, underwriting bank is committed either to purchase any notes the borrower cannot sell or to provide standby credit at a predetermined spread relative to some reference rate such as London interbank offered rate (LIBOR or Libor) (emphasis added)].

For information on securitization in the eurodollar market, e.g., click here to view an excerpt from Francis D.Logan, William J. Mahoney, David R. Slade, and Harry E. White, The Securitization of U.S. Bank Activities in the Eurodollar Market -- Issues for U.S. Counsel, 11 N.C.J. Int'l L. & Com. Reg. 539, at 539 (1986) [discusses FRNs, NIFs, and other instruments as of 1986 (pre-repeal of Glass-Steagall) and here. For more information on this subjectclick here[google™ results] andhere [HeinOnline]. For more on Libor see Joseph Palazzolo, Jean Eaglesham, and Carrick Mollenkamp, U.S. Asks If Banks Colluded on Libor, Wall Street J., at page C1 (April 14, 2011) [investigation into whether banks formed a global cartel to manipulate Libor; if rate kept artificially low, borrowers likely were not harmed, though lenders could complain that rates they charged on loans were too low].Click herefor more on this and other related articles on Libor.

Sometimes a bank prefers selling its share in a syndicated loan (very large loan made by syndicate of banks) where, e.g., each bank may transfer its share of the loan; transferable syndicated loans indicate the trend from bank lending to marketable securities. Id. at page 807, note 18. For more information on floating rate notes (FRNs) in eurodollar market, click here. For more information on note issuance facilities (NIFs) in eurodollar market, click here and here. For more information on revolving underwriting facilities (RUFs) in eurodollar market, click here. For more information on syndicated loans in eurodollar market, click here.

Accounting for securitization of bank assets: Floating-rate notes (FRNs) would be reflected on the bank's balance sheet as notes payable (liabilities) to account for the funds borrowed by the bank. Note issuance facilities (NIFs) that the borrower cannot sell would be recorded on the bank's balance sheet as investments in notes receivable (assets).When securitized, the NIFs are distributed (sold) to interested investors and then may be traded on the secondary market outside the United States; the NIF secondary market appears to resemble the mortgage-backed securities world-wide secondary market.Presumably a bank would participate in this market by distributing (selling) the NIFs to investors, recording the cash received on its balance sheet in place of the notes receivable that were securitized.

The bank could then enter further NIF underwriting arrangements, in effect, skirting the demand deposits reserve ratio regime, were such a requirement in effect outside the U.S. In any event, demand deposits and reserve ratio are unchanged on receipt of cash proceeds from securitization/sale of receivable sold and packaged as securities (e.g., expanding volume of NIFs held or traded, or both, in secondary market
yet not violating the usual reserve ratio requirement in the U.S. (which is designed to reign in unlimited expansion of credit)). Instead of lending the cash attributable to demand deposits, the bank can relend the cash received on the sale of notes receivable (e.g., NIFs) without disturbing its reserve requirements, if any, or reducing demand deposits, if any. Securitization renders reserve requirements ineffective. The resulting monetary expansion could continue until investors declined to purchase additional NIFs.

Click here, e.g., for more information on securitization generally[banks charge fees for services associated with securitization (re underwriting, loan servicing, and other aspects of securitization)].This scenario is to be inferred given the trend from bank lending to marketable securities. Click here , e.g., for more information on this trend. Query whether the NIFs are covered instruments (e.g., like covered bonds)?Were the NIFs to drop substantially in price in this secondary market, would international financial reporting standards require the bank's marking the NIFs to market?Click here, e.g., for more information on mark to market. Click here for IFRS versus Generally Acceptable Accounting Principles (GAAP). For more information on International Financial Reporting Standards (IFRS), e.g., click here and here. Click here, e.g., for more information on IFRS. In light of the importance of the Eurodollar market to the world's financial institutions and the world economy, and possible serious unforeseeable consequences from securitization, some form of disclosure de minimis regulation may be advisable for the eurodollar market. Click here for more information on benefits and risks.Click here, e.g., to view Francis Cherunilam, International Business: Text and Cases (2007).


History of mortgage-backed securities and Glass-Steagall: Mortgage-backed securities activity grew in the 1980s. See, e.g., Yves Smith, How the Banks Put the Economy Underwater, New York Times (Oct. 30, 2010) [mortgage securitization grew in the 1980s, transactions were written carefully, packaged loans were put into a trust to protect investors, a process that worked well until roughly 2004, when volume of transactions greatly expanded; an important problem was that many lenders ceased to be concerned about quality of the loans, because the investors in the securities, not the bank (originator of loan), would incur the risk of loss on borrower's default]. Click herefor more information on securitization. Click here for more on Yves Smith article.


Four reasons have been suggested for enactment of the Glass-Steagall Act: (1) investment banking is risky; (2) conflict of interest for banks (to be taking deposits, lending, and distributing securities); (3) concentration of power in banks; (4) promote specialization of securities market. Dennis E. Logue, Handbook of Modern Finance 4-1 to 4-3, 4-5 to 4-8 to 4-9, 4-29 (1984). Commercial banks in 1982 specialized in commercial lending rather than mortgages, yet constituted a substantial share (over 18%) of the mortgage market; institutional investors (e.g., pension funds and insurance companies) were buying mortgage-backed securities. Id. 10-25, 31-38, 33-7 to 33-18.


See also, e.g., William A. Lovett, Banking and Financial Institutions Law (3rd ed. 1992) [Glass-Steagall remained largely intact though 1987, although more substantial erosion occurred in the later 1980's; banks actively sought more securities powers, with emphasis on underwriting commercial paper, mortgage-backed securities, and revenue bonds, along with marketing of mutual funds; some large banks demanded full repeal of Glass-Steagall's separation of the commercial banking and securities industries; Congress refused to repeal Glass-Steagall (despite repeated lobbying pressure from many large banks, and, at times Reagan and Bush administrations), major erosion of Glass-Steagall occurred between 1987-1990; a series of regulatory decisions by Federal Reserve Board and the Comptroller of the Currency, some of largest money center banks were allowed to underwrite commercial paper, securitized mortgage-backed instruments, and many corporate bonds and stocks, plus to engage in lending to support private placements; most of this underwriting required to be effected via affiliates so as not to violate prohibition against being "principally engaged" in underwriting corporate securities; by 1989 some of largest U.S. banks (e.g., Citicorp, Morgan, and Banker's Trust) had became strong participants in U.S. domestic underwriting and were even stronger abroad]; David Skeel, The New Financial Deal (2011) at 5 [Dodd-Frank effects disclosure/transparency re derivatives by requiring them to be traded on an exchange]; William D. Cohan, Introduction to David Skeel, The New Financial Deal (2011) at xiv [Gramm-Leach-Bliley Act made de jure what had been de facto: Glass-Steagall was dead].


Securitization in the mortgage-backed-securities market: Securitization in the mortgage-backed securities market is similar in many respects to that described above for the eurodollar market (see supraSecuritization implications at "Securitization in the eurodollar market"). See also, e.g., the ProPublica's series of Jake Berstein and Jesse Eisinger, "The Wall Street Money Machine" [Summarized on its site -- "The Story So Far: As the housing market started to fade, bankers and hedge funds scrambled for ways to maintain the lavish bonuses and profits they had become so accustomed to, repackaging mortgages in complex securities called collateralized debt obligations. The booming CDO market masked how weak the housing market was, and exacerbated its collapse. (emphasis added)"].


Click here for information on the ProPublica's series (Google™ results). Click here for more information on the ProPublica's series, “The Wall Street Money Machine”, for which ProPublica won the Pulitzer Prize for National Reporting. Click here re suggestion made on 5/2/2011 NPR's "How Some Made Millions Beting Against Market" (available athttp://www.npr.org/2011/05/02/135846486/how-some-made-millions-betting-against-the-market?ft=1&f=13) that, e.g., disclosure (transparency) for parts of financial institutions involved in the bubble (e.g., hedge fund (Magnetar)) that had hand in repackaged securities (collateralized debt obligations or CDOs) that helped enlarge the crisis]. See also, e.g., Dan Fitzpatrick and Jean Eaglesham, SEC Eyes Wachovia over Sale Of CDOs, Wall Street J., at C1 (April 4, 2011) [part of broader probe by SEC into Wall Street's sales of about $1 trillion worth of CDOs].


See also, e.g., Alan Zibel, Small Banks Shield Mortgage Giants: Some Lenders, Wary of Big Rivals Like BofA, Fight Efforts to Wind Down Fannie Mae, Freddie Mac, Wall Street., Global Finance, at C3 (May 2, 2011) [Fannie Mae and Freddie Mac, buy up mortgages, package them, and sell the packages as securitiies; many of nation's bigger lenders have backed a system in which Fannie and Freddie would be replaced with new entities that would sell mortgage-backed securities issued with a government guarantee].


Was Glass-Steagall law root cause of financial crisis? For role of Glass-Steagall law in financial crisis, click here[quoting in Wikipedia (see Contents at 12.2 "Controversy: Defense") former Senator Gramm: if Gramm-Leach-Bliley Act was the problem, crisis would have been expected to have originated in Europe where they never had Glass-Steagall requirements to begin with (emphasis added); also, financial firms that failed in this crisis, like Lehman, were the least diversified, and the ones that survived, like J.P. Morgan, were the most diversified]. For views expressed in The Curious Capitalist on Senator Gramm's defense (http://curiouscapitalist.blogs.time.com)click here, e.g., for Justin Fox, Critiquing Phil Gramm's explanation of the financial crisis, The Curious Capitalist (Jan. 24, 2009) [Gramm says that Glass-Steagall repeal couldn't have been the problem, because continental Europe has never had a Glass-Steagall-like separation of banks and investment firms, and yet they didn't have a mortgage mess (although of course some of their banks have gotten caught up in our mortgage mess)].


Click here for another version (Justin Fox, Phil Gramm Says the Banking Crisis Is (Mostly) Not His Fault,The Curious Capitalist (Jan. 24, 2009) [Gramm was dismissive of the charge that Glass-Steagall repeal has been a big problem; "Europe never had Glass-Steagall," he said. "So why didn't this happen in Europe rather than here?"]. Click here for previously posted version Justin Fox, Breaking News! Phil Gramm still believes in capitalism!, The Curious Capitalist (Jan. 23, 2009) re an event of American Enterprise Institute for Public Policy Research, "Is Deregulation a Cause of the Financial Crisis?" (Jan. 23, 2009, Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036) [available at http://www.aei.org/event/1862 or by clicking here].


See also, Op-Ed Opinion, Wall Street J.,Deregulation and the Financial Panic: Loose money and politicized mortgages are the real villains, at page A17 (Feb. 20, 2009) [former Senator Gramm, wrote re Gramm-Leach-Bliley Act (GLB) that if GLB was the problem, the crisis would have been expected to have originated in Europe where they never had Glass-Steagall requirements to begin with; that, also, the financial firms that failed in this crisis, like Lehman, were the least diversified and the ones that survived, likeJ. P. Morgan, were the most diversified; and that moreover, GLB didn't deregulate anything; it established the Federal Reserve as a super regulator, overseeing all Financial Services Holding Companies; all activities of financial institutions continued to be regulated on a functional basis by the regulators that had regulated those activitiesprior to GLB (Inscription at bottom of Op-Ed opinion: Mr. Gramm, a former U.S. Senator from Texas, is vice chairman of UBS Investment Bank. UBS. This op-ed is adapted from a recent paper he delivered at the American Enterprise Institute)].Clickhere for more information on Op-Ed Opinion.

Click here, e.g., for more information on former president Clinton's defense [In response to criticism of his signing the bill when President, Bill Clinton said in 2008: "I don't see that signing that bill had anything to do with the current crisis. Indeed, one of the things that has helped stabilize the current situation as much as it has is the purchase of Merrill Lynch by Bank of America, which was much smoother than it would have been if I hadn't signed that bill; On the Glass-Steagall thing, like I said, if you could demonstrate to me that it was a mistake, I'd be glad to look at the evidence; I really believed that given level of oversight of banks and their ability to have more patient capital, if you made it possible for [commercial banks] to go into the investment banking business as Continental European investment banks could always do, that it might give us a more stable source of long-term investment"].

Click herefor James Joyner, Phil Gramm Destroyed Our Economy, Outside the Beltway(Feb. 21, 2009). For more information on this subject,click here, (for Google™ results).For views of John Reed, former CEO of Citigroup, on Glass-Steagall, click here [keep consumer banking separate from trading bonds and equity] and here [wants Glass-Steagall back]. For view of Paul Volker, e.g., click here or here (Google™ search results or here (bing™ search results).

See also below
Securitization implications at Glass-Steagall Act repealed; universal banking; at Glass-Steagall type regime v. universal banking; and at Covered bonds (on-balance sheet"); mortgage-backed securities (off-balance sheet). See belowFinancial System Structure at "Possible alternative future models" and at "Other Alternative models".

Glass-Steagall Act repealed; universal banking:Glass-Steagall Act was repealed in 1999. See, e.g., Sewell Chan, Congressional Negotiators Start Effort to Merge Versions of Financial Reform Bills, New York Times at B2 (June 11, 2010) [ "The negotiators called for reviving some version of Glass-Steagall, which had been eroded before being repealed in 1999; both sides called for avoiding a repeat of past mistakes; Maxine Waters, a California Democrat, recalled that on a similar conference committee for Gramm-Leach-Bliley Act, the legislation that repealed Glass-Steagall: "I feared deregulation would have serious consequences; "I voted no. I was right."]. Click here for more information on Logue's Handbook. of Modern Finance.Click here for more information on Lovett's Banking and Financial Institutions Law. For information on the Glass-Steagall Act. click here, its repeal, here, and Bill Clinton's signing its repeal, here.See also, e.g., Julia Collins, Harvard Law Bulletin, at 38 (Summer 2010) [Byron Georgiou '74, one of 10 appointees to Financial Crisis Inquiry Commission charged with evaluating the prime causes of financial crisis in 22 areas from impact of housing crisis to repeal of Glass-Steagall]; Bethany McLean, Meet the Real Villain of the Financial Crisis, at A23 (April 27, 2010) [Congress sat idly by as consumer advocates warned that people were getting loans they'd never pay back; Congress refused to regulate derivatives; Congress repealed the Glass-Steagall Act]. Cf. John B. Taylor, The Dodd-Frank Financial Fiasco, Wall Street J. at A 19 (July 1, 2010) [By far most significant error of omission in bill is failure to reform Fannie Mae and Freddie Mac].

But see "universal banking" popular in Europe in which commercial banking and investment banking activities are permitted to be engaged in by banks, available by clicking here. Cf. Michiko Kakutani, Deeper Looks at the Crisis Of '08 and the Oval Office, N. Y. Times, Dec. 14, 2010 [Glass-Steagall Act, passed during Great Depression, prohibited commercial banks from engaging in investment business] by clicking here. For information on, e.g., Citibank's attempt at universal banking, click here. For an article on repeal of Glass-Steagall Act, click here.


Glass-Steagall regime v. universal banking:Covered bonds seem to be a possible safeguard to replace that protection effected, albeit in a different manner, in the United States by the Glass-Steagall law before its substantial erosion from the 1980s and 1990s. See supraSecuritization implications at "History of mortgage-backed securities and Glass-Steagall". For information on "universal banking" popular in Europe in which commercial banking and investment banking activities are permitted to be engaged in by banks, click here.

Covered bonds (on-balance sheet); mortgage-backed securities (off-balance sheet): The covered bond, popular in Europe for over 240 years, is a "securitized" (see qualifications below) debt instrument protected (secured) by assets in a cover pool that remain as collateral on the issuer's balance sheet, in contrast to securitizations in. e.g., the U.S. housing market when the mortgage loan receivable is pooled and sold to underlie the mortgage-backed security (MBS) that is distributed to investors and traded on a secondary market, it no longer is on the bank's balance sheet. Both the covered bond and the typical U.S. created MBS are called securitizations, but the terminology is somewhat inconsistent, unsettled, or ambiguous; the covered bond is more accurately likened to a secured bond that is sold and traded as a security (the collateral remaining behind on the bank's balance sheet). For a definition of covered bonds, click here. For an introduction to questions related to insolvency, bankruptcy, and other complications, click here, here, here, or here.

The typical U.S. securitization of loans receivable into MBS's results in the bank being more liquid on the receipt of cash from the sale of the loans to be pooled and securitized--transforming an illiquid asset (mortgage note receivable) that was on the bank's balance sheet into a liquid one (cash). See, e.g., Julie Satow, An Effort to Adapt a European-Style Tool to U.S. Mortgages, New York Times, Nov. 2, 2010. C
lick here, e.g., for basics on covered bonds. Click here for more information on covered bonds. For information on covered bonds replacing securitization, e.g., click here and here. For information on securitization generally, e.g., click here and here.


Tax issues:Foreign persons' gains on sales and exchanges of property is generally not taxed by the United States unless the gains are effectively connected with a business in the United States. See, e.g., Boris I. Bittker and Lawrence Lokken, Fundamentals of International Taxation, ¶66.4.1 (1997) [Bittker and Lokken]; Joseph Eisenbergh, International Taxation, ¶40.1 (3rd ed. 2002) ["Eisenbergh"]. The Foreign Investment In Real Property Tax Act of 1980 ("FIRPTA") imposes a tax gains of foreign taxpayers from the sale of U.S. property.Bittker and Lokken ¶66.4.1;Eisenbergh ¶40.3].Gains and losses of foreign taxpayers from the disposition of a "United States Real Property interest" ["USRP interest"] are treated as effectively connected with a United States trade or business.Internal Revenue Code § 897(a)(1). Direct interests in real property in the United States and interests in any domestic corporation whose assets consist principally of United States real property interests holding corporation at any time during the period 5 years while the interest was owned by a foreign taxpayer. Bittker and Lokken ¶66.4.1-66.4.4; Eisenbergh ¶¶40.6-40.11]. Real property includes, inter alia, buildings; all forms of ownership in real property may be a USRP interest including, inter alia, leasehold interests, options to buy or lease real property. An interest in rel property solely as a debtor is not a USRP interest; a secured creditor's right to foreclose or repossess considered to be a creditor. Bittker and Lokken ¶66.4.2; Eisenbergh ¶¶40.12, 40.11, 40.12]. Sometimes, interests held solely as creditor are aggregated with equity interests, and the aggregate is treated as an equity interest. Treas. Reg. § 1.897-1(c)(1).

Query, e.g., whether "solely as creditor" might be interpreted to exclude a foreign debtholder of a U.S. corporation if the foreign debtholder also has a small holding (less than 5% of publicly traded shares) of common stock in a large U.S. corporation?
Eisenbergh ¶40.12.


Congressional and other reports


Financial Crisis Inquiry Commission Report: For information on the Financial Crisis Inquiry Commission (FCIC) Report, click here. For index to FCIC Report, click here. For an appraisal of the report, see, e.g., Gretchen Morgenson, A Bank Whodunit, With Laughs and Tears, New York Times, Sunday Business, at page 1 (Jan. 30, 2011) [further bailouts lie ahead with potentially disastrous consequences; restructure financial system by breaking up "too-big-to-fail financial institutions]

The FCIC Report's Index has no reference to either covered bonds or universal banking. See also, e.g., Jesse Eisinger, In Postcrisis Report, a Weak Light on Complex Transactions, New York Times at B3 (Feb. 3, 2011). Cf. Financial Crisis Inquiry Commission, Preliminary Staff Report: Securitization And The Mortgage Crisis: at IIA p. 20 [Ultimately, the extent to which the originate-to-distribute model resulted in a moral hazard problem that led to riskier loans being originated is an open empirical question.(emphasis added)]; IIB p21-22 [If the expansion of credit caused by securitization contributed to the bubble in the housing market, it may thereby have indirectly contributed to the sharp rise in defaults when that bubble burst.]; IIC p21 [In addition to potentially resulting in riskier mortgage loans being originated, securitization may have increased the probability that a defaulting mortgage went into foreclosure; when originator retains and services a mortgage and the borrower defaults, originator can decide whether to foreclose and sell the home, which is costly and can depress the value of the home, or instead to negotiate a modification to the terms of the loan that results in the borrower beginning to once again pay on the mortgage; in contrast, when a loan is securitized,investors in the MBS hold the rights to most of the cash flows generated by the loan, and a separate entity—the servicer—is responsible for negotiating with the borrower if the loan is in default. The servicer may not have the same incentives to negotiate a loan modification as a portfolio lender would, and hence may foreclose on loans for which the efficient outcome is a modification. (emphasis added)].

Query: to what extent were commercial banks (deposit-taking institutions) participants in the
originate-to-distribute model? See Inside Mortgage Finance, 2009, The 2009 Mortgage Market Statistical Annual. The scale of distribution of mortgage-backed securities would have been enlarged to that extent. Had a Glass-Steagall regime in effect before its having been substantially eroded (see supraSecuritization implications at "History of mortgage-backed securities and Glass-Steagall" ( at Lovett discussion)), how would the market scale been diminished in volume and geographically?


Click here for excerpt from Bloomberg Business Week article/interview. Click here for excerpt from Wall Street Journal article. See also supra"Covered bonds (on-balance sheet) v. mortgage-backed securities (off-balance sheet)". Click here. for more information on this issue. Click also "publications" (at "Articles") on Navigation Bar.


Senate Report on Financial Crisis: The United States Senate, Subcommittee on Investigations (co-chairs: Carl Levin (D., Mich.); Tom Coburn (R., Okla.)) released a report "Wall Street and the Financial Crisis: Anatomy of a Financial Collapse" [Senate Report]. Click here for the Senate Report. See also, e.g., Gretchen Morgenson and Louise Story, Naming Culprits in the Financial Crisis, New York Times, at page B1 (April 14, 2011) [report finds evidence of shoddy, risky, deceptive practices of a lot of major financial institutions aided and abetted by credit rating agencies; the report focuses on an array of institutions (Washington Mutual (mortgage lender), Office of Thrift Supervision (regulator), Standard & Poor's and Moody's (credit rating agencies), and Goldman Sachs and Deutche Bank (investment banks))]; Carrick Mollenkamp and Liz Rappaport, Senate Report Lays Bare Mortgage Mess, Wall Street J., at page C1 (April 14, 2011) [e.g., settlements with Wall Street firms likely; Goldman Sachs sales force rewarded for finding investors anywhere in the world].


Congressional legislation and regulation


Dodd-Frank Wall Street Reform and Consumer Protection Act: Dodd-Frank's title (atPublic Law 111 - 203, July 21, 2010)is "An act to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ``too big to fail'', to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes {emphasis added}].Sections of the Act on disclosure are, e.g., Sec. 942 (re Asset Backed Securities); 953 (re employee and director hedging); 953 (re pay v. performance); 972 (chairman/CEO structure); 1103 (public access to information); 1419 (re minimum mortgage standards).Other sections of interest, e.g., are: 932 [enhanced regulation, accountability, and transparency of nationally recognized statistical rating organizations]; 936 [qualification standards for credit rating analysts]; 939 [removal of statutory references to credit ratings]; 939 [review of reliance on ratings]; 941 [regulation of credit risk retention]; 951 [shareholder vote on executive compensation disclosures]; 952 [compensation committee independence]; 953 [executive compensation disclosures]; 954 [recovery of erroneously awarded compensation]; 956 [enhanced compensation structure reporting]. For more on Dodd-Frankclick here (Google™ results) and here(bing™ results). For text of Dodd-Frank click here(Google™ results) and here(bing™ results).

Section 942 (b) of the Act amends the Securities Act of 1933 §7 (15 U.S.C. 77g) by adding at the end the following: (c) Disclosure Requirements. (1) Regulations: In general.--The Commission shall adopt regulations under this subsection requiring each issuer of an asset-backed security to disclose, for each tranche or class of security, information regarding the assets backing that security; (2) Content of regulations.--In adopting regulations under this subsection, the Commission shall (A) set standards for the format of the data provided by issuers of an asset-backed security, which shall, to the extent feasible, facilitate comparison of such data across securities in similar types of asset classes; (B) require issuers of asset-backed securities, at a minimum, to disclose asset-level or loan-level data, if such data are necessary for investors independently to perform due diligence, including (i) data having unique identifiers relating to loan brokers or originators, (ii) the nature and extent of the compensation of the broker or originator of the assets backing the security, and (iii) the amount of risk retention by the originator and the securitizer of such assets [emphasis added].

Effectiveness of Dodd-Frank: On the effectiveness of Dodd-Frank, see, e.g., Floyd Norris, Looks Like Banks Lose on Risk Plea,New York Times, at B1 (Feb. 18, 2011) [banks must have 5% "skin in the game" or stake in the securitized loans, but "qualified residential mortgage" loansmay be securitized without the bank's retaining any risk]; David Enrich, Wall Street J., at A8 (Jan. 26, 2011) [U.S. official crafting rules that will determine sharpness of Dodd-Franks teeth]; Gretchen Morgenson, A Bank Whodunit, With Laughs and Tears, New York Times, Sunday Business, at page 1 (Jan. 30, 2011) [that Dodd-Frank gives greater regulatory powers to Federal Reserve Bank, an institution that was defiantly inert and uninterested in reining in the mortgage mania, is disturbing indeed]; Review & Outlook, Still Too Big, Still Can't Fail, Wall Street J., at A 14 (Mar. 5-6, 2011) [Dodd-Frank is making big banks bigger and more protected than ever against failure]; Landon Thomas Jr. and Eric Dash, Battle Starts Over British Bank Rules, New York Times, April 8, 2011 at B1 (consideration of separating deposit-taking from investment banking operating as distinct subsidiaries, not as independent companies as required in the United States in the Depression; more direct challenge for British banks than Dodd-Frank (and Volker rule) has been for American institutions; for some experts in Britain the approach in the United States is not strong enough ("be prepared to split the casino bank from the utility bank")); Steven M. Davidoff, In Regulator's Proposal, Incentive for Excessive Risk Remains, New York Times, DealBook, at B9 (April 13, 2011). Click here for more on Floyd Norris article. Click here for more on Gretchen Morgenson article.Click here for more on Review & Outlook article.Click here for more on Landon Thomas Jr. and Eric Dash article.For more details and fuller discussion contained in Steven M. Davidoff article, click here(viz., the April 12, 2011, version:In F.D.I.C.’s Proposal, Incentive for Excessive Risk Remains). Click here for more on the Davidoff article and other related articles.Query: what if evidence exists that the institution failed (in whole or part) as the result of market conditions (in whole or part) beyond its control?

Dodd-Frank on accountability and executive compensation:

Accountability and executive compensation: Executive Compensation has been under increased scrutiny.
See, e.g., Gretchen Morgenson, Enriching a Few At the Expense of Many, New York Times, Sunday Business, Fair Game, at page 1 (April 10, 2011) [e.g., excessive compensation is a red flag (does company exist for benefit of shareholders or executives?); at CPFL Energia in Brazil routinely compare highest executive pay with lowest-paid workers(in 2010 ratio was 79 to 1) with comparable ratios in the United States ranging from 100 to 300 depending on size of company; according to Albert Meyer a massive wealth transfer occurred from middle-income retirement accounts to the bank accounts of a privileged few]; Daniel Costello, The Drought is Over (At Least for C.E.O.'s), New York Times, Sunday Business, Fair Game, at page 1 (April 10, 2011) [Dodd-Frank regulations, e.g., require shareholder say on executive pay for nearly all public companies, though company not bound by such votes; forfeit pay where fraud or poor performance; clawbacks].

See, also, e.g., Steven M. Davidoff, In Regulator's Proposal, Incentive for Excessive Risk Remains, New York Times, DealB%k, at B9 (April 13, 2011) [e.g., proposed clawback rules of "too big to fail" financial institutions that fail are weak; Dodd-Frank provides F.D.I.C. with right to recover compensation responsible for institution's failure if an executive failed to conduct the executive's responsibilities with the requisite degree of skill and care required by the executive's position; substantial responsibility is not a legal standard of care but Congress most certainly meant that the term to refer to a person who was part of decision-making in the institution and, if the institution fails, are clearly "substantially responsible" if the institution fails being responsible for its governance].
For more details and fuller discussion contained in Steven M. Davidoff article, click here(viz., the April 12, 2011, version:In F.D.I.C.’s Proposal, Incentive for Excessive Risk Remains). Click here for more on the Davidoff article and other related articles.Query: what if evidence exists that the institution failed (in whole or part) as the result of market conditions (in whole or part) beyond its control?

Dodd-Frank covers in Accountability and Executive Compensation (Subtitle E) at Sec. 951 (Shareholder Vote on Executive Compensation Disclosures) [not less frequently than once every 3 years, a proxy or consent or authorization for an annual or other meeting of the shareholders for which the proxy solicitation rules of the Commission require compensation disclosure shall include a separate resolution subject to shareholder vote to approve the compensation of executives; golden parachute disclosure on clear and simple form]; Sec. 952 (Compensation Committee Independence); Sec. 953 (Executive Compensation Disclosures)[e.g., require each issuer to disclose (A) the median of the annual total compensation of all employees of the issuer, except the chief executive officer (or any equivalent position) of the issuer; (B) the annual total compensation of the chief executive officer (or any equivalent position) of the issuer; and (C) the ratio of the amount described in (A) to the amount described in (B)]; Sec. 954 (Recovery of Erroneously Awarded Compensation); Sec. 955 (Disclosure Regarding Employee and Director Hedging); Sec. 956 (Enhanced Compensation Structure Reporting); Sec. 957 (Voting by Brokers).

Corporate law on management compensation: Corporate law
, generally a matter of state law, pertains to these matters. See, e.g., New York Business Corporate Law (McKinney's Consolidated Laws of New York Annotated, vol. 6 (2003; cumulative pocket part 2010) at, e.g., §§ 712 (Executive committee); 713 (Interested directors); 715 (Officers)[under business judgment rule stockholders may not question judgment of board of directors to fix compensation of executive officers even where executive is also a director, absent clear abuse (note 4, citing cases), but must bear reasonable relation to services rendered and corporation's income; what is reasonable compensation for a corporation's officers is primarily for its shareholders]; 719; 720 [re, e.g., conflict of interest; corporate waste; compel return of compensation; excessive compensation; reasonable compensation; unfair appropriation to compensation rather than dividends; gift (notes 117-120, citing cases)].

For treatment of corporate law on, e.g., management compensation in a leading text
designed for use in business law and legal environment courses generally offered in universities, colleges, and schools of business and commerce, see, e.g., Richard A. Mann and Barry S. Roberts, Smith and Roberson's Business Law (9th ed. 1994) at page 887 [Management Compensation: Board of directors usually determines compensation of officers and may include cash bonuses, share bonuses, share options, share purchase plans, insurance benefits, deferred compensation, and a variety of other fringe benefits].

See also, e.g., 2 Model Business Corporation Act Annotated (Fourth Edition 2008) at §§ 7.42 [demand excused re allegations of excessive compensation where no disinterested majority of board to approve compensation award]; 8.11 (Compensation of Directors) [officers included in Selected Cases discussion (citing cases on (1) Compensation for services as director and (2)
Compensation for services as officer) waste; disinterested directors; fairness and reasonableness of compensation; golden parachute]; 8.25 (Committees) [nominating and compensation committees composed primarily or entirely of independent directors widely used in public corporations (Official Comment citing Committee on Corporate Laws, Corporate Director's Guidebook (5th ed. 2007)]; 8.60 (Directors' Conflicting Interest Transactions) [27 jurisdictions either prohibit loans to directors and/or officers or expressly allow these loans in limited circumstances (at 3. Loans in Limited Circumstances)]; Committee on Corporate Laws, ABA Section of Business Law (A. Gilchrist Sparks, III, Chair), Report on Roles of Boards of Directors and Shareholders of Publicly Owned Corporations and Changes to the Model Business Corporation Act -- Adoption of Shareholder Proxy Access Amendments to Chapters 2 and 10, 65 Business Lawyer 1105, at 1105 (Aug 2010) [reaffirms view that centralized management under board of directors maximizes corporations' ability to contribute to long-term wealth creation and view that shareholders should have a process to participate meaningfully in the selection of directors].

Credit rating agencies: The credit rating agencies have been criticized. Click here and here for more information on this subject.See, e.g., Janet Morrissey, Kidnapping. Espionage. Credit Ratings? A Corporate Sleuth Enters Humbled Field, New York Times, Business Section, at page 1 (Feb. 27, 2011) [top three rating agencies have 97 % of all ratings; issuer-pay model lets companies shop around for best ratings; S.E.C. to wean financial industry off ratings under Dodd-Frank]; Jesse Eisinger, Vows of Change at Moody’s, but Flaws Remain the Same, New York Times, at B5 (April 14, 2011).For a list of agencies worldwide, click here.

Dodd-Frank provides for
Improvements to the Regulation of Credit Rating Agencies in, e.g., sections 932 (enhanced regulation, accountability, and transparency of nationally recognized statistical rating organizations); 935 (consideration of information from sources other than the issuer in rating decisions); 936 (qualification standards for credit rating analysts); 939 (removal of statutory references to credit ratings); 939D (Government Accountability Office study on alternative business models); 939E (Government Accountability Office study on the creation of an independent professional analyst organization); 939H (sense of Congress that SEC should exercise its rulemaking authority to prevent improper conflicts of interest arising from employees of nationally recognized statistical rating organizations providing services to issuers of securities that are unrelated to the issuance of credit ratings, including consulting, advisory, and other services).

Dodd-Frank regulations forthcoming; possible repeal (in whole or in part) of Dodd-Frank: On forthcoming regulations resulting from Dodd-Frank, click here. For various moves to change or repeal elements of Dodd-Frank click here. See also, e.g., Landon Thomas, Jr. and Eric Dash, Battle Starts Over British Rules, New York Times at B1 (April 8, 2011) [After successfully diluting toughest elements of Volker Rule before it passed, the banking lobbyists are now putting their effort into other parts of Dodd-Frank].


Financial system structure


Criticism of, and action/inaction against, Wall Street:

Criticism:For criticism of Wall Street, see, e.g., Nelson D. Schwartz and Eric Dash, Inquiries May Bring Big Fines, Banks Say, New York Times at B1 (Feb. 26, 2011) [e.g., abusive mortgage loan practices re loan origination, loan servicing, and foreclosures]; DealBook, After Expose, Filmmaker Sees Little Change on Wall Street, New York Times at B7 (Feb. 25, 2011); Mathias Rieker and Randall Smith, Citigroup Could Lose $4 Billion on Lawsuits, Wall Street J., at page B5 (Feb 26, 2011); Nick Timiraos, Victoria McGrane, and Ruth Simon, Big Banks Face Fines On Role of Servicers, Wall Street J., at C1 (Feb. 17, 2011) [re mortgage servicing practices (e.g., deficiencies in documentation); Mortgage Electronic Registration Systems (an electronic-lien registry set up by the mortgage industry to handle documentation on loans bundled into pools and sold as securities)]; Gretchen Morgenson and Louise Story, Naming Culprits in the Financial Crisis, New York Times, at page B1 (April 14, 2011) [re United States Senate report, "Wall Street and the Financial Crisis: Anatomy of Financial Collapse", released by Senate Permanent Subcommittee on Investigations; report finds evidence of shoddy, risky, deceptive practices of a lot of major financial institutions aided and abetted by credit rating agencies]. Click here for more on Deal Book article, After Expose, Filmmaker Sees Little Change on Wall Street. For more on Gretchen Morgenson and Louise Story, Naming Culprits in the Financial Crisis, click here.

Action/inaction: For various action/inaction against Wall Street, see., e.g., Joe Nocera, Biggest Fish Face Little Risk of Being Caught, New York Times at B1 (Feb. 26, 2011) [top executives behind financial crisis face little risk of jail time];
Gretchen Morgenson and Louise Story,A Financial Crisis With Little Guilt: After Widespread Reckless Banking, a Dearth of Prosecutions, New York Times, at page A1 (April 14, 2011) [despite finding reckless lending and excessive risk taking, dearth of civil and criminal cases pursued against major financial institutions or senior executives (emphasis added)]; Carrick Mollenkamp and Liz Rappaport, Senate Report Lays Bare Mortgage Mess, Wall Street J., at page C1 (April 14, 2011) [settlements with Wall Street firms likely; Goldman Sachs sales force rewarded for finding investors anywhere in the world (emphasis added)]; David Streitfeld, Report Criticizes Banks for Handling of Mortgages: Consent Actions Require Servicers to Hire Outside Consultants and Overhaul Operations, New York Times, at page B3 (April 14, 2011) [enforcement action include, e.g., consent agreements and planned monetary penalties]; Jean Eaglesham, Banks Near Deal with SEC, Wall Street J., at A1 (April 15, 2011) [SEC aiming to reach series of settlements with individual firms, with settlements expected to vary significantly among banks; settlements in lieu of facing civil fraud allegations; criminal prosecutions have not been brought against senior executives of any of major financial firms involved in the crisis (emphasis added)]; Liz Rappaport, Banks Hit For Credit Union Ills, Wall Street J., at page A1 (March 23, 2011) [National Credit Union Administration (NCUA) has threatened to sue several investment banks (Goldman Sachs Group Inc, Bank of America’s Merrill Lynch unit, Citigroup Inc., J.P. Morgan Chase & Co.) unless they refund over $50 billion in losses on mortgage-backed securities suffered by five wholesale credit unions; NUCA has stated that it intends to pursue on behalf of certain credit unions for which acts as conservator claims that offering documents for certain securities sold contained untrue statements of material facts and material omissions; other federal entities, such as the FDIC, the Treasury, and the Federal Reserve, who hold similar securities, have not threatened suit against firms that created such bonds (emphasis added)].For more on Gretchen Morgenson and Louise Story,A Financial Crisis With Little Guilt: After Widespread Reckless Banking, a Dearth of Prosecutions, click here.

See also on Navigation Bar in gallery 1: selected publication (excerpts ... ) at "quantitative analysis in settlement negotiations (article excerpt) " and "quantitative aspects of legal analysis (article excerpt)" and in gallery 7: commentary at "Business Lawyer: Belated comment".

Consequences beyond financial industry:

Financial crisis impact on states: The financial crisis has had a significant impact on the states in the U.S.
For budgetary problems affecting the municipal bond market, see, e.g., Meredith Whitney, State Bailouts? They've Already Begun, Wall Street J., A27 (11/3/2010) [re federal government subsidies of state spending in excess of state tax collections (budgetary deficits); "structural problems" of many states and municipalities; "expect multiple municipal defaults"]; Bill Marsh, Where Budget Gaps, and People, Are Few, New York Times, Week in Review, The Nation, at page 3 (Jan. 23, 2011) [the recession brought at least 44 states staggering budget gaps between the inflow and outflow of funds; the drop of personal and corporate income tax revenues have devastated budgets]; Monica Davey, The State That Went Bust, New York Times, Week in Review (The Nation), at page 3 (Jan. 23, 2011) [states finding deficits in the billions of dollars; times now for states are undeniably grim]; Mary Williams Walsh,A Path Is Sought for States To Escape Debt Burdens,New York Times, at A1 (Jan. 21, 2011) [traditional bankruptcy not an option, but versions of it gain support]; Michael Corkery, Roubini Sees Rising Muni Defaults, Wall Street J., at C1 (Mar. 2, 2011) [Roubini consulting firm report predicts significant increase municipal bond defaults over next five years, but state and local debt problems are not systemic, nor will they infect the financial system, and defaults will continue to be isolated events; not as dire as prediction of analyst Meredith Whitney {see first cite in this paragraph}].

Cf., e.g., Louis Uchitelle, Wealthy Suburb Cuts Corners To Keep a Lid on School Taxes, at A1 (Mar. 9, 2011) [austerity budget implemented; some residents argue that the town should be more businesslike]; Conor Dougherty, States Fumble Revenue Forecasts,
Wall Street J., at A4 (March 2, 2011) [states' budget deficits stem in part from their unduly rosy revenue forecasts; they increasingly overestimate their tax revenue during tough economic times; rather than saving the surpluses, they tend to cut taxes or spend the surplus funds]; Alexandra Berzon; States Make Play For Web Gambling, Wall Street J., at A1 (March 2, 2011) [states debates on online gambling come they attempt to balance budgets in face of large deficits].
See "municipal bankruptcy; municipal securities" in Gallery 7 on Navigation Bar. See also"municipal bankruptcy"in Gallery 1 and "municipal securities" in Gallery 1 on Navigation Bar.

Financial crisis impact on world economy: The financial crisis' worldwide impact also has been significant. Click here (Google™ results) and here (bing™ results) for information on this issue. Click here for more information on this issue in, e.g., IMF Survey online:Subprime Impact -- Financial Crisis Weighs on Global Economy (Sept. 17, 2008) [U.S. financial turmoil adversely impacting global growth prospects].

Securitization impact on expansion of credit and effectiveness of reserve requirements:Securitization would seem to have its own impact. The expansion of credit in the United States and in the global economy would seem to be unchecked by reserve requirements being skirted by securitization--whether in the eurodollar market or, e.g., in the mortgage-backed securities market. The combined effects of securitization in the mortgage-backed securities market and in the eurodollar market would seem to be inflationary as well as depreciation of the United States dollar. See supra Securitization at "Accounting for securitization of bank assets".

Concentration of banking industry: The banking industry is, despite the number of banks nationwide, highly concentrated among the too-big-to-fail institutions. See, e.g., David Reilly, Fed's Dr. No Targets the Big Banks, Wall Street J., Heard on the Street (Feb. 26-27, 2011) [Thomas Hoenig says: breaking up big banks is only way to end threat posed by too-big-to-fail institutions; does not buy the idea that better supervision, more capital and powers in Dodd-Frank Act to wind down tottering institutions will solve too-big-to-fail problem because of too many connections that will bring down other institutions; a proposed accounting rule on derivatives spotlights how concentrated and intertwined derivative use is by just a handful of the biggest banks (J.P. Morgan Chase, Bank of America; Citigroup, Goldman Sachs Group, and Morgan Stanley) accounting for 98% of the derivatives total; the systemic risk from too-big-to-fail firms is, if anything "even worse than before the crisis".]Click here for more on David Reilly article. For views of , e.g., John Reed, former CEO of Citigroup, on the desirability of a return to a Glass-Steagall regime in the aftermath of the financial crisis,click here [keep consumer banking separate from trading bonds and equity] and here [wants Glass-Steagall back].

Alan Zibel, Small Banks Shield Mortgage Giants: Some Lenders, Wary of Big Rivals Like BofA, Fight Efforts to Wind Down Fannie Mae, Freddie Mac, Wall Street., Global Finance, at C3 (May 2, 2011) [Fannie Mae and Freddie Mac, buy up mortgages, package them, and sell the packages as securities; small lenders warn that getting rid of Fannie and Freddie will increase the power of the four largest U.S. mortgage lenders (Wells Fargo, Bank of America, J.P. Morgan Chase, and Citibank) whose share of the home-loan market rose to about 60% of new mortgage loans up from 36% in 2007 according to trade publication Inside Mortgage Finance; small banks argue that the big banks would assume role of Fannie and Freddie issuing their own mortgage-backed securities; many of nation's bigger lenders have backed a system in which Fannie and Freddie would be replaced with new entities that would sell mortgage-backed securities that would be issued with a government guarantee; without a government mechanism other than FHA to guarantee motgges smaller lenders could have a difficult time competing with big banks for business].

Click here for 4/19/11 post to http://forestpolicy.typepad.com/economics (Economic Dreams - Economic Nightmares) by RDG on too big to fail.Click here for 4/21/11 post to http://forestpolicy.typepad.com/economics (Economic Dreams - Economic Nightmares) by RDG [***A lingering question for me is that competition (with, e.g., all "too big-[to]-fail banks" being smaller) coupled with deposit insurance might impart necessary discipline. And, further, Glass-Steagall should [be] reinstated, in a fairly strong form, with or without covered bonds usage (for all financial institutions) or securitization (for investment banks only, not depositary institutions (banks, credit unions, et al.)) **** Banking is critical to the health and wealth of worldwide society. Dodd-Frank and other measures (e.g., in England [see below Other alternative modelsat Landon Thomas Jr. and Eric Dash, Battle Starts Over British Bank Rules, New York Times, at B1 (April 8, 2011)]) may be effective. In addition I hope that the general tone and culture found in the financial system tends to emphasize its historic (on the whole) honorable, along with its profit, dimension. (emphasis added)].

For issues of competitionsee Louise Story and James Kanter, Europe Opens Antitrust Cases over Banks Dealing in Derivatives, New York Times, at B1 (April 30, 2011) [sweeping investigation of whether small network of big banks unfairly controls derivative market, into the world's largest banks in battle to rein in $600 trillion business that until now has operated mostly in the shadows, whether banks have shut out competitors to keep profits high (emphasis added)]; Matthew Dalton, EU Opens Probes of a Swaps Market, Wall Street J., at B2 (April 30-May 1, 2011) [First probe: investigation into whether 16 investment banks and Markit Group Ltd. (a provider of swap prices) are blocking competitors who might disseminate information; other probe: examination whether agreements between clearinghouse ICE Clear Europe (a subsidiary of Atlanta-based IntercontinentalExchange Inc.) and nine investment banks pose an incentive for these banks to route swaps through ICE Clear, blocking other clearing houses from entering market; and whether contracts stemming from IntercontinentalExchange's purchase of Clearing Corp. in 2009 from the nine banks give these banks an unfair advantage over other swaps dealers; global credit-default market is controlled by fewer than 20 of the world's largest financial institutions; antitrust watchdog European Commission has been concerned for several years about lack of competition in Europe among clearignghouses; IntercontinentalExchange spokeswoman said company had become dominant European credit-default-swaps clearing house by offering better services and more products[than otherwise?] not because of profitsharing or discounts[than otherwise?] offered to the banks (emphasis added)].

Click here, or here, e.g., forLandon Thomas Jr. and Eric Dash, Battle Starts Over British Bank Rules, New York Times, at B1 (April 8, 2011) [consideration in Britain of separating deposit-taking from investment banking operating as distinct subsidiaries, not as independent companies as required in the United States in the Depression; more direct challenge for British banks than Dodd-Frank (and Volker rule) has been for American institutions; for some experts in Britain the approach in the United States is not strong enough; quotingAndrew Hilton, the director of CSFI in London, a financial services research group: “In the end, you just can’t regulate these banks — they have too much money and too many lawyers. We should be prepared to split the casino bank from the utility bank" (emphasis added)]. For more on this issue, click here(Google™ results) and here (bing™ results).

Possible alternative future models: In view of the uncertainty of Congressional action (amendment? repeal?) with respect to the Dodd-Frank two possible alternative models for consideration are as follows below: Click here, e.g., for Republican intent to repeal Dodd-Frank. See supraCongressional legislation and regulation at "Dodd-Frank Wall Street Reform and Consumer Protection Act" and at "Dodd-Frank regulations forthcoming; possible repeal (in whole or in part) of Dodd-Frank").

1. Loose-fitting regulatory jacket -- universal banking structure with covered bonds plus disclosure with secured right of government to reclaim any bailout funds: Universal banking would be permitted in this model with its version of securitization using covered bonds. If investors
demand government guaranteed mortgage-backed securities, would full disclosure be required for the government to be able to assess risks to the market? And even if full disclosure were the model, would the government require additional safeguards if it bailed out banks, such as, e.g., the right to reclaim funds advanced to banks bailed out (secured by the banks' assets)? Assuming, arguendo, that these safeguards would be adequate, would the rigors of capitalism (competition) and free market be preserved on both the upside (profits inure to banks, not the government) and the downside (banks incur losses, not the government). This model would be applicable whether universal banking with or without covered bonds were permitted. Query what form of disclosure would be desirable and feasible? For information on covered bonds, see supraSecuritization implications at "Covered bonds (on-balance sheet); mortgage-backed securities (off-balance sheet)". For a view of the desirability of covered bonds in the aftermath of the financial crisis, e.g., click here. See also supra, Financial system structureat "Concentration of banking industry".

2.Tight-fitting regulatory jacket -- Glass-Steagall type of structure plus disclosurez:If universal banking were not permitted, commercial banks would be prohibited from distributing most securities, including mortgage-backed securities under a fairly strong version of Glass-Steagall without, e.g., its 1980's and 1990's erosion. See supraSecuritization implications at "History of mortgage-backed securities (MBS's) and Glass-Steagall". Still, a species of disclosure would be the law, similar to, but perhaps less full than, that of model 1 above. Mortgage-backed securities could be either covered bonds or not, for those non-deposit-taking financial institutions, if any, distributing the securities (but who had originated the underlying mortgages, pooled and packaged them, and distributed them as mortgage-backed securities). Financial institutions receiving deposits would be outside of this regime. Query what form of disclosure would be desirable and feasible?For views of , e.g., John Reed, former CEO of Citigroup, on the desirability of a return to a Glass-Steagall regime in the aftermath of the financial crisis,click here [keep consumer banking separate from trading bonds and equity] and here [wants Glass-Steagall back]. See also supra, Financial system structureat "Concentration of banking industry".

Other alternative models: Other models could be, and have been, suggested/devised.
Click here, e.g., for more on this subject in Paul Krugman, OpEd Columnist: Financial Reform 101, New York Times, at A23 (April 1, 2010) [Even among those who really do want reform, however, there’s a major debate about what’s really essential. One side — exemplified by Paul Volcker, the redoubtable former Federal Reserve chairman — sees limiting the size and scope of the biggest banks as the core issue in reform. The other side — a group that includes yours truly — disagrees, and argues that the important thing is to regulate what banks do, not how big they get. **** Here’s how I see it. Breaking up big banks wouldn’t really solve our problems, because it’s perfectly possible to have a financial crisis that mainly takes the form of a run on smaller institutions. In fact, that’s precisely what happened in the 1930s, when most of the banks that collapsed were relatively small — small enough that the Federal Reserve believed that it was O.K. to let them fail. As it turned out, the Fed was dead wrong: the wave of small-bank failures was a catastrophe for the wider economy. The same would be true today. Breaking up big financial institutions wouldn’t prevent future crises, nor would it eliminate the need for bailouts when those crises happen. The next bailout wouldn’t be concentrated on a few big companies — but it would be a bailout all the same. I don’t have any love for financial giants, but I just don’t believe that breaking them up solves the key problem. So what’s the alternative to breaking up big financial institutions? The answer, I’d argue, is to update and extend old-fashioned bank regulation. (emphasis added.)].Query whether a combination of Volker side's view and Krugman side's view would be politically feasible? See supraFinancial system structureat "Possible alternative future models: 1. Loose-fitting regulatory jacket..."and " 2. Tight Fitting Regulatory Jacket ..." with a view of the concentration among too-big-to-fail banks (seeFinancial system structureat "Concentration of banking industry").

See also, e.g., Floyd Norris, Crisis Is Over But Where's The Fix?, New York Times, at B1 (Mar. 11, 2011) [regulatory failure may be inevitable; regulators likely to be less prescient than bank executives]; Nick Timeraos, Views of Life After Fannie, Freddie, Wall Street J., at A5 (Feb. 12-13, 2011) [government proposal: option 1 would put vast majority of the mortgage market in private sector, where lenders would originate mortgage loans and securitize them without any government backing (middleman role currently played by Fannie and Freddie would no longer exist); option 2 would create a mostly private market with limited government backstop that would primarily become active in periods when private lenders retreated during financial shocks; option 3 would create new privately owned companies to buy mortgage loans from banks and sell them as securities guaranteed by government]; Gretchen Morgenson, Imagining Life Without Fannie and Freddie, New York Times, Business Day, Fair Game, at page 1 (Jan. 13, 2011) [Mortgage Bankers Association Financial Services Roundtable, and Center for American Progress are lining up against significant reductions in government's role as backstop to mortgage industry (recommending, e.g., creating private entities over seen by federal regulator); but Morgenson concludes that "we must be sure that the solutions bring us back to where we began"].

Cf.. e.g., David Reilly, Fed's Dr. No Targets the Big Banks, Wall Street J., Heard on the Street (Feb. 26-27, 2011) [Thomas Hoenig says: breaking up big banks is only way to end threat posed by too-big-to-fail institutions; does not buy the idea that better supervision, more capital and powers in Dodd-Frank Act to wind down tottering institutions will solve too-big-to-fail problem because of too many connections that will bring down other institutions;a proposed accounting rule on derivatives spotlights how concentrated and intertwined derivative use is by just a handful of the biggest banks (J.P. Morgan Chase, Bank of America; Citigroup, Goldman Sachs Group, and Morgan Stanley) accounting for 98% of the derivatives total; the systemic risk from too-big-to-fail firms is, if anything "even worse than before the crisis".]

To cf. further, e.g., click here for Peter J. Wallison, A Way Forward for the Mortgage Market, Wall Street J. (
Feb. 15, 2011) [American Enterprise Institute proposal that sound U.S. mortgage loan system could be built without public backing through securities regulation to enforce mortgage loan standards so that most loans are prime loans to assure high quality securitization; private secondary market entities could service the markets from which the two government sponsored enterprises have withdrawn.]

Click here, or here, e.g., forLandon Thomas Jr. and Eric Dash, Battle Starts Over British Bank Rules, New York Times, at B1 (April 8, 2011) [consideration in Britain of separating deposit-taking from investment banking operating as distinct subsidiaries, not as independent companies as required in the United States in the Depression; more direct challenge for British banks than Dodd-Frank (and Volker rule) has been for American institutions; for some experts in Britain the approach in the United States is not strong enough; quotingAndrew Hilton, the director of CSFI in London, a financial services research group: “In the end, you just can’t regulate these banks — they have too much money and too many lawyers. We should be prepared to split the casino bank from the utility bank" (emphasis added)]. For more on this issue, click here(Google™ results) and here (bing™ results).

For more on these and other subjects, e.g., click here (universal banking); here (universal banking; mortgage-backed securities); here (universal banking; Glass-Steagall); here (covered bonds); here (Citibank abandons universal bank model); here (blog: Economic Dreams -- Economic Nightmares). See also supraSecuritization implications at "Glass-Steagall Act repealed; universal banking" and at "Glass-Steagall regime v. universal banking".

All these models probably involve some species of disclosure or transparency. The goal would be to attain a banking regime having a substantially reduced inherent probability of an occurrence of a financial crisis of proportions experienced in the late 2000's. The freedom of and competition in the banking market must be maximized with due consideration to undue consequences to society from excessive banking practices. The shibboleth "one's freedom to swing stops at another's nose" applies. No market is absolutely free. Laws on as diverse areas as, e.g., contracts, fire prevention, speed limits, building codes (re, e.g., electricity, plumbing, structural aspects), structural safeguards (re, e.g, bridges, buildings), defamation, torts, crimes, copyright, patents, trademarks, trade-names, antitrust, environment, discrimination, are needed in a highly civilized society.

Goals of banking regulatory regime

Enhance virtues of capitalism/free markets:The goal would be to devise a regime/model for banking that enhances the virtues of capitalism/free markets that maximizes freedom of action, but keeps these virtues within reasonable limits. See, e.g., Paul A. Samuelson, Economics (9th ed. 1973; now in 16th ed. as Paul Samuelson & William Nordhaus (posted on 1/30/2010)) at 17-18 [basic problems of economic organization of every society are: "what", "how", "for whom"]; at 41 [gradually feudal and pre-industrial conditions replaced by "free enterprise" or "competitive private-property capitalism" but before trend reachedfull laissez faire
U.S. reached a "mixed economy" in which both public and private institutions exercise economic control]; at 867-885 [compares laissez faire, mixed economy, anarchism, fascism, socialism, communism].

Reasonable decision makers may differ on details. Yet, they should reach a decision that is sound on broad principles. Though disclosure or transparency adds to the costs of financial markets, some degree of feasible disclosure for any banking regime remains desirable when the costs of another globalized meltdown are taken into account.
However, whatever the character of the model for banking that survives Congressional scrutiny, it should provide a certain degree of market discipline through competition, yet permit a reasonably free banking market to flourish.

The views of much of banking industry are described in, e.g., Floyd Norris, Looks Like Banks Lose on Risk Plea, New York Times, at B1 (Feb. 18, 2011) [re an ill-defined loophole that may allow banks to escape the requirement to retain at least 5 percent of the mortgage loan risk; banking industry assumes that "skin in the game" is unreasonable and unnecessary because banks can be trusted not to repeat the mistakes that gave rise to the financial crisis and assumes that many of the loan products and characteristics under consideration were for many years not problematic when underwritten prudently].
See supraSecuritization implications at "History of mortgage-backed securities (MBS's) and Glass-Steagall". See also supraSecuritization implications at "Covered bonds (on-balance sheet); mortgage-backed securities (off-balance sheet)". See also, e.g., R. S. Sayers, Banking In Western Europe (1962) [re mixed (universal) banking].

None of these models (see supra
Financial system structureat "Possible alternative future models" and at "Other alternative models") are to suggest measures that are punitive to correct for any alleged wrongdoing, whether criminal or civil. That function is for the courts, regulatory agencies, and perhaps others (including public opinion, which varies) to determine.

These models are presented to solve perceived problems that perhaps remain despite Dodd-Frank. They are not meant to be critical of the banking industry but instead try to focus on root causes of the financial crisis. The models assume, arguendo, that
bankers for the most part made honest management decisions in good faith that resulted in unforeseeable consequences (e.g., possible reliance on mathematical models that did not factor in sufficiently an unusually broad housing market downturn, the influence of much larger scale of securitization with commercial banks' participation in securitization, weakened loan origination standards, government policy encouraging home ownership, skewed profit incentives). Nevertheless, a stable financial structure/system must be established to avoid a repeat of the recent painful financial consequences in the United States and internationally.

See also above: Securitization implications;
Financial system structureat "Possible alternative future models", at "Other alternative models", and at "Consequences beyond financial industry". Click here, or here, e.g., forLandon Thomas Jr. and Eric Dash, Battle Starts Over British Bank Rules, New York Times, at B1 (April 8, 2011) [consideration in Britain of separating deposit-taking from investment banking operating as distinct subsidiaries, not as independent companies as required in the United States in the Depression; more direct challenge for British banks than Dodd-Frank (and Volker rule) has been for American institutions; for some experts in Britain the approach in the United States is not strong enough; quotingAndrew Hilton, the director of CSFI in London, a financial services research group: “In the end, you just can’t regulate these banks — they have too much money and too many lawyers. We should be prepared to split the casino bank from the utility bank" (emphasis added)]. For more on this issue, click here(Google™ results) and here (bing™ results).

Overcome difficulty of reaching a consensus:
The consensus of sovereigns required to enter into this enterprise would be extremely difficult to attain. But the consequences to the world economy are probably severe enough to all the world's nations that each nation might be willing to make the trade off of a portion of its sovereignty (which probably be required in any successful worldwide regime) to secure a more stable order in the world's financial system. See supraFinancial system structure at "Consequences beyond financial industry:Financial crisis impact on world economy". Cf., e.g., Paul M. McBride, The Dodd-Frank Act and OTC Derivatives: The Impact of Mandatory Central Clearing on the Global OTC Derivatives Market, 44 The International Lawyer, 1077 (Winter 2010) [voluntary, not compulsory, clearing market participants strike optimal balance between costs and benefits of clearing; sustained cooperation with gentle regulatory pressure will perhaps result in financial stability and reduced systemic risk; some jurisdictions seem to feel that this type of market evolution is better suited to incentives rather than prescriptive rules (from Jill Sommers, Comm'r., U.S.CFTC, Address at Georgetown University: Financial Reform, What's Nezt? A U.S. and Global Perspective Examining the Opportunities and Challenges Ahead (Oct. 26, 2010) available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opasommers-11.html]. Click herefor speech [With regard to international coordination, earlier this month I chaired a meeting of the CFTC’s Global Markets Advisory Committee, where representatives of the European Commission and the Japanese FSA described their ongoing regulatory initiatives. While I was encouraged by the number of areas where we seem to be on the same page, the United States is clearly moving ahead to implement our G-20 commitments in areas such as mandatory execution of standardized OTC derivatives on exchanges or platforms. Other jurisdictions seem to feel that this type of market evolution is better suited to incentives rather than prescriptive rules. Global consistency is an integral part of the success of such sweeping changes to financial regulation (emphasis added)].

See also supra at Focus
The Eurodollar Market: The Case for Disclosure (at 1506-1510) for a discussion of the difficulties of reaching a transnational uniformity [e.g., where no international body exists with the authority to require regulations within countries, unanimous agreement is a prerequisite for multinational regulation; international political agreements are exceptional occurrences, especially when more than two nations are involved; enforceable agreements are often subject to special ratification procedures; even if an multinational agreement is reached, its long-term viability is questionable an difficult to sustain; given all these obstacles "extremely unlikely that an international agreement is a feasible solution"; "no matter how desirable a multinational accord might be in theory, it is a remote solution in practice"]. Difficult. Not impossible.

Recognize banking's special role and responsibility: Banking is of crucial importance -- a critical cog -- in the economies of the world. A worthy goal would be to see if the peoples of the world were to be able somehow (1) to fashion a financial system that incorporated reasonable technical measures and thinking like those discussed above and elsewhere and (2) to fashion a financial system whose predominant thrust would be to encourage a culture in banking that emphasized its specialrole in, and responsibility to, the greater good of society. Cf. Stephen M. Davidoff, As Wall Street Banks Grow, Their Reputations Wither, New York Times, Deal Professor, DealBook, at B9 (April 27, 2011) [growth of capital markets and global economy created much larger financial institutions than before; reputation no longer matters; much diminished financial system as a consequence].

Another way to express the importance (and encouragement) of implementation of this goal is that banking must be viewed as a calling to be attended with a certain honor it deserves in pursuance of the business of banking. Difficult. Not impossible.

Click herefor many of these ideas as captured so brilliantly in the film It's A Wonderful Life,a 1946Americancomedy/dramafilm produced and directed by Frank Capra and based on the short story "The Greatest Gift" written by Philip Van Doren Stern.

Banking is a for-profit financial industry in a capitalistic system and should remain so. Yet even though the following comments about professional tournament golf's metamorphosis may not be as meaningful here regarding banking, something might be found in the experience of professional golf that is worthwhile to banking. See, e.g., John Paul Newport, The Man Who Groomed the Game, Wall Street J., at A16 (April 30-May 1, 2011) [PGA Tour commissioner Deane Beman (1974-1994) pointed to two developments he thinks were most significant of his tenure: first, reorganizing Tour as a not-for-profit association instead of a for-profit corporation in 1979; second, recognizing that tournament volunteers and charities they support were key to Tour's future success because the Tour had to stand for something and that volunteers were not going to give up their vacation time if the only purpose of a tournament was for golfers to come in from out of town and leave a week later with a lot of money; if tour had to pay for volunteers' directing parking, marshalling the fairways, working the scoreboards not much money would remain for charity; according to estimates the Tour provided Adam Schupak, author of new book (Deane Beman, Golf's Driving Force: The Inside Story of the Man Who Transformed Professional Golf Into a Billion-Dollar Business) the switch yielded $500 million in benefits over the years; according to Beman (?) Tour events had raised through the end of last year $1.6 billion for charities, most of them local; the charitable work has proved effective in attracting corporate sponsors, who value the association; Beman said that the culture of the game and the players is golf's most valuable asset, much more than the tournaments themselves or the television contracts and that he tried to protect that tradition above all else, even as he commercialized professional golf and transformed it from a minor-league sports enterprise to the big time.].


Conclusion/summary:
In the eurodollar market for its early to middle years the lending banks usually did not know the identity or creditworthiness of the finalborrower. In securitizations of mortgage-backed securities (MBS), the investors may be unknown to the originating institution, though its borrower's identity is known. But the borrower's creditworthiness frequently had been questionable and had weakened the pool of mortgages that is to be securitized. Both markets have involved the lack of sufficicient or adequate financial information on the relevant borrower--whether at the end of the chain of lending (eurodollar market lending) or at the beginning of the chain of distribution of MBS (housing market lending).

With the trend in the eurodollar market away from lending to securitization, the underwriting bank will or should know the identity of the borrowers, as does
the loan originator in the MBS market. In both the eurodollar market and MBS market, a note receivable (loan on the bank's balance sheet) that is packaged (by, e.g., Fannie Mae or Freddie Mac) with others' notes is sold to investors and traded by them on the secondary market.In both the eurodollar market and MBS market, thesale of a note receivable results pursuant to securitization in a decrease in the institution's notes receivable account and an increase in cash account on institution's balance sheet.Thus the amount of the bank's assets is unchanged, its reserve requirements are not diminished, and its capital reserves are maintained while the bank nevetheless is able to expand credit in the economy by repeating this securitization so long as investors continue to buy the secuitized loans.

A possible, but partial, regulatory model for both markets might be a reasonable disclosure regime that would measure certain market activities while maintaining the participants' privacy with presumably appropriate protections. The market for mortgage-backed securities, like the eurodollar market, has international dimensions. Both markets might benefit from a reasonable disclosure or transparency model providing oversight and guidance by a supranational body or international treaty.

I suggested a similar scheme almost 40 years ago in The Eurodollar Market: The Case for Disclosure on the chain of lending in the eurodollar market. This suggestion would now seem to be equally applicable both to the trend to securitization in the eurodollar market as well as the securitization in the MBS. CDO, and credit default swap markets.


A remaining issue would be to cope with each country's reviewing the structure of its financial system. This review would require its analyzing the the merits of (1) a so-called "loose-fitting regulatory jacket" regime -- universal banking structure with covered bonds plus disclosure with a secured right of government to reclaim any possible future bailout funds, (2) a so-called "tight-fitting regulatory jacket" -- Glass-Steagall type of structure (e.g., weak, modestly strong, or fairly strong) plus disclosure (transparency) regime, or (3) some other alternative model or regime.

In light of the aftermath of the severe financial crisis of recent years the various soveriegn nations must cope with this issue somewhat along the lines suggested here resulting, more or less, with a worldwide disclosure or transparency regime having substantial benefit to the world's economy as a whole compared to what should be the much lesser cost or loss to each nation's soverienty.
This loss-benefit trade-off should be viewed by each country as possibly even more favorable to each of them when measured against the worldwide financial and economic stability that probably would accrue to the stability of each country's financial and economic systems as these systems interact with those of the world.