We argue that the US Financial Stability Oversight Council would likely make little difference were we to experience a rerun of the factors that caused the last crisis. It has no macroprudential levers under its direct control, and not all of its members have mandates to protect financial stability. ... And given the role played by loosely regulated nonbank financial institutions prior to the last crisis—and the continuing evolution of the financial system—a successful macroprudential intervention would likely require political backing to be nimble in widening the perimeter of regulation to capture such institutions. More generally, such a regulator would have to be fairly aggressive in using its powers. Given the novelty of these powers, there is no clear evidence on whether such forceful interventions would be realistic were risks to escalate again. ...As one example of the powers that US regulators do not have:
After the crisis, the Dodd–Frank Act did ban certain types of mortgages, such as interest-only mortgages or those with negative amortization. But it left the question of minimum down-payment restrictions to a group of six regulators involved in housing, which ultimately opted against introducing such a requirement. While risks in the housing market have significantly declined since the crisis, average loan-to-value ratios on mortgages are not lower than they were in the early 2000s. Furthermore, no US regulator has the ability to impose loan-to-income requirements, even if the Financial Stability Oversight Council wished to recommend this action. ... Moreover, the Fed lacks authority over many parts of the financial system and has no tools that can be used to tackle household debt vulnerabilities. A June 2015 “war game” exercise conducted by four Reserve Bank presidents concluded that the Fed had insufficient macroprudential powers to address a build-up in risks that resembled the earlier financial crisis. Also, Fed officials have cast doubt on whether its mandate permits it to use monetary policy to act against a build-up in financial stability risks.Thus, Aikman, Bridges, Kashyap, and Siegert are pointing out that financial regulators are unprepared for a literal rerun of the financial crisis that already occurred. The regulators also remain unprepared for financial crises that arise form other sources or in other forms.
Within the perimeter of prudentially regulated banking organizations, post-crisis financial regulation has made considerable strides, though liquidity regulation needs more work and capital requirements for the biggest banks should probably be somewhat higher. ... While there is at least a chance for maintaining the progress toward more resiliency for the largest banks, it is considerably harder to conjure up a benign outcome with respect to financial activity that occurs outside the perimeter of banking organizations. Recycled or new forms of shadow banking will almost surely increase over time, whether from existing nonbank financial firms or from new fintech (financial technology) entrants. Some of these will present risks to financial stability.For an example of one set of shadow banking issues, Amit Seru argues that 'Regulation of the Mortgage Market Must Consider Shadow Banks" in a Policy Brief written for the Stanford Instituted for Economic Policy Research (December 2018). As he notes: " Mortgage lending in this country is highly segmented and traditional banks represent only an increasingly small part of the story. For many decades, banks have competed with independent mortgage companies that don’t take deposits and typically don’t have brick-and-mortar branches, a group that can be called `shadow banks.'” This figure shows that the share of mortgage lending that doesn't come from banks is over half and rising.
A key change is the increased use of central clearing, which was directly mandated in post-crisis regulation and further encouraged by new regulatory capital requirements that, in effect, expressed a preference for central clearing. A central counterparty (CCP), also known as a clearinghouse, enters a derivatives trade as the buyer to the original seller, and as the seller to the original buyer. In this way, original counterparties become insulated from each other’s default risk—provided of course that the clearinghouse meets its own obligations. Central clearing also improves the transparency of derivatives positions and enforces uniform collateral practices that are more easily supervised by regulators. ...
There do remain, however, important concerns over the ability to resolve the failure of central counterparties, which have become enormous concentrations of risk under post-crisis regulations. If a clearinghouse has insufficient resources to manage the default of the derivatives obligations of a clearing member, the consequences could be catastrophic, now that hundreds of trillions of derivatives have been cleared by a small number of systemically important central counterparties. The default management resources of the central counterparty consist primarily of the margins provided by clearing members against their positions, and by a default fund to which all clearing members contribute. If the initial margin of a failed clearing member is not enough to cover the losses, the default fund is then applied. If the clearinghouse burns through both of these paid-in default management resources, and a small layer of its own capital, it then has the contractual right to stop paying clearing members the amounts otherwise due on their derivatives, even to the point of “tearing up” their derivatives positions. In the worst scenarios, the cessation of payments to clearing members and tear-ups would be catastrophic, and contagious. The largest clearing members are generally also large members of other central counterparties. This tail contagion risk is subject to regulatory stress tests and ultimately to regulations that could trigger a failure resolution process for central counterparties. However, actual implementable plans for the failure resolution of clearinghouses have still not been designed, at least in the United States...In November 2018, the Federal Reserve started publishing a Financial Stability Report, with lots of information about various possible sources of financial risk in the economy, as well as a Supervision and Regulation Report about trends and patterns in these areas. My general sense is that there aren't any major systematic financial risks threatening the US economy right now. But one hopes that financial regulators can be proactive, rather than reactive, to risks that could easily emerge in the future.