By Dylan Ellis

The Consumer Financial Protection Bureau (CFPB) has been one of the most divisive government agencies since its inception in 2010. The CFPB was installed with far greater protections than most government agencies are afforded, including protections against both presidential[1] and congressional[2] influences on the agency’s decision making. As a result, the CFPB has faced multiple challenges against its constitutionality. Most notably in 2020 where the Supreme Court held that the requirement placed on the President which only allowed removal of the lone CFPB Director “for-cause” was an unconstitutional restraint on the separation of powers.[3] The CFPB suffered another judicial defeat on October 19th, 2022, where the Fifth Circuit held that the CFPB’s funding structure is unconstitutional under the Appropriations Clause of the Constitution.[4]

The Unique Funding Structure of the CFPB:

Appropriations allow Congress to exert control over agency action because the expenditure of federal agency monies that come from appropriations are conditioned upon compliance with prescribed policy.[5] Therefore, if Congress disagrees with an agencies activity, it can prohibit the use of appropriated funds for the given activity.[6] When the CFPB was established in the wake of the 2008 financial crisis, Congress believed that the agency could best carry out its mandate of protecting consumers if it were shielded from the political influences of future iterations of Congress.[7] Thus, while most agencies rely on annual appropriations from Congress for their funding, the CFPB does not.

Instead of relying on Congressional appropriations for funding, the CFPB requests from the Federal Reserve an amount determined by its lone Director to be “reasonably necessary to carry out the authorities of the Bureau.”[8] The Federal Reserve must grant the request, so long as the request does not exceed 12% of the total operating expenses of the Federal Reserve.[9] The funds transferred to the CFPB shall not be construed as Government funds or appropriated monies[10] and shall not be subject to review by the Committees on Appropriations of the House of Representatives and the Senate.[11] The Bureau’s ability to fund itself beyond Congress’s appropriation powers lies at the heart of the Fifth Circuit’s finding that the CFPB’s funding structure unconstitutional.[12]

The Fifth Circuit’s Reasoning:

The Court reached its conclusion by finding that the CFPB’s funding structure violates the separation of powers principles set forth in the Appropriations Clause of the Constitution.[13] The Appropriations Clause commands that, “No money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law.” [14] The Supreme Court has interpreted the clause as limiting the power of the executive branch by ensuring Congress’s exclusive control over the federal purse.[15] Accordingly, any exercise of a power granted by the Constitution to one of the other branches of Government shall be limited by a valid reservation of congressional control over funds in the Treasury.[16]

The Fifth Circuit determined that the CFPB’s ability to unilaterally fund itself with “unappropriated monies” directly from the Federal Reserve—which is itself outside the appropriations process—has yielded an unprecedented “double insulation” from the appropriation powers of Congress.[17] The Bureau is further insulated by the express exemption from Congressional review of its funding.[18] According to the court, the Bureau’s unchecked funding structure renders the agency “no longer dependent and, as a result, no longer accountable” to Congress and, ultimately, to the people.[19] Therefore, Congress’s cession of its power of the purse to the Bureau violates the Appropriations Clause and the Constitution’s underlying structural separation of powers.[20] Accordingly, the Fifth Circuit vacated the CFPB rule in question on the grounds that it had been promulgated using unconstitutional funds.[21]

Going Forward:

The ruling opens the door to challenges against the CFPB for both future and prior action as nearly all the agency’s actions can be connected to the unconstitutional funding structure. In fact, parties that have been adversely affected by the CFPB began challenging their lawsuits as void in light of the Fifth Circuit’s holding almost immediately after the decision.[22] For example, on October 20th, TransUnion–who had been sued by the CFPB for violating a consent order through the continued use of deceptive marketing–cited the Fifth Circuit’s holding in a court filing supporting a motion to dismiss the suit.[23]

There are a few ways in which this conflict can be resolved. The CFPB could seek review of the decision before the entire Fifth Circuit; however, the odds that the decision is reversed are slim as seven of the sixteen active judges have already expressed their view that the funding structure is unconstitutional.[24] The Bureau could also seek review from the Supreme Court, but the odds are not in their favor once again as five of the justices who ruled against the CFPB in 2020 remain on the bench.[25] Ironically, the funding structure was put into place to protect the CFPB from Congress, however it seems most likely that a legislative fix will be required if the CFPB and its previous regulatory actions are to survive the Fifth Circuit’s decision.

  1. 12 U.S.C. § 5491(c).

  2. § 549(a)(2).

  3. Seila L. LLC v. Consumer Fin. Prot. Bureau, 140 S. Ct. 2183, 2197 (2020).

  4. Cmty. Fin. Servs. Ass’n of Am., Ltd. v. Consumer Fin. Prot. Bureau, No. 21-50826, 2022 WL 11054082, at *12 (5th Cir. Oct. 19, 2022).

  5. Kate Stith, Congress’ Power of the Purse, 97 Yale L.J. 1343, 1363 (1988).

  6. Id.

  7. 156 Cong. Rec. 8931 (2010) (statement of Sen. Dodd) (“[T]he [CFPB’s] funding will be independent and reliable so that its mission cannot be compromised by political maneuvering.”).

  8. 12 U.S.C. § 5497(a)(1).

  9. § 5497(a)(1)-(2).

  10. § 5497(c)(2).

  11. § 5497(a)(2)(C).

  12. Cmty. Fin., 2022 WL 11054082, at *12.

  13. Id.

  14. U.S. Const. art. I, § 9, cl. 1.

  15. Cmty. Fin., 2022 WL 11054082, at *13.

  16. Id.

  17. Id. at *14.

  18. Id. at *15.

  19. Id.

  20. Id. at *19.

  21. Id. at *18.

  22. TransUnion Defendants’ Notice of Supplemental Authority, Consumer Fin. Prot. Bureau v. TransUnion et al., No. 1:22-cv-1880 (N.D. Ill. Oct. 20, 2022).

  23. Id.

  24. See Consumer Fin. Prot. Bureau v. All Am. Check Cashing, Inc., 33 F.4th 218, 220 (5th Cir. 2022) (Jones, J., Concurring) (four Fifth Circuit Justices find in concurrence that the CFPB has been unconstitutionally funded); See also Cmty. Fin., 2022 WL 11054082, at *12 (three other Fifth Circuit Justices find that the CFPB is unconstitutionally funded).

  25. See Seila, 140 S. Ct. 2183 (2020).

By Kelsey Hyde

On March 17, 2017, the Fourth Circuit published an opinion in the civil matter of Sharma v. USA International, vacating the district court’s grant of summary judgment and remanding for further proceedings. In departing from the lower court’s ruling, the Court found the U.S. District Court for the Eastern District of Virginia improperly granted the defendant’s motion for summary judgment based solely on the contested issue of plaintiff’s purported damages.

Factual & Procedural Background

The plaintiffs in this case, Jatinder Sharma & his corporation Haymarket Fast Foods, Inc., were involved in a business transaction with defendants Khalil Ahmad and Mahrah Butt, partners at USA International, LLC. Sharma became interested in purchasing two restaurants– a Checkers and an Auntie Anne’s– from defendants upon learning how these restaurants were generating high sales. Throughout negotiations for the purchase of these restaurants, Sharma reviewed USA International’s tax returns and financial statements, which indicated the combined sales of the restaurants for the most recent months were about $75,000 per month.

The parties’ first purchase agreement specified a price of $720,000, and made the sale contingent on the stores collectively acquiring $90,000 in monthly sales in the two months prior to a settlement. Subsequent financial statements revealed lower monthly sales, thus the price was later reduced to $600,000 and the conditional-sale provision was eliminated from the final agreement. Sharma formed the entity Haymarket Fast Foods, Inc. in relation to the transaction, and also applied for a loan at his bank to secure part of the purchase price. His application represented that the restaurants’ average monthly sales based on the figures presented in the financial statements provided by defendants.

Shortly after the closing, Sharma noticed sales well below the figures that had been conveyed by defendants. Sharma looked further at other elements of the business– namely the supply orders, employee’s personal observations, and bank records– in an attempt to uncover the discrepancy. This investigation made Sharma realize that, based on the supplies available, the amount of sales defendants had purported to make were simply not possible; he then suspected that defendants had inflated their sales on the income statements provided to him before closing. Further, employees who had been working for defendants revealed to Sharma that defendant Butt had, on numerous occasions, rung up high sales for food not ordered by customers, and then directed employees not to prepare the food that coincided with these orders. Moreover, Bank of America accounts revealed that deposits attributable to the restaurant were substantially lower than those represented in the statements given to Sharma.

In response to these findings, Sharma filed on action for fraud against the defendants, alleging they had inflated sales figures and lied during negotiations, resulting in fraudulent inducement to pay a higher price for the business than it was truly worth. He proposed that damages be calculated by either (1) multiplying weekly sales by 36, or (2) multiplying monthly earnings by 48, either of which meant to provide the proper valuation of the business.

Defendants filed a motion for summary judgment, claiming plaintiffs had failed to sufficiently establish the materiality of the alleged misrepresentations, their reliance on the misrepresentations, and their damages (i.e. three of the particular elements necessary to succeed on a fraud claim). The district court found that plaintiffs had adequately shown the materiality of and reliance on defendants’ misrepresentation, but had indeed failed to provide enough evidence for a factfinder to estimate with reasonable certainty the amount of damages they sustained. Namely, the court rejected the two methods proposed by plaintiff for finding the actual value of the two restaurants, concluding that neither method conformed to any generally accepted methods for valuing a business, nor sufficiently proved they were independently reliable. Thus, because damages are a necessary element of a fraud claim under controlling state law, the court granted summary judgment. On appeal, the sole issue presented regarded the district court’s finding of insufficient evidence of damages.

Elements of the Claim & Standards to be Met on Motion for Summary Judgment

On a motion for summary judgment, the court takes the record in the light most favorable to the non-movant party. The moving party is entitled to a grant of summary judgement as a matter of law if they show there is no genuine dispute as to any material fact. F.R.C.P. 56(a).

To establish a claim for fraud under Virginia law, a plaintiff must show: (1) false representation, (2) of a material fact, (3) made intentionally and knowingly, (4) with intent to mislead, (5) reliance by the party misled, and (6) resulting in damages to the party so misled. Evaluation Research Corp. v. Alequin, 439 S.E.2d 387, 390 (Va. 1994). Because all such elements are necessary, failure to satisfy any one element is enough to bar relief for a fraud claim, as the district court found in their ruling based on failure to establish damages.

Under Virginia law, when a dispute involves the transfer of goods or property, damages are measured by the difference between the asset’s actual value at the time of contract and the asset’s purported value if the representations made had instead been true. Courts have previously treated sales prices as sufficient evidence of value, especially in arms’ length transactions. Virginia law maintains that plaintiffs need not prove damages with absolute certainty, but a plaintiff still must provide sufficient evidence to allow a factfinder to make an intelligent, probable estimate of the damages or losses allegedly sustained.

Fourth Circuit Finds Plaintiffs’ Evidence Regarding Estimated Damages Sufficient to Survive Motion for Summary Judgement

The Court concluded that plaintiffs had indeed met their burden and had put forth sufficient evidence to allow an estimate of damages by a factfinder. Namely, the Court emphasized that the parties’ arms-length transaction would allow a reasonable factfinder to conclude that the restaurants’ final sales price represented their value, as needed for the calculation of damages. Viewing the record most favorably for the plaintiffs, the Court found that negotiations surrounding the final price of the restaurants evidenced that both parties’ relied on a valuation of the businesses derived from a multiple of weekly and/or monthly sales. Moreover, the entire content of negotiations between the parties clearly revolved around the restaurants’ weekly or monthly sales, from Sharma’s initial interest in purchasing the restaurant to the later financial statements used by defendants to further persuade Sharma to go forward with the purchase. The Court even performed its own calculations to affirm this result, despite the defendants’ refusal to confirm the calculation methods used to arrive at the sales price.

However, the Court also emphasized that the actual multiplier-numbers used or derived are not dispositive in this case, and that defendants could indeed challenge those numbers as a matter of fact later in the case. Instead, the true question was whether plaintiffs provided sufficient evidence, as a matter of law, for a factfinder to estimate a probable calculation of damages. In the Fourth Circuit’s opinion, the plaintiffs did just that by presenting their own estimate with reasonable precision and support for their own calculations, using an accepted approach based on income and computing their results with specific numbers provided by defendants to estimate the purchase price.

Vacated & Remanded

Based on their finding that Plaintiff’s purported estimates of damages were acceptable and sufficient to create a material dispute of fact, the Fourth Circuit vacated the District Court’s grant of summary judgement and remanded for further proceedings to continue plaintiff’s fraud claims.

By: Lauren Durr Emery

In Susquehanna Bank v. United States of America/ Internal Revenue Service, the Fourth Circuit examined competing claims from Susquehanna Bank  and the Internal Revenue Service (IRS) to a company’s assets following its filing of Chapter 11 bankruptcy.

On September 20, 2004, the IRS assessed tax deficiencies in excess of $60,000 from Restivo Auto Body, Inc. (Restivo) for unpaid employment taxes.  However, the IRS did not file a lien until January 10, 2005.  On January 4, 2005, Restivo borrowed $1 million from Susquehanna Bank secured by a deed of trust for two parcels of property.  Susquehanna Bank did not record the deed until February 11, 2005.    In April of 2011, Restivo filed for Chapter 11 bankruptcy and Susquehanna sought a declaratory judgment from the court that its security interest had priority over the tax lien filed by the IRS.

Though federal law governs federal tax liens, 26 U.S.C. §6323(h)(1)(A) gives an IRS tax lien only those protections that local law would afford  to “a subsequent judgment lien arising out of an unsecured obligation.”  Thus, the court had to examine Maryland law to see if any of its provisions gave the bank priority in those circumstances.

Does a bank’s security interest in a parcel of land have priority over a federal tax lien if it was secured by a deed of trust executed before the lien, but not recorded until after?

The district court found that the security interest held by the bank had priority over the federal tax lien for two reasons.  First, the district court found that Md. Code Ann., Real Prop. § 3-201 allows a deed of trust’s effective date, upon recordation, to be the date when the deed of trust was executed.  In this way, it concluded, that though the deed of trust was recorded on February 11, 2005, the relation-back provision meant it was effective as of January 4, 2005 when the deed was executed.  In this way, Susquehanna’s interest had priority.  Second, the district court found that the bank’s security interest would have taken priority even if the deed had never been recorded based on Maryland’s doctrine of equitable conversion.  This doctrine entitles the holder of a deed of trust to the same protections as a bona fide purchaser, who takes title free and clear of all subsequent liens regardless of recordation.”

Fourth Circuit says Maryland’s relation-back provision does not give Susquehanna Bank priority over IRS

The Fourth Circuit held that the district court erred in its application of the relation-back provision in Md. Code Ann., Real Prop. § 3-201.  It reasoned that the deed was only subject to the relation-back protections after it had been recorded.  Thus, since the deed was not recorded until February 11, 2005, it did not yet relate back by when the IRS had filed its tax lien on January 10, 2005.

Fourth Circuit finds Susquehanna Bank does have priority over the IRS tax lien as a result of equitable conversion

Under Maryland’s doctrine of equitable conversion, when lenders, like Susquehanna Bank, receive a conditional deed to secure repayment of its loan, it receives the same protections as a bona fide purchaser for value.  In contrast, the IRS is treated as a judgment creditor and its claim is “subject to prior, undisclosed equities” and “must stand or fall by the real and not apparent rights of the defendant in the judgment.”  Thus, upon the execution of the deed of trust on January 4, 2005, Susquehanna Bank secured an interest in the property which precedes the IRS tax lien of January 10, 2005.

Dissent: Susquehanna Bank’s interest is not protected by equitable conversion

In Judge Wynn’s dissent, he argues that Restivo never had an unencumbered title which it could convey to Susquehanna Bank.  Instead, he states that the federal tax lien arose at the time of the original assessment on September 20, 2004.  Judge Wynn explains that this is a tax lien, rather than a judgment lien as the majority argues, and thus is governed solely by federal law.  Thus, this lien did not need to be filed or recorded in order to have priority.  Instead, he argues that the case should be governed by the principle “first in time is first in right.”

By: Lawrence G. Baxter*


In early May 2012, a select group of America’s most powerful bankers was ushered into a meeting with the Governor most responsible for bank regulation at the Board of Governors of the Federal Reserve System (“Fed”).[1]  The bankers were there to express their concerns about far-reaching proposed regulations designed to promote financial stability and reduce their banking organizations’ exposure and potential for creating systemic risk.  Such meetings are ordinarily held in secret, but a notice and an agenda for this one were leaked to the media, apparently angering that most secretive of financial agencies.[2]

Few events could more perfectly illustrate the close relationship between the Fed and the nation’s leading bankers.  One commentator concluded in advance of the meeting that the purpose of this “unusual pow-wow” was, in short, “to protect these banks’ cushy bottom lines, consequences to the overall economy be damned.”[3]  This cynical conclusion added to a popular refrain that the Fed has been “captured” by the industry it regulates.[4]

Yet, reality seems to have been somewhat different.  In the first place, the bankers were permitted to express their views, but, under a long-standing Fed rule, neither the Governor nor Fed staff was permitted to respond.  The Fed made it clear that no responses specific to the bankers’ views would be given and that the bankers’ views “were just one perspective the Fed was considering.”[5]  The bankers certainly had much to fear from the proposed rules—enough to divert the time of their CEOs for half a day in efforts to dilute their regulatory impact.  Shortly before this meeting, the Governor conducting the meeting made a public speech[6] calling for regulatory reform; a similar speech by the Governor of the Fed’s British counterpart,[7] the Bank of England, had already caused anguish in the industry.[8]

Perhaps this whole affair could be dismissed as a charade, but if it was, the charade was extraordinarily elaborate.  It seems that something much more complicated than capture is at work, even in big bank regulation and even within the close relationship big bankers undoubtedly have with their regulators.[9]

The Wake Forest Law Review, in its Spring 2012 Symposium, invited participants to consider, among many fascinating questions relating to the problems of participation in the administrative process, whether “the domination of industry interests necessarily results in agency capture?”  This Article focuses specifically on the capture question as it might apply to financial regulation, and in this context the question is quite problematic.  It will be suggested that in the world of financial regulation, particularly “bank” regulation, the concept of “capture” loses much of its analytic power for two principal reasons.  First, no single regulator is involved, and those that are engaged have different, very important missions.  Their respective susceptibility to capture ought inevitably to vary.  Capture of all of them by any one group of financial interests, however large, seems implausible.  Second, the quasi-public role of banks—particularly, but not only, large banks—renders the supposed government/private enterprise distinction, upon which the notion of “capture” depends,[10] quite enigmatic and volatile.  As a result, exactly who can capture whom, and exactly what is to be captured, is very hard, and perhaps sometimes simply impossible, to discern.[11]

If these are accurate descriptions of the regulatory environment, then “capture” is a very unsteady concept for assessing whether the public interest is being served in financial regulation.  “Public participation” also becomes difficult to apply as a normative criterion because there are many “public participations” and many forums of participation.

There are two traditional normative approaches to combating perceived capture by one interest group of the regulatory regime for all the groups.  The first, a “pro-market” approach, is to avoid or reduce agency involvement as much as possible, on the expectation that regulatory agencies can be—and, in the view of many, are inevitably going to be—captured by the most powerful industry interests.  Such an approach would increase reliance on market discipline on the assumption that markets are, or could be, less susceptible to discreet industry dominance.  The second, a “pro-regulatory” approach, would increase rulemaking safeguards (such as transparency, independence from industry, and rigorous isolation of regulatory decisions), which are designed to prevent, or at least minimize, the opportunity for improper influence by particular groups.[12]  This Article builds on a view of the process of agency policy formation to conclude that avoidance of “capture” (or undue influence by one set of interests) should properly embrace both approaches.[13]

In place of an either/or approach, we should focus on attempting to strike the right balance of market discipline and agency processes.  In order to understand the overall process, Part I of this Article briefly characterizes financial policy formation as the outcome of contests between all the participants involved, all acting in their own interests as “agents” in a complex adaptive system.  Part II describes the multiple-part system of regulatory agencies involved in the formation of financial regulatory policy in the United States, a system that inevitably introduces a diversity of agency views and tends to inhibit the formation of a single regulatory view that might be captured.  Part III considers the “quasi-public” role played by banks, even small banks, that is usually overlooked in debates about agency capture, yet which greatly complicates any assessment of the role banks play in relation to government.  Put quite simply, they are not merely “private” market actors, and it is therefore often appropriate for them to engage very closely with government, sometimes even at the cost of appearing to “be in bed with their regulators.”  Part IV of the Article considers the ways in which undue sectoral influence might be averted in the process of policy formation and how a balanced overall result—one that takes into consideration the interests of all the stakeholders affected—might realistically be promoted.  These recommendations are not novel, but they retain their merit at a time when debates about financial regulatory policy have tended to become highly adversarial and, in the end, unconstructive.

I.  Public Policy Formation in the Contested Arena

As a working definition, “capture” is defined here as “the heavily disproportionate influence by one of the interest groups covered by a regulatory framework to the improper disadvantage, or exclusion, of other groups also intended to be embraced, restricted or protected by the regulatory regime.”[14]  Using this definition, if ever there were an apparent example of the appearance of massive industry capture of the government, the world of financial regulation would be it.  Yet, a complexity view of this world suggests an environment rather more nuanced than this “winners and losers” model invoked by traditional capture analysis.

The financial market provides a prime example of a complex adaptive system.[15]  Global and domestic financial systems consist of a wide diversity of participants (or “agents”) all interacting with each other in sophisticated networks, in large part without central direction, and evolving in a constant state of flux.  It is equally applicable to the process of financial policy formation, in which regulators (even legislatures and courts) are themselves agents interacting not only with the agents of industry, consumers, and other organizations but also with each other.[16]  In effect, public policy is developed in an arena of contest—through a process Professor Thomas McGarity has aptly described as a “blood sport.”[17]

In this view, finance comprises a complex ecology.  The policies generated by legislatures and agents are shaped by the contesting forces of many diverse players.  No matter how hard and firm the rules erected to structure and control financial markets might be, the policies shaping and implementing these rules are never static.  Instead they are dynamic, buffeted by and reacting in their interpretation to the actions and reactions of the agents impacted by them.  This is not to say that rules and agency decisions are ineffective; on the contrary, they are forces that themselves influence, with varying degrees of specificity (depending on how clear and simple they are), the actions of participants in the market.  But they compete with many other forces to produce outcomes.

An important conclusion to be drawn from this “complexity” view of financial regulation is that the policies resulting from this dynamic interaction are not linear.  They are themselves in flux and adaptive, for good or ill, and they are continually being shaped by a variety of forces.  In a suitably diverse and resilient financial ecology, improper influence by any one set of agents or interest groups would be ephemeral and perpetually subject to the dynamic forces of market competition, counterefforts by other interest groups, and contestation among agencies with differing interests and views of financial policy.[18]

This way of looking at the process does not mean that the danger of improper influence, or ultimate “capture,” is not real.  Indeed, it is likely to be the natural ambition of all the agents in the process.  But such a view helps us focus on the elements important to the continuing resilience, market efficiency, and democratic health of the financial system as a whole.

II.  The Regulatory Policy Matrix

A major factor complicating capture analysis, and perhaps even mitigating the dangers of capture in financial regulation, is the oft-criticized, highly matrixed financial regulatory structure.[19]  America still has a vibrant “dual banking” system.  Although the biggest banks tend to be federally chartered national banks, many thousands of banks are still chartered by state banking agencies.  The biggest differences in the relative powers of national and state-chartered banks have been considerably reduced over recent decades, but banks do still have a real choice, and they still make it.[20]  The ability to make the choice, not only between federal and state charters but, until recently, between different types of federal charters,[21] has given rise to the fear, empirically unsubstantiated,[22] of a “race to the bottom,” in terms of which states and the federal government compete for charters by granting wider powers to banks or relaxing regulatory standards.  So this dual system itself can affect the relevance of “capture.”  On the one hand, the dual system could increase the possibility of capture to the extent that state-chartered banks might be able to exercise influence over relatively weak state regulators, or national banks might be able to concentrate their influence on one federal regulator.  On the other, the differing constituencies and varying views of state and national chartering and supervisory authorities introduce a diversity of interests that would make it more difficult for any one sector of the industry to ensure that its preferences would dominate the regulator.

The dual system has also given rise to conflicting interests that help provide balance in the contest for influence.  Most small banks, for example, are state chartered, and their interests are represented vigorously through various organizations, including the Conference of State Bank Supervisors[23] and the Independent Community Bankers of America.[24]  In recent years, the interests of these organizations have clearly been at odds with those representing the very big banks.  These divergent interests have made a difference in both legislative and regulatory outcomes[25] and still function as  criteria for choosing a state charter over a federal one, or vice versa.[26]

Of course the sheer scale of modern banks and the fact that big banks are now regulated almost exclusively at the federal level[27] suggest that concerns with capture and deficiencies in public participation ought to focus on federal financial regulation.  Yet even at the federal level there is a complicated regulatory framework that can, and often does, work to prevent, or at least make it very difficult for, the strongest financial sectors to exercise undue influence.  The Fed has emerged as the central regulator for large financial conglomerates, including foreign financial organizations operating in the United States.[28]  At the same time, the primary regulator for national banks continues to be the Comptroller of the Currency,[29] whose Office (the “OCC”) is located within the Treasury Department but whose head is separately appointed by the President.[30]  And the interests of the Treasury Department and the Fed, while often seemingly unified, are in reality often at odds.[31]  Indeed, the OCC and the larger Treasury Department itself are not always in mutual agreement on matters of financial policy and regulation.[32]

Even more importantly, there is a third major regulator, the Federal Deposit Insurance Corporation (“FDIC”), with regulatory authority over almost all financial conglomerates that have banks or savings associations within their corporate combinations—and this means all banks of significance in the United States.[33]  The FDIC manages the deposit insurance fund and is the receiver or liquidator for all insured depository institutions (banks and savings associations)[34] and potentially all systemically important financial institutions, even if they are not banks.[35]  These roles often place the FDIC in stark opposition to the OCC or the Fed, and sometimes both.  The FDIC has an interest in preventing reckless bank activities that might endanger depositors and the deposit insurance fund, whereas the OCC, for example, has an interest in promoting and expanding the national banking industry, just as the state regulators have an interest in promoting the state banking system.  It is therefore not surprising that the OCC and the Fed, on the one hand, and the FDIC on the other, have clashed over what bank activities and investments should be permitted or prohibited.[36]  Similarly, the Fed and the FDIC have clashed over policy governing bank capital requirements because the Fed and the FDIC are not always in agreement over where the balance between safety and soundness, on the one hand, and credit expansion, on the other, should be struck.[37]

A new regulatory perspective has also been introduced as a result of the addition of the new Consumer Financial Protection Board (“CFPB”),[38] which adds a consumer protection focus to the investor protection and financial exchanges regulation traditionally provided by the Securities and Exchange Commission (“SEC”)[39] and Commodity Futures Trading Commission (“CFTC”).[40]  Together these agencies provide yet another center of divergent interest on matters of financial regulatory policy, and they, too, can and do differ, sometimes vehemently, on regulatory policy.[41]  They are focused on market conduct and, as such, perform something of the umpireal role that would make regulatory capture a particularly acute concern.  The CFPB has been fiercely opposed by the banking industry and other credit providers[42] because some in the industry have feared the additional regulatory burdens the new agency would bring.  In reality, however, it might be less the burden of new regulation that bankers fear and more the different center of interest and specialized enforcement focus that the new agency will represent.[43]

Finally, the international layer should not be overlooked.  The Basel Committee on Banking Supervision (“BCBS”),[44] the Financial Stability Board (“FSB”),[45]and to some extent even the International Monetary Fund (“IMF”),[46] all play a substantial role in influencing domestic regulatory policy.  Basel III[47] and the new Global-Systemically Important Financial Banks and Financial Institutions (“G-SIFIs”) surcharges,[48] emanating from the BCBS and the FSB, provide important examples of policy pressure that has helped shape, and has been shaped by, the views of the Fed and Treasury Department via a mechanism that has come to be described in international relations theory as a transnational regulatory network (“TRN”).[49]

This hodgepodge of regulatory structures is often criticized as being irrational and incomprehensive.[50]  There are certainly huge elements of the financial industry, including hedge funds and mutual funds among many others, that are tightly connected to the banking industry but are not fully covered by regulation in ways that would ensure against “leakage” and regulatory arbitrage.[51]  However, in the opinion of this author, the call for a single federal banking regulator has so far been resisted for good reason.  A divergence of regulatory opinion is probably far more valuable as an assurance against major regulatory mistakes than whatever benefits the real or imagined coherence of a single regulator might bring.  And this divergence of expressions of the public interest through the mechanism of multiple, powerful regulators might well constitute an important safeguard against excessive industry influence.

III.  Government & Financial Institutions: A Complicated Embrace

The Financial Crisis of 2008 (“Crisis”) certainly seems to have produced many potential illustrations of capture.  The phone logs of the then-President of the New York Federal Reserve Bank, Timothy Geithner, indicate that the captains of the financial industry talked regularly with him, on some occasions many times in a single day.[52]  Subsequent records, disclosed under sanction of Congress or through Freedom of Information Act (“FOIA”) lawsuits, indicate that the Federal Reserve System had itself arranged for huge, secret loans or other forms of emergency funding to be made available to domestic and foreign financial institutions on such terms that serious questions of political accountability were and continue to be raised.[53]  Recently, controversy has raged around whether it is appropriate that prominent bankers, such as Jamie Dimon of JPMorgan Chase & Co., should be members of the Federal Reserve banks that are supposed to regulate their institutions.[54]

Since that time, and even long before, the revolving door between government and the financial industry has spun around at a breathtaking pace.[55]  The volume of comment by industry representatives during the rulemaking process implementing the Dodd-Frank Act[56]—a massive legislative reform designed to address the causes of the Crisis—has been disproportionate to the substantive input by other stakeholders in the process.[57]  Finally, the raw political power of firms and agencies participating in the financial industry, from individual banks and their industry representatives to the giant government-sponsored enterprises (“GSEs”) Fannie Mae and Freddy Mac, seems evident from their vast collective spending on lobbying, both in Congress and to the financial regulatory agencies.[58]

With all these issues and events, the appearance of undue industry influence certainly seems great.  Yet, there are also many benign explanations for a good deal of industry influence peddling.  The financial industry, perhaps unlike any other (with the possible exception of public utilities), possesses some fundamentally distinct characteristics that make its level of influence both inevitable and, to a certain degree, essential.  It is not just that the financial business is exceptionally complicated; this can be said of many other businesses too, such as pharmaceutical development and manufacture and deep sea oil drilling.  It is because, since the founding of the Republic, we have maintained an assumption that banking is or should be a “private” activity,[59] when in fact it has always been critical for central banking and monetary policy purposes, both of which are core to the operation of modern government.[60]  Ironically, what was perceived as a mark of sophistication in American banking—the dominance of “private” banks—has obscured the critical “public” functions banks perform.[61]

Even before the creation of “central” banks, either in America or Britain, bankers were critically important to government funding.  Indeed, the Bank of England was created in part with the support of the goldsmiths of London to fend off robbing sovereigns, while also enabling the sovereign to bypass Parliament when raising finance.[62]  The creation of both the First and Second Banks of the United States, and even the subsequent establishment of a national banking system, was accompanied by political controversy at the level of the highest branches of government.[63]  Certainly the two Banks of the United States and even the seemingly “private” national banks were considered essential for the conduct of government.  The U.S. Supreme Court and various state courts recognized the Banks of the United States to be instrumentalities of government.[64]  National banks, chartered under the subsequent National Currency Act of 1863[65] and the National Bank Act of 1864,[66] were similarly recognized to enjoy the privileges of government agencies.[67]

This quasi-governmental function and status has continued to the modern day, blurring the divide between public and private—between government and private industry—in ways that confuse any simple analysis of either “capture” or “public interest.”  It often appears as if “capture” oscillates between government and the banks in a mutually codependent relationship that is sometimes coercive, sometimes supportive.

A.     Vehicles of Government Finance

The most visible role of banks as instrumentalities of government has been to provide the financial means for government to function.  Governments have felt a compelling need for either central banks or “private” banks (and, in practice, both) in order to fund wars or other more peaceful enterprises.  In the United States the national banking system itself was created for two reasons: to create a national system of legal tender and to provide a market and mechanisms for raising public finance.[68]  As the federal government found itself unable to fund itself effectively, and when the drains on its coffers during the Civil War proved overwhelming, a compromise in the form of the National Bank Act of 1864 led to the creation of a federal chartering system for private “national” banks.[69]  Thus from their inception, national banks had a public mission alongside their private banking functions.  Whereas they were restricted from the outset in the degree to which they could invest in and underwrite private debt, national banks have always been permitted, and even strongly encouraged, to invest in the debt of the U.S. government, states, and their political subdivisions.[70]

And this role has continued to escalate to the present day.  Now the investment and dealing in government debt is a major component of modern banking business; national banks and their affiliates within complex holding company structures deal in trillions of dollars of government debt.[71]  It is a role that has only escalated as modern government deficit spending itself has burgeoned.  In 1991 total outstanding U.S. public debt stood at under $4 trillion.[72]  This balance took nearly fifteen years to double.[73]  In 2012, six years later, it has almost doubled again, and outstanding debt is already nearly $16 trillion.[74]

B.     Conveyor Belts of Monetary Policy[75]

Closely related to their roles as market makers and investors in government debt, banks—particularly national banks (which comprise the overwhelming portion of the banking industry by assets)—are instruments for applying monetary policy.  They are, as has famously been put, the “transmission belts” [76] by which the Fed enlarges or contracts the money supply and stimulates or dampens the economy, whether through setting overnight interbank lending rates or buying securities from and selling them to banks.

It is of course true that other participants in the financial services industry are also engaged in these roles, but here banks are indeed “special.”  In any event the other participants are tightly interwoven with the banks, either as corporate affiliates or counterparties.  Like the tentacles of an octopus, banks form a quasi-governmental web in the ocean of public finance.

C.     Bailout Agents of the Government

Two lesser-known “quasi-governmental” functions of banks are just as important as those previously described.  The first is that they act as blotters on behalf of the government when other banks fail.  The second is that they are vehicles for the emergency restoration of liquidity in the aftermath of a significant bank failure or a widespread financial crash.

The first role is particularly true for very big banks: they are most needed when other very large financial institutions fail and are beyond the capacity of the government itself to resolve directly.  In such situations the government uses devices such as “purchase and assumption” (“P&A”) transactions so that the net public outlay is reduced as far as possible and disruptions to the economy are kept to a minimum.[77]

The role of banks as bailout agents for the government is particularly evident in the case of big banks.  One will recall the absorption by JPMorgan Chase & Co. of Bear Sterns and Washington Mutual, the catastrophic acquisitions by Bank of America Corp. of Countrywide and Merrill Lynch, and the snatching by Wells Fargo and Co. of our venerable Wachovia from the jaws of Citicorp at a frantic time when it was not always clear who was the savior and who was being saved.[78]

In the process of these dramatic government-triaged acquisitions, the big banks of course grew much bigger.  Indeed, even at a time when public objections to the size of our largest banks had become central to the debate on financial regulatory policy, the Financial Stability Oversight Council (“FSOC”),[79] which had been charged by Congress to conduct a study on whether the national deposit and debt caps imposed on bank mergers were adequate, concluded that banks should be exemptedfrom these caps when acquiring other distressed banks.[80]  This provides both a key to the persistence of the “too-big-to-fail” phenomenon and an indication of the national criticality, for good or ill, of the nation’s system of big banks.[81]

The second role is much more subtle, and it is by no means confined to large banks.  When a bank fails, and particularly when a series of banks fail, the economy served by that bank is placed under immediate distress.  Depositors do not have access to their savings, and employers cannot meet their payrolls.  Local and national economies instantly bear the impact of the failure because depositors and employees are not able to pay their bills or continue spending, and suppliers are, in turn, impacted.

In order to minimize these impacts, other banks must step in, not only to act as bailout agents in the manner described above but also to restore liquidity to local and national markets.[82]  While this function has been well noted in the aftermath of the Crisis, as attempts have been made to “get banks lending again,” it is often assumed that such a role is confined to large banks.  Indeed, it is seldom remembered that the same role was considered important for the creation of the federal deposit insurance system in 1933.[83]  And to this day the role of community banks as maintainers of liquidity remains important.[84]

In light of these economically critical functions, it is obvious that banks of all kinds play a quasi-governmental role that is qualitatively different from that of other financial institutions[85] and industries.[86]

IV.  Vehicles for Promoting and Sustaining the Public Interest

The situation just described would seem at first blush to be starkly antidemocratic.  The lobbying power of big banks, their powerful access to senior regulators, and their ongoing, codependent relationship with government all suggest the potential for, and probability of, capture in the extreme.  And this is not even to take into consideration the enormous power of the government-sponsored enterprises directly charged with implementing government housing and education policy.

It is therefore not surprising that the accusation of “capture” has been one of the most common charges leveled at banks, politicians representing their interests, and senior officials, particularly since the Crisis.[87]  Yet there are some mitigating elements, including increased publicity requirements, a raised public consciousness, and, perhaps least understood, the virtue of America’s “hodgepodge” financial regulatory system.  Furthermore, it is important to consider the reality that a good deal of the interaction between banks and the government is highly technical in nature and necessarily so.  This is not to excuse the lopsided nature of political influence that banks often enjoy, but one must address the different levels of interaction in order to start assessing whether and when the overall public interest is being smothered because regulators appear to be held captive by the industry.

A.     Expert v. Democratic Voices

When two very complicated elements of the Dodd-Frank reform legislation were being translated into enforceable regulations, namely the Volcker Rule[88] and the new system for exchange-traded derivatives,[89] the level of ex parte access enjoyed by the banks seemed astonishing.  Numerous form comments were filed by ordinary members of the public in the case of the Volcker Rule far outnumbering the formal comments filed by the financial institutions that were most likely to be affected.  But the substance of the industry comments was far more detailed.  Logs of meetings between representatives of the financial industry and regulators appear to tell a similar story.[90]  In a similar vein, many of the senior officials involved in implementing the reforms have been drawn directly from the very industry that was the object of reform.  Many of these officials have since returned to the same industry.[91]

Yet it seems unrealistic to expect a more “balanced” picture.  Regulating proprietary trading (Volcker Rule) and derivatives, or bank capital structures,[92] is an exceptionally technical matter.  While some public interest and consumer organizations might possess sufficient expertise, the ability of the lay public to offer meaningful input is likely to be very limited.  Even financial journalists often struggle to understand the issues and mechanisms involved.

Complicating matters still further, financial regulation involves the application of contested policies to these highly technical fundamentals.  While ex post empirical economic studies might sometimes validate the effectiveness of certain policies, trying to determine ex ante which policies should be applied, even when complex technical issues are well understood, is inherently a matter of ideology, narrative, and trope.  The long-running battles between Keynesians and Hayekians provide, of course, vivid examples.[93]  To this extent, financial regulation, perhaps less than other regulatory strategies addressing the natural environment,[94] inevitably renders policy formulation a political process that, in turn, not only requires effective policy participation to be highly expert but also becomes indeterminate in ways that encourage mutual suspicion between contesting participants.  It is this suspicion that can make capture rhetoric so pernicious because capture offers a spuriously “scientific” veneer to the analysis.

So it is in the world of complex financial regulation that our democratic norms supporting public participation and our desire to be sure that “technocrats” who really understand the industry they are trying to regulate come into direct conflict.  This does not mean that public representation cannot be made independent of the industry, which will naturally be looking out for its interests and not those of a wider public, but it does mean that a substantial amount of technical input will be necessary.  This input is most likely to derive from deep knowledge of the industry, and therefore to emanate in practice from the industry itself.  Indeed, in the case of rapidly evolving modern financial markets it is hard to imagine where else, other than very well-funded public interest groups, academia, retired regulators, and members of the industry, such input might come from.

B.     Traditional Balancing Mechanisms

To the extent that deep reliance on the industry is indispensible to meaningful financial regulation, it would seem that industry influence, though critical to realistic regulation, should be balanced by other well-informed forces in order to prevent the influence from becoming excessive to the point that it leads to regulatory outcomes that ignore or prejudice competing public considerations.  These balancing forces take a variety of forms, each designed to provide an offsetting mechanism.  Some are very traditional, some are internal to the regulatory process, and others are external checks and balances.  Some are still emerging.  Some rely on regulatory capability and expertise, others on objectivity, and others invoke processes of participation in order to bring a variety of views to bear in the deliberative process by which policy is decided.  All have received considerable attention in administrative law and will only be summarized here.

1.     Adequate Regulatory Capacity

An emerging literature has drawn attention to the difficulties in the United States, where regulators lack the status sometimes enjoyed by their foreign counterparts and where regulator salaries do not compete with those of their expert counterparts in the financial markets.[95]  In addition, regulators are subject to the sometimes-whimsical budgetary and legislative mandates of Congress.  It is difficult for them to match the power and resources of a well-funded array of industrial players, and it is difficult for regulators to hold on to their best performers when these individuals are faced with the temptations of private sector salaries while having to meet high living expenses.  When regulators are given jurisdiction, it is simply not enough to provide them with legal authority to act; they must also be able to discharge this legal authority.[96]

2.     Meaningful Transparency

In financial services, regulators tend to have a penchant for secrecy.  Yet this opacity makes meaningful policy input difficult unless one has inside access—a factor that often provides the basis for accusations of capture.[97]  The Fed is particularly notorious for avoiding publicity concerning its accusations and has had to be forced, by Congress[98] and through Freedom of Information Act lawsuits,[99] to divulge key information relating to its actions during the Crisis.  Yet it is a truism that transparency is a prerequisite not only for the proper functioning of markets[100] but also for the proper formulation and application of public policy in regulations—as much in financial regulation as anywhere else.[101]

3.     Meaningful Access by Stakeholders

The notice and comment model of administrative law is designed to facilitate access by all interested parties to the policy formulation process.  As has already been noted, however, access alone is not necessarily meaningful; the subject matter of financial regulation tends to be intensely specialized and beyond the abilities of ordinary members of the public.  Therefore meaningful access requires proponents of expert views, and this in turn introduces an additional requirement for comment on technical financial matters.[102]

4.     External Checks

These checks on the actions of regulators and policy outcomes are traditional and include Congress, congressional committees,[103] the Administration (including the Office of Information and Regulatory Affairs (“OIRA”)), the courts, inspectors general,[104] and specially created oversight committees such as the Congressional Oversight Panel[105] and the Financial Crisis Inquiry Commission.[106]

Rather than cover ground much more fully explored elsewhere, this Article will conclude with a consideration of some recent ideas and developments that are intended to create or develop institutions designed to enhance and promote non-industry-sponsored considerations of the public interest.

C.     Institutional Enhancement of Public Interest Representation

While it is true that technocratic regulation is not necessarily captured regulation, and that divergent, multiple regulators help generate the “democracy of ideas” so critical to balanced public policy, it is also true that all of these interests are likely to be biased in general toward the industry in one way or another.  In other words, the constant focus on the welfare of the industry, and the perpetual interaction with the industry at various levels, is likely to produce a distorted view of the overall interests of the public.  Taxpayers, for example, and laid off employees have borne the biggest brunt of industry mistakes, yet those interests seldom figure in any strong way when financial regulators make decisions.  The views of taxpayers and the general public are too dispersed to receive adequate representation in agency decisions.  They are a stakeholder who is not at the table even when their interests are likely to be genuinely affected.

The proposal of a public interest representative in such decisions would no doubt provoke angry rejection by the financial industry itself as yet another illegitimate intrusion by government into the realm of free enterprise.  In fact banking, and most of financial services, is not “free enterprise.”  On the contrary, it is a heavily subsidized industry that carries out major quasi-governmental functions and is fully dependent on government business and support for its current scale of operations.  In the author’s view this fact has been too often ignored or insufficiently understood.  Without taking this reality into account, the public will always be short changed and the “public interest” that emerges from the interaction of the regulators as earlier described will not likely be sufficiently balanced to avoid the charge of “capture” by the public at large.[107]

This would suggest the balance should be restored by additional, more formal representation of the public interest.  There are various ways such “tripartism”[108]might be enhanced.

1.     Formal Public Interest Representation

One way to intensify policy input from the “general public”—in other words, views not specifically represented by a discreet stakeholder—might be the introduction of formal mechanisms for promoting representation of “public interests” through institutions and procedural requirements.  At least three examples have been suggested.  One would be a mandated requirement for an independent third-party opinion or brief in the administrative process.  Elsewhere I have raised the example of the MITRE Corporation, which provides entirely independent, self-funding, and expert consulting on government decisions affecting the public interest yet besieged by strong commercial interests.[109]

The second method of promoting an independent view of the public interest comes from public utility regulation[110] and is illustrated by the recent decision of the Federal Energy Regulatory Commission (“FERC”) involving the proposed acquisition by Duke Energy of Progress Energy.[111]  The proposed merger had not yet satisfied the concerns of the Commission about its possible anticompetitive effects.[112]  The process for upholding public interest considerations is, as the Duke Energy decision illustrates, well supported by the standing of numerous collectivities, such as local authorities, who are properly organized to represent the general interests of their taxpayers.[113]

A broad proposal along similar lines has been made by Ross Levine, who advocates for—in terms of financial services regulation—the creation of an agency or “Sentinel.”[114]  This agency would have power to demand information, have expertise to evaluate this information and the financial policies being adopted by the agencies, and have the responsibility to report its views to Congress and the executive branch.[115]  With purview over the whole financial system, the Sentinel would bring a broader perspective to bear than might otherwise be held by the specific agency whose action is under review.  Being independently funded and situated, the Sentinel would also be in a position to offer impartial views as between the various financial agencies.

Another such broad proposal, made by Saule Omarova, is a “Public Interest Council” (“PIC”).[116]  The PIC would consist of an expert independent government agency appointed by Congress and located outside the executive branch, charged with participating in the regulatory process as the designated representative of “the public interest in preserving financial stability and minimizing systemic risk.”[117]  Like the Sentinel, the PIC would possess neither legislative nor executive powers; it would, however, have broad authority to collect information from both government agencies and private market participants, conduct investigations, publicize its findings, and advise Congress and regulators to take action “with respect to specific issues of public concern.”[118]

The difficulty with each of these ideas is that they are predicated on a substantive “public interest” that can be identified in some detached way by experts.  Yet it is unlikely that any of the agents in the process would acknowledge or even perceive that their positions were not in fact the best ones for the public interest, and it is has become naïve to expect otherwise.  As one critic of the Sentinel idea has put it, “[i]t is misleading to suggest that these [regulatory] judgments do not have a strong political dimension to them.  They cannot be put on autopilot, or entrusted to a group of disinterested ‘wise men.’”[119]  Proposing the addition of new layers to the regulatory process is also a questionable strategy, politically and financially.  The regulators tend to be underresourced as it is, and regulatory burden in financial services has become a rallying cry for the industry, sometimes with good reason.  Proposing to allocate even more funds to yet more external public agencies would have little prospect of success in today’s Congress.

2.     Private Public Interest Representation

A third option of expert representation by independent yet well-resourced private groups is now emerging in the field of financial regulation.  This is a cadre of privately funded and diverse expert organizations akin to the “shadow banking committee” that played a prominent role in critique of financial regulatory policy in the United States in the ‘80s and ‘90s.  The original shadow banking committee is now known as the Shadow Financial Regulatory Committee, an independent committee sponsored by the American Enterprise Institute.[120]  Additional examples are the Brookings Institution,[121] Center for Economic Policy Research,[122]PublicCitizen,[123] new deal 2.0,[124] Project on Government Oversight (“POGO”),[125] and Americans for Financial Reform.[126]  Similar institutions are developing in the United Kingdom and elsewhere.[127]  Important academic centers are also providing growing and deeply informed input to the public policy process,[128] and financial regulators are beginning to take advantage of seemingly independent advisory boards.[129]

Perhaps the most prominent and potentially influential example of independent expert public interest representation is the new “Systemic Risk Council,” recently formed by Sheila Bair, former chair of the FDIC, with support and sponsorship from the Chartered Financial Analyst (“CFA”) Institute and the Pew Charitable Trusts.[130]  The Council will comprise some of the leading and most senior former regulators,[131] at least two of whom took extraordinarily independent lines even while in government office.[132]

Bodies like these are independent of the industry itself and presumably reflect independent perspectives, accumulating financial expertise, and the potential for much needed expert input and balance on the complicated issues of financial regulation.


Despite appearances, it is too facile to assert that financial agencies are simply “captured.”  To be sure, the great power of large financial institutions strongly suggests that their interests will receive considerable attention—perhaps even unduly special consideration—and that they are sometimes inappropriately favored.  Yet, given the nature of the financial system and its operations, it is hard to envisage a more active interplay than the one between government and big banking.  The implicit safeguard of the complex regulatory matrix, however, can operate as a brake on the inclinations of one particular agency to lean too far in the direction of a favored sector of the industry.  At the same time, we are also seeing the growing organization and capability of powerful private groups that are providing expert voices to the policy formulation process.  While it is difficult to sustain the argument for a single “public interest” representative, the growing number of organized, “public interest” oriented and independent participants offers the promise of an important counterbalance to the influence of industry.

It is possible that the complicating considerations reviewed in this Article—matrixed regulation and multiple layers of regulators, on the one hand, and a blurred division between government and private market functions on the other—are entirely unique to the financial industry.  Yet it seems that some similarities in other regulated industries might also suggest that the charge of “capture” should often be taken with the proverbial pinch of salt, or at least with a healthy dose of detailed understanding of the complexities of the regulatory field under discussion.  Such an approach might not win a Nobel Prize, but it will be grounded in greater reality.

       *            Professor of the Practice of Law, Duke Law School.  Developed from a paper for the Wake Forest Law Review Spring Symposium, March 30, 2012, entitled The Asymmetry of Administrative Law: The Lack of Public Participation and the Public Interest.  I am grateful to the participants in the symposium for their helpful comments.

   [1].           The Governor was Daniel Tarullo, who has the lead role on regulatory policy among the Governors at the Fed.

   [2].           See Donna Borak, FAQ: The Story Behind the Tarullo-CEOs Meeting on Stress Tests, Am. Banker (May 1, 2012),

   [3].           Akshat Tewary, Big Banks Version of May Day, Am. Banker (May 2, 2012),

   [4].           The claim has become very common in academic and popular literature.  It was perhaps most elegantly put by Simon Johnson, The Quiet Coup, Atlantic, May 2009, at 46, 48–50.  For a more recent example, see, for example, Lawrence G. Baxter, Capture in Financial Regulation: Can We Channel it Toward the Common Good?, 21 Cornell J.L. & Pub. Pol’y 175 (2011); Daron Acemoglu & Simon Johnson, Who Captured the Fed?, N.Y. Times Econ. Blog (Mar. 29, 2012),

   [5].           Zachary Goldfarb & Brady Dennis, Fed’s Tarullo Emerges as Banks’ Key Federal Foe on Regulating Risk, Wash. Post (May 18, 2012),
-banks-key-federal-foe-on-regulating-risk/2012/05/18/gIQA9MhCYU_story.html; see also Dan Fitzpatrick et al., Well, That Was Awkward . . .  Bank Chiefs’ Regulatory Concerns Met With Official Silence, Wall St. J. (May 2, 2012),

   [6].           Daniel K. Tarullo, Member, Fed. Reserve Sys. Bd. of Governors, Regulatory Reform Since the Financial Crisis: Remarks to the Council on Foreign Relations 8 (May 2, 2012), available at (insisting on “rigorous implementation” of a wide suite of reforms); see also Donna Borak, Fed’s Tarullo: Risk of ‘Too Big to Fail’ Rises Without Dodd-Frank, Am. Banker (May 2, 2012),
/tarullo-dodd-frank-too-big-to-fail-1048965-1.html (reporting on similar views expressed by Chairman Ben Bernanke the week before).

   [7].           See Sir Mervyn King, The Today Lecture 2012, BBC Today Programme (May 2, 2012),

   [8].           See, e.g., Liam Halligan, Bankers’ Vitriol has Masked Sir Mervyn King’s Uncomfortable Message, Telegraph (May 5, 2012), (describing the angry reaction of bankers to King’s expression of regret that the Bank of England was not more severe on banks in the run up to the Financial Crisis of 2008 (“Crisis”)).  For the United States situation, see, for example, Goldfarb & Dennis, supra note 5.

   [9].           This is not to say that undue influence is never at work.  Sometimes laxity in supervision seems to leave one with no explanation other than either regulatory incompetence or undue favoritism.  See, e.g., Shahien Nasiripour, US Regulator Under Fire for JPMorgan Oversight, Fin. Times (May 21, 2012),
#axzz1vVZLSSwJ (discussing the failure by JPMorgan’s primary regulator, the Office of the Comptroller of the Currency (“OCC”), to catch the buildup of risk that led to a massive trading loss on the part of the bank, and quoting one commentator as saying that “[t]here’s some sort of cultural and ideological capture at the OCC”).

   [10].         See infra text accompanying notes 60–68.

   [11].         Capture theory is simplistic in other respects as well.  For example, it is unable to differentiate between excessive industry influence, on the one hand, and less conspiratorial explanations of agency performance such as incompetence or mere lack of resources.  An additional embarrassment for capture theorists is the role played by many obviously independent regulators who have earned public recognition for standing up to both industry and other regulators.  See infra text accompanying notes 31–43, 131.

   [12].         For sophisticated reviews of the various ways in which “capture” has been used, sometimes to further ideological ends, see, for example, Daniel Carpenter & David Moss, Introduction to Preventing Capture: Special Interest Influence In Regulation and How to Limit It (Daniel Carpenter & David Moss eds.) (forthcoming 2012); Stefano Pagliari, Introduction to The Making of Good Financial Regulation: Toward a Policy Response to Regulatory Capture (Stefano Pagliari ed., 2012), available at
-June—The-Making-.aspx; Jørgen Grønnegaard Christensen, Public Interest Regulation Reconsidered: From Capture to Credible Commitment (Jerusalem Papers in Regulation & Governance, Working Paper No. 19, Jul. 2010), available at (reviewing the logic of the three major theories underlying public interest regulation, namely public interest theory, capture theory, and credible commitment).

   [13].         Cf. Christensen, supra note 12 (advocating an approach to the formulation of public policy that takes the notion of “public interest” seriously but does not assume an objective “public interest”; rather, the important element in the process is to ensure a “wide inclusion of both regulated and third party interests”).

   [14].         Of course this definition begs many questions, such as what is meant by “disproportionate” or “improper.”  This Article, however, proceeds upon the assumption that answers to these questions are inherently contested and very seldom clearly determined by the legislature—which is precisely why we have processesfor reaching the outcome, delegation of details to the agencies, and the anticipation of ever-changing circumstances in the financial markets, which anticipation is embodied in the discretionary nature of the rulemaking and adjudication powers delegated to the regulators.

   [15].         Complex adaptive systems share a number of common characteristics.  They are not merely complicated; instead they are complex in the sense that they comprise a diverse variety of “agents” or actors all interacting with each other in a constantly evolving ecology that might or might not endure over time.  Those that do endure have the quality of resilience or robustness, but, even if robust, a complex adaptive system also has the danger of developing self-criticality or the potential for sudden collapse.  To be properly understood, the interactions of all the agents—in the case of financial markets, industry players, consumers, supporting utilities,and the regulators—must be taken into account through the application of a variety of disciplines ranging from game theory to network science.  For an introductory review of how complexity theory is being applied to the understanding of financial systems, see, for example, Lawrence G. Baxter, Betting Big: Value, Caution and Accountability in an Era of Large Banks and Complex Finance, 31 Rev. Banking & Fin. L. 765 (2011–12) (Part III and the references cited therein).  For a general introduction to the subject, see generally Melanie Mitchell, Complexity: A Guided Tour (2009).

   [16].         See Mark A. Chinen, Governing Complexity, in Globalization and Governance 55, 59–64 (Laurence Boulle ed. 2011) (discussing the application of complexity science to understanding public policy, and citing the leading works in the field); Robert Geyer, Beyond the Third Way: The Science of Complexity and the Politics of Choice, 5 Brit. J. Pol. & Int’l Rel. 237, 243 (2003) (outlining the characteristics of complex systems, including the rich interactions within them).  See generally Org. for Econ. Co-operation & Dev. Global Science Forum, Report on Applications of Complexity Science for Public Relations: New Tools for Finding Unanticipated Consequences And Unrealized Opportunities (2009).

   [17].         See generally Thomas O. McGarity, Administrative Law as a Blood Sport: Policy Erosion in a Highly Partisan Age, 61 Duke L.J. 1671 (2012) (describing how extreme partisanship has attracted high spending on the part of the players/stakeholders and has attracted new stakeholders to the process).  I would only differ from Professor McGarity in arguing that this contestation is inherent to the process and has only become more visible and more distasteful now because popular political division seems to have deepened dramatically.

   [18].         In the end, the objective should be to prevent the field of contest from becoming so tilted that a meaningful contest cannot take place.

   [19].         See Elizabeth F. Brown, E Pluribus Unum—Out of Many, One: Why the United States Needs a Single Financial Services Agency, 14 U. Miami Bus. L. Rev. 1, 5–6 (2005) (describing and criticizing the complicated structure of financial regulation in the United States, including the involvement of well over 115 federal and state regulators).  Numerous commentators and assessments have long blamed the multiplicity of regulators for the failure to anticipate the problems at specific institutions and the escalation of risk leading to the Crisis.  See, e.g., U.S. Gov’t Accountability Office, GAO-05-61, Financial Regulation: Industry Changes Prompt Need to Reconsider U.S. Regulatory Structure, at abstract (2004), available at (describing numerous instances of disagreements among the financial regulatory agencies and attributing to this disagreement a failure to apply “consistent, comprehensive regulation”).

   [20].         See, e.g., Barbara Rehm, Natural Selection?  Questioning the Future of The Dual Banking System, Am. Banker (Dec. 1, 2011),
-1.html (discussing the evolution of the dual banking system in light of recent regulatory reforms).

   [21].         A financial institution wishing to engage in banking can choose either a bank charter or a savings and loan charter (“thrift” charter).  While the former is the more traditional form, a thrift charter has offered more attractive powers in some circumstances.  Banks are chartered by either a state banking commissioner or the Office of the Comptroller of the Currency (“OCC”).  Until recently, savings and loan associations were chartered by either a state regulator or the Office of Thrift Supervision (“OTS”), a separate agency within the United States Treasury.  The Dodd-Frank Act eliminated the OTS and transferred the federal chartering powers for thrifts to the OCC.  Dodd-Frank Wall Street Reform and Consumer Protection Act, §§ 311–313, 12 U.S.C. §§ 5411–5413 (Supp. IV 2010).

   [22].         See Dain C. Donelson & David Zaring, Requiem for a Regulator: The Office of Thrift Supervision’s Performance During the Financial Crisis, 89 N.C. L. Rev. 1777, 1796–1811 (2011) (evaluating the impact of competition for charters and finding no significant differences in returns between institutions that converted federal thrift charters to bank charters and vice versa).  The OTS was heavily criticized for being a weak regulator, perhaps even captured by the industry it regulated (savings and loan associations).  A number of the largest financial institutions (“FIs”) that collapsed or had to be bailed out during the Crisis, including American International Group (“AIG”), IndyMac, and Washington Mutual, were under OTS supervision.  Among the criticisms leveled at the OTS was the suggestion that lax OTS rules encouraged FIs to flip their charters in order to avoid more rigorous regulation and to gain the favor of a “captured” regulator.  Yet, as the authors show, the evidence that charter flips actually did produce advantages is mixed at best.  Id.

   [23].         See generally Conf. St. Bank Supervisors, (last visited Sept. 4, 2012).

   [24].         See generally Indep. Community Bankers Am., (last visited Sept. 4, 2012).

   [25].         For example, smaller banks and their holding companies have been able to secure more lenient treatment in the case of certain kinds of regulation, such as slightly broader investment powers (trust-preferred securities), more lenient capital compliance requirements, enhanced systemic risk supervision (holding companies with consolidated assets of less than $50 billion), and oversight by the Consumer Financial Protection Board (“CFPB”) (banks with assets of less than $10 billion are not subject to direct oversight by the CFPB).  In light of the number of other new regulations introduced by Dodd-Frank, whether these exemptions confer net benefits is the subject of fierce debate.

   [26].         See Esther L. George, President and Chief Exec. Officer, Fed. Reserve Bank of Kan. City, Perspectives on 150 Years of Dual Banking, Speech to the Conference of State Bank Supervisors (May 22, 2012) available at (explaining the resilience of the dual banking system and why it still offers real choices).

   [27].         Although seventy-four percent of banking charters (including thrifts) are issued at the state level, see Conference of State Bank Supervisors, 2011 Annual Report 14 (2012), available at
/annualreports/Documents/2011FINALCSBSANNUALREPORT.pdf, nationally chartered banks (including thrifts) own seventy-six percent of all commercial banking assets in the United States.  See Office of the Comptroller of the Currency, 2011 Annual Report, at cover insert (2012), available at

   [28].         The Fed has long had direct supervisory authority over state-chartered banks that became members of the Federal Reserve System; national banks were directly regulated by the Comptroller of the Currency and continue to be so regulated.  See infra.  Since the passage of the Bank Holding Company Act in 1956, the Fed has also had significant supervisory jurisdiction over the holding companies that might own one or more national banks.  Two major elements of the Dodd-Frank Act have now ensured that the Fed is positioned to become the primary regulator for banking conglomerates.  The first is the “enhanced” supervisory powers conferred on the Fed, Dodd-Frank Wall Street Reform and Consumer Protection Act §§ 115 & 165, 12 U.S.C. §§ 5325 & 5365 (Supp. IV 2010), over bank holding companies with consolidated assets of $50 billion or greater, and non-bank financial organizations designated as systemically important financial institutions (“SIFIs”) by the Financial Stability Oversight Council in terms of section 113.  The second is the Collins Amendment to the Dodd-Frank Act in section 171, in terms of which the Fed must apply very important capital and leverage ratios across the holding company structure (prior to Dodd-Frank such ratios were applied only to the depository institution subsidiaries of these conglomerates).

   [29].         National Bank Act, 12 U.S.C. §§ 1–16 (2006).

   [30].         Id. § 2.

   [31].         For one of many examples, see, for example, Donna Borak, OCC Joins Other Agencies in Fight Against Debit Interchange Limit, Am. Banker (Mar. 8, 2011),

-interchg-limit-1034149-1.html (describing strong differences of opinion between the Fed, on the one hand, and the OCC, FDIC, and even the Fed Chairman, on the other, regarding the setting of debit card interchange fees).

   [32].         See, e.g., Letter from George W. Madison, Gen. Counsel, Dep’t of the Treasury, to John Walsh, Acting Comptroller of the Currency, Office of the Comptroller of the Currency (June 27, 2011), available at (criticizing the OCC’s proposed rulemaking relating to federal preemption of state consumer protection standards); see also Victoria McGrane, Treasury Assails OCC on Draft Rule, Wall St. J. (June 29, 2011),

   [33].         The FDIC insures over 7000 depository institutions.  See FDIC, 2011 Annual Report 4 (2012), available at  FDIC insurance covers almost eighty percent of all insured deposits in the United States.  Id. at 130.

   [34].         Credit unions are separately insured by the National Credit Union Share Insurance Fund, and if they fail, the National Credit Union Administration acts as receiver.  While not insignificant in national financial policy, credit unions are not covered in the discussion in this article.

   [35].         See Dodd-Frank Wall Street Reform and Consumer Protection Act § 204(b), 12 U.S.C. § 5384(b) (Supp. IV 2010) (noting that the FDIC is appointed as receiver for “covered financial companies” placed into liquidation upon a determination that their impending failure could pose a significant threat to the financial stability of the United States).

   [36].         See, e.g., Joe Nocera, Sheila Bair’s Bank Shot, N.Y. Times Mag. (July 9, 2011), (describing numerous disagreements between the FDIC under the chairmanship of Sheila Bair and the OCC and other agencies).  One well-publicized example was the disagreement between the FDIC and the Fed over whether large banks should be permitted to move their derivatives businesses into their insured depository institutions in order to reduce the amount of collateral they would need to post.  See Bob Ivry et al., BofA Said to Split Regulators over Moving Merrill Derivatives to Bank Unit, Bloomberg (Oct. 18, 2011),

   [37].         As the Crisis developed, the FDIC vigorously disagreed with the Fed over whether to permit banks to continue using trust-preferred securities as a means of raising capital.  In the end, the FDIC’s concerns were proven well founded.  See, e.g., Greg Gordon & Kevin G. Hall, How the Fed Let Small Banks Take on Too Much Debt, Then Fail, McClatchy Newspapers (Dec. 22, 2010),

   [38].         The CFPB (legislatively designated the “Bureau of Consumer Financial Protection”) was created by section 1011 of the Dodd-Frank Act.  See Consumer Fin. Protection Bureau, (last visited Sept. 4, 2012).

   [39].         Securities and Exchange Act of 1934, Pub. L. No. 73-291, § 4, 48 Stat. 881 (1934); see U.S. Sec. & Exchange Commission, (last visited Sept. 4, 2012).

   [40].         Commodity Futures Trading Commission Act of 1974, Pub. L. No. 93-463, § 201, 88 Stat. 1389 (1974); see U.S. Commodity Futures Trading Commission, (last visited Sept. 4, 2012).

   [41].         See, e.g., Kevin Wack, Closed-Door Battle over Volcker Spills into Public View, Am. Banker (May 21, 2012),
/issues/177_98/Gary-Gensler-Mary-Schapiro-Volcker-Rule-JPMorgan-Chase-1049494-1.html (describing the deep differences—a “long running, closed-door battle”—between the CFTC, on the one hand, and the Fed, OCC, FDIC, and SEC, on the other, over how vigorously to enforce the Volcker Rule, which prohibits proprietary trading by banks).  See generally Eugene F. Maloney, Banks and the SEC: A Regulatory Mismatch, 25 Ann. Rev. Banking & Fin. L. 443, 454–58 (2006) (discussing numerous examples of the differences in philosophical outlook between the banking agencies and the SEC).

   [42].         For a collection of articles reporting on the partisan positions for and against the CFPB, see Bureau of Consumer Financial Protection (C.F.P.B.), N.Y. Times, (last updated Aug. 10, 2012).

   [43].         Apart from a new standard by which to assess the acceptability of consumer financial services (whether a product or service is “unfair, deceptive or abusive” standard, as defined in section 1031 of the Dodd-Frank Act), most of the powers possessed by the CFPB were already within the scope of authority of other financial regulators and were simply transferred from them.  It is the reinvigorated focus on these powers that is probably one of the biggest reasons for resistance to them.

   [44].         The BCBS was created in 1974 as a committee of the Bank for International Settlements.  It has no formal legal powers, but its influence has become central to modern banking, and its latest iteration of minimum bank capital and liquidity standards—Basel III—is one of the most important points of reference for modern financial regulation.  See Basel Committee on Banking Supervision, Bank for Int’l Settlements, (last visited Sept. 4, 2012);see also infra note 48.

   [45].         The FSB was created by the G20 nations in 2009 as a response to the Crisis.  It was upgraded from an earlier, rather anemic committee (the Financial Stability Forum) that had been formed in the wake of the Asian Financial Crisis of the late 1990s.  The FSB now plays a major role in shaping regulatory thinking on the so-called Global-Systemically Important Financial Banks and Financial Institutions (“G-SIFIs”), whose thinking contributes to and influences the way in which domestic regulators approach important elements of financial regulation.  On the FSB, see History, Fin. Stability Board, (last visited Sept. 4, 2012);  see also infra note 48.

   [46].         The IMF and World Bank jointly conduct a Financial Sector Assessment Program (“FSAP”) in terms of which the quality of financial regulation applied by member countries is reviewed as a peer assessment process.  See IMF, Factsheet: The Financial Sector Assessment Program (FSAP) 1–2 (2012), available at  See generally Chris Brummer, Soft Law and the Global Financial System: Rulemaking in the 21st Century 157(2011).

   [47].         See generally Basel Comm. on Banking Supervision, Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems (2011),available at

   [48].         See generally Fin. Stability Bd., Policy Measures to Address Systematically Important Financial Institutions (2011), available at

   [49].         The literature on TRNs is now extant.  For a critical assessment, see generally Pierre-Hugues Verdier, Transnational Regulatory Networks and Their Limits, 34 Yale J. Int’l L. 113 (2009).

   [50].         See, e.g., supra note 19.

   [51].         Perhaps most important is the vast ecology of financial institutions (“FIs”) that comprise the so-called “shadow banking industry.”  These are FIs such as hedge funds, broker-dealers, mutual funds, insurance companies (such as AIG), and other non-insured depository institutions that complement and interconnect with the traditional banking and investment industry.  See generally Zoltan Pozsar et al., Shadow Banking (2010); Steven L. Schwarz, Regulating Shadow Banking, 31 Rev. Banking & Fin. L. 619 (2012); Erik F. Gerding, The Shadow Banking System and its Legal Origins (Jan. 24, 2012) (unpublished manuscript), available at

   [52].         See, e.g., Baxter, supra note 4, at 184–85 (citing examples); see also infra note 99 and accompanying text.

   [53].         See, e.g., Bob Ivry et al., Secret Fed Loans Gave Banks Undisclosed $13B, Bloomberg (Nov. 27, 2011),
-income.html (describing massive, low-interest loans extended by the Fed to domestic and foreign banking organizations to help them recover from the Crisis.  These loans were secret until the Fed was forced to disclose them as a result of court orders).

   [54].         Local bankers have traditionally played a major role in the governance of the twelve district Federal Reserve banks, and to this day their nominees are Class A directors of the district banks.  Class A directors constitute one-third of the total board.  When JPMorgan Chase, one of the largest U.S. banks, suffered severe trading losses, numerous commentators and politicians were prompted to demand the resignation of the bank’s chief executive officer, Jamie Dimon, from his position as a Class A director of the New York Federal Reserve Bank.  See Donna Borak, Dimon’s Role on N.Y. Fed Board Sparks Fierce Debate, Am. Banker (May 18, 2012),
-Dimon-Chase-Fed-New-York-board-director-resign-1049463-1.html; Directors of Federal Reserve Banks and Branches, Fed. Res. Board, (last updated July 25, 2012); see also Peter S. Goodwin, Elizabeth Warren is Right: Jamie Dimon Needs to Resign from the N.Y. Fed, Huffington Post (May 14, 2012), (reporting on calls for, and directly calling on, Dimon’s resignation from his NY Fed position); Simon Johnson, Dimon and the Fed’s Legitimacy, N.Y. Times Econ. Blog (May 24, 2012),; Simon Johnson, Jamie Dimon and the Fall of Nations, N.Y. Times Econ. Blog (May 31, 2012),; Simon Johnson, Jamie Dimon Should Resign from the Board of the New York Fed, Baseline Scenario (May 21, 2012),

   [55].         See, e.g., Simon Johnson & James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown 92–104 (2010) (citing many examples of what the authors call “The Wall Street-Washington Corridor”).

   [56].         Dodd-Frank Wall Street Reform and Consumer Protection Act, 12 U.S.C. § 5301 (Supp. IV 2010).

   [57].         See, e.g., Kimberly D. Krawiec, Don’t Screw Joe the Plummer: The Sausage-Making of Financial Reform (forthcoming 2012), available at (showing that although the numerical quantity of comments by members of the general public has been much greater, the depth of public comment by business interests is much more substantive).  See generally Jason Webb Yackee & Susan Webb Yackee, A Bias Toward Business?  Group Influence on the U.S. Bureaucracy, 68 J. Pol. 128 (2006) (indicating that business input in the rulemaking process tends to be more influential than that of private citizens, particularly where expertise is required).

   [58].         See, e.g., Bank Lobbying on Track to Reach Record High This Year: Analysis, Huffington Post (Nov. 22, 2011),
/2011/11/21/bank-lobbying-record-high_n_1106350.html (reporting on lobbying outlays by financial institutions in 2011 for the purpose of resisting the rules implementing Dodd-Frank).

   [59].         The belief that government-sponsored banking is illegitimate is reflected in at least three major strands of development in American financial history: first, in the long running battle over whether to create a central bank and the ensuing creation of the First and Second Banks of the United States; second, in the repeated reversion by the states toward permitting “free banking,” under which numerous private banks were permitted to operate largely without restraint and which system was vigorously defended in the face of the impending creation of a national banking system; and third, in the curious structure of the federal reserve system, which continues to provide a major role for private banks in the operation of central banking functions.  There is a vast literature on these events and the accompanying, vigorous political debates.  See generally, e.g., Davis Rich Dewey, Financial History of the United States (2d ed. 1903) (giving history prior to the creation of the federal reserve system); Milton Friedman & Anna Jacobsen Schwartz, A Monetary History of the United States, 1857–1960 (1963) (outlining the development of the modern federal reserve system).

   [60].         On the evolving central bank functions of the Banks of the United States and the national banking system, see, for example, Richard H. Timberlake, Monetary Policy in the United States: An Intellectual and Institutional History 10–12 (1978) (explaining the functions of the First Bank of the United States); id. at 30–33 (explaining the functions of the Second Bank of the United States); id. at 160–164 (explaining the functions of national banks).

   [61].         See Baxter, supra note 15, at 818–25 (describing the various “quasi-public” functions banks perform).

   [62].         See, e.g., 1 Walter Thornberry, Old and New London, ch. 40 (1878), available at

   [63].         Of course this role has historically operated in tension with the other prerogatives of legislatures and sovereigns.  In Britain both Whigs and Tories fiercely resisted the creation of the Bank of England in 1694.  It was damned in the usual manner of the times as yet another dastardly idea from Holland.  Id.  So, too, was the resistance met by the idea of a Bank of the United States.  The history of the veto of the Second Bank by President Andrew Jackson in 1832, in terms remarkably reminiscent of those uttered against the Old Lady of Threadneedle Street herself, is well known.  The story is once again retold in his biography.  See Jon Meacham, American Lion: Andrew Jackson in the White House 208 (2008).

   [64].         See, e.g., Osborn v. Bank of the United States, 22 U.S. 738, 860 (1824) (describing the Bank of the United States as “the great instrument by which the fiscal operations of the government are effected”); McCulloch v. Maryland, 17 U.S. 316, 354, 396, 422 (1819) (referring to the Bank as a “convenient, a useful, and essential instrument in the prosecution of fiscal operations” and remarking that “[it] is as much an instrument of the government for fiscal purposes, as the courts are its instruments for judicial purposes”).

   [65].         12 Stat. 665, repealed by National Bank Act of 1864, 13 Stat. 99 (1864) (codified as amended in scattered sections of 12 U.S.C.).

   [66].         13 Stat. 99 (codified as amended in scattered sections of 12 U.S.C.).

   [67].         See National Bank v. Kentucky, 76 U.S. 353, 361 (1869) (calling national banks “the instrumentalities by which the government proposes to effect its lawful purposes in the States”).

   [68].         See generally Bray Hammond, Banks and Politics in America from the Revolution to the Civil War, ch. 22 (1957) [hereinafter Hammond, Banks]; Bray Hammond, Sovereignty and an Empty Purse (1970) [hereinafter Hammond, Sovereignty].

   [69].         See Hammond, Banks, supra note 68.  The statute initially giving effect to this system was the National Currency Act of 1863, which created the OCC within the Treasury Department.  This legislation was substantially amended in 1864 by what came to be known as the National Bank Act, subsequently codified at 12 U.S.C. §§ 1 et seq.

   [70].         The most important piece of financial regulation before Dodd-Frank, namely the Glass-Steagall Act of 1933, had established a separation of investment and traditional or “commercial” banking by prohibiting banks from investing and trading in securities on their own account.  See The Banking Act of 1933 §§ 16, 20, 21, 32, 12 U.S.C. §§ 24, 78, 377, 378 (2006).  Section 16 allowed for a most important exception: U.S. Government obligations, obligations issued by government agencies, college and university dormitory bonds, and the general obligations of states and political subdivisions.  During the 1990s, sovereign bonds were again given special treatment in that those issued by OECD member countries have received zero-risk weightings—hence requiring no capital charge—in assessing required minimums for bank risk adjusted capital.  Though clearly specious in light of numerous threats of sovereign default, this policy certainly encourages banks to invest and deal in sovereign debt.  Most recently, the Volcker Rule specifically exempts U.S. government debt from the prohibition against proprietary trading.  See infra note 89; see also Dodd-Frank Wall Street Reform and Consumer Protection Act § 619(d)(1)(A), 12 U.S.C. § 1851(d)(1)(A) (Supp. IV 2010) (adding § 13(d)(1)(A) to the Bank Holding Company Act of 1956, 12 U.S.C. § 1841 (2006)).

   [71].         See Baxter, supra note 15, at 818–21 (citing more detailed statistics); see also Richard Bove, Why Do Banks Need More Capital? 16 (2012), available at (citing the need for banks to act as primary dealers and maintain liquidity in the Treasury markets as the major reason for protection of the big banks).

   [72].         Historical Debt Outstanding-Annual 1950-1999, TreasuryDirect (Aug. 18, 2008),

   [73].         Historical Debt Outstanding-Annual 2000-2010, TreasuryDirect (Oct. 1, 2010),

   [74].         See Dep’t of Treasury, Monthly Statement of the Public Debt of the United States 1 (2012), available at
/reports/pd/mspd/2012/opds062012.pdf (reflecting an outstanding balance of $15.85 trillion as of June 30, 2012).

   [75].         This imagery was used by E. Gerald Corrigan, then President of the Federal Reserve Bank of Minneapolis, to illustrate an important quasi-governmental role played by banks, and one of such roles that differentiated banks from other firms.  See E. Gerald Corrigan, Are Banks Special?, Fed. Reserve Bank Minn. (1982),

   [76].         Id.

   [77].         A P&A transaction is one in which another bank acquires the assets (branches, etc.) of the failing bank and assumes some or all of its liabilities (mostly to depositors).  This saves the FDIC from having to make a net cash outlay to depositors.  On P&A transactions, see FDIC, Resolutions Handbook, ch. 3 (2003),available at

   [78].         Among the many books describing these convoluted events, see generally Andrew Ross Sorkin, Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves (2009); David Wessel, In Fed We Trust: Ben Bernanke’s War on the Great Panic (2009).

   [79].         The FSOC was created by section 111 of the Dodd-Frank Act. Dodd-Frank Wall Street Reform and Consumer Protection Act § 111, 12 U.S.C. § 5321 (Supp. IV 2010).

   [80].         Fin. Stability Oversight Council, Study & Recommendations Regarding Concentration Limits on Large Financial Companies 16 (2011).

   [81].         In general, the banking industry is not very concentrated in the United States.  A recent analysis indicates that for the banking industry as a whole, the four largest organizations (JPMorgan Chase, Bank of America, Citicorp and Wells Fargo) hold a total market share of about 35%.  Ibisworld, Bank On It: After a Roller Coaster Ride, Government Aid Will Revive Industry Revenue 25 (2012).  Partly as a result of their critical public service as bailout agents, however, these banks have increased their concentration by almost 50% since 2008 (23% to 34.2%).  See id. at 21.  The industry is highly concentrated in certain areas.  For example, the five largest banking organizations in the United States own over 53% (in 1913 it was 6%) of all the banking assets, which represent 57% of nominal GDP (2.6% in 1913), provide over 60% of all mortgages, issue 62% of all credit cards, and control 95% of all corporate lending. Heather Draper, Hoenig Targets Fed, Wall Street, Big Banks in Denver Talk, Denver Bus. J. (July 12, 2011),
/2011/07/12/hoenig-targets-fed-wall-street-big.html?page=all; see also David J. Lynch, Banks Seen Dangerous Defying Obama’s Too-Big-To-Fail Move, Bloomberg (Apr. 16, 2012),
/obama-bid-to-end-too-big-to-fail-undercut-as-banks-grow.html (reporting on the rapid recent growth of the large banks as a proportion of economic activity).

   [82].         See generally Douglas W. Diamond & Philip H. Dybvig, Bank Runs, Deposit Insurance, and Liquidity, 24 Fed. Res. Bank Minn. Q. Rev. 14 (2000) (modeling the way in which deposit insurance offers a more efficient mechanism for stabilizing local liquidity than exchange markets, which lead to runs on the banks).

   [83].         See 77 Cong. Rec. 3840 (1933) (setting forth Representative Steagall’s explanation that the billions of dollars banks would have loaned but for the fact that they feared another bank run and therefore found it impossible to extend credit).

   [84].         See, e.g., Ben S. Bernanke, Chairman, Fed. Reserve, Community Banking, Speech at the Independent Community Bankers of America National Convention and Techworld, Nashville, Tenn. (Mar. 14, 2012), available at (explaining the important role of community banks in their local economies).

   [85].         Note that this does not mean that banks are not tightly connected with other financial institutions, which, indeed, underlines the dilemma of modern, desegregated/post-Glass-Steagall banking.

   [86].         See Corrigan, supra note 75 (continuing, rightly in the author’s view, to hold the view that, enormous changes notwithstanding, banks are “special” players in the economy); see also E. Gerald Corrigan, Are Banks Special? A Revisitation, Fed. Res. Bank Minn. (Mar. 1, 2000),  See generally Biagio Bossone, What Makes Banks Special? A Study of Banking, Finance, and Economic Development (World Bank, Working Paper No. 2408, 1999) (supporting Corrigan’s position by arguing that the banking industry is “special” and still distinct from its complementary nonbank financial partners).

   [87].         See Baxter, supra note 4, at 181–82.

   [88].         Dodd-Frank Wall Street Reform and Consumer Protection Act § 619, 12 U.S.C. § 1851 (Supp. IV 2010) (explaining the details of the Volcker Rule, which is the name given to section 619 of the Dodd-Frank Act, and adding a new section 13 to the Bank Holding Company Act of 1956 that prohibits proprietary trading by banks and their affiliates).

   [89].         The Dodd-Frank Act added extensive provisions governing the regulation of the derivatives business, a highly technical area of financial services activity.  See Dodd-Frank Act §§ 711–774.

   [90].         See, e.g., Krawiec, supra note 57, at 29–35.

   [91].         See supra text accompanying note 54.

   [92].         For example, the Collins Amendment to section 171 of the Dodd-Frank Act extends minimum capital requirements to holding company structures.  The international Basel III standards add yet another complex dimension to such requirements.  See supra text accompanying note 47.

   [93].         See generally Nicholas Wapshott, Keynes—Hayek: The Clash That Defined Modern Economics (2011) (tracing the profound consequences for, and differences in approach to, the role of government, including regulation, in the economy, and the way in which Keynesian and Hayekian macroeconomics defines many clashes over regulatory policy).

   [94].         Environmental regulation might provide an example of more scientifically verifiable policy results.  When it comes to complex human system failures, such as financial collapses, one only has to review the great classics on the origins and causes of bank failures in the Great Depression to recognize that in financial regulation we cannot agree even when presented with a specific event, such as the Crash of 1929, to study.  See generally George J. Benston, The Separation of Commercial and Investment Banking: The Glass-Steagall Act Revisited and Reconsidered (1990); Ben S. Bernanke, Essays on the Great Depression (2000); Milton Friedman & Anna Jacobson Schwartz, A Monetary History of the United States, 1867-1960, ch. 7 (1963); John Kenneth Galbraith, The Great Crash 1929 (reissue 1997).  Similar disagreement is to be found in the Financial Crisis Inquiry Commission set up to examine the causes of the 2008 Crisis.  See Nat’l Comm’n on the Causes of the Fin. and Econ. Crisis in the U.S., The Financial Crisis Inquiry Report 3, 411, 441 (2011) [hereinafter Financial Crisis Inquiry Report] (containing a majority report and two dissenting reports).  In complex systems involving multiple human agents, any efforts to rely on linear, reductionist causal connections is bound to be incomplete and misleading.  See generally George F. R. Ellis, On the Nature of Causation in Complex Systems, 63 Trans. Royal Soc. South Afr. 69 (2008), available at (exploring the multiple forms of causation operating in real world systems).

   [95].         See, e.g., Baxter, supra note 4, at 194–96 (discussing the importance of elevating the status and rewards of regulators).

   [96].         See, e.g., James R. Barth et al., Guardians of Finance: Making Regulators Work for Us 206–13 (2012) (discussing various elements of regulatory capacity and vulnerability that must be addressed in order to ensure effective implementation of regulation).

   [97].         During the Crisis, the then-Secretary of the Treasury, Henry Paulson, and the then-President of the New York Fed, Timothy Geithner, spoke repeatedly to only a few of the industry titans.  See, e.g., John Carney, Look Who Really Controls Tim Geithner, Bus. Insider (Oct 8, 2009), (reprinting an AP report, no longer available, revealing Geithner’s phone logs during the Crisis); Andrew Ross Sorkin, Paulson’s Call Logs, Andrew Ross Sorkin Blog (Oct. 17, 2009), (reproducing Paulson’s call logs during the September 2008 meltdown).

   [98].         See Monthly Report on Credit and Liquidity Programs and the Balance Sheet, Board Governors Fed. Res. Sys., (last updated May 3, 2012) (describing the legislation and its application to fed disclosures).  See generally Nancy Watzman, Federal Reserve Forced to Report Which Banks Benefit from Loan Programs, Sunlight Found. Rep. Group (Oct. 18, 2011), (describing the legislative and judicial actions necessary to force Fed disclosure).

   [99].         See Bob Ivry, Revealing Fed’s Secrets Fails to Produce Harm that Banks Cited, Bloomberg (Apr 2, 2011),
-02/revealing-fed-s-secrets-fails-to-produce-harm-that-banks-cited.html (describing the FOIA lawsuits brought by Bloomberg and Fox News to force the Fed to release information).

   [100].        Pillar 3 of Basel II, which will operate alongside Basel III, is the “Market Discipline” element of the international framework for financial regulation and its focus is on transparency as a means of promoting market discipline.  See Query for Pillar 3 Documents, Bank of Int’l Settlements, (documents relating to Pillar 3); supra note 47.

   [101].        See generally Craig Holman & William Luneberg, Lobbying and Transparency: A Comparative Analysis of Regulatory Reform, 1 Int. Grps. & Adv. 75 (2012), available at
/pdf/iga20124a.pdf (discussing the criticality of transparency rather than mere access, and making recommendations for enhancing transparency in the policy making process).

   [102].        For further review of the devices for making access more meaningful for non-industry participants, see infra text accompanying notes 110–133.

   [103].        Including such entities as the Government Accountability Office, which produces numerous reports on financial regulation and its effectiveness, and the U.S. Senate Permanent Subcommittee on Investigations, which recently produced a meticulously researched, three-volume report, Permanent Subcomm. on Investigations, Wall Street and the Financial Crisis: Anatomy of a Financial Collapse (2011), available at

   [104].        The inspectors general of various financial regulatory agencies have produced important reports concerning regulatory failure.  See, e.g., U.S. SEC Office of Inspector Gen., Report of Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme (Public Version) (2009), available at; Welcome to SIGTARP, SIGTARP, (last visited Sept. 5, 2012).

   [105].        This panel was created to oversee the deployment of the TARP funds committed by Congress to help remedy the economic collapse of the 2008 Crisis (documents now archived at

   [106].        This bipartisan commission conducted hearings and researched the causes of the Crisis.  See generally Financial Crisis Inquiry Report, supra note 94.  The Commission’s proceedings, documents, testimony, and report are now archived at

   [107].        See Baxter, supra note 15, at 825–31  (identifying the various forms of public subsidy enjoyed by banks).

   [108].        “Tripartism” has been defined as “regulatory policy that fosters the participation of [public interest groups] in the regulatory process” in order to promote fuller participatory democracy at the level of implementation of policy.  Ian Ayres & John Braithwaite, Tripartism: Regulatory Capture and Empowerment, 16 Law & Soc. Inquiry 435, 441, 475 (1991); see also Ian Ayres & John Braithwaite, Responsive Regulation: Transcending the Deregulation Debate, ch. 3 (1992); Baxter,supra note 4, at 191–92.

   [109].        Baxter, supra note 4, at 199.

   [110].        A potential model for applying tripartism in financial services regulation can perhaps also be found in insurance regulation, where some states have developed proxy advocates for advocating the public interest in regulatory proceedings.  See Daniel Schwarcz, Preventing Capture Through Consumer Empowerment Programs: Some Evidence from Insurance Regulation, in Preventing Capture: Special Interest Influence in Regulation, and How to Limit It (forthcoming 2012).

   [111].        See Duke Energy Corporation and Progress Energy Inc., 137 FERC ¶ 61,210 (2011), available at (order rejecting compliance filing).

   [112].        Id. at para. 90 (applying the statutory “public interest” standard to reject the plans to mitigate adverse effects on competition of two energy companies that are seeking approval to merge).  Public utility regulation has a long (and controversial) history of applying public interest standards, but these are usually reinforced by statute and assisted through well organized public and private representations (as was the case in the Duke Energy case).

   [113].        See also Schwarcz, supra note 110, at 2.

   [114].        This idea was first proposed by Ross Levine and is now incorporated into a book he has coauthored.  See Barth et al., supra note 96, at 215–24; Ross Levine, The Governance of Financial Regulation: Reform Lessons from the Recent Crisis 2 (BIS, Working Papers No. 329, 2012).

   [115].        Levine, supra note 114.

   [116].        Saule T. Omarova, Bankers, Bureaucrats, and Guardians: Toward Tripartism in Financial Services Regulation, 37 J. Corp. L. 621, 658–59 (2012),available at

   [117].        Id.

   [118].        Id. at 623–24.

   [119].        Howard Davies, Comments on Ross Levine’s Paper “The Governance of Financial Regulation: Reform Lessons from the Recent Crisis” 20 (Bank of Int’l Settlements, Working Paper No. 329, 2010).

   [120].        The Shadow Financial Regulatory Committee is sponsored by the American Enterprise Institute.  Special Topic: Shadow Financial Regulatory Committee, Am. Enterprise Inst., (last visited Sept. 5, 2012).

   [121].        Brookings Inst., (last visited Sept. 5, 2012).

   [122].        Center for Econ. Pol’y Res., (last visited Sept. 5, 2012).

   [123].        Pub. Citizen, (last visited Sept. 5, 2012).

   [124].        New Deal 2.0, Roosevelt Inst., (last visited Sept. 2012).

   [125].        POGO: Project on Gov’t Oversight, (last visited Sept. 5, 2012).

   [126].        Am. for Fin. Reform, (last visited Sept. 5, 2012).

   [127].        Such developments are described in a forthcoming chapter by Christine Farnish, chair of Consumer Focus in the United Kingdom.  See Int’l Ctr. for Fin. Reg., Regulatory Capture: The Optimal Relationship Between the Regulator and the Regulated (working title, forthcoming Sept. 2012).

   [128].        See, e.g., The Volatility Institute, NYU Stern Sch. Bus.,
-initiatives/centers-of-research/volatility-institute/index.htm (last visited Sept. 5, 2012); see also INET@Oxford, Inst. for New Econ. Thinking, (last visited Sept. 5, 2012) (bringing together in a recently established institute various disciplines, including complexity science, to analyze issues such as systemic risk and financial crises).

   [129].        See, e.g., FDIC Systemic Resolution Advisory Committee, Fed. Deposit Ins. Corp., (last visited Sept. 5, 2012) (revealing a recently established committee, which has as its members some independent experts who have been highly critical of regulatory policy).

   [130].        See Former FDIC Chair to Lead Systemic Risk Council, Monitor Financial Regulation, Bus. Wire (June 6, 2012),
-Monitor [hereinafter Former FDIC Chair]; Sheila Bair to Lead Private Financial Risk Council, Reuters (June 6, 2012),; Sheila Bair: From Regulator to Watchdog, Frontline (June 12, 2012),

   [131].        The Council will be Paul Volcker, former chairman of the Fed, and several former financial agency chairs.  For the full list, see Former FDIC Chair,supra note 130.

   [132].        Sheila Bair herself exhibited fierce independence as chairman of the FDIC, and Brooksley Born, former chair of the CFTC, attempted herself to impose regulation on financial derivatives in the face of fierce industry and, ultimately, Congressional opposition.  See, e.g., Ryan Lizza, The Contrarian: Sheila Bair and the White House Financial Debate, New Yorker (July 6, 2009), (providing a profile on Sheila Bair after her Profile in Courage award for her independent line on financial regulation); Brooksley Born, Wikipedia,
/wiki/Brooksley_Born (last visited Sept. 5, 2012) (providing a profile on Brooksley Born, also a Profile in Courage award recipient).



By: José Gabilondo*


The financial sector has by now mostly sprung back from the crisis that began in 2007, as have corporate profits; but the labor market still sags, mortgage credit is scarce, and the future prospects for the economy, while not bleak, are not rosy either.  Seeing this ongoing harm to the real economy caused by financial activities, Congress enacted the Dodd-Frank Act (“Act”) with an eye to limiting future financial instability.[1]  The Act hopes to do this by updating financial regulation and creating better incentives for the private sector.

To see how the crisis developed and whether the Act will work, we need to understand how financial instability develops in capitalist market systems like ours.  Economist Hyman Minsky claimed that the financial sector in capitalist market systems tends to chase returns by gorging on risk until its own financial structure becomes unstable, leading to a crisis like the last one that started in 2007.[2]  The claim—known as the financial instability hypothesis—merits our attention because, though critical of the financial sector, evidence for it is derived from observing how banks actually operate over the business cycle.

I use the hypothesis in Part I to show what animated the last corporate leverage cycle: escalating expectations for profit financed on progressively riskier credit terms.  In fact, the hypothesis belongs to a larger critique of conceptual approaches that deny the intrinsic instability of capitalist market systems, so I also use Minsky’s work to challenge claims made by nabobs of neoliberal negativism who are resisting the implementation of the Act.  Part II addresses two aspects of the Act that bear directly on how the financial sector creates potentially destabilizing liabilities: (i) new requirements that leverage caused by financial swaps be margined and cleared; and (ii) a new mandate that federal regulatory capital requirements go in the opposite direction of the boom-bust dynamics characteristic of the business cycle.

I.  Liability Structures Do Matter

Hyman Minsky was an economist trained at Harvard in the 1940s under economic historian Joseph Schumpeter.[3]  His theoretical work on the financial system was informed not only by the then recent memory of the Depression but by his service as a bank director.[4]  Minsky observed that “[i]t turns out that the fundamental instability of a capitalist economy is a tendency to explode—to enter into a boom or ‘euphoric’ state,” followed by a bust.[5]  When times were good, he said, firms took on riskier debt to invest in speculative assets, an unsustainable strategy that would lead, in time, to a crash.[6]  He believed that government policy could contribute to the long term viability of capitalism by slowing down these boom-bust cycles.[7]  Doing this would mean going against prevailing market sentiment.

Minsky’s conceptual framework was not widely received by the academic establishment of his day, which followed the direction of Platonic quantitative modeling that assumed away the grittiness of economic life.[8]  The last crisis painfully illustrated the financial instability hypothesis, which is now being reappraised and adopted more widely.  As before, though, the idea that the government should actively intervene in the financial market faces renewed political opposition.

A.            Borrowing by Firms

Minsky’s analysis starts by looking at a firm’s balance sheet, an accounting report that estimates a firm’s net worth for a given moment in time by subtracting what the firm owes to creditors from what the firm owns and is owed by others.  Assets are the firm’s claims on others.  Liabilities are what the firm owes to others.  Assets minus liabilities leaves what belongs to owners, called “equity.”  In the analysis, liability structure as a whole is central because it suggests how much and when the firm will face demands for payment, which must be settled with liquid resources or refinanced with another liability.[9]

Among firms in general, the liability structure of those that borrow to lend—so called “financial intermediaries”—is particularly telling of potential troubles because these firms influence how nonfinancial firms fund themselves.  A manufacturing or a services firm will have financial items—liability and equity—on the right-hand side of its balance sheet, but a financial intermediary has financial claims on both sides of its balance sheet because it invests borrowed money in the liabilities of other firms.

Commercial banks are the typical example of a firm that borrows to lend, but if we define lending functionally then investment banks, hedge and private equity funds, pension funds, sovereign wealth funds, and other pools of investment capital are also financial intermediaries.  Like all firms, they leverage themselves, borrowing to increase their ability to invest in other firms, both financial and nonfinancial ones.  Leveraging is a fact of business life, but when a firm borrows too much, it risks its solvency and its ability to honor contracts to others, because the firm’s liability structure becomes unsustainable.

Minsky saw a troubling pattern in the liability growth of firms that borrow to lend.  Again and again, their balance sheets would become more fragile because they took on more debt and borrowed on deteriorating credit terms.[10]  This cycle took place during good times as firms would borrow at more speculative rates so as to hunt for return in riskier investments, adding fragility to both sides of the balance sheet.  The rub was that these firms had to re-enter the credit market to refinance liabilities.  This was fine when interest rates were stable, but tighter money meant certain loss when refinancing at higher rates.  Now that serial refinancing and secondary trading are more common in the credit market, this analysis is more relevant than ever.

He classified debt into three types based on its propensity to require future refinancing, even in a rising interest rate environment: hedged, speculative, and Ponzi.[11]  In hedged borrowing, the borrower could pay all maturing interest and principal payments from the cash flow proceeds of the investment made with the borrowed funds.[12]  In speculative borrowing, the borrower could pay only interest from investment proceeds without refinancing, having to re-enter the market to refinance some amortization of principal.[13]  The riskiest of the three was Ponzi borrowing because the initial terms of the debt meant that the borrower would have to re-enter the credit market for all contractual payments of interest or principal.[14]  So there is nothing shady per se about Ponzi finance—it simply assumes that investment return will keep escalating, which can be true for a while but not forever.  The distinction matters because many financial assets have useful lives longer than an investor’s holding period, so the asset’s longer-term value matters, especially on re-transfer.[15]

This classification focuses on the borrower to emphasize its liability structure.  But it can also sort the lender’s loan assets by their risk from refinancing.  For an asset to be deemed hedged, it would have to be serviced from a dedicated income stream produced by the investment of the loan proceeds.  If the lender assumed that the borrower would have to refinance some of the principal payments—perhaps by further borrowing from the lender, as is common with home equity lines of credit when the principal begins to amortize—then the loan would be a speculative asset on the lender’s balance sheet.  If the lender knew that the borrower would need to refinance during each scheduled payment period, then the loan asset would be Ponzi to both the lender and the borrower.

As the cycle accelerated during the last crisis, firms borrowed and lent at increasingly speculative and Ponzi terms, setting up their balance sheets for loss in the event that market prices ever stopped escalating, which they always do.  And when they did, this fragility would devolve into a crisis in which financial promises could not be kept on a grand scale, a so called “Minsky moment.”[16]  Citigroup’s chief executive officer Charles Prince said it best: “As long as the music is playing, you’ve got to get up and dance.”[17]  The result was borrowing and lending yourself (and others) into financial instability.

The fragility cycle in the financial crisis of 2007 emerges in time series data of the Securities Industry and Financial Markets Association.[18]  Figure 1 compares gross corporate debt issuance from 1990 to 2009 by firms, both financial and nonfinancial.  The increase in debt issuance starts in 2000.  After peaking in 2006 (the last full year before the crash), issuance dropped, with the low numbers in 2008 and 2009 reflecting the challenges firms faced in raising new debt capital after the crash.

Figure 1



Gross debt issuance tells only part of the story. A firm with enough equity can sustain a corresponding debt load, even during periods of financial stability.  It is rising leverage that adds up to financial instability.[19]  So Figure 2 tracks leverage trends by dividing the amount of debt that corporations issued by the equity capital raised during the same period.  Between 1990 and 2001, the leverage ratio ranged from between 4:1 and 6:1, suggesting the “old normal.”  During 2001, the Federal Reserve began to tamp down interest rates,[20] and from then on, easy money fed the cycle, which peaked in 2006.  That year, corporations issued fourteen dollars of debt for every dollar of equity—double and, in some cases, triple the leverage ratios of the old normal.

Figure 2



The financial correction originated during the third quarter of 2007 as markets began to be spooked, and by the end of that year the leverage ratio had dropped to 10:1.  During the heart of the financial crisis, in 2008 and 2009, the ratio was back to the old normal, although it feels like deprivation after the bubble.

Insofar as they were securitized into private-label mortgage-backed securities bought by commercial banks, some of these liabilities ended up on the balance sheet of the Federal Reserve (“Fed”).  Doing just what a central bank should, the Fed lent money against collateral and bought bank assets outright during the crisis, although the ultimate quality of some of these acquisitions remains to be seen.[21]  As a result, the Fed’s financial structure morphed.  Figure 3 compares its balance sheet in March 2007[22] (before the trouble started) with those of March 2009[23] and March 2010,[24] after the Fed’s liquidity and credit programs had been largely completed.  During this period, the Fed’s leverage ratio increased from 27:1 to 44:1.

Figure 3

Trends in Fed Balance Sheet Composition (in millions)





Total Assets




Securities held outright




U.S. Treasuries




Total Liabilities




Deposits from depository institutions




Total Capital




Leverage Ratio
(Leverage ratio is calculated by comparingTotal Capitalto Total Assets)




During this period, the asset portfolio of the Fed more than doubled, while the credit quality and liquidity of the assets declined.  In 2007, U.S. Treasury securities were almost 90% of the Fed’s asset portfolio.[25]  By 2010, they made up only 33% as the Fed acquired investments in private-label mortgage-backed securities (“MBS”), which were then trading at a steep discount.[26]  Though riskier than Treasury securities, these investments are not themselves subprime, as they tend to be super-senior investment-grade rated tranches of MBS.[27]  This means that junior tranches in these MBS will be the first to shoulder losses if borrowers default on the underlying loans.  Time may show that the market discounted their value too much, giving the benefit of the bargain to the Fed.[28]  In this case, it will be the taxpayer who benefits—the Fed is a proxy for the country’s general fund because each year, the central bank transfers its net profit to the Treasury, which, in a corporate finance sense, is the Fed’s residual claimant.[29]

As the Fed took on these new assets, its own leverage spiked since it funded its balance sheet growth by borrowing, mainly through taking deposits of commercial banks.  In 2007, these deposits made up just over 2% of the Fed’s liability base.[30]  By 2010, they had increased sixty-fold, amounting to 50% of the institution’s liability base.[31]  In large part, these deposits represent resources that the Fed had made available to banks through stabilization programs.  Even commercial banks know that few things feel as good as money in the bank, so they deposited these resources rather than making new loans to firms and individuals, which would have created new loan assets for these banks.

Though it seems to be a monolith, the new Fed is best understood as a complex of separate balance sheets, each with its own distinct asset-liability schedule and an ad hoc governance regime that serves different public purposes.[32]  With respect to the special-purpose balance sheet created by taking on the private label MBS of commercial banks, the central bank lent its balance sheet to the banks by letting them substitute a Fed-backed asset with no credit risk but some inflation risk (the bank’s Fed deposit) for the private label MBS about which a panicked market was being finicky.  In effect, this on-balance sheet venture takes the place of a free-standing resolution vehicle, like the Resolution Trust Corporation used after the savings and loan crisis.[33]

In Minsky’s analysis, the Fed validated the speculative and Ponzi investment decisions of banks by buying their assets closer to par than to their then-impaired market value.[34]  This probably made the Fed the last bank in the cycle to do a speculative Ponzi trade, albeit for the public interest.  Although these credit terms are unsustainable for private firms, a central bank can depart more freely from hedged borrowing and lending because it has a monopoly on the production of legal tender and, hence, faces no short-term pressure to be profitable in a real sense.  And because the Fed can hold debt to maturity more freely than private banks, it has time to ride out the troughs of economic cycles.

Overall, the financial sector has been substantially mended through this Fed initiative, other efforts to recapitalize the banking system by shoring up assets, and troubled asset relief program (“TARP”) support for the liability side of bank balance sheets.  What has not worked as well is the spreading of this recovered stability onto consumers and other firms, as banks remain cautious about lending.  This bottleneck of liquidity in the financial sector may reflect that chastened banks have yet to reenter the early stage of the cycle, in which more hedged borrowing and lending takes place.  More research is needed to understand the links between the financial sector and the real economy—the topic of the Levy Economics Institute’s 2011 Minsky Conference.[35]

B.            Contesting Market Primacy in the Age of Ideology

Minsky’s financial instability hypothesis addressed how individual firms borrow and invest and how these behaviors—in the aggregate—lead to sectoral tendencies.[36]  As noted above, this was so because, left to their own devices, financial markets tended to overheat, leading the public sector to intervene as needed against the confidence (panic) cycle.  At the same time, the public sector could precipitate instability by removing regulatory restraints on speculative and Ponzi financial activity.  Implicated in this are political economy questions about whether real markets work as theorized, how much state influence over economic life is justified, whether individuals are rugged enough to go it alone or whether unavoidable human vulnerabilities call for systematic state action, and who should pay for non-private costs of bailouts.

So around the core of the financial instability thesis, we can imagine criticism of ideologies that promote financial instability by hamstringing the public sector’s efforts to counter the cycle.  For example, some economic orthodoxies may deny that financial crises recur, insisting on inaction because, like the common cold, these cycles will work themselves out in time.[37]  Moreover, ideological orthodoxy in economic matters from anywhere on the spectrum can exacerbate crises by not being flexible when what is needed is pragmatism.  For example, the Community Reinvestment Act[38]— pushed by Democrats and progressives—encouraged commercial banks to originate subprime mortgage loans.[39]  Because of their foreseeable exposure to interest rate risk from refinancing, when underwritten, many of these loans would almost certainly have been classified as speculative or Ponzi assets.  The subprime market grew in tandem with deregulation of financial markets,[40] a view promoted from across the aisle but which, converging on federal efforts to promote homeownership, intensified the trends toward financial instability.

While ideologies that promote financial stability can come from either side of the aisle, the Right has largely captured the terrain of finance.  Since the 1980s, the United States has witnessed a flowering of anarcho-capitalist, libertarian, neoconservative, and reactionary social formations that, despite other differences, unite against financial regulation.[41]  We have yet to appreciate how these networking successes have rezoned our political imagination Right-ward, even that of liberals and supporters of financial regulation.  Because Minsky died as these formations were quickening, he did not get much of a chance to contest them using the financial instability thesis.  For example, many who would shudder at the label “Keynesian” have referred to a “Minsky moment” without owning the wider context for the financial instability thesis.  It is ironic because Minsky sought to give a fuller account of John Maynard Keynes’ radicalism, which he thought had been excised by the economics establishment of Keynes’ day when it accepted his work.  Minsky wanted to integrate the excluded elements.[42]

This latent dimension of Minsky’s work deserves extending because its technical credibility could counter some of the ideological posturing advanced in the name of capitalism.  In fact, there is more than one conception of capitalism, and his views might help elaborate alternative forms.  This point matters because, despite the debt overhang from the last crisis, neoliberal hostility toward financial regulation is back in arguments based on market primacy.[43]  This is the view that the uncoordinated, self-propelled actions of unregulated private actors will lead to better outcomes for them and for society than would state coordination.[44]

Markets are said to be better than the state for utilitarian and categorical reasons.  First, the market is alleged to produce more than the state would with the same resources.[45]  And the market is better than the state on moral grounds because it stands in for pure freedom.[46]  Adding the modifier “free” to “market” intensifies this devotional quality, sacralizing the market.

In theoretical accounts of the financial system based—explicitly or not—on market primacy, liabilities are no big deal.  In a market, it is assumed price mechanisms will adjust by themselves to reflect the risks and effects of these liabilities.  If a firm fails, creditors will devour it.  This is the take on liabilities in Merton Miller’s acceptance speech for the Nobel Prize, which he received for the capital irrelevancy thesis.  He said there was no such thing as an “overleveraged” firm because market price mechanisms would adjust its cost of debt and equity capital to reflect its risk.[47]  Lenders would evaluate risk, bargain for an appropriate rate of return, demand collateral as needed, and, if necessary, sue for breach.  There is no systemic risk here because all risk stays private.

True enough, if one stays inside of an abstraction that, necessarily, assumes away actual liabilities, real financial risks, and losses in the real world.  So, in the market primacy narrative, there was no “problem” with the 2007 crash.  It was a routine repricing of credit by forces of supply and demand, though the growth of the Fed is not ideal.

C.            Enter Reality Stage Right

However, market primacy faces some challenges.  First, financial crashes always spill over into the public sector.  In the now familiar script, an adventurous financial sector borrows itself into a crisis that threatens innocent bystanders, drawing in even advocates of market primacy.  The Federal Reserve Act of 1913 grew out of the 1907 Knickerbocker Trust Company crisis;[48] the New Deal’s financial architecture responded to speculative overinvestment, intensified by easy margin credit;[49] and the 1989 Financial Institutions Reform, Recovery, and Enforcement Act responded to the savings and loan crisis of the 1980s.[50]  The Act is merely the last iteration of this political economy cycle.  So models that turn a blind eye to obvious, foreseeable public impact should be taken with a grain of salt.

Second, it was supply and demand—the self-adjusting hydraulics of market primacy—that contributed to the financial crisis.  After all, it was devotees of deregulation—George W. Bush in the White House and Alan Greenspan at the Fed—who let subprime debt mushroom thanks to easy money and, it would come to light later, systematic mortgage fraud.[51]  The risk to the financial system originated not in the state but—to further refute market primacy—from innovation in an overheated private sector whose private-label MBS came to displace the other MBS issued by government-sponsored agencies like Fannie Mae and Freddie Mac.[52]

The government’s error was to validate this innovation by investing in some of these private-label securities.[53]  Lenders in markets were wrong.  And the quantitative financial models were wrong too because they did not predict how markets act in a panic, so called “extreme liquidity events.”  It is only the latest example of mistaking unsustainable practices for benign financial innovation.[54]

Were the marketplace of ideas and reputation to work as its libertarian custodians claim, we could have shorted market primacy and captured the spread as brand names like Alan Greenspan, Friedrich Hayek, and Milton Friedman went down in a bear raid.  Instead, the spirit of deregulation has survived a financial crisis that it had a hand in creating.  It is not as odd as it sounds because, like limited liability for corporations, market primacy is a potent distillation of exclusions, erasures, and omissions of facts that might compromise its theoretical integrity.  It saves face by ignoring corporate insolvencies, credit scarcity, unemployment, foreclosures, losses in retirement funds, growth in the federal deficit, incipient inflation of energy and food, and sagging real estate values—in other words, other people’s problems.  Indeed, it is these efficiencies of externalization that have allowed corporate profits to rebound despite other weaknesses in the economy.[55]

An example of market primacy about the Act is the street’s hue and cry against the Act’s mandate that regulators bear down more on the swap markets.  Swaps are financial bets about future price movements that banks and other large firms place with each other, acting as “counterparties.”  The Act requires the Commodity Futures Trading Commission and the banking agencies to establish margin requirements and collateral policies to reduce the risk of default on these bets.[56]  Doing so, it is thought, will reduce the risk not only to the counterparties but to the financial system as a whole.[57]

However, the prospect of regulation has been met with objections by many firms, including nonfinancial ones that use swaps for hedging rather for speculative investment.[58]  In part it is because swaps are the poster child of imaginaries of the market.  Since Wendy Gramm, then head of the Commodities Futures Trading Commission, secured a major exemption from their regulation in 1993,[59] swaps have been sacralized as financial play in the libertarian forest primeval, away from the grasping hands of the state.  The resistance from firms seems to have worked given the broad exemptions that have been given to noncommercial end-users of swaps.[60]

Once put in focus, market primacy shows up as an attack on the very notion that there could be such a thing as a public interest and, insofar as it is recognized to exist, justifying it only insofar as a public function serves private interests.  This is what lies behind challenges to how the state provides services that have been the hallmark of the public sector.

Consider the new reach of market logic into higher education and state government.  A narrow cost logic is at work in legal education through the American Bar Association’s recent proposals on security of position, reforms that would reduce the agency costs of having faculty.[61]  A similar cost logic is at play in reform proposals about state government.  The proposals to allow states to declare bankruptcy would allow them to cleanse their balance sheets of liabilities for the pensions of public employees.[62]  Like the perennial anti-hero of the Nightmare on Elm Street, Freddie Kreuger is back, this time in the citadels of the public.

The attack is old news.  What is new and worth attention is how the discursive formations of reactionary thought are maturing.  By “discursive formation” I mean the way that institutions, individuals, and political narratives move in tandem to form a new consensus of reality, one that amplifies neoconservative values by erasing those of others.  At the institutional level, this is evidenced by the rise of foundations and advocacy groups whose influence reaches deep into private enterprise, the federal courts, and state government.[63]  These activist networks produce and market—and are in turn legitimated by—narratives, symbols, and social scripts that create a conceptual framework for understanding reality through a reactionary lens.  On economic matters, Minksy’s theory can help to contest these discursive formations of the Right.

II.  Internalizing Liabilities Through the Dodd-Frank Act

If we believe, as did Minsky, that capitalist market systems could be enhanced by mitigating leverage cycles, then we judge the Act by whether it does so.  Because it was passed during a window of financial ruin that temporarily muffled some libertarian activists, the Act does take some steps to limit financial instability caused by liability financing.  While market primacy shifts some of the costs of overleveraging onto strangers, the Act tries to do the opposite, allocating more of the total effect of liabilities onto those who generate the debt.  Below I discuss two examples of this internalization: risk management rules for leverage created by financial swaps and regulatory capital requirements that slow down, rather than intensify, boom-bust cycles.

A.            Limiting Swap-Induced Leverage

As explained here, many financial swaps include contingent leverage that springs into effect when the market moves against a bank.  These sudden market moves can turn a swap from an asset to a liability or from a small liability to a giant one.  An example illustrates the problem.  Assume that Party A and Party B enter into an interest-rate swap.  If the market moves against Party A, the swap becomes an out-of-the-money position, with Party A owing money to Party B as a net swap payable.[64]  To Party B, the swap is an asset because it is in-the-money and, hence, a net swap receivable.

As this example shows, a swap can fluctuate between being an asset or a liability based on market movements and contingencies that are built into the swap.  (Such was the case at AIG when swap commitments made by its financial products unit became liabilities rather than assets.)  These market contingencies are the heart of the bargain that is entered into every time someone enters into a swap position.  Moreover, because many swap counterparties waive margin for an entity with a good credit rating, swaps can produce uncollateralized debt that can suddenly increase a firm’s effective leverage.

The moral of the story is that the unintended—though foreseeable—liabilities that can arise through swap contracts also need provisioning and risk management.  The Act reduces the growth of speculative and Ponzi liabilities that might arise from swaps activities—especially by financial firms—by requiring that standardized swaps be settled through a clearinghouse that would impose margin requirements to eliminate the risk that a liability would lack adequate collateral.[65]

Once swaps clear on a central counter party, each member will have to post initial margin, post variation margin based on market changes, and make a contribution to the guarantee/clearing fund as it begins to accumulate a liability with respect to a swap position.  Centralized clearing of swaps and margining generally may also reduce the funding liquidity of some firms.  Not all swaps will have to be cleared centrally.  To create a kind of parity, the Act also imposes margin and collateral rules on swaps that remain on the books of the original counterparties.[66]  The margin rules for uncleared swaps may also reduce the funding liquidity of swap counterparties who post margin.

From the perspective of the financial instability hypothesis, do the new clearing and margin rules for swaps increase or decrease financial fragility?  To apply Minsky’s debt classification to the new swap rules, first convert the margin or collateral into an income stream that backs the interest payments and amortization of principal on the debt.[67]  The analysis is different for cleared and uncleared swaps.

The margin requirements keep the individual clearing members from accumulating uncollateralized liabilities to the clearing house.  This limits the risk that swaps will add speculative and Ponzi exposure to the liability structure of a clearing member.  The swaps clearing house will be subject to strict risk management rules that limit its overall risk.[68]  Assuming, then, that it behaves like clearing houses for other asset classes, the swaps clearing house will not generate speculative or Ponzi risk.

The implications of margin on an uncleared swap, that is, one that stays on the books of the counterparties, follow below using the example from above.  As suggested, Party A is short on the swap and would have to post margin to cover his liability to Party B.  By collateralizing this debt, Party A’s liability structure moves toward hedged borrowing from speculative and Ponzi positions.  Posting margin may reduce Party A’s borrowing cost because Party B should accept a lower interest rate on collateralized debt.  If Party A posts cash collateral, however, its balance sheet also becomes less liquid and it is left with less unpledged collateral.  Less potential collateral limits Party A’s ability to invest in the other firms (including in the liabilities) and its own ability to borrow on a collateralized basis.

The leverage and liquidity implications are the converse to Party B, who receives margin from Party A.  By reducing counterparty credit risk to Party A, the margin shifts Party B’s asset structure toward hedged from a potentially more speculative or Ponzi position.  If Party B can re-hypothecate the margin collateral, he has two more options.  First, he can collateralize his own debts, making his own liability structure more hedged.  Second, he could do the opposite by using the collateral to borrow more and use the proceeds to acquire a new asset, whose value would reflect the leveraged demand made possible by borrowing.

Given that margin can directly affect a firm’s access to liquid resources and its ability to leverage itself, the new margin rules—both for cleared and uncleared swaps—give regulators another tool that can be used counter-cyclically against the confidence (crisis) cycle.  A tight collateral policy during good times would slow down growth, but a loose collateral policy on the downside of a credit bubble would take pressure off firms.[69]

The effects are more variable in the case above of an uncleared swap, because margin redistributes risk, liquidity, and leverage between the payor and payee.  Because neither the market nor regulation require all liabilities to be margined, the ultimate effect of imposing margin on leverage created by uncleared swaps will depend on the opportunity costs to the payor of posting margin and the reinvestment opportunities to the payee.

Two other provisions of the Act that further limit the risk of sudden leverage from financial swaps by limiting the amount of swaps activity that certain financial institutions engage in are the Volcker Rule[70] and the swaps pushout rule.[71]  Both require divestiture by many banks of certain derivatives activity.  The Volcker Rule limits the amount of swaps activity that a bank can conduct.  Separately, the swaps pushout rule limits the ability of banks to enter into swap agreements for their own account, although some important exceptions remain, including entering into swaps positions to accommodate customer interest.  Together, these provisions may cleanse much springing and contingent leverage out of the bank.

B.            Countercyclical Capital Requirements

The Act also nods to Minsky by calling for capital requirements that go against rather than with the prevailing direction of the business cycle.[72]

Federal law requires a bank’s capital structure to meet certain prudential standards for its balance sheet.[73]  Potential investors may apply more stringent standards, but federal law establishes the minimum.  These standards promote solvency by measuring the bank’s assets conservatively and ensuring that the bank has enough equity capital free from the contractual constraints that creditors impose on debt financing.  The standards do this by subjecting the bank’s balance sheet to various solvency and liquidity tests, each of which must be satisfied for the bank to remain in the best standing with its federal regulator.

For example, the tests promote conservative valuation when determining the bank’s net worth (reflected in its equity capital) by aggressively discounting assets to reflect what they might fetch in a distressed market.[74]  These asset discounts reduce the bank’s net worth on a dollar-for-dollar basis, a loss that is born first and wholly by the bank’s equity.  So a bank’s net worth calculated for its regulatory capital requirements will often be lower than its net worth based on generally accepted accounting principles.  This is how the conservative valuation is accomplished.  The federal government wants to have this conservative measure because the federal promise to insure certain bank deposits leaves the government on the hook as a back-up source of downside risk capital if the bank fails.

To complement this conservatism, other tests apply to the right-hand side of the bank’s balance sheet.  These rules are conservative because they limit how much the bank can leverage itself with borrowed money, including federally-insured deposits.  The limit is expressed as a multiple of the equity that determines the maximum amount of debt that the bank can take on.[75]  Capping debt leverage increases the bank’s financing costs because the interest costs of debt are deductible, while equity investors demand a higher rate of return for investing as owners.  Hence, a bank—like any firm—tends to pay more for equity capital than for debt capital.  Although there is no limit to how much owners can make from a successful company, lenders can, at best, expect to receive only their contractual entitlement.  As a result, lenders have more contractual rights to protect their expectancy in the firm than do its owners.  Enough equity reassures regulators that the bank has an adequate resource cushion free from the contractual rights that, if breached, give the creditor rights to interfere in how the bank is run.  One effect of ensuring a minimum amount of owner’s capital is to limit the overall size of the bank’s liability base with respect to which the bank owes contractual duties that limit its freedom of action.

At present, these regulatory capital requirements have the unintended effect of amplifying the credit cycle.[76]  When interest rates are low and the bank can easily make loans, its assets increase, marking up the bank’s net worth and making it easier for the bank to borrow more, replenishing its ability to repeat the asset growth-equity-growth-borrowing growth cycle.  More credit means more dollars chasing the same assets, which means that prices go up in the aggregate.  The discounts used to haircut assets do not take into account the risk that assets are rising because a credit bubble may be underway, based on unsustainable escalation of market values.  As a result, the intended conservatism of regulatory capital is somewhat offset by inflated asset, equity, and debt values.  So the capital tests do nothing to slow down this inflation and, instead, by continuing to signal that the bank is solvent and liquid, give a green light as the bubble inflates.

The opposite kind of amplification happens as the bubble deflates.  This time, the market value of outstanding loan assets begins to drop, shrinking the bank’s balance sheet as the market applies a haircut of its own.  Regulatory capital makes matters worse by adding another asset haircut, one that may be less justified because the market is already discounting.  Every time an asset loses a dollar of value, the bank’s net worth (its equity capital) drops by a dollar.  As the equity base shrinks this way, the bank loses its ability to keep borrowing because of the leverage limits keyed to the bank’s equity.  To avoid losing regulatory status by becoming over-leveraged, the bank will begin contracting.  If this means cutting its leverage, then the bank may have to dispose of assets to pay a liability.

Unfortunately, the asset may fetch less than par in a hasty sale, so the bank may face a nasty cycle of deleveraging leading to fire sale prices, leading to more deleveraging.[77]  Moreover, during this cycle credit is harder to get because the bank is pickier about investing in loan assets, the more attractive ones being those not subject to a regulatory asset haircut because they boost the bank’s net worth most directly.  Less credit means fewer dollars chasing the same assets, which drives prices down.  So, on the downside of the cycle, regulatory capital rules discourage lending just when the market could use a boost from more credit.

One way to mitigate the tendency of regulatory capital to amplify the direction of the boom-bust cycle in asset prices would be by taking account of whether asset prices were rising or falling and, consequently, whether the market was overestimating or over-discounting an asset’s ultimate value.  On the upswing of the cycle as banks expand their balance sheets with new loans—adding inflationary momentum by financing more demand—banks should be subject to higher rates of required equity on the right-hand side of the balance sheet.  Because equity capital is more expensive and generally harder to get, increasing the equity bite delays the bank’s ability to keep growing with borrowed funds.  This pause in financing on the upside is likely to slow down asset growth.

The opposite happens on the downswing.  As the value of outstanding loan assets begins to drop, the regulatory discounts on the asset values should be relaxed, avoiding a direct dollar-for-dollar reduction in net worth for every loss in a loan asset.  Preserving the bank’s net worth this way keeps it from having to quickly deleverage by shedding impaired assets into an already illiquid market.  This cannot stop the cycle, but it slows it down and tries to produce a softer landing.

This is what is meant by countercyclical requirements.  Reducing the unintended and highly undesirable amplification of the boom-bust cycle caused by regulatory capital rules goes to the heart of Minsky’s advice for reducing the growth of fragility and slowing down the contraction of debt-financed consumer demand.  Banking regulators have recommended that regulatory capital eliminate this procyclicality by building in additional counter-cyclical capital requirements.[78]  Many implementation issues remain but it is an important step in the right direction.


New financing arrangements will always require original analysis to determine how they affect the financial system as a whole.  That analysis should draw on liquidity and leverage axioms derived from Minsky’s framework about financial instability.  Doing so would help to forecast an individual firm’s financial future, especially if it must refinance.  This kind of analysis also sheds light on how firm borrowing impacts the stability of the financial system as a whole.  Now more than ever, perspectives like this matter because the ultimate impact of the Dodd-Frank Act still hangs in the balance.  If implemented in good faith, the Act could enhance our capitalist system by mitigating financial cycles.  Whether or not it will live up to this promise remains to be seen.

* Associate Dean for Academic Affairs and Associate Professor of Law, College of Law, Florida International University, Miami, [email protected].  My thanks go to Alan Palmiter and Kent Greenfield for including me in the Symposium, “The Sustainable Corporation.”  As always, I am overleveraged to Charles Pouncy for his valuable comments on this Article.  I would also like to thank and praise the Wake Forest Law Review staff for their extraordinarily fine contributions to this piece.

[1]. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010) (codified in scattered sections of the U.S. Code).

[2]. John Cassidy, The Minsky Moment, New Yorker, Feb. 4, 2008, at 19.

[3]. See James S. Earley, Joseph Schumpeter: A Frustrated “Creditist,” in New Perspectives in Monetary Macroeconomics: Explorations in the Tradition of Hyman P. Minsky 337, 338 (Gary Dymski & Robert Pollin eds., 1994).

[4]. Cassidy, supra note 2.

[5]. Hyman P. Minsky, Financial Instability Revisited: The Economics of Disaster, in Can “It” Happen Again?  Essays on Instability and Finance 117, 118 (1982).

[6]. See id. at 122–24.

[7]. See Hyman P. Minsky, Capitalist Financial Processes and the Instability of Capitalism, in Can “It” Happen Again?, supra note 5, at 71, 86.

[8]. See generally Gary Dymski & Robert Pollin, Introduction, in New Perspectives in Monetary Macroeconomics, supra note 3, at 1–18.

[9]. See Hyman P. Minsky, Stabilizing an Unstable Economy 165–67 (1986).

[10]. Id. at 213–20; see José Gabilondo, Leveraged Liquidity: Bear Raids and Junk Loans in the New Credit Market, 34 J. Corp. L. 447, 475–76 (2009).

[11]. See Minsky, supra note 9, at 206; Gabilondo, supra note 10, at 471–74.

[12]. See Minsky, supra note 9, at 206–07.

[13]. Id. at 207.

[14]. Id. at 207–08.

[15]. Id. at 174.

[16]. Justin Lahart, In the Time of Tumult, Obscure Economist Gains Currency, Wall St. J., Aug. 18, 2007, at A1.

[17]. The whole quote is even more troubling because it knowingly discounts the liquidity crashes that are in the making: “When the music stops, in terms of liquidity, things will be complicated.  But as long as the music is playing, you’ve got to get up and dance.” Michiyo Nakamoto & David Wighton, Bullish Citigroup is ‘Still Dancing’ to the Beat of the Buy-Out Boom, Fin. Times, July 10, 2007, at 1.

[18]. U.S. Corporate Issuance, Sec. Indus. & Fin. Mkts. Ass’n,‑US‑Key-Stats-SIFMA.xls (last visited Aug. 30, 2011).  Borrowing by households and government units also contributed to these conditions, but this Article focuses only on borrowing by private business units.

[19]. See, e.g., Minsky, supra note 9, at 220–21.

[20]. Historical Changes of the Target Federal Funds and Discount Rates, Fed. Res. Bank of N.Y. (last visited Aug. 30, 2011),

[21]. Sudeep Reddy & Anusha Shrivastava, Fed’s Lending Ebbs as Crisis Subdues, Wall St. J., July 20, 2009, at A2.

[22]. Bd. of Governors of the Fed. Reserve Sys., Consolidated Statement of Condition of All Federal Reserve Banks, in Federal Reserve Statistical Release H.4.1 (Mar. 29, 2007), available at

[23]. Bd. of Governors of the Fed. Reserve Sys., Consolidated Statement of Condition of All Federal Reserve Banks, in Federal Reserve Statistical Release H.4.1 (Mar. 26, 2009), available at

[24]. Bd. of Governors of the Fed. Reserve Sys., Consolidated Statement of Condition of All Federal Reserve Banks, in Federal Reserve Statistical Release H.4.1 (Mar. 25, 2010), available at

[25]. Bd. of Governors of the Fed. Reserve Sys., supra note 22 (percentage derived by dividing current “U.S. Treasury” securities by “Total assets”).

[26]. Bd. of Governors of the Fed. Reserve Sys., supra note 24 (percentage derived by dividing current “U.S. Treasury” securities by “Total assets”).

[27]. See generally Mkts. Grp. of the Fed. Reserve Bank of N.Y.ork, Markets Group of the Federal Reserve Bank of New York, Domestic Open Market Operations During 2010, at 11–16 (Mar. 2011), available at (describing the Fed’s complete portfolio at the close of 2010).

[28]. Jerry Markham, Regulating Credit Default Swaps in the Wake of the Subprime Crisis 19 (2009) (unpublished working paper for Int’l Monetary Fund Seminar on Current Dev. in Monetary and Fin. Law) (on file with author).

[29]. 12 U.S.C. § 290 (2006).  See generally Jeffrey Rogers Hummel, Federal Reserve Accounting and Its Solvency, History News Network (Mar. 10, 2011), (discussing Fed changes to its accounting for remittances to Treasury).

[30]. Bd. of Governors of the Fed. Reserve Sys., supra note 22 (percentage derived by dividing current “deposits” of “Depository institutions” by “Total liabilities”).

[31]. Bd. of Governors of the Fed. Reserve Sys., supra note 24 (percentage derived by dividing current “deposits” of “Depository institutions” by “Total liabilities”).

[32]. See, e.g., Peter Stella, The Federal Reserve System Balance Sheet: What Happened and Why It Matters (Int’l Monetary Fund Working Paper WP/09/120, 2009),available at (arguing that assets acquired due to financial rescue interventions are “policy” assets as distinguished from the ordinary monetary ones acquired during routine central bank operations).

[33]. On the Resolution Trust Corporation, see generally Lee Davison, The Resolution Trust Corporation and Congress, 1989–1993 (pts. 1 & 2), 18 FDIC Banking Rev., no. 2, 2006 at 38, no. 3, 2006 at 1.

[34]. See Minsky, supra note 9, at 206–08.

[35]. Press Release, Levy Economics Institute, Leading Economists and Policymakers to Discuss Ongoing Impact of the Global Financial Crisis at the Levy Economics Institute’s 20th Annual Hyman P. Minsky Conference (Apr. 11, 2011), available at

[36]. See generally Hyman P. Minsky, The Financial Instability Hypothesis (Levy Economics Inst. Working Paper No. 74, 1992), available at

[37]. See, e.g., Gabilondo, supra note 10, at 247–54 (giving examples of objection to financial cycle theory).

[38]. Community Reinvestment Act of 1977, 12 U.S.C. §§ 2901–2908 (2006).

[39]. See Markham, supra note 28, at 4–7 (noting that large banking organizations seeking approval for mergers from the Federal Reserve pledged to allocate credit to borrowers who may not have otherwise met credit underwriting standards).

[40]. Philip Ashton, Troubled Assets: Financial Emergencies and Racialized Risk 7 (May 2009) (unpublished working paper for Great Cities Inst.), available at

[41]. These political alliances against regulation flow out of the generic mobilization of the new Right that began in 1968 with Richard Nixon and reached its apotheosis through the “emerging Republican majority” theorized by Kevin Phillips.  José Gabilondo, When God Hates: How Liberal Guilt Lets The New Right Get Away With Murder, 44 Wake Forest L. Rev. 617, 618–21 (2009).

[42]. See generally Éric Tymiogne, Minsky and Economic Policy: “Keynesianiasm” All Over Again? (Levy Economics Institute Working Paper No. 547, 2008), available at (contrasting Minsky’s Keynesianism with mainstream Keynesianism).

[43]. See, e.g., Todd Zywicki, Dodd-Frank and the Return of the Loan Shark, Wall St. J., Jan. 4, 2011, at A17 (“Congress can pass all the laws it wants, but it can’t repeal the law of supply and demand and the law of unintended consequences.”).

[44]. Ironically, given its role in promoting neoliberal values, it was a paper on government securities by the International Monetary Fund that made me see the inevitable role of the state in influencing market structure.  See Peter Dattels, The Microstructure of Government Securities Markets (Int’l Monetary Fund Working Paper WP/95/117, 1995).  The paper analyzes the choices that governments have when setting up markets for their own public debt markets, e.g., auction pricing, specialist versus market-makers.  That there are choices to be made by public officials negates any “naturalness” of market structure.  A second example came while at the U.S. Securities and Exchange Commission on an inspection of the specialist system at the New York Stock Exchange.  This arrangement gives a monopoly on all the order flow for a security to one trader (the specialist) in exchange for his duty to make a fair and orderly market.  The specialist does this by crossing the buy or sell orders of customers or, as needed, by using his own capital to effect a trade.  An aesthetic of price is at work that favors incremental changes—in either direction—to swings.  Issuers of the specialist’s securities could complain when—in their profoundly interested opinion—the specialist had not “made markets” appropriately by creating a bumpy price path.  An investigation and market reconstruction would follow.  Here again were policy decisions at work rather than the canonical idea of forces of supply and demand meeting at a clearing price—so wide-eyed claims that markets are “free” suggest, to me, that the speaker is either profoundly naïve or disingenuous.

[45]. See, e.g., F.A. Hayek, The Use of Knowledge in Society, 35 Am. Econ. Rev. 519 (1945) (emphasizing the importance of disbursed, localized knowledge in the economy).

[46]. See, e.g., Robert Norzick, Anarchy, State, and Utopia (1974).

[47]. Merton H. Miller, Leverage, Nobel Prize Lecture (Dec. 7, 1990), in 1990 Econ. Sci. 291, 298–300, available at
/economics/laureates/1990/miller-lecture.pdf (arguing that unregulated market forces can regulate the pricing of liabilities through interest rates).

[48]. See Steven A. Bank, Origins of a Flat Tax, 73 Denv. U. L. Rev. 329, 379–80 (1996).

[49]. See A.C. Pritchard & Robert B. Thompson, Securities Law and the New Deal Justices, 95 Va. L. Rev. 841, 847–57 (2009).

[50]. Tim Curry & Lynn Shibut, The Cost of Savings and the Loan Crisis: Truth and Consequences, 13 FDIC Banking Rev. no. 2, 2000 at 26.

[51]. See, e.g., S. Permanent Subcomm. on Investigations, 112th Cong., Wall Street and the Financial Crisis: Anatomy of a Financial Collapse 95–103 (2011).

[52]. An industry journal of the time noted the development with glee:

Now, issuers of private-label residential MBS are holding the aces that were once held by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac.  Once a junior—but powerful—player in the market, private-label residential mortgage backed securities (RMBS) are now the leading force driving product innovation and the net overall volume of mortgage origination.

Robert Stowe England, The Rise of Private Label, Mortgage Banking, Oct. 2006, at 70, 70.

[53]. Theresa R. DiVenti, Fannie Mae and Freddie Mac: Past, Present, and Future, 11 Cityscape 231, 237 (2009) (“The private-label securities contributed significantly to the GSEs’ losses in 2008; in many cases, the value of the securities fell as much as 90 percent from the time of purchase.”).

[54]. Legal scholarship, in particular, has a duty to evaluate these practices carefully, although it has not done so enough.  See Charles R. P. Pouncy, Contemporary Financial Innovation: Orthodoxy and Alternatives, 51 SMU L. Rev. 505, 508 (1998) (“Legal scholarship has not produced critical examinations of financial innovation as an economic process. . . .  The products generated [by financial innovation] are readily accepted and adjudged good.”).

[55]. See Luca Di Leo & Jeff Bater, New Jobless Claims Cloud Economic Outlook, Wall St. J., May 27, 2011, at A3 (reporting increasing corporate profits).

[56]. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §§ 701–754, 124 Stat. 1376, 1641–1754 (2010) (to be codified in scattered sections of 7, 11, 12, and 15 U.S.C.).

[57]. See generally Michael Greenburger, Overwhelming a Financial Regulatory Black Hole with Legislative Sunlight: Dodd-Frank’s Attack on Systemic Economic Destabilization Caused by an Unregulated Multi-Trillion Dollar Derivatives, 6 J. Bus. & Tech. L. 127 (2011).

[58]. Victoria McGrane, Risk Rule Riles Main Street: U.S. Wants Car Makers, Brewers to Back Derivatives Bets with Cash; Cost at Issue, Wall St. J., Apr. 13, 2011, at A1 (summarizing objections by nonfinancial users of swaps to CFTC’s margin and collateral proposals).

[59]. See Carolyn H. Jackson, Have You Hedged Today?  The Inevitable Advent of Consumer Derivatives, 67 Fordham L. Rev. 3205, 3221–22 (1999).

[60]. Cheyenne Hopkins & Joe Adler, Regulators Give Banks Win on Key Derivatives Proposal, Am. Banker, Apr. 13, 2011, at 1 (noting that pressure from Congress resulted in ongoing exemptions from margin and collateral rules for corporate end-users).

[61]. Mark Hansen, Too Much Momentum?, A.B.A. J., May 2011, at 55.

[62]. See Lisa Lambert, State Bankruptcy Bill Imminent, Gingrich Says, Reuters, Jan. 21, 2011, available at

[63]. See generally Lester M. Salamon, The Resiliant Sector: The State of Nonprofit America, in The State of Nonprofit America 3 (2002).

[64]. This is what out-of-the-money credit swaps did to AIG.  See Mary Williams Walsh, Risky Trading Wasn’t Just on the Fringe at A.I.G., N.Y. Times, Jan. 31, 2010, at B1.

[65]. For those swaps that are cleared bilaterally rather than being moved to a central clearing house, an additional regulatory capital charge may apply on the theory that this nonstandard position imposes more systemic risk than a position that has been moved to a CCP.  See Margin and Capital Requirements for Covered Swap Entities, 76 Fed. Reg. 27564 (proposed May 11, 2011) (to be codified at 12 C.F.R. pts. 45, 237, 324, 624, 1221); Capital Requirements of Swap Dealers and Major Swap Participants, 76 Fed. Reg. 27802 (proposed May 12, 2011) (to be codified at 17 C.F.R. pts. 1, 23, 140); Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 76 Fed. Reg 23732 (proposed Apr. 28, 2011) (to be codified at 17 C.F.R. pt 23).

[66]. Pub. L. No. 111-203, § 731, 124 Stat. 1376, 1703–12 (2010).

[67]. Though not explicit, Minsky’s classification appears to assume uncollateralized borrowing.  The following discussion applies the leveraged liquidity framework developed in my article on leveraged loans.  Gabilondo, supra note 10, at 474–76.

[68]. Pub. L. No. 111-203, § 725(D), 124 Stat. 1376, 1688–89 (2010).

[69]. This is what the Fed did by expanding the kinds of acceptable collateral that banks could use for discount window borrowing.  See Steve Goldstein, Fed Expands Auction, Accepts Wider Collateral, Marketwatch (May 2, 2008),‑expands‑auction‑accepts‑wider‑collateral-to-boost-liquidity-200852105100.

[70]. See Megan Davies & Svea Herbst-Bayliss, Volcker Impact Sends Shivers Through Banks, Reuters, Aug. 9, 2010, available at

[71]. Annette L. Nazareth, Dodd-Frank Act Finalizes Swap Pushout Rule, Harv. L.F. on Corp. Governance & Fin. Reg., (July 7, 2010, 9:13 AM),‑frank‑act‑finalizes‑swap‑pushout-rule.

[72]. Michael Kowalik, Countercyclical Capital Regulation, Fed. Res. Kan. City Econ. Rev., 2d Quarter 2011, at 63, 63–64, available at

[73]. For an example, see 12 C.F.R. § 3 (2011) for the regulatory capital rules that apply to national banks.

[74]. See Kowalik, supra note 72, at 66.

[75]. For example, banks are generally required to hold 4% of their financial capital, i.e., debt and equity capital, in relatively permanent forms of risk capital designed to bear residual loss known as Tier 1 capital, e.g., common stock and noncumulative preferred stock.  Id. at 80 n.6.  Disregarding for the moment other capital ratio rules that apply, that requirement would limit the bank’s potential debt to equity ratio to 25:1.  In practice, it is lower because of concurrent requirements that apply to less residual forms of financing like subordinated debt.

[76]. See generally James B. Thomas & Joseph Haubrich, Keeping Banks Strong: Countercyclical Capital Requirements, Forefront, Winter 2011, at 16, available at

[77]. See, e.g., Adrian Blundell-Wignall, The Subprime Crisis: Size, Deleveraging and Some Policy Options, 2008 Fin. Market Trends 29 (examining deleveraging of subprime mortgages).

[78]. See Kowalik, supra note 72, at 66–69; see also Basel Comm. on Banking Supervision of the Bank for Int’l Settlements, Countercyclical Capital Buffer Proposal (July 2010), available at