As the US Congress turns more attention to potential loosening of regulation of the financial system, important voices in the Federal Reserve continue to defend key aspects of Dodd-Frank, and other post-Crisis regulation.
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“Securitization markets suffered from a number of defects, including poor design for many securitized products and misaligned incentives in the credit ratings regime.” While there is a grain of truth in this analysis, President Dudley misses the main cause of the ‘Financial Crisis’; the deterioration in the quality of the underlying assets (mortgages) because of a housing bubble stoked by banks, Congress, Democratic and Republican presidents, and overly optimistic borrowers; not to mention the lack of action taken by Alan Greenspan. How you divide the cash flows of a pool of mortgages is nowhere near as important as the quality of those mortgages. On the Volker Rule, it is shocking that President Dudley would ‘walk back’ regulators’ endorsement of this central tenant of financial reform. Despite the hand wringing over the LCR, the NSFR, the Leverage Ratio, etc. it is the Volker Rule which has caused the most damage to the financial markets. Limiting leverage and extending liabilities can be addressed by central clearing, netting and liability management. The Volker Rule prevents market makers from fulfilling their vital role in providing liquidity. What I don’t not understand is how he can suggest that it could be modified…isn’t the solution to concentrate on effective risk management and not on dictating how dealers should trade their books?