Introduction to Regulation and Enterprise from Professor Robert Shiller

Regulatory bodies US government set up

Freddie Mac and Fannie May

Freddie Mac and Fannie May

Picture source: Google

In 1968, the US government set up Federal National Mortgage Association (Fannie May) and in 1970, the US government set up Federal Home Loan Mortage Corporation (Freddie Mac).

In essence, the purpose of this two organization is to buy mortgages from the banks and pools them together – after that sells it to back investors as a mortgage-backed securities.

This activity increases the supply of money available for mortgage lending by banks and increases the money available in the market for new home purchases for the people.

These two companies are examples of financial solutions that were created to solve financial issues in the society. Can you think of one such company in Singapore?

Read: The whole Summary of Yale University Financial Markets Course series here

Misbehaviour, Regulation and Self-Regulation in Finance

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5 Types of Regulations in Finance

Picture source: Author’s work

1) Within firms

Companies have the board of directors to impose some kind of regulations for the firm. They usually have internal directors and outside directors – which made the directors some kind of regulators.

Directors are also human, and human being human, some of them will misbehave.

For example, some of them will engage in tunneling. Tunneling is sneaking away with the value of the company and putting it in their own pocket instead of the stockholder.

For example, in asset sales, people may sell the company’s asset to their relatives at a price that is below the market – and it is hard to detect as stock holder cannot possibly look at every deal, can they?

As a board member, everyone has a duty of care and duty of loyalty to stockholders and their individual reputation is at stake.

That is why when companies appoint a director, they are extra careful on who they choose – most of the time they will choose someone who is of a proven capability. For example, on 31 August 2015, JTC company from Singapore just appointed our Chief Of Defence (COD) MG Perry Lim as a new board member.

It is important to realize the distinction that they are not managing the company; they are managing the management of the company.

2) Trade group

Trade group is simply a business that is founded and funded by businesses that operate in a specific industry.

An example of a trade group is the New York Stock Exchange (NYSE) which was set up in 1792.

Can you think of one example of a trade group in Singapore? An obvious example is the Singapore Stock Exchange (SGX)!

3) Local government

A long time ago, there are a lot of miselling in the financial industries that lead to a law being passed on – it was called blue sky law: it is a state law in the United States that regulates the offering and sale of securities to protect the public from fraud.

Unfortunately, state laws were often unsuccessful as the finance trade is more of a national trade rather than a state trade. Meaning that not every state has that law and someone from a state which has the law being passed on can call another person from another state and still do mis-selling! That is a problem, right?

4) National

Securities and Exchange Commission (SEC)

In 1934, securities and exchange commission (SEC) was created: It regulates any firm listed on the stock exchange and protecting small investors.

To be a listed company, you need to go through a procedure dictated by the SEC called Initial Public Offering (IPO) – in a public company, public trust is involved.

They also manage the private company and one particularly important company is the hedge fund – a fund for wealthy investor – it is still surviving as a largely unregulated organisation.

Financial Accounting Standards Board (FASB)

Financial Accounting Standards Board (FASB) was created when the SEC realized companies fake their books in too many ways, but they do not want to completely take over the function of accounting of companies for themselves.

Subsequently, they came out with Generally Accepted Accounting Principles (GAAP) which is the principles used to present the accounting of companies.

Securities Investors Protection Corporation (SIPC)

Securities Investors Protection Corporation (SIPC) is an effort by the US government to secure your brokerage account against loses (with limits) due to the failure of your stock broker.

Financial Stability Oversight Council (FSOC)

The Dodd-Frank act creates Financial Stability Oversight Council (FSOC) which deals with systemic risk – risk that affects the whole system – the too big to fail company.

European Systemic Risk Board (ESRB)

European Systemic Risk Board is the FSOC of Europe: it publishes a report on the systemic risks arising from the activities of European insurers and re-insurers.

Read: The whole Summary of Yale University Financial Markets Course series here

5) International

It is important for international cooperation in finance because there is a way for people to use offshore banking to skip the regulation in specific country – finance always goes to places with the cheapest regulatory cost.

A good example of this is tax inversion done recently by a Pharmaceutical company called Pfizer – it recently underwent a $160 billion merger with another drug company called Allergan and it is now able to cut it tax rate to 17% instead of 25% – by moving the headquarter to Irish instead of New York.

For international regulations, they usually do not and cannot impose on anyone but they can suggest solutions.

Bank for International Settlements (BIS)

In 1930, the bank for International Settlements (BIS) was formed in Basel: Where the heads of 57 central banks meet regularly in Basel to suggest on how to run the central banks.

G7 to G20

G7 – Where Finance ministers in 7 major countries (Canada, France, Germany, Italy, Japan, United States and Japan) met together. Subsequently, there was resentment as the G7 countries were made up of mostly North American countries so they came up with G20 which included China, India and other developing countries.

Guest Speaker – Carl Icahn

When Carl takes a position in the company, it would become active in the management of the company – changing the way they do business and he has done that with enormous success.

Read: The whole Summary of Yale University Financial Markets Course series here

Guide:

Mortgage-backed securities = Mortgage-backed securities are bonds backed by payments on mortgage loans.

Tax Inversion = a move in which a US company merges with a foreign-domiciled company to shift its address to a country with a lower tax rate.

Important: Please read my disclaimer.

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Further Reading:

My Week 6 Summary of Yale University Financial Markets Course: Key Role of Banks and Monetary Policies