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In other words the whole financial system must be

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In other words, the whole financial system must be looked at and treated in unison. In addition, without concentration limits or a systemic risk tax, it is highly likely that nonconforming mortgage finance would just end up with financial firms that have government guarantees, such as FDIC-insured banks and too-big-to-fail institutions. As we have argued in the earlier chapters, the more guarantees that a firm receives, the lower are its costs of debt funding, which could lead to an alternative group of private GSE firms in the mortgage finance area. 62 Recently, President Obama signed the most comprehensive financial regulation since the Great Depression: the Dodd-Frank Act. What effect will it have on the market for nonconforming mortgages? The Act can be evaluated in light of the distinction between legislating the systemic risk of financial institutions and placing restrictions at the mortgage level. It is not clear at this stage how the Dodd-Frank Act will treat risky mortgages on the balance sheet in terms of systemic risk contribution. But this aside, with respect to systemic risk, the Act recognizes that systemic institutions must be subject to more stringent standards that
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123 should increase with the degree of systemic risk. 63 Moreover, these prudential standards cover the likely suspects such as risk-based capital and liquidity requirements. While the devil is in the details, there is room to be skeptical. The rules will most likely end up following the latest Basel accords – we are now on Basel number 3 -- but a number of economists point to earlier Basel accords as partially responsible for the current financial crisis. 64 Perhaps, recognizing this point, the other way that the Act deals with systemic risk is to try to end too-big-to-fail institutions by setting up a resolution authority. This is clearly a step in the right direction, but the authority is most likely inadequate for this purpose. Its preference is to put the institution through a receivership process, which is not a particularly credible way to ensure that systemic liabilities will be left unprotected in a crisis. A more transparent and predictable design would be one based on the bankruptcy code, possibly restructured to deal with the financial King Kongs. 65 The Dodd-Frank Act, therefore, might be more successful at the individual asset level -- in this case, regulating nonconforming mortgages. The Act implements two major pieces of legislation on this front. The first is that, in order to align incentives better on the underwriting front, securitizers of mortgage loans must hold at least 5% of the credit risk -- i.e., they must have “skin in the game”. 66 The second route is to rely on a consumer finance protection bureau (CFPB), housed at the Fed, to monitor and create rules for the nonconforming mortgage market. While some observers worry about the potential for overreaching, at least with respect to mortgages, the CFPB is in the spirit of limiting the nonconforming mortgage market. Specifically, Title XIV of
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