Great Expectations for the Office of Financial Research

Abstract

The Office of Financial Research (“OFR”) is a rarely-discussed but potentially powerful agency established by the Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”). Often compared to a storm-warning system, the OFR, through its two units, a Data Center and a Research and Analysis Center, can continually gather up and analyze detailed financial information collected from a variety of banks and other financial firms. The OFR will share this with the Financial Stability Oversight Council (“Council”) and its member agencies so they can act as the storm approaches to prevent, prepare and intervene. As a result, for the first time it is hoped that regulators will have the necessary tools to evaluate the stability of the entire financial system, not just individual banks. Moreover, instead of outsourcing to the financial firms themselves, as was done on occasion in the past, regulators may control the data and possess the capability in-house to make independent determinations.

For those who consider the Dodd-Frank Act to be a small step in the right direction, the OFR presents an opportunity to gather evidence to determine which additional steps are necessary. One hopes that the OFR performs or sponsors research that attends to those areas for which the Dodd-Frank Act left exceptions, provided weak solutions or deferred action until further study was done. For example, the OFR might examine the risk impact of failing to limit any bank from holding non-deposit liabilities of greater than 2% and total liabilities of greater than 3% of GDP, as proposed under the Safe Banking Act (also known as the Brown-Kaufman Amendment). The OFR might also monitor the risk impacts of the exceptions to the Volcker Rule that permit banks to invest in hedge funds. It could assess whether naked credit default swaps and synthetic securitizations provide system-wide benefits that exceed their counterbalancing risks. It might model the impact that a secured creditor haircut would have on risk reduction. It could consider the problems of a liquidity and maturity mismatch, examining how rolling back special treatment under the bankruptcy code for certain repos and derivatives might have impact. Finally, recognizing the risks of regulatory arbitrage, the OFR should look to those places where firms may not be required to be forthcoming with data. For example, some financial entities are not within the scope of required data providers. Accordingly, this would be a shadow upon which the OFR should shine some light and find other modes to gather data and analyze risk. And to avoid creating more shadows, the OFR Director should also avoid granting reporting exemptions for firms without sufficient data to support the projected impact of such a carve-out – considering of the habit for capital to flow to the place of least regulatory resistance. Prior to granting carve-outs, the OFR should create an opportunity for academics and other experts who have no ongoing ties to the financial sector to independently analyze and comment upon the wisdom of such exemptions.

Keywords: Office of Financial Research, Financial Crisis

JEL Classification: G2, G3