Isenberg Finance Professors Gain New Analytical Lens from Washington Experience
November 12, 2013
Two Isenberg finance professors returned to Isenberg with valuable new insights after recent stints at two federal regulatory agencies in Washington, D.C. Mila Getmansky Sherman spent six months at the Securities & Exchange Commission; Nikunj Kapadia spent much of a year at the U.S. Treasury Department's Office of Financial Research. Both expanded their skill sets and gained new perspectives, including an overarching appreciation of the financial system.
"Spending the last six months at the Securities and Exchange Commission (SEC) in Washington, D.C. was a fantastic experience," recalls Sherman. "My work at the SEC underscored the reality that financial markets operate in a regulatory environment. It gave me a new lens into the way that the financial system and its components work and new tools for evaluating them." Working with the SEC's Division of Economic Research Analysis and the SEC's chief economist, Craig Lewis, Sherman focused on the financial reform of money market funds and the evaluation of nonbank financial institutions as significant players in the overall financial system. She also contributed to several SEC enforcement cases.
"Congress writes the general laws, but they leave their concrete interpretation and enforcement to regulators like the SEC," observes Sherman. "The SEC subjects all rules and regulations to rigorous cost-benefit analysis," she continues. "They don't just discuss costs and benefits, they analyze them with precision." In Sherman's assessment of money market funds, that entailed analyzing actual and proposed rules such as the introduction of fees, buffers, innovations like floating net asset value, and other factors. "The SEC aims to systematically decrease financial risk for investors," remarks Sherman. "My previous research in financial crises, systemic risk, and hedge funds gave me a strong skill-set to begin with. I leveraged that in learning a great deal about money market funds."
Professor Sherman also did research that assessed risk to the financial system from major nonbank institutions, including financial insurers like AIG and Prudential. The Dodd-Frank Financial Regulatory Act, she notes, mandates evaluative oversight of all systemically important financial institutions (SIFIs), including insurers and other nonbanks. In their research, Sherman and her SEC colleagues looked at variables like an institution's size and leverage, and its interconnectedness with the rest of the financial system.
Back at Isenberg, Sherman's SEC experiences are informing her teaching and research. "I'm doing research that investigates the credit risk in the financial system by highlighting and studying explicit and implicit connections between sovereigns, global insurers, and global banks," she observes. She is also working on research of studying the role of the insurance industry in the financial markets. "And in the classroom, my students are learning that financial regulation is a critical factor in financial analysis and the financial system. For them and me, that's brought a deeper appreciation of what systemic risks are all about."
"Before the financial crisis of 2008, there was little understanding of the overarching, systemic risk in financial markets," notes Nikunj Kapadia. "The system was essentially organized by accident. When the crisis hit, it revealed severe defects in the financial plumbing."
Improving the quality of financial data for policy makers and their understanding of the financial system itself were central concerns for Kapadia during his year-long (2012) post with the U.S. Treasury Department's Office of Financial Research (OFR) in Washington. The OFR and the group that it serves-the U.S. Treasury's Financial Stability Oversight Council (FSOC)-were established by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, a sweeping overhaul of financial regulation in the wake of the crisis.
With the Act in place, policy makers and the public are increasingly seeing the financial forest for the trees, emphasizes Kapadia. The Council, he notes, meets periodically to identify destabilizing risks to the financial system and to promote market discipline. Its ten voting members include the directors and chairs of all of the federal government's major financial regulatory bodies. And its five nonvoting members include OFR's director, underscoring the office's critical role as provider of data for the Council's policy decisions.
At OFR, Kapadia helped set up systems for maintaining and analyzing "live" financial risk measures of the financial system. With access to transaction and position data, he researched the interconnectedness of significant players in the system, including private institutions involved in CDS (credit default swap) markets.
"We were also asked to weigh in on a variety of policy issues," Kapadia continues. "In general, our approach was broadly economic, macro-prudential rather than micro-prudential or legalistic. Among the many policymakers at the table, only we [OFR] have the mandate to gather data on all markets and participants. When our analysis was based on sensitive data, we typically spoke in generic policy terms.
"It's no surprise then that much of my research in Washington will remain unpublishable," he continues. "But I've gained terrific insights into the financial system-a more nuanced understanding of its interconnections and stress points. At Isenberg, I'm able to share many of those insights with my colleagues and students."