Essays on Financial Regulation

Abstract

The three essays of this dissertation consider post-crisis financial regulation. In the first essay, which is co-authored with Vladimir Mukharlyamov, we study the impact of the Durbin Amendment (“Durbin”), which capped debit swipe fees. The goal of Durbin was to lower costs for merchants, who would in turn pass through these savings to consumers in the form of lower prices. For Durbin to achieve its intended effect, regulated banks needed to not respond to Durbin by increasing other prices, and merchants needed to pass through their savings to consumers. Using proprietary data from a large payments industry player, we find that banks recover Durbin losses by increasing fees and merchants do not fully pass through savings to consumers. These results add empirical support to theoretical work that cautions against cost-based regulation in two-sided markets (Rochet and Tirole 2003). The second essay is co-authored with Lawrence Summers. Its main observation is that, despite a substantial overhaul of the regulatory regime, market-based measures of bank health do not suggest that large financial firms are substantially safer today than they were in the pre-crisis period. We think the most likely explanation for this surprising result is that regulation that has made banks safer has simultaneously decreased their profitability, as reflected in sharp declines in price-to-book ratios. This franchise value was a form of capital for banks to draw down upon to absorb losses. While we believe strongly that Dodd-Frank has substantially improved the safety of the financial sector, we also believe it is a mistake for regulators to be complacent going forward. The third essay, co-authored with Divya Kirti, focuses on the growth of private equity (“PE”) investments in the life insurance industry following the crisis. These investments have drawn substantial scrutiny from regulators, who argue that PE’s interests are not aligned with policyholders. We seek to inform this debate, studying how PE ownership changes insurance firms. We find that PE-backed insurers are most aggressive about taking advantage of opportunities for tax and capital arbitrage and that some of these savings are passed on to consumers through more attractive annuities rates.