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i
Capital Markets, Derivatives, and the Law

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iii
Capital Markets, Derivatives,

and the Law
P OSI T I VI T Y AND P REPA RAT ION
Third Edition
Alan N. Rechtschaffen
1
Capital Markets, Derivatives, and the Law. Alan N. Rechtschaffen.
© Alan N. Rechtschaffen 2019. Published 2019 by Oxford University Press.
1
Oxford University Press is a department of the University of Oxford. It furthers the University’s
objective of excellence in research, scholarship, and education by publishing worldwide. Oxford is
a registered trademark of Oxford University Press in the UK and certain other countries.
Published in the United States of America by Oxford University Press

198 Madison Avenue, New York, NY 10016, United States of America.
© Alan N. Rechtschaffen 2019
First Edition published in 2009

Second Edition published in 2014
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system,
or transmitted, in any form or by any means, without the prior permission in writing of
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Library of Congress Cataloging-in-Publication Data

Names: Rechtschaffen, Alan N., author.
Title: Capital markets, derivatives, and the law : positivity and preparation / Alan N. Rechtschaffen.
Description: Third edition. | New York : Oxford University Press, [2019] | Includes
bibliographical references and index.
Identifiers: LCCN 2018048101 | ISBN 9780190879631 ((hardback) : alk. paper)
Subjects: LCSH: Financial instruments—United States. | Derivative securities—
Law and legislation—United States. | Capital market—Law and legislation—United States. |
Securities industry—Law and legislation—United States.
Classification: LCC KF1070 .R42 2019 | DDC 346.73/096—dc23
LC record available at https://lccn.loc.gov/2018048101
9 8 7 6 5 4 3 2 1
Printed by Sheridan Books, Inc., United States of America
Note to Readers
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v
B’H
Thank you for Miera, Ronit, Evie, Sarah, Emunah, my mother, my father,
and my teachers. Thank you to Miera for more things than I could ever say.
Thank you Josh, Tevi, Jason, and R. Green for your friendship.
And thank you to my students who are an unstoppable source

of inspiration and positivity.
Alan Rechtschaffen
vi
vi
Contents
Acknowledgments xix
Preface xxiii
Introduction xxv
1. The Financial Crisis: The Seeds of New Regulation 1

I. Origins of the Great Recession 5
II. Subprime Lending 6
III. Government-Sponsored Entities 6
IV. Legislative Reforms 9
A. Multiple Guarantor Model 10
B. Multiple Insurer Model 11
2. The Liquidity Crisis and Government Reaction 13

I. Buildup to Crisis 13
II. Providing Liquidity and Stabilizing the Financial Markets 18
III. Regulatory Reaction at the Height of the Crisis 19
A. The Emergency Economic Stabilization Act 19
B. American Recovery and Reinvestment Act 21
IV. Dodd-Frank 23
3. Dodd-Frank and the Regulation of Depository Institutions Capital Requirements 25

I. The Volcker Rule and “Too Big to Fail” 26
II. Bank Holding Companies and Systemically Significant Nonbanks 29
III. Living Wills, Credit Exposure Reports, and Concentration Limits 32
IV. Other Prudential Standards 35
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4. Using Financial Instruments 37
I. Goal-Oriented Investing 37
A. Using Financial Instruments to Hedge Risk 39
B. Using Financial Instruments to Enhance Yield 39
C. The Economy’s Impact on Financial Instruments 40
II. Achieving Investment Goals 41
A. The Investor’s Perspective 41
B. Financial Instrument Objectives 43
III. Managing Risk 45
5. Financial Instruments and the Capital Markets 47

I. The Capital Markets 48
A. Primary versus Secondary Markets 49
B. Long-Term versus Short-Term Marketplaces 50
C. Case Study: The Auction Rate Securities (ARS) Market 50
II. Financial Instruments 51
A. Types of Financial Instruments 51
1. Equity-Based Financial Instruments 51
2. Debt-Based Financial Instruments 52
3. Derivatives 53
4. Cryptocurrency and Digital Assets 54
B. Distinction between Debt and Equity 54
C. Federal Regulation 57
III. The Role of the Attorney 61
A. Competent Representation 61
B. Duty to Advise Client 61
C. Drafting Financial Instruments 62
D. Regulatory Compliance 62
E. Opinion Letters 63
6. Bureau of Consumer Financial Protection 65

I. Structure 66
II. Roles and Function of the BCFP 68
A. The Bureau’s Regulatory Authority 68
B. The Bureau’s Supervisory Authority 69
C. The Bureau’s Enforcement Authority 70
III. Significant Changes in Financial Consumer Protection by the BCFP 70
A. The Judicial Review of BCFP’s Power 71
IV. B CFP under President Trump’s Administration 73
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Contents ix
V. The Judicial BCFP Structures under President Trump’s Administration 77
A. Constitutionality of the Bureau 77
B. Single Directorship 77
VI. Ongoing Enforcement Action Status 78
A. Wells Fargo Case 78
7. Understanding Interest Rates and the Economy 81

I. Background 82
A. The Federal Reserve 82
B. The Federal Reserve Banking System 83
1. Composition 84
2. Purpose 84
3. Responsibilities 85
II. Economic Indicators and Interest Rates 86
A. Key Economic Statistics 86
1. Statistics 88
B. Monetary Policy Objectives 92
C. Inflation Targeting 95
III. Monetary Policy: The Financial Crisis and Beyond 96
IV. Quantitative Easing 97
A. Balance Sheet Normalization 104
B. Fiscal Considerations 106
V. FOMC Minutes 107
8. Asset Valuation 111

I. The Use of Interest Rates in Asset Valuation 111
II. Interest Rate Yield Curve 112
A. Types of Yield Curves 113
B. Why the Yield Curve May Be Flat or Inverted 117
1. Increase in Market Demand for Long-Term Securities 117
2. Long-Term Yield Affected by Federal Reserve Monetary Policy 118
9. United States Treasury Securities 121

I. Purpose and Goals 122
A. Risk-Free Nature 123
B. Primary Dealers 124
II. Description of U.S. Treasury Securities 125
A. Types of Treasury Securities 125
1. Treasury Bills 125
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2. Treasury Notes and Bonds 126
B. Pricing 126
1. Discounts and Premiums 126
2. Factors Affecting Yield 127
III. Bond Auctions and Price 128
A. Interruption of Supply: SEC v. Davis et al. 129
B. Manipulation of the Auction Process: United States v. Salomon
Brothers 130
IV. Interest Rates 132
A. Fixed-versus Floating-Rate Securities 132
B. Treasury Inflation-Protected Securities (TIPS) 132
V. STRIPS 134
A. Description 134
B. Valuation 134
C. Uses 135
D. Abuses: In the Matter of Orlando Joseph Jett 136
10. Debt Securities 139

I. Description 140
A. Features of Bonds 140
B. Types of Bonds 141
C. The Indenture 142
II. Bond-Rating Agencies 142
A. Independence and Conflicts of Interest 144
B. Regulation of Bond-Rating Agencies 146
III. Special Types of “Debt” Instruments 146
A. Repos 146
1. Description 146
2. Orange County Case Study 147
B. Mortgage-Backed Securities 149
1. Mortgage-Backed Bonds 150
2. Pass-Through Securities 150
3. Collateralized Mortgage Obligations and Real Estate Mortgage Investment
Conduits 151
4. Stripped Mortgage-Backed Securities (SMBS) 151
5. Subprime Mortgage Crisis 151
IV. Securities Act Registration 152
A. Government Securities 153
B. Government Agency Securities 153
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Contents xi
C. Municipal Securities 154
1. SEC Disclosure Requirements 154
2. MSRB Disclosure Requirements 154
D. Corporate Debt Securities 155
1. Securities Act Requirements 155
2. Trust Indenture Act Requirements 155
E. Private Placements of Debt Securities 156
11. Derivatives 157

I. Introduction 158
A. Description 158
B. Counterparty Credit Risk 158
C. Over-the-Counter versus Exchange-Traded Derivatives 161
D. Exchange-Traded versus OTC Derivatives 162
II. Shifting Risk 163
A. The Concept of Leverage 163
B. Basis Risk 164
C. Market Risk 164
D. Effective Tools of Risk Management 165
III. Types of Derivatives 165
A. Forwards 165
B. Futures 166
1. Reduction of Counterparty Risk 167
2. Suitability as Hedging Instruments 167
C. Distinction between Forwards and Futures 168
D. Foreign Exchange Forwards and Futures 169
E. Options 170
F. Swaps 172
1. Characteristics of Swaps 172
2. The ISDA Master Agreement 173
G. Credit Derivatives 174
Appendix CME Filing: Self-Certification for the initial listing of the Bitcoin
Futures Contract 176
12. Types of Swaps 199

I. “Plain Vanilla” Interest Rate Swaps 200
II. Currency Swaps 202
III. Credit-Default Swaps 203
A. Purpose and Function 204
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B. ISDA Master Agreement 206
C. Importance of Clearly Defined Terms 206
1. Credit Event 207
2. Reference Entity 209
D. Collateralized Debt Obligations 214
E. OTC Derivatives and the Financial Crisis 215
IV. The Move toward Regulatory Reform 220
A. The Central Clearing Model 221
B. The OTC Model 222
C. Confidence in the New Regulatory Regime: The Case of MF Global 223
13. Options 231

I. Characteristics of Options 232
II. How Options Work 233
A. Calls and Puts 234
1. Call Option 234
2. Put Option 235
B. Case Study: Levy v. Bessemer Trust 235
1. Facts 235
2. Theories of Liability in Levy 236
III. The Black-Scholes Model and Option Pricing 238
A. Assumptions 238
B. Required Data 238
C. Volatility 239
1. Types of Volatility 239
2. Measures of Volatility 240
D. Authority of the Black-Scholes Model 241
IV. Delta Hedging 242
A. Contracts That Are Economically Options 244
B. OTC versus Exchange-Traded Options 245
C. Regulation of Options 246
V. Option Strategies 247
A. Synthetic Call 248
B. Covered Call 248
C. Collar 248
14. Regulation of Swaps 249

I. The Dodd-Frank Regulatory Regime 250
A. Dodd-Frank and Derivatives Trading 250
B. Jurisdiction and Registration 252
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Contents xiii
C. Clearing Requirements, Exchange Requirements, and the End-User
Exemption 254
D. Capital and Margin Requirements 259
E. Reporting Requirements 260
1. Commodity Position Limits 261
F. Futures Commission Merchants, Dodd-Frank, and Regulation 1.25 262
1. Title VII Enforcement 263
2. Updated Enforcement Advisory on Self-Reporting and Full
Cooperation 263
3. Enforcement Actions for Data Reporting Violations 265
4. Action for Failure to Submit Accurate Large-Trader Commodity Swap
Reports 266
5. Increase of CFTC’s Enforcement Actions following the Change of CFTC
Chairman 267
6. Reduction of Counterparty and Systemic Risk 267
a. Counterparty Risk 268
b. Systemic Risk 270
G. Rationale behind Exemptions and Exclusions 271
1. The End-User Exemption 271
2. Physical Settlement Exclusion 273
3. Customization Exceptions 273
H. The Lincoln Rule 274
1. Futures Commission Merchants 275
I. Criticisms of Dodd-Frank’s Derivatives Trading Provisions 276
1. Concentration of Systemic Risk in Clearinghouse and “Too Big to Fail” 276
2. Exceptions Swallowing the Rule: Incentivizing of Customization and De
Minimis Exceptions 277
3. Lack of Global Harmonization 278
4. The Impact of the Change of U.S. Administration 279
5. The Change of CFTC Chairman 279
a. CFTC’s New Priorities 280
b. Improving SEF rules 280
c. Fixing Data Reporting 280
d. Achieving Cross-Border Harmonization 281
e. Project KISS 281
6. Recent Actions of the CFTC and Announcements of Further Actions
to Come 282
a. Amendment of Swap Trading Rules 282
b. Review of Swap Dealers De Minimis Threshold 283
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c. Review of Position Limits 283
d. Improvement of Clearinghouse Stress Testing 283
7. Propositions of Reforms from the U.S. Treasury Report on Capital
Markets 284
15. Securities Regulation 287

I. Regulatory Overview 288
A. The Securities and Exchange Commission 288
1. Jurisdiction 288
B. What Constitutes a Security 290
1. Stocks 290
2. Notes 292
3. Investment Contracts—The Howey Test 298
a. Control and Splitting the Transaction 304
b. Prepurchase Efforts 307
c. State Regulation and the Hawaii Market Test 308
C. Sellers’ Representations 310
D. Consequences of Securities Violations 311
1. Preliminary Injunction 312
2. Disgorgement 313
3. Permanent Injunction 313
4. Antifraud Statutes 314
5. Attorney’s Potential Liability 314
E. Hedge Funds 315
1. Post-crisis Hedge Fund Regulation 319
2. Other Regulations 320
II. Derivatives Regulation: The SEC after Dodd-Frank 321
Appendix A: Implementing the Dodd-Frank Wall Street Reform and Consumer
Protection Act 323
Appendix B: Checklist for Stocks, Notes, and Investment Contracts 323
16. Suitability 325

I. The Suitability Doctrine 326
A. Suitability Duty 326
B. Scope and Applicability 327
C. Control and Enforceability 327
D. Investment Advisors 328
1. Rule: A Fiduciary Standard 328
E. Scope and Applicability 329
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Contents xv
F. Control and Enforceability 330
G. Basis of the Suitability Doctrine 331
H. Special Circumstances 333
I. FINRA and Self-Regulated Organizations (SROs) 334
1. Financial Industry Regulatory Authority Creation of the Agency 334
J. Rule: A Suitability and Know-Your-Customer Duty 335
K. Scope and Applicability 336
L. Control and Enforceability 337
M. NYSE Know-Your-Customer Rule 337
1. Consumer Financial Protection Bureau 339
2. Scope and Applicability 340
3. Control and Enforceability 341
4. Department of Labor 342
a. Employee Retirement Income Security Act 342
5. Scope and Applicability 343
a. The Antifraud Provisions of the Federal Securities Laws—Section 10b
Cause of Action 343
II. Futures and Options: Suitability 345
A. Commodity Futures Trading Commission Disclosure Rules 345
1. Commodity Futures Trading Commission 345
a. Commodity Exchange Act 345
b. Rule: A Suitability and Fair-Dealing Duty 346
c. Scope and Applicability 348
d. Control and Enforceability 348
B. National Futures Association 349
1. Rule: Suitability and Know-Your-Customer Duty 349
a. Scope and Applicability 350
b. Control and Enforceability 350
C. CEA Antifraud Provision 351
D. Municipal Securities Rule-Making Board 351
Appendix A: Various Suitability Rules and Diagrams of Applicability 352
Appendix B: Survey of Rules Adopted by the SEC under Dodd-Frank 360
17. The History of the CFTC 367

I. Role of the CFTC 369
II. Structure 369
III. Disciplinary Action 370
IV. Regulatory Background 371
A. Commodity Exchange Act (CEA) of 1936 371
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B. Commodity Futures Modernization Act (CFMA) of 2000 372
C. Jurisdictional Disputes 373
D. The Commodity Futures Modernization Act 373
E. Exclusions 374
F. Forwards 375
G. Options 376
H. Futures 376
I. Regulatory Distinctions between Forwards and Futures 378
J. Swaps 381
K. Hybrid Instruments 383
L. Foreign Exchange Products 384
1. The Treasury Amendment 384
2. CFTC Reauthorization 385
Appendix A: Enforcement Case Study: CFTC v. Amaranth Advisors, LLC 388
Appendix B: Case Study: CFTC v. Zelener 391
Appendix C: Structure of CFTC 393
Appendix D: Case Study: CFTC v. Patrick McDonnell 394
18. Fiduciary Obligation to Manage Risk 397

I. Controlling Risk 398
A. Duty to Manage Risk 398
1. Risk Management for Financial and Non-financial Institutions 400
B. Financial Risk 401
C. Quantifying Financial Risk 402
1. Value at Risk 402
2. Volatility Risk 403
3. Stress Testing 403
D. Portfolio Dynamics 405
II. Operational Risk Management 405
A. Directors’ and Officers’ Understanding of Financial Instruments 406
B. Risk Policy 407
C. Reporting Lines and Audit Techniques 408
D. Empowering Board Members 409
E. Reporting Structures 410
F. Information Flow 411
1. Daily Exception Report 411
2. Red Flags 412
G. Ethical Concerns 412
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Contents xvii
1. Compensation 412
2. Code of Conduct 413
3. Free Flow of Information 414
H. Flexibility 414
III. Executive Protection 414
A. Responsibility for Risk Management 415
B. Business Judgment Rule 415
C. Education at Financial Institutions 416
D. Disclosure under Sarbanes-Oxley Act 416
1. Disclosures in Management’s Discussion and Analysis (MD&A) 416
2. Off-Balance-Sheet Transactions 417
Appendix A: Case Study: JPMorgan and the London Whale 419
19. Litigation Issues 423

I. Federal Securities Laws 424
A. The Retail Investor: Broker-Dealers and Investment Advisers 424
B. Securities Exchange Act of 1934 Rule 10b-5 Claim 426
C. Securities Act of 1933 428
D. Liability under the Commodity Exchange Act 430
1. Antifraud Provision 430
2. Disclosure 431
II. Common Law Theories 432
A. Breach of Fiduciary Duty 435
B. Common Law Fraud 438
C. Shingle Theory 438
D. Tort Theory 439
E. Contract Theory 439
III. State Blue Sky Laws 439
IV. Swaps Case Study 440
20. Synthesis and Conclusion 443

I. Synthesis 443
II. Structured Note Case Study: Securities and Exchange Commission v. Goldman,
Sachs & Co. & Fabrice Tourre 445
III. Historical Example: Erlanger “Cotton” Bonds 447
IV. Range Notes 450
V. Internal Leverage and Market Risk 452
VI. Risks Involved 455
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xviii Contents
A. Interest Rate Risk 455
B. Liquidity Risk 455
C. Reinvestment Risk 456
D. OCC Warning 456
Index 459
xi
Acknowledgments
Capital Markets, Derivatives and the Law: Positivity and Preparation

explains complex financial and legal information in a way that is easy to grasp. While
regulation is rapidly evolving, understanding the building blocks of capital market
trading activities is valuable far beyond a survey of the latest legal structures.
For more than twenty years, I have taught students at New York University School
of Law and at Fordham University. A number of my finest students helped me write
and update this book to describe innovation, regulation, and capitulation within the
global economy.
We would like to thank each of them for their contribution, and acknowledge
their fine work:
Ying-Tien Chen earned both Bachelor’s and Master’s degrees at National

Taiwan University and works as an attorney in Taiwan. Tina’s knowledge of
the law is broad, having worked internationally in civil, criminal, and domestic
relations litigation, including real estate and contract disputes, breach of fidu-
ciary duty claims, fraud, and family law.
Melanie de Marnix, who contributed portions relating to suitability and
standards of care, attended NYU Law School after having been an attorney for
five years in Brussels, specializing in corporate and finance law. Her experience
in advising clients in the Belgian public markets gave her valuable insight into
European surveillance authorities and their expected standards of care.
x
xx Acknowledgments
Michael Jaroslawicz earned his JD in 2018 from NYU Law School. While
at NYU, he was my teaching assistant and demonstrated depth and under-
standing in conveying information to others. He simultaneously earned his
MBA in 2018 from NYU Stern School of Business, specializing in financial
instruments and markets, quantitative finance, and economics. In 2014, he re-
ceived his BA in economics, magna cum laude, from Yeshiva University.
Maria Khan worked as an attorney in India and the United Arab Emirates,
advising on corporate and commercial law, banking and financial law, sec-
ondary market transactions, and syndicated financing of aircraft, vessels, and
mega-infrastructure projects. Her experience advising clients from India,
Singapore, the United Arab Emirates, the European Union, and the United
States gives her a unique perspective in global capital markets and regulations.
Giovanni Patti holds an LLM in corporate law from NYU Law School and
a PhD in corporate law from the University of Roma Tor Vergata. He served
as a graduate editor of the NYU Journal of Law & Business and as a research
assistant at the NYU Pollack Center for Law & Business and at the University
of Roma Tre.
Alexandre Reignier attended the University of Law of Nancy in France
and NYU Law School. He will start his legal career at Cleary Gottlieb Steen
& Hamilton, in Paris, with a practice focusing on corporate and financial
transactions.
Melanie Simon interned with the capital markets practices of Allen &
Overy and White & Case in Paris. She graduated from the banking and finan-
cial law master's degree program at Paris II—Pantheon-Assas University. She
won the Spitz & Poulle prize for best student in financial services (regulatory)
before coming to NYU Law School.
Masahiro Suzuki works as an attorney at Nagashima Ohno & Tsunematsu
in Tokyo, specializing in capital market, structured finance, real estate, banking
and financial law. He attended Kyoto University and NYU Law School.
Vinca Vinenska contributed a portion relating to the passage covering the
current state of the Consumer Financial Protection Bureau. She worked as an
attorney at Hiswara Bunjamin & Tandjung, in association with Herbert Smith
Freehills in Jakarta, Indonesia, for more than four years, specializing in cap-
ital market law, corporate law, mergers and acquisitions, banking, and financial
law. In 2018, she received an LLM from NYU Law School in corporation law.
Prachi Tadsare was an incredible help with writing and editing sections of
this book. Prachi works as a legal consultant in the Operations Policy Group of
the World Bank in Washington, DC, advising on operational issues in finance,
specifically in the areas of fragility, conflict, and violence. She received an LLM
xxi
Acknowledgments xxi
from NYU Law School after completing her legal education in India. As a stu-
dent in my class on financial instruments at NYU, Prachi researched capital
markets and disruptive technologies, some aspects of which we are excited to
incorporate into this edition of the book.
Much of the fine work from former students for the second edition of this
book survives in this latest iteration. I wish to once again thank, acknowledge,
and send my personal regards to:
Andraz Jadek, who, at the time of the second edition, worked as an attorney
in Ljubljana, Slovenia, specializing in corporate and commercial law, mergers
and acquisitions, venture capital, securities regulation, banking, and financial
law. His experience advising clients from the European Union and the United
States, among them large financial institutions, gave him a unique perspective
on U.S. capital markets and regulation.
Richard Kim, who contributed portions relating to the passage of Dodd-
Frank and the regulatory developments that ensued. He attended Binghamton
University and NYU Law School. While at NYU he was a student in my sem-
inar on financial instruments.
Grant Munyon, who graduated Phi Beta Kappa and with honors from
Stanford University with a B.A. in international relations. He graduated in
May 2013 from NYU Law School, where he acted as a notes editor for the
Journal of Law and Business and participated in the Children’s Rights Clinic.
Omar Radawi, who attended Princeton University and majored in the
Woodrow Wilson School of Public and International Affairs. After Princeton,
Omar earned a master’s degree in international political economy from the
London School of Economics and a J.D. from NYU Law School. His academic
background proved invaluable in doing research for this work.
Daniel Wolf, who received his B.A. in economics from the Johns Hopkins
University and earned his J.D. (magna cum laude, Order of the Coif ) from
NYU Law School. His ability to synthesize regulation and economic reality
helped me immensely as we reviewed new legislation and the evolution of the
capital markets.
And to the students who participated in the first edition, we once again ex-
press our gratitude:
Colin Addy, Boriana A. Anguelova, Andrew Arons, Alice Dullaghan, Steven
Eichorn, Lee J. Goldberg, David E. Gravelle, Sarah Hayes, Robert A. Johnston,
Jim Kelly, Michael Kuzmicz, Benchen Li, Gabriel Mass, Katie McDonald,
Robert Pierson, Jr., Justin Quinn, Joshua Riezman, Adam J. Tarkan, and
Marshall Yuan.
xxi
xxi
Preface
This book provides the basic knowledge necessary to understand the financial
markets. Much of the work contained in this treatise is adapted from outstanding
research by others.
Under my guidance, a group of some of my finest students assembled cases and
commentary to explain the capital markets and their evolving regulation.
The structure of this work is based predominantly on the lectures of the author.
However, where a regulator, judge, government official or economist describes a
financial instrument or a situation better than the author might have, that com-
mentary has been included in its entirety (or paraphrased for editorial consistency)
without regard to political affiliation or philosophic disposition.
In synthesizing materials such as the speeches of the Chairman of the Board of
Governors of the Federal Reserve System, leading judicial rulings, and government
sources from disparate administrations, the book is designed to immerse the reader
in the structure and regulatory history of the capital markets. This treatise offers
real-world examples of how financial instruments actually work. The outline and
methodology is unique. The treatise is designed to cover the functioning of the
markets and the various applicable regulatory regimes.
The subject matter cuts across a number of legal disciplines, including securities,
corporate finance, banking, financial institutions, and commodities. Cases describe
the subject matter and demonstrate to the reader the functioning of the capital
xvi
xxiv Preface
markets. The pedagogical approach is to describe financial instruments in a way that
everyone can understand.
As capital market events evolve, it is impossible to freeze time. The treatise seeks
to serve as a foundation for understanding world economic events as they unfold.
This book covers the basic issues affecting capital markets trading, regulation, litiga-
tion, risk management, and internal controls.
It further outlines the basic knowledge that every participant in the capital
markets should have of the complexity of the role of the Federal Reserve in U.S. cap-
ital markets, the use of financial instruments to manage risk and to enhance yield,
and the steps regulators take to address systemic vulnerabilities.
xv
Introduction
After one of the greatest periods of economic turmoil in American history,

the capital markets are enthusiastically embracing positivity. Indeed, the idea that
America is on the road to economic “Great”ness is seen in positive economic data
and domestic stock prices.
Major sources of new-found confidence include a change in the global “animal
spirits,” increased liquidity, and a domestic unemployment rate that is approaching
record lows. Importantly, regulatory constructs specifically designed to address
some of the causes of the great crisis also allowed investors to gain resolve after a po-
tentially apocalyptic time in economic history.
President Trump’s administration clearly embraces a limited regulatory approach.
This is a powerful juxtaposition to the crisis-era actions of President Obama, who
signed the Dodd-Frank Act into law. Dodd-Frank was designed to reduce systemic
risks in the financial and banking sectors through enhanced regulatory control, trans-
actional accountability, and transparency. Under President Trump these regulations
have come under increased scrutiny. Secretary of the Treasury Steven Mnuchin
explained: “The U.S. has experienced slow economic growth for far too long . . . we
examined the capital markets system to identify regulations that are standing in the
way of economic growth and capital formation . . . By streamlining the regulatory
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xxvi Introduction
system, we can make the U.S. capital markets a true source of economic growth which
will harness American ingenuity and allow small businesses to grow.”1
In this period of positivity, it is important to reassess the effectiveness of crisis-era
legislation to prevent systemic risk in the future. The overwhelming goal of Dodd-
Frank was to address the causes of the financial crisis.
While there may have been many early warning signs and lessons about frailties
within the system that could have prevented the events of 2008, Dodd-Frank
attempted to fill in the gaps that existed at the time of the genesis of the Great
Recession. The vulnerabilities that came to the fore in 2008 serve as powerful
guideposts for the evolution of regulation for generations to come.
As markets respond to monetary and fiscal policy that has enhanced economies
around the globe, regulators and legislators continue to devote an enormous amount
of attention to ensuring that we have robust financial systems that promote respon-
sible risk-taking and efficient allocation of resources. Despite success, financial sta-
bility cannot be taken for granted. While some financial vulnerability is cyclical in
nature, rising and falling over time, others are structural, stemming from longer-term
forces shaping the nature of credit intermediation.2 Much of the regulation that has
evolved in the wake of the financial crisis focuses on four areas of vulnerability that
came to the fore during the financial crisis:3
1. Macroeconomic Imbalances
In the context of the financial crisis, macroeconomic imbalances resulted when low in-
terest rates forced investors to create instruments to enhance yield. Foreign investors sent
large flows of cash into America seeking higher returns. Such an inflow of cash created
financial bubbles as investors abandoned traditional risk–reward analysis in pursuit of
disproportional benefit. One area in particular that attracted foreign and domestic in-
vestment was real estate. Capitalizing on this “yield chasing,” financial engineers created
products that were highly leveraged and often opaque in terms of pricing structure.
2. Unrestrained Entities
Entities such as Fannie Mae and Freddie Mac encouraged investment in real estate by
creating inexpensive financing opportunities for home investors by purchasing and
1
Treasury Releases Second Report On The Administration’s Core Principles Of Financial Regulation 10/6/2017 avail-
able at https://www.treasury.gov/press-center/press-releases/Pages/sm0173.aspx (last visited February 24, 2019).
2
See: An Assessment of Financial Stability in the United States, June 27, 2017 Vice Chairman Stanley Fischer avail-
able at https://www.federalreserve.gov/newsevents/speech/fischer20170627a.htm.
3
Ken Raisler, head of the derivatives group at Sullivan and Cromwell, LLP joined me in a class at New York
University School of Law in identifying four key areas leading to the financial crisis.
xxvi
Introduction xxvii
aggregating mortgages to increase liquidity. Increased liquidity drove the market for
real estate higher. As the real estate market rose, financial engineers structured real
estate–related investments linked to the underlying mortgages. These instruments
were often detached from the underlying asset except in the sense that a small move
in the price of the underlying real estate would have far-reaching effects on the
economy beyond the initial home price.
At the same time, entities not sponsored by the government such as American
International Group (AIG) sold insurance look-alike products (derivatives) that
made investors overly confident in taking on risk. Emboldened by the idea that AIG
would take the loss in the event of financial default, investors took risks with little
consideration of the repercussions of a decline in asset prices that might impact the
insuring entity and might actually lead to counterparty failure when AIG was called
upon to pay under the terms of its agreements.
As there were no capital requirements for entities such as AIG to engage in this
financial engineering, there were no safeguards in place to address the counterparty
risk inherent in its contracts. These derivatives contracts looked like tools that could
virtually eliminate the risks of an investment.
3. Complex Products
Complex financial instruments, such as derivatives, allowed investors to speculate

on contingencies without regulatory or capital restraint. Key to appreciating how
derivatives and other financial instruments contributed and arguably caused the fi-
nancial crisis is looking at how they concentrate risk, and how prior to the crisis they
were used to shift risk to systemically important institutions.
The derivatives instrument itself is not inherently problematic. The risk inherent
in a derivative contract can be misunderstood, and its use might be misapplied.
Valuing models in complex transactions can prove useless when the world operates
in new and unpredictable ways.
The derivatives market knows no bounds—a contract whose value fluctuates
based on an asset can represent a notional value far in excess of the total amount
of the asset that actually exists. Derivatives, therefore, created systemic leverage
impacting the entire banking system.
4. Regulators
Regulatory constructs did not evolve as rapidly as the capital markets. As a result,
the fragmented regulatory construct of the pre-crisis area allowed transactions and
entities to slip through the cracks.
xxvii
xxviii Introduction
In addition, there was no formal regulatory process for the oversight of the
unwinding of systemically important institutions. When the time came and all the
coins came up heads, there was no one regulator to oversee the orderly liquidation
of systemically important market players.
In summing up the vulnerabilities that existed at the time of the crisis, Ben
Bernanke, the crisis-era Chairman of the Federal Reserve, observed:4
The . . . private sector vulnerabilities include‌the excessive debt taken on per-

haps because of the period of the Great Moderation . . . the banks’ inability
to monitor their own risks, excessive reliance on short-term funding . . . and
increased use of exotic financial instruments like credit default swaps and
others that concentrated risk in particular companies or in particular markets.
The public sector had its own vulnerabilities including gaps in a regula-
tory structure. Important firms and markets did not have adequate oversight.
Where there was adequate oversight at least in law, sometimes the supervisors
and regulators didn’t do a good enough job. For example, there wasn’t enough
attention paid to enforcing banks to do a better job of monitoring and man-
aging their risks. And finally, an important gap that we’ve really begun to look
at since the crisis is that with individual agencies looking at different parts of
the system, there was not enough attention being paid to the stability of the
financial system taken as a whole.
. . . [A]‌nother important public sector vulnerability . . . were the so called
government-sponsored enterprises Fannie Mae and Freddie Mac. . . . In par-
ticular, the GSEs, Fannie and Freddie, when they sell their mortgage-backed
securities, they provide guarantees against credit loss. So if mortgages go bad,
Fannie and Freddie make the investor whole. Now, Fannie and Freddie were
permitted to operate within adequate capital. So in particular, they were at risk
in a bad situation where there were a lot of mortgage losses. They didn’t have
enough capital to pay off, make good those guarantees that they have prom-
ised . . . What made the situation even somewhat worse was that Fannie and
Freddie besides selling these mortgage-backed securities to investors, they also
purchased on their own account large amounts of mortgage-backed securities,
both their own and some that were issued by the private sector. So they made
profits from holding those mortgages, but again, that created an additional
[danger] to the extent that those mortgages were not insured or protected,
they were vulnerable to losses and again, without enough capital they were at
4
Ben S. Bernanke, The Federal Reserve and the Financial Crisis, The Federal Reserve's Response to the Financial
Crisis, Lecture 3, George Washington University School of Business (Mar. 27, 2012), available at http://www.
federalreserve.gov/newsevents/files/chairman-bernanke-lecture3-20120327.pdf.
xi
Introduction xxix
risk. Now an important trigger . . . wasn’t just the house price boom and bust
but it was the mortgage products and practices that went along with the house
price movements that was particularly damaging.
The result of the vulnerabilities of the pre-crisis economy led to the undoing of the
American capital markets. Credit froze, markets tumbled, and institutions failed.
Today we are in a post-crisis world where there is increasing focus on how to mod-
erate the initiatives that were taken to save an economy on the brink of collapse.
The new regulatory order was designed to resurrect confidence in the system and
to prevent future crises. But President Trump has made the observation that in this
post-crisis period, overregulation stymies growth.
The financial crisis not only created new regulation but also laid the groundwork
for revolutionary technologies like cryptocurrency, robo-advisors, and artificial in-
telligence designed to undermine our historic reliance on humans’ ability to make
decisions. Bitcoin, for instance, mocked the centralized federal reserve banking
system and fiat currency system it sought to replace. The Bitcoin genesis block
contained the explicit political message: “The Times 03/Jan/2009 Chancellor on
brink of second bailout for banks.”5
Unfortunately, even with history as a guide and computer driven decentraliza-
tion, humans are still capable of creating macroeconomic imbalances, mistakes, and
misfits. The stories we will tell our grandchildren and the fortunes to be made or
lost in the years to come will be based on our ability to adapt to realities as they
present themselves. No legislation or regulatory authority can replace prudence and
thoughtful analysis in seeing what tomorrow might bring—even if decisions are
masked by the latest technologies.
With the backdrop of fortified markets and economies, America is experiencing
a period of growth, “full” employment, and increasing asset prices. Confidence
and investment have greatly improved the U.S. economy. Indeed, the Trump
Administration has taken to stimulate growth by cutting taxes and decreasing reg-
ulatory burdens. Policies and pro-growth perception have enhanced spending and
investment; even trade wars are yet to substantially dampen current economic
enthusiasm—but enthusiasm itself can increase risk.
A positive outlook should not be maintained at the expense of prudent policy
to manage systemic vulnerabilities. It is incumbent on government to be sensitive
to remaining flexible to react to events of unexpected shock that will, no doubt,
occur in the years and decades to come. Enhanced regulation has done much to
5
An Abridged History of Bitcoin available at https://archive.nytimes.com/www.nytimes.com/interactive/
technology/bitcoin-timeline.html (last visited February 24, 2019).
x
xxx Introduction
address vulnerabilities and shore up market confidence. These gains should not be
compromised. Prudence requires a fundamental understanding of market innova-
tion and vulnerabilities within the context of positivity to prepare for the inevitable
challenges that lie ahead.
To that end, we present this description of capital markets, derivatives, and the law.
Alan N. Rechtschaffen
May 2019
1
1 The Financial Crisis

THE SEEDS OF NEW REGUL ATION
I. Origins of the Great Recession 5

II. Subprime Lending 6
III. Government-Sponsored Entities 6
IV. Legislative Reforms 9
A. Multiple Guarantor Model 10
B. Multiple Insurer Model 11
on November 8, 2016 Donald Trump was elected the 45th president of the
United States. After many years of financial crisis, and several years of modest re-
covery, the American electorate chose a president advocating less regulation as a
means to greater growth.
The reaction of the stock market the night that the votes were cast was quite dra-
matic. The stock market futures sold off dramatically and then, over the next 48
hours, recovered to levels that would remain the low price for years to come. It seems
the markets bought into the notion that light touch regulation and a focus on busi-
ness would be better for the American economy.
The idea of less regulation was anchored in a notion that part of what was holding
back domestic growth was an overreaction by regulators to the global financial

2
2 Capital Markets, Derivatives, and the Law

crisis. Indeed, beyond the financial realm, candidate Trump declared that regulatory
burden stymies growth across a multitude of industries.
President Trump makes clear that deregulation is a focus of his administration.
He declared, “We’re here . . . to cut the red tape of regulation. For many decades, an
ever-growing maze of regulations, rules, restrictions have cost our country trillions
and trillions of dollars, millions of jobs, countless American factories, and devastated
many industries.”1
In Executive Order 13789, identifying and reducing regulatory tax burdens, he
expressed the view that “numerous tax regulations issued over the last several years
have effectively increased tax burdens, impeded economic growth, and saddled
American businesses with onerous fines, complicated forms, and frustration.”2 This
viewpoint is consistent with his view of financial regulation under the Dodd–Frank
Act that “regulation is stealth taxation.”3
President Trump established a set of core principles to be used to regulate the
U.S. financial system via Executive Order 13772. These principles are to (1) empower
Americans to make independent financial decisions and informed choices in the
marketplace, save for retirement, and build individual wealth; (2) prevent taxpayer-
funded bailouts; (3) foster economic growth and vibrant financial markets through
more rigorous regulatory impact analysis that addresses systemic risk and market
failures, such as moral hazard and information asymmetry; (4) enable American
companies to be competitive with foreign firms in domestic and foreign markets;
(5) advance American interests in international financial regulatory negotiations and
meetings; (6) make regulation efficient and effective, while ensuring that it is appro-
priately tailored; and (7) restore public accountability within the federal financial
regulatory agencies, while rationalizing the federal financial regulatory framework.4
In operationalizing Executive Order 13772, the Treasury Department provides a
review of the financial system through a series of reports covering:
• The depository system, including banks, savings associations, and credit

unions of all sizes, types, and regulatory charters;
• Capital markets: debt, equity, commodities and derivatives markets, central
clearing, and other operational functions;
1
Remarks by President Trump on Deregulation (December 14, 2017), https://www.whitehouse.gov/briefings-
statements/remarks-president-trump-deregulation/.
2
Exec. Order No. 13,789, 82 Fed. Reg. 19317 (Apr. 26, 2017).
3
Supra note 1.
4
Exec. Order No. 13,258, 82 Fed. Reg. 9965 (Feb. 8, 2017).
3
The Financial Crisis 3

• The asset management and insurance industries and retail and institutional
investment products and vehicles; and
• Nonbank financial institutions, financial technology, and financial innova-
tion (unpublished).
The events driving financial markets to the precipice of collapse during the global fi-
nancial meltdown gave rise to a regulatory framework that may have been a rational
response to a market in free fall. The Trump administration seeks to restrain that
regulatory burden now that the economy is recovered.
Beginning in 2007, the world witnessed dramatic events affecting the global
economy. Failures in individual markets and institutions rapidly devolved into
global financial recession. Financial markets and regulators the world over scram-
bled to navigate systemic imbalances and avoid stagnation as unemployment, debt
crises, and recessions fostered political, social, and economic unrest. In response, the
United States passed a host of legislative acts that completely reshaped the regula-
tory landscape.
Since the darkest days of the financial crisis we have seen an unemployment rate
that has more than halved and economic growth that has more than doubled. We
are near or beyond full employment.5
As an emergency measure, it is certainly plausible that the slew of crisis reac-
tionary regulation contributed to order and confidence in the financial markets.
Their utility, now that the economy is quite robust, is less clear.
To better understand the current state of financial market regulation, it is nec-
essary to review the systemic vulnerabilities that led to the Great Recession. The
financial crisis arose in large part as a result of “the complexity and sophistication
of . . . financial institutions and instruments and the remarkable degree of global fi-
nancial integration that allows financial shocks to be transmitted around the world
at the speed of light.”6 As the financial markets evolved up until the crisis, finan-
cial instruments took on dynamic and sophisticated structures allowing returns to
investors, contingent on variables other than credit. For example, mortgage-backed
bonds, backed by the cash flow of underlying mortgages, were particularly vulner-
able to the macroeconomic imbalances that existed at the onset of the crisis.
5
Monetary Policy Report, Board of Governors of the Federal Reserve System (Feb. 23, 2018), at https://www.
federalreserve.gov/monetarypolicy/files/20180223_mprfullreport.pdf.
6
Ben S. Bernanke, Stabilizing the Financial Markets and the Economy, Address at the Economic Club of New
York (Oct. 15, 2008), http://www.federalreserve.gov/newsevents/speech/bernanke20081016a.htm.
4

Adair Turner, chairman of the U.K.’s Financial Services Authority during the
crisis,7 explained that “[a]‌‌t the core of the crisis was an interplay between macro-
economic imbalances which have become particularly prevalent over the last 10–15
years [prior to the crisis] and financial market developments which have been going
on for 30 years but which accelerated over the last ten under the influence of the
macro imbalances.”8 Chairman Turner explained that very large current account
surpluses piling up in the oil exporting countries and corresponding deficits in the
United States and other countries led to a dramatic “reduction in real risk free rates
of interest to historically low levels.”9 Two effects of extremely low interest rates were
“[a] rapid growth of credit extension . . . particularly but not exclusively for residen-
tial mortgages . . . and . . . a ferocious search for yield.”10
In part, as a result of low interest rates and legislative incentives to own a home,
the U.S. real estate market saw enormous gains in the decades leading up to the crisis.
When the real estate market reversed, it carried securitized debt with it. Prices of
securities that were purchased to enhance yield tumbled, and the dramatic reversal
proved devastating for market participants who created and invested in mortgage-
linked debt. As a result of the implosion of the real estate and credit markets,
companies such as Lehman declined from positions of financial supremacy to illi-
quidity in a matter of days. Firms that took on the credit default risk of others, such
as American International Group (AIG), were subsequently devastated.
In 2019, the U.S. economy is viewed by many as wholly recovered from the eco-
nomic impact of the crisis. At the time of the writing of this work, the U.S. stock
market is trading at record highs, having erased all the losses of the crisis period and
then some. Indeed, the Federal Open Market Committee (FOMC) in commenting
on the accomplishments of the economy recently observed:
Information received since the Federal Open Market Committee met in

March indicates that the labor market has continued to strengthen and that ec-
onomic activity has been rising at a moderate rate. Job gains have been strong,
on average, in recent months, and the unemployment rate has stayed low.
Recent data suggest that growth of household spending moderated from its
strong fourth-quarter pace, while business fixed investment continued to grow
7
The Financial Services Authority (FSA) is an independent non governmental body in the United Kingdom,
given statutory powers by the Financial Services and Markets Act 2000. The U.K. Treasury appoints the FSA
Board. The FSA is accountable to Treasury Ministers and through them to Parliament. It is operationally inde-
pendent of government and is funded entirely by the firms it regulates.
8
Adair Turner, chairman of the FSA, The Economist’s Inaugural City Lecture ( Jan. 21, 2009).
9
Id.
10
Id.
5

strongly. On a 12-month basis, both overall inflation and inflation for items
other than food and energy have moved close to 2 percent. Market-based meas-
ures of inflation compensation remain low; survey-based measures of longer-
term inflation expectations are little changed, on balance.11
While the economy may be approaching full recovery and robust growth, the long-
lasting effects of the crisis continue to be felt throughout the global regulatory
systems, and it remains to be seen what the impact will be of a reduction in those
constructs.
I. Origins of the Great Recession
After years of robust growth in the American real estate markets, prices began to de-
cline in the second half of 2007. The decline in real estate prices had a direct impact
on the prices of financial instruments linked to the mortgages on those properties.
In addition, the prices and market for instruments deriving their values directly or
synthetically from mortgages rapidly declined. Systemically important financial
institutions owned these securities, while others such as AIG “insured” the financial
health of the security holders.
Mortgage-backed securities are financial instruments that derive their cash flow
and/or value from pools of mortgages; they include mortgage-backed bonds. The
ripple effect caused by a downdraft in the value of mortgage-backed securities
resulted in diminished liquidity at financial institutions and systemic threats to
the broader capital markets. The undertow created by mortgage foreclosures and
deficiencies rocked the financial world and changed the essential functioning of fi-
nancial institutions in the global economy. Ben S. Bernanke, the chairman of the
Board of Governors of the Federal Reserve System at the time, explained that:
Large inflows of capital into the United States and other countries stimulated
a reaching for yield, an underpricing of risk, excessive leverage and the devel-
opment of complex and opaque financial instruments that seemed to work
well during the credit boom but have been shown to be fragile under stress.
The unwinding of these developments, including a sharp deleveraging and a
headlong retreat from credit risk, led to highly strained conditions in financial
markets and a tightening of credit that has hamstrung economic growth.12
11
https://www.federalreserve.gov/newsevents/pressreleases/monetary20180502a.htm (last visited May 30,
2018).
12
Id.
6
II. Subprime Lending
In 2007 and 2008, the high levels of delinquencies, defaults, and foreclosures among
subprime borrowers led to the undoing of the broader capital markets, the shock
waves of which were felt throughout the global economy. The effects of mortgage
lending on the broader capital markets demonstrate both how global banking sys-
tems and international economies are increasingly interconnected and the effect
that a unique capital market disruption has on the broader U.S. economy. Today
more than ever before, improvements in communication and financial innovation
have increased the effects of market disruptions anywhere in the world on the global
capital marketplace.
The rise in real estate prices in the 10 years prior to the crisis was encouraged, in
large part, by low interest rates facilitating the purchase of homes and investment
properties, mortgage brokers on commission, and federal policies encouraging
home ownership. This increase in real estate activity, combined with easy access to
funding, allowed borrowers to access equity contained in their homes and allowed
speculators to make investments in property that would never have been possible
without the availability of cheap money.
Borrowers take on debt for many purposes including the funding of long-term
purchases such as a home. In the years leading up to the mortgage meltdown, banks
aggressively pumped capital into the economy by making loans, advantaging them-
selves of the spreads between the rates at which banks borrow money and the mort-
gage rates they charge their customers. Cash was readily available to banks to lend
to their customers, since the loans they created were resold in the form of mortgage-
backed securities.
The concept of financing mortgages by issuing securities backed by the revenue
stream generated from those mortgages was not new. Indeed, the federal govern-
ment sponsored the establishment of several enterprises specifically designed to pro-
vide liquidity to banks participating in the mortgage markets.
III. Government-Sponsored Entities
There are several entities that are sponsored by the federal government to refinance
mortgages. Federal agencies are direct arms of the U.S. government, while feder-
ally sponsored agencies were historically privately owned and publicly chartered
organizations that were created by acts of Congress to support a specific public
purpose (also referred to as government-sponsored entities or GSEs). Until the
7

changes resulting from the crisis, several executive branches had overseen GSEs. The
Department of Housing and Urban Development (HUD) monitored the activities
of Fannie Mae and Freddie Mac.13
During the financial crisis, the Housing and Economic Recovery Act of 2008
(HERA) established the Federal Housing Finance Agency (FHFA) as the overseer
of Fannie Mae, Freddie Mac (the Enterprises), and the Federal Home Loan Bank
System (which includes the 11 Federal Home Loan Banks and the Office of Finance).
Since 2008, FHFA has also served as conservator of Fannie Mae and Freddie Mac.14
In 2008, Fannie Mae and Freddie Mac experienced large losses related to the
plummeting real estate market in the United States. As a result, the U.S. govern-
ment placed these two leading mortgage lenders into conservatorship. This action
blurred the distinction between government and government agency beyond an im-
plicit guaranty for survivorship. This action was taken to avoid unacceptably large
dislocations in the mortgage markets and the economy as a whole.
The U.S. Treasury, drawing on authorities granted by Congress, made financial
support available to the housing agencies. As the recovery unfolded, we witnessed
a recovering credit market and a more robust mortgage lending market. As housing
prices recovered, Fannie Mae and Freddie Mac returned to profitability after
teetering on the edge of collapse. In May 2013, Fannie Mae announced a record
profit and the return of $59.4 billion to the government that bailed it out:
WASHINGTON, DC—Fannie Mae (FNMA/OTC) reported pre-tax in-

come of $8.1 billion for the first quarter of 2013, compared with pre-tax income
of $2.7 billion in the first quarter of 2012 and pre-tax income of $7.6 billion in
the fourth quarter of 2012. Fannie Mae’s pre-tax income for the first quarter
of 2013 was the largest quarterly pre-tax income in the company’s history. The
improvement in the company’s results in the first quarter of 2013 compared
with the first quarter of 2012 was due primarily to strong credit results driven
by an increase in home prices, including higher average sales prices on Fannie
Mae-owned properties, a decline in the number of delinquent loans and the
company’s resolution agreement with Bank of America. Including Fannie
Mae’s release of the valuation allowance on its deferred tax assets, the com-
pany reported quarterly net income of $58.7 billion for the first quarter of
2013. Fannie Mae reported comprehensive income of $59.3 billion in the first
13
Federal Housing Enterprises Financial Safety and Soundness Act of 1992. Fannie Mae and Freddie Mac
are subject to supervision by a newly created regulator within HUD, called the Office of Federal Housing
Enterprise Oversight (OFHEO).
14
https://www.fhfa.gov/AboutUs (last visited June 30, 2018).
8

quarter of 2013, compared with comprehensive income of $3.1 billion for the
first quarter of 2012.
As a result of actions to strengthen its financial performance and con-
tinued improvement in the housing market, Fannie Mae’s financial results have
improved significantly over the past five quarters. Based on analysis of all rel-
evant factors, Fannie Mae determined that release of the valuation allowance
on its deferred tax assets was appropriate under generally accepted accounting
principles (“GAAP”), which resulted in a benefit for federal income taxes of
$50.6 billion. The release of the valuation allowance in addition to operating
income and comprehensive income for the first quarter of 2013 will result in a
dividend payment to taxpayers of $59.4 billion in the second quarter of 2013.15
In August 2012, before the announcement of record profits, Treasury and FHFA
amended the Senior Preferred Stock Purchase Agreements (the so-called “Third
Amendment”) that facilitated the bailout of Fannie Mae and Freddie Mac during the
height of the crisis to include significantly more favorable terms for the government.
In addition to requiring a faster wind-down of their portfolios, the 10 percent fixed-
rate dividend that was to be paid to the government on “bailout” contributions was
replaced with a variable structure directing all net income earned by the Agencies to
be paid to the Treasury.
According to the FHFA, “replacing the current fixed dividend in the agreements
with a variable dividend based on net worth helps ensure stability, fully captures fi-
nancial benefits for taxpayers, and eliminates the need for Fannie Mae and Freddie
Mac to borrow from the Treasury Department to pay dividends.”16
While the Treasury continues, at the time of the writing of this book, to collect
profits from the GSEs, the shareholders of the GSEs are restless about the dividend
distribution scheme, which does not allow them to receive any dividend return on
their GSE investments. The Third Amendment has resulted in approximately 20
lawsuits by various classes of shareholders in the GSEs. These litigations all spring
from the same set of facts and have taken a number of different approaches to
attacking the validity of the Third Amendment.17
The Appellate Court held that HERA’s Succession Clause18 allowed FHFA to
succeed to all rights, titles, powers, and privileges of the GSEs’ shareholders as
15
Press Release, Fannie Mae (May 9, 2013), available at http://www.fanniemae.com/resources/file/ir/pdf/
quarterly-annual-results/2013/q12013_release.pdf.
16
https://www.fhfa.gov/conservatorship/pages/senior-preferred-stock-purchase-agreements.aspx (last visited
June 28, 2018).
17
Altering the Deal: The Importance of GSE Shareholder Litigation, 19 N.C. Banking Inst. 109.
18
HERA, 12 U.S.C. 4617(b)(2)(A)(i).
9

conservator and barred plaintiffs from bringing a derivative claim on behalf of
the GSEs during a conservatorship. In rejecting petitioners’ assertion that the
Succession Clause included a “manifest conflict of interest” exception that permitted
shareholders to sue on behalf of the enterprises to challenge FHFA’s decisions, the
Appellate Court recognized a limited conflict-of-interest exception in interpreting
an analogous FIRREA provision, and declined to extend that rationale to HERA.
However, the Appellate Court held that stockholders retained the right to bring
direct claims against FHFA during a conservatorship, and subsequently determined
that plaintiffs’ breach-of-contract claims were direct and remanded the issue to
the District Court for further proceedings, the only relief the plaintiffs secured in
their appeal. The plaintiff shareholders’ appealed to the Supreme Court of United
States for the reversal of the order passed by the Appellate Court by filing a petition
for a writ of certiorari in January 2018. The Supreme Court declined the plaintiff
shareholders’ petition.
IV. Legislative Reforms
GSEs enjoy lower operating and funding costs, a line-of-credit with the U.S.
Treasury and issue debt and mortgage-backed securities at lower yields than compa-
rable corporate entities due to their government-sponsored status. The credit rating
of many GSEs is AA+. The credit spread between GSEs and Treasury securities
is small. While the mortgages purchased by Fannie Mae and Freddie Mac are not
“government-insured,” a perception had always existed that they “carry an implicit
government guarantee [because] the companies are so large that the government
would never let them fail.”19
The biggest criticism for bailout of GSEs was the notion of privatization of gains
and socialization of losses. The use of $400 billion of taxpayers’ money to bailout
private GSEs was a hot topic in the legislature. In order to shape the post-crisis
world, the regulatory focus has shifted to the taxpayer protections with respect to
government sponsored entities especially in the light of GSE’s federal government
conservatorship. Equity holders initially suffered under federal conservatorship.
However, in 2013, as investors considered the robust profits at the agency, the future
of GSEs generally, and the potential outcome of shareholder lawsuits, the stock of
Fannie Mae rose from 25 cents to over three dollars. As of this writing the shares are
trading at about $1.50.
19
Ally Coll Steele, Fannie, Freddie, and Fairness: Judicial Review of Federal Conservators, 53 Harv. J. on
Legislation 417, 420.
10

Bondholders immediately benefited from the federal government’s new and ac-
tive role in overseeing Fannie Mae and Freddie Mac. Indeed, after Fannie Mae and
Freddie Mac were placed into federal conservatorship, investors’ moral obligation
inference seems to have been well placed as credit spreads tightened in the wake of
government intervention into the ownership and operation of these entities.
GSEs were created to ensure adequate credit flows. They were deemed necessary
because of the types of loans they facilitated. The aggregate amount of GSE loans
is in the trillions of dollars. Much of the loans outstanding represent growth in the
issuance of mortgage-backed securities by home-lending GSEs. Mortgage-backed
securities are supported by mortgages the GSE purchases. Fannie Mae and Freddie
Mac also purchase loans from banks and repackage the loans into debt securities
called residential mortgage-backed securities (collateralized mortgage obligations or
CMOs). The GSEs enhanced liquidity by affording homeowners the opportunity
to borrow money to spend in the economy.
There is a long line of housing finance reforms proposals made by various
policymakers since the financial crisis of 2008. At their core these policies differ
on two conceptual issues: (1) whether to keep the GSEs or dissolve them, and
(2) whether we continue affording federal guarantee to refinancing agencies. The
best way to analyze the legislative reforms surrounding the housing finance market
would be to examine two different models that propose different solutions for these
questions.20 One of the models is the Corker-Warner “multiple guarantor model”
(“Multiple Guarantor Model”) and the second is DeMarco-Bright-Hensarling
“multiple issuer model” (“Multiple Insurer Model”).
A. Multiple Guarantor Model
The model proposes the creation of additional market competition and dissolu-
tion of the GSEs. The new system would allow new guarantor firms (“Guarantor
Firms”) to purchase mortgages from originators and then bundle them into mort-
gage backed securities (MBS). The qualified MBS shall have a federal guarantee
that can only be invoked where private capital arranged by Guarantor Firms takes
considerable losses. The model also proposes the creation of a single government
agency, the Federal Mortgage Insurance Corporation (FMIC) that would, among
other things, provide a common securitization platform, develop standard form
risk-sharing mechanisms, expand access to credit, impose disclosure requirements
20
Eric Kaplan, Michael A. Stegman, Phillip Swagel & Theodore W. Tozer, Bringing Housing Finance Reform
over the Finish Line, Milken Institute ( Jan. 2018), available at http://assets1b.milkeninstitute.org/assets/
Publication/Viewpoint/PDF/FINAL-Housing-Finance-Reform-Proposals-to-Legislation-2.pdf.
1

in collaboration with the Securities Exchange Commission (SEC), provide insur-
ance on principal and interest for qualified MBS when Guarantor Firms suffer cata-
strophic losses, and charge fees in exchange for providing this insurance.
All resources and functions of FHFA would be transferred to FMIC. Once fully
functional, the GSEs charters will be repealed, except that provisions of the charters
will continue to apply with respect to mortgage-backed securities guaranteed by the
GSEs, as well as outstanding debt obligations, bonds, debentures, notes, and other
similar instruments, and the full faith and credit of the U.S. government would con-
tinue to apply to them.
The idea behind the model appears to increase competition in the market so that
the status of Fannie Mae and Freddie Mac can be reduced as systemically important
and also reduce the scope of the federal guarantee.
The deficiencies of the model revolve around the federal guarantee that it
proposes. The model would make the implicit federal guarantee into an explicit one.
Considering the explicit federal guarantee, the model also flusters on the design of
capital loss of the Guarantor Firms that would trigger the federal guarantees and
pricing of the guarantees.21 A separate issue triggered by the model is the introduc-
tion of competition in the refinancing market. With too many Guarantor Firms
and high level of competition we might end up in a similar situation as the housing
bubble of 2008.
B. Multiple Insurer Model
The model proposes to end the receivership and reconstruct the GSEs (Fannie Mae,
Freddie Mac, and Ginnie Mae22) by amending their charters and dissolving their
investment portfolio. The GSEs will be turned into lender-owned mutuals. They
would continue to provide credit enhancement by syndicating mortgage credit
risk through a variety of credit risk transfer structures and provide access to small
and mid-sized lenders to sell mortgages for cash. Other than being approved by the
FHFA as a credit enhancer, the GSEs would no longer have any government role.
Ginnie Mae would be reconstructed to become a stand-alone government entity
providing guarantees on MBS issued by newly reconstituted GSEs.
FHFA shall continue to exist and would regulate the securitization and the quan-
tity and quality of private capital with respect to government guarantee. FHFA
21
David Scharfstein & Phillip Swagel, Legislative Approaches to Housing Reform, p. 7, (2016), available at http://
assets1b.milkeninstitute.org/a ssets/Publication/V iewpoint/P DF/L egislative-Approaches-to-Housing-
Finance-Reform-Oct16.pdf.
22
For the purpose of this chapter we will only focus on Fannie Mae and Freddie Mac.
12

would also be responsible for setting standards for private credit enhancement and
overseeing the winding down of the conservatorships, including managing the out-
standing securities issued by Fannie Mae and Freddie Mac backed by the Treasury.
The model, like in the case of multiple guarantor model, promotes standardiza-
tion across the housing finance market with regard to disclosure requirements and
market systems.
A major concern with the proposal is whether such mutual ownership of poten-
tially systemic financial institutions can survive a financial crisis such as the one in
2008. Just like the Multiple Guarantor Model, this model is unclear on the pricing
of government guarantees by Ginnie Mae and the extent to which it can or should
take risk, to avoid looking increasingly like the previous GSEs.
On January 16, 2018, FHFA Director Mel Watt provided his views on housing fi-
nance reforms in a letter and supporting report23 to the Senate Banking Committee
chairman, Mike Crapo, and Senator Sherrod Brown. Both the previous models
recommend the retention of FHFA, but FHFA leans more toward the Multiple
Guarantor Model.
Watt’s term as FHFA director ended on January 6, 2019. As of the writing of
this book, the FHFA is led by Comptroller of the Currency Joseph Otting, who
was picked by President Donald Trump to serve as acting director of the FHFA
while Mark Calabria, the President’s nominee for permanent Director awaits Senate
confirmation.
23
See Federal Housing Finance Agency Perspectives on Housing Finance Reform ( Jan. 16, 2018), available at http://
nlihc.org/sites/default/files/FHFA_011618_Letter_Crapo-Brown_Housing-Finance-Reform_011718.pdf
and http://nlihc.org/sites/default/files/FHFA_Housing-Finance-Reform-Perspective_011718.
13
2 The Liquidity Crisis and Government Reaction
I. Buildup to Crisis 13
II. Providing Liquidity and Stabilizing the Financial Markets 18
III. Regulatory Reaction at the Height of the Crisis 19
A. The Emergency Economic Stabilization Act 19
B. American Recovery and Reinvestment Act 21
IV. Dodd-Frank 23
I. Buildup to Crisis
Purchasing a home is an extremely interest-rate sensitive decision. The ability to buy

a home is often contingent on the debt available to the homebuyer and the interest
rate of that debt.
Banks provide debt financing by analyzing the ratio of household net worth to
income. A declining interest rate environment affords homeowners the opportunity
to initiate or refinance mortgages at lower rates. By fixing a long-term mortgage rate,
homeowners are insulated from rising rates.1
1
Ben S. Bernanke, The Economic Outlook and Monetary Policy, Address at the Bond Market Association
Annual Meeting (Apr. 22, 2004).

14

Mortgage-backed pass-through securities are created when mortgages are pooled
together and sold as undivided interests to investors. Usually, the mortgages
in the pool have the same loan type, similar maturities, and similar loan interest
rates.2 Leading up to the financial crisis, a number of Wall Street brokerage firms,
including the former Bear Stearns, created private-label mortgage-backed securi-
ties to help lenders fund more purchases of real estate. The securities were backed
by mortgages from subprime borrowers, and when these borrowers were unable
to meet the demands set by the mortgage pools, the securities derived from these
mortgage pools became worthless. In circumstances where mortgagors continued to
meet their obligations, the securities’ value may have suffered as firms simply did not
know how to value them in the face of a changed economic environment. Mortgage-
backed security issuance was so lucrative and ubiquitous that a glut of mortgage-
derived securities wound up on the balance sheets of a number of the leading Wall
Street firms. As the securities’ value declined, the liquidity of the securities declined
as well, thus leading to a liquidity crisis. So severe was this liquidity crisis that the
Federal Reserve (the Fed) took the aggressive step of facilitating a buyout of Bear
Stearns by J.P. Morgan to prevent the collapse of the Wall Street powerhouse.
In Chairman Bernanke’s speech describing the buildup to the liquidity crisis and
the steps the Federal Reserve took to shore up the system in facilitating the acquisi-
tion of Bear Stearns,3 he confirmed the Federal Reserve’s role in providing liquidity
to a banking system in a crisis. The duty of the central bank is to respond to a sharp
increase in the demand for cash or equivalents by private creditors. The way to re-
spond to a crisis in liquidity is for the central bank to lend freely.4
Chairman Bernanke commented that liquidity risks are always present for
institutions—banks and nonbanks alike—that finance illiquid assets with short-
term liabilities. However, mortgage lenders, commercial and investment banks, and
structured investment vehicles experienced great difficulty in rolling over commercial
paper backed by subprime and other mortgages. Furthermore, a loss of confidence
in credit ratings led to a sharp contraction in the asset-backed commercial paper
market as short-term investors withdrew their funds. Some financial institutions
even experienced pressures in rolling over maturing repurchase agreements (repos).
2
Federal Reserve System, Trading and Capital-Markets Activities Manual § 4110.1 (Board of
Governors of the Federal Reserve System, 1998).
3
Ben S. Bernanke, Liquidity Provision by the Federal Reserve, Address at the Federal Reserve Bank of Atlanta
Financial Markets Conference (May 13, 2008), via satellite. Bernanke presented identical remarks to the Risk
Transfer Mechanisms and Financial Stability Workshop, Basel, Switzerland, on May 29, 2008 (via videoconfer-
ence). See http://www.federalreserve.gov/newsevents/speech/bernanke20080513.htm for the complete text of
the remarks.
4
Id.
Another random document with
no related content on Scribd:
might have gone farther back and mentioned the Negro contingent in
the army of Xerxes the Great (when Britons were savages) and
about which Herodotus so glowingly writes.
But even if Mr. Wells likes to take a popular crack at history, he is
none the less a first-rate novelist in the tradition of Charles Dickens
and I don't think he imagines himself a historian any more than I do,
so one must be tolerant if his Outline has the earmarks of a glorified
Research Magnificent.
Also, I did not like Mr. Wells's inspired articles on the Naval
Conference. Paradoxically, I found myself sympathizing with the
Daily Mail, which rebuked him for his offensive against Japan. Mr.
Wells injected much violent prejudice into what should have been
unbiased reporting. While Mr. Wells was outlining history, he might
have reserved a little of his English sentimentality for Japan, from the
knowledge that Japan might not have been a "yellow peril" today if
the white powers hadn't broken open her door and forced their
civilization upon her.
Wells's little Liberator reception was a question-time picnic for the
Liberator collaborators—especially for the ladies, to whom Wells is
exceptionally attractive. They asked him many questions about the
war and the peace and the aftermath, about Russia and Europe,
Japan and America and universal peace. Mr. Wells smilingly and
slickly disposed of all problems to the satisfaction of all.
William Gropper, the artist, and I had concocted a plan to ask some
impish questions. But everybody was very pleasant. It was a nice
party. So we said nothing. I was standing, leaning against the
mantelpiece, and Mr. Wells approached me in a sly way as if he
desired a close-up scrutiny of me without my knowing it. I seized the
opportunity to take a good quick look at Mr. Wells's eyes. Journalists
always write about the jolly twinkle in Mr. Wells's eyes. I didn't like
them. They made me think of a fox.
Some years later, after my trip to Russia and returning to France, I
met Frank Harris in Nice. I was in the company of a brilliant
American writer who was meeting Frank Harris for the first time. We
went to the Taverne Alsacienne for our drinks. Mr. Wells had recently
published his William Clissold, which we had all read and were
discussing.
Frank Harris said that what amazed him about H.G. Wells was the
fact that the more he tried consciously to expand his writings on a
world scale, the more provincial they became. I said, "The higher a
monkey climbs, the more he shows his tail." Frank Harris roared.
Then he said that perhaps Wells himself was not aware that his early
novels of fantasy and sentiment were his most universal things.
The American writer, said that an English gentleman had remarked
to him in London that Wells as a writer was a cockney. I didn't like
the reference to class, especially as I had at least two very dear
cockney friends. Harris said that Wells wasn't a cockney as a writer;
that he was a fifth-form public school boy, the same as Kipling. I said
I always thought of Kipling as the bugler of the British Empire, and
that perhaps Wells was the sub-officer.
It was interesting, after another little lot of years had passed along, to
read what Wells had to say about Harris in his Experiment in
Autobiography. Wells's first encounter with Frank Harris interested
me, especially because of the fact that my own meeting with Harris
was one of the high spots of my life. But it appears as if Wells could
not forgive Harris for once being a big and successful editor and
discovering him a poor and unknown writer. He writes of Harris's roar
receding with the years until it sounded something like a bark. But a
lion may lose its voice through age and worry. Wells mentions one
interesting fact, which must be one of the reasons why Harris was
such a great editor. The first story he sent to Harris was excellent;
the second, Wells admits, was bad. And Harris summoned and gave
him a loud talking to over the bad one. Yet when Harris became
editor of another magazine, he remembered only the good story and
wrote to Wells asking him to become one of his special contributors.
And that gave Wells his real start. The point is that many editors
wouldn't remember at all, or if they did, they would remember only
that the second contribution was bad.
The American writer left us for Cannes, and Harris invited me to
drink champagne with him. We went to the terrace of a café on the
Promenade. Harris was not a steady free drinker as he was when I
had known him seven years before in New York. His skilful hands
trembled under the weight and accumulated cares of three-score
years. His hair was dyed, and from the heat of the Midi and of
alcohol some of the color had dissolved and mixed with the
perspiration oozing from the deep lines of his face, which resembled
an antique many-grooved panel with some of the paint peeled off.
Again Frank Harris talked reminiscently and interestingly as always
of his acumen in perceiving greatness in Bernard Shaw and H.G.
Wells and getting them to write for him when they were unknown.
"But I am prouder of Shaw," he said. "Shaw is really a great genius. I
don't always agree with what he says, and he went wrong about the
War, but his 'Common Sense' was a great piece of polemic. Shaw
has intellectual integrity. But I don't think Wells understands what
intellectual integrity means. He is too full of vanity to be a serious
intellect. He is a modernistic fiction writer who is discontented with
his talent and wants to be a social philosopher. But he is impossible
because he has never learned to think."
I said I thought it was a marvelous thing, something like second-
sight, for a man to pick a genius by his first inadequate efforts. Harris
said that it took a genius like himself to discover geniuses, and that
as an editor, he never played favorites. When he found good stuff he
accepted it. But he didn't go back-slapping and printing bad verses
by pretty women. He had had great temptations, but he never let his
desires interfere with his intellectual judgment.
His manner was boastful but not offensively so, for I think Frank
Harris had something to boast about. After all, he was Gaelic, and I
preferred his manner to the hypocritical English way of boasting by
studied understatement. And when he spoke of the enormous
financial as well as artistic success of Shaw and Wells, there was no
envy, but I could detect a shade of personal defeat and frustration in
his voice.
Frank Harris's phrase, "intellectual integrity," kept agitating my
thoughts like a large blue-bottle against a window pane. For a long
long time I had carried something on my mind which I had hesitated
to get off. But now, with the champagne working in my head and a
warm and mellow feeling suffusing me, and with Frank Harris's
features softening a little, I was emboldened to let go.
During my second year as assistant editor on The Liberator a
woman called to see me one day bringing a little book of poems. She
offered me ten dollars if I would review it in The Liberator. I said that
The Liberator did not accept money for printing reviews, but if her
poems seemed worth while, we would review them. She said that
she had paid Frank Harris a thousand dollars to get the book printed,
yet he hadn't even reviewed it in Pearson's. And afterward, she said,
she had seen a literary agent who informed her that the cost of
printing was about two hundred dollars. She thought that Frank
Harris had swindled her. I did not review the verses, because to my
mind, they were not worth while.
Also, I had heard stories of Frank Harris posing as an art
connoisseur and palming off fake pictures as old masters, and of his
getting material for his magazine from writers who thought they
would be paid and then not paying them—tales of petty racketeering
that were more funny than vicious. And so, being champagne drunk
with Harris on a café terrace looking out on the calm blue
Mediterranean, and feeling elastic and free, I, who admired the
extraordinary ways of Frank Harris more than any other intellectual
of my acquaintance, was interested to hear from himself the truth. I
told him the story of that woman who had visited The Liberator and
complained about him.
Frank Harris was wonderful to look at under the influence of the
champagne, his lion-roaring, his face like a pirate's, yet with a
sublime gleam of genuine kindliness in his eyes! What I said he did
not affirm or deny. He just exploded with a mighty sermon about the
artist and intellectual integrity. He said that the way of the artist was
hard, for if he had a talent that appealed to popular imagination,
everybody desired to use him—women and men, politicians,
philanthropists, reformers, revolutionists, organizations,
governments. Many artists won success by sacrificing their
intellectual integrity. He himself had had large success. But
whenever he felt the urge and the bounden duty to declare his
opinion, he could not restrain himself, and so he had not remained
successful. He had not been a puritan about life. Perhaps he had
done things that Jesus would not have done. But he had not given
his soul entirely to Mammon. Perhaps he had taken gifts from
persons who thought they had been swindled and who were better
off perhaps, if they were. But whatever he did he had reserved intact
his intellectual integrity.
It was a great sermon and I felt that Frank Harris was greater
because of it. He was no hypocrite. He had no social pretensions,
although he delighted in the company of smart and fashionable
people. He was aware, that there was plenty of dross inseparable
from the gold of life, and he embraced the whole. Nobody could deny
that he was indeed a follower of the Jesus who dominated his mind,
that he sincerely believed in sin and redemption.
XII
"He Who Gets Slapped"
MY radical days on The Liberator were sometimes rosy with
romance. Friends vied with friends in giving me invitations to their
homes for parties and car rides and in offering tickets for plays and
concerts. And even more. I remember I had a pressing debt of honor
to settle. And one day a staunch friend of The Liberator, Elizabeth
Sage Hare, handed me a check for five hundred dollars. She also
invited me to tea at her house in Park Avenue or Fifth, I don't quite
remember, but it was somewhere in the exclusive Faubourg
Bourgeoisie.
Liberator friends introduced me to a few of those Greenwich Village
tearooms and gin mills which were not crazy with colorphobia. And I
reciprocated by inviting some of them up to the cabarets and cozy
flats of Harlem. I did not invite my friends to the nice homes of the
Negro élite, simply because I did not have an entrée.
Once Sanina condescended to entertain I think four friends—all
men. When we arrived we found Sanina set in a circle of dark-brown
girls, all cunningly arranged to heighten her quadroon queenliness. It
was an exciting tableau, with a couple of sweetmen decorating the
background.
But Sanina knew that I held a genteel position, sitting in an editor's
chair among the whites downtown. (She was a faithful reader of True
Stories.) So more than ever that night Sanina invested her unique
position in Harlem with majesty. She was the antithesis of the Little
Brown Jug of Charlie Chaplin's party. She brought out a bottle of rum
for the glory of Jamaica, and holding it like a scepter, she poured
royally. I believe my friends were thinking that they also would have
to pay royally. But the evening was Sanina's affair. She provided
everything free and formally and with the air of a colored queen of
respectability and virtue. Meanwhile her shrewd brown eyes seemed
to be saying: "I'll show you white folks!" She was a different Sanina
to me. Indeed, she was a creature of two races that night, with the
blood of both warring in her veins.
Our editor-in-chief possessed none of the vulgar taste for cellar
cabarets. Yet one evening Max Eastman said he would like to go on
a cabaret party to Harlem. He was accompanied by another friend.
We were welcomed at Barron's, where white people were always
welcome and profitable business. Barron was a big man in Tammany
politics. But I wanted particularly to go with my white friends to Ned's
Place on Fifth Avenue. Ned and I had been friends when I had run a
restaurant in Brooklyn some years previously. He was living in
Brooklyn and often dropped in at my place to eat. Then my business
went bankrupt and we lost sight of each other. A few years later,
when I was waitering on the railroad, I discovered Ned operating a
cabaret on Fifth Avenue in Harlem. I introduced all of my railroad
friends to the place. Our crew used to rendezvous there and unload
ourselves of our tips.
Ned's Place was a precious beehive of rare native talent and
customers. A big black girl from Brooklyn with a mellow flutelike
voice was the high feature. And there was an equivocal tantalizing
boy-and-girl dancing team that I celebrated in Home to Harlem.
When that boy and girl started to shake together they gave
everybody the sweet shivers. The place was small and Ned was his
own master of ceremonies. With a few snappy flashes he could start
everybody swaying together in a merry mood, like a revival leader
warming up his crowd.
Ned's was one place of amusement in Harlem in which white people
were not allowed. It was a fixed rule with him, and often he turned
away white slummers. This wasn't entirely from pride-of-race feeling,
but because of the white unwritten law which prohibits free social
intercourse between colored and white. The big shots of the
amusement business in Harlem, such as Barron, got by the law, for
they were Tammany men. But even they were surprised and messed
up sometimes by the vice squads. Ned said he preferred to run a
"small and clean business" rather than to start treading in the
quicksands of bribes.
However, I had become so familiar with Max Eastman, and his ideas
and ways were so radically opposed to the general social set-up of
white-without-black, that it was impossible to feel about him as a
black does about a white alien. And I was such a good and regular
customer of Ned's that I thought he would waive his rule for me. But I
thought wrong that time.
We arrived at the door of the cabaret, from where Max Eastman
could get a glimpse inside. He was highly excited by the scene, and
eager to enter. But the doorman blocked the way. I beckoned to Ned,
but his jovial black face turned ugly as an aard-vark's and he acted
as if I was his worst enemy. He waved his fist in my face and roared:
"Ride back! Ride back, or I'll sick mah bouncers on you-all!"
Max Eastman and his friend and I made a quick retreat. Eastman
didn't mind. He said he was happy that there was one place in
Harlem that had the guts to keep white people out. There are no
such places left today. Harlem is an all-white picnic ground and with
no apparent gain to the blacks. The competition of white-owned
cabarets has driven the colored out of business, and blacks are
barred from the best of them in Harlem now.
Always I was inflamed by the vision of New York as an eye-dazzling
picture. Fascinated, I explored all points in my leisure moments, by
day and by night. I rode all the ferries. I took long trips, from the
Battery to the Bowery, from Broadway through Harlem to the Bronx. I
liked to walk under the elevated tracks with the trains clashing and
clanging overhead. There was excitement when the sudden roaring
of the train abruptly blotted out conversation. Even the clothes
suspended in the canyon tenements appeared endowed with a
strange life of their own. In the stampeding hours of morning, noon,
and evening, when the crowds assumed epic proportions, I was so
exalted by their monster movement that I forgot that they were white.
I particularly remember some nocturnal wanderings with Adolf Dehn,
the artist, spanning blocks upon blocks along the East River, and the
vast space-filling feeling of the gigantic gas tanks. One loves in New
York its baroque difference from the classic cities, the blind chaotic
surging of bigness of expression. I remember how, when I worked in
the West Eighties and spent my rest time loitering along Riverside
Drive, the black giants of the New York Central, belching flame and
smoke and dust along the façades of the fine palaces, created a
picture like a caravan of modern pirates coming home in a rolling
cloud of glory. The grim pioneer urge of the great pragmatic
metropolis was a ferment in my feeling.
Often I was possessed with the desire to see New York as when I
first saw it from the boat—one solid massive mammoth mass of
spiring steel and stone. And I remember one week-end when Eugen
Boissevain offered a ride over to Jersey, whence one could see New
York in that way. Max Eastman was with us. We drove up to a
summit commanding a grand view of the city. We stood there a long
time drinking in the glory of the pyramids. Afterward we drove
aimlessly around the country. Finally we became hungry. We
stopped at several hotels and restaurants, but none would serve the
three of us together. At last one place offered to serve us in the
kitchen. So, being hungry, all three of us went into the kitchen. The
cooks were frying and roasting at the stove. Kitchen help were
peeling potatoes, washing dishes, cleaning up garbage. We sat
down at the servants' table, where a waiter served us.
It was one of the most miserable meals I ever ate. I felt not only my
own humiliation, but more keenly the humiliation that my presence
had forced upon my friends. The discomfort of the hot bustling
kitchen, the uncongenial surroundings—their splendid gesture, but
God! it was too much. I did not want friends to make such sacrifices
for me. If I had to suffer in hell, I did not want to make others suffer
there too. The physical and sensual pleasures of life are precious,
rare, elusive. I have never desired to restrict the enjoyment of others.
I am a pagan; I am not a Christian. I am not white steel and stone.
On many occasions when I was invited out by white friends I
refused. Sometimes they resented my attitude. For I did not always
choose to give the reason. I did not always like to intrude the fact of
my being a black problem among whites. For, being born and reared
in the atmosphere of white privilege, my friends were for the most
part unconscious of black barriers. In their happy ignorance they
would lead one into the traps of insult. I think the persons who
invented discrimination in public places to ostracize people of a
different race or nation or color or religion are the direct descendants
of medieval torturers. It is the most powerful instrument in the world
that may be employed to prevent rapproachement and
understanding between different groups of people. It is a cancer in
the universal human body and poison to the individual soul. It saps
the sentiment upon which friendliness and love are built. Ultimately it
can destroy even the most devoted friendship. Only super-souls
among the whites can maintain intimate association with colored
people against the insults and insinuations of the general white
public and even the colored public. Yet no white person, however
sympathetic, can feel fully the corroding bitterness of color
discrimination. Only the black victim can.
It was at this time that I wrote a series of sonnets expressing my
bitterness, hate and love. Some of them were quoted out of their
context to prove that I hate America. Mr. Lothrop Stoddard was the
chief offender in his The Rising Tide of Color.
Here are the sonnets:
BAPTISM
Into the furnace let me go alone;
Stay you without in terror of the heat.
I will go naked in—for thus 'tis sweet—
Into the weird depths of the hottest zone.
I will not quiver in the frailest bone,
You will not note a flicker of defeat;
My heart shall tremble not its fate to meet,
My mouth give utterance to any moan.
The yawning oven spits forth fiery spears;
Red aspish tongues shout wordlessly my name.
Desire destroys, consumes my mortal fears,
Transforming me into a shape of flame.
I will come out, back to your world of tears,
A stronger soul within a finer frame.
THE WHITE CITY
I will not toy with it nor bend an inch.
Deep in the secret chambers of my heart
I brood upon my hate, and without flinch
I bear it nobly as I live my part.
My being would be a skeleton a shell,
If this dark Passion that fills my every mood,
And makes my heaven in the white world's hell,
Did not forever feed me vital blood.
I see the mighty city through a mist—
The strident trains that speed the goaded mass,
The fortressed port through which the great ships pass,
The tides, the wharves, the dens I contemplate,
Are sweet like wanton loves because I hate.
THE WHITE HOUSE
Your door is shut against my tightened face,
And I am sharp as steel with discontent;
But I possess the courage and the grace
To bear my anger proudly and unbent.
The pavement slabs burn loose beneath my feet,
And passion rends my vitals as I pass,
A chafing savage down the decent street,
Where boldly shines your shuttered door of glass.
Oh I must search for wisdom every hour,
Deep in my wrathful bosom sore and raw,
And find in it the superhuman power
To hold me to the letter of your law!
Oh I must keep my heart inviolate,
Against the poison of your deadly hate!
AMERICA
Although she feeds me bread of bitterness,
And sinks into my throat her tiger's tooth,
Stealing my breath of life, I will confess
I love this cultured hell that tests my youth!
Her vigor flows like tides into my blood,
Giving me strength erect against her hate.
Her bigness sweeps my being like a flood.
Yet as a rebel fronts a king in state,
I stand within her walls with not a shred
Of terror, malice, not a word of jeer.
Darkly I gaze into the days ahead,
And see her might and granite wonders there,
Beneath the touch of Time's unerring hand,
Like priceless treasures sinking in the sand.
The Liberator was gaining strength in its stride. We were always

receiving praiseful letters and faithful promises of support. And we
were preparing to celebrate our struggling through to a happy New
Year. But suddenly the magazine was knocked off its feet. Our
bookkeeper, Mylius, disappeared, and with him went the four
thousand dollars left from The Liberator's government bonds.
Unfortunately Mylius had been intrusted with the key to the bank's
vault in which they were kept. I always felt that I could have trusted
my friend, Michael, the gangster, with my life, while I wouldn't have
trusted Mylius with my shadow.
Max Eastman was discouraged. Always worried about the raising of
money to run the magazine, he had never had the necessary leisure
for his own creative writing. Most of the money he raised came from
liberal rentiers. And now that the magazine editorially had taken a
stand for Lenin and Trotsky and the Bolshevik revolution, it was less
easy to obtain money from these rentiers, whose class had been
ruthlessly expropriated in Russia.
Max Eastman wanted to relinquish the editorship and go abroad to
live and write as he desired. We called a meeting of Liberator artists
and writers and sympathizers. All of us wanted to carry on with the
magazine. But money mocked at us. None of us had Eastman's
combination of talents for the money-raising job. That had been no
picnic for him, either, in spite of his fine platform personality and
attractive presence.
The only person at that meeting who felt that The Liberator could
carry on without Max Eastman was Michael Gold. Gold was always
critical about the way in which the magazine was run. He thought
that Eastman was too much of an esthete, too Baudelaire-like in his
poetic expression. He maintained that The Liberator should express
more of the punch and the raw stuff of life and labor. Max Eastman
had made up his mind to get out from under. We decided that all the
collaborators should endeavor to keep the magazine going as a
collective enterprise. And upon Eastman's suggestion, Michael Gold
and myself were appointed executive editors. There could have been
no worse combination, because personally and intellectually and
from the first time we met, Michael Gold and I were opposed to each
other.
Michael Gold's idea of The Liberator was that it should become a
popular proletarian magazine, printing doggerels from lumberjacks
and stevedores and true revelations from chambermaids. I
contended that while it was most excellent to get material out of the
forgotten members of the working class, it should be good stuff that
could compare with any other writing.
I knew that it was much easier to talk about real proletarians writing
masterpieces than to find such masterpieces. As a peasant and
proletarian aspirant to literary writing I had come in contact with
reams of stuff, pathetic attempts of working people toward adequate
literary expression. My sympathy was with them, but my attitude was
not mawkish. Because I was also an ordinary worker, without benefit
of a classic education. And I had had the experience of the hard
struggle and intellectual discipline and purposefulness that were
necessary to make a fine stanza of verse or a paragraph of prose.
And Michael Gold also knew. He was still intellectually battling up
from the depths of proletarian starvation and misery. And like myself
he was getting hard criticism and kind encouragement from Max
Eastman. But Michael Gold preferred sentimentality above
intellectuality in estimating proletarian writing and writers.
I preferred to think that there were bad and mediocre, and good and
great, literature and art, and that the class labels were incidental. I
cannot be convinced of a proletarian, or a bourgeois, or any special
literature or art. I thought and still think that it is possible to have a
proletarian period of literature, with labor coming into its heritage as
the dominating social factor, exactly as we have had a Christian
period, a Renaissance period, and the various pagan periods. But I
believe that whenever literature and art are good and great they leap
over narrow group barriers and periods to make a universal appeal.
The intelligentsia of our southern states may boycott a Negro's book
or a Negro's painting. Hitler may burn the creative work of Jews,
liberals and radicals, Mussolini may proscribe literature and art that
he considers anti-Fascist, the Pope may index works that he
interprets as anti-Catholic, and the Communists may damn works of
literature and art that appear to them unfavorable to international
Communism. I don't minimize the danger of the obstruction of talent
and the destruction of art. But if the works are authentic they will
eventually survive the noise and racket of the times, I think.
Michael Gold and I on The Liberator endeavored to team along. But
that was impossible. Gold's social revolutionary passion was
electrified with personal feeling that was sometimes as acid as lime-
juice. When he attacked it was with rabbinical zeal, and often his
attacks were spiteful and petty. One day I was informed that he had
entered the Civic Club (a rendezvous of liberals and radicals) in his
shirt sleeves and with an insulting attitude. I remarked that I didn't
see any point in doing that to the pacifist Civic Club; that he might
have gone instead to the Union League Club.
Someone repeated my comment, and one evening when I was
dining with Marguerite Tucker at John's Italian restaurant in Twelfth
Street, Gold came in and challenged me to box. He had been a
champion of some note on the East Side. I shrugged and said the
difference between us was intellectual and not physical, but that I
was willing to box, if he thought that would settle it. So we laughed
the matter off and drank a bottle of dago red together. However, I
saw clearly that our association could not continue. Shortly after that
we called a meeting of Liberator editors and I resigned.
Meanwhile I had been devoting most of my time to dramatic
criticism. Happy Harlem had come down to Broadway in a titillating
musical piece called Shuffle Along. The metropolitan critics
dismissed it casually at first. There were faults. Technically the piece
was a little too rhythmically lazy and loose-jointed. But there were
some luscious songs and singing: "Shuffle Along," "Love Will Find a
Way," and "Bandanna Land." And there was Florence Mills. Florence
Mills was so effortless in her perfect mimicry and elfin brown voice
that the Negro impressarios were not even aware that they
possessed in her a priceless gold star. For they had given her a
secondary rôle in the revue.
Never had I seen a colored actress whose artistry was as fetching as
Florence Mills's. After the show I went backstage to see her. I said:
"You're the star of the show." No, she said, the stars were Lottie Gee
and someone else whose name I don't remember. I said, "You're the
star for me, and I'm going to say so in my review." She laughed
deliciously.
I thought I'd feature Shuffle Along in The Liberator. I wanted
especially to do this because the Negro radicals of those days were
always hard on Negro comedy. They were against the trifling,
ridiculous and common side of Negro life presented in artistic form.
Radical Negroes take this attitude because Negroes have
traditionally been represented on the stage as a clowning race. But I
felt that if Negroes can lift clowning to artistry, they can thumb their
noses at superior people who rate them as a clowning race.
I asked William Gropper, the cartoonist, to go along with me to see
Shuffle Along and make some drawings. Gropper made some
excellent things, but they were too savagely realistic for the airy fairy
fascination of Negro comedy. Gropper realized this, and didn't mind
my asking Hugo Gellert to take a stroke at them, because I thought
Gellert's style more suitable to the kind of thing I wanted. I did not
rate Gellert's talent anywhere near Gropper's. But Gellert possessed
a more receptive mind and cunning hand for illustrative work. Gellert
made some clever drawings with a modernistic accent. We printed
them with my article, and that issue of The Liberator was a sensation
among the theatrical set of Harlem.
Florence Mills ran away with the show, mimicking and kicking her
marvelous way right over the heads of all the cast and sheer up to
the dizzying heights until she was transformed into a glorious star.
Shuffle Along was conceived, composed and directed by Negroes.
There had been nothing comparable to it since the Williams and
Walker Negro shows. It definitely showed the Negro groping,
fumbling and emerging in artistic group expression. When its best
artists were bought out by white producers and it was superseded by
such elaborate super-productions as Blackbirds, which was
projected and directed by a white impresario, there was no artistic
gain for the Negro group. But the Negro artistes made more money,
and thoughtless Negroes, like all good Americans, think that the
commercially successful standard is the only standard by which
Negro artistic achievement may be judged.
I have no prejudice against white persons leading and directing
Negroes artistically and otherwise, if they can do it with more than
merely technical competence. Negroes using the technique of the
white peoples to express themselves must necessarily have to go to
school to the whites. But it is no easy achievement for any outsider
to get on the inside of a segregated group of people and express
their hidden soul. Many white people see Negroes from a white point
of view and imagine that they know all about the Negro soul and can
express it even better than the blacks themselves. When I saw the
white man's Blackbirds in Paris and remembered Shuffle Along I was
very sad. The Blackbirds flashed like a whip from beginning to end,
rushing the actors through their parts like frightened animals. There
was not a suggestion in it of the inimitably lazy tropical drawl that
characterizes Negro life even in the coldest climate. And that was
the secret of the success of the charming Shuffle Along.
In the midst of my career as a dramatic critic I bumped into one of
those acute snags which remain in the memory even as the scar of a
bad wound that has been healed remains in the body. It wasn't
because I was thin-skinned. When I went to work on The Liberator I
knew that I would have to face social problems even greater than
before, but I was determined to face them out. But what happened to
me hurt more because it came from an unexpected source.
I think that instead of rewriting it, I will let the article I wrote at the
time (for The Liberator of May, 1922) tell the story for me:
"Wouldn't your dramatic critic like to see He Who Gets Slapped?"
So, very graciously, wrote the Theater Guild's publicity agent to The
Liberator. Our sometime dramatic critic, Charles W. Wood, having
deserted us for the season, I elected myself dramatic critic by
acclamation. It would be pleasant to sit in a free front-row parquet
seat along with "The Press," instead of buying a ticket for the second
balcony. And as for the other seat—free seats come in pairs—I
decided to take along William Gropper, Liberator artist of the
powerful punch and vindictive line, and master of the grotesque.
So on the appointed night we presented ourselves at the box office
of the Fulton. It was with keen pleasure that I anticipated seeing this
fantastic play of Leonid Andreyev's, He, the One Who Gets Slapped.
A curious and amusing theme!
The stubs were handed to Gropper and we started toward the
orchestra. But the usher, with a look of quizzical amazement on his
face, stopped us. Snatching the stubs from Gropper and muttering
something about seeing the manager, he left us wondering and
bewildered. In a moment he returned, with the manager. "The—the
wrong date," the manager stammered and, taking the stubs marked
"orchestra," he hurried off to the box office, returning with others
marked "balcony." Suddenly the realization came to me. I had come
here as a dramatic critic, a lover of the theater, and a free soul. But—
I was abruptly reminded—those things did not matter. The important
fact, with which I was suddenly slapped in the face, was my color. I
am a Negro—He, the One Who Gets Slapped....
Gropper and I were shunted upstairs. I was for refusing to go, but
Gropper, quite properly, urged compromise. So, brooding darkly,
madly, burnt, seared and pierced, and over-burdened with hellish
thoughts, I, with Gropper beside me half-averting his delicate pale
face, his fingers, run through his unkempt mop of black hair, shading
his strangely child-like blue eyes, sat through Leonid Andreyev's
play.
Andreyev's masterpiece, they call it. A masterpiece? A cleverly
melodramatic stringing together of buffoonery, serio-comic
philosophy, sensational love-hungriness and doll-baby impossibilism,
staged to tickle the mawkish emotions of the bourgeois mob! So I
thought. I sat there, apart, alone, black and shrouded in blackness,
quivering in every fiber, my heart denying itself and hiding from every
gesture of human kindliness, hard in its belief that kindliness is to be
found in no nation or race. I sat inwardly groaning through what
seemed a childish caricature of tragedy. Ah! if the accident of birth
had made Andreyev a Negro, if he had been slapped, kicked,
buffeted, pounded, niggered, ridiculed, sneered at, exquisitely
tortured, near-lynched and trampled underfoot by the merry white
horde, and if he still preserved through the terrible agony a sound
body and a mind sensitive and sharp to perceive the qualities of life,
he might have written a real play about being slapped. I had come to
see a tragic farce—and I found myself unwillingly the hero of one. He
who got slapped was I. As always in the world-embracing Anglo-
Saxon circus, the intelligence, the sensibilities of the black clown
were slapped without mercy.
Poor, painful black face, intruding into the holy places of the whites.
How like a specter you haunt the pale devils! Always at their elbow,
always darkly peering through the window, giving them no rest, no
peace. How they burn up their energies trying to keep you out! How
apologetic and uneasy they are—yes, even the best of them, poor
devils—when you force an entrance, Blackface, facetiously,
incorrigibly, smiling or disturbingly composed. Shock them out of
their complacency, Blackface; make them uncomfortable; make them
unhappy! Give them no peace, no rest. How can they bear your
presence, Blackface, great, unappeasable ghost of Western
civilization!
Damn it all! Goodnight, plays and players. The prison is vast, there is
plenty of space and a little time to sing and dance and laugh and
love. There is a little time to dream of the jungle, revel in rare scents
and riotous colors, croon a plantation melody, and be a real original
Negro in spite of all the crackers. Many a white wretch, baffled and
lost in his civilized jungles, is envious of the toiling, easy-living
Negro.
XIII
"Harlem Shadows"
MEANWHILE I was full and overflowing with singing and I sang in all
moods, wild, sweet and bitter. I was steadfastly pursuing one object:
the publication of an American book of verse. I desired to see "If We
Must Die," the sonnet I had omitted in the London volume, inside of
a book.
I gathered together my sheaf of songs and sent them to Professor
Spingarn. He was connected with a new publishing firm. Many years
before I had read with relish his little book, entitled Creative
Criticism. I wrote to him then. He introduced me to James
Oppenheim and Waldo Frank of The Seven Arts, and they published
a couple of my poems under a nom de plume. That was way back in
1917. Now, five years later, I asked Professor Spingarn to find me a
publisher.
I had traveled over many other ways besides the railroad since those
days. Professor Spingarn was appreciative of me as a Negro poet,
but he did not appreciate my radicalism, such as it was!
Paradoxically, Professor Spingarn supported and advocated Negro
racial radicalism and abhorred social radicalism. Professor Spingarn
preferred my racial jeremiads to my other poems. Well, I was blunt
enough to tell Professor Spingarn that he was a bourgeois. He didn't
like it. Nevertheless he found me a publisher.
When I told a Yankee radical about myself and Professor Spingarn,
this radical said that it was impossible for any man to be pro-Negro
and anti-radical. He said, he believed that Professor Spingarn was
pro-Negro not from broad social and humanitarian motives, but
because he was a Jew, baffled and bitter. I said, "But Oswald
Garrison Villard is also pro-Negro, and he is not a radical nor a Jew."
The radical said, "Oh, Villard is an abolitionist by tradition." And I
said, "Isn't it possible that Professor Spingarn is also an abolitionist,
and by even a greater tradition?"
If only individual motives were as easy to categorize and analyze as
they appear to be! Anyway, Professor Spingarn got Harcourt Brace
and Company to accept my poems. Max Eastman wrote a splendid
preface, and the book was published in the spring of 1922.
Harlem Shadows was a succès d'estime. The reviews were
appreciative, some flattering, flattering enough to make a fellow feel
conceited about being a poet. But I was too broke and hungry and
anxious about the future to cultivate conceit. However, I was not
discouraged. The publication of my first American book uplifted me
with the greatest joy of my life experience. When my first book was
published in Jamaica, I had the happy, giddy feeling of a young goat
frolicking over the tropical hills. The English edition of my poems had
merely been a stimulant to get out an American book. For to me
America was the great, difficult, hard world. I had gone a long,
apparently roundabout way, but at least I had achieved my main
purpose.
The last Liberator affair in which I actively participated was an
international dance. The winter had been cold on our spirits and our
feelings warmed currently to celebrate the spring. We trumpeted
abroad our international frolic and the response was exhilarating. All
shades of radicals responded, pink and black and red; Left liberals,
Socialists, Anarchists, Communists, Mayflower Americans and
hyphenated Americans, Hindus, Chinese, Negroes. The spirit of The
Liberator magnetized that motley throng. There was a large freedom
and tolerance about The Liberator which made such a mixing
possible. (How regrettable that nothing like the old Liberator exists
today! Social thinking is still elastic, even chaotic, in America. Class
lines and ideas here are not crystallized to such an extent as to
make impossible friendly contact between the different radical
groups.)
Our spring frolic brought that international-minded multitude into
Forty-second Street. But the metropolitan police resented the
invasion. They were aghast at the spectacle of colored persons
mixed with white in a free fraternal revel. So they plunged in and
broke it up, hushed the saxophones, turned the crowd out of the hall,
and threw protesting persons downstairs, lamming them with their
billies.
After leaving The Liberator I took a holiday from work. I had not had
one for over a year. I was in a small circle of friends and we convived
together, consuming synthetic gin. Meanwhile I was thinking about a

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Capital markets, derivatives, and the

law : positivity and preparation Third

Capital Markets, Derivatives, and the Law

Capital Markets, Derivatives,

Published in the United States of America by Oxford University Press

© Alan N. Rechtschaffen 2019

First Edition published in 2009

You must not circulate this work in any other form

Library of Congress Cataloging-​in-​Publication Data

Printed by Sheridan Books, Inc., United States of America

(Based on the Declaration of Principles jointly adopted by a Committee of the

And thank you to my students who are an unstoppable source

1. The Financial Crisis: The Seeds of New Regulation 1

2. The Liquidity Crisis and Government Reaction 13

3. Dodd-​Frank and the Regulation of Depository Institutions Capital Requirements 25

5. Financial Instruments and the Capital Markets 47

6. Bureau of Consumer Financial Protection 65

7. Understanding Interest Rates and the Economy 81

8. Asset Valuation 111

9. United States Treasury Securities 121

10. Debt Securities 139

11. Derivatives 157

12. Types of Swaps 199

13. Options 231

14. Regulation of Swaps 249

15. Securities Regulation 287

16. Suitability 325

17. The History of the CFTC 367

18. Fiduciary Obligation to Manage Risk 397

19. Litigation Issues 423

20. Synthesis and Conclusion 443

Capital Markets, Derivatives and the Law: Positivity and Preparation

Ying-​Tien Chen earned both Bachelor’s and Master’s degrees at National

After one of the greatest periods of economic turmoil in American history,

Complex financial instruments, such as derivatives, allowed investors to speculate

The . . . private sector vulnerabilities include‌the excessive debt taken on per-

1 The Financial Crisis

I. Origins of the Great Recession 5

Capital Markets, Derivatives, and the Law. Alan N. Rechtschaffen.

2 Capital Markets, Derivatives, and the Law

• The depository system, including banks, savings associations, and credit

The Financial Crisis 3

4 Capital Markets, Derivatives, and the Law

Information received since the Federal Open Market Committee met in

The Financial Crisis 5

I. Origins of the Great Recession

6 Capital Markets, Derivatives, and the Law

The Financial Crisis 7

WASHINGTON, DC—​Fannie Mae (FNMA/​OTC) reported pre-​tax in-

8 Capital Markets, Derivatives, and the Law

The Financial Crisis 9

10 Capital Markets, Derivatives, and the Law

A. Multiple Guarantor Model

The Financial Crisis 11

B. Multiple Insurer Model

12 Capital Markets, Derivatives, and the Law

2 The Liquidity Crisis and Government Reaction

Purchasing a home is an extremely interest-​rate sensitive decision. The ability to buy

Capital Markets, Derivatives, and the Law. Alan N. Rechtschaffen.

14 Capital Markets, Derivatives, and the Law

The Liberator was gaining strength in its stride. We were always

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Library of Congress Cataloging-in-Publication Data

3. Dodd-Frank and the Regulation of Depository Institutions Capital Requirements 25

Ying-Tien Chen earned both Bachelor’s and Master’s degrees at National

1 The Financial Crisis

I. Origins of the Great Recession

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B. Multiple Insurer Model

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