Heavier Regulation May Do Little to Reduce Financial Risk

Increased competition rather than heavier regulation may be a better way to deal with the problem of financial institutions (FIs) that are too big to fail (TBTF), according to an article in Booz & Co’s strategy+business.

“It is debatable whether a heavier degree of regulation will actually make financial institutions safer,” write Alan Gemes, Peter T. Golder, and Thorsten Liebert. “Throughout 2008, markets, not regulators, provided the first signals of crisis. The true riskiness of FIs and financial transactions can best be determined closest to the source of risk buildup. Proposals for different types of FIs need to take into account their different risk profiles. This asymmetry of information and the lack of transparency are likely to lead to a more restrictive level of regulation than would be optimal.

In that light, the objective of financial regulation should be not to identify and reduce risk per se, but rather to ensure that the risks are dealt with appropriately by those financial institutions that are best equipped to handle them.

“Most proposals that address the TBTF problem rely on regulating complex FIs more tightly. An alternative is to address the root cause — namely, to prevent FIs from becoming so big in the first place. Options for doing so include antitrust or anticompetitive measures, and levying capital charges on institutions in proportion to the level of systemic risk they pose. In effect, that would charge these institutions a market price for their TBTF guarantee.”

Comments

[a fat panda]

The only thing that the government has shown the ability to do is close the gate after the horses have left the barn, and now want back in.

Why should anyone trust their ability to accomplish this lofty goal. Keep in mind that the regulator overseeing Freddie and Fannie decided that the solution to the falling home values was to increase the size of conforming loans. There is virtually no evidence that the government can successfully regulate financial institutions over an extended period of time.

2009 Nov 03 07:45 PM

[surfgeezer]

There are 2 types of "regulation". The rules that set up the competition and the umpires that enforce the rules. Getting rid of the depression era regulations and allowing securitization of real estate in the mid 90's was a mistake. All it did was allow banks to acquire other banks and get into products and thus too big to fail. Also remember the small government people had cut the funding of the umpires (SEC) and are now their chief critics of the job they did and refuse to blame the excess on the "free market".


On Nov 03 07:45 PM a fat wrote:

> The only thing that the government has shown the ability to do is
> close the gate after the horses have left the barn, and now want
> back in.
>
> Why should anyone trust their ability to accomplish this lofty goal.
> Keep in mind that the regulator overseeing Freddie and Fannie decided
> that the solution to the falling home values was to increase the
> size of conforming loans. There is virtually no evidence that the
> government can successfully regulate financial institutions over
> an extended period of time.

2009 Nov 03 08:25 PM