The Importance of Monitoring and Mitigating the Safety-Net Consequences of Regulation-Induced Innovation

Edward Kane

No 2009-PB-08C, NFI Policy Briefs from Indiana State University, Scott College of Business, Networks Financial Institute

Abstract: To be effective, programs of regulatory reform must address the incentive conflicts that intensify financial risk-taking and undermine government insolvency detection and crisis management. Subsidies to risk taking that large institutions extract from the financial safety net encourage managers to make their firms riskier, harder to supervise, and politically and administratively more difficult to fail and unwind. Except in the very short run, repealing the Gramm-Leach-Bliley Act or breaking up so-called too-big-to-fail institutions will do little to arrest subsidy-induced activities. Rebuilding Glass-Steagall barriers between banking, securities, and insurance firms would instead make implicit taxpayer support of large institutions less transparent and serve foreign interests by encouraging conglomerate firms to operate affected businesses through foreign subsidiaries. To discourage financial institutions from abusing safety-net support, government supervisors must be made specifically accountable for delivering and pricing safety-net benefits fairly and efficiently. If it wants to make the system more stable, Congress should focus on: rewriting top officials’ oaths of office; changing the ways top officials are recruited, trained, and compensated; reworking the ways they measure and report regulatory performance; and changing the kinds of securities that large institutions have to issue.

Keywords: Financial Crisis; Financial Reform; Gramm Leach Bliley Act; Glass-Steagall Act; Financial Safety Net; Accountability (search for similar items in EconPapers)
JEL-codes: F42 G21 G28 G32 G38 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2009-11, Revised 2010-08
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Journal Article: The Importance of Monitoring and Mitigating the Safety-Net Consequences of Regulation-Induced Innovation (2010)
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