Market Failures and Regulatory Failures: Lessons from Past and Present Financial Crises

41 Pages Posted: 8 Feb 2011

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Thomas F. Cooley

New York University - Leonard N. Stern School of Business; National Bureau of Economic Research (NBER)

Matthew P. Richardson

Department of Finance, Leonard N. Stern School of Business, New York University

Ingo Walter

New York University - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance

Date Written: February 8, 2011

Abstract

The paper analyzes the financial crisis of 2007-2009 through the lens of market failures and regulatory failures and presents a case that there were four primary failures contributing to the crisis: excessive risk-taking in the financial sector due to mispriced government guarantees; regulatory focus on individual institution risk rather than systemic risk; opacity of positions in financial derivatives that produced externalities from individual firm failures; and runs on the unregulated banking sector that eventually threatened to bring down the entire financial sector. In emphasizing the role of regulatory failures, the paper provides a description of regulatory evolution in response to the panic of 1907 and the Great Depression, why the regulation put in place then was successful in addressing market failures, but how, over time, especially around the resolutions of Continental Illinois, Savings and Loans crisis and the Long-Term Capital Management, expectations of too-big-to-fail status got anchored. The paper proposes specific reforms to address the four market and regulatory failures we identify, and we conclude with some lessons for emerging markets.

Keywords: global financial crisis, LTCM, market failures, regulation, emerging markets

JEL Classification: E44, G01, G15, G18, G21, G24

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Cooley, Thomas F. and Richardson, Matthew P. and Walter, Ingo, Market Failures and Regulatory Failures: Lessons from Past and Present Financial Crises (February 8, 2011). ADBI Working Paper No. 264, Available at SSRN: https://ssrn.com/abstract=1757711 or http://dx.doi.org/10.2139/ssrn.1757711

Viral V. Acharya (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business ( email )

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HOME PAGE: http://www.stern.nyu.edu/~vacharya

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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Centre for Economic Policy Research (CEPR) ( email )

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Thomas F. Cooley

New York University - Leonard N. Stern School of Business ( email )

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Matthew P. Richardson

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Ingo Walter

New York University - Leonard N. Stern School of Business ( email )

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New York University (NYU) - Department of Finance

Stern School of Business
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New York, NY 10012-1126
United States

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