Avoiding Eight-Alarm Fires in the Political Economy of Systemic Risk Management
Jeffrey N. Gordon
Columbia Law School; European Corporate Governance Institute (ECGI)
March 26, 2010
Columbia Law and Economics Research Paper No. 369
ECGI - Finance Working Paper No. 277/2010
The inherent tensions in the financial sector mean that episodes of extreme stress are inevitable, if unpredictable. This is so even if the regulatory and supervisory regimes are in many respects effective. The capacity of government to intervene may determine whether the distress is confined to the financial sector or breaks out into the real economy. Although adequate resolution authority to address a failing financial firm is a necessary objective of the current regulatory reform, a firm-by-firm approach will be unable to address a major systemic failure such as the Crisis of 2007-08, which may require capital support of the financial sector to avoid severe economic harm. We therefore propose standby systemic emergency finding authority, triggered by agreement among Treasury, the Federal Reserve, and the FDIC. Such a fund, scaled appropriately to the size of the US economy, $1 trillion, should be funded (and partially pre-funded) by risk-adjusted assessments on all large financial firms, who benefit from systemic stability. Standby emergency authority avoids the need for high stakes legislative action mid-crisis, which can be destabilizing even if successful and catastrophic if not. The triple key‖ constraint and on-going monitoring and oversight should address concerns of legitimacy and accountability.
Number of Pages in PDF File: 75
Keywords: Financial Crisis, Bank Regulation, Emergency Authority, Financial Innovation, Federal Reserve, Credit Default Swap, Lehman Brothers
JEL Classification: E61, G28, H81, K23, P16working papers series
Date posted: February 16, 2010 ; Last revised: May 14, 2010
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