Bankers and Brokers First: Loose Ends in the Theory of Central-Bank Policymaking

Abstract

The strategies of financial stabilization embodied in the Dodd-Frank Act and Basel III ignore the efficiency and distributional issues raised by back-door bailouts. Neglecting the role of influence-driven incentive conflict in macroeconomic and financial stabilization helps regulators to avoid blame for sowing misconceptions, nontransparencies, and outright loopholes into the capital standards and regulatory definitions of capital and risk that were supposed to assure financial stability.Bankers understand the financial safety net – not as something external to their economic balance sheet – but as a politically enforceable implicit contract that they have negotiated with national governments. This contract allows governments to impose capital requirements in exchange for committing themselves to bail out large portions of the financial industry in crisis circumstances. The resulting taxpayer put casts taxpayers as equity investors of last resort. This paper argues that information and regulatory systems should be reformed in ways that would impose and enforce fiduciary duties to taxpayers on managers of protected institutions and regulatory officials parallel to those that corporations owe to shareholders.

Keywords: bailouts, financial crises, Basel III, regulatory capture, safety net subsidies