Networks Financial Institute, Policy Brief No. 2009-PB-08
17 Pages Posted: 18 Nov 2009 Last revised: 29 Jul 2014
Date Written: November 1, 2009
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 even 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 paid and 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
JEL Classification: G21, G28, G32, G38, F42
Suggested Citation: Suggested Citation
Kane, Edward J., The Importance of Monitoring and Mitigating the Safety-Net Consequences of Regulation-Induced Innovation (November 1, 2009). Networks Financial Institute, Policy Brief No. 2009-PB-08; Finlawmetrics 2010 Conference Paper. Available at SSRN: https://ssrn.com/abstract=1507802 or http://dx.doi.org/10.2139/ssrn.1507802