Uncertainty and the Financial Crisis

Journal of Financial Transformation, Vol. 29, pp. 79-93, 2010

ECGI - Law Working Paper No. 159/2010

32 Pages Posted: 4 Mar 2010 Last revised: 24 Nov 2010

See all articles by Alessio M. Pacces

Alessio M. Pacces

Amsterdam Law School / Amsterdam Business School (ACLE); European Corporate Governance Institute (ECGI); European Banking Institute

Date Written: May 10, 2010


The majority of commentators, along with the public opinion, are inclined to identify the causes of the last financial crisis in a combination of traditional market and regulatory failures in the operation and regulation of financial markets. Whatever cannot be explained along these lines is interpreted as evidence of inability of individuals, including market professionals, to make rational choices. Without denying the importance of these factors in explaining the behavior of some of the players involved, this paper argues that the extraordinary proportions of the crisis we have experienced are better understood by looking at the specific dynamics of financial innovation through securitization of illiquid assets. Particularly, a perverse combination of Knightian uncertainty and externalities in banking seems to have been the major responsible of the financial crisis.

This paper investigates the role of uncertainty and externalities in the unfolding of events that determined the financial crisis. In this perspective, financial regulation has not been just too lax or too lenient. Rather, it has distorted the choices of financial intermediaries ex-ante (inducing them to rely too much and too quickly on liquidity for funding and profits) and it has turned out to be too rigid ex-post (failing to provide the banking system with incentive-compatible forms of resilience). The implications of this approach are discussed with regard to the regulation of credit rating agencies, the pro-cyclicality of capital adequacy regulation, and the corporate governance of banks.

Keywords: Securitization, Liquidity, Maturity Transformation, Externalities, Shadow Banking, Ratings, Capital Adequacy, Corporate Governance of Banks

JEL Classification: D80, G01, G21, G24, G28, G38

Suggested Citation

Pacces, Alessio Maria, Uncertainty and the Financial Crisis (May 10, 2010). Journal of Financial Transformation, Vol. 29, pp. 79-93, 2010, ECGI - Law Working Paper No. 159/2010, Available at SSRN: https://ssrn.com/abstract=1564103 or http://dx.doi.org/10.2139/ssrn.1564103

Alessio Maria Pacces (Contact Author)

Amsterdam Law School / Amsterdam Business School (ACLE) ( email )

Roetersstraat 11
Amsterdam, 1018 WB

HOME PAGE: http://www.uva.nl/profiel/p/a/a.m.pacces/a.m.pacces.html

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

HOME PAGE: http://https://ecgi.global/users/alessio-pacces

European Banking Institute ( email )


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