The Importance of Monitoring and Mitigating the Safety-Net Consequences of Regulation-Induced Innovation

24 Pages Posted: 23 Jul 2010 Last revised: 20 Nov 2010

See all articles by Edward J. Kane

Edward J. Kane

Boston College - Department of Finance; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: 2010

Abstract

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 politically and administratively 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 recruited, trained, and compensated; reworking 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

Kane, Edward J., The Importance of Monitoring and Mitigating the Safety-Net Consequences of Regulation-Induced Innovation (2010). Paolo Baffi Centre Research Paper No. 2010-77. Available at SSRN: https://ssrn.com/abstract=1646887 or http://dx.doi.org/10.2139/ssrn.1646887

Edward J. Kane (Contact Author)

Boston College - Department of Finance ( email )

Fulton Hall
Chestnut Hill, MA 02467
United States
520-299-5066 (Phone)
617-552-0431 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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