Regulators' Irrational Rationality and Bankers' Rational Irrationality: Too Big to Fail, Self-Regulation, Moral Hazard and the Global Financial Crisis, 2007-2009

Austrian Journal of Historical Studies (Oesterreichische Zeitschrift für Geschichtswissenschaften) 26 (May 2015), pp. 21-45

25 Pages Posted: 13 Oct 2014 Last revised: 15 Jul 2018

Date Written: March 25, 2015

Abstract

Banks and other financial institutions which were too-big-to-fail (TBTF) played a central role during the Global Financial Crisis of 2007-2009. The present article lays out how misguided policies enabled banks to grow both in size as well as in complexity and therefore acquire TBTF status, particularly in the 10-year period preceding the crisis. The article then proceeds by detailing how an ill-designed policy framework, relying on supposed market approaches to regulation – including self-regulation and credit rating agencies – enabled TBTF financial institutions to game the system and thereby exploit negative externalities which the flawed policy framework in connection with TBTF status had granted large, systemically important financial institutions. The article therefore identifies defective government policies as the chief cause for the financial crisis of 2007-2009, revealing an urgent need for financial sector reform.

Keywords: financial crisis of 2007-2009, too-big-to-fail, financial regulation, regulatory capture, deregulation, regulatory failure, self-regulation, rent-seeking, moral hazard, externalities, rating agencies

JEL Classification: B02, E58, E61, E65, G01, G18, G21, G22, G23, G24, G28, N12, N22, N42

Suggested Citation

Umlauft, Thomas S., Regulators' Irrational Rationality and Bankers' Rational Irrationality: Too Big to Fail, Self-Regulation, Moral Hazard and the Global Financial Crisis, 2007-2009 (March 25, 2015). Austrian Journal of Historical Studies (Oesterreichische Zeitschrift für Geschichtswissenschaften) 26 (May 2015), pp. 21-45, Available at SSRN: https://ssrn.com/abstract=2508922

Thomas S. Umlauft (Contact Author)

University of Vienna ( email )

Vienna, Vienna 1090
Austria

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