Regulation and Deregulation: The Baseline Challenge

19 Pages Posted: 18 Sep 2018

Date Written: June 1, 2018

Abstract

A core challenge for financial regulation is how best to address the inherent dynamism of finance. The financial system is engineered to change. Periods of stability, evolving macroeconomic conditions, and regulation are among the forces driving the constant shape shifting of finance. As a result, rules established at Time A often have a different substantive effect at Time B. And because efforts to reduce the cost of complying with regulatory burdens, commonly known as regulatory arbitrage, are among the forces driving this change, a static regulatory regime will tend to be inherently deregulatory.

Currently, the processes through which the law is made are ill suited to accommodate this dynamism. Frictions built into legislative and regulatory processes make it difficult to update the law even when the substantive impact of a proposed change merely replicates the originally agreed upon balance. Complicating matters further, changing market structures may make it impossible to replicate the precise balance a law had been designed to achieve. Financial regulation often entails tradeoffs among competing values and new environments and innovations may enable but also necessitate different tradeoffs.

There is no easy way to reconcile the dynamism of finance with the lawmaking processes better suited for static environments. Proscribing innovation may be warranted in some domains, but has real costs and is unlikely to be feasible as applied to the system as a whole. Nonetheless, recognizing this tension is a critical to understand why regulation has failed to achieve desired aims and why it may well fail again. This tension also helps to explain the heated debate about the scope of deregulation prior to the 2007-2009 financial crisis and its role contributing to that crisis. Only by grappling with the myriad reasons for financial innovation and the mixed impact of that innovation can we develop the common ground needed to forge a better approach.

Suggested Citation

Judge, Kathryn, Regulation and Deregulation: The Baseline Challenge (June 1, 2018). Virginia Law Review, Vol. 104, 2018; Columbia Law and Economics Working Paper No. 590. Available at SSRN: https://ssrn.com/abstract=3248524 or http://dx.doi.org/10.2139/ssrn.3248524

Kathryn Judge (Contact Author)

Columbia Law School ( email )

435 West 116th Street
New York, NY 10025
United States

HOME PAGE: http://www.law.columbia.edu/fac/Kathryn_Judge

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