Saturday, November 13, 2010

Missing Elements in US Financial Reform

By Edward Kane @ HLS Forum on the Dodd-Frank Act.
The Act’s treatment plan presumes that the current crisis was caused by “defective” risk management at private institutions. This narrow theory of blame is inadequate in four ways. First, it excuses safety-net officials for caving to political pressure to expand the safety net during the bubble and subsequent crisis. Second, without addressing ongoing weaknesses in their incentive structures, it calls upon government agencies that failed society during the buildup (such as the SEC) to devise and enforce rules tough enough to prevent their clienteles from engendering future crisis. Third, by accepting this assignment without protest, agency leaders have set their staffs up to be scapegoated for future crisis. Fourth, the theory accepts the unlikely hypothesis that the interest-rate and default risk inherent in long-term nonrecourse mortgage instruments can be fairly and efficiently financed for years on end by short-term debt protected by the safety-net guarantees.
To make firms and regulators accountable to the citizenry, I call for a series of informational reforms designed to exploit econometric advances in the measurement of contingent liabilities. This program has three components: (1) expanding the range of information that financial institutions generate and report; (2) separating bureaucratic responsibility for measuring growth in the safety net from responsibility for limiting safety-net growth; and (3) improving the tools and incentives of safety-net managers.
Click Here to Read: Missing Elements in US Financial Reform

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