Guardians of Finance

Guardians of Finance: Making Regulators Work for Us

James R. Barth
Gerard Caprio
Ross Levine
Copyright Date: 2012
Published by: MIT Press
Pages: 296
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  • Book Info
    Guardians of Finance
    Book Description:

    The recent financial crisis was an accident, a "perfect storm" fueled by an unforeseeable confluence of events that unfortunately combined to bring down the global financial systems. Or at least this is the story told and retold by a chorus of luminaries that includes Timothy Geithner, Henry Paulson, Robert Rubin, Ben Bernanke, and Alan Greenspan. InGuardians of Finance, economists James Barth, Gerard Caprio, and Ross Levine argue that the financial meltdown of 2007 to 2009 was no accident; it was negligent homicide. They show that senior regulatory officials around the world knew or should have known that their policies were destabilizing the global financial system and yet chose not to act until the crisis had fully emerged.Barth, Caprio, and Levine propose a reform to counter this systemic failure: the establishment of a "Sentinel" to provide an informed, expert, and independent assessment of financial regulation. Its sole power would be to demand information and to evaluate it from the perspective of the public--rather than that of the financial industry, the regulators, or politicians.

    eISBN: 978-0-262-30152-7
    Subjects: Finance

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
  3. Preface
    (pp. vii-x)
  4. Acknowledgments
    (pp. xi-xiv)
  5. 1 Introduction
    (pp. 1-20)

    It was a terrible, terrible accident—something awful to watch unfold. This is the narrative told by many of the world’s most influential policy makers and financiers to explain the financial crisis. It was a terrible accident precipitated by an unforeseeable confluence of events that conspired to bring down the global financial system. A global savings glut, integrated international capital markets, and poorly designed macroeconomic policies fueled large capital flows. In several major economies, those flows in turn triggered lower interest rates, weaker loan standards, a boom in toxic financial innovations, and an unsustainable explosion of credit.² The inevitable crisis...

  6. 2 Regulating Finance Is Hard to Do
    (pp. 21-56)

    Financial regulation is extraordinarily hard to do. The economics is complex. The politics is tricky. And the economic and political ingredients are constantly changing as economies evolve, financiers innovate, lobbyists lobby, and older political constituencies weaken as new ones emerge. This chapter, by describing the economics and politics of financial regulation, explains why regulating finance is so hard to get right and stresses that societies sorely need—and can obtain—effective financial regulation, not simplistic dogmas or theories that do not work.

    Four cornerstones underlie our view of financial regulation. First, there are sound economic reasons for regulating finance. Thus...

  7. 3 Incentives Run Amok
    (pp. 57-84)

    Why did senior managers at so many financial institutions around the world take actions that resulted in the failure or the bailout of their institutions? Why didn’t shareholders—and especially directors of banks’ boards—step in to prevent this disaster? If a crisis was inevitable, why didn’t it happen during the turbulence that buffeted industrial country financial systems in the 1990s? Why did the “big one” happen in the early twenty-first century, after supposedly dramatic advances in the “science” of risk management and all the knowledge gained from earlier crises?

    In this chapter we explain that a confluence of factors...

  8. 4 How US Regulators Encouraged the Financial Crisis
    (pp. 85-120)

    Senior US financial policy makers and regulators repeatedly designed, implemented, and maintained policies that increased the fragility of the global financial system in the ten to fifteen years before the crisis that shook the world in 2008. Those policies encouraged financial institutions to engage in imprudent activities that generated enormous short-term profits while increasing long-term fragility. These policies were not simply mistakes or accidents. They do not primarily reflect unforeseeable and unstoppable events. Time after time, regulators recklessly endangered the economy by selecting and, most important, by maintaining destabilizing policies. Even though regulatory agencies learned that their policies were undermining...

  9. 5 American Crisis? Ain’t Necessarily So
    (pp. 121-146)

    The predominant view of the global financial crisis that began in 2007 is that it originated in the United States, and that financial innovation and an array of complex financial products had a leading role in the drama. US monetary policy, the housing bubble, US subprime mortgages, complex financial securities, regulatory loopholes, the handling of the failure of Lehman Brothers, and the strong belief of a few regulators in the power of markets are all blamed for what became a crisis that spread globally and led to large-scale government interventions in numerous countries. This narrative is particularly convenient for regulators...

  10. 6 Been Down This Road Many Times Before
    (pp. 147-170)

    A timeline that lays out major events in the history of financial regulation in the United States is quite revealing, but also downright disturbing. Whenever there has been a crisis originating in the financial sector, the governmental response has become all too predictable—establish more regulators and grant them more and broader powers (see figure 6.1). This approach has not worked over the past two centuries. The most obvious outcome of the cumulative reforms following crises is an overly complex and inefficient regulatory regime. More troublesome, regulators have frequently used their powers—or failed to use those powers—in ways...

  11. 7 More of the Same: Post 2007–2009 Financial Crisis Regulation
    (pp. 171-202)

    This time is no different. In response to the worst financial crisis since the Great Depression, the US government established more regulations, created new regulatory bodies, and granted the Guardians of Finance more and broader power, without addressing the core defects in the financial regulatory system that produced the crisis. The Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd–Frank) is certainly the longest reform law ever passed, and it gives regulators complete discretion with respect to bank capital standards, liquidity, requirements, and numerous other financial policy considerations. Furthermore, since the financial crisis was global in...

  12. 8 Making the Guardians of Finance Work for Us
    (pp. 203-232)

    The Guardians of Finance too frequently do not work for the public at large because the public lacks the institutional mechanism to compel financial regulators to do so. Around the world, there is no authoritative institution that (1) is independent of short-run politics, (2) is independent of the financial services industry, (3) has the power to demand and obtain information necessary for assessing and monitoring the Guardians of Finance, (4) contains the multidisciplinary expertise necessary for fruitfully processing that information, and (5) has the prominence to deliver such an assessment to the public and its elected representatives in a ongoing...

  13. Glossary
    (pp. 233-236)
  14. Notes
    (pp. 237-258)
  15. Index
    (pp. 259-278)
  16. About the Authors
    (pp. 279-280)