CLS Blue Sky Blog
Dodd-Frank Act, financial regulatory reforms, Fintech
Business Organizations Law | Law
What should the government’s financial-crisis-response toolkit consist of? How should we think about its optimal scope and design? In Kate Judge offers a novel perspective on these questions. At a high level she agrees with Summers, Bernanke, Paulson, and Geithner that the existing toolkit is inadequate. In this respect she joins a number of other legal scholars and commentators. . .
The day after Lehman’s bankruptcy, Ken Rogoff—among the world’s leading experts on financial crises—wrote an op-ed titled “No More Creampuffs.” He applauded regulators for letting Lehman fail and “forc[ing] some discipline onto the system.” (To be fair, Rogoff acknowledged that “the risks are very real” and that “there really is no telling where the unprecedented failure of a big investment bank might lead”—but this is exactly my point.) Another prominent economist, Vincent Reinhart, opined that same day that “Lehman did not cast a long enough shadow over markets to warrant support.” It is easy to identify risks in hindsight, much harder ahead of time. Because a large, interconnected financial institution’s failure may imperil the financial system as a whole, such an institution would seemingly always be eligible for EGA support if on the brink of default—simply its size and interconnectedness. The distinction between “idiosyncratic” and “systemic” comes close to collapsing in these cases. The larger and more interconnected the institution, the more likely it will get a lifeline. And if the likelihood of support is an increasing function of size and complexity, firms have incentives to get bigger and more complex. This is a problem not just for Judge’s EGA proposal but for any system of discretionary public support for financial firms.
Guarantor of Last Resort: Is There a Better Alternative? CLS Blue Sky Blog.
Available at: https://scholarship.law.vanderbilt.edu/faculty-publications/1109