The Politics of Financial Regulation and the Regulation of Financial Politics
75 PagesPosted: 3 Mar 2014Last revised: 21 Mar 2014
Date Written: March 21, 2014
This review essay considers six recent books on the financial crisis (Bernanke, Blinder, Bair, Barofsky, Connaughton, and Admati & Hellwig). The essay discerns two basic narratives of the crisis in these books and in the regulatory response to the crisis: the perfect storm narrative and the regulatory capture narrative. The perfect storm narrative is a story of dynamic financial markets outpacing static regulation, which was then overwhelmed by a perfect storm. In this narrative, no one was at fault for 2008, and financial regulators were the heroes who saved the economy. The regulatory capture narrative, in contrast, is a story of a completely preventable crisis that was enabled by feckless regulators who deserve faint praise for putting out the fire they started.
Most of the policy response to the crisis responds to the problems perceived by the perfect storm narrative. Yet, it is hard not to credit the regulatory capture narrative to at least some degree, and most of the books reviewed acknowledge a capture problem. Some post-crisis reforms are in fact responsive to perceived capture problems: the elimination of the Office of Thrift Supervision, the change in federal preemption standards, the creation of the Consumer Financial Protection Bureau, and the Durbin Interchange Amendment. These responses, however, represent very different approaches to capture. The CFPB is a doubling down on agency independence, while the Durbin Interchange Amendment represents an embrace of political contestation of policy that carries on the Glass-Steagal Act's tradition of divide-and-conquer on industrial organization lines.
The essay argues that the lesson from the books reviewed is that we are simply having the wrong debate about financial regulation. The real issue in financial regulation is politics, not technical regulatory questions. A focus on the technical details of regulation without addressing the politics of financial regulation will result in unsustainable regulatory reforms. Only by reforming the politics of financial regulation will we achieve lasting financial regulation that achieves the socially optimal balance of stability and growth.
To this end, the essay explores the range of approaches to dealing with financial politics illustrated in the Dodd-Frank Act and suggests that rather than doubling down on agency independence, we might do better by trying to harnessing rent-seeking impulses through industrial organization in order to neutralize political influence on the regulatory process.
Keywords: financial crisis, bailout, Federal Reserve, cramdown, capture, CFPB, Durbin, interchange, money market mutual funds, NAV
JEL Classification: G21, G28, K23
Suggested Citation:Suggested Citation
Levitin, Adam J., The Politics of Financial Regulation and the Regulation of Financial Politics (March 21, 2014). Harvard Law Review, Vol. 127, 2014. Available at SSRN: https://ssrn.com/abstract=2401298
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Title: Bank regulation in a post-financial crisis landscape : essays of the interaction between financial institutions
Author: WERGER, Charlotte
Citation: Florence : European University Institute, 2016
Series/Number: EUI PhD theses; Department of Economics
This thesis is a nexus of three topics; financial stability, banking regulation and financial influence. In four separate chapters, this work examines how financial institutions interact with their regulators, in particular after the financial crisis of 2008. Size, incentives, guarantees, moral hazard, treatment, capture and influence play an important role in the analysis. The first chapter focusses on the relation between bank size and support, confirming the hypothesis that bank size is positively related to support ratings. It also finds evidence that the effect is non-linear, confirming the ‘too-big-to-rescue’ theory. Chapter two tests whether the expectation of individual and systemic government support induces moral hazard. It shows that banks tend to be more leveraged, funded with capital of lower quality, more heavily invested in risky assets and exposed to more severe liquidity mismatch when they are perceived as being more likely to benefit from government support. In the last two chapters the focus is shifted to banks’ political activities and connections. Both chapters leverage a unique dataset that links U.S. banks’ sources of influence (e.g., lobbying expenditures, proximity to the relevant legislative committee, prior affiliation with regulatory or government institutions) to bank financial data, actual bank supervisory actions, and market-inferred expected government support. The findings in chapter three suggest that banks’ political influence indeed matters for the regulatory treatment of distressed banks, as well as for the expectation of support regardless of bank distress. Chapter four further dives into determinants of bank lobbying, and explores whether political connections and risk taking influence the decision to lobby. In combination, these findings are instructive for understanding the political landscape surrounding banks and their regulators. It also helps us to have a broader understanding of what drives government support to banks, and how in turn that support can trigger moral hazard within banks.
LC Subject Heading: Banks and banking; Banks and banking -- Government policy; Financial crises -- Prevention; Bank failures
Defence date: 4 February 2016; Examining Board: Professor Elena Carletti, Bocconi University and EUI, Supervisor; Professor Evi Pappa, EUI; Professor Luca Deidda, Universita’ di Sassari; Professor Wilko Bolt, Dutch Central Bank.
Type of Access: openAccess
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