Misdiagnosis: Incomplete Cures of Financial Regulatory Failures

Oct 22, 2014

By James R. Barth, Gerard Caprio Jr., and Ross Levine

Publisher: Milken Institute

Regulatory authorities in countries around the world are attempting to improve financial regulation and supervision. In the aftermath of the global financial crisis, these attempts involve a three-step process: (1) diagnose what went wrong, (2) design regulatory and supervisory reforms that address these defects, and (3) implement the corrective reforms.

We argue that US efforts to enhance financial regulation and supervision have faltered along each of these three dimensions. In particular, we provide numerous examples demonstrating that US authorities misdiagnosed, or perhaps in some cases even wilfully disregarded, the causes of the crisis both by overemphasizing factors that did not play decisive roles in causing the onset or severity of the crisis and by underemphasizing factors that did. To increase regulatory accountability and help prevent another financial crisis, we propose the creation of an agency that would have access to all of the information available to regulators and whose sole function would be to publish regular reports on the key systemic risks in the financial system, and assessments of the adequacy of regulators’ responses.