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Ethical Failures in Regulating and Supervising The Pursuit of Safety Net Subsidies

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  • Edward J. Kane

Abstract

This paper traces the financial institution crisis of 2007-2008 to a breakdown in the incentives of regulators, supervisors, managers, and investors to perform adequate due diligence on securitized investments. Investors allowed their trust in the reputations of credit rating firms and the giant financial firms that manufactured highly rated tranches of securitized loan pools to blind them to the casino ethics of these firms’ managers and line employees. Government credit allocation schemes generate incentive conflicts that undermine the effectiveness of government supervision and eventually produce financial crisis. In 2007-2008, technological change and regulatory competition led incentive conflicted supervisors to outsource much of their due discipline to credit rating firms and accountants. This outsourcing encouraged institutions to leverage and securitize their loans in ways that pushed credit risks on poorly underwritten loans into hidden corners where supervisors and credit ratings firms were not obliged to look for them and failed to discern the dangers posed until it was too late.

Suggested Citation

  • Edward J. Kane, 2008. "Ethical Failures in Regulating and Supervising The Pursuit of Safety Net Subsidies," NFI Working Papers 2008-WP-12, Indiana State University, Scott College of Business, Networks Financial Institute.
    • Handle: RePEc:nfi:nfiwps:2008-wp-12
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    References listed on IDEAS

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    1. Honohan, Patrick & Klingebiel, Daniela, 2003. "The fiscal cost implications of an accommodating approach to banking crises," Journal of Banking & Finance, Elsevier, vol. 27(8), pages 1539-1560, August.
    2. Kane, Edward J, 1977. "Good Intentions and Unintended Evil: The Case against Selective Credit Allocation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 9(1), pages 55-69, February.
    3. Kane, Edward J., 2003. "What kind of multinational deposit-insurance arrangements might best enhance world welfare?," Pacific-Basin Finance Journal, Elsevier, vol. 11(4), pages 413-428, September.
    4. Barth,James R. & Caprio,Gerard & Levine,Ross, 2008. "Rethinking Bank Regulation," Cambridge Books, Cambridge University Press, number 9780521709309, January.
    5. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-325, August.
    6. Kane, Edward J, 1988. "Interaction of Financial and Regulatory Innovation," American Economic Review, American Economic Association, vol. 78(2), pages 328-334, May.
    7. Larry D. Wall, 1997. "Taking note of the deposit insurance fund: a plan for the FDIC to issue capital notes," Economic Review, Federal Reserve Bank of Atlanta, vol. 82(Q 1), pages 14-30.
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    Cited by:

    1. Cardillo, Giovanni & Cotugno, Matteo & Perdichizzi, Salvatore & Torluccio, Giuseppe, 2024. "Bank market power and supervisory enforcement actions," International Review of Financial Analysis, Elsevier, vol. 91(C).
    2. Gerard Caprio & Asli Demirgüç-Kunt & Edward J. Kane, 2010. "The 2007 Meltdown in Structured Securitization: Searching for Lessons, not Scapegoats," The World Bank Research Observer, World Bank, vol. 25(1), pages 125-155, February.
    3. Argandoña, Antonio, 2012. "Three ethical dimensions of the financial crisis," IESE Research Papers D/944, IESE Business School.
    4. Chris Terry, 2009. "The new Basel Capital Accord: A major advance at a turbulent time," Agenda - A Journal of Policy Analysis and Reform, Australian National University, College of Business and Economics, School of Economics, vol. 16(1), pages 25-44.
    5. Argandoña, Antonio, 2009. "Can corporate social responsibility help us understand the credit crisis?," IESE Research Papers D/790, IESE Business School.

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    More about this item

    Keywords

    Financial Crisis; Regulation; Financial Safety Net; Subsidies; Credit Allocation;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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