Greenspan's Lament: Incentive Mechanisms and the Contamination of the Safety and Soundness of Depository Institutions from Risky Derivative SecuritiesTransactions: The Tennessee Jounal of Business Law (2009)
AbstractThe attached paper attempts to synthesize the foundational tools of industrial organization economics and how they interacted with law and public policy choices to explain the genesis of the current competitive dynamics in banking and financial products. The paper examines the underlying assumptions of microeconomic theories of efficiency and competitive equilibrium including externalities, information asymmetry, game theory and mechanism design, and how those combine dynamically with the process of formation, implementation and adjudication of the law to allow actors to rationally and systematically adjust their ownership structures and their transaction costs to internalize benefits and externalize costs and risk. This dynamic played out before us in the current financial crisis, illustrated dramatically in the abandonment of concerns over “subtle risks” embedded in the Glass-Steagall Act as we evolved toward an integrated financial services industry, eventually enshrined in the Gramm-Leach-Bliley Act. During the process of this evolution, notional values of credit and interest rate derivatives grew to over $460 trillion, dwarfing global GDP and market capitalizations. Yet, the SEC describes their regulation as “lacuna,” and bank regulatory authorities have acquiesced in their widespread use despite their threat to safety and soundness. The paper contrasts the policy concerns over safety and soundness of the banking system with those of disclosure of risk to allow freedom of contract in the securities regime. These different policy objectives may require prophylactic measures and regulation to avoid contamination of the health of the depository institutions from these credit derivatives.
Publication DateSpring 2009
Citation InformationDaniel J Boyle. "Greenspan's Lament: Incentive Mechanisms and the Contamination of the Safety and Soundness of Depository Institutions from Risky Derivative Securities" Transactions: The Tennessee Jounal of Business Law Vol. 10 Iss. Spring 2009 (2009)
Available at: http://works.bepress.com/daniel_boyle/1/