Behavioral Economics, Regulatory Games and Errors, and Why the Next Global Financial Crisis Might Be Inevitable (?)

Abstract

The major argument of this working paper is that the findings and insights from the behavioral, neuroscience and wicked problem literatures, and their implications for past, current and future regulatory errors, will play an important role in determining whether, why, how and when the next global financial crisis will take place. The paper therefore brings a behavioral economics and regulatory error lens to current, contested and unresolved debates on the drivers and causes of the last global financial crisis, and the anticipated causes of the next crisis -- which based on the extensive literature and numerous blogs reviewed by the author has nearly as many predicted causes as the number of authors who have offered their perspectives on this topic. The working paper describes a number of major findings and cross-cutting themes, which require greater research and policy analysis from a behavioral regulatory perspective. These themes include: (i) The much greater diversity, complexity and “wicked” characteristics of financial markets, products, instruments, institutions, and business relationships compared with most other regulated markets and industries; (ii) How and why this diversity, complexity and “wickedness” are magnified during a crisis, leading to even greater risk, frequency and consequences of regulatory error. (iii) The potential for reducing the risk and frequency of regulatory errors when governments and external stakeholders become more aware of the many sources and reasons for regulatory error, and focus greater attention on the benefits that many companies receive from well designed and effective regulatory authorities and regimes. (iv) The differences between micro- and mega-regulatory errors and their contributions to explaining why national and international financial regulatory reform efforts after the last crisis are deemed by many to be incomplete and inadequate for preventing the next crisis. (v) The regulatory errors that result from the misdirected efforts of governments and their regulatory authorities to sustain and protect their reputations for competence and serving the public interest. (vi) And the role and contributions of the intentional strategies of “strategic complexity” of global banks, other financial intermediaries, and other international corporations to transforming national financial problems into global financial crises. The major conclusion of the working paper is that the micro-and mega-regulatory errors that impede financial market regulatory reform and are expected to contribute to the next global financial crisis would be best addressed and minimized through the establishment and operation of more inclusive, polycentric, responsive and shared accountability financial regulatory regimes at the sub-national, national, multi-national and global scales -- based on what is called the “sustainable governance” model and approach to regulatory compliance, performance and success.