Delegation and the Regulation of Financial Markets

Abstract

We explore the determinants of U.S. financial market regulation with a formal model of the policy-making process in which government regulates financial risk at both the firm and systemic levels, and test these predictions with a novel, comprehensive data set of financial regulatory laws enacted since 1950. We find that political factors impact Congress' decision to delegate regulatory authority to executive agencies, which in turn impacts the stringency of financial market regulation. In particular, Congress delegates authority to regulators when: 1) policy preferences between Congress and executive officials become more similar; 2) Firms' investment risks become more uncertain; and 3) Congress' concerns about a bailout are greater. As a result, financial markets are more heavily regulated when firm-specific and systemic risks are uncertain. However, when inter-branch preferences differ or perceived systemic risk is low, Congress may allow risky investments to be made that, ex post, it wished it had regulated.