Misdiagnosis: Incomplete Cures of Financial Regulatory Failures

Abstract

In the aftermath of the global financial crisis, U.S. authorities are attempting to improve financial regulation and supervision. This involves a three-step process: (1) diagnosis of what went wrong, (2) design regulatory and supervisory reforms that address these defects, and (3) implement the corrective reforms. In our paper, we argue that ongoing efforts to enhance U.S. financial regulation and supervision have faltered along each of these three dimensions. We support our arguments with several specific example that highlight deficiencies in the diagnosis of and policy response to the financial crisis. The focus is on regulatory and supervisory reforms since 2009. It is documented that the U.S. authorities misdiagnosed the causes of the crisis both by over-emphasizing factors that did not play decisive roles in causing the onset or the severity of the crisis and by under-emphasizing factors that did. As a result of the misdiagnosis, we explain how many of the reforms advanced by the authorities will do little to fix problems with the regulations and supervision of financial markets and institutions and improve the safety and soundness of the U.S. financial system.