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Regulation and Sausages
File(s)
Manchester School v2.docx (67.57 KB)
Accepted version
Author(s)
Gale, DM
Type
Journal Article
Abstract
The experience of market disruption during the recent financial crisis has focused attention on the requirements for increasing the resilience of financial markets. Theoretical research has provided new insights into the sources of “market freezes.” These models offer new explanations for the sudden drying up of liquidity in terms of adverse selection, ambiguity aversion, coordination failure, hoarding and market manipulation. The challenge is to make use of these insights to help design better regulatory frameworks and improve the structure of the financial system. Reform of the regulatory framework has taken the form of increasing capital requirements and liquidity coverage ratios (Basel III) and restricting proprietary trading (Dodd-Frank), but it does not attempt to reform the structure of the financial sector. The analysis of the moral hazard created by bailouts suggests that institutions that are “too big (interconnected, important, complex) to fail” (TBTF) should be eliminated. Equally, the analysis of market freezes suggests that innovations in the “parallel banking system” (PBS) have the potential to provide a more resilient structure for the financial system, but there has been no attempt to revive the PBS. The failure to eliminate TBTF or revive the PBS represents a lost opportunity and leaves the financial system vulnerable to future crises.
Date Issued
2015-08-24
Date Acceptance
2015-03-27
Citation
The Manchester School, 2015, 83 (Supplement S2), pp.1-26
URI
DOI
ISSN
1467-9957
Publisher
Wiley
Start Page
1
End Page
26
Journal / Book Title
The Manchester School
Volume
83
Issue
Supplement S2
Copyright Statement
This is the peer reviewed version of the following article: Gale, D. (2015), Regulation and Sausages. The Manchester School, 83: 1–26. doi: 10.1111/manc.12109, which has been published in final form at https://dx.doi.org/10.1111/manc.12109.  This article may be used for non-commercial purposes in accordance With Wiley Terms and Conditions for self-archiving.
License URL
Publication Status
Published