Oversight & Regulation of Financial Institutions
In the article entitled "How Financial Oversight Failed & What it May Portend for the Future of Regulation," economist Richard J. Herring identifies the government policies he believes contributed to the current financial crisis. These policies include:
Credit rating outsourcing.
Government housing.
The call for investment banks to form holding companies.
Basel I and Basel II minimum capital requirements.
After describing the policies and the financial repercussions of each in detail, Herring presents three arguments in favor of the policies, followed by three refutations of these arguments. From there, Herring goes on to address the principal/agent problems surrounding the financial crisis in both the private and public sectors, and then concludes with the description of two incentive plans -- contingent capital and resolution policy -- he believes will encourage "greater market discipline" (Herring, 2010).
Regarding credit rating outsourcing, Herring argues that outsourcing caused a "regulatory-induced increase in the demand for highly rated assets . . . [of] investment grade or higher" (Herring, 2010). The result of this demand was an imposed pressure on credit rating organizations (CROs) to rate institutions more liberally than they otherwise might have been inclined to. An institution whose credit rating would at one time have been rated average or slightly below average, was then being rated as slightly above average, which in turn skewed the perception of the institution's stability or lack thereof, resulting in a rapid decline credit rating standards. It is here that Herring puts forth his thesis statement: "What began as an attempt to improve the supervision of credit risk ultimately had the unintended consequence of exposing the financial system to a devastating credit shock" (Herring, 2010).
Regarding the government housing policy, Herring argues that imposed...
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