Regulation and The Great Recession
Markets are institutions where participants take part in the supply and demand of goods. With certain rules, participants can work towards the most efficient use of resources. When the rules do not create the right incentives, such as when there is a total lack of rules, they may lead to inefficient uses of resources. The U.S. financial sector has undergone waves of increased and decreased regulatory pressure since the 1960's, as demonstrated by the evolution of the Community Reinvestment Act, and the amendment of the Glass-Steagall Act. These regulatory changes were the result of government attempts to increase home ownership, but in the process they created small but significant misalignments of incentives. Financial innovations became tools to hide risks rather than tools to disperse risk. There was little transparency and no accountability: it was impossible to trace the asset that backed a security. As a result, investors took on excessive risks thinking they were being conservative. The goal of the financial reform is to increase transparency, accountability and the availability of information in the financial sector, as well as supervising large financial institutions whose failure can threaten the entire economic system.
In short, the misalignment of incentives stemming from changes in financial regulatory policy was one of the causes of the financial crisis. New regulation is expected to prevent future financial crises by taking a view of the financial system as a whole, and determining how to reposition incentives in order to minimize market exposure to systemic risk.
In short, the misalignment of incentives stemming from changes in financial regulatory policy was one of the causes of the financial crisis. New regulation is expected to prevent future financial crises by taking a view of the financial system as a whole, and determining how to reposition incentives in order to minimize market exposure to systemic risk.
Timeline
• 1933: Glass-Steagall Act is created
• 1960s: Senate allows commercial banks to enter municipal bonds market
• 1970s: Brokerage firms start acting like commercial banks (eg: offer checking accounts)
• 1977 Congress passes the Community Reinvestment Act
• 1986: Commercial banks can have up to 5% revenue from investment banking activities
• 1987: Commercial banks can underwrite commercial paper
• 1989 FIRREA, “Glass-Steagall loophole”
• 1994: Riegle-Neal Act
• 1995 CRA Amendments
• 1999: Glass-Steagall Repeal
• 2005: CRA Regulatory Amendments Finalized
• 2009 Obama’s Financial Reform Bill was introduced
• 1933: Glass-Steagall Act is created
• 1960s: Senate allows commercial banks to enter municipal bonds market
• 1970s: Brokerage firms start acting like commercial banks (eg: offer checking accounts)
• 1977 Congress passes the Community Reinvestment Act
• 1986: Commercial banks can have up to 5% revenue from investment banking activities
• 1987: Commercial banks can underwrite commercial paper
• 1989 FIRREA, “Glass-Steagall loophole”
• 1994: Riegle-Neal Act
• 1995 CRA Amendments
• 1999: Glass-Steagall Repeal
• 2005: CRA Regulatory Amendments Finalized
• 2009 Obama’s Financial Reform Bill was introduced