Regulatory Reform in the Wake of the Financial Crisis of 2007—2008
Author(s)Lo, Andrew W.
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Purpose – The purpose of this paper is to analyse regulatory reform in the wake of the financial crisis of 2007-2008. Design/methodology/approach – The paper proposes a framework for regulatory reform that begins with the observation that financial manias and panics cannot be legislated away, and may be an unavoidable aspect of modern capitalism. Findings – Financial crises are unavoidable when hardwired human behavior – fear and greed, or “animal spirits” – is combined with free enterprise, and cannot be legislated or regulated away. Like hurricanes and other forces of nature, market bubbles, and crashes cannot be entirely eliminated, but their most destructive consequences can be greatly mitigated with proper preparation. In fact, the most damaging effects of financial crisis come not from loss of wealth, but rather from those who are unprepared for such losses and panic in response. This perspective has several implications for the types of regulatory reform needed in the wake of the financial crisis of 2007-2008, all centered around the need for greater transparency, improved measures of systemic risk, more adaptive regulations, including counter-cyclical leverage constraints, and more emphasis on financial literacy starting in high school, including certifications for expertise in financial engineering for the senior management and directors of all financial institutions. Originality/value – The paper stresses how we must resist the temptation to react too hastily to market events, and deliberate thoughtfully and broadly, instead, craft new regulations for the financial system of the twenty-first century. Financial markets do not need more regulation; they need smarter and more effective regulation.
DepartmentSloan School of Management
Journal of Financial Economic Policy
Emerald Group Pub.
Lo, Andrew W. “Regulatory reform in the wake of the financial crisis of 2007-2008.” Journal of Financial Economic Policy 1.1 (2009): 4-43.
Author's final manuscript