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What You Can’t Know Might Hurt You: Regulation and Risk Generators in Financial Reform Efforts in the U.S. and the Europ

What You Can’t Know Might Hurt You: Regulation and Risk Generators in Financial Reform Efforts in the U.S. and the European Union. Mark Blyth Brown University and the Watson Institute February 2009 * *with apologies for (some) wrong dates on the X-axis (Macintosh Excel problem).

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What You Can’t Know Might Hurt You: Regulation and Risk Generators in Financial Reform Efforts in the U.S. and the Europ

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  1. What You Can’t Know Might Hurt You: Regulation and Risk Generators in Financial ReformEfforts in the U.S. and the European Union Mark Blyth Brown University and the Watson InstituteFebruary 2009* *with apologies for (some) wrong dates on the X-axis (Macintosh Excel problem)

  2. Innovation, Access and Growth…a few questions • Does innovation necessarily add to growth? • Is access to finance necessarily linked to the degree of financial innovation? • Is global business growth related to financial innovation? • How does financial innovation feature in the recent global financial crisis?

  3. Government Responses to the Crisis:Capitalization, Liquidity or Confidence Building? International Monetary Fund

  4. And this might be bad because…

  5. Governments levered-up as the private sector de-levered International Monetary Fund

  6. And so public debt (and hence YOUR future tax burden) soared International Monetary Fund

  7. WHY DID THE WORLD BLOW UP? SOME COMMON (AND NOT WRONG) EXPLANATIONS

  8. Prime Suspects Local - USA • The Subprime Trigger • “Too Loose” Monetary Policy Global – USA + China • Wall Mart Dollar Recycling • Sequential Bubbles Stoked by Financial Innovation?

  9. What You Can’t Know That Might Hurt You…The Risk Generators that Financial Regulation Cannot Account for (in advance at least…) 1) Bonuses: “Its not the amount of the bonus, it’s the damage the bonus system generates that’s important” (European Central Banker) 2) Model Homogeneity and Tail Risk: “The Math Doesn’t Work” (Professor of Mathematics/Industry Consultant) 3) Model Fit: “Even Texas isn’t Texas any More” (Senior Ratings Agency Economist) 4) Correlation Bombing: “Gaming the Ratings Agencies was Easy” (Hedge Fund Financial Engineer) 5) Ideology: “We just didn’t think in terms of Systemic Risk” (Federal Regulator) 6) Instruments and Innovation: “They are only WMD in the right hands” (CDS trader)

  10. So What Does this Mean for Regulation? • Current Plethora of reforms proposals in US and EU miss these risk generators • Develop a Consumer Product Safety Commission and consolidate regulators (US) • Focus on Instruments and Types of Firms (France, US) • Focus on Positions as a proxy for Systemic Risk via macro-prudential oversight boards (EU, UK)

  11. And What does this Mean for Financial Innovation? • It continues, but its not clear that it adds to business financing or growth outside of finance itself • Is the game worth the candle when the candle costs $4trillion dollars? • Can we Identify the ‘right’ kind of innovation?

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