Financial Markets and Institutions (2-downloads)

1. Fully privatize them by taking away their government sponsorship, thereby

removing the implicit backing for their debt.

2. Completely nationalize them by taking away their private status and make

them government agencies.

3. Leave them as privately owned government-sponsored enterprises, but

strengthen regulations to restrict the amount of risk they take and to impose

higher capital standards.

4. Leave them as privately owned government-sponsored enterprises, but

force them to shrink dramatically in size so they no longer expose the

taxpayer to huge losses or pose a systemic risk to the financial system

when they fail.

Credit Rating Agencies

Regulations to restrict conflicts of interest at credit rat-

ing agencies and to give them greater incentives to provide reliable ratings have

already been strengthened in the aftermath of the 2007–2009 financial crisis, but

even more is likely to be done. The inaccurate ratings provided by credit rating

agencies helped promote risk taking throughout the financial system and led to

investors not having the information they needed to make informed choices about

their investments. The reliance on credit ratings in the Basel 2 capital require-

ments may also have to be rethought, given the poor performance of credit rat-

ing agencies in recent years.

The Danger of Overregulation

As a result of the 2007–2009 financial crisis, the

world of financial regulation will never be the same. Although it is clear that more

regulation is needed to prevent such a crisis from ever occurring again, there is a

substantial danger that too much or poorly designed regulation could hamper the

efficiency of the financial system. If new regulations choke off financial innova-

tion that can benefit both households and businesses, economic growth in the

future will suffer.

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Chapter 18 Financial Regulation