Edited by Kern Alexander and Rahul Dhumale
Chapter 3: Ethical Failures in Regulating and Supervising the Pursuit of Safety Net Subsidies
* Edward J. Kane Editors’ abstract: Professor Edward Kane argues that the crisis of 2007–2008 can be attributed to a major misalignment of the incentives of regulators and supervisors, managers, and investors. Political pressure contributed to these incentive problems and led to three contradictory elements: (1) politically-directed subsidies to beneficiaries; (2) subsidised provision of payment guarantees to bank creditors (i.e., depositors); and (3) defective monitoring of supervisors’ actions in controlling subsidies to leveraged risk-taking activity and weak accountability mechanism between regulators and public stakeholders. Kane observes that differences in regulatory rules and in levels of enforcement have led to a worldwide market for regulatory services and safety-net subsidies which results in regulators competing in the provision of subsidies to attract financial services firms to their jurisdiction which leads to a suboptimal level of regulation. He analyses how incentive-conflicted national regulatory cultures evolve and consist of values and practices that are determined slowly over time by changing ethical norms and principles. These norms and principles provide the basic framework for a regulatory community that influences the institutional design of regulation and supervision and the rules of a regulatory regime. He argues that rules are necessary in regulatory institutions because they limit the opportunity for ‘regulatees’ to take advantage of ‘gaps’ and ambiguities in regulations and in ethical standards that could otherwise result in behaviour that would undermine the objectives of a regulatory regime. These rules must be based, however, on clearly understood principles or values of a regulatory community. Moreover, the...
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