Causes, Consequences and Implications for Reform
Edited by Lawrence E. Mitchell and Arthur E. Wilmarth, Jr
Chapter 9: Regulating the Financial Markets by Examinations
9. Regulating the financial markets by examinations Tamar Frankel SUMMARY This chapter proposes changing future government examinations of market intermediaries and focusing on bubbles and crashes as the main dangers to the financial system and the economy. Prior substantive regulation has an undesirable effect on innovations and freedom of the markets. Regulating after a crash (when the ‘horse has left the barn’) is undesirable and ineffective. Therefore the chapter proposes tighter and closer examinations somewhat different from the current ones: (1) Examine more frequently when market prices rise (not when they have fallen). (2) Examine entities that are too large to fail; those that are highly leveraged; those whose shares-prices rise steadily with little or no fluctuation; and entities that have obtained exemptions from regulation. (3) Examiners should search for violations of the law (and the spirit of the law), but not economic or financial rationalizations. (4) Examiners should be experts, highly paid and incentivized to remain in government employ. Expert information about the markets will hopefully reduce the impact of bubbles and inevitable crashes and the loss of investors trust that decimates the financial system. INTRODUCTION It is time to reevaluate the regulation of the financial markets. This reevaluation should include the fundamental regulatory philosophy and its implementation. For the past 60 years two principles guided market regulation. One principle was disclosure by securities issuers to investors. The second principle underlying market regulation was self-regulation by the financial intermediaries, subject to the supervision of the Securities and Exchange Commission...
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