Redefining and Containing Systemic Risk

25 Pages Posted: 9 May 2010 Last revised: 27 May 2010

See all articles by Edward J. Kane

Edward J. Kane

Boston College - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: May 8, 2010

Abstract

Official definitions of systemic risk leave out the role of government officials in generating it. Policymakers’ support of creative forms of risk-taking and their proclivity for absorbing losses in crisis situations encourage opportunistic firms to foster and exploit incentive conflicts within the supervisory sector. To restore faith in the diligence, competence, and integrity of officials responsible for managing the financial safety net, reforms need to rework incentives in the government and financial sectors. The goal should be to align the incentives of private risk managers, accountants, credit-rating firms, and government supervisors with those of ordinary taxpayers. This article describes a series of complementary ways of advancing toward this goal. The most important steps would be to measure regulatory performance in terms of its effect on the loss exposures that the safety net passes through to taxpayers and to require institutions that benefit from the net to produce information that would support this effort. This entails estimating the explicit and implicit safety-net benefits individual institutions receive and issuing extended-liability securities whose prices would improve the accuracy of these estimates.

Keywords: Systemic Risk, Financial Crisis, Regulation, Supervision

JEL Classification: G28

Suggested Citation

Kane, Edward J., Redefining and Containing Systemic Risk (May 8, 2010). Available at SSRN: https://ssrn.com/abstract=1603323 or http://dx.doi.org/10.2139/ssrn.1603323

Edward J. Kane (Contact Author)

Boston College - Department of Finance ( email )

Fulton Hall
Chestnut Hill, MA 02467
United States
520-299-5066 (Phone)
617-552-0431 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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