Rational Financial Meltdowns

40 Pages Posted: 30 Aug 2014

See all articles by Manuel A. Utset

Manuel A. Utset

Florida State University College of Law

Date Written: August 28, 2014

Abstract

This article shows that the behavior of perfectly rational financial actors can cause financial meltdowns like the ones that occurred in 2007 and 2008. It analyzes the nature of informational asymmetries and group pathologies common in financial transactions and the role of intermediaries and markets in dealing with both. All other things being equal, the greater the costs associated with acquiring and processing information about transactional risks, the greater the option value of delaying investing in that information. This is important in financial transactions given the inherent complexity of the parties and financial contracts involved. The article argues that rational actors will have an incentive to delegate to financial intermediaries the risks associated with informational asymmetries. And that intermediaries themselves will often find it more economical to in turn transfer those risks to other intermediaries. This chain of “blind” transactions can become quite long, and can lead to information losses within a financial system. As a result, they can increase the likelihood of financial meltdowns.

Keywords: financial regulation, financial institutions, banking, systemic risk, financial contracts, bank runs, Dodd-Frank, financial meltdown, financial crisis

Suggested Citation

Utset, Manuel A., Rational Financial Meltdowns (August 28, 2014). Hastings Business Law Journal, Vol. 10, No. 2, 2014, FSU College of Law, Law, Business & Economics Paper No. 14-6, FSU College of Law, Public Law Research Paper No. 702, Available at SSRN: https://ssrn.com/abstract=2488828

Manuel A. Utset (Contact Author)

Florida State University College of Law ( email )

425 W. Jefferson Street
Tallahassee, FL 32306
United States
(850) 644-7274 (Phone)

HOME PAGE: http://law.fsu.edu/faculty-staff/manuel-utset-jr

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