Redefining and Containing Systemic Risk

• Published in: Atlantic economic journal Vol. 38; no. 3; pp. 251 - 264
• Main Author: Kane, Edward J
• Format: Journal Article
• Language: English
• Published: Boston Boston : Springer US 01.09.2010; Springer US; International Atlantic Economic Society; Springer; Springer Nature B.V
• Series: Atlantic Economic Journal
• Subjects: Analysis; Default; Economic crisis; Economic policy; Economics; Economics and Finance; Employee incentives; Executive compensation; Financial crisis; Financial institutions; Financial services; Incentives; Indigent care; Insolvency; Insolvency detection; International Economics; Macroeconomics/Monetary Economics//Financial Economics; Microeconomics; Politics; Public Finance; Public officials; Rating services; Regulation; Risk; Safety net subsidies; Studies; Subsidies; Systemic risk; Taxpayers; United States; Insolvency detection; Systemic risk; Safety net subsidies; Financial crisis
• ISSN: 0197-4254; 1573-9678
• DOI: 10.1007/s11293-010-9233-3

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.