Academic journal article Case Western Reserve Law Review

Back in the Saddle Again: But Which Way Do We Go from Here? A View of Agency Suggestions for Systemic Risk Regulation

Academic journal article Case Western Reserve Law Review

Back in the Saddle Again: But Which Way Do We Go from Here? A View of Agency Suggestions for Systemic Risk Regulation

Article excerpt


When you hear the term "systemic risk," (1) what is the first thing that pops into your mind? Do you think about a "run on the bank"? The subprime mortgage crisis? The collapse of Bear Stearns or Lehman Brothers? Bernie Madoff? All of these are elements of systemic risk, and presently there is no governing body that has the ability to regulate these kinds of risks on a grand scale.

Attempts to define systemic risk have led to confusion and uncertainty. Alan Greenspan acknowledged this uncertainty as he remarked: "It is generally agreed that systemic risk represents a propensity for some sort of significant financial system disruption.... [O]ne observer might use the term 'market failure' to describe what another would deem to have been a market outcome that was natural and healthy, even if harsh." (2) Through this definition and his later statements, Greenspan has acknowledged that the very definition of systemic risk is "still somewhat unsettled." (3)

Even honest attempts to analyze all the available definitions of systemic risk may not lead to a concrete understanding of the subject. However, the various definitions (4) share at least one basic element--systemic risk involves a trigger event that leads to a chain reaction of negative effects. (5) The Chairman of the Securities and Exchange Commission ("SEC"), Mary L. Schapiro, provided information about systemic risk in a recent speech. Chairman Schapiro stated that "there are two different kinds of 'systemic risk': (1) the risk of sudden, near-term systemic seizures or cascading failures and (2) the longer-term risk that our system will unintentionally favor large systemically important institutions over smaller, more nimble competitors, reducing the system's ability to innovate and adapt to change." (6) With the various definitions for systemic risk, and the difficulty in truly understanding systemic risk, the regulation challenge is even more pronounced.

This Comment explores various agency proposals for establishing some kind of systemic risk regulation with a single entity regulator. According to Chairman Schapiro there are two different types of systemic risk regulation: "(1) the traditional oversight, regulation, market transparency and enforcement provided by primary regulators that helps keep systemic risk from developing in the first place and (2) the new 'macro-prudential' regulation designed to identify and minimize systemic risk if it does [develop]." (7) The agency reports discussed throughout this Comment will focus on systemic risk regulation most similar to the types described by Chairman Schapiro. Part I will provide a background picture of systemic risk and outline the need for this kind of regulation. Part II will examine and compare the four main proposals. Finally, Part III will suggest future steps the government can take to establish a systemic risk regulator that prevents future financial meltdowns.


A. General Background

Following the financial collapse of 2008, the relevant agencies' (8) main concern revolved around the means of protecting the financial systems from systemic risk. This same financial crisis also paved the way for the idea of a systemic risk regulator. (9) The gaps in the financial system presented themselves in full force when the crisis began, at which point the flaws in the system became apparent to financial reformers. (10) According to Federal Reserve Chairman Ben S. Bernanke, the present financial crisis is the worst since the Great Depression, and it has "precipitated a sharp downturn in the global economy." (11) In discussing potential causes of the crisis, Bernanke further stated that the downturn occurred, at least in part, due to the fact that "risk-management systems of the private sector and government oversight of the financial sector ... failed to ensure that the inrush of capital was prudently invested, a failure that has led to a powerful reversal in investor sentiment and a seizing up of credit markets. …

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