Perspectives on Regulating Systemic Risk

Abstract

This book chapter, which synthesizes several of the author’s articles, attempts to provide useful perspectives on regulating systemic risk. First, it argues that systemic shocks are inevitable. Accordingly, regulation should be designed not only to try to reduce those shocks but also to protect the financial system against their unavoidable impact. This could be done, the chapter explains, by applying chaos theory to help stabilize the financial system. The chapter then focuses on trying to prevent excessive corporate risk-taking, which is one of the leading triggers of systemic shocks and widely regarded to have been a principal cause of the financial crisis. It begins by inquiring why so few managers have been prosecuted for the excessive corporate risk-taking that led to the financial crisis. Targeting managers in their personal capacity would be a greater deterrent to excessive risk-taking than fallbacks such as imposing firm-level liability. The chapter finds, however, a host of reasons why managerial prosecution is not — and is unlikely to become — a credible deterrent. Finally, the chapter examines how else excessive risk-taking could be regulated, including by mandating a public governance duty and narrowing limited liability protection for owner-managers of shadow-banking firms.