Frank Partnoy returns to the subject he wrote about early in his academic career, the role of law and regulation in financial crises, with a new book chapter on Financial Systems, Crises, and Regulation. I read Frank's earlier 1999 article avidly: this was back before the topic was fashionable. This new chapter includes a discussion of theories of the roles that information asymmetries and agency costs play in propagating crises. Later, the chapter moves on to talk about mandatory disclosure, anti-fraud enforcement, and corporate governance as crisis prevention tools. This swims against the tide of conventional wisdom which has focused more on prudential financial regulation (which Partnoy also discusses) as antidote to crisis.
Here is a critical excerpt from the chapter:
In the aftermath of the 1929 crash, regulators imposed a twin pillar regime of mandatory disclosure and anti-‐fraud enforcement. Those two pillars were the key architecture features that supported well functioning markets for decades. Both have been eroded in recent years, as disclosures became boilerplate and anti-‐fraud prosecution more limited and infrequent. The response to the Global Financial Crisis could have included architecture moves to rebuild those pillars. But instead the Dodd-‐Frank legislation focused on other priorities and architecture changes in the areas of disclosure and anti-‐fraud enforcement were minimal.
This provocative line of thought raises an important question: If disclosure and corporate governance rules are key for systemic risk too, should these rules be tailored for financial institutions? After all, Coca Cola's securities disclosure and corporate governance played no role in our latest crisis. Shouldn't we tailor securities disclosure and corporate governance reforms for banks rather than a blunderbuss approach? After all, banks (including those by any other name) are special; they play special roles in the economy and pose special risks.
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