The Faculty Lounge continues to be the hub for law professor posts on the Greek crisis (how long will we be able to call it just that? Remember when the global credit crisis was “just” the subprime crisis). Anna Gelpern posts again on defending the EU/IMF bailout.

Since all Greek tragedy is supposed to be moral education, here’s another reflection on the implications of the Greek crisis for our own financial reform. On an abstract, macroeconomic level there are many parallels between the causes of the Greek crisis and some of the narratives on the causes of our own domestic crisis. Most notably, a lot of foreign capital from creditor nations helped fuel a borrowing binge and a bubble.

As I’ve written last week, one of the less explored facets of financial reform is fixing the incentives of regulators. To put it bluntly, how do we make sure regulators do not fall asleep at the wheel?

There is often a strong connection between low interest rate environments, lending/borrowing binges, and the failure of regulation to meet its objectives – be it safety-and-soundness of financial institutions or protection of investors and consumers. At the same time, boom times provides a strong disincentive for regulators to do their jobs. So we get a cycle of deregulation (or under-regulation) followed by re-regulation after the crash.

One way to fix the incentives of regulators is to think about creating triggers for either regulations to kick in or at least for regulators to conduct some sort of readiness review. At the very least, this would short circuit post hoc apologia like “we could never have seen this Black Swan coming.” The question is what would those triggers look like?

Economic analysis of the Greek crisis has provided an array macroeconomic gauges of debt and trade/capital imbalances (Gelpern cites budget deficit, public debt, and current-account deficit measured as a percentage of GDP; see this Economist article for other metrics) as a means to determine which would be the next Eurozone countries to be hit by contagion. We might also examine whether some of these gauges would be appropriate triggers for crisis prevention regulation.

You might say that, depending on the metric chosen, some very large, advanced countries like Japan and the United States have been ripe for a crisis for years. There’s two responses to an alarm that keeps going off. You can keep judge the alarm faulty and keep hitting snooze. Or you can actually wake up.

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