Capital Standards, Regulatory Ignorance and the Financial Crisis of 2008

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In their new book, “Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation” (University of Pennsylvania Press, 2011), Jeffrey Friedman and Wladimir Kraus argue that the primary cause of the financial crisis of 2008 was minimum capital standards intended to steer banks toward safer investments. Regulators adopted these standards with little understanding of how they related to other rules—especially those requiring mark-to-market accounting and those sanctioning ratings bureaus as the arbiters of investment risk. The result was a dangerous concentration of risky mortgage-backed securities at leading financial institutions. But Friedman and Kraus argue that the ultimate culprit is not a single policy decision, but rather the idea that systemic risk can be managed by the decisions of regulators—whose knowledge of the future is necessarily as limited and partial as the knowledge of those being regulated. In the face of uncertainty, the best protection against catastrophic failures like the collapse of 2008 is to permit multiple competing approaches toward financial risk, rather than imposing any single, uniform approach. At this AEI book forum, Friedman will present his book’s arguments, followed by comments from AEI’s Peter Wallison and Alex Pollock and a general discussion.

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About the Author

 

Christopher
DeMuth
  • Christopher DeMuth was president of AEI from December 1986 through December 2008. Previously, he was administrator for information and regulatory affairs in the Office of Management and Budget and executive director of the Presidential Task Force on Regulatory Relief in the Reagan administration; taught economics, law, and regulatory policy at the Kennedy School of Government at Harvard University; practiced regulatory, antitrust, and general corporate law; and worked on urban and environmental policy in the Nixon White House.

     

  • Phone: 2028625895
    Email: cdemuth@aei.org
  • Assistant Info

    Name: Keriann Hopkins
    Phone: 2028625897
    Email: keriann.hopkins@aei.org

 

Peter J.
Wallison

 

Alex J.
Pollock
  • Alex J. Pollock is a resident fellow at the American Enterprise Institute (AEI), where he studies and writes about housing finance; government-sponsored enterprises, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks; retirement finance; and banking and central banks. He also works on corporate governance and accounting standards issues.


    Pollock has had a 35-year career in banking and was president and CEO of the Federal Home Loan Bank of Chicago for more than 12 years immediately before joining AEI. A prolific writer, he has written numerous articles on financial systems and is the author of the book “Boom and Bust: Financial Cycles and Human Prosperity” (AEI Press, 2011). He has also created a one-page mortgage form to help borrowers understand their mortgage obligations.


    The lead director of CME Group, Pollock is also a director of the Great Lakes Higher Education Corporation and the chairman of the board of the Great Books Foundation. He is a past president of the International Union for Housing Finance.


    He has an M.P.A. in international relations from Princeton University, an M.A. in philosophy from the University of Chicago, and a B.A. from Williams College.


  • Phone: 202.862.7190
    Email: apollock@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: (202) 419-5212
    Email: emily.rapp@aei.org

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