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When Free Markets Fail: Saving the Market When It Can't Save Itself

When Free Markets Fail: Saving the Market When It Can't Save Itself

Scott McCleskey

ISBN: 978-1-119-20011-6 September 2015 198 Pages


Authoritative guidance for navigating inevitable financial market regulation

The reform of this country's financial regulation will be one of the most significant legislative programs in a generation. When Free Markets Fail: Saving the Market When It Can’t Save Itself outlines everything you need to know to stay abreast of these changes.

  • Written by Scott McCleskey, a Managing Editor at Complinet, the leading provider of risk and compliance solutions for the global financial services industry
  • Looks at the intended result of these regulations so that institutions and individuals will have a greater understanding of the new regulatory environment
  • Offers a realistic look at how these regulations will affect anyone who has a bank account, a car loan, a mortgage or a credit card
  • Covers the reforms that have been enacted and looks forward to future reforms

Both theoretical and practical in approach, When Free Markets Fail provides a strong overview of coming regulation laws with insightful analysis into various aspects not easily understood.

Acknowledgments xi

About the Author xiii

Preface: In Defense of Regulation (and of Free Markets) xv

In the Beginning, There Was Adam xvi

The Shift from Philosophy to Math xvii

Can Markets Regulate Themselves? xix

Regulation versus Justice xx

Conclusion xx

Introduction: Why Regulatory Reform Matters to You xxiii

The Structure of the Book xxv

Chapter 1: Meltdown in the Markets: Systemic Risk 1

How Systemic Risk Works 2

The Case for Government Intervention 9

Why Hasn’t the System Collapsed Before? 10

Conclusion 12

Chapter 2: Can an Institution Be Too Big to Fail? 15

Policy Options 17

Conclusion 22

Chapter 3: Moral Hazard 24

The Theory 25

The Reality 26

Punish the Leaders, Not the Organization 27

The Other Moral Hazard 28

Conclusion 30

Chapter 4: Toxic Assets 31

What Are Toxic Assets, and Why Are They Toxic? 32

Building Low-Risk Assets Out of High-Risk Ones 33

Credit Rating Agencies and Structured Finance Products 35

Credit Default Swaps 37

Conclusion 40

Chapter 5: Should Regulation Stifle Innovation? 41

Policy Implications 44

Conclusion 45

Chapter 6: Rewarding Success, Rewarding Failure: Incentives and Compensation 46

Big Brother is Paying You 47

Regulating the Level of Pay 47

Performance Goals and Risk 49

Methods of Aligning Reward with Risk 50

Who Matters? 53

The 2009 Federal Reserve Guidance 53

Was Adam Smith Right? 56

Chapter 7: Who Protects the Consumer? 57

Were Existing Regulations Effective? 59

Is a Separate Consumer Regulator the Right Answer? 61

What Powers Would the Agency Have? 65

A Word about Consumer Protection and Systemic Risk 67

Conclusion 68

Chapter 8: Transparency: Letting the Sun Shine In, or Sipping Water from a Firehose? 69

Transparency as Regulation 69

Degrees of Transparency 71

What to Consider When Transparency Is the Proposed Remedy 73

Chapter 9: Rebuilding the Regulatory Structure 75

Why So Many Regulatory Agencies? 76

The SEC and the Investment Banks 77

The Federal Reserve 78

Other Proposed Changes 79

Consumer Protection 80

Do We Need a Systemic Regulator? 80

To Concentrate or Not to Concentrate 81

Chapter 10: Rating the Raters: The Role of Credit Rating Agencies 83

NRSRO Status 84

How Ratings Are Made 89

What Really Keeps the Rating Agencies Up at Night (And It Is Not Your Mortgage) 92

The End of the NRSRO? 94

Conflicts in the Rating Agency Business Model 97

Are Rating Agencies Utilities? 97

Conclusion 98

Chapter 11: The Politics of Regulation 100

The Political Process 101

Chapter 12: Nice Law, Now Go Do It: Regulators and Compliance Officers 106

The SEC 107

Examinations and Inspections 108

Conduct of Examinations 110


Compliance Departments 113

Conclusion 119

Chapter 13: Cost-Benefit Analysis 121

Basics of Cost-Benefit Analysis 122

The Benefits of Cost-Benefit Analysis 128

Government Use of Cost-Benefit Analysis 129

Cost-Benefit Analysis as a Negotiating Tactic 130

Conclusion 132

Chapter 14: It’s a Small World, After All 133

Sunday Is the New Monday 133

Overseas Regulators 135

International Organizations 139

Conclusion 141

Chapter 15: Where Do We Go from Here? Conclusions, Observations, and Recommendations 142

Modern Markets Are Too Complex to Regulate Themselves 143

Planning for the Next Crisis 144

The Need for a Professionalized Regulatory Service 146

Creating a Federal Regulatory Service 148

Elevating the Compliance Profession 151

Decisions Are Made by Individuals, Not Organizations 152

Keep the Rating Agencies—But on a Short Leash 153

Put Down the Pitchforks 154

Conclusion 154

Chapter 16: Judging for Yourself 156

Conclusion 161

Appendix 1: Summaries of Regulatory Concepts and Issues 163

Moral Hazard, Too Big to Fail, Systemic Risk 163

Unlevel Playing Fields 165

Unintended Consequences 166

Self-Regulation 168

Regulatory Capture 169

Information Asymmetries 172

Conflicts of Interest 173

One Size Fits All 174

Appendix 2: Excerpt from Obama Administration’s Reform Proposal, ‘‘Financial Regulatory Reform: A New Foundation’’ 177

Index 187