Risk Management: Foundations for a Changing Financial World

CHAPTER 48

REGULATING FINANCIAL MARKETS: PROTECTING US FROM OURSELVES AND OTHERS^av

Meir Statman

The current global financial and economic crisis highlights the ongoing tug-of-war between those who pull toward free markets and those who pull toward strict regulation of markets—between those who pull toward libertarianism and those who pull toward paternalism. Rising stock markets and economic prosperity empower those who favor free markets and libertarianism; stock market crashes and economic recessions empower those who favor strict regulation and paternalism. This article discusses the current crisis against the backdrop of earlier crises and focuses on margin regulations, which limit leverage; suitability regulations, which require providers of financial products to act in the interests of their clients; blue-sky laws, which prohibit securities deemed unfair or unduly risky; and mandatory-disclosure regulations, which require providers of financial products to disclose pertinent information even if potential buyers do not ask for it.

Any doubts that financial markets are global and that actions by one institution can bring down others have surely been dispelled by the current and still unfolding financial crisis. Any doubts that financial markets are built on confidence and trust have been dispelled as well. The crisis has brought the demise of Lehman Brothers; the U.S. government’s rescue of Fannie Mae (Federal National Mortgage Association), Freddie Mac (Federal Home Loan ...