Rogues of Wall Street

CHAPTER 22 The Role of Government and Regulators in Managing Risk

As we saw as a result of the 2008 Financial Crisis, the government and its regulators play a very significant role as the final line of defense in managing systemic risk. We will look at the role of the key regulators in this chapter: the SEC and CFTC, and the Federal Reserve.

Regulating the Markets: The SEC and the CFTC

The desire to cut off‐market, off‐exchange deals is ever‐present. This was played out in the original battles fought by Washington and the SEC to establish US securities laws in the 1930s.¹ More than 80 years later, the battle is still being fought. Lest we forget, it was, in part, issues in the off‐exchange credit markets that helped to create the conditions that led to the market meltdown of 2008. There were no limits to the demand for credit insurance (credit default swaps) and untold billions were written. There were limits, however, to how much could be paid out in the event of actual default. The subsequent bailout of AIG and the complex chain of counterparties behind it was a prime example.² The proposal to create a central counterparty, overseen by the Commodities and Futures Trading Commission (CFTC), was conceived in order to address this mismatch and its lack of transparency in derivative, and particularly fixed‐income derivative, markets.³ The SEC, meanwhile, has continued to fight the battle for open and transparent markets in equity trading. Today's threats are posed by dark ...