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funk and hirschman on derivatives

All around super nice guys and scholars Russell Funk and Dan Hirschman have a new paper in ASQ on financial regulations. The basic idea is that new securities can slowly unravel regulatory schemes:

Regulators, much like market actors, rely on categorical distinctions. Innovations that are ambiguous to regulatory categories but not to market actors present a problem for regulators and an opportunity for innovative firms. Using a wide range of primary and secondary, qualitative and quantitative sources, we trace the history of one class of innovative financial derivatives—interest rate and foreign exchange swaps—to show how these instruments undermined the separation of commercial and investment banking established by the Glass–Steagall Act of 1933 even as overt political action failed to do so. Swaps did not fit neatly into existing product categories—futures, securities, loans—and thus evaded regulatory scrutiny for many years. The market success of swaps put commercial and investment banks into direct competition and, in so doing, undermined Glass–Steagall. Drawing on this case, we theorize that ambiguous innovations may disrupt the regulatory status quo and shift the political burden onto parties that want to maintain existing regulations. Our findings also suggest that category-spanning innovations may be more valuable to market participants if regulators find them difficult to interpret.

Read the whole paper here.

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Written by fabiorojas

October 13, 2014 at 4:16 am

Posted in economics, fabio, markets

One Response

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  1. Or politicians that bright!

    Sent from my iPhone

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    John Dickson

    October 13, 2014 at 4:52 am


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