Existencia, Estabilidad y Regularidad de la Solución Débil

The European Commission should also consider stricter regulatory requirements to ad- dress excessive risk taking and high frequency trading. In the wake of the financial crisis, many different strategies have been suggested for restructuring regulation of financial markets to ensure proper alignment of incentives between the financial sector and the economy at large. Notably, it appears that increased regulation is gaining notoriety, and that the financial crisis has significantly changed attitudes about the proper scope of government intervention. In fi- nancial markets the most typical form of regulations pertain to the following areas: executive compensation, restrictions on ownership, disclosure of information, capital adequacy re- quirements, and limits on investment activities. The need for market regulation arises from the fact that markets are not perfect, and inefficiencies develop for several reasons, including asymmetrical information that exists between market participants, transaction costs deter op- timal behavior, and misalignment of incentives such as moral hazard.

One country that has significantly increased its level of regulation following the finan- cial crisis is the United States. In the United States, the comprehensive Dodd-Frank Wall Street Reform and Consumer Protection Act (H.R. 4173) was enacted. Even though the Act had many vocal opponents, it gained traction with the general population as the wide-rippling effects of the financial crisis became known. The Dodd-Frank Act is the greatest overhaul of financial regulation in the United States since the Great Depression. The goal of the legisla- tion as stated in the preamble is

[t]o promote the financial stability of the United States by improving ac- countability and transparency in the financial system, to end “too big to fail,” to protect the American taxpayer by ending bailouts, to protect con- sumers from abusive financial services practices, and for other purposes.

The Act contains changes to the regulatory structure of the financial sector by creating several new agencies, either with completely new supervisory responsibility or taking over responsibili- ties from an existing agency. Among these agencies are the financial Stability Oversight Coun- cil, the Office of Financial Research, and the Bureau of Consumer Financial Protection. These agencies are required to report to Congress on either an annual or biannual basis to update legislators on the progress of current plans and future goal setting. While the two latter agen- cies are primarily focused on “monitoring systemic risk and researching the state of the econ- omy and clarif[ying] the comprehensive supervision of bank holding companies by the Federal Reserve,” the Financial Stability Oversight Council focuses on identifying threats to financial stability of the United States, and responding to these threats. In the course of pursuing these goals, the council maintains several duties: (i) to enhance the integrity, efficiency, competitive- ness, and stability of the United States financial markets, (ii) to promote market discipline, and (iii) to maintain investor confidence (U.S. Treasury, 2012, p. ii). The Act also aims to in- crease oversight of the industry by increasing supervision of institutions that are perceived as creating systemic risk, and increasing reporting requirements. Additionally, the Act tries to create a “warning system” to enable regulators to predict when the economy is on the brink of a recession. Moreover, the Act imposes stricter restrictions on executive compensation, which would remedy the agency issues explained previously.

Thus, the Commission should also look into potential changes to the regulatory struc- ture. Currently, monitoring and regulation of the financial sector primarily takes place on a national level. The European Union could make a greater effort to increase regulation on an EU-wide basis. Alternatively, the European Union can encourage changes to the member states’ regulation. The specific regulatory measures could pertain to stricter disclosure re- quirements or higher capital adequacy requirements. A higher requirement of capital or a minimum equity capitalization ratio would make financing more expensive for companies because equity is relatively more expensive than debt. However, if this regulatory change could reduce the risk of future crises, this cost will be partly offset by the lesser likelihood of fall in share prices as a result of a financial recession. Furthermore, currently many types of financial

transactions, including a large portion of OTC trading, takes place in the shadow of regulatory oversight. To more effectively combat systemic risk, regulatory authorities should expand the scope of monitoring so as to include these transactions as well. Additionally, by increasing the level of detail for required disclosure for each transaction, regulators may be able to single out market participants that consistently engage in transactions without economic substance, but merely exist for the purpose of “beating the system.” Although many parts of finance are viewed as “zero-sum games”—where one party to a transaction loses, while the other wins—the outcomes of these games should be determined based on fundamental analyses of market conditions, rather than strategic bets against the market. The key to aligning incentives be- tween market participants will be to restore the focus to long-term, fundamental values. The goal should therefore be to encourage socially useful transactions that contribute to restoring prices towards equilibrium. Conversely, because high frequency trading generally disregards fundamental information, such trading will tend to destabilize prices and should be discour- aged. As such, regulators should ensure that computer-driven or algorithmic trading would not pay off as a long-term strategy. Moreover, regulations should be focused on maintaining proper capitalization of companies, including a healthy balance of debt-to-equity. This can be accomplished by implementing stricter capital adequacy requirements for financial institu- tions. Similarly, current tax structures and mark-to-market arrangements encourage financial institutions to realize gains early and defer losses, which gives outside parties a skewed picture as to the true condition of the financial institution. Exactly which regulatory measures should be implemented to accomplish these goals is uncertain, however, it is undisputed that a tax on financial institutions alone will not accomplish the stated goals, but should be accompanied by proper regulatory measures.