The fiscal crisis of 2008 revealed manifold weaknesses in national financial regulatory frameworks. Many jurisdictions have made legislative efforts to address these flaws, with varying degrees of promise and success. The United States has been through this process before, most recently in the wake of the savings and loan crisis of the 1980s, and before that, in the aftermath of the stock market crash of 1929. Both crises afforded Congress the opportunity to make landmark changes to the U.S. financial regulatory architecture, most of which have strengthened and safeguarded U.S. markets. Although some of
the changes had international dimensions, prompting agencies to interact more frequently with their foreign counterparts, the traditional focus of financial regulatory reform efforts has been domestic.
This domestic approach will no longer suffice. The 2008 crisis revealed that financial activity has now so thoroughly outstripped national borders as to demand an international approach to regulatory reform. A prime example of the need for an international approach is the downfall of Lehman Brothers and AIG. Lehman Brothers’ catastrophic failure not only exposed the lack of coordination and resolution planning among national regulators but also the basic inability of national bankruptcy regimes to deal with complex financial organizations of global scope. AIG’s descent derived from concern that if AIG could not meet its obligations on the credit-default swaps (CDS) it had issued, financial institutions around the world would have to sell off securities en masse to remain adequately capitalized. This same concern also formed the core rationale for the U.S. Government’s decision to give billions of dollars of financial support to AIG. Neither regulators nor market participants had any picture of the extent to which CDS liabilities were woven throughout the system because they were almost entirely unregulated and traded over the counter. Further, the crash of 2008 revealed both the systemic importance and the under-regulation of the so-called “shadow banking” system, in which nondepository institutions conduct bank-like activities that expose them to similar run-risks as banks while not being regulated as such.
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