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Abstract

This Essay examines the subprime crisis through the lenses of the known, the unknown, and the unknowable in financial policymaking. The first two Parts focus on information and incentive problems faced by monetary policymakers and prudential supervisors in trying to prevent crises. The third Part emphasizes challenges that arise when preventative measures fail and financial policymakers must manage financial crises. These include pressures to oversupply public subsidies in the short-run at the risk of providing incentives for institutions to take greater risks and cause larger crises in the long run, and conflicts and gaps between micro- and macro-prudential supervision. Some micro-prudential regulation may make individual institutions safer, while increasing the vulnerability of the financial system to systemic risk.

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