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Authors

Edward J. Kane

Abstract

Structured securitizations transform traditional default and interest-rate risks into hard-to-understand and hard-to-monitor counterparty and funding risks that in distressed times pass onto financial safety nets. This Essay explains the chain of incentive conflicts that led private and government supervisors to neglect their commonsense moral obligation to understand and control these risks and to underinvest in planning and staffing for adverse events. Lack of planning for the bursting of the mortgage-lending bubble made it easy for asset-backed securities markets to sink into turmoil and for authorities to adopt policies that turned market turmoil into crisis. The analysis makes it clear that to bring safety-net subsidies under control, the United States does not need to make major changes in the structure of its regulatory bureaucracy. What it needs to repair is the incentive structure under which financiers and government officials operate.

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