Addressing the Regulatory Sine Curve

Warren’s and McCain’s proposal to reinstate the Glass-Steagall Act epitomizes bipartisan agreement that the Dodd-Frank Act falls short in several respects. Because crises are inevitable regulation should not merely follow crises but rather anticipate unknown future contingencies.

CLS Blue Sky Blog

A common denominator of regulatory responses to crises is the use of stable and presumptively optimal rules. The term “stable and presumptively optimal rules” refers to rules that, once in place, do not change other than through other rules and Acts of Congress. Congress, financial regulators, and the literature on financial regulation rely almost exclusively on such rules. However, the economic conditions and the corresponding requirements for optimal and stable rules are constantly evolving, suggesting that different sets of rules could be optimal – in contrast with previous expectations. This has played out in the reaction to the financial crisis.  Congress made adjustments via stable rules. Later, these were followed by relaxation, revisions, and retractions. The resulting regulatory cycle has been costly and has produced suboptimal regulatory outcomes. Jack Coffee refers to this phenomenon as the “regulatory sine curve” (see here and here).    The regulatory sine curve results…

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