Literature Review Global Financial Crisis Regulation

“Global Financial Crisis: Regulatory Arbitrage and Paradigm Shifts” In early 2008, the economy ground to an almost complete halt. As the stock indexes were overwhelmed by a virtual tsunami of never relenting red digits, it became clear that the financial markets had been hit by a crisis the scope and scale of which had not been witnessed since the Wall Street Crash of the 1930’s.

Over time the causes became more clear, and as the dust settled, the world was left with several important questions to answer. First of all, there was the question of whether or not the global financial crisis was actually caused by flawed regulations and financial institutions or whether it is the fundamental behaviour of the financial market that is flawed, as caused by behavioural issues such as moral hazard and principle agent problems.

As an extension of this, the second question involves whether or not financial regulation will be sufficient in realizing a stable and sustainable financial system or if a true paradigmal and behavioural shift is required. Finally and more practically, the third question is how such a change may be brought about in practice, and which exact aspects of the financial paradigm should be altered in order to realize sustainable financial markets.

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As we look more closely at the following questions and the appropriate literature, one can discern several issues, which may form the basis for further academic inquiry. First of all, it is clear that despite far reaching efforts of scholars, governments and other institutions to develop and introduce financial regulation in response to the financial crisis, recent evidence suggests that these measures fail to recognize fundamental flaws in the paradigms and values Freewriting exercise – Skills 3: Academic Writing S. N. Geesing – 342570 2010-2011 underlying actions of main financial institutions and firms, which need to be addressed in order to realise a sustainable financial process in the long term. From this main statement, we can now look into several direct causes of the crisis that can be related to the incentives that underlie these markets.

One of these causes, as it appears, is the fact that Wall Street managed to lure the brightest minds in economics and mathematics with promises of wealth and fame, thus managing to consistently outsmart governmental institutions. By exploiting loop holes in regulatory frameworks, often done by developing complex financial derivates, the bulge bracket firms that set the tone in investment banking gained access to nearly limitless profits, foregoing issues of ethics and risk minimization in favour of short term and often personal gain.

After recognizing this pattern, one may conclude that simply increasing bank reserves or bailing out mortgages (as many governments have done so far) will not allow for long term sustainability within financial markets. Other measures, such as increased transparency, caps on bonuses and reinvented incentive reward systems are more effective, but have proven difficult to practically implement. Introducing new regulation is always troublesome and this type of regulations has been met by heavy resistance, especially in the US, the place where new regulation is especially necessary.

For this reason and more, a more indirect way of changing values and paradigms must be sought. Scholars have suggested that such measures are most likely to be found in economic theory and, more specifically, in forms of game theoretical applications, in which the government and the financial institutions act as “players” in a game that can be described as the general economy and financial markets.

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