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From bombs to boons: changing views of risk and regulation in the pre-crisis OTC derivatives market

2020

Lockwood, Erin

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https://doi.org/10.1007/s11186-020-09386-1

Creative Commons 'BY' version 4.0 license

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Ultimate source of change
Who is a legitimate bearer of risk?
Who deserves public protection from adverse financial consequences?
Protection from what?
Perception of risk
1970s-1980s
Commodity Futures Trading Commission Act + Treasury Amendment
Financial innovation (financial derivatives)
“sophisticated” or “professional” investors
Small-scale financial market participants
Protection from own lack of technical mastery of market dynamics and opaque workings of the market
Only manageable via sophisticated quantitative models; inheres in firms
Ultimate source of change
Who is a legitimate bearer of risk?
Who deserves public protection from adverse financial consequences?
Protection from what?
Perception of risk
Early 1990s
Ideology (public regulation is needed to manage systemic risk vs. private regulation is sufficient to prevent systemic risk) + crisis (S&L crisis)
Sophisticated investors and banks armed with risk management divisions; the market as a system (market discipline)
Financial market participants not involved in off-balance-sheet financial activity + non-financial actors such as municipalities (GAO)
Financial industry can and should regulate itself (G-30 report; CFTC in exempting OTC transactions from CEA)
Protection from financial system collapse/crisis (1994 GAO report)
Normal workings of a market do not merit protection (G-30 report)
Systemic phenomenon (Corrigan, 1994 GAO report)
firm-level phenomenon amenable to quantitative modeling and management
Ultimate source of change
Who is a legitimate bearer of risk?
Who deserves public protection from adverse financial consequences?
Protection from what?
Perception of risk
Mid-1990s-early 21st century
Ideology (self-regulating markets are in the public interest)
Firms, via private risk-management systems; the market as a system; individual “rogue” traders
Only victims of fraud
Protection from fraud; normal workings of the market, including firm collapse, do not merit protection
Financial risk is essential to deep and liquid financial markets and in the public interest

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