Translating 'Macro-Prudential Supervision' Principles Into Law

Sparked by the recent financial crisis, the push to incorporate a “macro-prudential” or “systemic” component into the U.S. financial regulatory framework is being spurred on by both populist resentment over the use of taxpayer money to bail out institutions seen as “too big to fail” and cutting edge studies by financial economists within academia, think tanks and central banks.

Over the past few years, a growing chorus of scholars, regulators and lawmakers has argued that the basic design of the U.S. financial regulatory framework leads supervisory agencies to focus almost exclusively on the individual U.S. financial institutions that they supervise (the “trees”) at the expense of the well-being of the financial system as a whole (the “forest”). Indeed it is now almost conventional wisdom that our predominantly “micro-prudential” (or, to follow the analogy, “tree”) approach to regulation is a weakness in the U.S. regulatory framework. This weakness has been most recently and sharply exposed during the financial crisis which, in its most acute stage, brought our financial system to the brink of collapse.