Regulation of the financial sector can never fully prevent the triggering of another systemic shock to the financial system like the one that led to the economic crisis of 2008. At least, that is the conclusion presented by Professor Steven Schwarcz of Duke University at a recent risk regulation seminar organized by the Penn Program on Regulation.
A better approach, he argued, would be for regulation to ensure that firms pay a fee that will help them internalize some of the external risks of their financial behavior. The approach he favored would require financial firms to pay into a private “systemic risk fund” that could be tapped into in the event of a large financial failure, thereby both better aligning market incentives as well as protecting liquidity in the markets when the next big firm fails.