nep-reg New Economics Papers
on Regulation
Issue of 2010‒03‒13
fourteen papers chosen by
Christian Calmes
Universite du Quebec en Outaouais

  1. The Financial Crisis and the Regulation of Credit Rating Agencies: A European Banking Perspective By Utzig, Siegfried
  2. Regulating Systemic Risk By Kawai, Masahiro; Pomerleano, Michael
  3. Competition in complementary goods: Airport handling markets and Council Directive 96/67/EC By Maria Cristina Barbot
  4. Regional Monitoring of Capital Flows and Coordination of Financial Regulation: Stakes and Options for Asia By Plummer, Michael
  5. Rethinking market discipline in banking : lessons from the financial crisis By Stephanou, Constantinos
  6. Enhancing Bank Transparency: What Role for the Supervision Authority? By Francesco Giuli; Marco Manzo
  7. Liberalization and Regulation of Capital Flows: Lessons for Emerging Market Economies By Mohan, Rakesh; Kapur, Muneesh
  8. Optimal Interventions in Markets with Adverse Selection By Thomas Philippon; Vasiliki Skreta
  9. Optimal market design By Jan Boone; Jacob K. Goeree
  11. On the institutional design of burden sharing when financing external border enforcement in the EU By Claus-Jochen Haake; Tim Krieger; Steffen Minter
  12. Intellectual Property Right Protection in the Software Market By Yasuhiro Arai
  13. Simulation and Prosecution of a Cartel with Endogenous Cartel Formation By Johannes Paha
  14. Foreclosures, Enforcement, and Collections under the Federal Mortgage Modification Guidelines By Casey B. Mulligan

  1. By: Utzig, Siegfried (Asian Development Bank Institute)
    Abstract: Credit rating agencies (CRAs) bear some responsibility for the financial crisis that started in 2007 and remains ongoing. This is acknowledged by policymakers, market participants, and by the agencies themselves. It soon became clear that, given the depth of the crisis, CRAs would not be able to satisfy policymakers by eliminating flaws in their rating methods and improving corporate governance. Although the CRAs were more or less unregulated before the outbreak of the financial crisis, after the crisis started, politicians became increasingly vocal in demanding regulation. Initially, these demands were confined to a more binding form of self-regulation. But as the crisis progressed, the calls for state regulation grew ever louder. It became apparent after the November 2008 G-20 summit in Washington that state regulation could no longer be avoided. <p>In Europe, the course had been set in this direction even before then. Since European policymakers saw the crisis as evidence that the Anglo-Saxon approach to the financial markets had failed, they believed they were now strongly placed to have a decisive influence on shaping a new international financial order. It is remarkable to note the shift in European policy from a self-regulatory approach, which was comparatively liberal in international terms, to quite rigorous state regulation of CRAs. Both the European Commission and the European Parliament drew up far-reaching plans. Although European policymakers knew that only globally consistent regulation would be appropriate for a new world financial order, their initial draft legislation was geared more toward stand-alone European regulation. While the final version of the European Union Regulation on Credit Rating Agencies focuses firmly on the European arena, the key point for all market participants is that this is unlikely to have an adverse effect on the global ratings market. It must nevertheless be recognized that the scope of the selected regulatory approach is extremely narrow. Certainly, it has the potential to improve the corporate governance of CRAs and prevent conflicts of interests. But it can do nothing to address the repeated calls for greater competition or for CRAs to be made liable for their ratings.
    Keywords: regulation credit rating agencies; europe credit rating agency; european bank financial crisis; financial crisis; credit rating agency
    JEL: G18 G21 G24
    Date: 2010–01–26
  2. By: Kawai, Masahiro (Asian Development Bank Institute); Pomerleano, Michael (Asian Development Bank Institute)
    Abstract: The failure to spot emerging systemic risk and prevent the current global financial crisis warrants a reexamination of the approach taken so far to crisis prevention. The paper argues that financial crises can be prevented, as they build up over time due to policy mistakes and eventually erupt in "slow motion." While one cannot predict the precise timing of crises, one can avert them by identifying and dealing with sources of instability. For this purpose, policymakers need to strengthen top-down macroprudential supervision, complemented by bottom-up microprudential supervision. The paper explores such a strategy and the institutional setting required to implement it at the national level. Given that the recent regulatory reforms that have been undertaken to address systemic risks are inadequate to prevent and combat future crises, the paper argues that national measures to promote financial stability are crucial and that the Westphalian principles governing international financial oversight should be rejected. The paper proposes that while an effective national systemic regulator should be established, strong international cooperation is indispensable for financial stability.
    Keywords: global financial crisis; systemic risk; macroprudential supervision; systemic stability regulation; regulating systemic risk
    JEL: G21 G28
    Date: 2010–01–27
  3. By: Maria Cristina Barbot (CEF.UP, Faculdade de Economia, Universidade do Porto)
    Abstract: This paper addresses the case of complementary services with vertical relations. Using the example of airport handling activities, we develop a model to investigate the effects on welfare and competitiveness of four different handling market situations. We find out that the usual Cournot result on welfare when firms compete in complementary goods is verified unless there are efficiency gaps between the firms, or if vertically related firms also compete on the same market. We also find that the presence of a horizontally integrated firm may lead to market foreclosure. Moreover, we add a few remarks on regulatory issues, where we show that regulation may be pointless or even anti-competitive. In particular, we show that Council Directive 96/67/EC, while intending to increase competition, may lead to anti-competitive situations and consumers surplus decreases.
    Keywords: Complementary goods competition; airport handling; vertical relations.
    Date: 2010–02
  4. By: Plummer, Michael (Asian Development Bank Institute)
    Abstract: The ongoing global economic crisis has punished Asian economies severely, despite the fact that its origins derive from outside the region. The global economic crisis was transmitted through real and financial channels, underscoring how vulnerable the region is to external shocks. This paper explores the microeconomic origins of the financial crisis and endeavors to ascertain how crises might be mitigated in the future through better regulation, supervision, and institution-building. Moreover, it makes the case for closer economic cooperation in order to internalize key externalities associated with modern global finance. This cooperation, in turn, should take place at the appropriate level, with incentives for cooperation at the global, regional, and subregional levels. It explores the potential for the creation of an Asian Financial Stability Board and deepening other initiatives in Association of Southeast Asian Nations (ASEAN)+3 and ASEAN forums. However, it stresses that the most important financial reforms in Asia will need to take place at the national level.
    Keywords: asian regional capital flows; mitigate future financial crises; financial regulation; capital flows
    JEL: F33 F36 G28
    Date: 2010–02–25
  5. By: Stephanou, Constantinos
    Abstract: The main objective of this paper is to rethink the use of market discipline for prudential purposes in light of lessons from the financial crisis. The paper develops the main building blocks of a market discipline framework, and argues for the need to take an expansive view of the concept. It also illustrates using actual bank case studies from the United States its apparent failures in the crisis, particularly the failure to prevent the buildup of systemic, as opposed to idiosyncratic, risks. However, while the role of market discipline in the design of macro-prudential regulation appears to be largely constrained, more can be done on the micro-prudential side to promote clearer market signals of bank riskiness and to encourage their use in the supervisory process.
    Keywords: Banks&Banking Reform,Debt Markets,Markets and Market Access,Emerging Markets,Access to Finance
    Date: 2010–03–01
  6. By: Francesco Giuli (University of Rome La Sapienza, Department of Public Economics, Italy); Marco Manzo (Ministry of Economics, Italy and OECD)
    Abstract: We apply a three-tier hierarchical model of regulation, developed along the lines of Laffont and Tirole (1993), to an adverse selection problem in the corporate bond market. The bank brings the bonds to the market and informs the potential buyers about the bond risks; a unique benevolent public authority aims at maximising investors welfare. The main goal is to investigate whether this unique authority is able to fully inform the market on a firms true credit worthiness when banks, in order to recover doubtful credits, favour the placement of bonds issued by levered firms by concealing their true risk. By establishing the necessary conditions that allow optimal sanctions to produce the first best equilibrium, we show that the core problem of adverse selection in the corporate bond market does not lie so much in the benevolence of the delegated monitoring system, but rather in the possibility of affecting and sanctioning a firms behaviour.
    Keywords: Corporate bond, Incentives, Collusion, Regulation
    JEL: D82 G28
    Date: 2009–11
  7. By: Mohan, Rakesh (Asian Development Bank Institute); Kapur, Muneesh (Asian Development Bank Institute)
    Abstract: Capital flows to emerging market economies (EMEs) have been characterized by high volatility since the 1980s. In recent years (especially since 2003), although gross as well as net capital flows to the EMEs have increased, they could not be absorbed domestically. Overall, savings have flowed uphill from EMEs to advanced economies, challenging the conventional view that capital flows to EMEs are always beneficial through augmentation of their resources leading to greater investment. Full capital account liberalization can impart avoidable volatility and have an adverse impact on growth prospects of EMEs. Available evidence is strongly in favor of a calibrated and well-sequenced approach to opening up the capital account and its active management, along with complementary reforms in other sectors. Greater caution is needed in the liberalization of debt flows. <p>Despite much advice to the contrary, most EMEs manage their capital accounts actively to cushion their economies from undue volatility, including interventions in the foreign exchange markets accompanied by sterilization. Sound macroeconomic and financial policies-accompanied by prudent capital account management, greater exchange rate flexibility, purposive use of prudential regulation, and continued financial market development practiced by most Asian EMEs over the past decade-have cushioned their economies from the current global financial crisis that started in 2007. They have successfully achieved a virtuous circle of continuing growth, low and stable inflation, and financial stability. How these elements can be best combined will depend on the country and on the period: There is no "one size fits all." <p>Such a discretionary approach does put a great premium on the skill of policymakers and can run the risk of markets perceiving central bank actions becoming uncomfortably unpredictable. Such risk is mitigated by a record of successful management.
    Keywords: capital flows emerging markets; liberalization regulation capital flows; emerging markets capital account management; capital flows; emerging market economies
    JEL: E42 E44 E52 E58 F30 F40 G15
    Date: 2010–01–14
  8. By: Thomas Philippon; Vasiliki Skreta
    Abstract: We study interventions to restore efficient lending and investment when financial markets fail because of adverse selection. We solve a design problem where the decision to participate in a program offered by the government can be a signal for private information. We characterize optimal mechanisms and analyze specific programs often used during banking crises. We show that programs attracting all banks dominate those attracting only troubled banks, and that simple guarantees for new debt issuances implement the optimal mechanism, while equity injections and asset buyback do not. We also discuss the consequences of moral hazard.
    JEL: D02 D62 D82 D86 E44 E58 G2
    Date: 2010–02
  9. By: Jan Boone; Jacob K. Goeree
    Abstract: This paper introduces three methodological advances to study the optimal design of static and dynamic markets. First, we apply a mechanism design approach to characterize all incentive-compatible market equilibria. Second, we conduct a normative analysis, i.e. we evaluate alternative competition and innovation policies from a welfare perspective. Third, we introduce a reliable way to measure competition in dynamic markets with non- linear pricing. We illustrate the usefulness of our approach in several ways. We reproduce the empirical finding that innovation levels are higher in markets with lower price-cost margins, yet such markets are not necessarily more competitive. Indeed, we prove the Schumpeterian conjecture that more dynamic markets characterized by higher levels of innovation should be less competitive. Furthermore, we demonstrate how our approach can be used to determine the optimal combination of market regulation and innovation policies such as R&D subsidies or a weakening of the patent system. Finally, we show that optimal markets are characterized by strictly positive price-cost margins.
    JEL: D4 L51
    Date: 2010–02
  10. By: Gerard Llobet (CEMFI, Centro de Estudios Monetarios y Financieros); Javier Suarez (CEMFI, Centro de Estudios Monetarios y Financieros)
    Abstract: We assess the effects of imitation and intellectual property (IP) protection in a model of industry dynamics in which the value of IP is eroded by further innovations and imitations. Innovations result from the development of ideas engendered by entrepreneurs. We find that innovation and welfare are decreasing in the protection of IP against further innovations, while their relationship with the protection against imitations typically has an inverted-U shape (partly because imitation reduces the resistance of incumbents to innovators). We also find that the welfare gains from increasing IP protection increase if entrepreneurs are financially constrained.
    Date: 2010–02
  11. By: Claus-Jochen Haake (University of Paderborn); Tim Krieger (University of Paderborn); Steffen Minter (University of Paderborn)
    Abstract: Illegal immigration affects not only EU member states at the Mediterranean Sea but also more Northern states due to open internal borders and onward migration. Northern member states may free-ride on border countries’ enforcement efforts, leading to a sub-optimal level of border control. While neither a centralized nor a coordinated policy appears to be feasible, we show that employing an expected externality mechanism leads to voluntary preference revelation with respect to immigration policy under several (but not all) scenarios. This policy measure requires, however, the EU Commission to take on a very active role as moderator between member states, which at the same time must accept the Commission to play this role.
    Keywords: illegal migration, immigration policy, border enforcement, interregional transfers, European Union, expected externality mechanism
    JEL: F22 J61 J68
    Date: 2010–01
  12. By: Yasuhiro Arai
    Abstract: We discuss the software patent should be granted or not. There exist two types of coping in the software market; reverse engineering and software duplication. Software patent can prevent both types of copies since a patent protects an idea. If the software is not protected by a patent, software producer cannot prevent reverse engineering. However, the producer can prevent the software duplication by a copyright. It is not clear the software patent is socially desirable when we consider these two types of coping. We obtain the following results. First, the number of copy users under the patent protection is greater than that under the copyright protection. Second, the government can increase social welfare by applying copyright protection when the new technology is sufficiently innovative.
    Keywords: Copyright Protection, Intellectual Property Right, Software
    JEL: D42 K39 L86
    Date: 2010–02
  13. By: Johannes Paha (Justus-Liebig-University Gießen)
    Abstract: In many cases, collusive agreements are formed by asymmetric firms and include only a subset of the firms active in the cartelized industry. This paper endogenizes the process of cartel formation in a numeric simulation model where firms differ in marginal costs and production technologies. The paper models the incentive to collude in a differentiated products Bertrand-oligopoly. Cartels are the outcomes of a dynamic formation game in mixed strategies. I find that the Nash-equilibrium of this complex game can be obtained efficiently by a Differential Evolution stochastic optimization algorithm. It turns out that large firms have a higher probability to collude than small firms. Since firms' characteristics evolve over time, the simulation is used to generate data of costs, prices, output-quantities, and profits. This data forms the basis for an evaluation of empirical methods used in the detection of cartels.
    Keywords: Collusion, Cartel Detection, Cartel Formation, Differential Evolution, Heuristic Optimization, Industry Simulation
    JEL: C51 C69 C72 D43 L12 L13 L40
    Date: 2010
  14. By: Casey B. Mulligan
    Abstract: Federal mortgage modification initiatives, targeting millions of borrowers, are intended to prevent foreclosures of underwater home mortgages. Those initiatives discourage principal reductions in favor of interest reductions, despite the possibility that the former would be a more durable foreclosure prevention tool. The programs also impose marginal income tax rates substantially in excess of 100 percent. Using the framework of optimal income taxation, this paper shows how alternative means-tested modification rules would simultaneously improve collections, efficiency, the number of foreclosures, and their total cost. As a result, lenders have an incentive to foreclose on borrowers deemed modification eligible by the federal programs.
    JEL: H21 L11 R31
    Date: 2010–02

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