Madoff and the regulation of financial markets

The Madoff scandal is yet more bad news for the financial sector. Several major banks may have lost hundreds of millions of dollars in the alleged scam.

An important question is whether this would have happened under a different regulatory environment. Without the false sense of security given by the government regulation of financial markets, investors would surely have been far more careful about where they put their money. They would have investigated the risks involved more fully and favoured reputable, conservative institutions.

Instead of investors in general having a responsibility for monitoring their counterparties we have handed the job over to a government institution. When that fails – tough. Also, the key objective for a financial institution is not to build reputation and trustworthiness but to make sure it complies with what the regulator wants. Financial institutions look upwards towards the regulator and not downwards towards their clients.

18 December 2008, IEA Blog

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