Unfortunately, little has happened over the past five to eliminate the ingredients of the political bubble. The Republican Party and much of the Democratic Party remain ideologically committed to financial deregulation. Congress remains polarized, gridlocked, and dysfunctional. Fragmented regulatory agencies remain under-resourced, yet authorized to formulate and enforce hopelessly complex rules for hopelessly complex markets. And most importantly, the political clout of the financial sector has scarcely diminished.
In Political Bubbles, we argue that good financial regulation is hindered by the Three I‘s: ideology, interests, and institutions. Today’s piece in the New York Times on how life insurers are reinsuring their policies through subsidiaries is a perfect example of the role that fragmented regulatory institutions play in creating opportunities for financial firms to reduce regulatory burdens. Because insurers are regulated by the states, they have the opportunity to increase regulatory capital by creating shell companies in states with lax regulation who in turn reinsures the parent company’s policies. Unless the shell companies are adequately capitalized, they are not much different than the structured investment vehicle that caused so much damage during the crisis. But because of regulatory federalism, there are limits to what individual state regulators can do to limit the potential damage of this practice.
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