Working Paper

Political Economy of Controlling Systemic Risk: What Governments Can Do Vs. What Governments Are Willing to Do

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In directing panelists to distinguish between what governments “can” and “will” do, this session’s title frames economic policymaking as a balancing act. Principled efforts to define and pursue the public interest are contested and repeatedly knocked off course by conflicting
personal, bureaucratic, and political concerns that impinge on government decisionmakers.

Nevertheless, in modeling processes of insolvency detection and resolution, economists have been reluctant to isolate the returns that large financial institutions make on their investments in building and exercising political clout. Mainstream models of safety-net management are just beginning to acknowledge that, even in good times, politically powerful financial firms shape their lobbying activity, product lines, accounting systems, and organizational forms to collect subsidies to leveraged risk-taking from national safety nets (Kane, 2009; Acharya, Schnabl, and Suarez, 2010; Eberlein and Madan, 2010).