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Deborah Lucas: "Government financial institutions must undertake better risk analyses"

According to Deborah Lucas government financial institutions lack transparency and are not valuing risks carefully enough. As they play a major role in society they should at least be scrutinized in the same way as private financial institutions. Deborah Lucas is professor of finance at MIT Sloan School of Management and director of MIT Center for Finance and Policy, and was one of the participants at the conference Bank Stability and Regulation organized by CFF on June 1-2, 2015.

What is your research about?
My research focusses on government financial policies. I am looking at the various ways governments intervene in capital markets to try to better understand the economic implications of those interventions. At MIT I am running a new centre called The Center for Finance and Policy which sponsors research and educational initiatives on government financial institutions, financial market regulations and systemic risk.

What do you see as the largest challenges to the financial system?
I feel that overall the financial system functions well although there are areas that could be improved upon. One of the biggest challenges for regulators is to strike a balance between adequate and excessive regulation. For government financial institutions, my main area of interest, one of the biggest and often overlooked problems is that compared to their private counterparts they lack transparency. When governments themselves run financial institutions there is no independent watchdog ensuring that they offer good products or make efficient investment decisions. And those institutions can be a source of systemic risk. For instance, the policies of Fannie Mae and Freddie Mac, the largest providers of mortgage capital in the U.S. and basically government institutions, arguably contributed to the financial crisis. While there can be a legitimate role for government financial institutions, because they play such a major role they should receive the same kind of scrutiny as private institutions.

Didn’t they learn that after the financial crisis?
Fannie and Freddie were rescued and taken over entirely by the government, and are now playing a bigger role than ever. But there hasn’t been much change since then and the government still exempts itself from new regulations designed to reduce the likelihood of future crises.

Does the centre give any policy advice on this matter?
We do not make recommendations, but we do provide policy analysis. Although it can be a fine line, our goal is to provide objective information that help policy makers themselves make better decisions.

How much do they listen?
Many policymakers are looking for good ideas and they listen to some extent. Objective information informs the policy debate, and making it available leads to better outcomes at least on average. Another centre initiative to encourage better policy decisions is an educational initiative for policy makers. Many government officials have gone to law school or a public policy school but lack the kind of financial education offered at business schools. We are developing curricular materials so that finance can be taught in a way that is relevant to future policymakers, and also creating some executive programmes to help people who are already working as financial professionals in the government.

What is your conference talk about?
I am going to talk about development banks, a type of government financial institution. They are important because they are responsible for funding a large share of investments in infrastructure all over the world. Infrastructure banks provide project financing on terms that are better than what would be offered by private financial institutions. Implicit in those favourable terms are subsidies, and development banks take uncompensated risks on behalf of society. The paper I am presenting is developing a model helpful in estimating the full value of these subsidies and the associated risks. Development banks themselves do a poor job of estimating costs. By systematically underestimating cost, they create incentives for overinvestment.

What do you think about this conference?
It’s fantastic that there is a centre on financial intermediation here in Gothenburg. This is obviously an issue that is more important than ever. With the financial crisis we saw that when financial institutions don’t work the whole economy doesn’t work. Presently in Europe there is still a great deal of uncertainty about the stability of banks and the financial system, so it is important to have researchers doing work that can shed some light on these issues. The conference is a good way to meet people from all parts of the world who are doing really interesting research on important topics.

Link to paper: Toward More Comprehensive Measures of the Costs and Risks of Development Banks

Link to Deborah Lucas’ website

By Marie Andersson
 

Page Manager: Katarina Forsberg|Last update: 9/7/2015
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