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Symposium 2009

Solution for Balancing Risk Taking and Financial Regulation

The Challenge

Many observers blame excessive risk taking and inadequate regulation as the core causes of the current global financial crisis that we have been witnessing.

Many observers blame excessive risk taking and inadequate regulation as the core causes of the current global financial crisis that we have been witnessing.

Create new retail financial instruments to insure consumers against risks, such as home equity insurance and house price futures.

Preventing the next bubble may or may not be possible, but we can reduce the risks and provide greater confidence to consumers. Spreading the scope of financial markets to cover a wider array of economic risks (for example, vastly expanded markets for managing real estate risk) would help. And improving the financial information infrastructure would empower consumers to make better and less emotional financial decisions.

For example, today the standard mortgage provides no protection against difficulties in repaying the lender due to changes in the marketplace. But mortgages could be designed to compensate for these changes by including provisions to ensure homeowners against their major risks.

Developing a liquid futures market, linked to an index of house prices, would enable homeowners to short-sell their home when home prices fall. If home prices fall sharply, the drop in the value of the home would be offset by an increase in the value of the futures contract.

Likewise, insurers could be encouraged to develop home equity insurance, which insures homeowners against drops in the market value of their home. The insurance should be linked to the overall house price index at the local level. Such insurance should be attractive to homeowners if it is offered as an add-on to their existing insurance policies.

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