Conflicts of Interest and the Financial Crisis *

If there is one issue on which policy makers, academics and commentators would all agree after this crisis, it is that Europe’s financial stability framework needs to be substantially strengthened. Although at this stage our reflections are bound to be tentative, given that we are still in the process of managing the crisis, any reform of the financial system needs to tackle a few fundamental issues. This article focuses on one issue in particular: the conflicts of interest that plague financial markets at all levels and during all phases of the cycle. To be effective, the changes that have to be made throughout the entire financial infrastructure, from accounting to prudential rules, from the oversight of rating agencies to risk management practices, will have to address this key issue. This requires that all parties involved think deeply about the role of the financial industry and legislation in our societies. The starting point of the reflection is to recognize that the whole financial infrastructure is potentially affected by conflicts of interest that can create negative externalities and to consider each of them in turn. These conflicts are between individual and collective interests.