Legal constraints weakened, not replaced by market mechanisms
As financial world became more complex, legal regulators were unable to evaluate the system's safety. Meanwhile, sources of market discipline (external auditors, security analysts, and rating agencies) all were compromised by conflicts of interest.
Three primary factors appear to explain these repeated failures in supervisory and market
discipline of LCBOs [Large complex banking organizations]. First, major banks have become more complex and harder to evaluate by regulators and the financial markets over the past three decades. Second, all of the three leading institutional sources of market discipline for LCBOs – securities analysts, external auditors and rating agencies – have been compromised by conflicts of interest. Third, while market discipline is frequently ineffective in predicting the onset of financial crises, it can be indiscriminate in punishing firms after a financial crisis begins.
Arthur E. Wilmarth, Jr.  Controlling Systemic Risk in an Era of Financial Consolidation.  2002
http://www.imf.org/external/np/leg/sem/2002/cdmfl/eng/wilmar.pdf
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Unintended consequences of earlier public policy choices »Unintended consequences of earlier public policy choices
Investment banks entirely outside the regulatory net »Investment banks entirely outside the regulatory net
Legal constraints weakened, not replaced by market mechanisms
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