Quis Custodiet Ipsos Custodes?

In the wake of the S&L debacle, the LDC crisis and other systemic banking shocks, several recent proposals have called for regulatory reforms that emphasize the development of market incentives for both bankers and regulators. This article suggests that market-based reform may be feasible and desirable. In the absence of effective regulatory bodies, early nineteenth-century Americans relied on two specialized players in the financial market--banknote reporters and banknote brokers--for bank monitoring and information provision. Historical evidence provided by these banknote reporters suggests that reporters and brokers efficiently priced bank default risks. Brokers typically downgraded the debt issues of a troubled banks two years prior to its failure. In other cases, brokers often downgraded a bank's debt, forcing the bank to shape up and causing neither the particular bank's failure nor a widespread bank run. Finally, a formal test based on the so-called market model supports the contention that markets can effectively monitor financial institutions.