Two people writing sense in one day. The excitement is almost too
much for me! [the other was in "EU proposing to cripple financial
markets with naked protectionism")
One thing he does not mention and I regard as vital is the separation
of retail banking from investment banking. (*commonly given the
short-hand title of 'Glass-Steagall' after the American act doing
just that abolished by Clinton in a hugely disastrous act )
xxxxxxxxxx cs
=====================
SUNDAY TIMES 17.5.09n UK
Think Tank: New ideas for the 21st Century: Removing the banks'
comfort blanket
Regulation can fuel financial excess
Philip Booth
The standard view of the crash of 2008 is that it was caused by greed
and instability in unregulated financial markets. This thesis does
not fit the facts. The general trend has been towards more
interference by the regulators.
Try drilling down into the Financial Services Authority (FSA)
handbook to get a feel for so-called "light-touch, principles-based
regulation". The full handbook contains 10 sections. The section
entitled "prudential standards" is divided into 11 sub-sections. The
sub-section "prudential sourcebook for banks, building societies and
investment firms" is made up of 14 sub-sub-sections. The sub-sub
section "market risk" is divided into 11 sub-sub-sub sections. The
sub-sub-sub-section on "interest rate PRR" has 66 paragraphs.
It is not just the FSA that has been generating financial regulation.
The European Union and the Bank for International Settlements have
spent decades developing new approaches to regulating bank behaviour,
financial reporting and capital requirements, purportedly to bring
stability to the international financial system. {wow; and look at
their success! -cs]
The authors of a new book, published by the Institute of Economic
Affairs (IEA), argue that regulatory bodies have not just failed to
stop markets going haywire, they have also contributed to the
problem. As Professor Kevin Dowd, one of the authors, says: "If
recent events represent the 'success' of the Basel accords on bank
capital regulation, then it is difficult to imagine what 'failure'
would look like."
Regulation and government intervention distorted behaviour, making
the crash more likely and its effects more damaging. If more
government intervention is the solution to instability in financial
markets, then regulators have to be one step ahead of the markets,
but the nature of regulators is that they are always several steps
behind.
The US government's fingerprints are all over both the boom in sub-
prime mortgages (encouraged by legislation and state regulation) and
the boom in securitisation: the raison d'être of the disastrous US
government-backed mortgage giants Freddie Mac and Fannie Mae. The
Basel accords and the tax system grossly distorted the behaviour of
banks. They in effect subsidised banks to wrap equity risk into ever
more complex fixed-interest products.
However, central banks are also to blame for the crisis. Just as
mismanaged monetary policy was at the root of the boom that preceded
the Great Depression and also that which preceded the recent Japanese
malaise, the same is true of the crash of 2008. Low interest rates
led to the money supply expanding, an asset-price spiral, low saving
and a boom in consumption. This exacerbated the problem of global
trade imbalances.
For most of the 21st century, the US Federal Reserve had a policy of
lowering interest rates to avoid recession at all costs. No wonder
investors underpriced risk. Central banks distorted market signals.
At last the political establishment has begun to wake up. Tim
Geithner, the US Treasury secretary, last week admitted that
"monetary policy around the world was too loose too long. And that
created this just huge boom in asset prices, money chasing risk.
People trying to get a higher return. That was just overwhelmingly
powerful".
Bankers still behaved foolishly and recklessly. This may imply that
changes in financial regulation are needed. However, the proposals by
the G20 governments, the FSA and the EU that involve extending
regulation further are misconceived. What must be done?
First, we must remember that central banks are at the root of boom
and bust. It is therefore essential that they properly monitor the
growth of broad money together with the build-up of wider
inflationary risks. It was a good old-fashioned money-supply boom
that led to the asset-price boom. Central banks need to monitor the
growth of money.
Specific changes to the law could also restore market discipline. For
example, giving depositors top priority in the winding up of a bank
would give incentives for other investors to monitor banks' behaviour
more carefully.
There must also be better provisions to ensure an orderly winding up,
recapitalisation or sale of any large financial institutions that are
in difficulty, so banks can fail in an orderly fashion. The "too-big-
to-fail" mentality that pervades policy encourages risk taking and
excessive size and has made our financial markets less stable.
The argument of the IEA's authors is not that markets are perfect.
Rather, it is that market participants cannot be perfected by
regulators. They therefore must not be cosseted by regulation, lax
monetary policy or taxpayers' guarantees but face the financial
consequences of their own actions.
------------------------------------------------------------
Verdict on the Crash: Causes and Policy Implications is available
from www.iea.org.uk Philip Booth is editorial and programme director
of the Institute of Economic Affairs
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