What banking regulators must consider

First an admission. I like Gillian Tett assistant editor of the Financial Times. Her economic analysis is especially good when the news is gloomy. Shame that much of her work sits behind the FT’s paywall. But, I guess that’s what you pay for. Occasionally, snippets are available in the FT’s Alphaville blog, which has prompted this post.

It’s my contention that the economic problems of 2007 to today stem from, to a larger extent than is discussed, regulatory failure. That’s the failure of legislators of banking and financial services to recognise the incipient causes of our economic woes.

Here in the UK, Gordon Brown’s policies were the primary cause of regulatory failure. Which both he an Ed Balls have now acknowledged [See in Iain Dale’s quote of the day by Gordon Brown, and here in the Guardian.

Gordon Brown’s much vaunted decision, by him at least, of changing banking regulation in 1997, by moving it from the Bank of England to the Financial Services Agency was one of the main causes of the banking problems we now face. It allowed control of the burgeoning complexity of banking to pass from expert to inexpert hands.

A wonderful, if complex, staff report by the New York Federal Reserve Bank’s on Shadow Banking, says of the 2007-9 banking crisis,

“Ultimately, the underestimation of correlation by regulators, credit rating agencies, risk managers, and investors permitted financial institutions to hold too little capital against the credit and liquidity puts that underpinned the stability of the shadow banking system, which made these puts unduly cheap to sell.”

Dense language I know. But their conclusion about the banking crisis is that of a failure of regulation. There’s a fantastic chart in this report, on the Shadow Banking System which is too big to show here. They recommend it is printed at 36″ x 48″. Heck, that’s 3 feet by 4 feet. Enormous.

Anyway, the point to note about this chart is that the ‘traditional banking system’ is one line across the top of the chart. The rest is a maze of interconnections of between a myriad of parties, other than banks, to the world of credit formation, and the bewildering number’s of credit instruments.

Sure, it’s arcane and often impenetrable. But, it’s worth a delve into as it presents a picture of the financial world that the authors say came briefly out into the open in 2007, and is now hidden again. This is what we want regulators to understand, and to control.

2 thoughts on “What banking regulators must consider

  1. I completely agree. But doesn’t the case for tighter regulation go against your statement of last week:

    “This was an excellent programme, describing the disastrous handling of our economy through the Blair and Brown years, and offering us a solution. No surprise here, low taxes, smaller state payroll, and less regulation. In summary, freeing the populace from the tyranny of state control, so that we can become prosperous again.”

    So which is it to be? Less regulation, so wealthy corporations are free to gamble, making and losing huge amounts of money, and wrecking the economy when it all goes wrong; or more regulation, and slower, more careful, less dramatic but safer economic growth? You can’t have it both ways.

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  2. Chris. An apparent contradiction, I give you that. In the space of short blog posts it’s not always easy to fully define arguments. I’m in favour of freeing the individual from regulation, but am keen to control the rapaciousness of big business.

    I remain in favour of less regulation, especially the myriad of regulation of small things that hinder our free choice. However, in the area of defining the fundamentals of our market-driven society, I’m in favour of intelligent regulation, which allows the big and small organisation to work side by side.

    Hope this clears up the contradiction.

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