David Prosser: Risk versus return: the familiar trade-off now facing regulators

Outlook In the end, Gordon Brown was forced to admit, albeit grudgingly, he had made mistakes in government. The example he cited was that he had been too willing to listen to those in the City who called for deregulation in the late Nineties. He was so blinded by the promise of riches from bankers keen to develop ever more intricate trading structures that he failed to see the credit bubble he was sanctioning would burst with such disastrous results.

It's easy, in hindsight, to throw the book at the former prime minister for his recklessness. But we should at least acknowledge that for any chancellor (as Mr Brown then was), encouraging economic development is a crucial part of the job, not least because of the tax revenues it generates. Mr Brown may have been wrong to relax City regulation, but he did so because he thought he was spurring innovation and enterprise.

This is going to be a thorny dilemma for the new Financial Policy Committee, the regulatory authority the Government is setting up as an equivalent to the Monetary Policy Committee. In announcing the appointment of four external members for the FPC yesterday, the Treasury confirmed its role will be to identify risks developing within the financial services system and that it will have powers to take action when it does so. But a vital proviso was added: the FPC will also have to consider the economic impact of whatever it chooses to do.

It is a proviso that will weigh heavily on the members of the FPC. At what moment does an activity or a theme with potential for risk become a risk that must be acted upon? Act too early and the FPC stymies what might be a valuable contribution to the economy. Act too late and the damage might already have been done.

This is not a theoretical debate. Take the housing market. One suggestion is that the FPC, had it been in existence a few years back, might have outlawed 100 per cent mortgages and other risky home loan products, with the aim of choking off the worst excesses of the housing bubble. Doing so might have been the right option in the round, but it would also have been a brake on parts of the economy – and prevented some people buying properties on which they have subsequently had no problems making mortgage repayments.

The FPC is a rational response to the crisis that did so much damage – and the regulatory failures that failed to prevent it. But its members will quickly discover that their job will be intensely political. And as with the ongoing arguments about the MPC's interest rate decisions, their debates and divides will be played out publicly and sometimes bitterly.