Jeremy Warner: Clamour grows for more regulation
Thursday 26 February 2009
Outlook Look out. Here comes Jacques de Larosiere, a former managing director of the IMF, to add the EU's penny's worth to the already raging debate on how to reform financial regulation. Strangely enough, Mr de Larosiere isn't quite the bull in the china shop you might expect. Europe has been itching to get its hands on the City, symbol of unruly Anglo-Saxon finance, for years. But Mr de Larosiere stops short of recommending the pan-European super regulator to take on the Square Mile and subsume all national regulation that some Europeans demand.
That may have been Mr de Larosiere's instinct, yet so long as individual sovereign nations remain financially liable for underwriting their own banking systems, you are never going to see taxpayers ceding regulatory responsibility to a non-sovereign organisation. Until there is a centralised European treasury function with the capacity to bail out failed banks, it's just not practical. Mr de Larosiere seems to have recognised it.
Instead, he proposes a dog's dinner of councils and committees, made up largely of national regulators, to co-ordinate standards and monitor day-to-day activities. There would also be a "European Systemic Risk Council" charged with system-wide oversight and risk assessment. All of this seems a wonderful excuse for junketing and meddling, but of little if any use in guarding against the next financial crisis, which when it hits is certain to be just as unexpected as this one. If you could fully anticipate financial crises, there wouldn't be any. All previous history dictates that any such aspiration is just a pipe dream.
Back here in Britain, Adair Turner, chairman of the Financial Services Authority, promises MPs a "revolution in regulation", by which he seems to mean that the "light touch", principles-based regulation that came to define the FSA's approach to oversight is now a thing of the past. Lord Turner didn't pull his punches. The previous system was deeply flawed, he admitted. Yet he stopped short of blaming anyone in particular.
Let the markets decide was the political mantra of the time, from Alan Greenspan to Gordon Brown and Her Majesty's Opposition. At the time, Labour tended, if anything, to get accused of over-regulating the City. In fact, all the pressure was the other way. London became famous for soft touch regulation, a view that the Government actively encouraged because of the growing profit and therefore tax stream that the City delivered.
Regulation as practised by the FSA tended to concentrate on sales practices and other potential forms of abuse, rather than systemic risk. In what the Americans sometimes call "regulatory capture", prudential oversight of the banks came to be dominated by the prevailing wisdom of the time – namely that securitisation had made inadequate capital and extreme leverage somehow safe.
Lord Turner promises that all that will now change. Trading functions will be required to hold much higher levels of capital than hitherto to compensate for the risks they are running. Nor is Lord Turner talking about token amounts of perhaps 20 per cent, but two to three hundred per cent more. That's going to make securities trading a good deal less profitable than it used to be.
The FSA chairman also promises direct intervention in markets where the regulator thinks products are too complex or unsafe. The size of mortgages might be regulated too, both in terms of loan to value and loan to income. I'm assuming that quite a bit of Lord Turner's message is just rhetoric. The politicians want to know he's on the case.
Yet he's also an intelligent chap who knows the risks of over-reaction as well as any. The City is public enemy number one right now, but if you remove the freedom of bankers and financiers to innovate and take risks, you'll end up junking the place entirely. Given what's occurred, you might reasonably think that's a good thing, but standing back from it all, it's hard to argue it would be in Britain's best interests.
Nor would it remove the threat that unfettered capital markets sometimes pose to economic stability. Economies that imposed stringent restrictions on finance have been just as badly hit by the credit crunch as those that allowed bankers to let rip. You can believe the present implosion is all down to unregulated, bonus-driven bankers if you like, but it comes nowhere near explaining what's occurred. Economies have never been more interconnected, and they have all been affected together by the fallout from the crunch.
This might seem to make the case for global regulation better than any number of Larosiere reports ever can, yet until there is global government and powers of taxation, it remains a somewhat unrealistic aspiration. Instead, national regulators must find ways of agreeing and enforcing common standards and practices, but even then it would be a mistake to put too much store by their actions.
Two standards that were agreed internationally and at the time were generally thought a breakthrough in global regulation – the Basel II capital adequacy rules and mark-to-market accounting – ended up perversely being very much at the centre of the mischief that caused the banking crisis. Such is the law of unintended consequences when it comes to well intentioned regulation. Don't expect too much of it.
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