Is Financial Regulation Fit for Purpose?
In the aftermath of the acute phase of the Great Financial Crisis, there was a rush to regulate the global financial system. Now, a decade later, is a pretty good time to ask what the purpose of the entire system of financial regulation is and are the existing regulations fit for that purpose.
For the most part, the post-acute phase reforms have focused on making the existing banking system safer. But is the banking system safer in any meaningful way now?
In theory, yes. In theory, all of these regulations work together and will prevent another financial crisis while at the same time allowing the banks that were bailed out during the acute phase of the last crisis to fail.
Pardon me if I am highly doubtful there is any remote connection between this theory and reality.
The Financial Times offered up a series of excuses for why I and other people might be doubtful about these regulations working.
So there are a few people talking about regulating the banks, but the conversation is mostly inaccessible. What emerges from the lack of open discussion about actual regulation is a kind of parallel and often misleading discussion based on over-simplified assumptions. One of these is that “deregulation” straightforwardly explains the financial crisis. Some parts of this are true, but a brief history of the securitisation market — the most commonly connected market to the crisis — tells a more complicated story.
The story is not very complicated. Deregulation started in the 1980s under Ronald Reagan. His administration pushed the idea Wall Street should be the SEC’s client. Wall Street seized the opportunity to grab control over the process by which disclosure regulations were set by the SEC. The result was the opaque securitization market where the limited disclosure prevented investors from knowing what they owned.
What is misleading is the whole notion that complicated regulations will prevent another crisis and still allow banks to fail.
Even the architects of these new regulations cannot make up their mind. One minute, it will prevent another financial crisis. The next, a financial crisis will inevitably occur, but these regulations will limit the damage to the real economy.
Back in the 1930s, policymakers had a choice to make. Bet the stability of the financial system on regulations or on transparency. Policymakers chose transparency.
We didn’t get another financial crisis until Wall Street figured out how to undermine the process by which disclosure rules are set.
Given transparency’s track record, why go through the exercise of all these complicated regulations when restoring transparency is simpler? The reason for the focus on regulation is so Wall Street can continue to operate behind a veil of opacity and sell opaque products.
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