What can regulation do now?

It is currently fashionable to argue that because there is a mess in the banking world there needs to be more regulation.

We need first of all to ask how this most regulated of industries got into the current difficulty? Why did all the regulaiton we already have fail to stop the crisis? Indeed, did the regulation itself in some ways allow the crisis or make it worse?

People want there to be easy answers. Let’s look at some of the suggestions:

1. Ban short selling. Most of the selling which has driven down share prices has come from owners of the shares selling. Banning short selling will not stop sharp falls in bank shares if people lose confidence in those banks.

2. Stop mortgage banks lending people more than say 90% of the value of a property. That looks like a good idea and would represent prudent banking. However, if Central banks decide to create very loose money with low interest rates again, as they did in the 2004-6 period, such a ban will not work. Offshore banks will be able to lend more than 90% and will steal some of the business. Onshore banks will obey the rules about mortgages, only lending up to 90%, but will encourage people to take out a personal loan at the same time so they can lend them more.

3. Raise the capital ratios for banks, to limit the amount they can lend. That would work, but is best done during the upswing. Doing it now will intensify the downturn. Today’s problem is banks do not want to lend very much at all, so making it dearer for them to lend makes that worse.

4. Offer a public sector bail out for difficult loans. This may be necessary to prevent worse damage to the system, but it sends out a dreadful message to banks who now know they are all “too big to fail”. Shouldn’t there be some financial penalty on the shareholders of banks who issued all those poor performing loans in the first place, if they need to take advantage of any subsidised public bail out?

5. Try to develop counter cyclical intelligent central banking. The errors of the last few years are errors of the whole banking system , led by the Central Banks. We need a new generation of Central bankers who raise interest rates earlier to choke off excess, and cut rates earlier, to prevent too steep a downturn.

Poeple should stop thinking there is a black box regulatory answer which will prevent another boom-bust cycle in the future. Indeed, it is more likely that action taken eventually to stimulate economies out of the present downturn will in its turn sow the seed of the next boom. Meanwhile, there is no way of appointing brillliant banking and mortgage regulators who will get the decisions right when the bankers and their clients are getting them wrong. There will always be mortgage excess if central banks allow money to become too easy, and there will always be a house price crash and mortgage default if central bankers make money too tight.


  1. Jonathan
    September 20, 2008

    You’ve missed one that relates to 2 above

    Make debts incurred which raise personal interest payments above a certain percentage of salary or which leaves only a certain residuary of salary e.g. £150pw not financing the debt unenforceable under English law.
    This only applies when the debt is taken out and to the last debt that is taken out that raises payments above the threshold. The debt remains valid but does not have to be paid off until the interest burden falls below the threshold i.e. it turns the new debt into an interest free, infinite period loan. Borrowers would have a legal obligation to declare all their income and existing debt to new lenders or the rule would not apply and the loan would be enforceable.

    No bank foreign or British is going to lend if they can’t enforce repayment.

    Its an end to loan sharking and retail banking over-enthusiasm without any moral hazard.

  2. David B
    September 20, 2008

    I wonder if the monetary policy that has been followed during this administration has had a flaw. The B of E was tasked with keeping inflation to 2 percent.

    Perhaps the real inflation rate in our economy has been 5 percent or more, but that has been masked by the China effect to the extent that really we have allowed overheating when deflation should have been happening.

    Had interest rates been higher there may not have been a boom, nor a massive rise in house values. And the bust may not have happened either.

    There is something wrong with how inflation is calculated.

    1. Tony Makara
      September 20, 2008

      Very good points. The overvalued Pound, with credit fuelled spending on going on imports, has allowed people to enjoy a fake feelgood factor, with the Labour government and BOE wallowing in this banquet and not preparing for the downturn. Now that the credit has dried up and Sterling has been knocked off its perch we see the true state of the economy. It is certainly true that we need to look at how inflation is quantified. There are clearly many different 'inflations' and each has to be approached differently. I hope the incoming Conservative government will usher in a new era of fiscal sobriety. If we don't have the money, we can't spend it, that especially applies to government.

  3. Bazman
    September 20, 2008

    Less regulation is for the birds John. Lets stop pretending that all of this is a force for good. Job losses, high prices, false profits by companies ripping us off. 'Us' means the general public. If you are not a member of the general public or have fantasies that you are not. You come second. This country should be run for the greater good not a few elite and their apologists.
    It was all a different story when the printers, miners, dockers shipyard workers and many more where having to listen to lectures from the City, other right wing institutions a there lackeys about the necessity of change no pain no gain and so on. The fires of tooth and nail capitalism. Crushing of the unions for the good of the country Blah! Blah!
    When it happens to them? they all expect to be bailed out by the government and crying like babies on the TV.
    I am not entirely unsympathetic as they are really just the workforce despite their high opinion of themselves. Nothing will happen to their rich bosses. Expecting these people to behave in a 'responsible' way is naive and foolish in the extreme.
    The unions where a threat in the 70's now the City is in this era.

    Reply : The issue is why with so much regulaiton has the system failed. I am saying regulate fewer things, but regulate the big ones well, and most of us will then be better off.

  4. mikestallard
    September 20, 2008

    In Wisbech, our little fenland market town, stands Peckover House, home of the Peckover family. The Peckovers were all Quakers. Today the house is owned by the National Trust, itself an invention of the Quakers of this little town.
    In the 18th century, the Quakers founded a little white Chapel on the smart North Brink of the dirty little river Nen. In it they prayed a lot in total silence for hours at a time.
    Sitting in silence, they had time to plan things.
    They were totally straight and worked for "the Lord of Hosts". Their word was their bond. Other people came first in all business dealings. People kept their money (honest) in the front room of Peckover House, because they knew it would be safe and not invested in Sub Prime Mortgages.
    The Peckover family grew very rich indeed.
    I wonder, myself if 1,2,3,and 4 above would have Been done by this very rich and businesslike Quaker family?

  5. Lola
    September 20, 2008

    John, I have a regulated FS business and I can confirm absolutely that the current regultory system is a large part of the problem. More of it would make things even worse and create even more risk. The thing that really sticks in my craw is that no-one ever asks us how to do it better. And blokes like me know. We really know.

    1. adam
      September 21, 2008

      How would you do it better. What are the top three things?

      Reply: Solvency and liquidity, coupled with a Central Bank that slows it down when it is going to fast and speeds it up when it is going too slow – our central Bank has been doing the opposite.

  6. Gareth
    September 21, 2008

    It would help if the FSA knew what the banks were doing. Light touch regulators were incompetent with their Northern Rock dealings for a start. They got suspiciously favoured treatment. John Moulton has said more than once the FSA people he has met over the years simply didn't understand the financial wheezes the banks were pulling.

    The civil servants at the FSA are not fit for purpose.

    So is Gordon Brown. Changing the measure of inflation has given this country a lasting legacy of debt. At what point will he be held personally responsible. Even the changes in student finance has engenders a culture of 'massive debt is okay' when really it isn't.

    I was reminded by a post on a message board recently that the Labour party has been big on home ownership. They saw the regulatory practises in the US whereby banks were told to lend to low income people who had no realistic means of paying off the debt, and instead of thinking 'that's going to bite them on the arse', they thought 'that'll win us the next election'. And so we've had an artificial inflation figure that created an interest rate detached from the real economy. This in turn created a roundabout of funny money that was entirely reliant on house prices going upwards.

  7. APL
    September 21, 2008

    JR: "What can regulation do now?"

    It has become commonplace to suggest that Sub Prime & the credit crunch that came to public notice last August in the UK is all the fault of the greedy banks.

    How about this? The lax lending standards were introduced by the Clinton administration and the banks were FORCED to relax their lending standards.

  8. Ken
    September 21, 2008

    A big part of the problem is that we have international comprehensive regulatory standards that failed miserably. Basle II was meant to deal with the issues of Basle I and the risk of different types of lending. I have always been unhappy with it – I particularly dislike the use of banks' own internal models and their implicit reliance on Value at Risk models (I always thought these were hokey – LTCM provided ample proof of that, and I always thought that the liquidity assumptions would be critical – which they were).

    The failure came about because of a lack of transparency and complexity as far as regulation is concerned. I think the idiots (Notably one Right Hon. Gordon Brown) who keep talking about regulating bonuses have no understanding of the problem. The logic of their argument is:

    Big bonuses were bad because they incentivised traders/bankers to do bad things because they were better off in the short term.

    This leads to the question of:

    Who paid these traders/bankers in this way? Their bosses. Were their bosses short termists? No, they were not, most bank bosses stay with their firms for significant periods of time. So they were stupid then? Seems unlikely since they did manage to become bosses of big smart firms. Yes, they do walk away with lots of cash, but did they just not care?

    The logic of big bonuses = short termist bad deals with full knowledge is flawed.

    Instead, the banks managements were lulled by the big profits and the internal VaR models into believing that everything was OK.


    I foresee much greater turbulence ahead. I thought that the US bank bailout is probably inevitable, given the size and scope of deleveraging going on, and I do think that Bush has seized the nettle swiftly and courageously. However, banking crises are always political economy problems. Surely some legislators are going to kick up a fuss about the cost and about moral hazard? The shareholders and executives can surely not expect to get away scot free? When these problems surface, expect some more unpleasantness.
    Then I foresee further problems outside the US. The great leveraged boom has allowed lots of banks and firms to borrow recklessly and go on spending sprees, buying assets that are now worth a lot less. Take Iceland – a country with a gross external debt of 10 times GDP. They also have external assets, but what price those assets bought during the past five years? Will they generate enough cash to cover the debt? Will they be able to pay it back when the debt needs to be rolled over? This is repeated in all kinds of places. This crisis is going to run and run.
    What do you think?

  9. chris pullen
    September 21, 2008

    Regulation ! The management of a population should be easy, but honesty seems to get in the way. TRUTH is a fundamental principle that is required to have sensible and open dialogue. The serious problems in society today are caused by deception, untruths and Lies. The Regulations are created by those at the top, so that those near the top, that do not have honest principles are encouraged to follow a straight path. The honest way forward is to tax the rich and better off. Taxing the rich should be a global effort with no where to hide. Stop taxing the poor…….! how can anybody buy a house, car, food and pay for all the bills and save for the future when the income is as low as 15k. The worthwhile people, nurses, carers, retailers, cleaners, drivers etc are all earning very low wages and being ripped off by government. House prices should be much lower. Bad debt is created by greed, large commissions and bonuses should be taken back and used to help low income families.

    1. mikestallard
      September 23, 2008

      "Bad debt is created by greed, large commissions and bonuses should be taken back and used to help low income families."

      1. chris pullen
        September 26, 2008

        my opinion is fast cars, gold taps and rolex watches are materialistic and the excessive wealth used to buy these unnecessary items is earned by encouraging the unwise and gullible to enter into unaffordable debt. I also think that the amount of reward in relation to the expended work effort is way to high. redistribute the money to low income families because the debt taken on by naive parents impacts the children and society should take responsibility for the young.

  10. StevenL
    September 22, 2008

    A few years ago they were talking about making lenders share more information about borrowers. We've heard a lot about mortgages, but not a lot about unsecured debts. During the inevitable downturn I would imagine a lot more unsecured debts will have to be written off.

    Now the banks have their begging bowl out it would be an ideal opportunity to make them start sharing this information to stop fraudulent applications in future.

    I read speculation on Bloomberg this morning that the US government is considering allowing bad credit card debt and hire purchase etc into the pool with the bad mortgages.

  11. Watervole
    September 22, 2008

    In response to Ken's comment, the Chancellor, and I use the word advisedly, is proposing to increase public borrowing still further. Who is he going to borrow from in these turbulent times?

    Kneejerk regulations is a singularly bad idea and is nothing more than PR spin designed to insulate Gordon and his cronies from the consequences of their actions. That is why the head of the FSA has been replaced.

    All such matters should lie with the Bank of England, as they used to. It should be independent of government, and especially this government, whose record in enacting good legislation is woeful, or worse.

  12. Lola
    September 22, 2008

    Regarding lending to those that cannot repay I have file evidence of a married couple with 6 children whose wages ( circa 19K gross) were inflated by benefits to the gross equivalent of £54,000 (!). And if you took into account his elder children's earnings the household income was even higher.

    Why did they seek our advice? They wanted to buy a bigger house based on benefit income. Could this have been done at the time (four or five years ago)? Yep. I could have easily finessed this past a number of lenders. Some of them high street, or subsidiaries of high street. Did I do it? No! Of course not. But I run a risk averse business. In my view it was irresponsible to do this. To get them into bigger debt based on benefit income. Others were certainly not so scrupulous. And many were directly sold by banks and the like.

    Please note that this bloke was a Good Dad.

    So I ask you. How can this be 'right'? How can it be so that so much money is paid over in benefits and is then used to buy a house? In two ways this is very bad. One it makes houses unaffordable for other earners not in the benefit net enjoyed by Mr X, and two the transfer payments from those other modest earners to Mr X make them poorer.

    Gordon Brown's insane fiscal regime is a disaster. It looks like it might just now overwhelm us.

    1. mikestallard
      September 23, 2008

      I want to say that this makes me angry. I was, for a time, on unemployment benefit myself and I needed every penny. Swindling the system is wrong and is well out of order.

  13. Eddie Allen
    September 22, 2008

    Government interference and crushing bureaucracy is at the midst of this along with too much deregulation of the industry itself. It's no good to have every Jack and man's neighbour selling finance and insurance, it's totally pathetic and doesn't even help people.

    It should be brought back into line under the Bank of England and through lenders operating with good practices based on prudence otherwise it'll end in another crisis somewhere down the line or an industry in handcuffs which will lead to business being done elsewhere out of the UK.

    If someone is responsible for losses caused by bad business then such practice can be limited to the bank concerned so it doesn't become a problem if banks are acting within strict limits set by the Bank of England's prudential financial management systems and guides. The FSA is NOT required for this nor is government intereference except to make the system less deregulated because deregulation went too far !

    Supermarkets selling financial products can't be right because trade and profit is taken away from the banking industry. It then has had to look to trade more imaginative products which otherwise it wouldn't need as deposits and profits from bread and butter financial products would otherwise have been higher if not sold in industries. Ordinary deposits are also being ploughed into supermarket banking, and so too insurance incomes. The whole system has turned into one of dog eat dog and financial prudence nowadays simply means "get rid of it quick"! This is not banking nor is it in the public's interest, nor is it prudent business for the bank or it's longterm desire which "should be" to give better service to the public.

    It's easy to see why the public are being drained by credit cards and bank charges when banks have no way of ensuring their business is protected in a world where every man and his dog are searching our to sell products which should be under bank control to Joe Public !

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