More regulation? I don’t think so – this sub prime crisis is a regulatory crisis.

The sub prime crisis, a run on a UK mortgage bank, and now the loss of $7 billion dollars through rogue trades at Soc Gen: and still they say regulation works!

I accept that financial services businesses can be different. Where they take money from people, on the promise they will repay it at some date in the future, people need reassurance that the promise will be kept. In most other businesses the business takes the risk and supplies the good and service before the customer pays.

It makes sense to have deposit protection, and it should make sense to have some additional checks and requirements to reduce the risk that a business will steal people’s money, or will fail to keep enough capital to pay for losses and mistakes and still be able to give people their money back when they want it or are entitled to it.

This proposition has led to a vast regulatory industry, where clever regulators try to interfere in ever more details of the banks’ lives in the belief that this will prevent mistakes being made. As the last few months have shown, it does not work.

We need to ask how did the world regulators get it all so wrong, and what changes do we need to reduce risks in the future?

The biggest problem is the so-called sub prime crisis, which is in practise a world crisis, not just a US one, and is not confined to mortgages alone. It is a securitisation and off balance sheet crisis – too many banks packaged up too many loans born of the easy money conditions the authorities encouraged, and spread them around the system. The Regulators through their Basel I requirements positively encouraged this, asking for less capital if you securitised your lending and pushed it off your own balance sheet. This crisis should be called the Basel regulatory crisis, rather than the sub prime crisis.

The solution is for monetary authorities to be more careful about making money too easy – not that this is an immediate problem in the middle of the Credit crunch! They also need to revise rules over capital requirements, without lurching to a position where too much banking capital is required, intensifying the Credit Crunch. The whole thing is complicated by the move to Basel II, which needs urgent review in the light of current circumstances.

The run on Northern Rock was an unfortunate event for London. I do not agree with the MPs who say the FSA got it all wrong. As I understand it, the FSA was warning about the problems of Northern Rock well before the run on the bank began. The failure was a system failure, which owed a lot to the failure of the monetary authorities to keep money markets liquid, and to the dithering of the Chancellor who was meant to hold the ring and make the decisions in areas of overlap between the Bank and the FSA.

The UK government should decide that in future the Bank of England will get back its old powers to regulate banks and to run the government’s debt financing programme, so it once again sees the whole range of business going through the money markets. The Bank should have prime responsibility for banking the commercial banks, ensuring adequate liquidity in markets and avoiding any future run on a bank. They always used to be able to do this before Brown’s botched reforms.

The Soc Gen debacle is difficult to believe. Most banks make dealers deal in open dealing rooms where colleagues can hear what they are up to. I thought most require two signatures on larger deals, most have real time reporting through a common system, and anyone needing cash to pay margin or settle transactions would need someone else to certify or check the requirement. As the trader apparently acted without other authority he must have found ways to circumvent the checks in the system. The regulator presumably was completely unaware that such a thing was happening.

I do not think Regulators can stop a Soc Gen event. Only better internal controls and procedures in a bank can do that. The fact that Regulators cannot should make more people suspicious of the cry that what we need is more regulation. In this case what we needed was better bank management.


  1. Brian Tomkinson
    January 26, 2008

    The sub prime crisis resembles a worldwide game of musical chairs – only in this case when the music stops you are not just out of the game but lose billions as well. The dealing rooms in the banks resemble massive casinos – the terminology even refers to "placing bets"! Fraud in banking doesn't seem to be taken seriously – consumer fraud isn't even reported to the police and I heard a security consultant recently state that corporate fraud is in most cases covered up by the management so that the shareholders and customers are kept in blissful ignorance. These activities are far removed from those expected by the average bank customer entrusting their money with the bank. We most certainly require much better bank management but how this will be achieved is the first question to be answered.

  2. mikestallard
    January 26, 2008

    "The UK government should decide that in future the Bank of England will get back its old powers to regulate banks and to run the government

  3. Steven_L
    January 26, 2008

    If only J

  4. Gollum
    January 27, 2008

    If the Bank of England had the regulatory powers instead of the FSA, how would this debacle have been avoidrd or ameliorated?

    reply: If the Bank knew the day to day positions of each of the banks it could have avoided too much momney sloshing around earlier, or realised it needed to supply more cash in August 2007. Before Brown took these powers away, the "Governor's eyebrows" kept the banks under a disciplined approach.

  5. Gollum
    January 27, 2008

    I believe that each banking organizations in the United States sends a report to one of the 12 Federal Reserve Banks including the amount of its cash and due from banks at least once every two weeks. This report is used by its Federal Reserve Bank to compute each bank's reserve requirement (i.e., funds that the banking organization must deposit with its Federal Reserve Bank).

    I believe that each bank that is a member of the Federal Reserve System must also submit numerous other reports to its Federal Reserve Bank. Other banking organizations in the U.S. may send some reports also.

    The above notwithstanding, arguably the Federal Reserve Board did not use a disciplined approach but deliberately increased the money supply to lower interest rates, that in turn fueled the credit euphoria.

    Why do you think that the Old Lady of Threadneedle Street would be more disciplined than the Federal Reserve Board?

    Reply: The Bank has a remit to control inflation only, whereas the Fed has a duty to keep the economy growing as well.

  6. Bazman
    January 28, 2008

    Heads we win. Tails you lose. Ultimately these banks know that theirs is not just a business like any other, but often the fabric of other businesses and society. They know that because of this fact they will be bailed out by the taxpayer when it all goes wrong and free to make vast profits for a few people often with little benefit to the rest of society in the good times. Trebles all round.

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