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.