Post-crisis banking re-regulation adds significant costs to the economy and thus reduces growth, while the pre-crisis light-touch regulation undermined the very financial infrastructure necessary for economic growth.
What were indicators of positive economic growth under light-touch regulation—rapid uptake in home mortgages—were indicators of regulatory failure later on. Indeed, mortgages were a relatively safe asset for banks to own, until they were the source of unimaginable losses.
Overregulation is nowhere better illustrated than in comparing the Dodd-Frank nearly 2000 pages of legislation to the less than 20 pages of the Depression’s Glass-Steagall Act—but under no circumstances are our regulators to repeat the 1930s! Whatever, those who lobby for simplifying regulation end up making it more complex.
It’s a bad thing for regulation to try to squeeze too much risk and complexity out of banking, especially when fresh risk reduction—less leverage, more capital reserves—is itself too risky a strategy. Regulation discourages risk taking and only with risk taking do we have innovation, except when too much innovation and risk taking are encouraged as in the deregulated finance sector up to the 2008 crisis.
New financial instruments, particularly derivatives, flowed to where they were not regulated, but regulated financial instruments always increase opportunities for perverse arbitrage and loopholes. If the last financial crisis showed anything it’s that we need systemic risk regulation and macro-prudential policies, but, to be sure, it’s individuals, like Alan Greenspan, who were to blame for things going terribly wrong.
Regulators must always have the best information, even when those regulated—the banks and investment firms—haven’t a clue as to their current real-time positions. Regulators will never have the capacity to know the real-time positions of actual firms, except in those cases where firms, like Lehman, insisted regulators did have the real-time information.
Global business and supply chains are great, except when the firms are too big to fail. Country defaults are horrible, except where they work through being regulated de jure as in Argentina or de facto as in Mexico.
Global markets are a permanent fact of life, but we must never suppose that the drive to regulate them for the better is just as permanent. Markets are best at price discovery, except where market efficiencies are realized because of lack of transparent discovery, as in unregulated dark pools.
In sum, what I’ve learned from the Financial Times is that capitalism is in crisis because of the shambolic understanding of regulation.