Perseverare diabolicum: the shortcomings of pre-crisis financial regulation, and the repetition of the same mistakes in the regulatory response to the crisis

Riccardo de Caria

Resumo


The paper addresses two issues: how poor regulation has contributed to the crisis, and how current regulatory responses to the crisis are (not) differing from the poor regulation that originated it.

 

In the first part, the paper offers an overview of the most relevant examples of poor regulation that have arguably played a role in determining the crisis, with a focus on the US and the EU: from the institutional design of central banks (that influences the type of monetary policy they implement), to the rules at the basis of fractional reserve banking (a source of great systemic instability, according to the perspective adopted in the paper); from the prescriptions in the Basel Accords I and II (that strongly encouraged banks to invest in the "wrong" assets), to the several policies adopted by the US authorities to encourage the purchase of a house by American households (resulted in a bubble whose burst triggered the global financial turmoil); from the regulatory requirements entrenching the oligopoly of credit rating agencies (more competition might have meant improved overall rating abilities), to the deposit insurance schemes (a source of great moral hazard and financial irresponsibility of consumers); from some shortcomings that can be identified in the way the institutions of the EU and of the Eurozone were designed (a major source of the current turmoil in this area), to the policies making the size of government grow, resulting in an increase of spending, taxation, deficit and public debt (something highly unhealthy for the economy from the perspective adopted in the paper), to some features of "regulation" narrowly meant (at best, an obstacle to the proper functioning of the markets). The concluding paragraph explains how all these failures might have led to the crisis, and reflects on what lessons can be derived from the inquiry made, what would be appropriate responses from legislators and regulators, and what mistakes it should be wise to avoid repeating: in particular, it is argued that definitely not more, but less regulation (and government intervention in general) is needed.

 

In the second part, the lessons summarized in the former one are contrasted with the actual legislative and regulatory responses adopted by the US and the EU: from the changes in central banking (that not only have fallen short of reducing the power of central banks to manipulate money, but have instead entrusted these institutions with even more power), to (non-existent) changes in fractional reserve banking (that unfortunately has not been subject to any rethinking in the mainstream thought); from the rules of Basel III (that do not seem to be truly capturing what went wrong with its two predecessors), to the still ongoing distortions of the real estate sector (GSEs were eventually bailed out and not surprisingly subprime mortgages seem to have resumed); from the legislative proposals in the field of credit rating agencies (that go as far as proposing the establishment of a public European-wide credit rating agency), to the EU agreement to set up a common deposit-insurance scheme (that will probably encourage consumers' recklessness to an even greater extent than national schemes); from the many attempts to fine-tune the European architecture (that do not seem bound to remedy the identified pre-crisis shortcomings), to the many decisions further increasing spending, taxation, deficit and public debt (thus putting recovery at stake), to the new flood of "regulation" (narrowly meant) that has struck the markets (all but helping them to restore their ordinary functioning). The final paragraph offers some reflections on what is the role that law and regulation should instead play in financial markets, and argues that it should be confined to a set of clear, broad and general principles, giving up the idea of pre-determining the outcome of the competitive game, but simply dictating its rules, in the spirit of Hayek's lesson in the first volume of Law, Legislation and Liberty.


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