In a new ASI briefing paper – The Financial Crisis: Is Regulation Cure or Cause? – Tim Ambler examines demands for financial stability and security though increased regulation. The question the paper poses is whether existing regulation mitigated the 2008 financial crisis, had no impact, or exacerbated it. Answering this question is the key to deciding how we respond to the crisis.
A few main points:
- The crisis may have begun in the US, where regulation introduced during the Carter and Clinton presidencies was a major contributing factor, but whatever the international aspects of the crisis there are clearly a number of home-grown elements that made the UK particularly susceptible to it.
- The financial crisis was triggered by the bursting of a credit-fuelled bubble. Regulation and regulators did not cause this fatal bubble, but they did indirectly help it to grow by fostering the illusion of financial security. At no point did the UK's main regulatory institutions warn of the dangers ahead.
- The over-regulation of traditional financial services shifted enterprise towards complex financial packages that were unknown to, unseen by, and not understood by the FSA or UK Treasury. In many instances, even bank directors did not know what they were investing in.
- The regulation enforced by the FSA is predominantly legalistic and rules-based, and amounts to the micro-management of the way firms are structured and run their businesses. Compliance with rules was mistaken for the validation of business models and management practices – clearly a mistake. Regulation should focus more on principles and outcomes, not processes. We need better oversight, not more regulation.
- The most important factor in the crisis was that the UK's financial regulators lacked a clear and simple remit. This led them to overlook the early signs of the crisis and hampered their response to it. The Treasury must take responsibility for the failings of the tri-partite system, since they were the architects of it.
- The paper singles out the Bank of England for particular criticism, arguing that it was so pre-occupied with its first objective – monetary stability – that it failed to give due attention to its second one – the stability of the financial system. And even the Bank's focus on interest rates and inflation was rendered ineffective by the exclusion of property prices from their remit.
- The main conclusion of the paper is that improving regulation will not provide more than modest help in future. The important thing is that the Bank of England, the FSA and the credit agencies do the jobs they are supposed to do more effectively. The paper suggests a number of structural modifications that should be made to allow this to happen.