Regular readers know that the simple reform needed to end dependency on the regulators is to require ultra transparency in all the opaque corners of the financial system. This includes, but is not limited to, banks, structured finance securities and Libor.
By providing market participants with access to all the useful, relevant information in an appropriate, timely manner, ultra transparency ends their dependence on the regulators to properly assess this data and communicate the results of this assessment.
“We should have shouted from the rooftops,” Sir Mervyn King, Governor of the Bank of England, said by way of an apology for the financial crisis and recession the country has endured on his watch....
The phoney apology has riled many in the City, including economists and politicians, for its revisionist version of history.
“It’s very odd that he talked about shouting,” one eminent economist politely observed, when the Governor was barely whispering about financial risks.
The Inflation Report press conference on August 8, 2007 is damning. One of the few occasions he had to shout, it was also held, coincidentally, the day before the credit crunch struck.
“Our banking system is much more resilient than in the past,” the Governor declared. “Precisely because many of these risks are no longer on their balance sheets but have been sold off to people willing and probably more able to bear it.”
Reason number one for ending dependence on regulators: failure to communicate the true level of risk.
Sir Mervyn’s critics point out that financial stability began to be sidelined at the Bank from the moment he took over as Governor in 2003, even though it remained a core role alongside monetary policy....Reason number two for ending dependence on regulators: the traits that make for a good monetary economist are not the same as the traits that make for bank supervisor.
The former tend to be big picture thinkers who are comfortable working with assumptions. The latter tend to be obsessed with the smallest detail.
Despite the shrinking budget, the division remained attuned to the dangers ahead. In 2005, both Sir Andrew Large, then deputy Governor for financial stability, and his successor Paul Tucker voted three times to raise rates – isolating themselves on the nine-strong MPC.
In April that year, Sir Andrew explained that a rate rise would “help to slow households’ persistently rapid accumulation of unsecured debt, hence reducing the risk of a sharp fall in demand at some later date”.
It was a prescient warning, which talked to the debt bubble, but one that was ignored by the Governor and the rest of the Bank until too late.Reason number three for ending dependence on regulators: even if a bank supervisor identifies a systemic problem, they have to overcome the internal institutional hurdle of convincing a majority of the senior policymakers if the problem is to be addressed.
The decision then has to be whether to address the problem internally or communicate the problem's existence to market participants.
Reason number four for ending the dependence on regulators: they have a bias for handling problems internally even if this means misrepresenting the true condition of banks to market participants.
Evidence for the Governor’s claim that the Bank did “preach about the risks” hinges largely on the Financial Stability Report from July 2006.
In the document, the Bank revealed it was conducting “war games” to plot the fall-out from a credit crunch. They found that a debt-fuelled crisis could trigger a severe UK recession, a 25pc fall in house prices and the destruction of about a third of banks’ tier one capital – around £40bn at the time.
But the Bank could only preach something it believed, and patently this was an extreme scenario it never envisaged....Reason number five for ending the dependence on regulators: when only regulators have the data, market participants cannot run their own independent analysis to confirm or deny the regulators' assessment or check it for reasonableness.
Economists yesterday also took issue with the Governor’s view that there had been a “bust without a boom”.
“There are no busts without booms,” former MPC member Andrew Sentance said. “[You] need to look harder to find the boom – in this case [it was] global and financial, not domestic UK inflation.”
In house prices, household debt and consumer spending, there had patently been a boom.
House prices trebled between 1997 and 2007. Household debt soared from 90pc of household income to 162pc in the same time. Driven by a sense of wealth, consumer spending fuelled the economy.
“There was a boom. But it was paid for by debt, particularly mortgage-backed debt,” Danny Gabay of Fathom Consulting said....Reason number six for ending the dependence on regulators: the more eyes looking at the data, the higher the probability that someone will see and call attention to a problem before it develops into a full-blown systemic crisis.
“Some parts of the Bank were right, but they were ignored. The Governor is trying to have his cake and eat it,” he said.Reason number seven for ending the dependence on regulators: while regulators speak with one voice and therefore stifle dissenting internal opinions, markets are designed so that multiple opinions can be expressed.
Danny Blanchflower, a former member of the MPC who has since become Sir Mervyn’s nemesis – recently accusing him of being a “cruel tyrant” - added: “If Mervyn King had thought more regulation was important he could’ve done something about it.
“And, because he didn’t, he must take responsibility for the fact the Bank missed the biggest financial crisis in a century.”
Reason number eight for ending the dependence on regulators: it allows investors to do something about a problem, for example reducing their exposure to the problem, rather than wait and hope that a regulator will see and address the problem.
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