I now have to admit that I was unduly optimistic about the UK response to the crash regarding the future of financial regulation. Initially, there seemed to be some humility on behalf of the government institutions. That humility was certainly justified. Loose monetary policy was an important contributor to the crash and the Bank of England’s MPC (with one or two exceptions) ignored the warning signals. A senior Bank figure suggested (albeit in a slightly qualified way – but all Bank statements are qualified) that the innovative and opaque instruments that many believe are at least partly responsible for the crash would reduce risks in the banking system just six months before the Northern Rock failure. The FSA probably has over a million paragraphs in its prudential regulation manual for banks (it is no longer possible to download the whole document to count them because it is so big) and that degree of regulation clearly did not work. International bank capital regulation also made the crash worse rather than better. Furthermore (I won’t say “finally” because there is much more I could add) the Prime Minister created a regulatory system that was not fit for the purpose of dealing with systemic risk in the banking system.
The authorities now believe they know how they could have regulated banks to avoid the last crash. Well done them! Unfortunately, it is three years too late. Despite the failure of over-regulation, the Chief Executive of the FSA told us last week that the FSA would get tougher and that banks should be “really scared” of the FSA. We know what that means. Have you tried to open a bank account recently – or undertake any other significant financial transaction? Financial institutions are so scared of the FSA that they impose all sorts of rules (going well beyond those required by the FSA) in the name of anti-money-laundering. It took me seven weeks to pay a very small extra contribution into my pension fund because of the identification requirements of the insurance company (and this was a pension fund into which I was already paying monthly contributions and from which I could take no money for 12 years – as if somebody would be stupid enough to use such a vehicle for money laundering). The problem was that the insurance company was scared of FSA retrospective action. The financial system is already scared of the FSA and customers suffer as a result. Covering your back is more important than looking after the customer.
The authorities made exactly the same mistakes as the banks in this crash. They under-estimated the risks of securitisation. They made many other mistakes too. Will the authorities learn more quickly than the markets so that the risk of mistakes is minimised? Of course not. RBS has lost 95% of its share value. Failure has cost it dear. Shareholders have an incentive to learn. The senior figure at the Bank of England mentioned above was promoted to Deputy Governor. Hector Sants, FSA CEO, will have his empire made bigger and more powerful. Regulators are rewarded for failure. No wonder “regulator failure” is so common.