Old-Fashioned Regulators Miss What's New in Finance
What might be done? Simply turning back the clock won't work. Securitization -- the bundling of loans into tradable assets that can be pledged as collateral -- can't be uninvented. Even if that were possible it might not be desirable: The modern short-term funding market means cheaper and more accessible finance, which in normal times is a good thing. But, as we've learned, the costs can be colossal when things go wrong. The risks have to be reduced.
The leading academic analyst of the repo and related shadow-banking markets is Gary Gorton of Yale University. In a 2010 paper with Yale's Andrew Metrick (which I recommend for its clear account of the larger problem), he suggested a two-part strategy that parallels the traditional deposit-taker approach - - combining elements of insurance on one side and extra resilience to losses on the other.
For instance, Gorton and Metrick recommend that money-market mutual funds should be told to choose: Either be a "narrow bank" that promises to redeem investments in full, and be regulated accordingly, or a conservative investment fund offering no guaranteed return. The first would be insured by the government; the second wouldn't.
Regulating repo is more complicated. Gorton and Metrick recommend a new system of oversight of haircuts and acceptable collateral, but working out the details is hard. TheFinancial Stability Board -- the international coordinating body for financial regulators -- has discussed some ideas but, as Tarullo noted, there's no blueprint yet, much less new laws or rules to put any such blueprint into effect.
"I do not think that the post-crisis program of regulatory reform can be judged complete until a more comprehensive set of measures to address this problem is in place," Tarullo says. He's right, but don't hold your breath. Nobody's in any hurry, and the complexity of the issue has shielded it from political attention.
Calling for stronger consumer protection or for the banks to be broken into smaller pieces is more thrilling than (yawn) demanding better regulation of repo and other non-deposit shadow-banking liabilities. That's a shame. If regulators keep moving this slowly on modern short-term finance, the next crash -- which will be thrilling, but in a bad way -- is just a matter of time.
David Fuller's view On a sunny, lazy day people are understandably
far more interested in fun things, rather than the dry subject of regulation.
The problem, however, is that in our big, bold, interconnected world, market downsides can be more traumatic if effective regulation and sufficient buffers are not in place. The problem, as I see it, is mostly a matter of unchecked leverage leading to reckless speculation of damaging proportions. The people who should know better sense the risk but are chasing the fashion because it is so lucrative. As Chuck Prince, chief executive of Citigroup said during 2007's build up to the credit crunch:
"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."
This article on the subject by Jeremy Warner provides a useful review. Here is a paragraph:
Indeed he was so worried about leveraged lending, he has just said, that he went along to the regulators to plead that they should do something about it. Blimey. I suppose this falls into the "somebody stop me" category of thinking, for it does rather beg the question of why he could not have simply limited himself. Don't you just love bankers. The crisis, you must understand, had very little to do with them, but was in fact the fault of the consumer for borrowing too much, the politicians for allowing it to happen and the regulators for not placing the right limits on the financial system. This is the same argument sometimes used by the petty criminal; I wouldn't have done it if the police had been doing their jo