Nettime mailing list archives

<nettime> WSJ editor: it's the politicians and their mignons, stupid!
Patrice Riemens on Tue, 18 Sep 2012 12:09:26 +0200 (CEST)

[Date Prev] [Date Next] [Thread Prev] [Thread Next] [Date Index] [Thread Index]

<nettime> WSJ editor: it's the politicians and their mignons, stupid!

In case u didn't now already: the market, and especially the financial
system can regulate itself perfectly, if it could only be left alone!
(Take that, Dmytri! ;-)


original to:

Speech of the Year
A regulator, of all people, shows how complex regulations contributed to
the financial crisis

While Americans were listening to the bloviators in Tampa and
Charlotte, the speech of the year was delivered at the Federal
Reserve's annual policy conference in Jackson Hole, Wyoming on August
31. And not by Fed Chairman Ben Bernanke. The orator of note was a
regulator from the Bank of England, and his subject was "The dog and
the frisbee."

In a presentation that deserves more attention, BoE Director of
Financial Stability Andrew Haldane and colleague Vasileios Madouros
point the way toward the real financial reform that Washington has
never enacted. The authors marshal compelling evidence that as
regulation has become more complex, it has also become less effective.
They point out that much of the reason large banks are so difficult
for regulators to comprehend is because regulators themselves have
created complicated metrics that can't provide accurate measurements
of a bank's health.

The paper's title refers to the fact that border collies can often
catch frisbees better than people, because the dogs by necessity have
to keep it simple. But the impulse of regulators, if asked to catch
a frisbee, would be to encourage the construction of long equations
related to wind speed and frisbee rotation that they likely wouldn't
even understand.

Readers will recall how ineffective the Basel II international banking
standards were at ensuring the health of investment banks like
Bear Stearns. The inspector general of the Securities and Exchange
Commission, which adopted the Basel standards in 2004, would report
in 2008 that Bear remained compliant with these rules even as it was
about to be rescued.

Messrs. Haldane and Madouros looked broadly at the pre-crisis
financial industry, and specifically at a sample of 100 large global
banks at the end of 2006. What they found was that a firm's leverage
ratio?the amount of equity capital it held relative to its assets?was
a fairly good predictor of which banks ended up sailing into the rocks
in 2008. Banks with more capital tended to be sturdier.

But the definition of what constitutes capital was also critical, and
here simpler is also better. Basel's "Tier 1" regulatory capital ratio
was thought to be more precise because it assigned "risk weights"
to each category of assets and required banks to perform millions
of complex calculations. Yet it was hardly of any use in predicting
disasters at too-big-to-fail banks.

We've argued that Basel II relied far too much on the judgments of
government-anointed credit-rating agencies, plus a catastrophic
bias in favor of mortgages as "safe." Instead of learning from that
mistake, the gnomes have written into the new Basel III rules a
dangerous bias in favor of sovereign debt. The growing complexity of
the rules leaves more room for banks to pursue regulatory arbitrage,
identifying assets that can be classified as safe, at least for
compliance purposes.

Messrs. Haldane and Madouros also describe the larger problem:
a belief among regulators that models can capture all necessary
information and then accurately predict future risk. This belief
is new, and not helpful. As the authors note, "Many of the
dominant figures in 20th century economics?from Keynes to Hayek,
from Simon to Friedman?placed imperfections in information and
knowledge centre-stage. Uncertainty was for them the normal state of
decision-making affairs."

A deadly flaw in financial regulation is the assumption that a few
years or even a few decades of market data can allow models to
accurately predict worst-case scenarios. The authors suggest that
hundreds or even a thousand years of data might be needed before we
could trust the Basel machinery.

Despite its failures, that machinery becomes larger and larger.
As Messrs. Haldane and Madouros note, "Einstein wrote that: 'The
problems that exist in the world today cannot be solved by the level
of thinking that created them.' Yet the regulatory response to the
crisis has largely been based on the level of thinking that created
it. The Tower of Basel, like its near-namesake the Tower of Babel,
continues to rise."

Exploding the myth that regulatory agencies are underfunded, they
note that in both the U.K. and U.S. the number of regulators has for
decades risen faster than the number of people employed in finance.

Complexity grows still faster. The authors report that in the 12
months after the passage of Dodd-Frank, rule-making that represents a
mere 10% of the expected total will impose more than 2.2 million hours
of annual compliance work on private business. Recent history suggests
that if anything this will make another crisis more likely.

Here's a better idea: Raise genuine capital standards at banks and
slash regulatory budgets in Washington. Abandon the Basel rules on
"risk-weighting" and other fantasies of regulatory omniscience. In
financial regulation, as in so many other areas of life, simpler is


(courtesy of the 'audi et alteram partem' deptt - we just like border
collies and don't really understand how they landed in this mess....)

#  distributed via <nettime>: no commercial use without permission
#  <nettime>  is a moderated mailing list for net criticism,
#  collaborative text filtering and cultural politics of the nets
#  more info: http://mx.kein.org/mailman/listinfo/nettime-l
#  archive: http://www.nettime.org contact: nettime {AT} kein.org