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Regulation at a dead end

Look at what Andy Haldane, Charles Calomiris, Bill Isaac and Richard Fisher are saying


Last week Charles Goodhart uttered what I called his cry of despair (See RP’s Diary 13/01/13); now it is BOE’s Andy Haldane’s turn.

Goodhart has realised that we are running out of monetary policy models – rules or frameworks like inflation targeting (IT) by which central banks steer interest rate policies. He warns of the dangers of nominal GDP targeting, but senses a change is inevitable. But then it will be difficult to go back to the old IT system, as it will have lost credibility.

Andy Haldane is experiencing the same dawning realisation with respect to regulatory policy. He acknowledges that the too-big-to fail problem has not been solved; indeed, that it is worse than ever. The implicit subsidy from the state now runs into the “hundreds of billions”, he says, a year rather than merely the tens of billions. He seems surprised and points to all the initiatives take by the official sector to address the problem. Yet is it really so surprising?

The banks receive a bigger subsidy now because it is evident everywhere that the local sovereign supports them and will support them up to the point at which the sovereign runs out of credit. Before 2008, the markets merely suspected this; after the Lehman experience – i.e. the lesson drawn that it was a terrible mistake to let it go – they know it. Central banks appear to be trying to get us to believe that their support is conditional and ambiguous: this is scarcely credible. Has any central bank announced withdrawal of support?

Until a large financial group is actually allowed to fail, and uninsured depositors and other unsecured creditors lose money, of course nobody will believe it will happen. There are no regulatory tricks that can remove the subsidy until then. Don’ t waste your time thinking about them!

The financial sector has reasserted its ascendancy over the state. Top management has a pipeline to the taxpayer’s pockets. They will go on squeezing the state until there is no more juice left. That is human nature.

Channels of intermediation have become instruments of intimidation.

Calomiris gets simple

Charles Calomiris, an excellent regulatory specialist, thinks meaningul reform is unlikely – but also that he has the answer.  He calls for a much “simpler” structure of regulation – the word simple appears no less than seven times in his short article. But any such rule book would have to be approved by governments and regulators. I have got news for Charles: once it emerges from that process your “simple” rules will be fiendishly complicated.

Simpler rules, he says, should be “grounded in an understanding of the incentives of market participants and supervisors”. Excuse me, but that is exactly what sensible observers have tried to do for many years – I co-edited a 500 page book (with regulatory gurus David Mayes and Michael Taylor) called “Towards a New Framework for Financial Stability” (Cetnral Banking Publications, 2009) dedicated to doing just that. You are putting your toes back in the same water!  Let uninsured depositors experience losses? Big haircuts for unsecured creditors? You must be kidding.

As Calomiris himself says, the implicit theory behind the “new” approach to regulation is that the old model failed because it was not complex enough.

Look at it this way: without a subsidy, the real cost of providing a traditional banking service to depositors – i.e. provision of liquid liabilities repayable at fixed nominal value on demand – is bound to be very expensive, given the absence of risk-free assets in which to invest. It could be a significant fraction of GDP per annum. “It’s not politically possible”, I hear you say. That’s right. Yet we can’t go on as we are. That’s the trap.

Bill Isaac’s remedy

One plan I personally like is by William Isaac ; the Subsidy Reserve Plan was first put forward in 2010 and Bill has revived it (see an FT piece on Jan 18). This calls for each “TBTF” bank to establish an internal reserve fund and add to it each year the estimated subsidy it receives from taxpayers in the form of reduced funding costs. Nice one, Bill, but just wait for the regulatory geeks to get their teeth into it. Does the subsidy include an estimate for access to the discount window? Lender of last resort loans? If it means a huge increase in bank charges or lending rates, what will the small business lobby say? All these taxes, just like all the fines for bad behaviour and scandals, are passed on to users. If the banks can’t afford them, they simply get new capital from the state. Or they widen their profit margins courtesy of the central bank.

And if you are right about the power of the big banks, then they will be able to stop your plan, won’t they?

Then there’s Richard Fisher…

As Richard Fisher, president of the Dallas Fed, notes, subsidies can’t be removed. He has drawn the right conclusions. Government action is needed to break up the big banks:

“…entrenched oligopoly forces, in combination with customer inertia, will likely only be overcome through government-sanctioned reorganisation and restructuring of the TBTF BHCs (bank holding companies).

“A subsidy once given is nearly impossible to take away. “

Serious people are daring to think the unthinkable.


PS It may be too much to expect central bankers seriously to consider the case for free banking – which has an excellent website here with George Selgin’s account of the modern approach to free banking here. But you never can tell…Serious people are daring to think the unthinkable.