:LPE:

The past six months have been a fascinating time to be watching financial regulators: the central banks, the “regulated industries” like banking, insurance and institutional funds. Nothing like a crisis in the credit markets to focus the attenti0n. We may be at some sort of turning point here, and what is on the line is the US-style banking and financial regulatory system, maybe even Basel II, the independence of central banks, or, if you’re more optimistic, the role of the financial system in the economy as a whole.

This week, the Fed in the US more or less repudiated Alan Greenspan’s approach to these matters and announced stricter regulation of predatory lending, which is way, way too late, but does make the nice point that not only was Greenspan wrong, but it was also his duty to do something about it, a suggestion he rejected his entire career (which did not stop him from co-ordinating “private” bailouts, mind you). Greenspan’s approach to speculation in financial markets was let it happen, and engage in ad hoc bailouts on a when-and-if basis. It’s a valid approach, but it is barely a regulatory system and if it is systematic, then it is ripe with that favourite term of the economist, moral hazard. To this, Greenspan shrugged.

Bernanke seems to believe that he ought to be somewhat more proactive, although as recently as last summer he was saying that it was just a little blip and business as usual, so his powers of prognostication are all too human. He has, as have other central banks (with the sometimes-exception of a rather more orthodox UK central bank), been propping up credit and asset markets for a good six months, maybe more. It seems that under this new approach. asset values have become as much a priority as price stability, and, to paraphrase the House of Lords, if one asset value, why not 50? Indeed, why not make full employment the priority in central policy? Ah, a bridge too far…

The BoC has moves in step, providing cheap money to banks who are experiences problems and lowering the interest rate (not exactly a surgical tool for this purpose), and there has been the usual rebuttals from OSFI and the BoC - it was not their job to be regulating the purchase and sale of securities. Indeed, it is not, that is for the OSC, a notorious enforcer of strict regulatory policy and rules. The BoC and OSFI could do a lot to add Transparency and Integrity to the capital markets if it decided to regulate ratings agencies with any kind of vigor. I’m not sure why an opinion purchased by the seller counts as information free from conflict of interest. Or, why are banks allowed to securities loans and move them off their balance sheets, does this not result in a mismatch of risk and ability to control it? Does it not provide an *incentive* to make riskier loans and package the risk out to investors (relying on those ratings agencies again to understand the deal).