As the weeks and months elapse since the most intense point of the financial crisis in October 2008, I for one find myself unclear about where major governments have got to in terms of reforming the financial sector. The banks are clearly back to business as normal – building bonus pots for next year, hiring madly, egging companies on to M&A activity and so on. Does this mean the momentum for reform has evaporated? Have governments wasted a good crisis?
Two recent books go a good way to refreshing my mind about the issues and in particular addressing global, systemically-risky institutions. One is a new report from the Centre for Economic Policy Research, A Safer World Financial System: Improving the Resolution of Systemic Institutions, by Stijn Claessens, Richard Herring and Dirk Schoenmaker. As the title indicates, it's about the thorny issue of cross-border regulatory co-ordination and bankruptcy procedures for large, important institutions, given that national authorities care only about national effects and ignore international spillovers. The report identifies three things policy makers want – national level decision-making, cross-border banking activity and global financial stability – and points out that there is a 'trilemma' – all can't be achieved simultaneously. Any reform procedures have to adapt to that reality.
The second book is Balancing the Banks: Global Lessons from the Financial Crisis, by Mathias Dewatripont, Jean-Charles Rochet and Jean Tirole. It too takes a cross-border perspective and focuses on two issues, the future of banking regulation and the treatment of distressed banks. On the former issue, nobody I've spoken to about Basel II believes the regime did anything other than make financial stability worse. One senior banker – working for a bank that didn't get in to trouble – even told me they made one set of risk assessments for the regulators and another for themselves, so dreadfully inadequate did they think the regulatory regime. The authors of this book aren't so scathing, although they do note the need for greater standardisation of liquidity rules and products, and revisiting capital requirements so that they can vary over the business cycle. On tackling distressed banks, they also argue that a single capital requirement isn't enough, and the authorities will need other indicators of distress and other levers. Under both headings, the book covers a wide range of necessary reforms, from improving and making more transparent credit rating to international regulatory architecture to improving the Basel regime. The book give a useful overview of the entire waterfront of necessary reforms – and my goodness, there's a lot to do.
However, my main conclusion after revisiting these various issues is the realisation that there is still so much that ought to be done in terms of regulatory reform. Given the lobbying power of the banks, and their evident lack of moral compass, it's going to be a long slow haul. I owe to the FT's John Plender the fact that there are five banking lobbyists for every member of the US Congress. Here in the UK, a good start would be the new Banking Commission under John Vickers recommending the break-up of the major banks, reversing decades of mergers and the consequent concentration of power, both economic and political. (For anyone in the UK who didn't catch last night's BBC Panorama on the high street banks, Banks Behaving Badly?, it's well worth a viewing.)
Meanwhile, let's hope economists for their part keep up the pressure by continuing to analyse what went wrong and what needs to be done. That includes pointing out unpalatable truths (always, I think, one of the strengths of economics and its delight in the absence of free lunches). The trilemma is one unavoidable truth. Another is the sheer long haul before we have anything like a socially useful financial sector.
