The financial crisis was caused by lack of insight, not lack of institutions

I had an interesting exchange on Twitter this morning with Rupert Harrison, formerly George Osborne’s chief of staff, now Managing Director at Black Rock, and tweeting under his own name.

He wondered out loud whether the financial crisis might have been prevented if we had already had the Financial Policy Committee up and running.

My own view is that the crisis was caused by a failure of insight, not a failure of institutions.  The key problem was the failure to apprehend the risks building up in the system, and to realise that we had therefore chosen the wrong place on the trade-off between regulatory tightness and growth.

Today’s institutional architecture I wager would have fared just as badly, staffed with the economists with the same misapprehensions, and the same over-confidence in the tendency for financial intermediaries to self-regulate.  [I’m not blaming others here, I was just as deluded].  And overseen by a Treasury peopled by economists taking the same view, and headed by politicians inhabiting a political consensus over light touch regulation that derived from the same incorrect economic analysis.

If today’s institutional architecture has its advantages, and the pre-crisis architecture was lacking, that itself is a manifestation of this changed insight.  But I wonder how important it is.

Rupert pointed out on Twitter that the Financial Services Authority, once carved out of the BoE, had lost its focus on the macro aspects of financial stability.

That may be true, but I wager that it was mostly due to the fact that these maro aspects weren’t considered relevant – because of the same prevailing economic analysis of financial stability – and not because they had offices now further from their monetary policy specialists.

Recall too that FSA was carved out of the BoE in the first place because it was thought – not without good cause – that the BoE had lost its supervisory focus and discipline, lines of responsibility muddled in an organisation that had many things to do.

The latest reshuffling of the regulatory chairs – bringing supervision back under BoE control – may be optimal.   Or it may simply recreate the old problems of the past.  Manifest in successive management studies tilting backwards and forwards on the question of prioritising synergies versus specialism and focus.  [Note to self to read the next Mais lecture and McKinsey Review].

Ian Martin pointed to the failures of the old Tripartate grouping of the BoE, HMT and the FSA, and the Memorandum of Understanding on which it operated.  What a mess it looks like now.

Well, maybe.  But we can apply the same critique to this view.

The same 3 people [now Carney, Bailey, Osborne] will still have meetings, and essentially about the same topics [should we put taxpayers money at risk to rescue/lend, or not?].  They will sit on chairs that have different labels, and the minutes will have different headers and footers, but will those labels really make a difference?  I speculate ‘not much’.

Though what will make a difference is the lived experience of the near total collapse of finance in the last decade.

 

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10 Responses to The financial crisis was caused by lack of insight, not lack of institutions

  1. Roy Lonergan says:

    Tony

    As the BoE has PRA/FCA back under its wing, how can the Governor avoid talking in public about issues outside a strictly central-banking remit?

    I have his climate change comments in mind. He was widely criticised for those, but the PRA had recently published this on insurance and climate change:

    http://www.bankofengland.co.uk/pra/documents/supervision/activities/pradefra0915.pdf

    Which I found very interesting. This means that he must be able to talk about wider macro risks as part of the expanded BoE role. Is that right?

    Roy

    • Tony Yates says:

      I don’t object to speches urging that financial firms consider the risks of climate change. [Though I suspect the motives somewhat in prioritising this, given that IMO the risks are much further down the track than other things, like the next financial crisis]. I do object when Carney, for example, includes in his words comments that Governments are running out of time to do something about climate change themselves. Though I agree with this as a substantive point, it’s not for Carney to interfere.

      • Nanikore says:

        I absolutely agree. But you cannot recruit an ex-director of Goldman Sachs and expect him to be quiet.

  2. eric says:

    My 35 years (though now long retired) of dealing with banking regulators tell me that the regulators
    using their discretion will always be a “day late and a dollar short” for a number of reasons other than “insight” or competence. Nor will self-regulation ever prevent crises unless constrained by
    a few simple, ironclad rules on leverage (tangible assets to common equity) and the valuation of
    non-performing assets (especially loans). Forget about risk-based capital. It’s just an excuse to
    justify excessive leverage.

  3. Charles Cara says:

    I don’t think it is just a lack of insight at the level of the FSA. Imagine they had had insight and gone to the Government and Parliament and said in 2006/7 that they would like to have heavier touch regulation and for higher capital requirements. It would have been a ‘brave’ regulator who would have done so as back then political parties were competing to cut financial regulation the most. They would have been sent back Canary Wharf with a flee in their ear.

  4. Nanikore says:

    “Though what will make a difference is the lived experience of the near total collapse of finance in the last decade.”

    Don’t bet on that.

    • Tony Yates says:

      To think it would make no difference whatsoever is too pessimistic.

      • Nanikore says:

        I do hope you are right that ‘this time is different’. But I have good reasons for scepticism. Galbraith (a good historian who was very critical of economist’s faith in their models) said whenever people say we have learned the lessons and we are in a new era “it is time to run for cover”. Another historian, Angus Maddison basically said that financial deregulation is axiomatic in capitalism (he said that in 1988). If Minsky is right the processes towards the next financial crisis are happening as we speak. The General Theory still has more to say about these things than what boffins are coming up with now who seem to think we can understand mood swings, animal spirits and other such irrational behaviour that lie behind these crises by staring into and tinkering with rational models of behaviour. If you really want to understand this stuff properly you have to plough through the archives, talk to businesses and banks and carefully read their company reports, and cross over to your history and psychology departments.

  5. am says:

    You and HRH seem to agree.

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