8: Regulatory Responses to the Crisis
A great deal of regulation in any industry reflects the lessons learned from history. In the wake of a disaster, people speculate about what might have been done differently in the past, and this becomes the basis of regulations that will be put in place to ensure that the same thing will never happen again in the future. There is no proof that these measures would have actually done any good, but they seem like good ideas and help to assuage anxiety about the past repeating itself.
Another large volume of regulation consists of decisions made during a period of crisis - or more specifically, from actions taken by government after the crisis has passed and society is attempting to clean up the wreckage in the aftermath. Such measures often are meant to be temporary emergency procedures to handle a temporary emergency situation - and then they become permanent and ongoing practices.
In this way, the regulatory responses to the world financial crisis of 2007-2009 have become the legal environment in which banks have had to do business ever since, and probably will have to do business ever after. There is very seldom a review of legislation to decide whether it's a good idea to perpetuate laws that are already on the books - and they will be unlikely to be repealed until they are found to be the cause of the next crisis.
Changes to Monetary Policy
In the area of monetary policy, interest rates are often brought to near-zero levels, and certainly less than the natural rate of inflation, to encourage a return to investment in the wake of a crisis. In the USA, interest rates have been below inflation for nearly a decade since the recent crisis. In Japan, their interest rates have been held down for almost three decades.
Such low interest rates will often encourage widespread investment in risky undertakings, except that investors who had taken substantial losses in the crisis have become skittish about financing new opportunities at any rate of return. Meanwhile, lenders have tightened credit restrictions to the point that even many qualified borrowers cannot be approved to borrow.
The method of stabilizing currency is often simply the creation of more currency, to the point where supply exceeds demand. Critics argue that this is tantamount to legal counterfeiting, and will inevitably lead to the debasement of currency and a return to high rates of inflation. The response of central banks seems nonchalant - it hasn't happened yet, so it probably won't. This is not a satisfactory response - and it is anticipated that the next financial crisis will be marked by extreme inflation and the question will arise of "why didn't the authorities see this coming?"
Another problem is that quantitative easing is based on normal patterns of behavior - the assumption that holders of capital will seek to put it to its best use, or in any case put it to some use that will protect its value against inflation. This behavior has not been seen, with dramatic increase in the balances of savings accounts and other vehicles whose return is beneath the level of inflation in most of the world's major economies, more pronounced in those that suffered the most from recent economic crises.
In the present day, we are seeing near-zero interest rates in many world economies, and some are toying with the notion of negative-interest policies in which banks charge their customers a monthly penalty (rather than paying a monthly interest) for keeping money in the bank. Until now, this has been considered a theoretical bauble - something that would never happen in reality. It's hotly debated as to whether negative interest will cause consumers to spend their savings on consumables, move them to investment vehicles, maintain physical cash in vaults, or simply shrug and pay the monthly rent to their banks.
Developments in Bank Regulation
Government regulation is seldom based on wisdom. Mandatory practice are handed down to the industry based on the imagination of politicians who have no experience in that industry, often pressured by the panicked emotions of an equally uninformed public. Those who have experience to make sound decisions are often pointedly excluded from making a decision, though they may be called to serve unofficially on an "advisory committee" whose advice is more often ignored than considered. This is particularly true when regulation is in reaction to a crisis - or worse, when it takes place during the heat of a crisis and the public demands swift action rather than a well-considered response.
Since the crisis impacted many nations, there has been organization on the international level: the organization of a Financial Stability Board that includes representatives of the world's 20 largest economies, which has no formal authority but can suggest policies and standards to its participants.
Efforts are underway to classify firms that can be critical players in future crises: firs that are "too big to fail" or "too interconnected to fail" or "systematically important financial institutions"
In some countries, additional taxes are being placed on financial institutions to create a war-chest for the next crisis, so that the money that is used to bail out the financial industry comes from the industry itself, and is not laden upon the common taxpayer. Though it doesn't seem to occur to the governments that levy these taxes that they will be paid by the public through lower returns and higher interest rates on loans. So essentially, the public is being made to pay in advance for a crisis that has not yet occurred. At least it will be a gradual process.
The crisis also caused a reconsideration of some of the deregulation that occurred a few decades earlier, when banks were permitted (or no longer forbidden) to engage in more aggressive and risky investment activities with their depositors' funds. Naturally, banks are protesting the notion of being put back on their former leash and a great deal of argument over precisely which kinds of investments should be allowed or forbidden.
Another suggestion in the UK is to allow banks to engage in a variety of activities, but to maintain separate accounting of banking and other operations to demonstrate that their banking operations are independently sustainable. Specifically, that banking operations should not be used to subsidize unprofitable lines of business to the detriment of the depositors.
There is also an ongoing attempt to define prudential regulation, to distinguish macro-prudential legislation (required of all banks at all times) from micro-prudential legislation (required only of certain banks based on specific criteria).
Some are taking aim at the compensation structure of banking executives, on the rounds that incentives related to performance encourage bankers to take an undue level of risk with their depositors' funds. This is coupled with ongoing public outrage at the bankers who, during the financial crisis, were receiving massive bonuses even while their companies were accepting government assistance for having failed.
There are calls for greater and more intrusive oversight of bank activities and a government-operated ratings and review boards to monitor and report on the solvency of banks and the stability of their capital assets - a reaction to the independent agencies who were suspected of maintaining high ratings of banks that were struggling during the crisis.
There is also interest in creating greater transparency of derivatives, as the DMOs issued during the crisis were able to prevent investors from inspecting the mortgages that were bundled and securitized, enabling sellers to misrepresent the level of risk they were taking on.
And finally, there is consideration of whether the organizations that compose the shadow banking industry should be allowed to remain within the shadows, or be subjected to more intensive monitoring and regulation.