CEP Election Analysis:
Financial Regulation: Can We Avoid Another Great Recession?
19 April 2010
The publication is summarised below and can be found in full on the CEP Election Analysis Site
For further information, contact Romesh Vaitilingam on 07768 661095 (Email: romesh@vaitilingam.com).
Financial Regulation: Can We Avoid Another Great Recession?
- The Great Recession of 2008-2010 had its roots in the crisis of financial markets, which spread to the real economy.
- The structural problem with the financial sector is that there is strong 'contagion' between institutions within the financial sector and also between the financial sector and other parts of the economy. A large bank can pull down the financial sector, which can, in turn, pull down large parts of the rest of the economy in a 'domino effect'.
- Because of these contagion effects, governments will inevitably bail out banks; and because banks know this, they take excessive risks. This structural 'moral hazard' problem has not been dealt with by the existing regulatory regime.
- To deal with the problem, we need to (a) make bankruptcy more credible; (b) shrink the size of banks so that there are fewer organisations that are 'too big to fail'; and (c) improve existing regulations in a variety of ways.
- Most current proposals do not deal with this fundamental problem. Improving corporate governance, reforming bankers' pay and crude taxes on all banks and/or financial transactions are mainly distractions.
- Without reform, the risks of a repeat of a repeat financial crisis have increased. There is less uncertainty that governments will bail out banks, and key sectors like investment banking are more concentrated.