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It May Take Another Crash to Learn the Lessons of the 2008 Crisis

September 11, 2018 in Economics

By Diego Zuluaga

Diego Zuluaga

It is a decade since the financial crisis, and no one is happy.
Progressives like Elizabeth Warren and John McDonnell think the
guilty bankers went unpunished. Free-marketeers despair over the
absence of meaningful reforms to discourage risk-taking on the
taxpayer’s dime. Ordinary people across much of the West have only
seen tepid growth since 2008. In response, they are turning to
political extremes that promise protection from competition and

It might have been different. People of good will may disagree
on how free financial markets should be, but among those who have
studied the crash, there is broad consensus that three key factors
led Western economies astray in late 2008.

First, bank regulation was too complex, which encouraged gaming
the system, complicated supervision, and raised barriers to
competition. Second, government programmes to extend credit to
disadvantaged groups were poorly conceived and ended up hurting the people they were meant to help.
Third, governments lacked the wherewithal to stand by their
commitment not to bail out financial institutions once the crisis

So long as governments
believe that they can allocate credit more productively than the
market, people will borrow beyond their means and eventually

An adequate regulatory response to these failings would have
simplified the regulation of banks, eliminated interest and deposit
subsidies on mortgages and other forms of credit, and credibly
affirmed that taxpayer funds were not for the banks to take during
bad times.

Unfortunately, that is not the response we got. Not long after
the crash, the Bank of England’s Andy Haldane bemoaned the relentless growth in the number of
regulators per financial services worker. But it has carried on
unabated. In the United States, the Dodd-Frank Act introduced an
estimated 27,000 new regulatory restrictions. Europe has
not been far behind, with a slew of EU-wide new bodies to monitor
financial institutions. The Eurozone too has birthed its own
additional alphabet soup of regulators.

A simpler regulatory structure this one is not, even though
complexity can cloud rather than illuminate regulators’ judgement.
For example, research shows that detailed risk-based capital
requirements are not sound predictors of bank failure. By
contrast, simple leverage ratios did a good job of forecasting
which banks would fail in the crash.

The US mortgage market, where the banking system’s troubles
originated, is little-changed from ten years ago. It is true
that lending rules are tighter, which banks report have made it more difficult to
extend credit, even to perfectly good borrowers. But the central
role of the government in buying and packaging mortgages, and the
concomitant public guarantee, are undiminished.

Worse, …read more

Source: OP-EDS

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