“We need less regulation – not more.” It’s hardly a fashionable idea these days, with the world still reeling from the biggest financial crisis since the Great Depression.
As far as many are concerned, it was a lack of financial regulation which got us into this mess to start with. That’s why we are currently seeing an onslaught of new rules about how banks do their jobs – from the Dodd-Frank and Volcker Rule regulations in the US to the Vickers reforms over here, the direction is towards more and stricter regulations of banks.
Which is why it’s so striking that now, one of the most prominent figures in Britain’s financial policymaking circles has argued that “In financial regulation, less may be more”.
Andy Haldane’s comments, delivered in Jackson Hole a couple of hours after Ben Bernanke’s speech, may well go down as the most interesting contribution from a central banker at the symposium. Quite something, given that Haldane isn’t a household name and doesn’t even have a say in his country’s monetary policy (he’s one of the lead financial policymakers at the Bank of England.
He delivered a rich, long and only occasionally esoteric speech about complexity and financial crises – a journey which also features serial killers, hospitals, frisbees and border collies (really).
But it’s that point about paring down financial regulation which is likely to resound. His point is that the more complex systems get – whether by systems you mean financial regulation or, for instance, sporting rankings – the worse they often get at doing their job.
Haldane mentions the ranking systems created by FIFA and the ATP in football and tennis respectively: they are extremely complex and detailed, but they are less effective at predicting success in a forthcoming tournament than simple surveys based on name-recognition.
He adds that the same is true across the broad:
Among physicians diagnosing heart attacks, simple decision trees beat a complex model. Among detectives locating serial criminals, simple locational rules trump complex psychological profiling. Among investors picking stocks, simple passive strategies outperform complex active ones. And among shopkeepers understanding spending patterns, repeat purchase data out-predict complex models.
And yet when it comes to financial regulation, the entire apparatus has become far more complex and unwieldy than it ever used to be. The Glass-Steagall bill of 1933 which split up American investment banks was a mere 37 pages long. Today’s equivalent, Dodd-Frank, is 848 pages, plus 400 pages of further rules. Haldane calculates that by last month, “two years after the enactment of Dodd-Frank, a third of the required rules had been finalised. Those completed have added a further 8,843 pages to the rulebook.”
The same is true when it comes to international regulations: the first big set of global banking rules, Basel I, was an agreement which clocked in at just 30 pages. Basel II was 347 pages while Basel III was 616 pages.
Longer and more complex regulations need more people to police them, and perhaps the most striking statistic in Haldane speech is that “in 1980 there was one UK regulator for roughly every 11,000 people employed in the UK financial sector. By 2011, there was one regulator for every 300 people employed in finance.”
It turns on its head that whole argument about the cause of the crisis being a lack of regulators. The over-riding point of the paper, which is a must-read, is that any new rules to police banks and finance should be far, far simpler than they are at present.
Quite how this will go down in financial regulation circles will remain to be seen, but it makes eminent sense. My argument about the financial sector has, for years, been that we need, somehow, to return to a world where those who own investment banks would, once again, face unlimited liability for their investments. In other words, if the bank was to collapse, they would face losing not merely their shareholdings but every penny of their wealth until the enterprise was wound down.
However, I’ll leave you with one final intriguing point from the Haldane paper: perhaps we are imperceptibly moving towards a big break-up of the banks, of the kind that was seen in the 1930s. In fact it might be happening already. Here’s Haldane:
Having risen to a peak of almost three in 1928, the largest US banks’ price-to-book ratios had by 1931 plummeted to below one. They remained close to these levels for several years afterwards. This discount implied that investors in the bank could improve their wealth by selling-off the banks’ assets separately. Investor pressures to separate began to mount.
In response, a number of banks began selling off their equity brokerage affiliates, including the two largest banks, Chase National Bank and National City Bank in 1933. A number of banks delisted their shares. This response, led by the market, paved the way for the passage of Glass-Steagall in 1933. As Fuller (2009) puts it: “Divorce made a virtue of necessity and cursed and condemned bankers jumped at the opportunity to demonstrate their virtue”. The market was leading where regulators had feared to tread.
Today, the situation is not so dissimilar. As then, many of the world’s global banks have fallen from heady heights to trade at heavy discounts to the book value of their assets. If anything, the discounts to book value are even greater today than in the early 1930s. As then, this conjunction is stirring market pressures to separate. Bankers today, many cursed and condemned, could make a virtue of necessity. The market could lead where regulators have feared to tread.
This article is also available on the Sky News website.