incidence of banking crises ... as high since 1980 as in any period since 1800 ... self-regulation [impossible]

Why Financial Regulation is Essential | By Robert Johnson | April 17th, 2008

The Financial Times article by Martin Wolf illustrates that a man who has alway been pro market can see the problems with no regulation and self policing of markets. While Wolf is right to point out that regulation and enforcement are also human activities that can generate their own follies, the work of the society is to set rules to protect people from the excesses of a given segment of society while maintaining the maximum freedom of those within the sector to be creative.

All agree now that:

• Risk management is appalling.
• Executive Compensation Incentives matter.
• Enhancing transparency is vital.
• Leverage is extreme.

What is not envisioned yet is how these changes will be made by a political system that is so dependent upon the campaign contributions from Wall Street. Self regulation is not viable. Having the market participants make the rules for themselves through legislative proxies who they fund is not much better. What is essential to this process is citizen scrutiny and participation. Citizens must blast through the tyranny of expertise that is used to intimidate them from participating in that which impacts their lives profoundly. They should also recognize that after the election the influence of voters will diminish for a couple of years.

Why financial regulation is both difficult and essential
By Martin Wolf, Financial Times
Published: April 15 2008
...

In an interim report on “market best practices”, the Institute for International Finance, an association of bankers, offers devastating self-criticism.* Here then are some of the weaknesses it identifies: “deteriorating lending standards by certain originators of credit”; a “decline of underwriting standards”; an “excessive reliance on poorly understood, poorly performing and less than adequate ratings of structured products”; and “difficulties in identifying where exposures reside”. Would you buy a voluntary code from people who describe their own mistakes in this brutal manner? I thought not. There are two powerful additional reasons for not doing so

First, in such a fiercely competitive business, a voluntary code is almost certainly not worth the paper it is written on. When they can get away with behaving irresponsibly, some will do so. This puts strong pressure on others. That is what Chuck Prince, former chief executive officer of Citigroup, meant when he told the FT that “as long as the music is playing, you’ve got to get up and dance”. So, as Willem Buiter of the London School of Economics remarks: “Self-regulation stands in relation to regulation the way self-importance stands in relation to importance.”

Second, the industry has form. The IIF itself was founded in 1983 in response to the developing country debt crisis. At that time, big parts of the west’s banking system were in effect bankrupt. Now, many upsets later, we have reached the “subprime crisis”. The IIF was created not only to represent the industry, but to improve its performance. It is clear that this has not worked.

Do not just take my word for it. Last month, Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard published an extraordinary paper on the long history of financial crises.** The chart shows that the incidence of banking crises (measured by the proportion of countries affected) has been as high since 1980 as in any period since 1800; that the incidence of crises is correlated with liberalisation of capital flows; and that there was, until 2007, a decline in the incidence of crises in the 2000s. ...