Wednesday, August 06, 2008

No alternative to tighter financial regulation

I wrote in my post yesterday that Greenspan's arguments in favour of competitive markets was misplaced in the context of financial institutions especially those that have a regulatory safety net.

Henry Kaufman, an erstwhile Oracle of Wall Street, echoes this viewpoint in an article in FT today that rebuts some basic premises of Greenspan:

First, we should recognise the deregulation illusion. When faced with the choice between regulated and deregulated financial markets, most nations try to sidestep. Market participants laud the virtues of unhindered competition over regulation for disciplining market behaviour. That works, by and large, for small and medium-sized companies, but not for the integrated financial giants that dominate many aspects of financial markets. These behemoths are “too big to fail”. Whenever one of these favoured institutions gets into serious trouble, some kind of formal or informal safety net is deployed.

A second and related precept is that comprehensive financial deregulation is impractical as well as politically and socially intolerable. This precept rests on the necessity that financial authorities safeguard the payments mechanism. Indeed, most large depositors are also fiduciaries (investment advisers, corporate treasurers and the like) that are compelled to shift funds out of institutions that seem to be in peril. Given these realities, the only way to abandon the “too big to fail” doctrine is to ensure that leading institutions are too strong to fail. That, in turn, requires close, ongoing official scrutiny.

The more free-market oriented our economy, the greater its need for official financial supervision. A truly ­market-oriented economy poses high risks of business failure and, correspondingly, high risks to institutions that lend to and invest in the private sector. Moreover we need to acknow­ledge that, while financial competition fosters innovation, it also contributes to instability

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