Bank Regulation

A common view is that banks were not sufficiently regulated. The fact that contradicts this is that most banks were more highly capitalised and more liquid than the regulations required.

Jeffery Friedman and Wladimir Kraus argue in their book called Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation that regulations intended to minimise risk actually encouraged perverse behaviour. By holding assets that regulators deemed to be safe, they could free up capital to fund the expansion of their operations.

A bank that bought bonds issued by Fannie Mae or Freddie Mac could reduce its capital requirements by 60 percent, because these were deemed by regulators to be safe. The regulations created an incentive to securitise loans through these agencies, because it expanded its lending capacity. Time proved that regulators were wrong about the safety of these government-sponsored institutions.

This is an example of government regulation increasing instability by trying to make the situation better.

Financial Fuss (5) - Regulation will Fail

Many commentators are claiming that the American financial system needs stronger regulation. They are totally unrealistic.

Government regulators will never be able to keep ahead of clever bankers. The current crop of regulators did not foresee the current problems. Only a few weeks ago, they were saying that the financial system was fine. If they were not clever enough to predict the credit crunch, how would they be able to come up with regulations that would have prevented it?

Most government regulations are designed to solve the last problem that occurred. They are usually incapable of dealing with the next problem, because they regulators do not know what it will be. You cannot regulate something that you cannot predict.