Centre for European Reform publishes 'How to Restore Financial Stability'
13 January 2010
The report analyses the macro- and micro-economic causes of the crisis. It also examines how policy-makers have responded, arguing that the macro-economic causes of the crisis have been largely side-lined. It concludes by calling for a clearer sense of priorities in the reform process.
Philip Whyte, senior research fellow at the Centre for European Reform, has written the report. In 2008, the global financial system came close to collapse. Ever since, policy-makers have been busy overhauling the way it is regulated and supervised. Will this flurry of activity produce a more stable financial system – and if it does, at what cost? Many of the changes afoot are desirable. But the reform agenda suffers from three flaws: side-issues are getting more attention than they deserve; regulation is doing all the heavy lifting; and not enough attention is being paid to the combined impact of all the changes underway. The regulatory burden is rising, therefore, but policy may not be taking the optimal path to greater stability. To do so, the reform agenda needs to be guided by a clearer sense of priorities.
The report is structured as follows. It starts off with a thumbnail sketch of the financial crisis, drawing attention to its macro- and micro-economic causes. It moves on to examine how policy-makers in the EU (and the G20) have responded to date, arguing that the macro-economic causes of the crisis have been largely side-lined; that the regulatory response has already been extensive; that the risk of that response going too far is as great as it not going far enough; and that the financial system which emerges could be less ‘globalised’ than the one which preceded the crisis. The report concludes by calling for a clearer sense of priorities in the reform process. In particular, it suggests that less attention should be paid to populist issues, and more to tackling important ones which have been neglected.
One of the conclusions concerns the relation between the state and banks, and says that one of the most urgent challenges facing policy-makers – vastly more important than, say, clamping down on hedge funds – is to reverse the long-standing deterioration in ‘terms of trade’ between the state and the financial sector. Over the past two decades, the risk and leverage of the financial sector has increased, while the state’s safety net has progressively widened. This is a noxious combination.
The banking sector cannot be allowed to continue living in suspended animation between the market and the state. No other sector enjoys such an exorbitant privilege. A status which allows banks to privatise rewards and socialise costs threatens the solvency of states – and will ultimately destroy public support for market capitalism. Banks must wake up to how important the stakes are.
© CER
