Three former regulators fault the U.S. and world regulatory systems for the global economic crisis and are proposing the adoption of a new institution to thwart future systemic dangers.
In a soon to be released book called Guardians of Finance, James Barth of the Milken Institute, Gerard Caprio of Williams College and Ross Levine of Brown University argue that global financial regulators have proved to be an insignificant impediment to known or knowable problems which they failed to address on a timely basis.
The authors argue that complex financial products, which often get the rap for having triggered the crisis, cannot have been its root cause since countries like Ireland and Spain where financial innovation were not big factors have also suffered severely through inadequate oversight of their financial industries.
Making the case that a weak regulatory system is key to the crisis, the authors ask: “Why, for example, did U.S. regulators not react to the alarming increases in leverage at financial institutions, or the shift of trillions of dollars of assets from banks’ balance sheets that were packaged into complex securities? Why were Irish regulators willing to sit around for two-and-a-half years waiting for a reply to a letter they sent to the Anglo Irish Bank expressing concerns about its meteoric (and unsustainable) growth? Why did U.K. regulators give the Northern Rock bank a blue ribbon for risk management, and allow it to increase dividends just three months before it failed?”
Yet the authors also decry the standard approach to regulatory lapses of adding further layers of regulations and new bureaucracies to enforce them. Instead, the book, which is excerpted in the current issue of the Milken Institute Review, calls for a novel institution the authors call the Sentinel “to provide expert, independent assessments of financial regulation.”
The problems the Sentinel is designed to overcome include political interference, closeness to regulated business interests, access to information and the expertise to analyze it, and the clout to be taken seriously. For example, the authors cite the lengths to which even the respected Federal Reserve Bank has stymied access to information, thus thwarting the regulatory oversight the public requires:
“In May 2008, Bloomberg News filed a Freedom of Information Act request for Fed documents on its lending to banks. The Fed said it would respond in June, but did not. Bloomberg News sued, and in August 2009, a federal court ruled that the Fed must release the documents. The Fed appealed, and in March 2010, an appellate panel unanimously sided with the lower court. At that point, the Senate called on the Federal Reserve to identify the banks and other financial institutions that received loans. The Supreme Court eventually ordered the Fed to comply. The Fed then released the thousands of documents in a nonsearchable PDF form, making it difficult for the public or the press to examine them.”