Problems In British Banking System

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For a while, this hands-off approach seemed like the right answer, especially when viewed against the Dr. Seussian American system, in which multiple agencies, often with overlapping jurisdictions, compete against one another.

“We are a much freer market, much more lightly regulated,” says Bob Penn, a London securities lawyer for Allen & Overy. “But ultimately, the regulators are just too timid about market abuse. We don’t have particularly clean markets.” The F.S.A., it turns out, has pitifully staffed and funded enforcement operations compared with the S.E.C. Though the London markets are about a third of the size of their U.S. counterparts, the F.S.A. has a mere 98 enforcement agents to the S.E.C.’s 1,111.

Of course, the financial world likes the light touch of the F.S.A. But amid panic about the solvency of financial institutions, the world is learning the value of a regulator that has the market’s respect. When Northern Rock started having trouble, the banking regulators at the F.S.A. dithered and fumbled. Northern Rock went under. The F.S.A. publicly flogged itself, and heads at the agency rolled. But the damage to the market was done, reflected in the financial sector’s continuing collapse.

This isn’t to say that American regulators have done much better. The S.E.C. is bigger and more professional and was more willing to wield its enforcement powers than the F.S.A. was, but S.E.C. chairman Christopher Cox has largely been missing in action during the credit crisis, most prominently on the weekend that the Federal Reserve brokered the J.P. Morgan takeover of Bear Stearns.

To distract from the mess, regulators on both sides of the Atlantic are staging a sideshow of rousting speculators. The hunt is on for the sowers of hate and fear among us, the short-seller behind every bush. The F.S.A. has proposed some modest rules advocating short-position disclosure while banks are in the middle of selling stock to raise cash.

Here, we’ve been treated to the spectacle of hastily drawn rules and publicly announced investigations that are more P.R. campaign than substantive response. You keep expecting Cox to rise before a congressional committee and shout, “I have a list! There are 150 secret short-sellers in the market! A list of 150—no, wait—160 known short-sellers!”

This is what’s meant by the term moral hazard: Investors who get in trouble are then bailed out, and thus have little incentive not to do it again. Yes, runs on financial institutions can happen. But the risk of a run requires financial firms to manage for the possibility. The threat should curb their recklessness. If they know, however, that when things get bad, the government will hinder betting against them, seek out those who speak ill of them, lend to them cheaply, and generally backstop them, then they have every reason to take huge risks

in the future.

We’re in a dangerous phase. In a crisis, you can either go toward fearmongering and scapegoating or toward real reform. But I’m an optimist. I think that after the denial, anger, and acceptance, after the failures, bankruptcies, losses, witch hunts, and punishments, we will come to realize that we have to rethink the way we regulate our financial system.

it’s noteworthy that both the U.S. and British economies have similar problems—and it’s not that both are plagued by secretive malign forces. Both countries are filled with bad loans and overleveraged institutions. Britain has the right structure but the wrong approach to remedy its problems. The U.S. has the wrong structure and, in recent years, the wrong approach.

We can still learn from the rest of the world. An F.S.A. would work in the States, provided it had teeth. It isn’t enough to reorient the S.E.C. toward enforcement after the neglect of the Bush-Cox era; financial regulation in this country needs a wholesale revamping. Regulators will need to focus on capital requirements. In Britain, this is already taken as a starting point. Over there, people are also contemplating regulation of banker pay to better align incentives. That’s highly unlikely here now, but the problem is clear: Bankers on both sides of the ocean are rational in taking big risks because the state protects them from serious consequences. Furthermore, monetary authorities will have to monitor asset bubbles and assume responsibility for deflating them.

Most of all, we need to restore the good name of regulation. For many years, the U.S. stock market provided the highest returns in the world yet was more regulated than foreign exchanges. Regulation and returns aren’t mutually exclusive. One leads to the other.

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