People ask if the regulators were asleep ;when ;subprime mortgages were created. The answer is that they were not asleep but their attention was elsewhere, doing things such as looking for insider dealers and making sure retail products were not oversold to the unsophisticated.
The majority of the UK and US populations have enjoyed the fruits of easy borrowing over the past decade. Only a handful of lonely voices spoke against it. Instead, while the experts wondered whether the next big crisis would be bird flu or no rain for the next three summers, the bubble was silently growing underneath us. It really does seem churlish now to say that every regulator around the world should have gone against all public and political will and stopped the party. Subprime lending was the trigger, but easy credit for all was the fundamental cause. It is the politicians and the public who should accept the blame for this. We all did it and benefited from it.
Few people now seriously think that short selling or large-scale market manipulation – for which no proof was discovered – was the cause of the banking collapse. Banning short selling might have reduced volatility for a few days but the real fireworks started long after the practice was outlawed – plus some economists say that its benefits outweigh the disadvantages. The hedge funds – the usual whipping boys in a financial crisis – actually come out of this looking rather good.
Looking back, it is obvious that capital requirements for lending institutions and over-reliance on short-term money market funding will in future have to be controlled more carefully. This in turn means less private and public borrowing – and it will not be popular. This is regulation, but it is twiddling at the edges. And in many ways, that is all a non-elected regulator should do. The big choice – rampant capitalism or command economy – is a political question.
Looking to the future, regulators will be more inclined to test every fundamental assumption underpinning every regulated business. When there are rumours circulating that small village post offices in rural England are taking millions in deposits from people switching out of their bank accounts, you know that every innocuous assumption in every regulated business model will in future have to be challenged, and the risks disclosed for investors to evaluate. We will see more disclosure of risk in the future, but the problem is that if the warnings are overdone, people will ignore them.
Neither UK business nor the public wants the clunking fist of more regulation.
Many in the US have criticised the chilling effect of Sarbanes-Oxley, zealous regulatory enforcement and shareholder litigation. It is said that this has scared business away from the country without achieving any improvement in financial ethics. In the aftermath of the storm, regulators will be asked to tread even more lightly. We have already seen this with the hasty lifting of anti-competition objections to bank amalgamations in the UK.
Most market participants will also behave defensively for a while after the turmoil blows itself out. Most will have learnt their lesson and will not need a regulator to remind them what they should and should not do when it comes to prudential matters. In 20 years time, of course, this will all be a distant memory and we will need re-educating. In the meantime, light-touch regulation that strives to let the market thrive while trimming the worst excesses at the edges is the only sensible and workable solution. The mistake is to think that regulators can stop bubbles or economic cycles – they cannot.
Will we see more litigation in the UK as a result of the fallout? Of course we will. Some hedge funds are even talking about suing the Financial Services ;Authority ;over ;the introduction of the shorting ban. This has certainly made for good headlines but it will be interesting to see whether the claim is actually pursued. But, as with more regulation, there is no political or business desire for US-style investor class actions in this country. It will not happen, not least because our legal system makes such claims virtually impossible.
In short, if we eliminate risk we end up with nothing; it is as true for school adventure activities as it is for the market economy. Enjoy the hike, but tread carefully.
Duncan Black is a financial services partner at Field Fisher Waterhouse