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30 June 2008

The Future of Regulation

The recent sub-prime crisis in the USA and the maelstrom of financial damage that has ensued in the USA and elsewhere has provoked an intense debate on the extent of regulation of financial markets. Debates on big issues such as these are a good thing for public policy, for the economy and for society in general, because clashing perspectives on a problem or cluster of problems often can be synthesised into a workable improvement of the status quo. The problem with this particular debate is that the clash of perspectives is so stark that it offers little for anyone who wants to improve present arrangements to work with.

In one corner we have the apologists, the defenders of the indefensible who continue to argue that all is fine and that our present problems are to be blamed on a few miscreants, who are now disgraced or on the way to gaol...or both. Of course, this leaves the system free of blame and not in need of change. Which leaves us all exposed to more crises of this type and probably even worse.

In the other corner we have the advocates of regulating everything to death, who are using the present circumstances to argue that the only way forward is to go backward, to a time when lending and borrowing money was a privilege reserved only for the rich. They may not know this, they who argue for ever greater regulation, they may not understand that this would be the outcome if their advice were followed - but that is what would happen if they had their way.

Because our present regulatory system is already somewhere between these extremes it is hard to find a constructive way forward. Allow me to suggest a possible path to a better world.

The first step is to understand that in a globalised, hi tech financial world, what happens in the USA will affect everyone. The next step is to understand that what happens in a large economy like the USA will affect everyone a great deal, for good or for ill. The third step is to build on this understanding to construct a more flexible global framework to regulate the world's finances. By flexible I mean a framework that can deal differently with different levels and types of risk and that can adapt quickly, to act more quickly than the lumbering processes of governments and central banks can do now in response to challenging circumstances.

In the next blog, I will explain how this could be done.

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