Andy Haldane again. He continues with his amazing papers/speeches. The recent one was at Jackson Hole symposium (papers have been put up).
In this paper he talks about how financial regulation is becoming increasingly complex. He nicely links it to a dog catching a frisby:
Catching a frisbee is difficult. Doing so successfully requires the catcher to weigh a complex array of physical and atmospheric factors, among them wind speed and frisbee rotation. Were a physicist to write down frisbee-catching as an optimal control problem, they would need to understand and apply Newton’s Law of Gravity.
Yet despite this complexity, catching a frisbee is remarkably common. Casual empiricism reveals that it is not an activity only undertaken by those with a Doctorate in physics. It is a task that an average dog can master. Indeed some, such as border collies, are better at frisbee-catching than humans.
So what is the secret of the dog’s success? The answer, as in many other areas of complex decision-making, is simple. Or rather, it is to keep it simple. For studies have shown that the frisbee-catching dog follows the simplest of rules of thumb: run at a speed so that the angle of gaze to the frisbee remains roughly constant. Humans follow an identical rule of thumb.
How does he show rising complexity in regulation? By looking at how number of pages and columns are being added to existing regulations.
Basel Accords are non-statutory. But since the 1980s, the trend has been towards underpinning these non-statutory greements with national legislation or additional rule-making. At first, this was simple. The 30 pages of Basel I were translated into 18 pages in the US and 13 pages in the UK. By the time of Basel III, the domestic documentation topped 1,000 pages in both countries.
Viewed over an historical sweep, this pattern is even more striking. Contrast the legislative responses in the US to the two largest financial crises of the past century – the Great Depression and the Great Recession. The single most important legislative response to the Great Depression was the Glass-Steagall Act of 1933. Indeed, this may have been the single most influential piece of financial legislation of the 20th century. Yet it ran to a mere 37 pages.
The legislative response to this time’s crisis, culminating in the Dodd-Frank Act of 2010, could not have been more different. On its own, the Act runs to 848 pages – more than 20 Glass-Steagalls. That is just the starting point. For implementation, Dodd-Frank requires an additional almost 400 pieces of detailed rule-making by a variety of US regulatory agencies. As of July this year, two years after the enactment of Dodd-Frank, a third of the required rules had been finalised. Those completed have added a further 8,843 pages to the rulebook. At this rate, once completed Dodd-Frank could comprise 30,000 pages of rulemaking. That is roughly a thousand times larger than its closest legislative cousin, Glass-Steagall. Dodd-Frank makes Glass-Steagall look like throat-clearing.
The situation in Europe, while different in detail, is similar in substance. Since the crisis, more than a dozen European regulatory directives or regulations have been initiated, or reviewed, covering capital requirements, crisis management, deposit guarantees, short-selling, market abuse, investment funds, alternative investments, venture capital, OTC derivatives, markets in financial instruments, insurance, auditing and credit ratings.
These are at various stages of completion. So far, they cover over 2000 pages. That total is set to increase dramatically as primary legislation is translated into detailed rule-writing. For example, were that rule-making to occur on a US scale, Europe’s regulatory blanket would cover over 60,000 pages. It would make Dodd-Frank look like a warm-up Act.
He calls Tower of Basel (as in regulation house) as Tower of Babel which continues to rise Superb
I could go on and discuss every bit ..It is that good.
In the end:
Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost certainly too complex. That configuration spells trouble. As you do not fight fire with fire, you do not fight complexity with complexity. Because complexity generates uncertainty, not risk, it requires a regulatory response grounded in simplicity, not complexity.
Delivering that would require an about-turn from the regulatory community from the path followed for the better part of the past 50 years. If a once-in-a-lifetime crisis is not able to deliver that change, it is not clear what will. To ask today’s regulators to save us from tomorrow’s crisis using yesterday’s toolbox is to ask a border collie to catch a frisbee by first applying Newton’s Law of Gravity.
However, reading Haldane’s work he might actually be wanting to say finance is too complex. The problem begins from tehre.
A nice discussion of the paper by Jose Gregario. He says why financial regulations have become complex and why simple ideas cannot really be made. He also says the problem is with financial sector and regulation has simply moved in that line.
Superb stuff…
