Archive for April 22nd, 2010

Is Reregulation of the Financial System an Oxymoron?

April 22, 2010

Jan Kregel of Levy Institute has written a short paper on the state of financial regulation. In short he says the crisis points to the need to overhaul findamentals of financial regulation. But what we are getting is just short fixes that stabilise value of assets. The basics keep getting ignored.

He divides the crisis into three stages and in each stage it was either lack of regulation or failure to apply existing regulation that led to the crisis.

There was no lack of regulation governing the financial institutions that engaged in the buildup of financial layering and pyramiding on an ever-declining cushion of cash. The response has been to try to improve and better apply those regulations while implementing short-term liquidity measures to stabilize asset values. Indeed, the fundamental problem is believed to have been the collapse in asset prices created by the disappearance of market liquidity, rather than any inherent problem with the assets themselves. However, if the assets are insolvent, as are the institutions that hold them, this approach cannot provide for the recovery of the system. The failure to recognize this fact is at the root of the failure to provide any meaningful reform of the system. As levels that allow banks to remain solvent with minimum capital injections, there can and will be no meaningful reform or regulation of the financial system.

He also adds one needs to apply Minsky’s idea of making financial instability as central to financial regulation:

As Minsky has emphasized since his earliest work on financial market regulation, it is impossible to design regulations that increase the stability of financial markets if you do not have a theory of financial market instability. If the “normal” precludes instability, except as a random ad hoc event, regulation will always be dealing with ad hoc events that are unlikely to occur again. As a result, the regulations are powerless to prevent future instability. Instead, Minsky argued that what was required was a theory in which financial instability was a normal  occurrence in the system. Only on the basis of such a theory could regulation be designed and understood.

Hmm. Different thought on finreg.

Differences between PIIGS

April 22, 2010

Alcidi Cinzia and Daniel Gros have an interesting post on the topic (HT: Eurointelligence daily edition).

They compare the PIIGS economies – Portugal, Italy, Ireland, Greece and Spain- and say each one is different:

The Southern members of the Eurozone are often lumped together because they all have overvalued currencies and twin deficits – fiscal and external current account (De Grauwe 2010).

Our analysis shows, however, that these countries are quite heterogeneous. Portugal and Greece share a key feature, namely an extremely low rate of national savings, which implies that they have to rely continuously on large inflows of capital to finance consumption (see Gros 2010). By contrast, Spain and Ireland have substantially higher savings rates, but are more exposed to financial markets because their construction booms went hand in hand with a huge expansion of financial activity. In short, for Greece and Portugal the problem is insolvency; for Spain and Ireland illiquidity. Italy seems different from both these subgroups in that its savings rate is higher than even in Spain and Ireland and its foreign imbalances are much smaller.

They analyse the fiscal costs needed to address the crisis and the amount owed to foreigners. Either way Greece stands out followed by Portugal.

Comparing economics with meteorology

April 22, 2010

Bank of England Governor Mervyn King and 6 other economists from BoE have written a fascinating paper on the topic (press release is here)

This paper looks at three things:


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