Wednesday 9 March 2011

Is the FSA going soft on governance culture?

Interesting Clare Distinguished Lecture in Economics and Public Policy speech recently by Lord Adair Turner, Chairman of the FSA, on whether the current reforms of the financial services sector are going far enough. Short answer is No - because the current fixes patch up the existing system without reforming it sufficient to prevent another crisis.

As rightly Lord Turner points out:
An appropriately radical response to the financial crisis requires that we take into account explanations of financial market imperfection and instability which go beyond the identification of specific information asymmetries or incentive problems.

However, having rightly pointed to broader fixes that include learnings from behavioural analysis, insuperable information asymmetries (a la Joseph Stiglitz), and the inherent irreducibility of some uncertainty (a la Frank Knight), Lord Turner simply suggests regulators should retain a discretionary macro-prudential capacity to intervene when they smell danger:
As a result, fixing poor incentives - such as those created by 'too big to fail' banks or by perversely designed bonus arrangements - while a necessary part of the regulatory response, cannot be sufficient. Our policy response needs also to include policies which focus on the complex dynamics of the whole system, above all through higher equity capital requirements, and macro-prudential policies which can arise even in a system where individual agents' incentives were always well designed.
Surely the recent crisis has demonstrated the FSA's shortcomings in acting as an all-seeing deus ex machina? Instead, they should actively research micro-prudential tools with which to regularise behaviour of individual agents. Something with which this group has made some headway. We await Lord Turner's call...

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