Realist, not conformist analysis of the latest financial, business and political news

IMF Warns That Regulation’s Great – As Long As Banks Don’t Escape It

It does rather depend upon who you read here over the IMF’s latest warnings about debt, the next downturn and the final crumbling of capitalism. It’s entirely true that debt is now higher than it was in 2008 – maybe not the problem some think – and that there will be another downturn at some point. The question is, well, will the next one be as bad as the last? There it’s not so certain, thus the warnings. But there’s an unsaid here too, that unsaid being the most important part of any warning:

THE world economy is at risk of another financial CRASH, the International Monetary Fund (IMF) warned as the international organisation spoke of “large challenges” ahead “to prevent a second Great Depression”. In a new report, downcast predictions pointed to cheap interest rates and surging debt levels as potential triggers for economic chaos.

Well, no, not really, what caused the Great Depression was the crass stupidity of Federal Reserve policy after the 1929 Crash – ably explained by Milton Friedman and Anna Schwartz – followed by the crass stupidity of Roosevelt’s New Deal policies. We here in Britain tried expansionary austerity and it was all over within 18 months.

In short, depressions are caused by bad policy reactions to crashes.

As to the next one being worse because there’s more debt. Well, yes, but there are also more people, there’s been inflation and the world economy is larger to boot.

Still, there are real things to worry about:

But the important thing is here:

Much has been done to shore up the reserves of banks in the last 10 years and to put in place more rigorous oversight of the financial sector, but “risks tend to rise during good times, such as the current period of low interest rates and subdued volatility, and those risks can always migrate to new areas”, the IMF said, adding, “supervisors must remain vigilant to these unfolding events”.

A dramatic rise in lending by the so-called shadow banks in China and the failure to impose tough restrictions on insurance companies and asset managers, which handle trillions of dollars of funds, are highlighted by the IMF as causes for concern.

Insurance companies – AIG excepted which was acting much more like a bank and not marking to market to boot – and asset managers just don’t pose the same risks. Because they’re not doing banking, they’re not borrowing short and lending long. It’s that feature of fractional reserve banking which is the danger. It’s also something which allows us to have maturity transformation and so is almost certainly a risk we’ll continue to put up with.

But add in “shadow” and we’ve a problem. This is true of any form of regulation too. Take drugs – they’re illegal. So, there’s no regulation of them at all which is why so many overdoses happen. Take regulation which pretty much everyone does obey – that’s great, there’s regulation therefore. But the stricter we make the regulation then the more scofflaws we’ll have and the less regulation. Yes, counterintuitive but stronger regulation, past a point, will mean less regulation.

Shadow banking is people doing banking – borrowing short and lending long – but not being regulated as a bank. The stronger we make bank regulation the more tempting it is to do it in the shadows. Pennies can be picked up before that bulldozer before until it catches and crushes. And what’s happening as banking regulation expands and becomes stricter, is that more people are doing that shadow banking in larger sizes. Our problem is not a lack of, nor inadequacy of, nor even insufficient regulation. It’s too much leading to too many doing too much with no regulation.

That’s really what panics regulators themselves, the people not obeying even the mildest form of it like squaring the books every day. And the more we push regulation to be more intrusive the more people will do it too.

Just as with banning legal payday lending we open the door again for Big Tom and his kneebreakers.

Strange as it may seem, and not something they’ll say directly, what worries the IMF is too much regulation leading to less regulation.

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