Philip Maymin highlights a problem with volatility:
…..securities with historically low volatility tended to have almost twice as much subsequent risk, while those with historically high volatility tended to have almost half as much subsequent risk. For both the riskiest and least risky securities, therefore, historical risk is a statistical illusion.
He further points out that regulation encourages banks to act in concert, increasing systemic risk, while deposit insurance reduces the level of self-imposed discipline among banks.
Read more at Philip Maymin, Why Financial Regulation is Doomed to Fail | Library of Economics and Liberty.
It has been “proven” over and over again that financial regulation fails and also that no financial regulation fails. The same could be said about criminal law. If the aim of criminal law is to prevent crime, it is an abject failure, however who wants to live in a society without criminal law.
I think there is too much absolutism in the whole economic debate.
In my opinion the cause of financial booms and busts has always been the fluctuations between the greed and fear motives of the general population. To the extent that people can and do become complacent when something (anything?) is regulated and fail to exercise enough care in their personal affairs, because “the system is regulated”, regulation becomes a problem. However there is enough historical evidence that a lack of regulation has consistently resulted in major economic earthquakes. Conservatives tend to say that these economic earthquakes are cleansing and should be allowed to take place unhindered. However these same conservatives do not apply the same reasoning in the area of criminal law, where they usually argue for more regulation (law) and more punishment.
I suspect that wealth begets conservatism and that those that believe that economic earthquakes are cleansing have an inate belief that the suffering will be borne by others, while a lack of criminal regulation will result in more criminality and is more likely to cause suffering to themselves. Or am I just being cynical?
Food handling regulations will never prevent all outbreaks of food poisoning, but to suggest that modern societies will accept no regulation whatsoever is naieve, I believe the same is true of financial regulation, the emphasis should be to make regulations more effective not non existent.
I’m sorry, but I think that the major problem with economics is economists, who think that the economy is somehow isolated from the rest of human activities
Good post.
We should not confuse free markets with unregulated markets.
Early stock exchanges were rife with manipulation and fraud. A strong regulatory environment helped to end this, creating a relatively free market. But we need simple, effective regulation rather than loads of red tape. Stock exchange regulators are once again being challenged, this time by high frequency trading which is sapping public confidence in the fairness of exchange prices. They have proved themselves unequal to the task, focusing on the fine print of their regulations rather than on the spirit of the regulation.
See Stephen King: Praise for Good Regulation