Important Global Regulators Call For More Regulation

Yesterday the President of the European Central Bank, Jean-Claude Trichet, called for increased regulation of non-bank financial institutions.  Specifically he was quoted as saying:

“Strengthening resilience is absolutely essential given the fragility exhibited by the global economy.”  He went on to ask for a, “serious advance in the way we regulate systemic institutions, including non-banking institutions.  We have a lot of work to do on non-banking institutions in terms of reinforcing the non-cyclicality of regulations governing these institutions.”

What the heck does that all mean?

• Systemic institutions are those that are a part of the global financial system.
• Non-banking institutions would mean: investment banks, mutual funds, hedge funds, and insurers.
• The non-cyclicality of regulations means a set of regulatory principles that would be in place no matter what the economic cycle.  Instead, regulations have ebbed and flowed with political and economic forces and have been reactionary, instead of principled.

But Mr. Trichet is not the only important global regulator who feels that the global economy needs and depends on more regulation.  On Thursday, Jaime Caruana, the General Manager of the Bank for International Settlements – the institution that logs data about all global financial markets – also called for additional regulation.  Specifically he said that there is a need to:

“Monitor and where appropriate address the risks represented by the shadow banking sector [which can] create opportunities for arbitrage that might undermine future banking regulation.”

And what the heck does that mean?

• The shadow banking sector is another way of saying the hedge fund, mutual fund and insurance industries.
• Arbitrage is simply a fancy way of saying the buying of an asset cheaply in one market and the sale of that same asset more expensively in another market.  Mr Caruana is suggesting that without a global regulatory framework that sophisticated traders will take advantage of lax regulation in one market for the benefit in another market.  He is smart to fear this outcome because that is exactly what has been happening over the last 30 years as financial markets have gotten more sophisticated in direct proportion to the sophistication of information technology and computing.

I highlight the fact that these important global regulators are calling for more regulation because their views are in alignment with my own.  In fact, the very first post I did on the “What My Intuition Tells Me Now” blog was to highlight the need for more regulation.

My belief is that if you removed the rules in American football that within three years you would have a sport that was almost unwatchable.  Why?  It would turn into a violent melee.  This is because there are huge financial stakes involved.  Without the prohibition to do violent things to your opponent there would certainly be players that would take advantage of the rule-less environment.  So too it is with financial markets.

The difference is that the participants that enrich themselves in the financial markets by exploiting a lack of regulation don’t have the fear of losing their lives if there is lax regulation.  Whereas, football players do.  So effectively, there is no counter measure to bad financial behavior other than regulation.

Jason