CSFI Publishes Report Analysing the Systemic Causes of the Crisis

17 July 2009

With some banks reporting bumper profits and banker remuneration heading for pre-crisis levels, the financial crisis might appear to be over. But Goldman Sachs is not a bellwether, and most banks remain braced for bumper write-downs. So the question of how to reform the financial system remains not only valid but urgent.

To stimulate debate, the Centre for the Study of Financial Innovation today publishes a report analysing the systemic causes of the crisis and suggesting reforms that are an antidote to the current “more of the same” trend.

In The Road to Long Finance: A systems view of the credit scrunch, co-authors Michael Mainelli and Bob Giffords argue that only systemic wisdom will provide a long-term solution to the crisis. A return to “business as usual” will leave unaddressed such important problems as ‘too big to fail’; abusive risk-taking; perverse incentives; and a dangerous lack of diversity within the system. Simply tightening the current system of regulation will not work because the crisis was “not a failure of open markets but a failure of highly regulated markets due to unexpected consequences of regulation and private decisions”.

Among their conclusions:
•too big to fail is too big to regulate – the fundamental regulatory tool in all markets is competition;
•a healthy financial ecosystem needs diversity, yet in financial services standardisation and economies of scale are over-valued;
•less regulation enforced within a coherent fiscal and monetary policy framework is better than more regulation;
•root causes, such as global trade imbalances and lack of savings in Western economies, must be addressed; and
•the sooner government involvement in financial services can return to minimal levels, the sooner longer-term reforms can begin.

Injecting more competition means a serious re-examination of concentration in banking, audit and credit rating. “We believe that the promotion of competition, then supervision, then regulation should be the order of discussion with an objective of promoting ‘open’ markets.”

The report advocates moving from short-term fixes to permanent reform. So, how will we know when the financial system is working? Answers might include: when a 20-year-old can safely enter a financial vehicle for retirement; or when a forest can be reasonably financed. “Sustainable finance is a necessity that we have not yet been prepared to pay for.”

The authors have drawn on a formidable array of evidence in surveying thinking about the financial system, and have woven together arguments about liquidity, leverage, business culture and technology to explain the fragility of the system. The questions come thick and fast. Some are answered, others are deliberately left as catalysts for debate. And in the cause of stimulating debate, the City of London Corporation has sponsored the report.

Michael Mainelli is co-founder of Z/Yen, a leading commercial think-tank based in London. Michael holds professorships at Gresham College and the LSE. His background is in aerospace and cartography, and he has been a partner and board member of an accountancy firm. He has won Foresight Challenge and Smart awards and was British Computer Society “Director of the Year” 2004-05.

Bob Giffords is an independent analyst and consultant in the European banking sector. Bob writes for leading financial journals, including Financial World, and has judged technology innovation awards and chaired major conferences. Previously, he was director, EMEA Research and Consulting, for Financial Insights, an IDC company, and chief technology officer of EuroMTS, the electronic bond-trading platform.

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