New Research: How inept regulation, incompetent regulators and bad policies drove the financial crisis

As the economic crisis tightens its grip on the budgets of individuals, families and national governments, the TaxPayers' Alliance (TPA) publishes the first comprehensive analysis of the inept regulation and poor policies that sowed the seeds for the current recession and made Britain particularly vulnerable to its effects. The report's authors are Matthew Sinclair, Policy Analyst at the TaxPayers' Alliance, David B. Smith, economist and Chairman of the Shadow Monetary Policy Committee, and Daniela Petrova, a TaxPayers' Alliance Associate.
On the eve of the pre-budget report, with debate raging about the causes of the crisis and potential solutions to it, this new report identifies a combination of regulatory oversights, badly drafted rules and damaging policies that drove the financial crisis.

To download the full report click here (PDF).

Key Findings

The report identifies:

Poor policies that built up the crisis by:

  • Driving up borrowing
  • Inflating an asset bubble
  • Encouraging off-balance sheet debt

Regulators that made the economy vulnerable by:

  • Limiting the Bank of England's power to act to assist struggling banks
  • Failing to provide sufficient depositor protection
  • Ignoring concerns about the Financial Services Authority's incompetence and ineffectiveness

Regulations that made the crisis worse by:

  • Raising the bar on capital adequacy requirements as the economy falls into recession, meaning regulation makes life harder for companies the worse economic conditions get
  • Forcing companies to behave in similar ways, encouraging herd behaviour and increasing the amplitude of the global credit cycle
  • Forcing firms to use mark to market accounting rules that do not function when markets shut down in a crisis. Had mark-to-market been in place in the 1980s, every one of the USA's top ten banks would have become insolvent

The report also recommends two crucial improvements to avoid similar crises in future:

  • Greater political scrutiny. There is insufficient parliamentary and public scrutiny of regulators and market regulation. MPs should be freed up from direct management of public services to allow them to spend more time scrutinising legislation.
  • Ending the EU's role. The EU's centralised, undemocratic nature means that legislation is difficult to scrutinise and adapt to suit the unusually large role financial services play in the British economy. Britain needs the right regulatory framework and the freedom to act swiftly in a crisis, both of which are hindered by the EU system of setting central, one-size-fits-all regulation to suit 27 member states.

Matthew Sinclair, Policy Analyst at the TaxPayers' Allance, said:

"With governments, industry and ordinary families struggling to cope with the fallout from one of the worst financial crises Britain has ever suffered, it is important to understand the real causes of the crisis.  Banking is a highly regulated industry, and it is vitally important to the stability of financial markets that politicians and officials put the right regulation and policy in place. It is increasingly clear that poor policy choices encouraged excessive risky lending, regulators failed to control mounting risks to the financial system and regulations exacerbated the crisis once it got underway.  Creating a new regulatory framework for banking will take time but it is already clear that the political system needs reform or mistakes will again be made, driving future crises."

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