On the eve of a G20 group meeting International Policy Network together with Lion Rock Institute and other think tanks published report How Not to Solve a Crisis. The report analyses governments interference in solving financial crisis and draws this attempts as counterproductive. The authors argue about the ways of managing the risks inherent in the financial system.
According to the report written by Bill Stacey and Julian Morris, one of the reasons for recent weak financial climate was discriminatory regulations against certain classes of asset that resulted in ‘regulatory arbitrage,’ whereby financial institutions created off-balance-sheet structures in order to generate synthetic credit. Well-meaning market interventions intended to enable low-income US households to own homes.
These factors drove lending to impecunious borrowers in the US, fuelling a housing boom. The subsequent bust has led to the collapse in value of the off-balance-sheet structures. Because those structures had been used to underpin loans, their collapse has caused banks to stop lending to one another.
Sequential attempts by governments around the world to intervene in the markets and bolster lending have been largely counterproductive they have pre-empted private market solutions and in many cases generated further moral hazard, contributing to further erosion of trust and weakening of incentives to lend. As a result, what started as a financial crisis is turning into a full-scale economic catastrophe.
Significant role authors give to the regulatory structures. Several smaller countries have suffered less in the crisis seemingly because of different regulatory regimes. If there had been only one global rule and it had been the wrong one, everybody would have suffered equally and we would have less knowledge as to why and what – to do. When governments compete with one another, they have stronger incentives to identify solutions rather than placate vested interests.
The report cautions against any direct intervention by government:
Governments are terrible at allocating resources and their attempts to boost our economies will almost certainly backfire. Economic growth is the result of entrepreneurs identifying and filling niches by developing better products and production processes, thereby boosting production and productivity. In contrast, when governments throw money at the economy, they divert resources away from their most efficient and effective uses, undermining innovation and growth.
The main conclusion report comes to is simple, clear rules that do not discriminate in favour of or against any particular class of asset.
The best way to stimulate the economies of the world would be to reduce the number of overbearing taxes and regulations that currently inhibit the development and delivery of all manner of products and services.
L.D.