Matt Ridley helpfully points out something that’s grossly underappreciated in the sturm und drang over financial market competition and regulation in the past five years — the lessons of evolutionary biology apply to human-designed systems too, including financial market institutions and regulatory institutions:
What is the cure? A change of personnel will not do it. The search for chief executives who are not motivated by greed and for regulators who are sufficiently god-like to know how to design rules that cannot be gamed will never succeed. The truth is, the financial system, like the whole of human society, was not designed in the first place; it evolved. And the answer is to allow a better one to evolve.
My own personal experience reinforces my view here, as I was chairman of Northern Rock when it ran into trouble. During that crisis it quickly became clear that not only did I not fully appreciate the liquidity risks in the markets but nor did far more expert people, including rivals and regulators.
That experience, plus some appreciation of evolutionary biology, makes me suspicious of utopian solutions. Regulating Libor will not prevent a scandal somewhere else; reinventing Glass-Steagall’s separation of retail and investment banking would not have prevented the failure of Lehmans or AIG; paying executives in shares rather than cash to lengthen their horizons has been tried and it failed; a culture of compliance can become lethally complacent.
What we need is an evolved, organic, bottom-up system that hands power back to customers and gets innovation working on potential improvements. The way to get that is to open up the banking sector to plentiful competition, dismantling its cosy, crony oligopolistic structure – in which, for example, the biggest customer, the Government, hands the bigger firms handsome income streams from the taxpayer for bond issuance.
Yes. Yes, yes, yes. He then points out that there are substantial entry barriers, largely regulatory entry barriers, that have prevented the emergence of competing banks to provide clearing services more generally. And isn’t clearing really the service that’s essential, at the foundation of improving the efficiency of the interaction of the supply of and demand for funds? He also argues for competing currencies, because isn’t the central bank’s government-granted monopoly on currency issuance one of those scale-creating top-down-imposed entry barriers that reduces the resilience of systems?
He closes by suggesting that we reform in ways that enable us to put trial and error to work. Financial systems are not the only ones for which that recommendation would be beneficial.