Financial regulation

Pre-crash financial regulation

Governments have long been aware of the danger that a loss of confidence following the failure of one bank could lead to the failure of others, and to limit that danger by the imposition of minimum reserve ratios. Following the crash of 1929 they also imposed restrictions upon the activities of the commercial banks. In the United States, for example, the Glass-Steagall Act prohibiting their participation in the activities of investment banks. In the 1980s, however, there was a general move toward "deregulation", those restrictions were dropped, and reserve requirements were relaxed, and there followed a period of financial innovation and substantial change in the nature of banking.

International recommendations

In 1974 the governors of the central banks of the Group of Ten leading industrial countries had set up The Basel Committee for Banking Supervision to coordinate precautionary banking regulations , and in 1988, concern about the increased danger of systemic failure led that committee to publish a set of regulatory recommendations that related a bank's required reserve ratio to the riskiness of its loans . In 1999 further concern about the danger of instability led to the creation of the Financial Stability Forum to promote information exchange and international co-operation in financial supervision and surveillance. In 2004, the Basel Committee published revised recommendations known as Basel II intended to require banks to take more detailed account of the riskiness of their loans. Responsibility for assessing risk was placed upon the banks and the credit agencies.

During the eighteen-month period between the middle of 2007 and the end of 2008 the "crash of 2008" resulted in the failure or enforced rescue of fifteen major banks, three of the world's largest mortgage-lenders and one of the world's largest insurance companies , a disaster that has been attributed to risk-management errors on the part of the banks and the principal credit-rating agencies and to inaction on the part of the regulatory authorities. The investments whose riskiness had been wrongly assessed were derivatives based upon mortgages in the United States housing market . In 2007, an international banking panic was triggered by the revelation of serious problems at a major United States bank stemming from its holdings of such derivatives, and in 2008 an international "credit crunch" was generally attributed to a loss of mutual confidence among banks that was prompted by the unexpected failure of the United States authorities to save the Lehman Brothers bank from bankruptcy. According to the Bank of England "The global banking system experienced its most severe instability since the outbreak of World War I" .

(The article on bank failures and rescues lists the major bank failures and banking crises from the end of the first world war and the crash of 2008)

Post-crash proposals

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The authorities' reactions

; and in a 2005 lecture, Jean-Claude Trichet, the President of the European Central Bank, argued that not all bubbles threaten financial stability, and that if policy-makers attempted to eliminate all risk from the financial system, they either fail or they would "hamper the appropriate functioning of a market economy". , and by Federal Reserve Board Governor Frederic Mishkin