Regulation Can’t Prevent the Next Financial Crisis

By Tyler Cowen.

"That is the topic of my latest Bloomberg column, here is one piece of it:

For another, an effort to make banks safer can effectively push risk into other sectors of finance. It can move into money market funds, commercial credit lenders, fintech, insurance companies, trade credit, and elsewhere. These institutions are generally less regulated than are banks and don’t have the same kind of direct access to the Federal Reserve’s discount window.

This is no mere hypothetical: In the 2008 crisis there were major problems with both money market funds and insurance companies.

There is a temptation, in light of recent events, to greatly stiffen bank capital requirements — to raise them to, say, 40%. Again, that would make banks safer, but it would not necessarily make the financial system as a whole safer.

And so policymakers allow banks to continue along their potentially precarious path. Whatever their reasons, the fact remains that bank regulations can get only so tough before financial risk starts spreading to other, possibly more dangerous, corners of the system.

And:

During the 2008 financial crisis, for example, there was an excess concentration of derivatives activity in AIG, later necessitating a bailout. Financial derivatives acquired a bad name in many quarters, and government securities were viewed as a safe haven. With Silicon Valley Bank, the problem was the inverse: Its portfolio was insufficiently hedged with derivatives and interest-rate swaps, leaving it vulnerable to major swings in interest rates. It should have used derivatives more.

It is easy enough to say, “We can write regulations so this won’t happen again.” But those regulations won’t prevent new kinds of mistakes from happening."