We can be sure of one thing. On both sides of the Atlantic the architects of the current failed system of regulation will conclude we need more regulation in the future. They will be interested in what they can add to an edifice which worked badly, not thinking about what they should demolish before rebuilding.
In the UK we should expect two things. They will wish to strengthen the tripartite system rather than replace it. Instead of transferring FSA powers over banks to the Bank of England, and giving the Bank a unified command over bank supervision and the money markets they use, both the Bank and the FSA will be given bigger roles in regulating banks.
There is unlikely to be a Glass Steagall law requiring the separation of investment banking from clearing bank activities. The authorities rightly understand that some of the weakest banks in the last crisis were either traditional mortgage banks like Northern Rock, or specialist investment banks like Lehmans. The large conglomerate banks got sucked in to the crisis at a later stage.
Instead they think they will increase the capital and cash requirements of both investment banking and traditional banking activities, probably being tougher on the former. This will limit the capacity of any large bank to do more of both and force choices about priorities to use the capital. It will also mean slower growth for the economy, and more difficulty in getting out of the slump, as it constrains bank balance sheet growth and therefore limits the amount of money in circulation. The regulatory policy is currently pushing against the monetary easing policy announced.
They will continue to devote a lot of effort to micro regulation – seeking to regulate each transaction and customer relationship – as well as putting more emphasis on high level or system regulation. Before and during the crisis the authorities had the powers necessary to demand more cash and capital but failed to do so. It was not a lack of power, but a lack of judgement which led them to permit the excessive build up of debt and books of financial instruments which characterised the period 2003-7.
We need to ask will they be any better next time round? The issue is do the regulators have a leader or top officials with both the judgement and the confidence to use that judgement to control bank balance sheets sensibly? It does not require more people or new armies of number crunchers. You can do it by just examining the balance sheets of the top half a dozen UK based large banks. Any annual reading of those between 2000 and 2007 should have told the informed reader that leverage was getting out of control. In say 2005 the regulators should have asked banks to raise more capital, keep more cash, or rein in their lending levels.
Today the regulators should not be raising their demands for cash and capital immediately. They should give the banks time to adjust their balance sheets, sort out their past bad debts and get their costs under control. The central Bank should be prepared to act as lender of last resort to ensure all the main banks have access to cash should they need it. The time to demand more cash and capital will come when we see money growth and bank balance sheet growth spurting ahead again.
Instead of hiring a new army of regulators and inventing a new sequence of regulations, we just need one or two people at the top of the system with judgement and confidence. They already have quite enough power to do the job. The worry is the West will hinder its recovery with too much inappropriate regulation, leaving the field more open for eastern competitors. We should also expect continued policy lurches, as the authorities have still not restored normality to interest rates, money markets or banking.