Transcript presentation 2

Counter-Cyclical Macro-Prudential Measures?
By C.A.E. Goodhart
Problem 1: Not capture, but common mindset:
(a)
Macro-economic stability (the Great
Moderation), plus sufficient capital (Basel II),
would always provide access to funding liquidity
from global efficient wholesale markets.
(b)
Over USA as a whole housing prices would
never fall significantly.
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Problem 2: Definition of capital whittled away by
clever use of hybridisation, so TCE often less than
2% of RWA. Leverage > 50x in major European
banks.
Problem 3: Basel II and mark-to-market accounting
makes regulation procyclical.
Result: Most everyone, markets and regulators,
thought that banking had never been safer than in
June/July 2007, on edge of precipice.
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Need to prevent regulation exacerbating cycles.
Role of regulation is to “take away the punch bowl just
when the party gets going”, McChesney Martin.
Not a popular activity; involves bucking the market.
The market, not the regulatory regime, will normally be
the constraint in a downturn. Regulators superfluous
then.
How can a regulator justify steps to check a boom?
Pillar 2 of Basel II was never used.
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Need for rules to give regulators backbone. Discretion
will rarely be used, even though Basel III proposes up to
2½% additional.
But question of which rules:C. Borio (BIS): Credit expansion (but coverage
and timing)
R. Barrell (NIESR): Housing prices and current
account
R. Repullo: GDP relative to trend
Arguments among academics mean that no
measures/indicators regarded as robust. Therefore will
be left to discretion. I would much prefer ‘comply or
explain’. It would change the incentives.
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Conclusion: Counter-cyclical macro-prudential
regulation is too difficult; will rarely be used.
Instead, the general level of regulation will be raised,
and some direct constraints imposed. May lead to
shifts of business outside the banking sector.
Regulation will not, and cannot, prevent crises, but
may mitigate their virulence.
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