Our banking system could learn a thing or two from the operation of our national, state and local highway system.
The pileup of 100 cars on a stretch of Interstate 10 in Texas last month during an unexpected fog reminds us that despite one of the safest highway systems in the world, catastrophes like this are rare but inevitable. The fact that they are not more prevalent is a direct reflection of advances in road safety engineering and automotive safety equipment, ongoing vehicle inspections and driver education and licensing.
The U.S. interstate highway system is a marvel of engineering scale and complexity, stretching across the entire country and totaling nearly 47,000 miles. Before the construction of the interstate system, there were about six fatalities for every 100 million vehicle miles traveled. That fatality rate is now at 0.8. This safety record was only achieved by a combined effort of government regulation and market self-regulation. Had we had such an emphasis on safety in our banking sector, it is a good bet we never would have experienced the financial crisis of 2008-2009.
But what exactly are the parallels we can apply for prudent regulation and market discipline?
If we think of the highway system as our financial markets, automobiles as our banking institutions and management as the drivers, we can begin to rationalize regulatory activities that seem somewhat disconnected by way of Dodd-Frank, and understand where deficiencies remain on the road to designing a safer banking system.
States own and operate our highways, but responsibility for coordinating and promoting a consistent set of safety standards belongs to the Federal Highway Administration. This comes in the form of minimal pavement and roadway standards, and signage and speed limits in collaboration with the states, but each state is ultimately responsible for setting speed limits based on the unique conditions in their area.
Beyond these highway standards, the federal government establishes certain minimal requirements for new cars such as safety equipment. States also may impose periodic vehicle safety inspections and subject drivers to testing and licensing before they can get behind the wheel. And importantly, such drivers'requirements vary by type of vehicle use, such as commercial or private.
With this as backdrop, what we experienced in banking in the years leading up to 2007 was a highway system with few guardrails, unmaintained in many places and that rarely had posted speed limits. In this system, many cars operated with bald tires, faulty brakes and no air bags. Many drivers were unqualified to handle their vehicles, including many operating the largest, most complex and dangerous vehicles: namely semi-trucks, the highway equivalent of a systemically important institution.
Various financial regulatory agencies have been at work patching our highways, installing guardrails on hazardous stretches of pavement and vastly reducing speed limits. Many of these improvements were overdue. However, as we are beginning to see, there may be a danger of overcompensating in our response to the crash. While the figurative roads are vastly improved in condition, the reforms may wind up creating nightmarish financial traffic jams.
One such worry of the banking system today is the final definition of qualified mortgages by the Consumer Financial Protection Bureau. Those rules will serve as minimum safety standards for the mortgage industry and some fear that restricting the product set too much will severely constrain the availability of credit to the mortgage market. This is just one example where our recent experience with an appalling accident paves the way for well-intended but overly cautious regulation.
1. Lack of regulation was not the cause of the 2008 mortgage problem. Wrong-headed regulation, turbocharged by the moral hazard of the GSEs, was
2. Government regulation in the form of speed limits and vehicle equipment requirements has not been the reason for improved safety in cars, nor will more regulation improve the soundness of the banking system.
In the US, speed limits are arbitrarily set with no real correlation to the safe traveling speed in the areas they cover. If speed limits were appropriate, we would not see 99% of drivers nominally "speeding", but we do. Artificially slowing traffic actually increases traffic density and collision rates. On the other hand, genuinely useful traffic laws, such as keeping right unless passing and not passing on the right, are not enforced. Meanwhile, now we have scandals in which municipalities "game" speed and red-light cameras to raise revenue - isn't that a form of official corruption? Doesn't this sound like some of the regulations under Dodd-Frank and Basel III?