By now, we all know the drill. We've ridden this roller coaster before.
Fast times in some corner of the financial world cause a crisis. Cautious regulators try to ensure this never happens again. Industry squawks about crippling oversight until collective amnesia and "innovation" combine to enable the return of fast times. Then, dizzy with newfound freedom – wheeee – banks precipitate another crisis.
Lately, the cycle has gotten compressed, swinging faster and higher than ever before.
At the Milken Institute Global Conference last week, certain panelists bemoaned this annoyingly predictable pattern and suggested we could recover more quickly and even break the cycle altogether if only regulators would stop overreacting.
Sure, it was the greatest financial calamity in 80 years, but c'mon regulators…show some restraint!
Among other crimes, policymakers are accused of: addressing a problem that was not at the root of the latest crisis (Volcker Rule), being too punitive (increased capital requirements), and not considering the cumulative effect of all the different new rules.
The alleged result for the industry is an escalation of compliance and legal costs and a distortion of their traditional business models. This, in turn, sends banks on a search to recoup their profits in ever-faster and more exciting places. Wheee. From the industry's view, regulators are at least as complicit in propelling this rollercoaster along.
Even if some of these charges have merit, they are not likely to persuade regulators to back off. Anyone in the prevention business – from doctors to airline security screeners to bank examiners – will tell you they face exponentially bigger downside from being too lax than from being too stringent. Abundance of caution will always win the day here.
The court of public opinion is not going to provide much sympathy on this front, either. In a February 2012 Pew Research Center study, a plurality of respondents (43%) felt there is still "too little" government regulation when it comes to banks and the financial sector.
It seems like the best way to stave off regulatory excess in the face of a financial crisis is to stop causing the crises in the first place. Sure, there are macroeconomic factors beyond any one firm's control, but more restraint on the part of financial institutions could help break the Boom-Bust-Regulate cycle – or at least dampen its severity. And the most important time for caution is when everything looks good.
Maybe instead of just managing exposures, banks should put more emphasis on preventing certain kinds of risk outright?
Madelyn Antoncic, the former Chief Risk Officer at Lehman Brothers, noted at the Milken conference how it is easy to get executives focused on risk management during difficult times when trouble spots are very apparent, but nobody wants to think about risk when business is booming and potential pitfalls are hidden or dwarfed by flush earnings. Who wants to bring Debbie Downer to the party?
But thoughtful, comprehensive risk prevention needs to be part of the conversation at every bank, especially when it seems least necessary. This could be our ticket off the roller coaster and onto the merry-go-round, where individual horses rise and fall but the system itself stays on solid ground.
Keeping oligopolies from forming, reforming incentive compensation arrangements, reducing government subsidies to the private and public GSEs, permitting orderly liquidations, and ensuring enterprise risk and management infrastructure is strong are keys to systemic health, stability and safety and soundness.