The banking crisis of the new millennium - why it was inevitable

But just as the 2003 SEC proposals to control hedge funds (registering Investment Advisors, introduction of standards on valuation and fees, limiting general solicitation in fund, monitoring capital introduction services provided by brokers) were never followed up, it is obvious that needed reforms to the US financial system will be lobbied against.

There is obviously an urgent need to review not only why the SEC was ignored in its recommendations for investors’ advisors, but also why the Federal Reserve did not object to state governments supervising mortgage originators and the writers of credit default swaps such as AIG. Other urgent questions need to be answered in order to be able to reform the US regulatory model.

Why was the number of regulatory bodies which allowed regulatory arbitrage never reviewed and integrated supervisors established such as in Canada, Europe, Australia and the UK? Why also was Basel II lobbied against when it would have brought to an abrupt standstill the excessive concentration on mortgage lending in the US financial system? Why was the banking industry but not the real estate industry allowed to deregulate. Why has the US never completely complied with money laundering rules? Why has the accounting standard of mark to market (FAS 157) never been reviewed when it allowed both incredible write ups and disastrous write downs.

The list is endless but there is a blatant need to redesign the US regulatory model from scratch. So how this should be done? A detailed method is described by the author in a 2005 publication. In essence this involves assessing the existing system in terms of inputs and outputs given constraining factors and then considering changes not only in terms of the regulatory model and its components, but also in terms of the existing human expertise and how it is motivated. Note the dysfunctional effect of incorrectly designed executive compensation was one of the conclusions by Bank of England studies in 1998 and by the author in the same year.

Urgent to such a redesign is a reconsideration of the legal infrastructure, government goals and starting economic resources. Just as Australia found a flawed federal system responsible for regulatory black holes, so too should the new US government re-examine its entire regulatory model to evolve a model that will never again bring the world financial system to the brink of a total implosion with disastrous effects on emerging nations attempting their own reforms.