Should Lax Financial Regulation be Blamed for the Crisis?

Lax financial regulation certainly bears part of the blame, not least with respect to undocumented mortgage loans, the emergence of a huge shadow banking system and the decision to allow banks to put into their trading books financial instruments which had never been traded, and indeed never could be traded. The fact that regulators have acted more recently to address these issues is a statement that they recognize these earlier shortcomings. That said, the regulators bear only part of the blame. Still more fundamental was the explosion of credit globally that was made possible by very easy monetary conditions, and the decision of bankers and others to ease credit standards in the pursuit of easy profits.

In sum, everyone involved is guilty of failing to see how the risks were building up and, in consequence, of not taking action to help avoid or even mitigate the ensuing crisis. Perhaps even worse, no one made any effort to prepare for managing the crisis when it did hit. In most countries, deposit insurance regimes were inadequate, insolvency regimes for financial institutions were non-existent and agreements for cooperation between various official bodies had real shortcomings.

Too Big to Fail: Should the Size of Financial Institutions be Regulated?

Behind this question is the assumption that the disorderly failure of some financial institutions could cause so much systemic damage that it could not be allowed to happen. Regulating ‘size’ has some superficial attractions but also some downsides.