It’s interesting to look back at international financial surveillance in the run-up to the global economic crisis and look at which risks were foreseen and by whom. 2006 is highly relevant, because it was the last full year before the crisis (which blew up in late summer 2007). Below is a couple of paragraphs from the IMF’s surveillance report for the UK in 2006 relating to financial sector supervision. Remember this is the system that was created by, and ultimately overseen by, Gordon Brown.
37. The authorities consider that financial sector prospects are strong and are taking action to further improve resilience. The UK banking system is in rude health, taking in stride the financial market correction in May-June 2006 and the tightening of monetary conditions in the second half of the year. Looking ahead, the authorities see prospects as favorable but risks as underpriced. One of their key concerns is rising correlations across countries and markets, which is partly attributable to similar strategies (for trading, risk management, and stress testing) across financial institutions. London’s role as a global financial center raises the risk of cross-border transmission of shocks, but it also yields benefits in terms of greater liquidity, which improves the financial system’s ability to absorb shocks. Regarding financial regulation, the FSA is determined to further develop the principles-based approach and underlines the importance of subjecting proposed regulations to a thorough cost-benefit analysis …
[staff appraisal]
43. Lastly, on the financial sector, which is in a position of strength, the authorities are appropriately promoting the system’s resilience. The key financial sector vulnerabilities are low-probability events with potentially severe consequences. In addressing these risks, the authorities are right to insist on balancing the costs and benefits of regulation. Plans to further enhance stress-testing and international crisis prevention and management arrangements are welcome.
A few points can be made. First, these paragraphs are always compromises. One doesn’t know what was said in the actual discussions and especially what the UK side would have requested to be removed from the staff appraisal. Second, as is typical of bureaucratic documents, there are plenty of CYA sentences in there, so that if something bad happens, they can always say “look there, we said that might happen”. Third, what stands out is that both sides were seriously deluded about the health of banks and the quality of bank supervision; in that sense, Lord Turner’s claims on Andrew Marr this morning are correct.
But finally, note the codewords for resistance to tighter regulation: “balancing costs and benefits”, “principles-based approach”. There was no appetite on either side of this dialog for getting into the details of what banks were up to. Which prompts the question: if you’re philosophically opposed to something in 2006, what’s your evidence that you’ll be any good at doing it in 2009?