In search of a more stable monetary and financial order

A popular view is that the “light” regulation of the financial industry during the 1990s and early 2000s allowed the financial excesses and the rise in indebtedness that eventually caused the financial crisis. Those who hold this view want regulation to be tightened to prevent another crisis in the future. In 2008, the G20 demanded that no actor, no product and no market remain unregulated. Since then authorities have been active at the national and international level to fulfill this promise. This paper argues that the premise for more regulation is wrong and hence the suggested therapy misguided. It was not too little but too much official intervention in financial markets that caused the crisis. Instead of more public meddling in private markets we need a stable framework that allows these markets to function properly. In a new framework for monetary policy, credit must be given a prominent role; and in a new framework for regulation, we must properly define safe and loss-absorbing assets and use the latter to cover the costs of bank failures (instead of passing the bill to the tax payers). When the costs of failure are internalized, banks will be under pressure to become more transparent for creditors and depositors and their cost of funds and lending rates will rise. However, the public subsidization of bank lending rates will end only when banks can rely on taxpayer funded bailouts and their efforts to expand so as to become “too big and interconnected to fail” are thwarted.