A new era for financial regulation

Lord Turner (picture FSA)

The report published yesterday by Lord Turner, chair of the FSA, proposing a new approach to financial regulation has been widely hailed as a significant change. It outlines a new set of regulatory standards, but also a conceptual change, too. The idea was that markets were efficient and rational, and that each actor pursuing what it believed to be its own self-interest would produce the best outcome for everybody.

This blog is not the place to discuss the details of financial regulation, but that conceptual change is at the heart of everything this website stands for.

The point is that a collection of self-interests does not add up to a collective interest. There are countless examples.

A pyramid investment scheme, where early investors make their money from the contributions made by later investors, ends up causing a lot of harm to those later investors, and they need to be protected. However, at any one stage, the interests of the people involved are to keep it going, not to bring it to a halt. In Albania in the early 1990s, after the fall of communism, the country was swept by pyramid schemes which were eventually brought to an end by various means, provoking demonstrations and outrage on the part of the people who were already members. Having been duped, their hope was to be able to dupe others, but that was what was stopped.

In a marketplace, what matters is not only knowing what will happen but knowing what other people think will happen. As Chuck Prince, chief executive of Citigroup, said, “As long as the music is playing, you’ve got to get up and dance.” There is a collective interest in somebody switching on the lights, switching off the music and telling everybody to go home.

Martin Wolf in the Financial Times today puts it like this: “if everybody relies on their ability to get out of the door before anybody else, many will die in the inferno.”

This is true for companies; it is also true for countries. Think of those ships contaminated with toxic waste limping from port to port trying to find somewhere to be broken up and dismantled. It’s got to happen somewhere, but nobody wants it to happen near them.

Or the attempt to deal with refugee problems by telling them to stay at home. Refugees take the desperate and dangerous decision to flee for a reason. The simple rejection of refugees may solve one problem but by creating a bigger one.

In the financial markets, each company has an interest in boosting its turnover and its profits. In part, that will come at the expense of its competitors, but the very existence of turnover and profit at all depends on the maintenance of a viable and sustainable marketplace. That is a collective interest, and will not come solely from the pursuit of individual interests. It is for the good of all of us that we seek ways to express the interests of all of us. In the financial markets, and in the world as a whole.

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