The IMF has established a new blog: the link is here. The most recent entry is about the measurement of potential output and the adverse impact of financial crises on the level of potential output – interesting reading.
The Annual Report of the Financial Services Consultative Industry Panel has been widely reported, and in particular an Addendum which addresses the theme Structural Reform of Financial Regulation in Ireland. The Irish Times report was headed “Quality of regulatory staff must be a priority…” and captures effectively the views of the Panel to the effect that the structure and rules associated with financial regulation may be less important than the personnel recruited to carry out the regulating. The Panel suggests that at all levels of the regulatory organisation responsible for financial regulation there should be staff with the necessary knowledge and expertise in national and international financial markets and that this can only be achieved through the recruitment of senior managers from the financial sector, with appropriate financial rewards.
I should first say that my expertise is in regulatory regimes generally, not in financial regulation in Ireland or any other jurisdiction. From this generic perspective I agree that an emphasis on the people, the knowledge and the competencies within the regulatory organisation is correct and that this may be more important than the content of the rules (since an effective regulator can blow the whistle on practices which are permitted but undesirable). However, expertise is not the only requirement for a credible and effective regulatory regime. Such a regime additionally requires a degree of independence both from the industry and from ministers. The requirement of such independence is not simply a matter of legitimacy – there is likely to be limited tolerance for putting foxes in charge of chicken coops in the current climate – but also a key aspect of effectiveness.
Expertise is a complex idea. Industry experience is valuable because those who have it know how things are done and understand the strategies of those they are overseeing. They understand the narratives put forward by regulated businesses and know what to look at to assess their credibility. Thus strong industry expertise gives a regulator a form of independence in the way that it uses knowledge. But in some instances it is equally important that a regulator is is capable of challenging the working knowledge of an industry. On one analysis the primary failure underlying the current financial crisis is the failure of banks to understand the systemic risks which their actions created. A regulator which fully mirrors the industry which it oversees is unlikely to be able to re-think the appropriateness of industry conduct, but only to assess whether particular businesses are within the normal range of what is considered appropriate at a given time.
A further issue surrounding the recruitment of regulatory staff from an industry arises from the observation that regulators who exhibit a high degree of shared experience (educational, industry, inspection) with those they oversee are liable to be less stringent in their application of regulatory rules than those with less shared experience. This ‘relational distance’ hypothesis, developed by Donald Black in the 1970s, has been tested and found to have considerable validity both in the context of business regulation in Australia ((by Grabosky and Braithwaite, 1986) and in the context of regulation of public bodies in the UK (by Hood, Scott and others, 1999). In the latter study we were struck by examples of regulatory design which opted for a deliberate ‘mixed relational distance’. So, for example, within the Inspectorate of Prisons, noted for robust independence and with a strong track record of re-thinking the appropriateness of prison standards, the head of the Inspectorate was routinely recruited from outside the prisons industry (a judge, a retired general, etc), whilst the next tier down within the organisation comprised seconded prison governors with strong industry expertise.The mixed approach can be developed at other levels of a regulatory organisation. In a small country such as Ireland we should be aware that shared educational and social experience is likely to be as important in generating low relational distance as shared industry experience. I believe this is one of the reasons why some have suggested a need to look outside Ireland for key regulatory officials in the financial sector (as has happened in the case of the Garda Inspectorate).
I do not think this mixed approach to staffing regulatory agencies is inconsistent with the views of the Consultative Panel. But it is important to recognise that an approach to staffing the new regulatory structures which fails to look beyond the experience and knoweledge of the industry is likely to be limited both in effectiveness and legitimacy.
Today’s Sunday Business Post carries two interesting opinion pieces. Alan Ahearne writes a defence of the NAMA approach (you can read it here), while Colm McCarthy recommends an inquiry into the banking crisis (you can read it here). The latter suggestion has been adopted elsewhere (for example, in Iceland).
I’ve been reading some funny stuff in the Sunday newspapers about how those who oppose the current NAMA plan are in favour of having a big fire sale of property assets. I’m not sure if anyone has ever proposed this as an alternative to NAMA (it would be interesting to know if any of the prominent NAMA critics have.) But since I’m generally associated with NAMA criticism, I thought I’d clarify that I certainly have never suggested this.
For instance, in the four point plan article I put forward in April, I proposed that after nationalisation of our two main banks the government could “set up a State asset management company to sell these assets over time to attempt to recoup as much as possible. “Over time” means over time, not an instant firesale. And an “attempt to recoup as much as possible” most likely would imply a careful sequencing of sales. But, of course, being in favour selling the assets over time in a careful sequencing is still consistent with starting to sell some of them soon.
Perhaps what’s going here is that there’s a (deliberate?) mixing up of the idea of transferring loans to NAMA at low prices with the idea of having a property firesale. I guess there may be people who think that calls to wipe out the bank shareholders via the losses incurred with the NAMA purchases and then nationalise (not my preferred sequencing, mind you) rely somehow on writing down development loans at Carroll-liquidation levels.
This is not all the case, however. AIB, for instance, have €24 billion in development assets alone and €8 billion in core equity capital. So one doesn’t need to rely on Carroll-liquidation levels of discounts on loans to conclude that this bank is insolvent.
Indeed, the current debate about “the right price” to transfer the assets illustrates a highly unfortunate aspect of the government’s plan that had been flagged by critics all along, which is that the pricing on transfer was always going to be incredibly controversial.
A plan involving nationalisation, an asset management company and a stake for the bank shareholders in the AMC (as proposed by Patrick Honohan) would allow for the banking system to be quickly placed on a sound footing and shareholders to be treated fairly without having to rely on the wisdom of Solomon to decide the right price at which the assets should be transferred. But, of course, that is an alternative and as we know now, There Is No Alternative.