cato-journal-v34n2

Financial MarketsThey persist because their weaknesses serve the purposes of keyinterest groups. An example is the Basel rule giving credit derivativesa 0.5 percent capital weight, which enables financiers to construct allmanner of dubious securitizations, such as the “how to destroy” scammentioned earlier. Other examples are the regulatory endorsementof the Gaussian assumption and the VaR risk measure. These lead tomajor underestimates of true risk exposures but are convenient forthe industry because they lead to low capital charges. Capital thatshould be used to buffer banks against risk can then be siphoned offas dividend and bonus payments, and senior management can playdumb when the bank later collapses and the taxpayer is required topay for the bailout. 18Putting these points together, we have an undisciplined rulegenerationprocess that is out of control. Everyone including theregulators complains that the rules are burdensome, excessive, andoften make no sense—and yet the system produces ever more ofthem. They also lose any contact with their underlying supposedrationale—to control risks, protect investors and so forth—andoften become counterproductive. In the end, the process of rulegenerationbecomes the end in itself. We then get to the pointwhere there are so many rules, so many consultation papers, somany meetings, so many agendas and so many changes in agendas,that even the regulators who produce all this gumpf can no longerkeep up with the juggernaut that they have set in motion.Nevertheless, the regulatory apparatus continues to grow, and itdoesn’t matter that the regulatory burden continues to expand orthat none of this regulation actually works.Basel II is a case in point. This was in essence just thousands pagesof regulatory gibberish with the ostensible objective of ensuring thatthe international banking system would be safe. It was rolled out inJune 2004 and had just been adopted—in the EU and Japan, thoughnot yet in the United States—when the crisis hit and the banking systemcollapsed. In their resulting panic, bank regulators across theworld then rushed out many thousands of pages of new draft rules,plus many more pages of discussion and consultation documents.Indeed, so great was the deluge of regulatory material that by spring18This said, other rules serve the interests of the government. The Basel zeroweighting of OECD sovereigns is a case in point. This was useful to governmentsbecause it artificially boosted the demand for government debt.383