Financial markets regulations are often very complicated and rarely make first page headlines, other than just the pure fact that they exist. But we have just seen a sequence of events that clearly indicate the possibility of far-reaching changes in supervisory regulations around the globe.

There was a meeting of the Financial Stability Forum in late March that issued a statement calling for far reaching reforms, a quote:

“The FSF discussed the report to be delivered to G7 Finance Ministers and Central Bank Governors in April that identifies the key weaknesses underlying the turmoil and recommends actions to enhance market and institutional resilience going forward. The report has been prepared by a working group comprising senior officials from major financial centers and from the international financial institutions and the chairs of international supervisory and regulatory bodies. It sets out specific policy recommendations in the following areas: prudential oversight of capital, liquidity and risk management; transparency, disclosure and valuation practices; the role and uses of credit ratings; the authorities’ responsiveness to risks and their arrangements to deal with stress in the financial system. These recommendations are concrete and operational and, if approved, the FSF will report on their prompt implementation”.

Then Secretary Henry M. Paulson Jr. presented on 31 March a blueprint for regulatory overhaul in the United States. Full report is here (212 pages)

Today the Economist has published an article reminding politicians, that regulation can be good and bad. Bad regulation will kill financial innovation and reduce long-term growth.  A quote:

“It is natural and right that regulators should seek to learn lessons. The credit crisis will damage not just the reputation of the financial system but also the lives of those who lose their houses, businesses and jobs as a result of it. But before governments set about reforming financial regulation, they need both to be clear about the causes of the crisis and to understand just how little regulators can achieve. […]

The view that the only sensible response to the 21st century’s first serious financial crisis is a wholesale reform of the system is now gaining ground. […].

But there are two reasons to hesitate before plunging headlong into a purge of the system. First, finance was not solely to blame for the crisis. Lax monetary policy also played a starring role. Low interest rates boosted the prices of assets, especially of housing, which in turn fed into complex debt securities. This created a spiral of debt that is only now being unwound. True, monetary policy is too blunt a tool to manage asset prices with, but, as the IMF now says, central banks in economies with deep mortgage markets should in future lean against the wind when house prices are rising fast.

The second reason to hesitate is that bold re-regulation could damage the very economies it is designed to protect. At times like this, the temptation is for tighter controls to rein in risk-takers, so that those regular, painful crashes could be avoided. It is an honourable aim, but a mistaken one. […]

The notion that the world can just regulate its way out of crises is thus an illusion. Rather, crisis is the price of innovation, so governments face a choice. They can embrace new financial ideas by keeping markets open. Regulation will be light, but there will be busts. The state will sometimes have to clear up and regulation must be about cure as well as prevention. Or governments can aim for safety and opt for dumbed-down financial systems that hobble their economies and deprive their people of the benefits of faster growth. And even then a crisis may strike.”

The debate is just starting and G7 finance ministers meeting in Washington will be an important next step. But as The Economist has reminded us, the debate should not be biased towards solving short-term problems. Good data, efficient information collection and sharing, transparency and improvements in risk management (including liquidity risk), as well as higher wages offered by market watchdogs to attract the best talent are natural decisions that should emerge from this discussion.