Stability in financial markets is unattainable; anyone who believes they can make it otherwise is pissing into the wind. Sadly many governments, banks and indeed market makers are included in this afflicted group. There’s a good article with the title “More regulation will not prevent next crisis” by John Kay in Financial Times of 25/03/2008. The key passage is:

… in financial services, the demand today is for more regulation. That call should be resisted. The state cannot ensure the stability of the financial system and a serious attempt to do so would involve intervention on an unacceptable scale. But to acknowledge responsibility for financial stability is to assume a costly liability for failure to achieve it. That is what has happened.

Since financial stability is unattainable, the more important objective is to insulate the real economy from the consequences of financial instability. Government should … ensure that the payment system for households and businesses continues to function. There should be the same powers to take control of essential services in the event of corporate failure that exist for other public utilities …

We cannot prevent booms and busts in credit markets, but today’s regulation of risk and capital – which is more reflective of what has occurred than of what may occur – does more to aggravate these cycles than to prevent them. Regulation in a market economy is targeted at specific market failures and should not be a charter for the general scrutiny of business strategies of private business. Banking should be
no exception.

How true. Not that politicians have a hope of understanding this. And not that bankers would want them to understand it.

[Hat tip to Wat Tyler at Burning Our Money.]