You thought Davos was a laissez-faire forum? Think again

2000px-World_Economic_Forum_logo.svgBusiness Insider reported that Mark Carney, the BoE Governor, said last week at the World Economic Forum in Davos that IT and online-enabled new financial business models could lead to “an Uber-type situation” in financial services, unless government acted fast to regulate those new firms. Carney worries that those financial entrepreneurs will damage banks’ established model.

I am a little shocked by Carney’s remark. To be fair, it is possible that BI reported those comments out of context, so I’ll give Carney the benefit of the doubt. But I find it hard to understand why Carney would intervene, or simply comment, on the normal laissez-faire Schumpeterian creative destruction process. If banks are to be superseded by more efficient business models (and potentially more stable?), why objecting to that? Why protecting banks? Unless protecting banks is a way of maintaining central banks’ powers (which could also potentially be affected by technological disruptions)?

A further divide between Carney and the private sector (here: banks) appeared in Davos. Carney appeared worried that there used to be an “illusion of liquidity” in financial markets, which is now “gradually being disabused.” This contrasts with what private banks and fund managers believe, as exemplified by Deutsche Bank’s co-CEO Jain, who reportedly clashed with Carney and Jack Lew (US Treasury Secretary) behind closed doors “over whether recent violent market swings were caused by a liquidity crisis fuelled by onerous regulation”, as reported by the FT. Both officials rejected this conclusion.

Carney may well be right when he says that there used to exist an illusion of liquidity. But perhaps not for the reasons he thinks. ‘Excess’ liquidity in markets in the pre-crisis era is likely to have emanated from central banks’ actions. In a free market, liquidity might have indeed been scarcer and markets a little more volatile, reflecting a rougher price discovery process (rather than a one way bet). But, as I have also described in a relatively recent post, regulation is definitely responsible for the liquidity deficiency that we now experience. Regulation created silos that effectively entrapped vast amounts of liquid assets. There isn’t much point denying it really. Regulation has drawbacks and regulators should instead acknowledge them and announce what they can do to alleviate the situation. If they don’t, we are likely to see an increasing number of clashes between the private sectors and regulators, which aren’t going to help our economic recovery much.

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