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Events happen

During the summer regulators have been busy. Latest musings highlight the risks that threaten. A perennial theme seems to be the housing market. Others include Brexit, QE tapering, market liquidity, personal sector debt, PCP and so on. Is it that by highlighting everything you can’t be blamed when things happen? To be sure, cast wide enough, include war and famine, then almost any misfortune is covered. But it’s as much use as the proverbial stopped clock.

What we know is that there are good times, bad times and occasionally very bad times. The useful question is one about survival. What happens when things unfold? Diversification is key. It takes you away from the extreme towards the average. Simple estimates of drawdown risk (equity 70%, property 60%, bonds 40%, bills 5%) can also help paint a picture.

However, it is by no means clear how the system will behave under extremes. It is conceivable that in the last ten years the amount and nature of regulation that has occurred has given false comfort.

An extraordinary amount of “groupthink” has gone into regulatory design. Banks therefore run their businesses along similar rules. Hardly a diversified system.

Instead of trying to point out all risks that may befall us regulators should be asking whether they themselves are unwittingly increasing the chance of systemic failure.

It seems to me that events will happen and the system will get tested. That’s obvious. A mixture of banks doing different things is potentially safer. Excessive size needs to be rebalanced. Unfortunately, that’s not what’s happening. Similarity and concentration rule.

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