In Shiler’s recent interview and book he raises the issue that financial capitalism is an invention and it should be further expanded and democratize so that financial systems can have a positive impact on a greater number of people around the world (Shiller r 2012). What Shiller means by this is making financial systems more accessible and serving the people better. In turn Shiller explains this will help to reduce the risk of another financial crisis like the recent 2008 economic down turn.
With the recent financial crisis there has been the introduction of regulatory reform measures to reduce risk of systematic failure within the financial system and investor protection. The main measures have included capital regulations e.g. basil 3, ring fencing investment and retail banking and the centralized clearing of derivatives.
The current regulatory reform proposals can be put into three main categories, reform of the markets, reform of the institutions and reform of the regulators. One of the key areas of reforming the markets has been to trade derivatives onto exchanges and to clear them centrally. This is aimed at stopping a repeat of the AIG collapse in 2008 when the US government had to intervene with a $85 Billion dollar bail out to stop it from collapsing, the government said it was an institution to big to fail (Egginton, Hilliard 2010). This has been implemented via the Dod Frank act and this legislation is aimed at increasing greater transparency to control the risk of systemic failure (PWC 2010). By increasing the central clearing of derivatives it is hoped that it will reduce the risk of systematic failure of the banks by ensuring the central party can handle a default. If derivative trading wasto carry on as it used to in could cause another systematic failure in the system. By trading the derivatives on exchanges it is hoped that it will ensure traders know how exposed they all are to the market. It has been argued that by centrally clearing all derivatives could in turn increase the pressure on centralized dealers (Langton 2011) and in turn cause systemic risks for the dealers. Another key reform act that is being proposed is the ring fencing of retail and investment banks, this is to ensure that investment banks cannot use commercial banks funds to fund riskier investments, this was first initiated by Paul Volckler who was a former president of the central bank (Sinn 2010), this was the case from 1933 until 1999 in America when it was repealed. By bringing back ring-fencing it should mean that when banks conduct riskier investment activities if they fail they government will not have to pay back the deposits of consumers who they have insured (Crawford 2011) which could cost the government millions of pounds, Although bringing back in an act like this again it has been argued that a lot of the damage done in the 2008-2009 financial crisis was done purley by investment banks eh Lehamn brothers who owed 450 billion (wolf 2011) so it would not have made much difference to the magnitude of the financial crisis. Another reason is why this is not appropriate is that banks that commercial and investment banks work successfully and simultaneously in other parts of the world and lessons can be learnt about how to run them simultaneously (Jackson W 1987).
Basell 3 has also been implemented to help enable the reform of institutions. Basel 3 is to be introduced after it was believed basil 2 did not have though enough regulatory constraints (SINN 2011). The two main aims of Basell 3 is to strengthen global capital and liquidity regulations and also mean that banks can absorb changes in the economy greater (BIS 2011). Basil 3 meant that banks must increase the amount of capital in which they hold. Basil 3 states that banks must hold at least 7% of risk weighted assets, this is up from 2.5 in Basil 2 (Treanor 2012), by doing this is should mean lower risk for investors and also higher leverage and liquidity ratios.
One of the main issues that could arise with Basell 3 is that is it not due to be implemented till 2019, and it has been estimated that there could beup to two financial crashes before then (Lybeck 2012). Another issues that could arise are that it could reduce the banks lending capacity (KPMG 2011), this could in have a large impact on business and individuals who need to borrow money from the main banks.
Shillers view to the regulation and control of the finance industry differs greatly from the measures put in place as mentioned above. In Shillers recent book he explains how the financial system is a tool than can enable people to achieve their goals (Shiller 2012) and that the financial system should democratized to enable a greater amount of people to participate in the financial markets around the world. By enabling greater democracy in finance, Shiller believes that it will create a fairer system and allow people to use financial tools to their advantage. Shiller also states that the recent financial crises was caused not by too much complexity within the financial system and believes that innovative products within the financial system have helped to create potential rewards aswell as risks. (Shiller 2009), this is unlike others who think it was caused due to too much complexity.
Shiller has argued that the only way to stop another financial crises is to democratize finance. This would involve extending the use of financial tools to a greater proportion of society and using the complex financial tools to our advantage to do this (Shiller), this is different views from government regualors like Hm treasury who have introduced more complex systems to stop another crisis for happening. Others also express the view that increasing complexity within the financial system will not stop another ciris, and is just patch over the recent crisis (Rogoff 2012).
One of the key views put forward by Shiller is that the current financial system does not benefit people on a lower income, this can been seen in the recent financial crisis with the selling of subprime mortgages to people who could not afford to pay them back. An example of this is that information about the more risky type of mortgages was not available to lower income families because it was published in materials that lower income families would not have had access to or would not have bought. The result of thiswas that these families bought mortgages that they had little information about (Shiller). This is also the case with financial advice that can be offered to families on a lower income. Over 80% of families on a lower income would like greater financial advice (Brodie 2007) but financial advisors do not see it as profitable enough. By providing financial advice and making available to a greater amount of people, it will mean a greater amount of people can use finance to their advantage and to achieve their goals.
Shiller has also expressed his concern with the recent reform regulations including the dodd frank act and basel 3 agreements. Shiller states that although these regulations will help to reduce the likely hood of another crisis they do not go far enough to stop systemic failure within the banking sector (Shiller 2010), this is due to the nature of the banking system. A way in which Shiller states that by democratizing finance can have a greater effect than increasing regulations is to set up a new financial watchdog, although financial watchdogs do all ready exist in the OECD countries like the financial service authority (UK) these watchdogs will be aimed at providing advice for the consumer, like the safety of financial products and regulations to impose safety. (Shiller 2008 p99) By introducing this watchdog in theory it could provide consumers with a greater amount of information about the products that they purchase and making sure that these products are sold correctly and do cause financial losses to consumers.
Democratizing finance helps to make it easier members of the public to use financial instruments to their advantage but does not deal with issues in the market. The current financial regulations that have been put in place have gone some way to reduce the risk of systematic risk thorough out the banking sector and this is one of the most important objectives of these measures. One of the main issues that is still around is the issue of moral hazards. There are still moral hazards around in the financial sector an example of this is the international monetary fund, which has funds of 456 billion dollars to bail out governments in OECD countries (LSE report 2010) if the governments are in trouble. By having an institution like the IMF it will still enable banks to be bailed out by the IMF indirectly if thegovernments cannot afford to pay them out and it has been proved that bailout insurance is detrimental to bank stability (Kunt,Detragiache 2005 p23) One way of dealing with this would be to remove deposit insurance completely from banks or to make sure that that the banks repay the governments if a bailout is needed. By ensuring that this happens it will ensure the banks are a lot more careful with the investment and gambling of depositors funds.
When looking at the views put forward by Shiller they seem to contrast with the current methods of regulation that have been implemented. Shillers views on democratizing finance would help to educate people on the uses and benefits of finance on society it might still not help to reduce the risk of systematic failures within the banking system as even if people were more educated they would still continue to put their money into banking systems. A key objective when regulating the financial system should also be to educate people but it should not be the only objective. An example of this would be to provide greater information to consumers as Shiller has suggested but also to implement tighter financial regulation like tighter capital rules so in the event of another crisis it can be controlled easier. (Guardian 2009)
After looking at the implications of increased financial regulation and democratizing finance there are both benefits from each of the two views put forward. By introducing tougher financial regulation upon the banking sector it will mean that in the event of another crisis it will be easier to resolve and less likely to happen again with regulations like Basill 3 and that by democratizing finance it will mean consumers are more educated as to what finance can help then achieve.
What needs to be done in light of the views and regulations is a combination of both with tougher financial regulations. Tougher regulations need to be bought in, for example reducing the size of the banks due to the fact they are overburnded by regulations and have trading operations that pose a risk to the tax payer (Harper Son 2012). By doing this it will remove banks which are too big to fail and the risk of moral hazards. Shiller views would alsogo some way to reducing the risk of finance but this alone is not enough, it would still be essential to have tighter financial regulation within the markets as this ensures that banks cannot create a repeat of the recent financial crises. By ensuring tighter financial regulation as well as educating people, I think this will have the best result.
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