As I watched the intricate social ballet that occurred as cars and bikes slowed to enter the circle (pedestrians were meant to cross at crosswalks placed a bit before the intersection) Monderman performed a favorite trick. He walked, backward and with his eyes closed, into the Laweiplein. The traffic made its way around him. No one honked, he wasn’t struck .Instead of a binary, mechanistic process – stop, go – the movement of traffic and pedestrians in the circle felt human and organic.”
The above quote is from the ever-readable Dylan Grice’s latest missive in which he argues that regulation acts much like traffic-lights, in that it lulls market participants into a false sense of security.
He uses the the small town of Drachten in Holland, where the removal of road safety measures has doubled traffic flow and resulted in zero fatal accidents, as his argument-vehicle. Go figure.
From Grice (with our emphasis):
The traffic lights and road signs are well intentioned, but by subtly encouraging us to lower our guard they subtly alter the fundamental algorithm dictating micro-level driving behaviour. This causes a perverse macro-level outcome.
You might be thinking that traffic lights dont have anything to do with the markets we all work in. But I think they do. Instead of traffic lights and road signs think rating agencies; think Basel risk weights for Core 1 and Core 2 bank capital; think Solvency 2; or think of the ultimatemarket regulators of our currencies – the central banks – and the Greenspan/Bernanke put which was once imagined to exist. Haven’t these regulators provided the same illusion of safety to financial market participants as traffic safety tools do for drivers? And hasn’t this illusion of safety been even more lethal?
The regulations which told banks that AAA-rated bonds were risk free were designed to make markets safer. But they created an artificial demand for such bonds, which created an incentive for issuers to dress up bonds as risk free when they were anything but. The regulations effectively incentivized ratings agencies to rate them as risk free when they clearly werent. And today, the same madness is going on in the government bond markets. It’s very difficult to see how government bonds are anything other than risk assets (lets face it, all assets are). Yet insurers are buying them because theyve been told to take less risk(whatever that means) by the regulators. So they are taking more risk, and they will one day suffer the consequences.
His argument is that if banks had never been given capital ratios and the like, and had been allowed to go bankrupt when they messed up instead, they would have been more careful about what they had been buying — there wouldn’t have been ab illusion of safety.
You might say “Well, it shouldn’t matter what the regulations say, it’s still stupid for a bank not to hold capital against assets, even low risk ones.” I’d completely agree. I tell my son that just because the green man is flashing doesn’t mean you dont look before crossing the road. Nevertheless, tailgating through amber at the traffic lights because the system says were allowed to pass through amber is stupid too. But we’ve all done it.
So, is this crisis one of regulation rather than capitalism? And, asks Grice, if that is the case, are we at risk of adding more “idiots” to the pile?
The full note is in the usual place.