Government's Response in Financial Crisis

Introduction

Nowadays, under the pressure of the uncertainty and chaos characterizing the global financial markets, the statement financial institution failures are a fact of life and little can be done to stop them? seems true, more than ever.

We are watching, as Roger Altman correctly pointed out, modern historys greatest regulatory failure. The globalisation, for a long time, has been analyzed only with refere Roger Altman, Modern historys greatest regulatory failure?, Financial Times, September 17, 2008.nce to the global supply chain for goods and services.

The digital technology shortened the distances between countries and revolutionized the global supply chain, allowing people to engage in business with one another across the globe, with each nation bringing its comparative advantage to the table of world commerce.

However, the globalization has not limited its impact to the supply chain: it has also seriously affected the development of the global financial markets. The new technologies have allowed a volume of financial transactions which could not be foreseen just few decades ago. The interaction between financial operators and markets, with the related know-how spill-over, induced an increasing sophistication of such markets, with the continuous creation of brand new financial products and services.

At the same time, globalization makes the financial markets even more fragile and instable than before, because now they are deeply linked and dependant upon each others performance.

In addition to the traditional banking system, new sophisticated financial operators appeared in the global markets: securities firms, investment banks, mortgage finance companies, hedge funds.

Unfortunately, the sophistication acquired by the global financial operators, and strengthened by globalisation, has not been acquired also by the public regulators, whose reaction to the new developments has been totally inadequate.

The degree of leverage taken on by the financial institutions during the past few years is totally unacceptable. Until the current international financial crisis, the global trend has been toward deregulation: the removal of government restrictions on the freedom of financial markets.

In an attempt to enhance competition, and for the fear of being left behind by less regulated and more competitive financial markets, the newly developed financial system has not been subject to any prudential supervision, and mainly left to its own self-regulation. Needless to say: the consequential lack of transparency was stunning.

Even in the traditional field of banking supervision, the development of a coordinated international regulation (in particular: the Basel Accords) seemed to be totally focused on the creation of an international level playing field? for the enhancement of international competition, more than prudential supervision .

Discussion

In particular, both Basel I and Basel II disciplined minimum capital requirements for banks, without taking into account any other important ground for prudential regulation (especially control of liquidity, the lack of which seems now to be one of the main causes of the current credit crunch).

The current financial meltdown, direct consequence of the lack of adequate regulation, will have a huge impact on the future of the worlds economies in the following years.

Governments, learning from their previous mistakes, are now trying to reform the ...