Tuesday, August 27, 2013

The problem with peer reviews is quite often the peers.

Peer review is the evaluation of work by one or more people of similar competence to the producers of the work (peers). It constitutes a form of self-regulation by qualified members of a profession within the relevant field. 

“The Dodd-Frank Wall Street Reform and Consumer Protection Act addressed the systemic risk oversight gap in the US regulatory framework by creating the Financial Stability Oversight Council (FSOC)… The peer review found that good progress has been made to date by the FSOC to establish systemic oversight arrangements and made some recommendations to further enhance its effectiveness. These involve:... providing a more in-depth and holistic analysis of systemic risks to financial stability;”... and; 

“The architecture for insurance supervision in the US, characterised by the multiplicity of state regulators, the absence of federal regulatory powers to promote greater regulatory uniformity and the limited rights to pre-empt state law, constrains the ability of the US to ensure regulatory uniformity in the insurance sector. Given the drawbacks of the current regulatory set-up, the US authorities should consider whether migration towards a more federal and streamlined structure may be a more effective means of achieving greater regulatory uniformity.”

My problem is that these regulators, and their peers, cannot get it into their heads to understand that the origin of the most dangerous systemic risks to the system might precisely be themselves and their uniform regulations.

For example, in the case of the Basel Committee's bank regulations: 

What a regulator could absolutely not do, if he knew what he was doing, was what they did in Basel II and are doing in Basel III, which is allowing for much lower capital requirements for assets perceived as “absolutely not risky”. In other words the regulators are 180° wrong. In other words they are making sure that the bank crises, whenever these occur, as a result of something ex ante considered to be “absolutely safe” turning out to be risky ex post, will be bigger than ever. 

Frankly are these peers willing to hold that their colleagues have been and still are 180° wrong? I don’t think so!