The political environment changes but regulatory underperformance persists

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By Cormac Lucey

An International Monetary Fund research paper written by Jihad Dagher last month examines the political economy of financial policy during 10 of the most infamous financial booms and busts since the 18th century.

The paper presents consistent evidence of pro-cyclical regulatory policies by governments: in other words, official policy tightens when it should loosen and loosens when it should tighten.

Dagher argues that financial booms — and risk-taking during such episodes — were often amplified by regulatory actions. He asserts that regulatory backlash that ensues from financial crises can only be understood in the context of the deep political ramifications of these crises.

Post-crisis regulations do not always survive the following boom. And, in a warning for our own central bank, he cautions that history suggests that politics can be the undoing of macro-prudential regulations.

Among the episodes that Dagher studied was the Irish financial crisis of 2008. He states: “The reasons why the regulatory failures took the form they did cannot be understood without acknowledging that this approach to regulation was tacitly endorsed by the government.”

It’s easy to blame the right-of-centre political line adopted up to 2007 by Fianna Fail and the Progressive Democrats (of which I was a member) for the regulatory failures that occurred then.

In my opinion, regulators had plenty of authority but were too lethargic to use it. That government has long since disappeared but official lethargy persists. How else are we to explain the glacial pace of addressing Ireland’s mortgage arrears problem or the Central Bank of Ireland’s ineptitude in handling the tracker mortgage scandal?

Published in The Sunday Times (Ireland edition)

February 4th 2018

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