Banking crisis: too many financial innovations, too little regulation?

Is the cause of the current financial market crisis unstable market mechanisms or ineffective regulation? Christoph Kaserer, Technical University of Munich, sees the cause in a combination of regulatory failure and an unresolved moral-hazard conflict. The current financial market crisis is also a clear indication of a failure of corporate governance both in the banking sector and among the rating agencies. But the financial market crisis must not be regarded as proof that still more regulation is needed. Instead we should ask ourselves how regulation can be more intelligently designed and how the supervisory quality can be improved. Hans-Peter Burghof and Felix Prothmann, University of Hohenheim, warn against the danger of a "reactionary hostility towards innovations". The key innovation in recent decades in the financial markets was the development of new generations of derivative financial securities that are primarily instruments of risk management and that have made it possible for enterprises "to devoid themselves of all risks, the holding of which would not have been wise from the perspective of risk diversification or the possibility of influencing risk occurrence and the results". Moreover, derivatives were a low-cost instrument for arbitrage and speculation and created additional solvency: "Speculators and arbitrators, in the context of functioning capital markets, are by no means superfluous but extremely useful. Without them capital markets could hardly function." The defect was thus not the new products but how these were dealt with. For this reason both the institution of the rating agencies and financial supervision should be redesigned to achieve a new, more secure financial market order. Forbidding certain financial products will not solve the problem since a comparable failure of institutions could occur with a variety of other products. In the opinion of Dirk Schiereck, Technical University of Darmstadt, politicians largely ignored the arising problems, and most banks falsely interpreted the failure of politicians to react as a sign that all was well and continued to invest incautiously. On the other side, the investment banker "now branded as greedy and irresponsible was also responsible for the upswing and for stability and was thus a good financial consultant. Without investment bankers and their product innovations, Deutsche Telekom would be not so solidly financed, small German businesses that shied away from the stock market would not have received hybrid capital and many young firms would not have found their way onto the stock market." Greater stability can only be achieved by means of regulation, transparency and limitation via greater amounts of equity capital. Roman Inderst, Frankfurt University, stresses that the discussion about the causes of the financial crisis has focused on the "wholesale" sector, completely ignoring the "retail" sector, i.e., the marketing of investment and credit products to private consumers. This is one of the greatest problems of the current debate. Government and regulators could take swift action here at the national level. Precisely in the "retail" area it is important to find the correct solutions, because with a sufficient basis in consumer protection, innovations could create clear added value for private consumers.