October 27, 2008

Instead of avoiding risks we must embrace the right risks

Sir, Lawrence Summers writes "The pendulum swings towards regulation" October 27. He is right but, when reminding us of the "need to ensure that the pressure to increase spending is directed at areas where it will have the most transformational impact", he should be aware that this also requires the pendulum to swing away from the regulations. Currently the single objective pursued by the regulators, with their strict minimum capital requirements for the banks based on default risks and the empowerment the credit rating agencies as the supreme risk overseers has nothing to do with transformational impact but, ironically, only with avoiding a financial crisis.

Lawrence Summers also holds that "we need to reform tax incentives that encourage risk taking, regulate leverage and prevent government policies and prevent government policies that give rise to a toxic combination of privatised gains and socialized losses." He sounds so right, but he is so wrong. The privatization of gains and socialisation of the losses has nothing to do with the regulations per se but with the lack of the know-how and the political will of how to react when the regulations fail. And, specifically on risk, what we most need is to encourage the right risk taking as it is the oxygen of human and economic development, while avoiding creating disastrous risks in areas like housing and that, almost by definition, should be among the least riskiest parts of our economy.