Internationalizing Financial Regulation (Part II)

This came up in comments to this post, so it’s worth saying explicitly: I think it’s a lot easier to imagine a workable financial regulation scheme if the leaders of major world economies become willing to back off dogmatic insistence on the completely free flow of capital. The case for a free flow of capital is strong, but the case for prudential regulation is also strong and effective regulation without the possibility of restricting the ability to use the existence of multiple countries to execute regulatory arbitrage is difficult to imagine.

Among the major countries what’s needed is cooperation, not capital controls. But it’s bizarre that major economies tolerate “offshore”-type banking activities. Having a place like the Cayman Islands integrated into your financial system isn’t making markets richer or deeper, it’s clearly just an effort to exploit regulatory loopholes. Angela Merkel keeps trying to raise this issue at international conferences, and the US & UK leadership keeps wanting to dodge it. It’s true that this kind of arbitrage didn’t “cause the crisis” but the continuing possibility of doing it is a major impediment to improving regulation.