The last eighteen months have witnessed a revolution in financial regulation — if by that we mean a fundamental reconstruction, total change or turn round from the previous orthodoxy occurring in a relatively compressed time.
In particular, the sheer scale of recent policy interventions in the banking system is throwing up very uncomfortable questions about the government’s role in the economy, centered on its function as the ultimate re-insurer of risk and its function via the central bank as “lender of last resort” (LOLR) to the banking system.
The classic statement of LOLR operations set out in Walter Bagehot’s “Lombard Street” is to “lend freely, at penal rates, against good collateral”.
But in the aftermath of recent rescues, not much remains of the original doctrine. The Fed and other central banks are now lending freely, but to a wider range of institutions never envisaged before, against poor collateral, on increasingly generous terms, and providing support for solvency as well as liquidity.