The end of crises: can we reach financial stability?

The Great Recession seems to be over: unemployment is low, the Dutch CPB has noticed GDP-growth rates that were previously thought to be unattainable and the Dutch government is finally running surpluses. The financial crisis is over.

And the financial crisis is not only over, it is ought to never come back. In 2013, Basel III was introduced, with a whole new set of regulations and capital buffers. Those should shield banks from shocks and should, in addition, shield the financial system from not only shocks to banks themselves, but the system as a whole. One could argue that the Great Recession showed us the importance of specific types of risks and helped regulators improve regulation, covering for the risks they previously did not know they existed.
The story as sketched above is a rather positive one: each crisis is costly, but also has a benefit. Each crisis has its pains, but also learns us new things about how financial systems function and how we can better prevent crises next time.
But the next question is: don’t we forget something? Something that cannot be grasped in rules or in numbers, but plays a very important role.
It’s optimism, culture: the propensity to take risks – really believing that it’ll be all right, while making old mistakes again because you forgot how bad things could be.
The period prior to the crisis, for example, was a period known as the Great Moderation: the years after the collapse of the Internet bubble. Global markets were growing and financial markets were stable. We know how it ended, and I would like to argue here that it was exactly the moderation that relaxed policymakers, bank regulators and those responsible for risk policy in the financial world. Like financial crises show us risks we previously did not know existed, financial stability makes people in financial world forget how large the risks possibly can be. There are, obviously, a number of other causes that lead to much more risk-taking by financial institutions. The point I want to make, however, is this: we should be prepared for new financial crises and even consider the possibility that new regulations make us feel more safe, but that this sense of security is misplaced and only leads us to take more risks.

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