Some economists might say the world economy is finally starting to recover after the 2008 crisis, but Carleton adjunct professor of economics David Longworth said we could see another meltdown in just a few decades without stiffer regulations on lending.
In a study released by the C.D. Howe Institute in December, Longworth and his research group made several recommendations to international financial institutions and banks.
Longworth, who has worked as the former deputy governor at the Bank of Canada, said after looking at what happened during the boom before the crisis, his group focused on tightening regulations for haircuts and margin requirements.
According to Longworth, haircuts are the percentage of a loan on a bond or security that a borrower has to put down to guarantee they can eventually repay the loan. Margin requirements are very similar but are used for future transactions, like an option to buy a stock or bond at a later date.
Finn Poschmann, an economist and vice-president (research) for the C.D. Howe Institute, said banking regulations on haircuts and margin requirements might seem like obscure details, but it is exactly these details that end up mattering to the average person.
“Financial instruments and the securities that are traded among banks have characteristics or impacts that can loop around and influence financial markets in a way that is felt on the street by us,” he said.
“So it might seem like a far-off business,” he said, “but when those institutions don’t trust each other and markets seize up, we feel it through shortages of credit. And that’s exactly what happened in 2008 and 2009.”
Still, Longworth cautions against over-regulation. He said world financiers should aim for macrocredential regulation, which means protecting the international financial system instead of just looking at systems in every country.
This means international financial watchdogs and central banks have to work together to act on his recommendations, rather than individual countries trying to get to the job done on their own.
According to Longworth, although Canada was better insulated from the 2008 crisis than other Western countries, it would not have the power to regulate international lending by itself.
“It’s important that we don’t lose any momentum here in terms of regulation,” Longworth said.
“The lesson of history is that we have to look at the behaviour of the system and focus on the policy tools that will . . . reduce the probability that will get us into a serious situation.”