Enforcers count, not just the rules

It is commonplace to say that the global credit crunch is the result of a monumental regulatory failure and bankers' greed.

In part it is also true, though the reality is that everybody was culpable. We all enjoyed the party; the population at large enjoyed their 125% mortgages and the opportunity for nigh on 10 years to spend 105% of their income, at very little extra cost and with very near full employment.

The politicians basked in the economic growth so effortlessly delivered. The bankers obviously enjoyed their bonuses. The entire Western world exported its inflation to China, by buying its cheap manufactured goods with never a thought as to how the huge financial imbalances created by this action would be unwound. So we were all at fault. But let's blame the regulators. Like PR men that's what they are there for, to absorb the blows when things go wrong.

However, it does create a problem. It is understandable that if the regulators are to blame people will suggest that the regulations need to be tightened, and indeed our Prime Minister said so in Washington after his Obama visit and Lord Mandelson told a City audience on Wednesday night that "light regulation would be replaced by right regulation".

But they make a fundamental mistake. It was not the rules that were at fault; it was the people enforcing the rules. There were more than enough regulations in place to curb the bulk of the excess which ultimately caused the system to blow up.

There were even people who warned that something deeply uncomfortable was likely to happen; Alastair Clark of the Bank of England and, in a more coded way, his boss Mervyn King did so in speech after speech long before the crash came.

This is at least the fifth banking crisis in my 41 years in the City: the fringe banks in 1974, Johnson Matthey 1984, BCCI 1990, the regional bailouts of the early 1990s and Barings in 1995. Most led to new banking acts "so it could never happen again" and no Banking act has prevented the next crisis.

What subsequent inquiries into all those failures also showed was that prior to their collapses there had been loads of warning signs, in the case of BCCI and Barings given in the most explicit terms to the authorities. But for various reasons the warnings were not acted upon.

It is not the regulations that matter, it is not even the regulatory structure that matters, be it a tripartite memorandum of understanding between FSA, Bank and Treasury, or a pan-European regulator out of Brussels.

It is the quality of the people who are the regulators that makes the difference, coupled with their courage in standing out against conventional wisdom, and the willingness of politicians and the public to back them when they do, in those immortal words, take the punchbowl away just as the party is getting interesting.

This is why regulation will always fail, because regulatory bodies will never be staffed in depth with enough top-quality people to be able to keep up with those on the other side. As a career it is not attractive enough, and it is unlikely, even if it gets the best brains, to be able to hold on to them when markets start to roar away.

As Professor Frank Partnoy said in Infectious Greed, a book about the derivatives markets published more than five years ago, the main purpose of most financial innovation is to find a way to circumvent some rule or other.

The US has a much stricter regulatory regime than our light touch approach here. Not only did it totally fail to anticipate any of the excess and corruption and fraud which underpinned the development of the subprime markets, but it has also failed majestically in other areas too, not least the Madoff and the Allen Stanford fund management frauds, to say nothing of more than 200 other cases under investigation.

These scandals do not appear to have imitators in the UK. Draw your own conclusions. Mine is that heavy-handed regulation is even less effective than light touch.

The other golden rule of regulation is, or ought to be, never to draft new laws in haste, or when the public is in a frenzy. Yet that is just what is happening now, with various bodies in the European Union being ordered to have a raft of new proposals ready for presentation to the 2 April meeting of the G20 summit in London.

No doubt this will suit the political agenda of Gordon Brown in being able to show that he is doing something. Whether that something will be anything other than damaging in the longer term is another matter.

One of the planks of London's success as a financial centre is that it has been intelligently regulated.

If it is to continue as a huge wealth generator for Britain it has to continue to be intelligently regulated. That means resisting the temptation to produce a financial Dangerous Dogs Act.