8  BIS Review 69/2010  The global financial crisis has shown that credit cycles and property market bubbles that burst represent one of the greatest challenges to economic policy. The experience of many countries over several decades has shown that house prices and residential mortgage lending usually rise prior to the outbreak of a banking crisis. 1 In Norway, interest rate expenses can be deducted from taxable income, while capital gains on dwellings and the benefit of home ownership are not taxed. Housing is taxed as an asset, but not at its market value. High tax subsidisation of home ownership and a large proportion of floating-rate loans contribute to considerable fluctuations in house prices in Norway. Furthermore, the rise in house prices over the past two decades has been high compared with countries where house price bubbles have now burst. High house prices and substantial household debt add to the economy’s vulnerability. In March, Finanstilsynet (Financial Supervisory Authority of Norway) issued new guidelines for prudent residential mortgage lending. The guidelines may have a somewhat dampening impact on the rise in debt and house prices. The global financial crisis has revealed weaknesses in the financial system. Regulation of financial institutions should seek to limit risk not only in individual banks, but also in the financial system as a whole. Risk is amplified by the interaction between financial institutions. Today, we can see that the crisis was amplified by the very surprise over the extent to which financial markets are interwoven.
But in a systemic sense, private placements, private markets – what goes on beyond or behind the transparency of our public markets – that too can be threatening to stability; and so we need to find a way to bring daylight into those markets and network of exposures without interfering with the efficiency of some private transactions. I am not convinced that we have really even started to think through what that means in practice. We should do so. This signals that the traditional financial stability authorities – including central banks – need to take a greater interest in some aspects of securities regulation than for a long time. So far I have covered the two broad areas where work has been actively underway. Now I shall say something briefly about two areas where, I hope, work lies ahead. Shadow banking First of all, shadow banking. I spoke about it at the beginning of the year, 2 and I and others have been pushing it behind the scenes. Mario Draghi, Chair of the FSB, flagged it in an article in the FT a few weeks ago. As we restructure the banking system, directly and indirectly, we have to keep firmly in our minds the pervasive effect of regulatory arbitrage. The sponsors and the framers of the first Basel Capital Accord – Paul Volcker, Robin Leigh-Pemberton, Bill Taylor, Brian Quinn, and their generation – were not unaware of regulatory arbitrage.