Yet they all failed to some degree to prevent the accumulation of risks that finally produced the crisis. So it is unlikely that there is a simple answer. Any plan for reform should take into account the nature of financial risk. Why were so many people misled for so long? And was there an inherent weakness in the structure of modern banking? Banks are dangerous institutions. They borrow short and lend long. They create liabilities which promise to be liquid and hold few liquid assets themselves. That though is hugely  BIS Review 32/2009  1  valuable for the rest of the economy. Household savings can be channelled to finance illiquid investment projects while providing access to liquidity for those savers who may need it. But given how risky banks are, it should not be surprising that from time to time they get into trouble. And they have done so regularly since banking began. Confidence in a bank can disappear quickly making it vulnerable to a destructive bank run. If a large number of depositors want liquidity at the same time, banks are forced into early liquidation of assets – lowering their value. And, of course, if banks make sufficient unwise loans to borrowers who do not repay, then that can threaten solvency as well. Banks can of course take their own actions to ensure that investor confidence is maintained. For example, a visible source of liquidity helps.
Rare events, even when dramatic at the time, lose their power to shape policy as memory recedes. The role of institutions is to retain a collective memory and to resist the temptations of the present. That is one of the most important roles of a central bank. It is accepted as such in the domain of monetary policy. And there is an equivalent role in financial stability. The introduction of simple and robust policy tools into a regulatory regime based on the exercise of constrained discretion would make it easier to resist overly rapid expansion of financial institutions. In particular, the authorities should maintain a clear focus on the issues that matter when the worst occurs – liquidity and leverage. It should be intrusive, in the sense of knowing what is going on, but not bureaucratic. A system in which it is easier for a large bank to expand and then destroy its balance sheet than for an individual to open a bank account has lost focus. That is not the fault of regulators, but a reflection of the pressures and incentives they have faced – from all of us. As a Kennedy Scholar at Harvard, I have always treasured Harold Macmillan’s words in his tribute to John F Kennedy. He was, said Macmillan, a man “whose eyes were on the horizon but whose feet were on the ground".