But problems in financial markets are not necessarily solved by bureaucratic agencies churning out rules and regulations. In 2011, the UK financial regulator issued regulations, guidance, advice, discussion documents or consultations totalling 4.3 million words – more than five times the length of the Bible. This will not help anybody. We need another approach.
In areas outside the financial sector, the Church has often stressed the importance of non-governmental institutions – for example in Centesimus Annus and especially in Quadragesimo Anno.
There is just a glimpse of a recognition of this aspect of Church teaching in the above-mentioned Vatican letter. Immediately after arguing that government deregulation of financial markets led to an institutional vacuum, the letter did add (in apparent contradiction):
Numerous associations emerging from civil society represent in this sense a reservoir of consciousness, and social responsibility, of which we cannot do without. Today as never before we are all called, as sentinels, to watch over genuine life and to make ourselves catalysts of a new social behavior, shaping our actions to the search for the common good, and establishing it on the sound principles of solidarity and subsidiarity.
If only the extraordinary history of regulatory institutions that arise from within markets themselves were appreciated, there might be less of a tendency to rush to the assumption that government bureaucracies should be the main regulators of financial markets.
The history of self-regulating markets
Until 1986 in the UK, and in earlier times in other countries, securities markets were more or less entirely regulated by exchanges These private bodies regulated the behaviour of investors, dealers, advisers and companies whose shares were quoted on the exchange.
In Britain, modern stock exchanges first developed in coffee shops. When the exchange first had an independent home at the beginning of the nineteenth century, it had restrictions on membership and tacit rules. For example, when delayed settlement was introduced to increase liquidity, those who did not settle their accounts would be labelled “lame duck” on a board and could be prevented from acting as brokers.
Over time, exchanges developed codified rules. These included rules for those trading on the exchange and rules for companies that wished to be listed on the exchange. It was in the interest of companies that rule-making was robust because an orderly exchange should enable companies to raise capital at lower cost.
It was also in the interest of members of the exchange that trade should be regulated, because it would reduce the costs of monitoring, reduce losses to fraud, and so on. A codified rule book covering default and settlement, arbitration, and bad debts was introduced in the London exchange in 1812. There were rules relating to the quotation of prices and also relating to general behaviour of members. These were designed to increase transparency. The exchange also dealt with problems caused by the misuse of insider information. The quotation of securities was regulated from 1844 onwards.
The London stock exchange was essentially a club or society which could determine its own rules for membership, for the behaviour of its members, and for companies the shares of which were traded on the exchange. Sometimes these were stringent, such as those which prevented conflicts of interest by prohibiting members from both trading on their own book (jobbing) and providing advice (broking).