If we were to look at the textbook roles defined for financial and economic regulators, three objectives would rise to the top: 1) maintaining market confidence 2) maintaining financial stability and 3) consumer protection.
While there is myriad literature addressing the second and third objectives, there is a surprising lack of paucity for the first one. This is a dilemma that regulators face all the time: how to maintain confidence of market participants in the market at a time of falling asset prices, especially when we live in an increasingly asset dependent “financialised” world?
Most regulators will tell you that it is not their job to prop up asset prices; rather, their role in maintaining market confidence is to ensure that there is a transparent flow of information, and that the rules in place are constantly fine-tuned to enable price discovery and an efficient allocation of resources. But that is clearly not been true for most of the developed world over the last two decades, when intervention has been specifically to buy assets in order to stop the downward spiral of asset prices.
Notice that the role is asymmetric; regulators have seldom moved to check asset price inflation, other than the conventional mechanism of increasing interest rates, which, in most countries, is a function performed by the central bank. When prices have fallen however, there has been increasingly unconventional means resorted to to prop up asset prices.
Tacit in these strategies has been the increasing role that asset prices play in economic growth. For example, the “wealth effect” in America is such that today a 10 per cent increase in equity and real estate prices feeds into nearly a 1 per cent GDP growth (with a lag), up five-fold from 50 years ago.
This creates expectations on behalf of the small investor. Anytime there is a market correction, there is always an expectation that there will be some sort of intervention. When it does not transpire, the media is filled with commentary that talks of the “loss in market confidence” and the failure of regulators.
Clearly this is tautology, but it places the regulators into a conundrum: their effectiveness is gauged increasingly by asset price declines. In the UAE, the rule book thus far in place has allowed for a much larger role for the private sector for the price discovery mechanism.
Regulators have focused on protecting small investors, and increasing the level of transparency. However, the influx of funds in the real estate sector post the freehold phenomena has meant that the economic fortunes of Dubai has been increasingly intertwined with the role of real estate prices.
And any time there has been market sluggishness, there have been calls for regulators to step in, to impose measures ranging from curbing of supply to regulating post handover payment plans. Whilst there is always room for improving regulation, the role cannot encapsulate a tacit guarantee of ever rising asset prices.
The link between asset price and economic growth may have become increasingly symbiotic. But asset prices (and economic growth) are a function of underlying economic vibrancy, and that happens in an open economy where the regulator’s role is to ensure maximum transparency and an economic level playing field rather than a deterministic outcome of ascertaining price growth of assets. The former is an objective; the latter becomes an emergent outcome.
In the current times (when much of the world is talking about increasing regulatory barriers to trade and industry), we forget that in the USSR under socialism, one of the roles of the regulator was to ensure a “minimum” level of annual economic and asset price growth.
It was an outcome that never was achieved, and ultimately led to the fall of communism. My opinion is not that regulators should not look at asset prices at all. In point of fact, they are constantly monitoring asset prices to determine the impact on underlying economic growth.
But, as some of my colleagues have pointed out, in a rapidly urbanising economy, there will always be a higher level of asset price volatility. Regulators can only do so much to dampen it.
Structural initiatives (such as the ones as I have talked about earlier) will always be a better bet for efficient price discovery. The private sector and its market participants will do the rest themselves.
Nasser Malalla Ghanem is Senior Partner at the law firm of NM Associates, which has a joint venture with GCP.