Stuff happens. People make mistakes, parts go wrong, unexpected things crop up. When disaster ensues, politicians, journalists and savants blame the blunderers, the component manufacturers, and the perversity of fate. But good systems , whether in engineering, in management or in regulation, are robust. When those that rely on infallibility, perfection and predictability break down, the fault lies with the structure, not the individuals, the parts or the gods. 

Richard Bookstaber’s fine book on modern financial  innovation, A Demon of our own Design, distinguishes loosely and tightly coupled systems. The postal service is a complex network, but individual failures are contained and have no consequences for the integrity of the whole. Aircraft are safe because every critical element has a back-up. But the indicators of reactor core temperature at Three Mile Island were designed to give readings only within the planned operating range. Although the plant itself had many of the belt and braces features of an aircraft, neither the control room nor the instrumentation, Bookstaber explains, had been designed with emergency operation in mind.

  It seems absurd to design a monitoring or regulatory system on the premise of normality, but that is what we routinely do. Our systems are tested on data from periods of stability, and our inspections confirm that everything functions as we intended.. Northern Rock did not fail because the FSA did not maintain adequate minutes, or because the tripartite authorities did not keep each other sufficiently well informed. It failed because the control room had not been designed with emergency operation in mind.

  The problems could, of course have been diffused at any time by the public authorities writing out a sufficiently large cheque – as they eventually did for Northern Rock, and as the Fed did much more promptly for Bear Stearns. Many social and economic problems can be ameliorated by the prompt disbursement of $30 billion, although it is difficult to see why protecting the counterparty exposures of large financial institutions comes near the top of the list.

  In a column last September, I made three proposals that would have led to more effective handling of the breaking emergency at Northern Rock. An adequate deposit protection scheme would have permitted an immediate assurance that no small saver would lose money, and ended the run. A special administration scheme would have given adequate power to deal with a failing bank The government now plans to implement both these measures. But it should also act on a third suggestion – that the Financial Services Compensation Scheme should become a preferred creditor in any liquidation.

  Banks traditionally borrowed short from the public and lent long to business. The growth of innovative intermediation severed the link between borrower and lender .But the outcome has been to make retail depositors less safe, not more, as their deposits have become  collateral for proprietary trading.

  In an ideal word, retail deposits would be  backed by genuinely first class and liquid assets. Competition in the retail market would then be on the basis of relative effectiveness in the collection and processing of deposits.  It is ironic that Northern Rock’s efficient  administration is now being wound down as a result of losses in different activities. 

  To impose that ideal through regulation would be intrusive – and also unnecessary. The preferential status of retail deposits would ensure that if deposits were not supported by government or similar quality obligations , wholesale lenders would be at risk for any shortfall. Such a structure would is probably the only realistic regulatory intervention that would have prevented the Northern Rock fiasco occurring in the first place. If not only the securitised mortgages but the retail deposit base had been ring fenced the residual balance sheet would have been insufficient to support the doomed bank’s headlong expansion.

  This amounts to privatisation of banking regulation because the right response to regulatory failure is less regulation not more. If public agencies are seriously to supervise the business strategies of both high street and investment banks we might as well nationalise them; the proposal is entertained only because everyone knows it is not really serious. Such supervision will continue to be an exercise in box ticking, analogous to confirming that today the reactor temperature was within the normal range, and equally helpless when, one day, it is not.