--Bank of England's Haldane says economics has been "bewitched by normality" --Haldane says evidence shows catastrophic events usually considered unlikely actually are more common --The official says policy makers should put strong fail-safes in financial system's structure By Jason Douglas EDINBURGH, Scotland--Policy makers need to radically rethink the role of risk and uncertainty in the financial system if they are to make it less prone to crisis, a senior Bank of England official said Friday. Andrew Haldane, the BOE's executive director for financial stability, said in a speech to a conference at the University of Edinburgh that policy makers must abandon the idea that events in financial systems follow normal patterns of probability. Economics, he said, has been "bewitched by normality." Rather, Mr. Haldane said, evidence shows that catastrophic events usually considered unlikely--or "fat tails"--are in fact a common feature of complex, adaptive networks such as ecosystems and modern, finance-driven economies. "If public policy treats economic and financial systems as though they behave like a lottery--random, normal--then public policy risks itself becoming a lottery," Mr. Haldane said, according to a text of his remarks. "Preventing public policy catastrophe requires that we better understand and plot the contours of systemic risk, fat tails and all." Mr. Haldane said policy makers reshaping financial sector regulation should put in place robust fail-safes in the structure of the financial system itself to lessen the chance of a systemwide collapse, in a similar way to building firebreaks in forests to prevent catastrophic forest-fires. The Volcker Rule in the U.S., aimed at preventing deposit-taking banks from engaging in risky trading, and the Vickers proposals in the U.K., which propose ring-fencing banks' investment activities in separate units from their retail arms, are examples of such thinking, he said. Mr. Haldane said regulators should continue their efforts to "map" the global financial system to enable them to spot systemwide risks and alert financial institutions to possible dangers. Such efforts are already under way at the Bank of England, he said, where staff are working on a new model to stress-test the U.K. financial system and potentially alert banks to mounting risks. Mr. Haldane is a member of the U.K. central bank's Financial Policy Committee, a new body established in the wake of the financial crisis that erupted in 2008 tasked with spotting risks to the financial system as a whole, and trying to deal with them. It has recently been urging U.K. lenders to build up their capital buffers to shield them from any shocks emanating from the sovereign-debt crisis in the neighboring euro zone. Mr. Haldane said banks too need to look again at how they calculate risk and uncertainty. J.P. Morgan Chase & Co.'s (JPM) recent $2 billion trading losses occurred despite the bank's internal risk models suggesting the maximum those trades were likely to cost would be a fraction of that, he said. Mr. Haldane said since such models are sometimes used to calculate regulatory capital requirements, they need a fundamental rethink. Write to Jason Douglas at jason.douglas@dowjones.com
