Philosophical Conversations Public Opinion Junk for code
parliament house.gif
Think Tanks
Oz Blogs
Economic Blogs
Foreign Policy Blogs
International Blogs
Media Blogs
South Australian Weblogs
Economic Resources
Environment Links
Political Resources
South Australian Links
"...public opinion deserves to be respected as well as despised" G.W.F. Hegel, 'Philosophy of Right'

regulating global financial markets « Previous | |Next »
April 7, 2008

As we know Treasury chief Hank Paulson says he doesn’t blame the current regulatory structure for current market turmoil. If it was not the non-regulatory structure that the US has now, then how do we explain the housing bubble and the credit meltdown and the taxpayer bailout of Wall Street? Paulson's plan is to overhaul” Wall Street by deregulating it, not by disciplining financial markets for their own mistakes.

In contrast, Tony Curzon Price in New Democracy recognizes that will be new regulation of finance. He states:

All the proposals to overhaul the regulation of banking are aimed at [trying] to stop banks and bankers behaving like the gatecrashers at a teenage party, happy to enjoy and wreck the common environment until the reckoning comes. Banking regulation is a good thing to be doing, but it is only half the story. The Fed and other central banks put on the party in the first place, and never switched the lights out. These are administrative arms of democratic states, and the question we should ask is: "what is it in our politics that allows democracy to be so irresponsible?''

Irresponsible for me means that there aren't any regulations for investment banks, hedge funds, and other currently unregulated financial institutions to hold capital assets proportional to the risks they’re taking on. This has helped to contribute to a dysfunctional global financial system.

Kevin Rudd is merely talking about a new system of global scrutiny in the form of domestic regulators reporting the weakness of any banks and finance companies to the IMF. It's an early warning system with a new role for the IMF, rather than a new regulatory regime. It has to be minimal because the IMF does not the capacity to act as an international regulator.

Rudd does recognize that the financial markets have changed as it no longer just includes the core institutions (the Banks) protected by the central bank acting a lender of last resort, prudential legislation, and explicit deposit insurance. We now non bank institutions such as hedge funds and securitised markets and the traditional regulatory regime had great difficulty in governing this new world, that underwent a systemic crisis. It was the central banks, as lenders of last resort, that acted with their chequebooks to ensure overall stability of the financial markets.

| Posted by Gary Sauer-Thompson at 7:00 AM | | Comments (14)


speaking of central banks. Did you see the attack by News Ltd on Glenn Stevens, the governor of Australia's central bank, which has acted to ensure the stability of the financial markets.

The attack began in the News Limited tabloid paper, the Daily Telegraph, on Saturday. Alongside a picture of Mr Stevens with hand on forehead it asked "Is this the most useless man in Australia". The story, which has no byline on the internet version, said:

the nation's most powerful economic figure has committed a double betrayal of working families - urging big banks to ignore the RBA's official interest rate and saying taxes could be increased.

Isn't Stevens doing what the law requires him to do as Governor of the RBA--squeezing inflationary pressures? So why the tabloid's personal attack?

This attack was continued with Glenn Milne's piece in the Australian who argued that the RBA may have failed to get off the interest rate bus a few stops back, where it ought to have alighted. They squeezed too hard for too long as consumer demand has dropped.

What's going on? Is this a reworking of the old narrative of ordinary, decent common sense Australians being betrayed , yet again, by the arrogant tertiary-educated, intellectual elite who are out of touch know-it-alls who wanted to run the country their way?

I agree that measures are needed to prevent similar escapades from occurring in future but capital adequacy provisions for non-bank institutions don't address the problem.

It was not lack of capital that sank Northern Rock and Bear Stearns. It was loss of confidence by the finance sector at large. Once it became apparent that there were unknown quantities of junk securities, perhaps hundreds of billions of dollars at face value, and nobody knew where they were or what they were really worth, nobody wanted to lend money to anyone.

Whether regulations should focus on arcane securities such as the famous collateral debt obligations and credit default swaps, the practice of placing stuff off-balance sheet, the conflict faced by the rating agencies in being paid by those whom they rate, all of those things or none of those things, is yet to be teased out.

good solid points.

I Interpret the credit meltdown in the US financial markets as signifying that the US is no longer the safe investment haven---deep financial markets and a stable banking system --that it once was. It is currently going through a slow burn crisis in which foreign investors are reassessing the strength of its banking and financial sectors. Confidence in the US financial system has weakened.

So what does China do with its massive accumulation of foreign exchange reserves in US Treasury bonds? Start pulling out looking for higher returns?That means less capital inflow into the US right?

I guess Glenn Stevens, the Governor of the Reserve Bank, holds firm as the shrills at News Ltd declare an open season on him.

As you point out he's doing the job he's required to do to keep the economy from overheating and blowing an inflation gasket.

the US Federal Reserve's bailout of Bear Sterns---too big to fail, and would cause a chaotic unwinding if let go --- means that the Fed has effectively become credit default guarantor for the US investment banking industry. If a big US bank gets into trouble----Bear Sterns was only America's fifth largest investment bank--- the Fed will lend a big protective hand to ensure salvation.

So they can continue to their wild west cowboy thing knowing that if they take to much risk and get into trouble the Fed will help them out and save the day.

Gretchen Morgenson has pointed out a further aspect of the sub-prime loan debacle that triggered the crisis.

WE’VE all heard a great deal in recent months about the greedy borrowers who caused the subprime mortgage calamity. Hordes of them duped unsuspecting lenders, don’t you know, by falsifying their incomes on loan documents. Now those loans are in default and the rapacious borrowers have moved on with their riches.

People who make these claims, with a straight face no less, overlook a crucial fact. Almost all mortgage applicants had to sign a document allowing lenders to verify their incomes with the Internal Revenue Service. At least 90 percent of borrowers had to sign, seal and deliver this form, known as a 4506T, industry experts say. This includes the so-called stated income mortgages, affectionately known as “liar loans.”

So while borrowers may have misrepresented their incomes, either on their own or at the urging of their mortgage brokers, lenders had the tools to identify these fibs before making the loans. All they had to do was ask the I.R.S. The fact that in most cases they apparently didn’t do so puts the lie to the idea that cagey borrowers duped unsuspecting lenders to secure on loans that are now — surprise! — failing.

Instead, lenders appear to be complicit in the rampant fibbery that is one of the root causes of our continuing mortgage nightmare.

Mike Summers, vice president for sales and marketing at Veri-tax Inc., in Tustin, Calif., knows plenty about this. His company handles the filing of these verification forms with the I.R.S. on behalf of lenders and loan originators. He began selling the service to lenders in 1999 and said he was surprised at the reaction he received — like that of a skunk at a garden party.

“In 2001, I was going around the subprime world trying to get them to sign up,” Mr. Summers recalled. “Ameriquest, and others I don’t want to name, just didn’t want to know because it would kill the deals. The attitude was don’t ask, don’t tell.”

Ameriquest, just to jog your memory, is now defunct....

Mortgage originators were making dodgy loans hand over fist, passing them off to Wall Street firms to be magically transmuted into AAA credit rated securities, pocketing the up-front commissions and happy to ride off into the sunset when the whole thing finally fell over.

Malcom Farr and Piers Ackerman have joined in the attack on Glenn Stevens. What is The Daily Telegraph's game plan-- to sell more newspapers in western Sydney?


The Fin Review editorialises today, "Stevens must stick to his guns", and concludes with, "Mr Stevens has to ignore his more shrill critics and stick to managing long-term economic fundamentals".

I imagine that Stevens pays rather more attention to that newspaper than to the popularist antics of Murdoch tabloids.


David Bassanese makes much the same points as you did, today in the Fin Review, "Bernanke bail-out a damning indictment". However he has no suggestions as to what Bernanke should have done instead, or what should happen now to mitigate future moral hazard.

But The Wall Street Journal Deal Journal blogger has a different point of view though:

"... what exactly did Bear Stearns do wrong, or differently from anyone in its industry? The brokerage house wasn’t taken down by 'moral hazard,' or credit-default swaps or derivatives or mortgage-backed securities. It was taken down by rumors that led worried counterparties to pull their financing agreements with Bear, resulting in a destruction of the firm’s capital base."

If the WSJ is right, was Bernanke wrong?

Re your comment:

agree that measures are needed to prevent similar escapades from occurring in future but capital adequacy provisions for non-bank institutions don't address the problem.

Excellent point. But the non- banking institutions do need to bought into the same regulatory framework as the banks. He says that the investment banks:
ability to enjoy the upside on the risks they run, while shifting parts of the downside on to society at large, must be restricted. This is not just a matter of simple justice (although it is that, too). It is also a matter of efficiency. An unregulated, but subsidised, casino will not allocate resources well. Moreover, that subsidisation does not now apply only to shareholders, but to all creditors. Its effect is to make the costs of funds unreasonably cheap. These grossly misaligned incentives must be tackled.

But it's more than that--Bear Sterns signifies that we have reached the limits of deregulation of financial markets. As Martin Wolf in the Financial Times observes:
the dream of global free- market capitalism died. For three decades we have moved towards market-driven financial systems. By its decision to rescue Bear Stearns, the Federal Reserve, the institution responsible for monetary policy in the US, chief protagonist of free-market capitalism, declared this era over. It showed in deeds its agreement with the remark by Josef Ackermann, chief executive of Deutsche Bank, that “I no longer believe in the market’s self-healing power”. Deregulation has reached its limits.

It's sure taken them a while to realize that.

I read the Wall Street Journal blog post by Heidi Moore that you linked to. It begins by asking:

Is Bear Stearns being punished for its own sins, or those of its entire industry?

Bear Sterns was rescued not punished. If it wasn't rescued by the Federal Reserve it would have gone under.

It went under because people realized that the securities market was a house of cards with no foundation. It was all smoke and mirrors in so far as it borrowed money on shares they never sold. Share price dropped, the margins were called in, and Bear Sterns run our of cash.

Isn't it called market clearing in free market speak?

a lot of the News Ltd attacks on the Reserve bank are based around comments from Myer chief executive Bill Wavish to higher interest rates.

We need to be sceptical here with Myer. Their problems arising from a fall in retail spending are compounded by the debt-heavy structure imposed by its private equity buyers.

It does appear that consumer confidence has plunged and a cut back consumer spending does appear to be happening. However, cutting back consumer spending through higher interest rates is one of the aims of monetary policy in inflationary circumstances.

the reason why my views were similar to those of David Bassanese, the AFR columnist, is that I'd read his column earlier that morning at work. I'd had an earlier morning coffee with banker type person who expressed faith in the self-regulating market and I was looking for what the AFR is saying about how to re-regulate fragile financial markets.

It's not saying much from what I could gather. I infer that they accept the Greenspan view of self-policy, laissez -faire regulator oversight, low interest rates, and linking a fostering of the bouyant housing and share market with the view that it was okay in a boom to borrow against the increased equity and spend more.

The legacy was an overheated housing market, a rapid build -up of debt on Main street and Wall Street, sub-prime mortgages and predatory lending. The consequence is a painful adjustment/ clearing in the form of a bust.

It is interesting how the IMF has played no role in helping to address this crisis.

In Mind the gap in the Financial Times John Plender compares today with the 1920s:

Income inequality in the US is at its highest since that most doom-laden of years: 1929. Throughout the main English-speaking economies, earnings disparities have reached extremes not seen since the age of The Great Gatsby.
Much like this decade, the 1920s were a period of strong corporate profits growth and increasing household debt. Awash with easy money, Wall Street became hooked on what the economist J.K. Galbraith in that subsequent seminal work on the period – The Great Crash – called “the magic of leverage”: the ability to increase returns through borrowing.
Investment trusts provided the vehicle for this financial merry-go-round, in which one investment trust would “sponsor” another investment trust, which would in turn sponsor a further investment trust. This paper-shuffling multiplication of risk bears a remarkable resemblance to the slicing and dicing of risk in highly leveraged structured credit markets today.

Interesting comparison. Plender says that In the 1930s, it ended with bank failures and the Great Depression. Now, after decades of “financialisation” in the US and other Anglophone economies banks are being bailed out – using public money – in an effort to ensure the same does not happen again.

The amount of leverage that hedge funds and other players are using needs to be regulated.