Sunday, April 20, 2008

Financial Regulation-Two Views

"Nice try; no cigar. That was my reaction to the attempt of the banking community to forestall additional regulation, by recommending a suite of best practices to be embraced voluntarily. ... The question is whether the additional regulation will do any good. In an interim report on 'market best practices', the Institute for International Finance, an association of bankers, offers devastating self-criticism. ... Would you buy a voluntary code from people who describe their own mistakes in this brutal manner? ... First, in such a fiercely competitive business, a voluntary code is almost certainly not worth the paper it is written on. ... The IIF was created not only to represent the industry, but to improve its performance. It is clear that this has not worked. ... Last month, Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard published an extraordinary paper on the long history of financial crisis. The chart shows that the incidence of banking crisis ... has been as high since 1980 as in any period since 1800. ... Yet why, I ask, should this industry have apparently failed to improve its standards of performance over the past century? After all, almost every other industry has done so. Consider how confident we are that the food we buy will not poison us. ... Consider, by those standards, the failures of the banking industry, as admitted by the IIF itself. ... The 'product' of the financial industry is promises for an uncertain future, marketed as dreams that can readily become nightmares. ... Boeing would not survive if its the aircraft it built fell out of the sky. Yet in the financial industry, huge blunders are also almost always made in common. If everybody is in the dance nobody is to blame and, in any case, governments, horrified by the consequences of a collapsing financial system, will come to the rescue. ...What then is to be done now? ... The agenda in the official report ... includes: strengthening prudential oversight of capital, liquidity and risk management; enhancing transparency, changing the role and uses of credit ratings; strengthening to authorities' responsiveness to risk; and improving arrangements for dealing with stress. But, it should go without saying, policymakers also believe regulation must be tougher. Given the damage done and the extent of the safety net provided, no alternative exists. Yet I am not that optimistic about regulation either. Regulators are doomed to close the stable doors behind financial institutions that always find new and more exciting ways of losing money. ... If regulation is to be effective, it must cover all relevant institutions and the entire balance sheet. ... It is impossible and probably not even desireable to create a crisis-free financial system", my emphasis, Martin Wolf (MW) at, 15 April 2008.

"No doubt nearly all bankers want the broad foundations of the existing banking system to be maintained. That system is their bread and butter and it has served them well. ... Who owns the ... Fed? ... The Fed's incorporation or very existence is a form of capital to it, and that's due to its being a creature of Congress. However, Congress makes no appropriations for it and lacks effective day-to-day control. The Fed's actions are largely independent of Congressional direction. ... Loeys said ... 'This was a run on the securitized world. The bank regulation and the structure of the supervisory system was created for a banking world of taking deposits and making loans. The world has moved towards capital markets, which were regulated from the point of view of consumer protection, but not from a systemic stability point of view.' ... 'Central banks' extension of liquidity to broker-dealers and (the) securitized world is permanent, and will be followed by regulatory control,' the [JP Morgan] analysts wrote. Notice the heavily bank-oriented (and slanted) world-view in these statements. To paraphrase them, the financial markets caused the recession, not the Fed, and not the banking system. The capital markets, although regulated for consumer protection, are not regulated enough. They are subject to excesses. They threaten the banking system's stability, so they need to be controlled. The banks cannot do this, so the Fed must. The Fed is the good guy. ... The banks, including the central bank, have clean hands. They were passive players in this disaster. The capital markets were the bad guys. The good guys will now have greater power over the bad buys. The good guys will save the system. ... Well, maybe the banking system will be saved so that it may continue to profit bankers for another cycle or two. ... Our current banking system ... produces economic instability ... a continuing loss in purchasing power of the dollar ... [and] support to ill-conceived and destructive spending policies of the state. ... Our banking system serves the interests of the bankers and the politicians very well. ... It is an interesting fact that the banking system is heavily regulated. This regulation provides the appearance that the banks are under public control. ... We will hear about reform ... It will be reform ... designed to prolong and enlarge the privileged position of the bankers. ... The fact is that the system cannot be reformed by any piecemeal regulation or deregulation, because the regulators are part of the system and help keep it alive. ... There is an optimal rate of inflation so as to hold up bank profits while ensuring the survival of various interests including the government itself. ... The Fed's current rescue operation is buying time so that banks can obtain more capital and liquidate bad loans or ship them off to the Fed in return for Treasury bills. ... The best solution to the financial problems brought about by the Fed's past bubblenomics is analagous to a 'big bath': write the old system off and start a new one with sound fundamentals. That means eliminating legal tender laws, doing away with monopoly government fiat money, and making institutions that claim to be depositories for money actually hold that money. ... Central banking must be destroyed before it totally destroys us", my emphasis, Michael Rozeff (MR) at, 16 April 2008.

I agree in part with MW. The problem is: "governments ... will come to the rescue". If bankers thought FBI agents would come for them with handcuffs, they would behave differently.

I agree with MR and have advocated repealing the Federal Reserve Act for decades. No proposed "reform" will do anything to protect the public from the banks. MR sounds like Cato the Elder, 234 BC to 149 BC, who ended every speech he made with: "Carthage must be destroyed", in Latin, "Delenda est Carthago". Similarly, the "Fed must be destroyed". Asking bankers to "reform" the banking system is about as sensible as asking CPAs to "reform" the CPA business. Not very. What can we expect? 31 more years, see my 28 December 2007 post.

No comments: