Page 2 of 2 When Timmy met Sheila
By Julian Delasantellis
The rest of the Obama financial reform is initiative is as uninspired and
lackluster as much of the rest of his policy agenda. Still, in the
hyper-politicized and polarized political environment that Obama's election has
only exacerbated, it is raising the same type of arguments in opposition as is
the super-regulator.
A new Consumer Financial Protection Agency, to be modeled after the Consumer
Products Safety Commission, which protects consumers from potentially dangerous
products like toys and power tools, could help steer uneducated financial
consumers from "dangerous" products such as credit cards that charge 30% on
unpaid balances or those killer mortgages. But this is criticized as an
outrageous abrogation of the people's freedoms, namely, the freedom to screw up
your finances so bad that only
going through the seven-year credit purgatory of bankruptcy court will save
you.
Similar tentativeness is displayed on the issue that probably most critically
needs a government rethink: the question of banks that have been allowed to
become "too big to fail". Bear Stearns was adjudged so in March 2008; that
spurred a joint US Treasury/Federal Reserve bailout that was wildly unpopular.
Hoping to avoid that unpopularity, the government allowed Lehman Brothers to
fail 51 weeks ago; that spurred the worst of the global equity market sell-off,
which was pretty dammed unpopular as well. Since then, virtually nothing has
been allowed to fail; no bureaucrat wants to roll those dice again.
The answer, of course, lies not in saving or abandoning institutions that are
adjudged to be, in the new lingo of the world's economic apparatchiks (probably
flying above you in a private jet right now), "systematically important
institutions".
By the time these banks and other financial institutions have grown this
corpulent, economic officials have only two options when they fall into
distress - and they are both bad. The real key to the too-big-to-fail policy is
to implement and administer regulations that prevent the banks from getting too
big.
In the past two weeks, reports have emerged of a new policy initiative by the
Obama administration as regards too big to fail. According to these reports,
proposals are being submitted to the Group of 20 coordinating council of
economics ministers and central bank officials to make large banks hold larger
capital reserves in their risk-free "Tier 1" Basel II portfolios than are
required to be held by smaller banks.
The big behemoths like this idea not one little bit. Instead of leaving money
collecting dust in low yielding Treasury-bill accounts, they want to go out and
find something with a higher rate of return - why worry about loans going bad
if the government will always be around to clean after up your messes?
It is interesting that the leaked reports about the new, higher reserve policy
stress that they would not be implemented unilaterally, in just the US or any
other individual country. The concern there is that banks operating under a
tighter regulatory regime from one country would be then be placed at a
competitive disadvantage to others not impacted by the requirements, a concern
that American economic policymakers apparently place before that of a
too-big-to-fail engorged bank taking the whole world finance system down with
it when it falls.
Stepping out of the trees of policy in development to see the greater picture
of the forest beyond, one wonders whether all this has any meaning, any real
significance, at all. The Christian philosopher CS Lewis once said that the
Devil can make scripture a vice. If that's true, imagine what mischief can be
made with financial regulations.
Illustrating this point was an op-ed in the Financial Times last week by
British business mandarin Sir Martin Jacomb. If the road to hell is said to be
paved with good intentions, the fiery Gehenna the world economy is currently
roasting in was but a highway exit to a supposed paradise called Basel II.
In June 2004, when finance officials from the world's major financial economies
released the second, more highly developed, version of their cross-border
banking regulatory architecture (what has come to be known as Basel II), they
probably thought they were firmly on the side of the angels; a triumph of light
and enlightenment following upon mankind's long history of barbarous ignorance.
Little did they know how wrong they were.
The regulatory framework required banks to hold as part of their capital
reserves three levels of capital accounts, differentiated by the degree of risk
of default each was believed to represent. Tier 1 was intended to be the safest
and least susceptible to default; it included government securities, bank stock
and highly rated corporate debt.
Of course, what made corporate debt "highly rated" was the ratings agencies. If
their integrity faltered, if they rated something safe that should not have
been, then the whole bank capital reserve system would be worthless, making the
system itself nothing but a chain breaking apart upon the frailty of its
weakest link.
The ratings agencies integrity, of course, did falter. They gave the supposed
senior "tranches" of collateralized subprime mortgage debt obligations far
higher ratings than they should have been given, and the system cracked.
According to Sir Martin:
In fact, at the heart of the present
catastrophe was a singular regulatory error: the failure of the Basel
international rules to impose weighty capital requirements on the super senior
tranche of securitized mortgage obligations held in banks' trading books. It
was there that vast quantities of the toxic stuff accumulated. Because these
securities could be held with minimal capital backing, banks thought it was all
right to do so, and some built up gigantic portfolios. When these holdings
turned out to be unsalable except at a huge loss, the disaster was exposed.
Sir Martin uses this point to argue that securitization is not the hairy
bugaboo people are now alleging it to be. I think a better lesson to be taken
from this is that any financial regulatory framework or system, of whatever
stringency, will invariably be tested and tried by those trying to poke a
whole, or rip a seam, in it for their own profit.
If a way exists to burrow under the fences protecting the general economy and
society from the excesses of the financial system somebody will find it. Why
shouldn't they? There's just about nothing on this earth more profitable than
running the financial system a lot hotter and harder than it should, or that
society thinks it should, be run.
But among all the miasma and confusion of the regulators - those trying to
preserve the financial system for the benefit a general populace far more
concerned with the latest results from "Who wants to be a millionaire?" - one
interesting idea has emerged. The rules of the financial system don't matter
all that much; what's really important for the financial system is that there
just be less of it.
In an interview with Prospect magazine, Lord Adair Turner, the head of
Britain's financial watchdog, the Financial Services Authority, said that the
City (financial shorthand for the British financial sector in the same fashion
Wall Street is for America’s) had grown "beyond a socially reasonable size",
representing too large a portion of the British national economy and output. He
called much of the financial sector's recent endeavors "socially useless
activity" and said the sector as a whole had "swollen beyond its socially
useful size".
Turner proposed a financial trading transaction tax, sometimes known as a
"Tobin tax" after Yale University Nobel Economics Prize laureate James Tobin,
as the slim-down diet for the financial sector. This automatically makes his
proposal nothing but the most stratospheric pie-in-the-sky fantasy. The
suffocating control of all arms of the US government by finance capital would
make it more likely that the late Ayatollah Khomeini will sing the national
anthem at the next Super Bowl than trading in the US be taxed sufficiently to
significantly discourage it.
Still, Turner certainly had a point when he had the courage to question whether
the financial sector in Britain, and by extension in the US, had grown beyond a
socially optimal size. Numerous times here I have referenced the fact that, by
the crest of the boom in 2007, over 40% of total US corporate profits were
earned by the financial sector, up from about 15% in the late 1970s and early
1980s. The ratio has fallen off now that the banks aren't earning profits.
The financial sector, once the economy's helpmate - its tool belt - had
penetrated the skin to become an economic and societal parasite, its leach.
From making the real economy load up on debt to fight off hostile takeovers, to
diverting future investment to current stockholders, the financial sector made
ruinous demands upon the real economy, and there was always a sheriff-for-hire
somewhere in the government to assure that its will be done.
Frantically, the effort now is to get it back up on its feet and once again all
bulked up. Maybe it would be better if we just left the financial sector as is,
prostrate and impotent on the ground, not currently much of a threat to
anybody.
"If we fail to anticipate the unforeseen or expect the unexpected in a universe
of infinite possibilities, we may find ourselves at the mercy of anyone or
anything that cannot be programmed, categorized or easily referenced", Agent
Mulder (David Duchoney) once cautioned Agent Scully (Gillian Anderson) in The X
Files.
Today, this could serve as apt advice for Geithner to give Bair. "That may be
so," Bair might reply, "but you're still not getting to first base with me as
long as you keep pushing that stupid super-regulator idea."
What a great teaser for the movie they'll be making about the first year of
economic and financial policymaking in the Obama administration! It's to be
titled When Timmy met Sheila.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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