Rebounding from financial crisis, the U.S. is still at a crossroads in mending the conditions that sent the country barreling towards an economic collapse. Macroeconomic imbalances, manifest in current account balances and asset bubbles, and fault-lines in the banking system went unnoticed by regulators who were unaware of the "gathering storm" (Begg).
On Monday’s episode of the Daily Show, Jon Stewart interviewed the former Reagan administration budget director, David Stockman, about his newest book, The Great Deformation: The Corruption of Capitalism in America. He describes the 2008 financial crisis as a “meltdown in the vertical canyons of Wall Street”, arguing that regulations on banks, akin with the Glass-Steagall Act, are a necessary measure in maintaining financial stability. He warns that we need to abandon the fervor with which we have chased low interest rates, and instead establish federal policies and regulations that do not enable risky speculative banking. (It seems the tides may be turning as rich world central banks, spearheaded especially by Japanese PM Shinzo Abe, are opening up to an era of higher inflation.)
Stockman’s assessment follows the same thread of thought as Stiglitz in The Autonomy of A Murder: Who Killed America’s Economy? – The idea that misguided incentives and the lack of good regulation gave banks the reckless momentum that fueled the crisis. He argues that the banks misjudged risk and wildly overleveraged without ever answering to anyone. For instance, mortgage brokers neglectfully dolled out loans since they escaped the rick of default once those mortgages were neatly packaged and sold as “asset-backed securities”, oftentimes concealed by ratings agencies that judged subprime securities as investment grade.
Rummaging through the aftermath of the financial crisis has not excavated a single player that is solely to blame for the meltdown. However, the banks have definitely come under due fire (despite the controversial moral hazard of the bail-out). But we might only be brushing the service of the regulatory problem in many of the world’s richest countries. According to the New York Times, pressure to convince regulators that they are standing on firmer ground has actually driven many banks, like Citigroup, into making hushed back ally deals, particularly in Europe. The article, Seeking Relief, Banks Shift Risk to Murkier Corners, says that banks, rather than sell assets at a loss can "transfer a slice of the risk" to other institutions in a manuever known as "capital relief trades" or "regulatory capital trades". The buyers, such as private equity firms, typically hedge funds, whose investors are often pensions. These trades push risk into a less “regulated corner”, so it can look less alarming on the books, which relaxes the amount of capital regulators expect banks to hold in reserves. Banks borrowing money to lend more than they have in deposits is a central problem in the European debt crisis in the first place. Capital in the banking system is important in insulating against the risk of unexpected market shifts and risky trading.
So I guess it remains to be seen if further regulatory reforms like the Dodd-Frank Act in the U.S., and others across Japan and the Eurozone will be robust enough to reduce the enticing loopholes for investment banks to deflect risk and neglect due diligence in the financial system.
Definitely interesting, I feel if I were in charge of creating regulations for these types of banks I would be a very unhappy person. There are so many different ways to make money and it would be so hard to create regulations that address the real threats and don't just constrain economic activity for no reason. There are a lot of practices that banks engage in that appear risky but are actually healthy for the financial system. At the same time, securitization which was perceived as a perfectly natural way to actually mitigate risk ended up creating a weak and implosive situation. Over-regulation could turn into a huge problem as well because there are so many things that can get out of hand before anyone even notices that regulators might end up playing it safe by just slapping rules on the banks. Anyway, I'm glad Im not a banker or a regulator; they seem to have a pretty tough job ahead of them.
ReplyDeleteThe transfer of risk throughout the market seems to be common phenomenon within the US economic sector. In hindsight, the regulatory bodies that supervise the economic transactions of these banks has been shown to have failed. The balancing act between regulation and deregulation and which degree works best for the United States economy, has been tasked to the regulatory bodies that govern the market. For years, the regulatory system that these practices existed within was seen as adequate and nearly efficient. But with the continuance of such practices over several decades, systemic problems were found and brought to the attention of the consumer and investor. The tasks of finding a middle ground between deregulation and over regulation, seems to be the most pressing issue within our financial sector. Regulations that are able to prevent systemic risks and are not too intrusive to the profitable operation of the economy are still yet to be found.
ReplyDeleteYeah to touch on what Ian had mentioned we're yet to see any regulatory functions that the private sector is comfortable with and that functions as something effective for preventing risky and irresponsible behavior. Another huge aspect of this is the people getting involved in hedging their money with innovative yet complex and risky financing. I don't think that pensions should invest portfolios in risky investment banks even if this means that there will be less money accumulated.
ReplyDeleteOn a related note, another Economist article called "Banksters" goes into depth about rate-fixing and the LIBOR scandal, which we briefly discussed in class. Basically, two things were happening. Investigations revealed that traders from Barclays, who came under immediate fire during the scandal, were "pushing their own money-market desks to doctor submissions" to LIBOR and EURIBOR. They were also colluding with other banks, "making and receiving requests to pass on to their respective submitters". Attempts to rig LIBOR, a benchmark interest rate, not only "betray a culture of casual dishonesty", but also set the state for lawsuits and more regulation around the world, according to the article. The article goes on to argue that a "clean-up" is necessary, for the "banking industry's credibility is shot" and it cannot survive without trust. After the story broke, investigations into rate-fixing ran probes of other prominent investment banks, including J.P Morgan, Citigroup, UBS, and Deutsche Bank.
ReplyDeleteIn what perhaps could be taken a prescription for banking scandals at large, the article suggests that judiciary measures should be taken to punish those responsible, but that modifications must also be made to LIBOR, in particular, intrusive monitoring by an outside regulator, but by no means a "witch hunt". I guess what I'm saying is that if the banking system used to conduct itself on principle, I feel like those days are behind us. It seems like what we need, like the article says, is a change in banking culture. But I'm really not sure how regulations will enact that change.