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Welcome to Big Brother II: WSJ brings us "The Future of Finance"

Further to my prior post, I decided to take a whack at laying out the WSJ`s online report and describing some of its contents.

The master page is here – is not outlined as clearly as the Asian print edition, which is in the following order, which I`ve linked to corresponding section of the online version:

Fixing Global Finance (intro)

A Call to Action (“A ranking of the 20 recommendations at The Wall Street Journal’s Future
of Finance Initiative, aimed at rebuilding the global financial system.”) Participants were divided into four groups, each one looking at a specific aspect of the future of finance:

• How to deal with financial institutions deemed too big to fail.

• How national regulatory authorities can effectively oversee global institutions.

• How to deal with financial institutions at the regulatory frontier that act like banks but aren’t regulated as banks.

• How to address complex, innovative products, like credit-default swaps and collateralized debt obligations.

Each group came up with five top priorities for how to rebuild its area of the financial system. All participants then voted on the order of prirority.

It is useful to actually review the four groups’ discussions, which are here:

Too Big to Fail

International Regulation

Financial Innovation

Regulatory Frontier

Paul Volker: Think More Boldly

Other articles that are linked at the main page do not appear in the print edition; I will look at them later.

The top 20 priorities identified are these (my emphasis, identification of buzz words & comments):

1) Higher Capital Requirements

Financial institutions whose “systemic importancerequires national
authorities to underwrite them if they fail
[they are apparently the institutions identified here] should be required to hold
more capital.
This should include increasing risk weightings,
asset/liability limits based on the business model rather than on
simple capital ratios, as well as “contingent capital” [a form of debt that converts to equity whenthe bank is in trouble] and “dynamic
provisioning”. [“Too big to fail” has been formally identified globally!]

2) Empower the 
The Financial Stability Board [created by the G-20 in April to “address vulnerabilities and to develop and
implement strong regulatory, supervisory and other policies in the
interest of financial stability
” and supported by a secreariat in the BIS; national member organizations are here] should be empowered to define and seek
agreement on broad-based principles that national regulators should try
to make operational in consultation with market participants. [This is our new global financial overlord]

3) Promote Risk Management

should be required to demonstrate a full understanding of risks
inherent in new products.
Elevate risk managers to at least the same
level as product makers and give them adequate representation at board
. Create globally recognized qualifications for risk managers, and
implement standard certification through a risk “driving test.”

4) Improve Regulator Resources

Ensure that regulators are high quality and have deep knowledge of the
industries and institutions they oversee. Regulator compensation should
be competitive with compensation in regulated industries. Industry
should “second” senior people to support the Financial Stability Board
and regulatory bodies. [Too big to fail firms, are required to place senior execs within the regulator.]

Better Governance

Hold systemically important institutions to “higher standards of
governance”. Chief risk officers should report to the board and not the
chief executive
. “Achieve greater transparency”.[Hard to see if any of this is meaningful; in any event, firms should be governing themselves, not adding governance structures to please the state.]

Avoid Regulatory Arbitrage

To make global co-operation feasible and promote a level playing field,
regulations should be of an achievable scope. Financial activities of
similar substance and economic reality should be regulated in the same
way from country to country. [Regulation has been foisted on the industry only because governments have taken control of money supply, and insure deposits. Surely we should be talking abot restoring markets, not beefing up government. Coordination of regulation may spread systemic risk, and make larger^scale gaming possible.]

Overhaul Rating Agencies

Restore investor confidence in rating agencies by eliminating conflicts
of interest between agencies and issuers, returning to an
“investor-pays” model, distinguishing between ratings of corporate debt
and structured financial products, and promoting new entrants to the
credit-rating business. [So rating agencies are further regulated? Why not scale back deposit insurance, and end the “investment grade” requirements that banks only cared about in a check-the-box kind of way? That there is little competition among rating agencies is also due to federal fiat.]

Market Infrastructure

Create a market structure to facilitate orderly unwinding of failed
financial institutions, including greater use of central clearing. [Maybe a development that makes sense on its own, if market participants want such clearing houses. But this will be forced on every Too Big bank, and smaller institutions will likey have to follow suit.]

) Countries Should Follow the Financial Stability Board

G-20 countries should commit to implement in their jurisdictions the
regulatory provisions put to them by the FSB, without significant
amendment or supplementation. [Big Brother replaces national legislatures!]

New-Product Transparency

Improve structural and price transparency of new products, using
modeling and stress testing to ensure that downside scenarios are as
visible as upside scenarios. [Transparency is a concern that should be one left entirely to market participants; governments are simply imposing new requirements on top of those that led to gaming, profits, opacity and market freeze-up. Since when has it become the job of government to help everyone make credit decisions?”]

Regulators Adopt Priorities

Global regulators over the next 18 months should achieve agreement on
the adoption of accounting standards set by the International Financial
Reporting Standards and “appropriate capital and liquidity standards”. [Accounting standards should also be entirely private; they became public as a result of government decisions to regulate stock markets, and the reporting of “public” companies.]

Effective Enforcement

The consequences of bad actions must include real “wallet harm” in
order to be effective, and enforcement must be consistent across
national boundaries. {Big Brother controls the stick everywhere.]

Global Imbalance Focus

The G-20 should focus on resolving global economic imbalances and
integrate that process with discussions on financial stability.

Rebuild Responsibility

Regulation alone is not the cure. The financial-services industry must
show cultural leadership and promote responsible behavior by all
practitioners. [Sure, but by strengthening regulation, market self-discipline is necessarily weakened. Does siimply mouthing the words make the moral hazard of the past decades go away? The KEY problem in fuelling government intervention has been the limited liability – and loosening control – of owners, leading to risk-shifting to the public and greater internal freedom of managers.]

Strengthen Infrastructure

Ensure financial infrastructure is “commensurate with the innovation” it supports, both at the firm and the market level. [Um, isn`t this a concern solely of a firm`s owners? Why is further regulating innovation the job of regulators? Aah, “systemic risk” introduced by deposit insurance and reserve regulation! Why not step back from underlying causes?]

Resist Over-regulation
Because financial innovation is central to growth and critical to a
speedy recovery, the G-20 and successors should recognize that new
rules and protocols should not thwart innovation, and the cost of
regulation must be balanced against the benefits.[Empty words. Who is to resist, and who will have the ability to do so, in the face of a global regulator?]

Regulatory Mandate
Regulators should have a clear and strong mandate for financial
stability, and should cooperate across borders and maintain a level
playing field.

Living Wills
Systemically important banks should present regulators with living
wills demonstrating how they would wind down business in the event of
unsustainable losses. Cross-border arrangements should provide for
burden-sharing in the event of failure. [Window-dressing to reassure taxpayers that Too Big to fail doesn`t mean Too Big to fail, and bailouts.]

Don’t Regulate Borrowers
Regulators should focus on the source of credit, not on borrowers,
using [bank] capital requirements to restrict excessive leverage among
borrowers, including alternative-asset managers. [This means that Big Brother will determine how much lending goes to ther unregulated financial sector!]

Clarify IMF Role

The International Monetary Fund should focus on global imbalances and
defer to the Financial Stability Board on financial-stability
principles while continuing to have surveillance responsibilities. IMF
quotas should be revised to reflect global economic realities. [Division of labor withing Big Brother.]


As I noted previously, Paul Volker seems to have noticed that our financial system has become an enormous drag on the economy, but while he comments that the regulated need to be bolder, and that they haven`t gone far enough in addressing moral hazard, he seems completely oblivious to the role of government in aiding and abetting the moral hazard.

More than a little wrong-headed and disturbing.

That`s it from me for now. Looks like 1984 is coming in 2010.




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