The new mantra for a cleaner City: regulation, regulation, regulation
Volatile markets mean reform is on Brown and Darling's summit agenda
This article appeared in the Guardian on Wednesday March 26 2008 on p25 of the Financial section. It was last updated at 17:26 on March 26 2008.
A demand by Britain's financial watchdog today for dozens more regulators to police the City will have been boosted by the speculative - and illegal - bear raid on HBOS shares last week. That attack has added to growing calls since the start of the credit crunch for a beefed-up regulatory regime. (AtW's comment: see chaps, they use my own words...)
Gordon Brown and Nicolas Sarkozy will discuss possible reforms of the financial system at their summit this week, while Paul Volcker, the former chairman of the Federal Reserve, America's central bank, made it clear last week that he favoured a policy of tough love for banks. "We're going to lend to them and protect them, shouldn't they be regulated?" he said.
UK Treasury sources said financial reform will be top of the agenda when finance ministers and central bank governors from the G7 meet in Washington next month. Alistair Darling is looking for greater cross-border cooperation to prevent a recurrence of the recent turbulence. (AtW's comment: meaning cut down on possibility to speculate like this - specifically shorting might not live long enough)
Vince Cable, the Liberal Democrats' Treasury spokesman, agrees there should be a greater role for the G7 and the Organisation for Economic Cooperation and Development, the body that represents 30 rich countries, but says there is a need for more than just greater transparency and accountability.
"There has to be a period of re-regulation. We have highly leveraged institutions such as hedge funds and private equity firms that are essentially pyramid selling and creating a mountain of instability based on debt. That is now unwinding in a dangerous way."
Some critics of Wall Street and the City would like to see the more "toxic" types of financial instruments banned. Others say the key to stability is far tougher control over money and credit creation. At the moment, these are not on the agenda and possible reforms fall into the following categories:
Short selling
Last Wednesday's raid on HBOS, which owns the Halifax and Bank of Scotland, has sparked a debate about short selling, which was last investigated by the FSA following the market volatility after the September 11 terrorist attacks. By lending out shares from their investment portfolios to short sellers who need to sustain their positions, investment companies can earn fees. One market source suggested that by raising the fees they charge, fund management firms could deter traders looking to borrow stock to sustain such positions.
The FSA review, published in 2003, concluded that short selling was a legitimate market practice and yesterday the authority maintained that stance. (AtW's comment: they failed in their duty just like they now admitted to have failed with oversight of Northern Rock) In 2003 it ruled out publishing "short" sales of shares or transactions in the derivatives market. But it did reach an agreement with the settlement system CrestCo for data to be compiled on a monthly basis that might be a proxy for short selling. This data shows the amount of shares which have been "lent" legitimately to investors.
But the debate about whether there is a need for "short" positions to be disclosed to the market in the same way as "long" positions - holdings of shares - has now been rekindled. Investors holding more than 3% of a company's equity are required to tell the stock market.
David Rule, chief executive of the International Securities Lending Association, said: "I can see why people would call for more transparency about large [short] positions. It is up the regulator to decide." He noted that the last review had concluded such a move was unnecessary.
Rule also argued that being able to lend stock is a crucial way for liquidity to be injected into markets at time when the credit crunch is biting into the ability of firms to raise finance.
Capital adequacy
Changes to the capital adequacy rules to affect the ability of banks to lend. Professor Avinash Persaud, chairman of Intelligence Capital, said: "The biggest market failure is that markets can't deal with risk over the economic cycle. They underestimate risk in booms and overestimate it in crashes. The cycle is absent from all regulation."
Persaud has been working with Charles Goodhart, a former member of the Bank of England's monetary policy committee, to come up with counter-cyclical measures to manage risk better. They propose that regulators look at the performance of equities or growth in loans to assess whether capital adequacy requirements should be tightened. He said regulators could do this by changing the capital adequacy levels of banks. The current minimum is 8%; Persaud said this should be doubled or even tripled when regulators fear there is a risk of booms getting out of hand.
Ratings agencies
There has been strong criticism of ratings agencies for providing top ratings for derivatives that later proved to be toxic. Alistair Darling says there should be "improvements in the role and methodology" of agencies but policymakers have yet to decide whether this should come about through tougher regulation or keener competition.
Bonus structure
Writing in the Independent this week, the Nobel prize winning economist Joseph Stiglitz said the system of bankers' compensation contributed to the crisis by encouraging risk-taking.
"In effect, it paid them to gamble. When things turned out well, they walked away with huge bonuses. When things turn out badly - as now - they do not share in the losses. Even if they lose their jobs, they walk away with large sums."
Stiglitz said the solution was not to cap bonuses, but to make sure traders share losses as well as gains - for instance, holding the bonuses in escrow for 10 years.
Accounting standards
Many banking executives have been calling for a review of fair value accounting as a result of the credit crunch. They blame the need to assign market values to highly complex financial instruments for opening up black holes in banks' balance sheets. (AtW's comment: they should not have involved with these derivatives in the first place. It's time to ban this tulip completely)
International accounting standards which were adopted three years ago require banks to mark financial instruments to market. What this means is giving all contracts an up-to-date value that could be realised if the products were sold tomorrow. That is difficult for many complex instruments which are bought and sold between banks and for which it is hard to determine a precise market value.
Structure of banks
The stock market crash of 1929 and the depression that followed led to reform of the US financial system, including the Glass-Steagall Act, which meant that banks could not do both investment and retail business. (AtW's comment: and some people on this forum accused me of being anti-market and such - clearly they did not learn macroeconomics in their Unis, probably getting drunk instead in pubs) Persaud says there is an argument for a modern form of Glass-Steagall which would mean tougher regulation for institutions, such as the high street banks, which have day-to-day contact with the general public, and those, such as hedge funds, that have a small, well-heeled client base.
Banks would resist anything that smacked of Glass-Steagall. But, as Persaud pointed out, in the midst of what former Fed chairman Alan Greenspan has called the most serious financial crisis since the second world war, their bargaining position is not strong.
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Everything developing as I have forseen
Volatile markets mean reform is on Brown and Darling's summit agenda
This article appeared in the Guardian on Wednesday March 26 2008 on p25 of the Financial section. It was last updated at 17:26 on March 26 2008.
A demand by Britain's financial watchdog today for dozens more regulators to police the City will have been boosted by the speculative - and illegal - bear raid on HBOS shares last week. That attack has added to growing calls since the start of the credit crunch for a beefed-up regulatory regime. (AtW's comment: see chaps, they use my own words...)
Gordon Brown and Nicolas Sarkozy will discuss possible reforms of the financial system at their summit this week, while Paul Volcker, the former chairman of the Federal Reserve, America's central bank, made it clear last week that he favoured a policy of tough love for banks. "We're going to lend to them and protect them, shouldn't they be regulated?" he said.
UK Treasury sources said financial reform will be top of the agenda when finance ministers and central bank governors from the G7 meet in Washington next month. Alistair Darling is looking for greater cross-border cooperation to prevent a recurrence of the recent turbulence. (AtW's comment: meaning cut down on possibility to speculate like this - specifically shorting might not live long enough)
Vince Cable, the Liberal Democrats' Treasury spokesman, agrees there should be a greater role for the G7 and the Organisation for Economic Cooperation and Development, the body that represents 30 rich countries, but says there is a need for more than just greater transparency and accountability.
"There has to be a period of re-regulation. We have highly leveraged institutions such as hedge funds and private equity firms that are essentially pyramid selling and creating a mountain of instability based on debt. That is now unwinding in a dangerous way."
Some critics of Wall Street and the City would like to see the more "toxic" types of financial instruments banned. Others say the key to stability is far tougher control over money and credit creation. At the moment, these are not on the agenda and possible reforms fall into the following categories:
Short selling
Last Wednesday's raid on HBOS, which owns the Halifax and Bank of Scotland, has sparked a debate about short selling, which was last investigated by the FSA following the market volatility after the September 11 terrorist attacks. By lending out shares from their investment portfolios to short sellers who need to sustain their positions, investment companies can earn fees. One market source suggested that by raising the fees they charge, fund management firms could deter traders looking to borrow stock to sustain such positions.
The FSA review, published in 2003, concluded that short selling was a legitimate market practice and yesterday the authority maintained that stance. (AtW's comment: they failed in their duty just like they now admitted to have failed with oversight of Northern Rock) In 2003 it ruled out publishing "short" sales of shares or transactions in the derivatives market. But it did reach an agreement with the settlement system CrestCo for data to be compiled on a monthly basis that might be a proxy for short selling. This data shows the amount of shares which have been "lent" legitimately to investors.
But the debate about whether there is a need for "short" positions to be disclosed to the market in the same way as "long" positions - holdings of shares - has now been rekindled. Investors holding more than 3% of a company's equity are required to tell the stock market.
David Rule, chief executive of the International Securities Lending Association, said: "I can see why people would call for more transparency about large [short] positions. It is up the regulator to decide." He noted that the last review had concluded such a move was unnecessary.
Rule also argued that being able to lend stock is a crucial way for liquidity to be injected into markets at time when the credit crunch is biting into the ability of firms to raise finance.
Capital adequacy
Changes to the capital adequacy rules to affect the ability of banks to lend. Professor Avinash Persaud, chairman of Intelligence Capital, said: "The biggest market failure is that markets can't deal with risk over the economic cycle. They underestimate risk in booms and overestimate it in crashes. The cycle is absent from all regulation."
Persaud has been working with Charles Goodhart, a former member of the Bank of England's monetary policy committee, to come up with counter-cyclical measures to manage risk better. They propose that regulators look at the performance of equities or growth in loans to assess whether capital adequacy requirements should be tightened. He said regulators could do this by changing the capital adequacy levels of banks. The current minimum is 8%; Persaud said this should be doubled or even tripled when regulators fear there is a risk of booms getting out of hand.
Ratings agencies
There has been strong criticism of ratings agencies for providing top ratings for derivatives that later proved to be toxic. Alistair Darling says there should be "improvements in the role and methodology" of agencies but policymakers have yet to decide whether this should come about through tougher regulation or keener competition.
Bonus structure
Writing in the Independent this week, the Nobel prize winning economist Joseph Stiglitz said the system of bankers' compensation contributed to the crisis by encouraging risk-taking.
"In effect, it paid them to gamble. When things turned out well, they walked away with huge bonuses. When things turn out badly - as now - they do not share in the losses. Even if they lose their jobs, they walk away with large sums."
Stiglitz said the solution was not to cap bonuses, but to make sure traders share losses as well as gains - for instance, holding the bonuses in escrow for 10 years.
Accounting standards
Many banking executives have been calling for a review of fair value accounting as a result of the credit crunch. They blame the need to assign market values to highly complex financial instruments for opening up black holes in banks' balance sheets. (AtW's comment: they should not have involved with these derivatives in the first place. It's time to ban this tulip completely)
International accounting standards which were adopted three years ago require banks to mark financial instruments to market. What this means is giving all contracts an up-to-date value that could be realised if the products were sold tomorrow. That is difficult for many complex instruments which are bought and sold between banks and for which it is hard to determine a precise market value.
Structure of banks
The stock market crash of 1929 and the depression that followed led to reform of the US financial system, including the Glass-Steagall Act, which meant that banks could not do both investment and retail business. (AtW's comment: and some people on this forum accused me of being anti-market and such - clearly they did not learn macroeconomics in their Unis, probably getting drunk instead in pubs) Persaud says there is an argument for a modern form of Glass-Steagall which would mean tougher regulation for institutions, such as the high street banks, which have day-to-day contact with the general public, and those, such as hedge funds, that have a small, well-heeled client base.
Banks would resist anything that smacked of Glass-Steagall. But, as Persaud pointed out, in the midst of what former Fed chairman Alan Greenspan has called the most serious financial crisis since the second world war, their bargaining position is not strong.
------
Everything developing as I have forseen
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