Financial Reform: rejoinder to Ferguson and Forstmann

We are honored by the fact that the Wall Street Journal refuses to post this comment on today's article by the ubiquitous Niall Ferguson and Ted Forstmann in which they argue that efficient capital markets, no bail-out of the banking system and the avoidance of a depression are incompatible goals. This is what we had to say to this:

"Wrong, Wrong, Wrong! The three goals CAN be addressed at the same time, it just depends on how you define the words depression economy, bail out and efficient capital markets. All these terms leave plenty of room for discussion (and disagreement). Bail-outs can be done in a phased way for example, first wipe out the shareholders (and management options and restricted stock), then impose haircuts on bondholders and large depositors. Assuming that banks in the future will face tighter regulation (limits on maturity mismatch, higher capital ratios, limits on risks by industry, geography, limits on prop trading, no non-bank investments such as hedge funds or private equity) bail-out costs will be more calculable. With respect to 'efficient' capital markets we give just one aspect where there may be disagreement with respect to an appropriate definition -does an efficient capital market have to include the ability to trade share in nano seconds at the expense of the broader investing public? Reforms are possible that leave us with capital markets that are sufficiently 'efficient' to finance business and industry."

Financial Reform Bills - the case for democratic reform

When financial reform bills are 1273 and 1336 pages long as in the case of bills that have been passed or debated by the US Congress one can only say that this is legislation run amok. I would not expect a single member of congress to pass a simple multiple choice exam about the content of these bills and as a consequence one has to assume that a lot of nonsense is being passed that will hardly improve the situation for investors or taxpayers in the country. What is demonstrated by this perverted legislative process is the need to reign in overbearing and/or incompetent governments and parliamentarians. Anyone interested in how to bring this change should visit www.dirdem.org

Fabrice Tourre: Goldman's sacrificial lamb?

News that Goldman Sachs has withdrawn Fabrice Tourre's registration with the FSA here in London leaves a somewhat sour taste. All too often employees accused of wrong-doing are immediately put on leave as soon as the allegations by this or that regulatory body comes to light. This basically is an at least partial admission of guilt against which the individual has very little redress. It is a truly Kafkaesque situation were large organizations threaten the single person who of course is in a much weaker position than the people behind the bureaucracy. The irony is, that Goldman Sachs prides itself time and again for having a team approach in all it does - so it would be particularly strange that suddenly one single individual can be the only responsible party in such a substantial transaction involving prestigious 'clients'. In Tourre's case, for example, the FSA has no prima facie evidence itself, it just is hanging on the coattails of the SEC. If Goldman Sachs has any reason to suspend Touree is would beggar belief that no one else in the whole food-chain - possibly up to CEO Lloyd Blankfein - has been involved in the transaction(s) that are the subject of the SEC's case against Goldman Sachs (which incidentally is not a case just against Fabrice Tourre).

IMF - full of bureaucrats and tax dodgers

When the IMF bureaucrats call for more taxes on the banking system one can only feel a sense of revulsion. Not enough that politicians think they have to justify their existence by dreaming up a never-ending flood of regulations and spending plans, - but with them we at least have the consolation that they are subject to elections (far too irregularly though). The bureaucrats in the IMF (and similar international organisations, including the EU) face no such threat. They have secure tenure gilded by tax-free salaries. Naturally their instinct is to tax and spend other people's money, the socialist creed that keeps them in their jobs in the first place.

Disclosure no safeguard against deception

The more complicated the securities and investment businesses become, the longer are the legal disclaimers that pepper the front and back of related documents become. No wonder the 'leading' law firms now are located in what only can be described as palatial surroundings. The (mostly) impenetrable legalese is the equivalent of a mugger telling the victim to sign a document that absolves him from risk of persecution. In a sane business environment the law should be simple and not just a starting point for lawyers on their search for loopholes. Regulations should not leave any backdoor and the laws should be included in any transaction by implication. If, for example, a conflict exists between the recommendation to buy a security and the trading position of a broker-dealer it should either be (1) irrelevant or (2) prohibited. So to 'disclose' the conflict is either unnecessary in the first case or should not be an effective way out in case of claims for compensation in the latter case.

What is socially useful work?

Topical opportunity for Adair Turner, Chairman of the FSA here in London to clarify his exacting standards with respect to what is or is not 'socially useful work': is sitting on a sofa and 'reading' the breakfast news socially useful work? This is the question we ask ourselves as the BBC's Adrian Chiles is signed by ITV for a reported £6million.

Glass Steagall is good for you!

We continue to be amazed by the hysteric reaction of bankers to the possible introduction of a separation of business lines along the regulations imposed by the defunct Glass-Steagall Act of 1932 that separated commercial and investment banking for more than sixty years in the USA. Looking at it from another perspective - and not just short term/short sighted business perspectives - was the global success and dominance of the US investment banks not partially due to this enforced separation? Would the enterprise spirit not have been severely dented by keeping the entrepreneurial spirit constrained by the bureaucratic management structures of the commercial banks? A similar argument could be made in case of the City of London where the free-wheeling spirit of the financial community goes back over centuries and is in stark contrast to the top-down models of the continental European banking industry.

Dick Fuld's Ignorance: argument for smaller Banks

When the former CEO of Lehman Brothers argues that he had no knowledge of the bank's use of an accounting gimmick to hide its deteriorating financial situation we may well give him the benefit of the doubt in the absence of a 'smoking gun' proving the opposite. But it also demonstrates that even managing a financial firm such as Lehman Brothers was beyond the capability of one manager. Lehman did not have all the other business units that the typical 'Universal' Bank has under its wings (Credit Card, Consumer loans, Corporate Banking to name a few) and it still was possible that the man in command - and given his length of tenure he had the ability to know the shop inside out - did not get involved in substantial transactions such as the regular Repo 105 transactions which involved billions in balance sheet exposure. The argument that breaking up banks into smaller units would harm the economy holds no water. Why should lending to industry, and in particular to middle-sized and smaller businesses be harmed if a bank can no longer play in - to pick just one example - the structured retail client product market in Germany?

Goldman's CDO Investors - were they stupid?

The CDO product at the center of the SEC's case against Goldman Sachs raises the question: were the 'sophisticated' investors (including ironically the middleman Goldman Sachs) that bought into this transaction stupid or victims (or both)? Leaving the legal and factual arguments for the moment out of the discussion - what was the motivation that caused the fund managers at IKB and ABN Amro to buy securities that were one or two steps removed from any real underlying economic transaction? Speaking from experience I can see them as busy, maybe even diligent people who were working in a set of parameters that prevented them from questioning certain assumptions at the heart of the structured product business: that securitised products contain what the label promises, that companies with a certain public image behave in a way that confirms this image, that all players on the field can be trusted to pursue goals that do not harm the other participants.
Securitisation in particular is critically dependent on trust as the buyers in effect must give a certain amount of leeway to the creator of the product they are purchasing. The whole business idea underlying securitisation is the fact that the buyer does not want to - or is not able to - to buy the underlying assets himself. In effect, he buys a packaged product and can never expect to fully analyse all the assets - would he do so he could as well purchase these assets directly thus disposing of the need for securitisation.

Betting on my neighbours house?

Lynn Stout's point about Goldman Sachs' Abacus Mortgage Derivatives Deal (New York Times) illustrates the need for stricter derivatives regulation:

"...much of the blame for investors’ losses in the Abacus deal can be laid at the feet of an obscure statute passed by Congress in 2000, the “Commodities Futures Modernization Act.”
If we allow the unscrupulous to buy fire insurance on other people’s houses, the incidence of arson would rise sharply. In one dramatic move, that act eliminated a longstanding legal rule that deemed derivatives bets made outside regulated exchanges to be legally enforceable only if one of the parties to the bet was hedging against a pre-existing risk."