Where Is the Leadership?
June 23, 2008
Nearly a year after turmoil hit the global financial markets, and three months since the Federal Reserve and Treasury Department stepped in to prevent the failure of Bear Stearns, is there any comprehensive effort by the financial services industry to explain what went wrong and what needs to be done to prevent a recurrence?
"The importance of the finance sector to the global economy has swollen along with the bonuses it awards itself," Bloomberg columnist Mark Gilbert wrote recently. "Standards of behavior, however, have failed to mature at anything like the same pace. And so far nobody in banking has apologized for the chaos caused by lax lending standards and monumental hubris." He added, "The backlash is gathering force. Every day brings fresh threats of increased oversight and tighter rules from blindsided regulators and angry lawmakers."
Writing in the Guardian, Nobel Prize-winning economist Joseph Stiglitz noted that "the U.S. has more than just a trade and fiscal deficit; it has a leadership deficit. The result is likely to be a downturn longer and deeper than need be. And the whole world will suffer."
When Timothy Geithner, president of the Federal Reserve Bank of New York, addressed regulatory reforms in a speech to the Economic Club of New York earlier this month, he cited only one person in the industry as helping "to share a set of recommendations to help us get the balance right." That was E. Gerald Corrigan, managing director at Goldman Sachs, former president of the New York Fed and an active participant in industry initiatives.
Geithner said that "the severity and complexity of this crisis makes a compelling case for a comprehensive reassessment of how to use regulation to strike an appropriate balance between efficiency and stability." That will mean broader supervision of market practices and market infrastructures with an eye on potential systemic risk.
"After we get through this crisis and the process of stabilization and financial repair is complete," added Geithner, "we will put in place more exacting expectations on capital, liquidity and risk management for the largest institutions that play a central role in intermediation and market functioning." He expects that firms will be required to hold more capital as a cushion against shocks. As several industry experts have observed, a regulatory reduction in leverage would likely lead to lower profitability in investment banking.
The Economist recently noted that investment banks have had great success in killing off proposed rules or circumventing them once enacted, "but regulators and politicians seem to be in no mood, for the moment at least, to let that happen this time." The magazine suggested that pressure is growing for heavier regulation of the credit default swaps market and for more trading to move to exchanges, which would eat into brokers' margins.
Assorted Interest Groups
P.J. Di Giammarino, managing director of JWG-IT, a London-based think tank that provides banks with guidance on new European regulations such as the Markets in Financial Markets Directive (MiFID), said that waiting for the industry to develop a consensus promises to be an exercise in frustration. "The industry is an amorphous construct that doesn't really exist," he explained. "What you have is a lot of interest groups that have looked to create loopholes and do regulatory arbitrage. They have no history of playing together to the depth required." There have been rare exceptions, such as cooperation on anti-money laundering, he added.
