Tuesday, June 30, 2009

New York Times Online ("DealBook" section) just published my proposal for a global approach to systemic financial risk

Please go to: http://dealbook.blogs.nytimes.com/2009/06/30/another-view-a-global-approach-to-financial-risk/

The first piece published by them last thursday pm is: http://dealbook.blogs.nytimes.com/2009/06/25/another-view-flaws-in-the-obama-oversight-plan

IF you are interested in reading any of the pieces, do comment on them at the NYT site - I will be keen to see your comments. Sphere: Related Content

Sunday, June 28, 2009

Good and bad news for the banking sector

Returns on equity in the banking sector reached a peak of 20 percent in 2007, though they averaged "only" 15 percent for the cycle up to the start of the crisis.

If the proposed new regulations come on stream in the US and Europe, I expect - here's the bad news! - returns on equity in this sector to come down to 8% or less. But the good news is that the returns will much more stable, the cycle smoothed. And the sector will continue to offer good returns when compared to other sectors. That is why bank equities will continue to be an essential part of any portfolio. Sphere: Related Content

Thursday, June 25, 2009

My evaluation of the Obama proposals for financial regulation, stability and propserity

My evaluation of the Obama proposals for financial regulation, stability and propserity have just been posted at New York Times Online in the DealBook section: http://dealbook.blogs.nytimes.com/2009/06/25/another-view-flaws-in-the-obama-oversight-plan

A second piece, arguing that a fundamentally different Council of Regulators is needed, may be published also in the same DealBook section, shortly. Sphere: Related Content

The emerging US system vs. the European system of financial services regulation

The Obama administration's proposals for financial system regulation have many important similarities and differences from the new European system.

For my comments on the US system as a whole, see my article(s) which should be published soon on the New York Times website.

The US system will have a purely advisory Council composed of all the Regulators, but the real power will lie with the Treasury and the Fed. By contrast, the European Systematic Risk Council (ESRC) will have as members all the EU central bank governors (chaired by the ECB president); all Treasury Departments and all regulators, even the powerful Financial Services Authority of the UK, will be left out in the cold.

Under the proposals, the US will receive a systemic risk assessment only once an year. The European Council is also to issue financial stability risk warnings, though their frequency is something I have not been to establish yet - the impression given is that warnings will be issued as when those are felt to be necessary; if so, this is a weakness in the system: it would be better to have the Council required to issue an assessment at regular and frequent intervals (weekly? monthly?), though they should have the additional power to issue a warning in the middle of the regular periodicity, if they feel it necessary.

In contrast to the U.S., however, EU central bankers will not oversee and regulate systemic cross-border institutions directly. This is another notable lacuna in the European system, as the ECB vice president Lorenzo Bini Smaghi noted in a speech he gave on June 19.

However, the European Council will provide macro-prudential recommendations for action to supervisors, as well as monitor their implementation. The US Council of Regulators, by contrast, will be merely a talking shop.

It is interesting that the US as well as Europe are privileging their Central Banks in the new system, even though it is clear that those Central Banks were complicit in the events that caused the crisis.

My own view of what should be done regarding systemic risk is different from both the European and the US view - and will be published soon, I hope, on the New York Times site. Sphere: Related Content

If things are this bad in the UK, imagine how bad they must be in the USA

The governor of the Bank of England, in a statement before the UK House of Commons Treasury Committee, agreed that the current balance of powers and responsibilities is “a mess”. He maintains that the Bank’s powers are not as great as its responsibilities to maintain financial stability: “parliament must be clear that the Bank of England can only publish reports and make speeches.”

He made these statements in the context of the discussion regarding whether or not proper consultation is taking place between the Bank, the Treasury and the Financial Services Authority.

John McFall, the committee chairman, called the lack of communication at the top level between the Bank, Treasury and Financial Services Authority an unbelievable “communications black hole.”

If this is the situation in the UK, which has a single regulator for all the financial services, you can imagine what the situation is in the US with its multiplicity of overlapping state and federal regulators, which nevertheless leaves actual regulatory black holes through which the black horses of the economic crisis charged several months ago.

The only positive thing that can be noted is that the UK is also in a political mess with hardly any leadership at present, while the US has clear political leadership even if it appears that the leadership is not being exercised in the matter of how best to organise regulation and stabilisation of financial services. Sphere: Related Content

Tuesday, June 23, 2009

Newly-elected Indian administration less open than China?

I have only just seen the following news release.

As USCIRF has been welcomed to countries such as China and Saudi Arabia, and as we are much more open than both countries, the refusal of a visa to USCIRF is puzzling and entriely incredible.

We have a free press - and everything, whether good, bad or ugly, is out in the open! So what does the government think will be achieved by denying USCIRF the visas?

6/17/09: India: USCIRF Regrets Absence of Visas for Visit to India

June 17, 2009

WASHINGTON, D.C. – The U.S. Commission on International Religious Freedom (USCIRF) regrets that visas have not been issued by the Indian government for a USCIRF visit to discuss religious freedom conditions with officials, religious leaders, civil society activists and others in the world’s largest democracy.

As a U.S. government body, visits by the Commission must have official status. USCIRF obtained U.S. State Department support, made travel arrangements, and requested meetings with a variety of officials. Despite this, the Indian government did not issue the USCIRF delegation visas. The Commissioners were to have left the United States on June 12.

The aim of the long-requested trip was to discuss religious freedom conditions in India, home to a multitude of religious communities that have historically co-existed. India has experienced an increase in communal violence against religious communities in recent years and the USCIRF Commissioners sought to discuss the Indian government’s responses to this, and its development of preventive strategies at the local and national levels. According to information before USCIRF, the Indian justice system has prosecuted only a handful of persons responsible for communal violence and related abuses since the mid 1980s.

In 2002, USCIRF recommended India be designated a “Country of Particular Concern” (CPC) following events in Gujarat that resulted in an estimated 2,000 deaths. Although India was removed from the CPC list in 2005, USCIRF has continued to monitor, report, and comment publicly on events in the country, including last year’s violence in Orissa, attacks in Mumbai, and other events.

The Indian government did not offer alternative dates for a visit. USCIRF first tried to obtain visas for India in 2001. This would have been the Commission’s first visit to India. India joins Cuba as the only other nation to have refused all USCIRF requests to visit.

“We are particularly disappointed by the new Indian government’s refusal to facilitate an official U.S. delegation to discuss religious freedom issues and government measures to counter communal violence, which has a religious component,” said Commission chair Felice D. Gaer. “Our Commission has visited China, Russia, Saudi Arabia, and over 20 other countries. India, a close ally of the United States, has been unique among democracies in delaying and denying USCIRF’s ability to visit. USCIRF has been requesting visits since 2001.”

USCIRF issues its annual report on religious freedom each May and this year’s India section was delayed because of the planned USCIRF trip. “We wanted to hear from all sectors of Indian society, and allow these diverse perspectives to shape our report,” said Gaer. In the absence of in-country travel, USCIRF will release a report on India later this summer.

USCIRF is an independent, bipartisan U.S. federal government commission. USCIRF Commissioners are appointed by the President and the leadership of both political parties in the Senate and the House of Representatives. USCIRF’s principal responsibilities are to review the facts and circumstances of violations of religious freedom internationally and to make policy recommendations to the President, the Secretary of State and Congress.

To interview a USCIRF Commissioner, contact Tom Carter, Communications Director: tcarter at uscirf.gov Sphere: Related Content

Friday, June 12, 2009

What are inspectors for? Apparently, not for inspections!

Well, perhaps that's unfair. But decide for yourself after watching the following interaction regarding the Federal Reserve, apparently on May 5 this year, between the Fed's Inspector General, Elizabeth A. Coleman, and Congressman Alan Grayson, in a Financial Services Committee question and answer session.

Grayson, who is a Democrat, asks Coleman to which individuals, organisations, companies or institutions the trillions of dollars lent or spent by the Federal Reserve have gone. He also asks about the further trillions of off balance sheet obligations entered into by the Fed. The answers are remarkable:

http://dailybail.com/home/there-are-no-words-to-describe-the-following-part-ii.html Sphere: Related Content

Geithner's impending new (revised) proposals

Treasury Secretary Geithner's new proposals are apparently due to be released next week, first for a Council of Regulators, and then for dealing with toxic assets.


ADVANTAGE: Geithner desire to create a Council of Regulators implicitly acknowledges officially that the Fed failed in performing its responsibilities, and therefore needs oversight.

A. The proposed Council body will consist of all the regulators put together. That is, they are supposed to watch each other!
It would be much better to create a genuinely independent body, as I have already proposed in this Blog among other places.
B. The Securities and Exchange Commission (SEC) and the Commodities and Futures Trading Commission (CFTC) do NOT merge; all the existing vested interests are happy; the multiplicity of regulation and regulatory bodies - and regulatory confusion - continues. In fact, regulatory confusion increases with another new body that is proposed, to to regulate consumer products, such as mortgages and credit cards
This is an extremely elegant way of doing no reform at all! Heads of the different regulatory bodies will now form a jolly new club in which they can keep an eye on the others and jointly neutralise anyone else in the Council who actually attempts to do anything.


I admire Geithner's continuing efforts to try and have OTC derivatives registered, with disclosure requirements imposed on exotic contracts; however, as far as I can see, the idea still seems to be that there will be only one exchange, regulated by the CFTC. I do not see the logic of having only one exchange, when we know that all monopolies lead to inefficiency, over-expensiveness and lack of service. At least seven or more exchanges, worldwide, please! And there's no reason why these complex instruments should be registered only in the USA! There's room here for international co-operation so as to grow a genuinely global marketplace! The rules and the framework should be global. Individual exchanges should be able to then compete with each other on a level playing field, freely. Sphere: Related Content

Tuesday, June 09, 2009

How safe is Europe for democracy?

The most important (and sad) news from the European elections is that the EU continues to raise less and less interest inside Europe.

The percentage of eligible voters who bother to exercise their democratic right has continued to fall, even from the poor show in the first direct democratic elections to the European Parliament (1979).

The last election in 2004 saw a turnout of only 45.5 percent. In this year's elections merely 43.4 percent could be bothered to vote.

My non-startling conclusion: Europe has a decreasing minority committed to the responsibilities entailed by democracy.

Is it therefore worrying that the result of the election is the increased prominence of parties on the far-right and centre-right?: Remarkably, the more or less far-right grouping called the Union for Europe of the Nations (UEN), which includes parties such as Italy's Northern League, more than doubled its seats, from 16 to 35 - though the centre-right European People's Party (EPP) is still the largest grouping in the European Parliament, with 267 of the assembly's 736 seats (that's just over a third of the total, according to the last results available to me at the moment of writing).

Worryingly for the EPP, Britain's Conservatives, Czechoslovakia's Civic Democratic Party (ODS) and Poland's Law and Justice Party (PIS) plan to leave the EPP to establish a new euro-sceptic group. What that will mean in terms of actual political positions remains to be seen, given that the number of seats for the (also euro-sceptic) Independence and Democracy (Independent/Democratic) group went down from 24 to 18.

Meanwhile, the other surprise was the Greens who won 11 seats on top of the 43 they already had, to bring their total up to 54.

The biggest losers in the elections are the centre-left Party of European Socialists (PES), who succeeded in gaining just 159 seats – 56 fewer than in the 2004 election. The other left-wing ("Left") parliamentary group lost 7 seats to be "left" with 34 members. The Alliance of Liberals and Democrats for Europe (ALDE) also saw their seats decline from 102 to 81.

So what is my answer to the question I raise in the title of this post: "How safe is Europe for democracy?"

Well, my answer is that, insofar as the rightward swing is going to be neutralised, it will not necessarily be neutralised by the euro-sceptics, but rather by the range of positions represented. As long as there is no clearly dominant party, democracy in Europe is safe. For the moment. The question is: how long will this moment last?

The centre-right is being given a chance to shape the solutions to the economic woes of the EU and of the world. If that chance is fluffed, what comes after the centre-right? I doubt if the answer will be the centre-left. Sphere: Related Content

Monday, June 08, 2009

Another response to my review of the book by Dr Brammertz

I have received a range of responses to my review.
Here is another:

"Hello Prabhu,

I admire and support much of what you say EXCEPT the thought that the Chairmen, CEO’s, etc. had “an insufficient idea of what is on their own accounts.” ALL of them knew exactly the risks that were being taken, the effect on their balance sheets, etc. To say otherwise is ridiculous as they all saw the bonuses that were being paid for the risks that were being taken…. And loved the appreciation in the value of their stocks.

The concept of greater regulation is admirable, but every system man has created, men have found a way around. I remain unconvinced that more regulation is a good idea, vis-à-vis improved scrutiny/review of what is being done under existing regulations (e.g., Madoff). Too much government, in my opinion, is still a bad idea and it is naïve to believe that it will help CEO’s, regulators, etc. Recent history would suggest that under existing regulations UNTIL the excess is unmistakable. I cannot imagine a government run GM surviving…look at our Defense Department, NASA or Homeland Security….!!

I understand the desire for transparency, but once again, at what cost, especially if it will require publication and distribution to shareholders, SEC, etc.??? I seriously doubt that the mound of material which is published and distributed, at very significant cost, to shareholders under existing SEC, NYSE, etc. regulations are looked at by 2% and read by 1/100 of 1% of the recipients. I am told that those clients to whom Madoff sent confirms would have recognized the fraud by reading what he sent them…including many of his “feeder funds.” Perhaps, the best answer is to require distribution to anyone who requests and pays a nominal fee. Then, those that want and believe they will understand it can get it.

“A Retired CFO in the USA” Sphere: Related Content

Was it Government failure that caused the crisis?

Fourteen economists connected with the right-wing think tank called the Institute of Economic Affairs in London published, in the Daily Telegraph, one of the largest-cirulation UK newspapers, an advertisement on the 12th of May this year.

This asserted that it was not a failure of markets, but rather a failure of government, that caused the crisis.

I did not comment on the matter then because I thought I had already covered the question of the origins of the crisis sufficiently.

However, as someone I respect asks me to comment directly on the advertisement and the study to which it refers ("Verdict on the Crash", available at: http://www.iea.org.uk/files/upld-pressArticle396pdf?.pdf), here goes.

Do let us note is that the fourteen are eminent economists from across the developed world:
- Dr James Alexander, Head of Equity Research, M&G
- Prof Michael Beenstock, Professor of Economics, Hebrew University of Jerusalem
- Prof Philip Booth, Professor of Insurance & Risk Management, Cass Business School
- Dr Eamonn Butler, Director, Adam Smith Institute
- Prof Tim Congdon, Founder, Lombard Street Research
- Prof Laurence Copeland, Professor of Finance, Cardiff Business School
- Prof Kevin Dowd, Professor of Financial Risk Management, Nottingham University Business School
- Dr John Greenwood, Chief Economist, Invesco
- Dr Samuel Gregg, Research Director, Acton Institute
- Prof John Kay, St John’s College, Oxford
- Prof David Llewellyn, Professor of Money and Banking, Loughborough University
- Prof Alan Morrison, Professor of Finance, University of Oxford
- Prof D R Myddelton, Emeritus Professor of Finance and Accounting, Cranfield University, and
- Prof Geoffrey Wood, Professor of Economics, Cass Business School.

They summarise their findings in more or less the following words (with my comments in brackets immediately after)

● Central banks created a monetary bubble that fed an asset price boom and distorted the pricing of risk (the 14 do not ask, and therefore do not answer, what caused central banks to "create" such a bubble)

● US government policy encouraged high-risk lending through support for Fannie Mae and Freddie Mac and through the Community Reinvestment Act and related regulations (clearly, the 14 think that the government should have no such acts and regulations – and that is certainly one point of view, but it is a point of view that is politically untenable – economists sometimes live in a rarefied world divorced from real life)

● Regulators and central bankers failed to use their considerable powers to stop risks building up in the financial system and an extension of regulation will not make a future crash less likely (again, the 14 fail to ask WHY regulators and central bankers did not use the powers they had and indeed abandoned the duties and responsibilities they had, and why those whose job it was to keep an eye on regulators and central banks failed to notice this and failed to call them to account)

● Much existing banking regulation exacerbated the crisis and reduced the effectiveness of market monitoring of banks. The FSA, in the UK, has failed in its statutory duty to "maintain market confidence" (so we need better regulation, not the absence of regulation)

● Tax and regulatory systems encourage complex and opaque methods of increasing gearing in the financial system (so the 14 do agree that tax and regulatory systems should discourage such methods and such gearing/ leveraging?)

● Financial institutions that have made mistakes have lost the majority of their value; on the other hand, regulators are being rewarded for failure by an extension of their size and powers (the first is a moot point, the second is valid – and I agree with them that this is neither proper nor just)
● Evidence suggests that serious systemic problems have not arisen amongst unregulated institutions (well, if unregulated institutions were simply enabling regulated institutions to play, much as a pimp does in the case of a prostitute, it is not the pimp who gets infected with HIV but the customer).

The conclusion of the 14 is that "no significant changes are needed to the regulatory environment surrounding hedge funds, short-selling, offshore banks, private equity or tax havens".

This is breathtakingly bold, but only what you would expect from a right-wing think tank.

They claim that what is needed, instead, is a "revolution in financial regulation", and the consider that the following sorts of things constitute that "revolution" (again, my comments are in brackets):

● Making bank depositors prior creditors (I agree). This will provide better incentives for prudent behaviour and make a call on deposit insurance funds less likely (I doubt that this would always be the result, but let that pass).

● Provisions to ensure an orderly winding up, recapitalisation or sale of systemic financial institutions in difficulty. Banks must be allowed to fail. (In theory, they are already "allowed to fail". In practice, governments have not felt able to let them fail. Where economics clashes with politics, remember, politics will usually win).

● Enhancing market disclosure by ensuring that banks report relevant information to shareholders (that IS a matter of making the regulation tighter or more efficient or more effective – choose your own language)

● Central banks should make "proper use" of lender-of-last-resort facilities to deal with illiquid banks (isn't this precisely what has been done?)

● Central banks should monitor he growth of broad money together with the build-up of wider inflationary risks (they probably do this already; even where they do not, it was not the absence of the information that was the problem, it was a systematic and consistent avoidance of attention to the information that was shouting for their attention).

In brief, IEA is a free market think tank – and of course therefore still thinks in old categories of market versus government, with a commitment to trying to roll back the government.

Actually, I have huge sympathy with this point of view in discussing NATIONAL economies (most governments around the world are, if not made up of rogues, thieves and murderers, at the very least more interested in lining their own pockets than they are in doing anything substantial for their countries).

However, as far as I can see framing the GLOBAL discussion in terms of "free markets" versus "non-free markets" is fundamentally misconceived:
1. There is in reality no such thing as a "pure free market"; moreover, there cannot be such a thing as a "pure free market" because that would be a free for all, which would soon establish the might of some dominant mafia or clique.
2. What we have are markets with less or more government intervention, and the question is: what is the right kind and level of government intervention for what stage of economic development or what phase of the economic cycle or degree of integration in the global economy?
3. There is huge confusion because of the terms used in the debate, such as "government". There are 3 branches of "government" that are relevant to the discussion: the executive wing (that actually implements rules, regulations, procedures, and so on), the legislature (which makes the rules) and the judiciary (which is there to decide whether the rules are being kept – and, to a certain extent, whether the rules are right).
4. When we talk of "government intervention", we usually refer to the executive branch of the government.
5. Regarding the level of "executive government"INTERVENTION, I don't think there is much left to debate: in general, there is agreement that, after a certain level of minimum development has been reached by a country, the less "executive government" INTERVENTION there is, the better
6. However, the level of "executive government" INTERVENTION is an entirely different question from the following, which is the key question: what are the right rules for a global free market to operate in a way that is just and responsible? That is a matter for the legislature and for the judiciary.
7. It is the legislature and the judiciary that have the job of creating the playing field within which business should pursue success, as well as the rules (good governance, transparency and accountability) by which the game is played. If countries have level playing fields with the right rules, they enable society (investors, managers, workers, suppliers and the public) to be confident that business (and every other area of national life) are being run in a trustworthy way. THAT is what makes for long-term success, not "free markets", not executive over-activity (which results in bribery and nepotism), and not even legislative and judicial over-activity (which can result, as in Russia, in the abuse of these to dispossess investors). So you can certainly have too much government, just as you can have too much "market freedom". What is critical, however, is "a space for business in which the rules are clearly defined, in which society nurtures virtue, with resulting responsible behaviour in relation to shareholders and other stakeholders in businesses, as well as in relation to the environment". At present, as the current crisis shows, we have neither society able to nurture virtue, nor governments laying down or implementing appropriate rules, nor business executives behaving with due consideration for anything beyond their own pockets (for that matter, we don't have consumers behaving with responsibility either).

In other words, we have a society-wide malaise, and neither legislative fiat nor "free markets" are going to sort cure that. What would cure that would be a spiritual and ethical resurgence which results in the transformation of markets as well as the transformation of politics and and the transformation of government. Sphere: Related Content

Friday, June 05, 2009

Interesting response to my review of the Brammertz book on Finance

Dear Prabhu,

Thanks for the summary.

I sense a similar analysis to my own.

Due to lack of financial control several UK banks and the UK Treasury recently ran out of money.

The management language of control is - cash flow - gearing - solvency - lending risk etc.

The government borrowed and printed money to fill up the financial fuel tanks to get things going again.

The economists language is - business models - quantitative easing - pricing of risk etc.

The economists language is not much use if you are sitting behind the Finance Director's What he needs is reporting for control.

Unfortunately regulators in the UK have been drawn from the ranks of academic economists. They have no experience of financial reporting and control.

Why is it that FDs and auditors have not been called to account in the banking crisis?

Lastly CEOs are too often flown in from outside with no knowledge of the company concerned. And they never find out eg Lloyds and HBOS.

Very best

John Pickering Sphere: Related Content

Thursday, June 04, 2009

China still does not play by global rules to which it has signed up

see the following story, for evidence regarding collusion between Chinese business and government: http://www.reuters.com/article/GCA-GreenBusiness/idUSTRE5532PS20090604

and, 20 years after Tienanmen Square, China's records on human rights is one of the worst for any of the countries that claim to be world leaders in any sense. The behaviour of the Chinese government was horrific, but it was entirely predictable for a Confucian/ Communist country.

It is difficult to see why China should be kept inside the WTO, the UN and other bodies.

The U.S. idea that you can befriend systems into changing seems naive.

Yes, systems need to be befriended if they are to change, but there are terms and conditions to every friendship. And if the conditions are violated, then friendship becomes impossible.

Anyone who wants to remain a "friend" but without accepting the responsibilities involved in being a friend, is not a friend but an exploiter.

So what's new, some people will say.

When you know the DNA, you know the behaviour that can be expected. True, but people have to be given a chance.

The problem is that if people don't take the chance, then they have to be shown the door. And few in the West seems to have the gumption to do that.

I do hope that China will change. But I don't see it changing at present. Sphere: Related Content