Hedge fund Elliott Management founder and CEO Paul Singer in today's WSJ, in part:
Reform must begin with a regulatory regime focused on "behavior"
instead of "systemically important institutions." Today, even small
entities that trade complex instruments or are granted sufficient
leverage can threaten the global financial system.
It's true that monetary policy was too lax for too long, and the
government encouraged lending to people who were unlikely to repay
their loans. But this crisis was primarily caused by managements and
individuals throughout the financial system who exercised extremely
poor judgment. The private sector, not the public sector, is where the
biggest mistakes were made.
In the past decade, most global financial institutions built highly
leveraged balance sheets -- sometimes as high as 30 to 1 -- that were
stuffed with risky assets. These institutions also bought on a large
scale for their own accounts the same securities they sold to their
customers. Our anachronistic regulatory framework didn't catch the
problems, and warped incentives and compensation schemes fueled the
risk-control failures that eventually brought on the crisis we face
today.
Now we must create a new regulatory infrastructure that will meet
three fundamental tests. First, it must assess and measure risks
accurately, including the compounded risks of herding (traders being
similarly situated and forced to unwind simultaneously). Second, it
must impose significant margin requirements on all exposures. And
finally, it must bring all investors and traders -- regardless of
whether the risk holder is a hedge fund, bank, private equity fund,
individual or government agency -- under the regulatory umbrella. These
three measures will diminish volatility and reduce the likelihood of a
future financial collapse.
Creating a regulatory system that reflects the
modern-day realities of financial markets is not as difficult as it may
appear. The financial structures that destabilized our markets have
definable characteristics. [...]
It is critical that any new regulatory
initiative have a global mandate and contain mechanisms to prevent
“risk infection” by countries that try to dodge risk controls. There
are legitimate concerns about the time needed to devise a global
risk-management system and staff it with individuals with the requisite
sophistication and experience. But there are relatively simple
solutions.
RTWT.
The premise that we need "some" regulation ignores the mountain that exists. I think Singer is far off the mark, as I detail with the following...
There is one huge problem with Mr. Singer's prescription: a
global mandate. This puts us all in the same boat--we sink or swim together, so
to speak. And it is based upon a faulty assumption: this time "we"
get it right. Under Mr. Singer's construct, the problem is simple
("Creating a regulatory system that reflects the modern-day realities of
financial markets is not as difficult as it may appear."), therefore, the
solution is simple.
Hindsight is always 20/20. After the fact, the problem was
never "as difficult as it may appear." We're geniuses now, though
apparently we were imbeciles before the collapse.
This is hubris.
The factors cited as contributors (or as answers) to the
financial collapse: leverage, margin, risk, and concentration, were already
regulated and under the purview of the SEC, the Fed, other bank, state, market,
or other regulators.
Capital controls, margin requirements, internal risk control
systems, disclosure (transparency) requirements, audit standards, compliance
regulations, performance (market) expectations, access to capital (public and
private) markets, are mere details that make up the foundation of the financial
system. Simple, this is not. And this foundational/regulatory complexity spawns
so-called loopholes, much like our legal and tax system--if it is not
explicitly forbidden, then it is allowed (and perhaps, required).
Humans make mistakes, and last I checked, regulators are
human too. This characteristic will not be overturned, by legislation or
regulation.
Our rules-based system attempts to remove human judgment,
and therefore ill-judged (usually, after-the-fact) mistakes, from of the
workings of the financial system. Moral and ethical judgment regarding right
and wrong are proscribed--supplanted by this rules-based system of do's and
don'ts.
And still, it was a fundamental judgment--an
assumption--that led to this calamity. And that assumption was home prices
would inexorably continue to rise--and in this rise was a cushion of safety
upon which our foundation would rest.
While pointing fingers can be politically satisfying, I
think the record is pretty clear--mistakes were made regarding the constancy of
rise in home prices, and all our institutions--legislative, executive,
regulatory, and financial markets--contributed.
While no one factor triggered the meltdown, the totality of
the commitment (and reinforcing feedback loops) to this assumption is pretty
impressive: the CRA; "affordability" mortgages; low (negative real)
interest rates from the Fed; Fannie Mae and Freddie Mac morphing into trillion
dollar, hedge fund-like institutions with, essentially, one-way bets on
interest rates and home prices; rating agencies rating securities lacking
transparency (CDOs, CDO-squared, et al.); over-the-counter derivatives, e.g.
CDSs, with its inherent counter-party risk, rather than exchange-traded that
reduces such risk; bank capital requirements advantaging AAA mortgage
securities; risk models based on Gaussian "normal" distribution when
financial market disruption is anything but normal; tax treatment of mortgage
interest and home re-sale capital gains; and on and on and on. While lengthy,
the list is not exhaustive of the contributors.
Markets are messy. They require rules and procedures. There is no
way around this fact-of-life. Tackle each of the issues and factors
individually in the appropriate venue. It will require hard work and
effort from many quarters. There is no omniscient (or centralized) body
that can “know” how to get each of these issues right.
I am not suggesting we throw our hands up in frustration and
futility because it will be difficult, but unlike Mr. Singer, I do not
see a silver-bullet answer–-passing the responsibility off onto another
layer of regulation and regulators, be it a global framework,
foundation, umbrella, or mandate, and hope they get it right.
Besides, hope is not a plan, it is a prayer.
