Monday, October 29, 2012

Germany's Merkel urges more financial regulation when what is needed is transparency

One of the consistent themes since the financial crisis started has been the substitution of complex rules/regulations and supervisory oversight for transparency and market discipline.

Regular readers know that complex rules/regulations and supervisory oversight are favored by the Blob (aka, politicians, financial regulators, Wall Street and its lobbyists).

There are several reason that complex rules/regulations and regulatory oversight are favored by the Blob including:

  • First, it is good for the regulators as it expands the number of individuals who work for them to oversee compliance with the rules/regulations.

  • Second, and more importantly, Wall Street knows that all the loopholes in the complex rules and regulations will be expanded over time so that they are not binding.  Don't take my word for this, Paul Volcker made this point in testimony to the UK parliament.

Complex rules/regulations and supervisory oversight effectively preserve opacity in wide swaths of the financial markets.

For example, look at the complex rules for bank capital known as Basel III.  According to the Bank of England's Andrew Haldane, it takes millions of assumptions to calculate Basel III.  Not only does it take millions of assumptions, but bank capital itself is meaningless as it is an easily manipulated number.

Contrast this with ultra transparency and requiring the banks to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  With this information, market participants could assess the risk of the banks directly.

Which do you think market participants trust, bank Basel III capital adequacy or their own independent risk assessment?

I bring this up because Germany's Chancellor, Angela Merkel, has called for more financial regulation.

The last thing we need is more financial regulation.  What is needed is to bring transparency to all the opaque corners of the financial system.

As reported by Reuters,

German Chancellor Angela Merkel urged the world's top economies to push ahead with further financial regulation, saying that not enough had been achieved so far.
Financial reforms that do not bring transparency in the form of disclosure of disclosure of all the useful, relevant information in an appropriate, timely manner do not achieve anything beyond ensuring opacity endures in the financial system.
The global financial crisis has prompted an overhaul of regulation in almost every part of the financial system from over-the-counter derivatives to bank capital requirements. 
But Merkel said in her weekly podcast that more was needed. 
"In my view, we are not where we ought to be yet," she said. 
"We had planned to regulate every financial centre, every financial actor and every financial market product. Significant progress has been made but the rules have not yet been implemented everywhere and we are still missing further areas."
What a singularly bad plan.  The plan should have been to bring transparency to every financial centre, every financial actor that the government implicitly or explicitly offers a guarantee to and every financial market product.
The chancellor pointed to "shadow banks", or non-bank financial institutions that are less regulated than banks, as an area where progress needed to be made. 
"For instance the regulation of shadow banks will hopefully be concluded at the next G20 meeting," Merkel said.
This should have been done already because all it takes is to require that structured finance securities provide observable event based reporting and that banks provide ultra transparency.
Leaders of the world's top economies (G20) made recommendations for regulation a year ago that also include hedge funds, special investment vehicles and repurchase agreements. 
Regulators worry that as traditional banks get more heavily regulated, risky credit activities will shift to shadow banks.
When it comes to regulation, as the Bank of England's Andrew Haldane has shown, less is more.

Specifically, banks should be required to provide ultra transparency and disclosing on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  This disclosure solves a host of problems ranging from inability of market participants to assess the risk of the banks to stopping proprietary trading to preventing manipulation of Libor.
Merkel meets with the heads of the International Monetary Fund, World Bank, International Labour Organisation, the World Trade Organisation and the Organisation for Economic Cooperation and Development in Berlin on Tuesday.

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