Sent: 03-11-2009 08:09:01
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U.S. congressmen joined with the executive branch in confronting some fundamental questions about systemic risk during hearings in the past week. They favour a radical change in the role played by government in day-to-day business decisions.
Giving evidence before both houses of congress in the past week, Treasury Secretary Timothy Geithner laid out publicly the critical points legislators are looking to embed in new financial services legislation.
The principles enunciated by Geithner on behalf of the administration have been embraced in both versions of the financial services reform legislation currently before the two houses of the Congress.
One part of the Geithner plan is to ensure that failing institutions can fail. He wants an agreed process in place to ensure that shareholders take the brunt of an orderly demise of their companies and that the government is not forced to engineer their survival at the expense of taxpayers.
Most legislators appear committed to this course. The more difficult part of the regulatory rewrite occurs when legislators start looking at how day-to-day regulatory oversight can pre-empt the need for corporate liquidations.
The administration is seeking new powers to impose tougher requirements on companies whose size, leverage or complexity signals that they warrant closer attention. So empowered, the government would be able to dictate unique commercial requirements as a precondition for such companies being able to trade.
This goes against how policy is normally applied in places like the United States, Australia and the UK where the same rules normally apply to all companies. The companies are left to decide themselves how they operate within the generally applicable bounds set by legislation.
Innovating companies tend to push out these bounds in ways governments might not have anticipated. That might require review and modification of legislation occasionally. Once changed, however, the same rules again apply to everyone.
This widely accepted legislative principle is now being gutted. For practical reasons, not many are complaining. For some, there is no alternative for dealing with the systemic risks which emerged in 2008, so scary were their likely consequences. Even more pragmatically, legislators know that electors are in no mood to deal sympathetically with the entreaties of anyone supporting financial institutions.
Despite the pressures, a few legislators are courageously asking how such powers can be constitutionally assumed. In dealing with this point, Geithner seemed hesitant and ill prepared to argue his case. The uncertainty suggests that the Supreme Court could become involved if the government steps in to stop companies exercising their rights to trade on the same terms as everyone else.
Right now, the large financial services companies understand that they are not being cut any slack by electors or their representatives. As memories of 2008 dim, however, and new business opportunities emerge and the appetite for risk becomes progressively greater, companies will become less inclined to comply with government demands.
The congressional leaders appeared to ignore how their deliberations are likely to fit with international regulatory efforts. Almost by definition, any big U.S. financial institution is going to be a big global financial institution and, therefore, subject to multiple regulatory jurisdictions.
Effective national regulation will require uniform international regulation to back it up. Even one or two gaps in the global coverage would be enough to undermine the intent of the tightest new national regulatory regime. Perceived gaps will encourage financial institutions to relocate activities to where the regulatory touch is going to be lightest.
If offshore regulators are not as tough as U.S. regulators, for example, US legislators will eventually have to choose between enforcing their new rules, on the one hand, and allowing their big banks to lose international business opportunities, on the other.
For those countries wishing to rebuild their financial services industries, there will be some incentive to ease up on the regulatory burden to be imposed.
In Australia, some consequential decisions will have to be made. Should Australia, for example, commit to the same capital controls on financial institutions operating here as are being proposed in the USA?
If Australian banks are of a different scale and behaving differently, the argument for duplicating the tough U.S. stance is not a strong one. However, the Australian government is already on record as supporting a global approach to reducing systemic risk in recognition of financial institutions naturally gravitating to where their activities are going to be least constrained.
Whether that place is Australia or somewhere less prominent like Iceland, the result will be similar. The most lax regulatory environment will be the place most likely to benefit from the next asset price bubble and, then, like Iceland suffer most when the party is finally over. Unfortunately, the risk for the rest of the world is that it is likely to be the source of the next financial contagion.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.