THE PUBLIC HAS NOT UNDERSTAND "DE RIEN' AND SHOULDN'T BE LIKE THAT

Facts and the Financial Crisis

The Financial Crisis Inquiry Commission, created by Congress to examine the causes of the crisis, held its first public meeting last week. In his opening remarks, the chairman, Phil Angelides, a former California state treasurer, likened the group’s potential impact to that of the Pecora hearings in the 1930s, which examined the stock market crash of 1929 and led to transformational changes in banking, investing and financial regulation.

And yet, last week’s meeting was oddly inauspicious, feeding doubts about the commission’s ability to realize that potential.

For starters, the meeting was a long time coming, and thin on substance. It has been four months since Congress passed a law authorizing the commission and two months since lawmakers selected its 10 commissioners — six chosen by the Democratic leadership and four by the Republican leadership.

Just days before the meeting, Mr. Angelides announced the hiring of the commission’s executive director, Thomas Greene, a chief assistant attorney general in California. Mr. Greene has performed ably in various cases, including those involving antitrust issues against Microsoft and civil prosecutions of Enron. But he will need to hire tough Wall Street experts to assist him. He may also find himself hobbled by restraints on his subpoena power, because the commission rules, written by Congress, require that Democrats and Republicans on the commission agree before subpoenas can be issued.

The meeting itself was mainly prepared statements from commission members, describing the group’s mission and expressing their commitment to a full investigation. In their more enlightening moments, some of the commissioners previewed specific concerns to pursue — like the role in the crisis of derivatives, of Fannie Mae and other too-big-to-fail institutions, and of the Federal Reserve and other regulators.

But the real work — gathering documents and taking testimony from financial executives and government officials — will not start before November. Public hearings are not expected until December. A final report is due to Congress on Dec. 15, 2010.

Is that slow start an early sign of drift? Does it reflect the apparent ambivalence of lawmakers to rein in the banks?

To dispel such questions, the commission will have to start now to mount a rigorous inquiry that explains both the underlying and immediate causes of the crisis. Stretching back decades, which beliefs and policies — especially deregulatory efforts — allowed for the tremendous growth of finance as a share of the economy, and for the increasing reliance on debt as the engine of economic growth?

Providing historical context will be easy compared with investigating more recent events, because near-term events involve people still in power. In the run-up to the crisis, what did regulators, particularly the Federal Reserve, know and do in response to unconstrained lending? What were their thoughts about the way banks and investors worldwide increasingly disregarded risk?

Publicly, they did not act to curb the excesses. But internally, was there contrary analysis or dissent? Were there chances to take another course that we may learn from now in hindsight?

Answers to these questions are in files that are not public and in the heads of the people in positions of responsibility at the time. The commission must be aggressive in its pursuit of documents and unflinching in taking testimony at even the highest levels of government and business.

The commission must also trace the facts and circumstances that connect the implosions of Bear Stearns, Fannie Mae, Lehman Brothers and the American International Group. What were the terms of the derivatives contracts between A.I.G. and its counterparties, like Goldman Sachs, which received $12.9 billion via the A.I.G. bailout? What was revealed in the meetings that resulted in the A.I.G. bailout and in the subsequent $700 billion taxpayer-provided lifeline for financial firms? Why was Citigroup, a failing institution last year, treated more favorably than A.I.G.? And to what extent have the survivors of the crash, like Goldman and JPMorgan Chase, benefited from cheap financing, loan guarantees and other government interventions?

In the months since the inquiry commission was created last May, other significant efforts have been undertaken to get to the bottom of the financial crisis.

Judge Jed Rakoff of the United States District Court in New York has demanded that Bank of America and the Securities and Exchange Commission be more forthcoming about the identities of bank officials who may have withheld from shareholders important information relating to BofA’s purchase of Merrill Lynch at the height of the financial crisis.

Bloomberg News has filed a Freedom of Information suit to learn the identities of banks that took emergency funding from the Fed, the amounts and the collateral they offered. The judge in that case has told the Fed to release the names; the Fed has until the end of September to appeal the decision. The Fed should not appeal. The truth will come out, and in the end, the nation will be better for it.

The commission can take its cue from those efforts. Probing questions, asked in order to advance the public interest and with a goal of ever greater transparency, are what Americans have a right to expect — and what the commission, if it so chooses, can deliver.

SOURCE NYT

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THE GLOBALIZATION -BASICS

a-free trade

THE BASIS OF GLOBALIZATION OF TODAY WERE PUT DURING THE PERIOD OF ENLIGHTENMENT,WHERE THE EUROPEAN IMPERIAL STATES WERE ENTERING AT A NEW ERA ,THAT ONE OF INDUSTRIALIZATION.
THE CHANGE OF PRODUCTION,TRADE AND CONSUMPTION WAYS,GUIDED HUMANITY IN A NEED FOR NEW POLITICAL INSTITUTIONS WHICH COULD SERVE BETTER PEOPLE’S RELATIONS.
SO FRENCH AND AMERICAN REVOLUTIONS ACTUALLY PUT AN END TO ARISTOCRACY’S FEUDALISM AND MERCANTILISM BY INTRODUCING ONE TYPE OF DEMOCRACY THE REPRESENTATIVE ONE,WHICH ALREADY HAD ITS PRACTICAL IMPLEMENTATION AT UK AND ITS THEORETICAL PARTIALLY AT ANCIENT ATHENIAN DEMOCRACY (DIRECT,LOT,SORT).
THE NEW(OLD) INSTITUTION BY SERVING MAINLY THE MIDDLE CLASSES BEGAN CREATING WEALTH AND PROSPERITY FOR THE NATIONS (A NEW-OLD TERM-IDEA),BASED ON THE THEORIES OF ADAM SMITH (THE THEORY OF MORAL SENTIMENTS,1759,WEALTH OF NATIONS,1776),WHO PUTS MORALITY DOWN TO THE LEVEL OF ECONOMY,BY INTRODUCING THE SYSTEM OF MARKETOCRACY AND HOMO-ECONOMICUS.

HIS THEORIES ABOUT THE NEW TERM OF POLITICAL ECONOMY,GAVE A PUSH FOR FURTHER DEVELOPMENT OF STATE ECONOMIES BY DIVIDING THE THEORETICAL PATHS IN CAPITALISM AND SOCIAL-COMMUNISM IDEAS. 

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NOW IT HAS COME THE TIME THAT THE PROBLEM WILL REACH CONSUMERS

Sept. 14 (Bloomberg) -- Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.

“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview yesterday in Paris. “The problems are worse than they were in 2007 before the crisis.”

Stiglitz’s views echo those of former Federal Reserve Chairman Paul Volcker, who has advised President Barack Obama’s administration to curtail the size of banks, and Bank of Israel Governor Stanley Fischer, who suggested last month that governments may want to discourage financial institutions from growing “excessively.”

A year after the demise of Lehman forced the Treasury Department to spend billions to shore up the financial system, Bank of America Corp.’s assets have grown and Citigroup Inc. remains intact. In the U.K., Lloyds Banking Group Plc, 43 percent owned by the government, has taken over the activities of HBOS Plc, and in France BNP Paribas SA now owns the Belgian and Luxembourg banking assets of insurer Fortis.

Obama’s Plan

While Obama wants to name some banks as “systemically important” and subject them to stricter oversight, his plan wouldn’t force them to shrink or simplify their structure.

Stiglitz said the U.S. government is wary of challenging the financial industry because it is politically difficult, and that he hopes the Group of 20 leaders will cajole the U.S. into tougher action.

“We aren’t doing anything significant so far, and the banks are pushing back,” said Stiglitz, a Columbia University professor. “The leaders of the G-20 will make some small steps forward, given the power of the banks” and “any step forward is a move in the right direction.”

G-20 leaders gather Sept. 24-25 in Pittsburgh and will consider ways of improving regulation of financial markets and in particular how to set tighter limits on remuneration for market operators. Under pressure from France and Germany, G-20 finance ministers earlier this month reached a preliminary accord that included proposals to reduce bonuses and linking compensation more closely to long-term performance.

Reluctant to Act

“It’s an outrage,” especially “in the U.S. where we poured so much money into the banks,” Stiglitz said. “The administration seems very reluctant to do what is necessary. Yes they’ll do something, the question is: Will they do as much as required?”

Stiglitz is too pessimistic and the banking system will probably continue to strengthen, said Jim O’Neill, chief economist at Goldman Sachs Group Inc. in London. “I’m not sure why he’s saying it,” O’Neill told Bloomberg Television today. “The banks were close to near death. We’ve been to hell and back, so to speak, and we’re on the road to recovery.”

Stiglitz, former chief economist at the World Bank and member of the White House Council of Economic Advisers, said the world economy is “far from being out of the woods” even if it has pulled back from the precipice it teetered on after the collapse of Lehman.

‘Economic Malaise’

“We’re going into an extended period of weak economy, of economic malaise,” Stiglitz said. The U.S. will “grow but not enough to offset the increase in the population,” he said, adding that “if workers do not have income, it’s very hard to see how the U.S. will generate the demand that the world economy needs.”

The Federal Reserve faces a “quandary” in ending its monetary stimulus programs because doing so may drive up the cost of borrowing for the U.S. government, he said.

“The question then is who is going to finance the U.S. government,” Stiglitz said.

Stiglitz gave the interview before presenting a report to French President Nicolas Sarkozy that urged world leaders to drop an obsession for focusing on gross domestic product in favor of broader measures of prosperity.

“GDP has increasingly become used as a measure of societal well being, and changes in the structure of the economy and our society have made it an increasingly poor one,” Stiglitz said.

Sarkozy Agrees

Sarkozy said today in a speech in Paris that focusing on GDP as the main measure of prosperity had helped to trigger the financial crisis. He ordered France’s statistics agency to integrate the findings of Stiglitz’s study into its economic analysis.

Assessing government’s contribution to economic output, which ranges from 39 percent in the U.S. to 48 percent in France, is one of the shortcomings of the GDP model, as is its difficulty in estimating improvements in the quality of products such as cars instead of just quantity, Stiglitz said.

Similarly, increased household debt may drive up output numbers, even though that doesn’t amount to a real increase in wealth, he added.

While Stiglitz doesn’t recommend dropping GDP altogether, he wants governments to consider such matters, along with issues of environmental sustainability, in policy making.

“Most governments make a fetish out of it. If you take one message out of our report, make it avoid GDP fetishism,” he said. “The message is to encourage political leaders away from that.”

BY Mark Deen

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Not only is macro-prudential regulation rubbish, but it gives rubbish a bad name" THE SOLUTIONS FOR THE SYSTEM'S SAFETY ARE LAID AT OTHER BASES

Respinning the web

If the financial crisis has taught us anything,” says Michael Taylor, “it is that too much conventional wisdom can be dangerous.” So there is something “slightly unnerving”, adds the former International Monetary Fund economist, about the speed with which a new consensus has emerged on the re-regulation of the financial system – especially when it comes to the concept known in bankerly jargon as “macro-prudential” regulation.

In essence this boils down to the idea that regulation should focus much more on systemic risks instead of assuming that a sound system can be built simply by supervising individual banks. It aims to restrain the kind of build-up of systemic risk that occurred during the credit bubble and which is difficult to address by raising interest rates to damp down asset prices. The chief weapon in the macro-prudential armoury is a capital regime for banks that curbs excessive credit growth.

The effectiveness of macro-prudential regulation is a core assumption behind the capital proposals in last week’s US Treasury white paper on financial regulation. The concept was also roundly endorsed by the de Larosière report to the European Union and in the Turner review in the UK. The underlying philosophy is that if macro-economic analysis had been brought to bear on the design of the financial system, the current debacle might have been either pre-empted or rendered less devastating.

Heavy reliance, then, is being placed on the ability of this new regulatory approach to prevent a future global financial crisis. Yet there is no agreement on how it might work in practice and good reason to question whether it will live up to its advance billing. One very senior former member of the global central banking establishment even says “not only is macro-prudential regulation rubbish, but it gives rubbish a bad name”.

The starting point in the argument is that banking is different. First, because banks borrow short and lend long in the interests of the wider economy but at the cost of putting themselves in a fundamentally risky position: if depositors demand their money back simultaneously, banks cannot pay up because of the mismatch in the maturity of their assets and liabilities. Second, because a loss of confidence in one bank can become contagious across the system. Third, bank failures have externalities, or side effects, that not only inflict losses on other banks but also damage the wider economy – for example, by curbing the supply of credit.

An important role of bank regulation, as the US Treasury white paper underlines, is precisely to address such externalities. It proposes to compel the largest, most interconnected, highly leveraged institutions “to internalize the costs they could impose on society in the event of failure” by imposing tougher capital requirements.

In the run up to the financial crisis the regulatory approach was entirely micro-prudential: it assumed that, if bank supervisors ensured individual banks were safe, systemic stability would look after itself. Yet in a recent report – The Fundamental Principles of Financial Regulation – a group of prominent bankers and academics points out that this view “sounds like a truism, but in practice it represents a fallacy of composition”. This is because, in trying to make themselves safer in a crisis, banks can behave in a way that collectively undermines the system.

It may be prudent, for example, for an individual bank to sell assets when the price of risk increases. Yet if many banks do the same, the asset price will collapse, causing banks to take further steps that can lead to a vicious, self-reinforcing downward spiral in asset prices.

The Turner Review highlights the practical consequences of an unbalanced regulatory approach. In the build-up to the crisis, it says, the Bank of England tended to focus on monetary policy analysis, as required by its inflation target. While the review praises the Bank’s analytical work for its regular Financial Stability Review, it notes that the analysis did not result in policy responses to off-set the risks identified.

For its part, the Financial Services Authority, the UK’s principal regulator, focused too much on the supervision of individual institutions, and insufficiently on wider sectoral and system-wide risks. The review concludes that the vital activity of macro-prudential analysis fell between two stools, leading to what Paul Tucker, deputy governor of the Bank of England, has called “underlap”.

Systemic instability has been further compounded by the pro-cyclicality of regulation, whereby banks are not required to build up enough capital in the good times and are obliged to increase capital in the downturn, so accentuating boom and bust. Much of the damage wrought in the financial crisis was a direct result of Basel I, the global capital regime agreed by the world’s financial regulators. This treated all mortgages as equally risky, so that bankers could take on very high-risk, high-reward subprime mortgage business without having to back it with more capital than that required for safer mortgage business.

Basel II, which started to be implemented last year, addressed this problem by breaking assets down into subcategories and applying risk weights to them. Yet this actually increases pro-cyclicality: as risk grows in the recession, in contrast to Basel I, banks are required to hold more capital just when they are most under pressure. This pro-cyclicality is further exacerbated by mark-to-market accounting, which adds to asset values in the good times and inflicts additional shrinkage when markets turn down.

Bank regulators around the world are already working to reduce the pro-cyclical bias in the system by tinkering with capital adequacy requirements. Yet Lord Turner, chairman of the UK’s FSA, argues that there is a case for going further to introduce overt counter-cyclicality, whereby required and actual capital would rise in good years when loan losses are below long-run averages, creating capital buffers that would be drawn down in bad years as losses increased. He also argues for an overall leverage ratio, looking at assets in relation to capital, as a backstop control measure. Such a ratio also features in the financial regulation plans of the administration of US President Barack Obama.

Capital requirements that track the cycle, together with overall leverage ratios, are thus central planks of the macro-prudential approach. Yet the attempt to counter pro-cyclicality raises huge questions, most notably on the issue of whether regulators should have discretion to change capital requirements in the course of the cycle or whether the capital regime should be subject to pre-determined rules. In a perfect world, giving discretion to regulators to calibrate capital requirements according to the state of the economy makes sense. In the real world, regulators would face the ever-difficult problem of defining where they were in the economic cycle.

Sir Andrew Large, former deputy governor of the Bank of England for financial stability, says the problems of judging how close the system is to a tipping point can be overstated. “I argue that people could put levels of probability on their assessment and then act to calm things down.”

Yet few deny that regulators making such judgments would be subject to huge pressures because, by definition, the purpose is to prevent financial institutions doing what they want to do by making it more expensive or off limits. Charles Goodhart of the London School of Economics, and a former member of the Bank of England monetary policy committee, says regulators and supervisors “will be roundly condemned for tightening regulatory conditions in asset price booms by the combined forces of lenders, borrowers and politicians, the latter tending to regard cyclical bubbles as beneficent trend improvements due to their own improved policies”.

As with monetary policy, it is politically difficult for the guardians of the financial system to take measures that will reduce economic growth in the short term in the interests of fending off a recession no one thinks will happen while the good times still roll.

There lies the case for a rules-based approach. Yet designing a set of rules is no easy task (see box). It would also bring added complexity, not least because big multinational banks operating in different economies would be affected by many different cycles. And there is a risk that inflexible rules could lead to regulatory arbitrage.

Regulatory expert Michael Taylor compares counter-cyclical capital buffers with the “corset”, a form of quantitative control introduced in the UK in 1973 that penalised banks whose deposits grew faster than a pre-set limit. This simply drove money off-shore and the regime had to be scrapped in 1980.

Nor are rules a guarantee against lobbying pressure. The Bank of Spain has been much praised for introducing counter-cyclical provisioning that helped the Spanish banking system to weather the crisis better than most. Yet, as Mr Taylor points out, the Spanish central bank watered down its rules in 2004 because of lobbying by the industry, which argued that the length of the economic expansion had made such rules redundant.

These difficulties with macro-prudential regulation notwithstanding, the direction of travel is clear. Perhaps the most articulate advocate is the FSA’s Lord Turner, who argues in his review for the counter-cyclical regime to be substantially rules based. Yet he wants the best of both worlds, saying that this could be combined with regulatory discretion to add a further layer of requirements if macro-prudential analysis suggested this was appropriate.

The debate on rules versus discretion is set to run and run. There is a risk that more is expected of the macro-prudential approach than it is capable of delivering. This is because financial crises are often precipitated by unprecedented shocks that are inherently difficult to foresee. Yet Sir Andrew Large makes a parallel with the argument for independent central banking 30 or 40 years ago. Most people thought it was too difficult. But it happened, with what he regards as quite creditable results. “We need to have the self-confidence to do the same with systemic stability,” he adds, “for without such a policy we will be condemned to repeat today’s disaster in 10 or 20 years time.”

Fallout and factions: the drama of rewriting the rules

The next 12 months could bring the most dramatic change in financial services regulation in decades, as the US, the UK and the European Union try to tackle the causes of, and fallout from, the global downturn. Plans are moving forward to tighten the rules on everything from hedge funds and over-the-counter derivatives to mortgages and basic bank capital requirements, writes Brooke Masters.

In the US, President Barack Obama has unveiled detailed reform plans. He wants to consolidate several federal banking regulators and give the Federal Reserve new power to regulate systemic risk, supplemented with a council of regulators from other agencies. He also wants to create a consumer financial protection agency to regulate credit cards and mortgages, and require registration for hedge funds and central clearing for many derivatives. Parts of the scheme are already meeting scepticism from Congress, so it is not clear how much will become reality.

The EU is moving in a more piecemeal fashion. The European Commission has put forward an alternative investment directive that would force hedge funds and private equity firms to seek regulatory authorisation, report their strategies and set aside capital against losses. Regulators would also be able to set limits on borrowing. The proposal has drawn sharp criticism from London, where much of the European alternative investment management industry is based, for being restrictive and anticompetitive.

EU leaders are also considering plans to create a pan-European board to monitor systemic risk, as well as a college of supervisors that would provide more consistency among national bank supervisors and resolve disputes among countries. But Gordon Brown, UK prime minister, is fighting plans to make the president of the European Central Bank (to which the UK does not belong) chair of the systemic risk board. London has already secured guarantees that the new supervisory system cannot force any single country to commit taxpayer funds to bail out a troubled bank.

In the UK, the Treasury is due to bring forward its proposal for financial regulation shortly, but splits are opening up. Mervyn King, governor of the Bank of England, wants his institution to be in charge of systemic regulation and has asked for more power to do it. But the Labour government is largely defending the tripartite system it set up more than a decade ago, which divides power among the Bank, the Treasury and the Financial Services Authority.

By John Plender

ps The beauty of the Spanish method

Creating a counter-cyclical capital regime for banks is tough but it has been done, most notably in Spain. Since 2000 banks there have had to make provisions for latent portfolio losses – those likely to occur but which are unrecognised by conventional accounting. This buffer takes the form of a reserve deducted from capital in good times and released in the downturn. It is calculated by comparing long-run credit growth in the economy with the current rate of credit growth. “Dynamic provisioning” offers a better idea of profitability and solvency over time and helps prevent dividend increases in good times that might undermine banks’ solvency. But the Spanish model is not compliant with global accounting standards. And it did not prevent a housing bubble as the macro-prudential approach battled a fierce monetary headwind – the European Central Bank’s one-size- fits-all interest rate was lower than appropriate for a boom economy. Spain’s banking system has nonetheless come through the crisis in better shape than most.

Copyright The Financial Times

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posted by The visioner @ 5:38 PM 0 comments

ECONOMICS WERE,ARE AND WILL BE BASED IN POLITICS ,THEY CAN'T BE SEPARATED.THE BELOW MENTIONED WAY OF THINKING WAS AND STILL DOES, GUIDING US TO ..

Till Debt Does Its Part


So new budget projections show a cumulative deficit of $9 trillion over the next decade. According to many commentators, that’s a terrifying number, requiring drastic action — in particular, of course, canceling efforts to boost the economy and calling off health care reform.

The truth is more complicated and less frightening. Right now deficits are actually helping the economy. In fact, deficits here and in other major economies saved the world from a much deeper slump. The longer-term outlook is worrying, but it’s not catastrophic.

The only real reason for concern is political. The United States can deal with its debts if politicians of both parties are, in the end, willing to show at least a bit of maturity. Need I say more?

Let’s start with the effects of this year’s deficit.

There are two main reasons for the surge in red ink. First, the recession has led both to a sharp drop in tax receipts and to increased spending on unemployment insurance and other safety-net programs. Second, there have been large outlays on financial rescues. These are counted as part of the deficit, although the government is acquiring assets in the process and will eventually get at least part of its money back.

What this tells us is that right now it’s good to run a deficit. Consider what would have happened if the U.S. government and its counterparts around the world had tried to balance their budgets as they did in the early 1930s. It’s a scary thought. If governments had raised taxes or slashed spending in the face of the slump, if they had refused to rescue distressed financial institutions, we could all too easily have seen a full replay of the Great Depression.

As I said, deficits saved the world.

In fact, we would be better off if governments were willing to run even larger deficits over the next year or two. The official White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years. If that’s at all correct — and I fear that it will be — we should be doing more, not less, to support the economy.

But what about all that debt we’re incurring? That’s a bad thing, but it’s important to have some perspective. Economists normally assess the sustainability of debt by looking at the ratio of debt to G.D.P. And while $9 trillion is a huge sum, we also have a huge economy, which means that things aren’t as scary as you might think.

Here’s one way to look at it: We’re looking at a rise in the debt/G.D.P. ratio of about 40 percentage points. The real interest on that additional debt (you want to subtract off inflation) will probably be around 1 percent of G.D.P., or 5 percent of federal revenue. That doesn’t sound like an overwhelming burden.

Now, this assumes that the U.S. government’s credit will remain good so that it’s able to borrow at relatively low interest rates. So far, that’s still true. Despite the prospect of big deficits, the government is able to borrow money long term at an interest rate of less than 3.5 percent, which is low by historical standards. People making bets with real money don’t seem to be worried about U.S. solvency.

The numbers tell you why. According to the White House projections, by 2019, net federal debt will be around 70 percent of G.D.P. That’s not good, but it’s within a range that has historically proved manageable for advanced countries, even those with relatively weak governments. In the early 1990s, Belgium — which is deeply divided along linguistic lines — had a net debt of 118 percent of G.D.P., while Italy — which is, well, Italy — had a net debt of 114 percent of G.D.P. Neither faced a financial crisis.

So is there anything to worry about? Yes, but the dangers are political, not economic.

As I’ve said, those 10-year projections aren’t as bad as you may have heard. Over the really long term, however, the U.S. government will have big problems unless it makes some major changes. In particular, it has to rein in the growth of Medicare and Medicaid spending.

That shouldn’t be hard in the context of overall health care reform. After all, America spends far more on health care than other advanced countries, without better results, so we should be able to make our system more cost-efficient.

But that won’t happen, of course, if even the most modest attempts to improve the system are successfully demagogued — by conservatives! — as efforts to “pull the plug on grandma.”

So don’t fret about this year’s deficit; we actually need to run up federal debt right now and need to keep doing it until the economy is on a solid path to recovery. And the extra debt should be manageable. If we face a potential problem, it’s not because the economy can’t handle the extra debt. Instead, it’s the politics, stupid.

By PAUL KRUGMAN

SOURCE NYT

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PROTECTIONISM FOR BIG ECONOMIC ZONES WILL HELP IN THE STABILIZATION OF ECONOMIES for a specific period

Regulatory protectionism won’t stop shocks

The financial markets crisis has led to many proposals for reform in an effort to prevent future calamities and increase stability.

To be sure, the urgency of bold moves to change things has vanished in the last few months. But one thing that hasn’t gone away is the thrust that may lead to more economic nationalism. The US, for example, intends to supervise the top 25 financial institutions in the US regardless of their ultimate domicile.

“There is a danger that changes in the regulatory environment will, by accident or design, lead to a re-fragmentation of markets,” warns Josef Ackermann, chief executive of Deutsche Bank. “The proposal that large internationally active financial institutions should essentially be reduced to holding companies of national operations as stand-alone institutions is not the right answer.”

“The regulators are putting an anchor on globalisation,” adds one senior HSBC executive succinctly. “We are seeing more territoriality on the part of regulators.”

Underlying that fear is the fact that regulators no longer trust each other. Indeed, they have quietly blamed peers (as Fed officials blamed the FSA in the UK for discouraging Barclays from buying Lehman before its collapse) and dread being hostage to the failures of their foreign counterparts.

One possible consequence of such a lack of trust may be a world in which each jurisdiction dramatically increases the amount of capital any bank operating within its borders has to hold. Such regulatory efforts to make one’s own markets safer may be logical when considered in isolation. Yet these proposed measures are already leading some banks to reconsider their global strategies and withdraw from some markets since they themselves can no longer allocate capital in ways they consider economically rational.

Of course, such regulatory concerns are natural given the rest of the world’s experience of America’s adventure into the brave new world of securitisation. Indeed, to many regulators around the world, it seems the primary export from the US in recent years has been dud financial products, the financial equivalent of toxic milk powder from China. “The American regulatory regime enabled the disaster,” says a top executive of an international bank in the US.

For example, Dutch authorities had to buy troubled US Alt-A mortgage securities to help one of its banks. Residents of Hong Kong and China were among the many victims of the bust debt of Lehman Brothers when the securities firm went under. The Swiss National Bank had to establish swap lines with the Federal Reserve in case ailing UBS (with assets four times the size of Switzerland’s GDP) needed shoring up, as a result of UBS’s calamitous foray into American mortgages.

At the same time, there has been a backlash in the US against providing funds to non-US banks. For example, the Fed is compensating foreign banks, such as Société Générale of France, that acted as AIG counterparties and backstopping the credit default swaps AIG sold these banks.

Of course the money that the US government has come up with to help recapitalise American financial institutions involves restrictions on foreign staff in their domestic operations.

Suddenly globalisation no longer seems like such a neat idea.

The problem with all this is that the consequences are likely to be unpredictable or unfortunate. For example, Vikram Pandit, chief executive of Citigroup, notes that his bank employs more Americans abroad than foreigners at home.

In Lords of Finance, Liaquat Ahmad’s look at international finance in the first half of the twentieth century, there is a wonderful scene in 1913 London where the British government is trying to get its head around the fact that Lloyd’s of London has insured the ships of the German merchant marine. Such interconnectedness wasn’t enough to prevent the First World War but one could argue that the greater the links, the less likely armed conflict becomes. Globalisation may have its drawbacks but so does its opposite.

By Henny Sender

http://www.ft.com/cms/s/0/313aeca4-7864-11de-bb06-00144feabdc0.html

Copyright The Financial Times Limited 2009

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