Regulate financial system, you will

Former Fed Chairman Alan Greenspan, pictured left, has made a remarkable back flip on the subject of regulation.  Greenspan, a devotee of free-market capitalism and self-regulated financial markets, is reported to be "very distressed" that his ideology has proven to be flawed.

You're not alone there Al!

According to reports, Greenspan said his mistake was thinking that financial institutions would act in their own self-interest to avoid the kind of risky lending that could bankrupt them.

Looking at the size of the golden parachutes handed out to the big players on Wall Street, you could hardly rule self-interest out of the equation.  In fact, with the wisdom of hindsight you could even say that self-interest would guarantee the sort of outcome we've had.

Waterloo

Michael West writing in The Age today makes a very interesting point in an article entitled "Waterloo for non-banks":

"Having said the banks were fine, it's clear someone tapped Kevin and Wayne on the shoulder and said, er...not all fine, actually."

My question is, if Kevin and Wayne were the tappees, who was the tapper?  Call me paranoid if you will, but do I detect a certain amount of Queensland influence here?

Too Late the Hero

I see that the Grey Men in Grey Suits have concluded that marking financial instruments to market isn't such a great idea after all, at least not when the market for those instruments disappears.  See the Australian story here and the IASB press release here.  Alas it's just a shade too late to help with the $700 bn of losses already booked.

Suggestions of bolting horses and stable doors.

It seems that organisations from the G7 to the BIS to the quaintly named Financial Stability Institute (a joint effort by the BIS and Basel people) are starting to point the finger at the accountants.  The BIS notes that the accounting treatment may have overstated the losses on AAA sub-prime mortgage backed securities by as much as 50%.

All this to avoid the evils of profit smoothing!

Confessions of a Risk Manager

Excellent article in the Economist, purporting to be from the risk manager of a large global bank.  Click here to get there.

Following on from my question posed in "Grey Men in Grey Suits" - namely, what impact the new accounting standards have had on the whole sub-prime/credit crunch fiasco, I was particularly interested to read this comment in the article:

Another lesson is to account properly for liquidity risk in two ways. One is to increase internal and external capital charges for trading-book positions. These are too low relative to banking-book positions and need to be recalibrated. The other is to bring back liquidity reserves. This has received little attention in the industry so far. Over time fair-value accounting practices have disallowed liquidity reserves, as they were deemed to allow for smoothing of earnings. However, in an environment in which an ever-increasing part of the balance-sheet is taken up by trading assets, it would be more sensible to allow liquidity reserves whose size is set in scale to the complexity of the underlying asset. That would be better than questioning the whole principle of mark-to-market accounting, as some banks are doing.

Crikey!

An interesting observation from Bernard Keane on Crikey.  Click here for the full story.

 

Some thought low interest rates and profligate government spending were what got the world into the financial crisis. Turns out they’re apparently the solution, at least in Australia. Not so much to the financial crisis, though, but the economic crisis which is following hot on its heels.

Grey Men in Grey Suits

Quietly contemplating the carnage currently besetting world financial markets, I found myself wondering what role in all this was played by the grey men (and women) behind the wonderful international financial reporting standards which have kept so many accountants so busy over the last few years.

Consider this.  If a financial institution holds $100m of mortgage backed securities it records those securities on its balance sheet at market value.  If market liquidity dries up, and the best price you can find for the securities is $50m, you write them down to that level and take a $50m hit through the P&L.  Simple right?

But what if the underlying mortgages were still reasonably sound?  What if a sensible assessment of the present value of the expected future cashflows was $80m?  The accountants have been so desperate to avoid "profit smoothing" that they've driven the banks to write their investments down to market value where no market exists.  No doubt there'll be a done of work to be done in sorting the mess out.

Frightening the Horses

So the RBA cuts rates by 1% - the first time it's done such a thing since 1992 (when rates were much higher) and the market jumps in response.

Perhaps I'm getting paranoid but doesn't this suggest a degree of concern at the RBA that we haven't previously appreciated?

If anything, I would have thought that a cut of this magnitude would frighten the horses in a fairly big way.