What role has regulation in the banking sector?

Dear Colleagues

There have been questions for a long time about what role regulation should have in the banking sector ... and all the related activities of the capital and commodity markets ... and appropriate use of the banking infrastructure for activities such as funding terrorism.

The New York Times reports on proposals now emerging from the Treasury in the United States to bring more regulation into play ... in part:

March 30, 2008
News Analysis
In Treasury Plan, a Reluctant Eye Over Wall Street
By NELSON D. SCHWARTZ and FLOYD NORRIS

The Bush administration is proposing the broadest overhaul of Wall Street regulation since the Great Depression. But the plan, to be unveiled on Monday, has its genesis in a yearlong effort to limit Washington’s role in the market.

And that DNA is unmistakably evident in the fine print.

Although the proposal would impose the first regulation of hedge funds and private equity funds, that oversight would have a light touch, enabling the government to do little beyond collecting information — except in times of crisis.

The regulatory umbrella created in the 1930s would grow wider, with power concentrated in fewer agencies. But that authority would be limited, doing virtually nothing to regulate the many new financial products whose unwise use has been a culprit in the current financial crisis.

The plan hands vast new authority to the Federal Reserve, essentially formalizing what has been an improvised process over the last three weeks. But some fear that the central bank’s role in creating the current mess will undercut its ability to clean it up.

All the checks and balances in the plan reflect the mindset of its architect, Treasury Secretary Henry M. Paulson Jr., who came to Washington after a long career on Wall Street. He has worried that any effort to substantially tighten regulation could hamper the ability of American markets to compete with foreign rivals, though he has intervened in the mortgage crisis to try to persuade banks to offer concessions to some troubled borrowers

As the full effect of the credit crisis becomes clearer, the political stakes are growing.

The New York Times correctly points to the reality that regulation as currently proposed is more likely to institutionalize freedom from regulation and maintain a "wild west" type status quo, than it is to provide an effective framework for regulation and oversight.

Bluntly put ... Washington does not seem to understand the need for the US banking and finance sector to reestablish trust, and to do it quickly. Swashbuckling entrepreneurism in the banking sector may be attractive to traders and others in the financial sector who have make a (very good) living using the capital markets as a casino ... but for investors, events like the Bear Stearn's debacle are very disconcerting.

The US banking and finance industry, I would argue, is faced with a very difficult challenge. They have been able to use "creative" accounting and complex mergers and complex financial instruments to build an image of success ... but in reality this image is a mirage. Underneath the dollar denominated paper, the tangible assets are miniscule. Or maybe not! The crisis is that nobody knows ... the accountancy profession has absolutely no way, as far as I know, of producing strong factual data that show what the value of all this paper might be.

Some of the global accounting profession argued years ago for "assets to be recorded on the balance sheet at cost" ... because this was the only number that good be validated reliably. But this idea has gone by the board as rule after rule has allowed cost to be increased over and over again as the item is "traded". Accountancy has not required these "silly" costs to be reserved agains ... why? ... because they had a market value higher than cost ... that is they could be sold for more than they had "cost". Everything is fine until the "market" disappears ... at which point, everything comes unstuck.

Regulation is not going to help much ... the issues are too complex ... and the process of regulation is far too slow, far too cumbersome and far too subject to "old boy network" abuse.

But there has to be an answer ... and there is. Within the banking sector and within the American corporate community, there are some people who stand for a far higher standard of ethical conduct than has been demonstrated by the leadership of banking and corporate organizations for most of the last decade or two. These are the people who have to be able to stand up and be counted ...

These people have been sidelined for years ... whistle blowers have not been welcome in banking and commercial organizations ... but they stand for something.

But they cannot be effective without a supporting fraemwork ... and this framework maybe emergisng in the form of a new Social Benefit Accountancy framework. This framework helps to get answers to questions about how any economic entity is performing, not only from the profit perspective and how the stockholders see things, but also from the public perspective and how society is being affected.

As a practical matter regulation is not an answer the the banking sector crisis ... there have to be changes ... and the changes have to be visible to the public and the subject of disclosure and deep transparency.

With best wishes for this.

Sincerely

Peter Burgess

Banking secrecy ... the issue of Swiss Banking

Dear Colleagues

An interesting article appeared in the New York Times this weekend. It concerned the fabled Swiss banking secrecy. In part:

March 29, 2008
Trying to Get the Swiss to Talk
By CARTER DOUGHERTY
GENEVA — Like Paul Revere, Konrad Hummler sounded the alarm last week as he made his way by train and by plane to his bank’s branches across Switzerland. This country’s storied role as secret banker to the world’s wealthy is under threat like never before, Mr. Hummler warned.

Later in the article, it was observed:

The concept of bank secrecy is deeply rooted in Switzerland, akin to the confidentiality rules governing doctors and lawyers in other countries, and a 1934 law makes it a crime for bankers to disclose client information. For foreigners, this combination is an effective shield against authorities at home.

It is going to be interesting to see how this plays out.

The idea that Switzerland was home to many of the UN institutions when it was not a member of the UN always seemed in appropriate.

Now Switzerland, physically located in the middle of Europe is not part of the European Union (EU) seems equally bizarre.

When weird things seem to be happening I am always intrigued by the economic issues that are behind the first impressions. In the case of Switzerland ... it is banking.

When I was a student ... about 50 years ago ... there was a lot of talk in the UK about the "Gnomes of Zurich", the Swiss bankers who had power over currencies and were of great concern to British economists worrying about the role of Sterling as a stable world currency. I travelled to Switzerland during one of my college breaks and met with some of the banks in Zurich ... probably at a very, very junior level, but how was I to know?

But years later I learned more about Swiss banking and the role that secrecy played in attracting money from around the world for safe keeping.

My first impulse is to be against the secrecy of Swiss banks because they make it possible for crooks, especially crooks who have official capacities in governments, to hide the wealth that they have acquired ... often by very dubious means ... and to keep it protected for themselves (if they live long enough) and their families to enjoy.

But there is another side to this as well. Governments throughout the world have, at one time or another, passed laws to take away the wealth of people who, arguably, have a legitimate right to the wealth. In recent times, the "State" has sometimes made itself an almost God-like institution and there is a legitimate need for people to be able to hide wealth somewhere to protect it from this sort of predatory behavior.

The scandalous behavior of wealthy people in avoiding reasonable tax liabilities should end ... clearly there is a need for taxation, and everyone should be paying. But is getting this information from a bank in Switzerland ... or Liechtenstein ... the answer. Rather, I would argue, a system of understanding wealth creation should be in place so that the tax authorities are much better able to do audit and investigation without requiring the Swiss to do their work for them.

I hate corruption ... but it would be better to stop corruption at source, rather than ex-post facto when the damage is long done and now all that remains is the loot in a Swiss Bank.

Of course, from a New York perspective, it is good to have an article that points to the banking sector in another country ... the banking sector in the United States and New York is in a shambles.

Sincerely

Peter Burgess

Making money ... on the way up ... and on the way down

Dear Colleagues

In my academic training in economics, we looked at the theory of economics, and we also looked at the "structure" of industry, of organizations, etc. Trying to match what I expect to happen in theory with what actually happens in practice has helped me to have a fairly good understanding of both corporate business and the relief and development sector.

Here is an example ... from the sub-prime melt-down ... in theory everyone loses ... but in practice there are some that do very well. As the New York Times put it:

March 30, 2008
The Foreclosure Machine
By GRETCHEN MORGENSON and JONATHAN D. GLATER

NOBODY wins when a home enters foreclosure — neither the borrower, who is evicted, nor the lender, who takes a loss when the home is resold. That’s the conventional wisdom, anyway.

The reality is very different. Behind the scenes in these dramas, a small army of law firms and default servicing companies, who represent mortgage lenders, have been raking in mounting profits. These little-known firms assess legal fees and a host of other charges, calculate what the borrowers owe and draw up the documents required to remove them from their homes.

This did not come about by accident ... I would argue that the system has been carefully put together by professionals who understand the power of the system, and have designed a process that is in the interest of the insiders and the most costly to society as a whole.

Muriel Siebert ... who became well known, I beleve, as the first lady member of the New York Stock Exchange ... and subsequently became the New York State Banking Commissioner help get State legislation passed to control the interest rate and fee abuses of credit card companies. Arguably, this was good law and served society well. It has been totally ineffective because the credit card issuers were able to move their "legal" residence to locations where there was little or no banking or credit card regulation ... and a convenient "loophole in the law" allows these organizations to go on with their business in New York State as if there were no New York banking laws.

American leadershop and the corporate world frequently talks about the importance of "Rule of Law" ... but sadly, the law has the power to protect the guilty ... and as time goes by gets more and more confusing and less and less pro-society. This is a dangerous development with consequences that are difficult to predict with certainty ... and needs attention.

Sincerely

Peter Burgess

Where were the accountants?

Dear Colleagues

The multi-billion write-offs in the banking industry show how much the basic principles of good accountancy have been ignored ... and replaced by what can only be described as a convenient reporting system for the industry.

It has been clear for many years that there was a disconnect between the profits from "banking" and the profits from fee based services ... with the latter being more important than the pure banking business. However, I would argue that the accountancy should have made it a lot clearer what was going on.

The Enron dabacle was big enough to put the accounting firm, Anderson, out of business ... and it is going to be interesting to see whether the melt-down of the global financial sector is going to create casualties in the global accounting industry.

It is difficult to predict what is going to happen ... but the level of "trust" that the accountancy industry has within the general public must be at an all-time low, and perhaps set to go even lower. This is a sad state of affairs ... but really was inevitable given the way in which the industry gave up on its public accountancy responsibilities and took to consultancy and fee making services of all sorts.

Clearly there is a need for "trusted" organizations that can help to confirm that the reported information about corporate performance is correctly stated ... but what organizations are now competent to do this ... and what role is the accountancy profession going to have in rebuilding this trust.

I am very disappointed at this turn of events ... but there might be some hope if a broader concept of social benefit accountancy is developed, and integrated with the profit focus accountancy so that phony profit can never be "booked" and taken into profit in the manner it appears has been commonplace in the past few years.

Sincerely

Peter Burgess