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