Will regulating banks avert another global crisis?

The G20 group’s discussions this weekend may lead to banks and other financial institutions having to pay two new taxes to fund future bail-outs. The global proposals by the IMF are “more radical” than most had anticipated.

“Too many Wall Street firms had no one looking over their shoulder, and they went off the deep end.”, Senator Charles E. Schumer of New York said. He has long been one of Wall Street’s best friends on Capitol Hill, but Mr. Schumer has embraced new legislation that will put constraints on his hometown’s leading industry.

Banks are likely to be horrified, especially about the proposed tax on pay.

Insurers, hedge funds and other financial institutions must also pay the taxes, the IMF argues, despite them being less implicated in the recent crisis. If not, activities currently carried out by banks would be reclassified as, for example, insurance or hedge-fund services to escape the levies.

The main focus is on the European Union and United States, where much of the financial crisis played out.

My feeling is that it is crucial to regulate complicated financial products that not even the people who invented them understand fully. A case in point are the subprime debt securities, not to mention the CDOs, sold in the United States and Europe that played a key role in the financial crisis. They were almost non-existent in Asia and a major reason why the region was able to recover more quickly from the global recession.

Good timing that a former Goldman CDO man just published a novel he wrote “about the cliched high life I had been living while creating and selling billions upon billions of these securitization and credit derivative products, now better known as ‘toxic assets”.

President Obama took his rhetoric of reform on Thursday to the nation’s financial capital in a high-profile foray to chide Wall Street bankers for their “reckless practices” and to press for tighter regulations meant to avert another financial crisis.

It is my belief that if there is no oversight and regulation of new complex financial products it is just a question of how long it takes before we have another global crisis. So I am pleased that the Senate approved legislation to tighten regulation of derivatives trading a couple of days ago. But will that be enough? We need similar legislation in Europe and the rest of the world. Debt securities based on life insurance instead of sub prime morgages have been sold for quite some time already. Let’s hope Wall Street isn’t, again, betting against them with a complicated CDO as well?

G20 countries have to find common ground on a variety of reforms to prevent a repeat of the credit crisis that led to a global recession. Otherwise operations will just move to countries where it is allowed. Do you think it will be possible to agree on regulations that make a difference? Or will financial companies just find loopholes and new ways of doing whatever is profitable.

photo: SBA73 – flickr

8 thoughts on “Will regulating banks avert another global crisis?

  1. Being a former bank regulator, never underestimate the creativity of the human mind. There are already regulations in place but the financial gurus have always found ways around them. That doesn't mean we should give them free reign to do as they please. What we really need to do is not regulate their actions after the damage is done but change their mindset to prevent the damage from being done. And of course this is easier said than done but nevertheless we have to continue trying.
    The problem is on both sides of the fence. Regulators who don't do the job they were hired or appointed to do and the greedy people and enormous amounts of money involved. If we are to try and fix this problem both groups of people need to be regulated.

    1. Rich, I was about to say: "never underestimate the creativity of the human mind".

      Unfortunately, this creativity is also our curse. Regulations are necessary in many areas of life (anarchy is overrated :-). By definition, creative minds identify NEW loopholes. Again, by definition: a NEW idea is NEW. This means that regulators have NOT considered it yet (sort of like regulating Internet in 1977 or whatever…).

      Result: regulators have always been and will continue to be 1 step behind INNOVATIVE exploitation of loopholes. As soon as loophole is closed, a new one opens up. Regulators cannot be blamed for failing to regulated something that doesn't exist.

      Regulators should be expected, however, to ensure legality of existing and new "loopholes" etc. (ie, analogous to police enforcing existing laws). This is the area where regulators SHOULD be held accountable for failure to identify illegal activities. Madoff case is a great example: SEC/regulators FAILED to act despite abundant evidence of fraud. If regulators fail to enforce existing regulations/laws, how can we expect them to prevent creation of new loopholes?

      Possible solution: treat regulators the same way we treat Enron execs, etc. If your negligence results in loss of billions of dollars for Enron's (or Madoff's) "victims", then you should be punished. Enron execs went to prison. Any regulators ever went to prison? If regulators mess up, they're not punished. If Madoff/Enron mess up, they pay for it dearly.

      Perhaps the question we should ask is: "does big government/regulations benefit or hurt economic/social progress?"

      I have no idea what the answer is. I do know 1 thing, though: Wall Street WILL ALWAYS (I MEAN: ALWAYS) BE 1 STEP AHEAD OF REGULATORS. So, what's the solution? 🙂

  2. There's no question that the banking industry needs much tougher regulation to prevent it causing another meltdown – and this regulation needs to include separating investment and consumer banking (again!)…

    Will banks find loopholes in any legislation? Probably. However, this tax should be see as a type of insurance policy enabling governments to build a 'war chest' of funds to be used when – invevitably again in the future – greed overtakes common sense and we once again find ourselves facing global financial turmoil.

    Consumers are more than tired of seeing bankers overpay themselves for gambling with those consumers' money and then taking no responsibility, nor facing any real consequences, when the gambles fail.

    1. Yes Guy. But the G20 can not agree. Canada notably is against it. So it looks like it is unfortunately business as usual.

      At least the Senate has passed some regulation against derivatives. But it is not enough since the whole world has to adapt the same regulations for it to make a difference. Otherwise risky financial products will for instance be sold out of Canada. Considering that banks like Royal Bank of Scotland and ABM Amro didn't understand what they got into, would the Canadian regulators understand the new complex financial products? Questionable isn't it?

  3. Events of the recent past have confirmed that the banking industry, and the bankers themselves, must be regulated. Many prominent economist are of the opinion that it was the deregulation of banking industry, specifically the repealing of the Glass-Steagall Act which segregated investment banking from consumer banking, that caused the financial crises and the resulting economic melt down in the United States.

    There is a realization among politicians, regulators as well the economists that proper regulation of the banking industry is what can save it from its greedy and irresponsible bankers. And that such regulation will be good for the economy as well as for the banking and larger financial industry.

    1. Agree with you in principal Zafar. Catch is the whole world needs to have the same regulation. Otherwise operations will just take place from another country. Sincerely believe that the most important thing is to regulate risky financial products such as derivatives and CDOs. If not, sellers will keep on selling products they do not fully understand to buyers who don't understand them neither. That is exactly what happened with the prime debt securities that was a major reason for the global crisis. We also have to get away from the "heads I win, tails I'm bailed out syndrome".

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