Nouriel Roubini on the Need to Regulate

A century ago we had banks. They created systemic risk. We decided to regulate them in order to limit the systemic risk they could create. That was wise.

Now we have non-banks. They create systemic risk...

Nouriel Roubini:

RGE Monitor: Since the onset of the liquidity and credit crunch last summer this column has been arguing that monetary policy would be impotent to address such a crunch because, in part, of the existence of a non-bank "shadow financial system"... conduits, SIVs, investment banks/broker dealers, money market funds, hedge funds and other non bank financial institutions... highly leveraged and borrow short and in liquid ways and invest or lend long and in illiquid ways... subject not only to credit and market risk but also to rollover or liquidity risk....

Unlike banks this shadow financial system does not have access to the lender of last resort support of the central bank as these are not depository institutions regulated by the central banks. What we are now observing... is a generalized liquidity run on this shadow financial system.

The response of the Fed to this run has been radical... lender of last resort support to non bank financial institutions... $200 bn term facility allows primary dealers... to swap their toxic mortgage backed securities for US Treasuries... Bear Stearns... JPMorgan... now the Fed is allowing primary dealers to access the Fed discount window at the same terms as banks.

This is the most radical change and expansions of Fed powers and functions since the Great Depression: essentially the Fed now can lend unlimited amounts to non bank highly leveraged institutions that it does not regulate.... [I]t is treating this crisis... as if it was purely a liquidity crisis. By lending massive amounts to potentially insolvent institutions that it does not supervise or regulate and that may be insolvent the Fed is taking serious financial risks and seriously exacerbate moral hazard distortions.... But this is not just a liquidity crisis; it is rather a credit and insolvency crisis. And it is not the job of the Fed to bail out insolvent non bank financial institutions. If a bail out should occur this is a fiscal policy action that should be decided by Congress after the relevant equity holders have been wiped out and senior management fired without golden parachutes and huge severance packages...

Comments

[Neal]

Exactly right-the giving of valuable assets to proven fools that are quite likely broke in exchange for potentially worthless paper makes the Fed the fool's fool.

Stop the charade--we cannot continue to obfuscate. The only way out is to vigorously pursue the identification of the bottom line with complete disclosure.

We depend far too much on international money to do anything else.

There are $35T or more in credit derivatives. Can the Fed even pretend to backstop this entire mountain?

The next crisis to come will be the commercial real estate holdings of the small and mid-size banks. What will be left to deal with those problems?

[David Lloyd-Jones]

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Makes sense to me. I particularly like that phrase "relevant equity holders have been wiped out and senior management fired without golden parachutes and huge severance packages..."

While we're at it, I'd like to see the Ontario and Canadian governments doing just a wee bit more to hunt down the folks who ran Nortel into the ground while collecting upwards of ten million a year. (I lost a couple of thousand bucks on that one after I reasoned that after losing 95% of its value it must have hit bottom. Wronnggg!! It dropped another 95% -- and then to make me really sick I missed the five-fold rebound. Ugh.)

And then there are those seven tobacco chiefs we saw perjuring themselves before Congress on TV. how come they're not in jail yet?

And shee-yit, why is Richard Perle still on the outside? Seems to me that peddling influence on the Defence Advirory Board, and taking consulting fees from the Saudis at the same time must be several crimes at once.

Seems to me this easy going attitude toward moral risk has gone just a tad too far.



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[kusaka]

What a great opportunity to get mortgage-backs at a heavy discount, use them as a collateral to get the loan from Fed and use those moneys to repay the loan you took to buy them. So if those MBS get back up, you sell them and return loan to the Fed and if they get completely worthless you just walk away and let the Fed deal with it. Profit!

[Dilbert]

If you've had any doubts at all about the worthlessness of Jim Cramer, assure yourself by watching this clown on March 11, 2008 pounding the table for Bear Stearns.

http://www.huffingtonpost.com/2008/03/17/cramer-called-bear-stearn_n_91878.html

[christofay]

In America you need a PhD to close the barn door after the horse has fled. At least that is the case in the field of economics. Greenspan just warned about regulation in creative finance sphere, so that seals the deal that we do need regulation. Every contract entered into by a financial company, gray market, black market, under-the-counter, behind the school gym, should be thoroughly put up for full review by anyone who wants to see it. As long as the losses are shared by all, at least let sunshine in. Several aspects of derivatives that should be repeated by everyone who they mention them are they are delibrately opaque in order for customers not to understand them, Wall St makes better margins on the misunderstood, they are designed to avoid regulation, and the management of the banks that sell them don't understand them, Rubin just confirmed this.

Roubini probably would have been calling for regulation before the crisis fully developed. Markets make opinions, and the opinion that is forming slowly is that Wall St has produced a mountain of crap, the crazy mortgage market of this century just produced the feed stuff for the crap

Keep in mind that we are already on the road to the 2 to 3 trillion dollars (huge numbers a sign of our inflated currency) in losses needed to be socialized. We have the original TAF to bail out Citigrope, the $200 bil Super Senior TAF, the $30 bil gifted to Moregain to help Bear executives avoid litigation.

[christofay]

How about an on-line review of Fleckenstein's book Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve?

The first chapter of Greenspan's disastrous before he got his iron-rice-bowl Fed job.

I would have prefered arrogance rather ignorance in the title.

Surely Greenspan is the perfect corollary to Bush.

[Bruce Wilder]

I think one can make a pervasive case that "financial innovation" going back to before Michael Milken has been aimed at escaping from and undoing the New Deal reforms. The task ahead is not just to reinvigorate regulation, but to reinvent it.

It is not clear to me, in the present crisis, how much "financial innovation" involved some efficiency or productivity gain, and how much was simply an effort to escape from regulation, and scam some fees and an executive bonus, before the house-of-cards collapsed. Would any bank form an SIV for any reason other than to keep stuff off the books, where capital requirments might be implicated?

Moreover, the new post-Glass-Steagall financial giants involved a lot of diseconomies of scale offset by class-warfare: the CitiFinancial unit of CitiGroup, for example, looks a lot like a loan sharking operation; meanwhile loan generation units replace loan administration. And, oh yeah, corporatization appears to have undermined the professional standards of appraisers, while the ratings agencies were corrupted, just corporate auditors were, a generation earlier.

Rather than rescue a deeply corrupt and dysfunctional "shadow banking sector" just as its corruption and dysfunction is exposed, why not let it die?

After the collapse, rather than after the bailout, we could get into the details of effective reform.

I am not so sure "transparency" is really always such a great idea, taken literally. But, the basic notion that more and better information, in this age of the computer, could contribute to genuinely more efficient finance, would be helpful. Certainly, no one should be buying (or selling) a security with no more real information about the underlying cash streams than its institutional rating. Vast databases -- a financial Google -- could replace Moody's and Fitch and S&P and maybe even the monolines and bring an order of magnitude greater efficiency.

Another critical reform, long overdue in the U.S., is a system for authenticating identity. Identity theft is out-of-control in the U.S. This is a financial crime, and a source of financial inefficiency. The whole Alt-A scam is of a piece with this obvious deficiency. We certainly don't need the privacy-busting RealID act, or the Bush Administration's efforts to establish a surveillance State, but we could use this opportunity to develop systems, which empowered and protected the individual. 33% credit card interest rates is a criminal inefficiency, if their justification is default and fraud rates.

[Pickled Shark]

I hope the investment bank heads are doing the right thing with those TSLF loans, which of course is giving themselves and their loyal friends and clients bi weekly bonuses in the form of treasury securities! Come on, think about it, do we really want to see our elite and social betters having to trade down a yacht size or driving a 2006 BMW 8 series because of a temporary technical blip in cashflow? Stop being so selfish and think about the stress they must be going through. And stop griping about the collateral, don't you think someone who bought a shark in formaldehyde for a mere 8 million dollars knows a little something more about intrinsic value in their own investment holdings than you? Bloody Peasants!
http://www.bloomberg.com/apps/news?pid=20601088&sid=al4y8JCGHR.k&refer=muse

[Bruce Wilder]

With regard to banks "creating systemic risk", I would say it somewhat differently.

Financial intermediation is a fundamental function in the economic system. When it functions well, it allows for insurance and investment, and prevents waste and fraud and theft. When it doesn't, it facilitates waste and fraud and theft.

[christofay]

Hirst also has problems similar to Delong's, is it curtain one or curtain two?

"He thus posed a neat problem to those who agonize over the philosophy of art. Was the essence of Hirst's work a particular shark, or was it the idea of putting a predatory marine carnivore in a tank and calling it modern art? (Personally, my feeling is that Hirst is correct and the answer is the latter.)"

[Matt]

You can't capture this genie, and it has been coming back again and again.

The best bet is to liberate the system and allow large funds to issue bank notes that are tradable. Then, with tradable securities, the fed can open the discount window to non-member banks and expand open market operations to trade uniformly in money notes from various sources.

The big advantage is it that other large funds can manipulate their own bonds to counteract any forward cyclic activity the federal reserve is creating.

In this scheme, it takes longer for the fed to relearn its monopilistic ways as it needs to keep the band of private issue notes trading within a variance that represents the aggregate yield of the economy.

In other words, competitive money has a better chance of catching these problems earlier. More regulation just creates another path to the same crisis in 20 years.

[STS]

Matt:

What I don't get about this competitive private currencies idea is: how is it different from what we have just witnessed? Private non-banking corporations were issuing vast quantities of paper in exchange for dollars. What material difference is there between issuing asset-backed securities and issuing bank-notes apart from the denominations involved? If you're allowed to issue $100K 'bills' which are traded by financial corporations and used to create credit available to sub-prime mortgage borrowers, why would being allowed to issue $20 'bills' and hand them over to random people in the street be an improvement?

[Blissex]

«By lending massive amounts to potentially insolvent institutions that it does not supervise or regulate and that may be insolvent the Fed is taking serious financial risks and seriously exacerbate moral hazard distortions.... But this is not just a liquidity crisis; it is rather a credit and insolvency crisis.» But Roubini is clearly pretending to not get the game here; the game seems pretty clearly to provide funds at way below inflation to enable banks to create immense profits with a kind of domestic carry trade. Hey, guys, if someone lent me a few dozen billion US$ at less than 3% I'd be buying oil wells in Texas and mines in Canada and flipping them and pocketing a few billions profits. «And it is not the job of the Fed to bail out insolvent non bank financial institutions. If a bail out should occur this is a fiscal policy action that should be decided by Congress after the relevant equity holders have been wiped out and senior management fired without golden parachutes and huge severance packages...» Oh Roubini, you mean that it is is not the job of the Fed to protect a whole lot of Republican campaign donors who are the most productive individuals in the USA according to the size of their compensation? They shouldn't be protected from losses caused by a mob of cheating mortgagees who are not paying the debts that they freely and loudly demanded to be offered? The moral hazard of letting the superior and the best of USA society brought low by the stealing thieving exploitative masses is too great for the Fed to stand by.