By George Feiger
President and CEO of Contango Capital Advisors
The evil financiers (perhaps I am one of them) caused the global financial crisis, in turn prompting voters everywhere to push politicians to layer new capital requirements and regulations on to the financial services sector. This is a big mistake.
Now, don’t misunderstand: Some of my best friends are regulators. But although one type of regulation – that concerned largely with disclosure – is a good idea, empowering bureaucrats to negotiate with banks behind closed doors on how to apply vague rules is not.
Why, Why, Why?
Why did virtually all the big European banks pass their stress tests with flying colors, only to have French-Belgian Dexia completely collapse?
Why do I have to read Zerohedge – a blog for financial professionals, presumably not including evil financiers – to learn of the likelihood of big problems with securities backed by prime mortgages (heavily California-originated, stated income only and with seconds outstanding as well)?
Why do I have to turn to the Institutional Risk Analyst to understand that big US banks are carrying home equity lines at par even though the firsts that precede them are underwater?
Why did we in Contango Capital Advisors have to do a lot of detective work to discover, over a year ago, that all the large U.S. money market funds were more than 50 percent filled with commercial paper from the big European banks most exposed to sovereign risk?
Why did we not know the magnitude of the off-balance-sheet entities supported by Citibank late in 2007? Or the magnitude of credit-default swap contracts that AIG sold uncollateralized? Why did we not know that our most famous broker/dealers were cooperating with short-sellers to create mortgage-backed bond issues designed to fail? Or that auction-rate securities auctions were, in fact, failing for months while being artificially supported by dealers?
Why did we not know that regulated financial institutions had loaned Long Term Capital Management enough to be leveraged 90 times? Why were we not told that Enron, an SEC-registered company with world-famous auditors, was creating sham transactions with entities that it controlled?
Who Should We Trust?
In all these cases, a variety of people did know. Of course, the managements of the entities concerned knew, but perhaps were not likely to volunteer a completely accurate picture of the situation. The other people who knew, or should have known, were the regulators. After all, even before the crisis, the finance industry was one of the most regulated on the planet.
Yet in each and every one of the cases cited, the regulators did nothing. Various and probably complementary explanations likely exist. No one listens to voices of prudence at the height of a boom – look at the success of the broker/dealers in persuading Congress to allow them much greater leverage not long before the crisis. The best and the brightest get paid much more at Goldman Sachs than at the Office of the Comptroller of the Currency and so tend to work for the former. The infrastructure and other resources available to the regulatory agencies represent a fraction of the tools available to the leading financial institutions.
More insidiously, if your next job after being a regulator is with the regulated, how tough will you be on prospective employer? This revolving door between government and its “dependents” is all too evident between the military and its contractors as well as between Congress and lobbyists.
Fine. But let’s learn our lessons from this.Relative to the regulators, the market has been much more effective at imposing discipline and ending dumb things. Bear Stearns’ and Lehman’s repo lines dried up as soon as it became apparent what they held and that the taxpayers would not step in. The Euro Zone is now approaching a crisis point because no one buys from governments unable to make good on their bonds, just as no one lends to the banks that are loaded with such debt. The market has been far from perfect in this regard, of course. But although Milton Friedman famously noted that the market predicted nine of the previous five recessions, he omitted to mention that economists and regulators predicted none.
Make Real Choices Not Wish Lists
Damon Runyon once said, “The race is not always to the swift, nor the battle to the strong – but that is the way to bet it.”
Markets have a much better track record than regulators in indicating increasing risk and in forcing actions that reduce that risk. Our actions to make another great crisis less likely should be focused on making markets more effective. That means forcing much greater levels of very timely disclosure of what is in trading and loan books as well as of what collateral stands behind obligations, not just at the transaction level but in terms of aggregate exposure to counter-parties and the like. Anyone who has tried to extract usable risk information either from public company filings or from published regulatory data knows that most of what counts has been deliberately obscured by aggregation, omission or worse.
The wave of new regulation has, in small part, attempted to address this issue. In particular, there has been an attempt to force all derivative transactions to be conducted through exchanges. This would both make price and volume visible and force adequate collateralization from all parties. Price and volume disclosure would enable much smarter purchasing as well as calculation of aggregate exposure. Full bilateral collateralization would prevent any entity from becoming dangerously over-extended: It would have to raise huge amounts of good collateral before it could do so. But no moves have been made to significantly amplify any other details of actual exposure to credit or market risk.
Even the small steps that have been taken triggered howls of protest, both from the broker/dealers and from “industrial users.” That the broker/dealers object is hardly surprising: OTC derivative business is their most profitable precisely because it is utterly opaque. Customers can’t shop for price and terms in any systematic way.
The “industrial users” say that the requirement to post collateral against “hedging” (they never speculate, of course) would raise their costs and be passed on to consumers. This is as risible as the posturing of the broker/dealers. First, no industrial company “hedges” 100% of whatever is at risk. Indeed, the big energy and commodities firms have trading operations bigger than those of most banks. Second, you can bet that if an industrial user exemption is granted, many financial institutions will sprout industrial subsidiaries. Third, if transparency helps to avoid market crises, the costs of holding collateral will be a very small price to pay to avoid losses of the type we saw in 2008 and 2009.
The big players have the money to lobby for the regulatory solution rather than the market solution of enormously enhanced disclosure. And of course the regulators support them – for jobs, resources and a secure future. We users of the market need to stand up for the market, for those with the loudest voices in the current debate will not.
George Feiger is CEO of Contango Capital Advisors (Contango), the wealth management arm of Zions Bancorporation and an affiliate of Zions First National Bank. The opinions expressed above are solely those of Mr. Feiger, and do not necessarily reflect the views of Zions Bancorporation, its affiliates or its management.
IMPORTANT NOTE: Wealth management services are offered through Contango, a registered investment adviser and a nonbank subsidiary of Zions Bancorporation. Investments are not insured by the FDIC or any federal or state governmental agency, are not deposits or other obligations of, or guaranteed by, Zions Bancorporation or its affiliates, and may be subject to investment risks, including the possible loss of principal value of amount invested.