Thursday, June 2, 2011

Building a Stronger Financial System

The other day, I posted that Mark Mobius thinks we will have another financial crisis:

"There is definitely going to be another financial crisis around the corner because we haven't solved any of the things that caused the previous crisis..." - Mark Mobius

From what seems to me an unexpected source, Carl Icahn similarly had this to say recently on CNBC:

"I know a lot of my friends on Wall Street will hate my saying this, but the Glass-Steagall thing or something like it wasn't a bad thing...a bank should be a bank. Investment bankers should be investment bankers. Investment bankers serve a purpose...but I think today, and I know a lot of people won't like hearing this...I think we're going back in the same trap, and I will tell you that very few people understood how toxic and how risky those derivatives were."

A little over a year ago, Bogle offered this opinion about the financial system in a CNBC interview:

"I would be cheering for the return of the Glass-Steagall Act," Bogle said, referring to the Depression-era law that banned banks from owning brokerage firms and other financial firms, among other restrictions. "It's pretty much common sense that if you're in the business of taking deposits, you shouldn't be speculating on your balance sheet."

We know Paul Volcker shares similar concerns. It has been difficult to even get a compromised version of his fairly mild (though certainly a step in the right direction in my view) Volcker rule put into place. The implementation of that rule is apparently still months away due, in part, to intense lobbying against the rule.

Reuters: Goldman Lobbying Hard to Weaken Volcker Rule

"They're totally freaked out about Volcker," said a Goldman lobbyist who declined to speak on the record for fear of losing the contract. "People are working on that a lot, with agency staff, with lawmakers, you name it."

Then later in the article...

Goldman has hired an all-star team of lobbyists and former government officials, leveraging powerful connections to get its message across to regulatory and political leaders.

Reuters: Volcker Says Identifying Speculative Trading is Easy

Volcker said he was concerned that the lobbying efforts might water down his eponymous law. He also said banks that find it hard to comply with proprietary trading restrictions probably should not be granted the protections and funding advantages of being part of the Federal Reserve system.

"Obviously, there's a lot of lobbying going on," said Volcker. "But if you want to be a bank, follow the bank rules. If Goldman Sachs and the others want to do proprietary trading, then they shouldn't be banks."

Charlie Munger, not surprisingly, expressed even stronger views against the current system.

In a Forbes interview last year, when many were balking that the Volcker rule was too harsh, Munger said he'd "make Paul Volcker look like a sissy" when it comes to reform:

"I would separate derivatives from the basic bridges of civilization. We don't want civilization contaminated by extreme speculation. I'd ban all the derivatives trading except for metals and commodities. The new stuff is a marvelous gambling game. It swamps any commercial transactions that are needed. Gambling does not become wonderful just because it pertains to commerce. It's a casino." -Charlie Munger

What I see here is a collection of, give or take, similar views that are largely being ignored (just a few hundred years of collective business and finance experience here). Their goals seem mostly oriented toward the promotion of greater system integrity. I just think it is worth noting that none of them seem to have much to gain personally if aspects of the restraints they are recommending become implemented. The conflicts of interest, it would seem, are minimal.

In contrast, the investment banks clearly have plenty to gain directly from blocking reform.

Yet, besides the Volcker rule which is still in flux, their concerns seem largely ignored with only token changes likely to be implemented. None of the proposed/pending reforms come even close to addressing the fundamental flaws in the system that got us into trouble last time.

James Grant wrote in Money of the Mind"Progress is cumulative in science and engineering, but cyclical in finance." 

John Kenneth Galbraith* also wrote the following in A Short History of Financial Euphoria: "The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version."

It would seem to be more than a little unwise to not seriously consider at least some of the above views and sentiments.


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