Amazing write up must read:)
The United States is supposed
to have not just great markets
and great enterprises, but also
great regulators. The Federal
Reserve and the Securities and Exchange
Commission are respected
and feared the world over. Those great
markets also rely on institutional
mechanisms, like the rating agencies
— all of which are now Americanowned.
The amazing thing about this
entire pack is that the financial crisis
has shown all of them to be as naked
as the emperor who strutted out in
what he thought were his new clothes.
What, for instance, was the SEC
doing when the great investment
banks (Bear Stearns, Lehman Brothers,
et al) were leveraging their equity
30 and even 40 times? If a company
runs $600 billion worth of assets
on an equity base of just $26 billion,
then if those assets drop in value
by just 5 per cent, the company
goes bankrupt — which is what has
happened. If the SEC wasn’t looking
at the problem, what were the rating
agencies doing when they gave
these
firms the best ratings in the book?
If the risks are blindingly obvious today,
why could the Fed not see them
and ask for corrective action from the
lawmakers or by the SEC?
It seems obvious now that the
whole investment banking model is
simply not viable. They made fat
profits because they ran risky, overleveraged
businesses; and they were
not regulated in the way that traditional
banks are, so they did not
have any defences in place for when
things go wrong. That explains why
it is banks like Bank of America
which are now gobbling up the investment
banks, and why Morgan
Stanley is running for cover to Wachovia
and others.
When Enron went bust, it was run
by a bunch of Harvard MBAs, advised
by McKinsey, and its accounts audited
by one of the big accounting
firms (which imploded). It turned out that the
accounting firms were busy
getting money from their clients
for doing consulting work — which
created a conflict of interest when
it came to proper auditing. That same
problem now affects the rating agencies,
which were getting a lot of work
and therefore revenue from the investment
banks. So did they go soft
in their ratings of the investment banks
— and mislead the markets? In any
case, did the people in the rating agencies
actually read and digest the thousands
of pages of legalese associated
with every complex financial instrument
before they gave a rating,
for which the fee was relatively modest?
You can guess.
In other words, it is not just the
investment banking model that is
broken, it is the entire system of complex
financial instruments that no
one fully understood, so that risk
was not properly measured — and
that is lethal when things start unraveling.
The trading practice that
makes things unravel even faster in
such a situation is called ‘going short’
— a practice long frowned on by Indian
regulators for being destructive
of value, but advocated by market
fundamentalists as being an
inalienable part of an efficient market.
Now, surprise, the SEC is talking
of banning ‘shorting’ because
that is causing the selling stampede
behind the bankruptcies!
Someone said the other day that
the worst is over. Don’t bet on it.
All the assets owned by the firms that
have gone bust (trillions of dollars
worth) have to be sold, and it will
be a fire sale at knocked down prices.
That means enormous destruction of
asset value, and someone has to feel
the pain. AIG, for instance, has been
given two years to sell down, so it
is going to last a while.
Closing thought: It isn’t funny any
more to say that the Indian financial
regulatory system shines because
of its innate caution.
T N Ninan
