Seven habits finance regulators must acquire
By Martin Wolf
“Simply stated, the bright new financial system – for all its talented participants, for all its rich rewards – has failed the test of the market place.” Paul Volcker, April 8 2008
Paul Volcker is the giant among contemporary central bankers, both literally and figuratively. He it was who had the moral courage to crush inflation as chairman of the Federal Reserve between 1979 and 1987. When Mr Volcker speaks, people listen. What he had to tell the economic club of New York last month was well worth listening to. His summation, cited above, was so devastating, because so true.
Mr Volcker noted that this crisis is not unique. On the contrary, “today’s financial crisis is the culmination, as I count them, of at least five serious breakdowns of systemic significance in the past 25 years – on the average one every five years. Warning enough that something rather basic is amiss.” Those who do not heed such warnings are fated to suffer something yet worse.
So what is to be done? There is a part of me – quite a large part, in fact – that says: “Forget regulation: it will never work. Apart from normal laws against fraud, let the financial system live and die by the laws of competitive markets. If businesses fail, let them simply go down, with all their shareholders, customers and employees. Meanwhile, we will remind users constantly of the dangers.”
I suspect this approach might give us a better financial system than the one we have today. But it is one we cannot have because governments will not dare let us, as experience with Northern Rock and Bear Stearns has reminded us. The public, governments feel, must be protected from banks and banks must be protected from themselves. Finance is deemed far too important to be left to the market.
Given this, regulation will need to be radically reconsidered, unless, as Mr Volker points out, we are comfortable with a substantial financial crisis every five years or so. However great the lobbying power of the financial sector, it will surely be unable to preserve a licence to commit havoc on such a scale, particularly when, as he also remarks, “it is hard to argue that the new system has brought exceptional benefits to the economy generally”.
So far tighter regulation is desirable in the longer-run interests of the industry itself, let alone the public’s. What, then, should such regulation look like? Here I would like to analyse what I see as the fundamental issues. I am influenced in doing so by an excellent recent paper* from Nouriel Roubini of New York University’s Stern Business School.
So here are seven principles of regulation. I call them the seven “Cs”.
First, coverage. Perhaps the most obvious lesson is the dangers of regulatory arbitrage: if the rules required certain capital requirements, institutions shifted activities into off-balance-sheet vehicles; if rules operated restrictively in one jurisdiction, activities were shifted elsewhere; and if certain institutions were more tightly regulated, then activities shifted to others. Regulatory coverage must be complete. All leveraged institutions above a certain size must be inside the net.
Second, cushions. Equity capital is the most important cushion in the financial system. Also helpful is subordinated debt. If Bear Stearns had had larger equity capital, the authorities might not have needed to rescue it. Capital requirements must be the same across the entire financial system, against any given class of risks. But there must also be greater attention to the adequacy of that other cushion: liquidity.
Third, commitment. The originate-and-distribute model has, it is now clear, a huge drawback: originators do not care sufficiently about the quality of loans they plan to offload on to others. They do not, in Warren Buffett’s phrase, have “skin in the game”. That makes for sloppy, if not irresponsible or even fraudulent lending. Originators should be required, therefore, to hold equity portions of securitised loans.
Fourth, cyclicality. Existing rules are pro-cyclical. Capital evaporates in bad times, as a result of write-offs, thereby forcing contraction of lending, worsening the economic slowdown and further impairing assets. Mark-to-market accounting, though inherently desirable, has a similar effect. One solution could be to differentiate between target levels of capital and a lower minimum level. Institutions that have minimum capital in bad times would only be required to aim for the higher target level over an extended period.
Fifth, clarity. Lack of information, asymmetric information and uncertainty are inherent in financial activities. These are why they are vulnerable to swings in collective mood. The transactions-orientated financial system is particularly vulnerable, because information has to flow freely across arms-length markets. So a big challenge is to generate as much clarity as is possible. One issue is the calamitous recent role of the rating agencies and the conflicts of interest under which they operate.
Sixth, complexity. Excessive complexity is a significant source of lack of clarity. It is particularly damaging, as we have seen, to the originate-and-distribute model, because markets in complex securitised products may, at times, seize up, forcing central banks to become “market makers of last resort”, with all the difficulties this entails. One possibility then is to insist that all derivatives be traded on exchanges.
Seventh, compensation. On this I can do no better than quote Mr Volcker: “In the name of properly aligning incentives, there are enormous rewards for successful trades and for loan originators. The mantra of aligning incentives seems to be lost in the failure to impose symmetrical losses – or frequently any loss at all – when failures ensue.” Whether regulators can do anything effective is unclear. That this is a challenge is not.
John Maynard Keynes wrote of an eighth “c”. He argued that “when the capital development of a country becomes a byproduct of the activities of a casino, the job is likely to be ill done”. He had a point. Features of a casino will always be present in a financial system that performs the essential functions of guarding people’s savings and allocating them where they can do most good.
Regulation will always be highly imperfect. But an effort must still be made to improve it.
Obama seizes back initiative
By FT Reporters in Washington
Barack Obama extended his lead in the Democratic presidential race on Tuesday night with a commanding victory in the North Carolina primary election.
Hillary Clinton held a narrow victory in Indiana and vowed to press ahead with her uphill battle for the nomination. As the final votes were counted, her margin was tightened further to 51 per cent against Mr Obama’s 49 per cent, aided largely by older voters.
In North Carolina, Mr Obama won by a resounding 56 per cent to 42 per cent, helped by overwhelming support from the state’s large African-American population.
The Illinois senator described the result as a victory against the “politics of division and the politics of distraction” after a fractious fortnight of racially-charged debate.
”Tonight we stand less than 200 delegates away from winning the Democratic nomination for president of the United States,” he told a victory rally in Raleigh, signaling confidence that the nomination was within grasp.
Mrs Clinton, however, struck a defiant tone in a speech to supporters in Indiana, declaring victory in the state despite news organisations declaring it too close to call.
She recalled how Mr Obama had described Indiana as a potential “tiebreaker” because it was a most finely balanced of the recent states to vote.
“Tonight we’ve come from behind, we’ve broken the tie and thanks to you, it’s full speed on to the White House,” she told cheering supporters in Indianapolis.
The New York senator made clear that she intended to fight on through the remaining seven state contests over the next month, despite having little chance of overhauling her opponent’s lead in elected delegates.
Mrs Clinton is counting on convincing “superdelegates” -- the nearly 800 Democratic party leaders whose votes could swing the race – that she has the best chance of beating John McCain, the Republican candidate, in November.
She appeared to be regaining momentum after victories in Texas, Ohio and Pennsylvania over the past six weeks, while the Obama campaign was engulfed by the controversy surrounding Jeremiah Wright, his former pastor.
But Mr Obama’s lopsided victory in North Carolina, compared with Mrs Clinton’s much slimmer margin in Indiana, appeared likely to inject renewed confidence into his campaign and lengthen the odds against his opponent snatching the nomination.
Voting patterns in both states showed a continuing demographic split among Democratic voters. More than 90 per cent of African-Americans voted for Mr Obama in North Carolina, where they make up almost a third of the voters, and exit polls showed blue-collar white Democrats again strongly backing Mrs Clinton in both states. Almost half of voters also said the controversy Mr Obama’s former pastor influenced their vote.
For Democrats, the most disturbing aspect of Tuesday’s vote was the high and growing proportion of Mrs Clinton’s supporters who told exit pollsters they would not vote for Mr Obama in a general election – and vice versa.
Almost half of Mrs Clinton’s supporters and one in three of Mr Obama’s said they would vote for Mr McCain in November if the other secured the nomination. This suggests the widely observed racial breach that has been generated by the rancorous contest between the two continues to grow as the race drags on and will make it increasingly tough for the winner to unite the party against Mr McCain in the autumn presidential election.
Mr Obama acknowledged there were “bruised feelings’ on both sides of the contest but insisted the party would heal its wounds once the nomination was decided.
”This fall, we intend to march forward as one Democratic Party, united by a common vision for this country,” he said. ”We can’t afford to give John McCain the chance to serve out George Bush’s third term.”
Mrs Clinton made a similar call for unity, saying: “No matter what happens I will work for the nominee of the democratic party because we must win in November.”
The next contest is on Tuesday in West Virginia, which Mrs Clinton is expected to sweep. With black voters making up less than 5 per cent of the total, the largely blue-collar Appalachian state could give her a landslide.
Mrs Clinton made clear that she would continue fighting to have her victories in Florida and Michigan recognised despite both states having been stripped of their delegates by the Democratic National Committee because of an infringement of party rules.
Rice Climbs for Fourth Day After Cyclone Hits Myanmar (Update3)
May 7 (Bloomberg) -- Rice surged for a fourth day on speculation that Myanmar may be transformed from a net exporter to a buyer on the international market after last weekend's cyclone damaged crops and left as many as 60,000 people dead or missing.
Rice for July delivery rose as much as 50 cents, or 2.4 percent, to $21.60 per 100 pounds on the Chicago Board of Trade. Weekly prices from Thailand, the world's biggest exporter, are set to be released later today by the country's main exporters group.
Cyclone Nargis struck the main rice-growing area of Myanmar, worsening a food crisis that threatens as many as 1 billion Asians. The staple food for half the world has almost doubled in the past year, stoking protests and poverty from Haiti to the Philippines.
``The cyclone damage in Myanmar will further tighten rice supplies, especially in Asia'' Takaki Shigemoto, an analyst at Tokyo-based commodity broker Okachi & Co., said today by phone. ``This may drive importers to rush for supplies as the cyclone has made the rice exporter rely on food aid.''
Before the storm, the Food and Agriculture Organization had estimated that Myanmar may have exported 600,000 metric tons of rice this year, with shipments set for Sri Lanka and Bangladesh. That compares with estimated global exports this year of 29.9 million tons, according the Rome-based United Nations agency.
The most-active Chicago contract, which traded limit-up at $21.60 per 100 pounds at 11:48 a.m. Singapore time, has gained as much as 4.7 percent in the past four days.
Death Toll
State television said 22,000 people died and more than 40,000 were missing, the UN's IRIN news agency reported. Myanmar has a population of about 48 million people.
Surging food prices are hurting 1 billion Asians as the poor struggle to cope with rising costs, Asian Development Bank President Haruhiko Kuroda said on May 5. The World Food Program warned last month of a ``silent famine'' in Asia and Africa as the price of basic foods rose beyond people's reach.
The storm whipped up a 12-foot (3.66 meter) wave that inundated low-lying regions of the Irrawaddy delta, Ken Reeves, director of forecasting operations for AccuWeather.com, said in a statement. ``Sea-water reached 10 miles (16 kilometers) inland.''
The delta ``is the country's main rice-growing region,'' John Sparrow, a spokesman for the International Federation of Red Cross and Red Crescent Societies, said in a statement dated yesterday. ``Roughly 24 million people live there.''
`Further Tightening'
Myanmar's rice-output estimate may be cut because of the crop damage, according to an e-mail from Concepcion Calpe, a senior economist at the Food and Agriculture Organization. A drop in exports from Myanmar or increased imports to the nation would lead to ``further tightening'' of the world rice market, Calpe wrote.
Estimates differ for Myanmar's pre-storm rice production. The Food and Agriculture Organization has forecast output of 18.9 million tons of milled rice in the crop year to Oct. 31. The U.S. Department of Agriculture forecast production of 11.3 million tons.
The Philippines, the world's biggest rice importer, canceled a tender for 675,000 tons of rice this week because of a lack of offers. The government said it may seek fresh supplies in the second half when prices may have declined.
``Rice in Chicago now is driven by speculation,'' Sompong Kitireanglarp, president of Longlarp Ltd., Thailand's third- biggest rice exporter, said by phone in Bangkok.
The damage from the cyclone was ``huge'' and Myanmar may be forced to seek imports of rice, Chookiat Ophaswongse, the president of the Thai Rice Exporters Association, said yesterday.
Myanmar Toll May Reach 60,000; UN Wants Aid Access (Update3)
May 7 (Bloomberg) -- Myanmar said as many as 60,000 people may have died in last weekend's cyclone as United Nations agencies called on the military government to allow international workers to start relief operations.
State television reported that 22,000 people died and more than 40,000 are missing after the southern Irrawaddy delta that feeds into the Andaman Sea was swamped by a surge of water as high as 12 feet (3.5 meters), the UN's IRIN news agency said.
``We are in close contact with the government on the response,'' said Chris Kaye of the World Food Program. ``Much more cooperation will be required.'' The WFP is distributing the 800 metric tons of food stocks it holds in Yangon, the former capital, Kaye said in an e-mail from Thailand.
More than 1 million people may be homeless after Tropical Cyclone Nargis hit the country, causing the worst natural disaster in Southeast Asia since a tsunami in 2004 killed more than 220,000 people across the Indian Ocean. Aid officials are waiting for the military to approve visas and allow them in to distribute supplies sent by countries including India and Thailand, the UN said.
Outside Influences
The military rulers are ``suspicious of outsiders and very sensitive to foreign influences,'' Maureen Aung-Thwin, director of the Burma Project, said in an interview with Bloomberg Television today. ``They admitted to 22,000'' people killed, she said. ``I believe the figure is higher than that. Somebody said 150,000 and I don't think that's untrue.''
The organization, set up the Open Society Institute, a New York-based pro-democracy body founded by billionaire investor George Soros, says it aims to raise international awareness of conditions in Myanmar, formerly known as Burma.
The country of 47.8 million people is regularly hit by cyclones that form in the Bay of Bengal between April and November. It has been under international sanctions since the military rejected the results of elections in 1990.
Such measures have restricted economic growth in Myanmar, which had proven gas reserves of 17.7 trillion cubic feet at the end of 2005, or 0.3 percent of the world's total, according to BP Plc, and resources including teak, zinc, copper and precious stones. Almost 33 percent of people live below the poverty line, according to U.S. government data.
Transparency International last year ranked Myanmar as the most corrupt nation in the world along with Somalia.
State of Emergency
Myanmar's government declared a state of emergency in five low-lying provinces, mostly in the rice-growing Irrawaddy delta, the UN said. The storm followed ``the worst track possible'' for the people of the region, forecaster AccuWeather.com said.
``As the storm moved eastward toward the delta, southerly winds over 100 miles per hour shoved a massive amount of water across the flatlands, which are barely above sea level,'' the U.S.-based service said. ``There was simply nowhere to flee from the fast onrush of the ocean.''
The worst-hit areas are becoming accessible for the first time and the death toll is ``increasing rapidly,'' Richard Horsey, a spokesman for the UN Office for the Coordination of Humanitarian Affairs said in an interview with Bloomberg Television from Bangkok today.
``We are struggling to get essential clean water and health provisions out to prevent a second wave, if you like, of disaster,'' he said. ``It may be the case that the current death toll is not the final death toll, unfortunately.''
Visas Approved
Some workers have had visas approved to enter the country and ``others are in the pipeline,'' John Sparrow, a spokesman for the International Committee of the Red Cross, said in Malaysia's capital, Kuala Lumpur, today.
Damage to the main rice-growing region is ``extremely worrying,'' he said. ``There is a concern that there may be hoarding of food. There certainly are reports of some food items running out.''
Myanmar ``needs the cooperation of people and well-wishers from at home and abroad,'' IRIN cited Information Minister Brigadier General Kyaw Hsan as saying at a news conference yesterday. The junta is ``doing its best'' to help victims.
The U.S., which leads international calls for the military to restore democracy to Myanmar, boosted its offer of aid yesterday to $3.25 million from $250,000 and said it is making available naval assets, which played a key role during relief efforts after the Indian Ocean tsunami.
``Let the United States come help you help the people,'' President George W. Bush said yesterday as he signed legislation lauding Myanmar's opposition leader Aung San Suu Kyi, the Nobel Peace Prize winner who is under house arrest.
Aid Offered
Countries offering aid include Canada, New Zealand, Finland, Norway, China and the European Union. Australia pledged $2.8 million toward providing clean water and shelters, Foreign Minister Stephen Smith said today.
Myanmar, ruled by the military since 1962, is scheduled to hold a referendum on May 10 for a new constitution before elections in 2010. The government said the vote will go ahead, except in the worst-affected areas where it will be delayed until May 24.
``Whether it is held on the 10th of May or the 24th of May or next year, is neither here nor there,'' Smith told Australian Broadcasting Corp. radio. ``It is a completely fundamentally flawed process just aimed to bolster the regime.''
Obama Moves Closer to Nomination With Victory in North Carolina
May 7 (Bloomberg) -- Barack Obama decisively defeated Hillary Clinton in North Carolina, while holding her to a narrow victory in Indiana, moving him closer to gaining enough delegates to clinch the Democratic presidential nomination.
Voters turned out in record numbers, handing Obama a 15- point victory in North Carolina, the more-populous and delegate- rich of the two states holding primaries yesterday. Clinton won by 2 points in Indiana.
``Once Obama won big tonight in North Carolina, he stopped her momentum train and picked up some serious steam of his own,'' Jenny Backus, an unaligned Democratic strategist, said after the vote. He ``rallied and turned the corner.''
Clinton isn't likely to make a dent in Obama's delegate lead in the five remaining states, plus Puerto Rico, that will hold contests in the next month. Before yesterday, he led 1,748 to 1,613 in delegates to the nominating convention, according to unofficial tallies by Bloomberg News and the Associated Press. A candidate needs 2,025 to win.
Obama won 19 more delegates than Clinton in the two states, according to a preliminary tally by AP.
Obama could seal the nomination if there's a rush of endorsements during the next week by superdelegates -- the 795 party officials and lawmakers who aren't bound by the results of primaries and caucuses. He has outpaced Clinton 51 to 23 in support from superdelegates since the March 4 primaries in Texas and Ohio, which Clinton won.
Time to Unite
Before yesterday's primaries, Clinton's lead in superdelegate endorsements was less than 20, according to a Bloomberg News analysis based on lists from the campaigns and public announcements. Obama's campaign says he's likely to erase that lead soon.
``I think we will see, with these outstanding results, a very logical increase in the number of superdelegates who support Barack,'' said campaign co-chairman Eric Holder. ``It is finally time to unite this party and get ready for the general election.''
Supporters of Obama, 46, an Illinois senator, say the superdelegates should follow the ``will of the people'' reflected in the results of primaries and caucuses that have favored him in the popular vote and delegate count. Clinton, 60, a New York senator, says she's the better candidate to take on presumptive Republican nominee John McCain.
McCain, who sewed up the Republican nomination in March, also posted victories in Indiana and North Carolina yesterday. Still, more than 20 percent of voters in each state opted for someone else in the Republican primaries, raising the prospect of support for a third party in November.
`Bruised Feelings'
Obama, speaking to supporters in Raleigh, North Carolina, last night, promised unity for the Democratic Party.
``Yes, there have been bruised feelings on both sides; yes, each side desperately wants their candidate to win,'' he said. Even so, ``we intend to march forward as one Democratic Party,'' he said.
He won North Carolina, which had 115 pledged delegates at stake, by more than 232,000 votes, topping the 214,000-vote edge Clinton took out of the April 22 Pennsylvania primary.
Clinton wasn't showing any sign of giving up. ``Thanks to you, it's full speed onto the White House,'' she told supporters in Indianapolis, while the votes were still being tallied in Indiana. ``Tonight, Hoosiers have said that you do want a president who stands strong for you.''
Racial Divide
Obama, who would be the nation's first black president, benefited from a racial divide in both states. He won 92 percent of black voters in Indiana and 91 percent in North Carolina, where they represented a third of the total number casting ballots, television networks reported, citing exit polls.
Clinton, the former first lady, captured majorities among her traditional constituencies in Indiana, drawing the support of 58 percent of white men, 71 percent of senior citizens and 51 percent of lower-income workers, according to exit polls cited by Fox News.
Obama's long-held lead in North Carolina polls narrowed in recent days as Clinton put up a fight for the state and Obama struggled through what he called ``a rough couple of weeks'' amid a controversy surrounding comments made by his former pastor, the Reverend Jeremiah Wright.
Tax `Holiday'
Much of the back-and-forth between the two candidates over the last week involved Clinton's proposal for a ``holiday'' from the gas tax over the summer months. She criticized Obama for not doing enough for consumers because he opposed the plan.
Obama called the idea an election-year ``gimmick'' and said it wouldn't save consumers money because oil companies would probably pocket the money. Economists agreed with him.
The Obama campaign also said exit-polling data suggested some Republicans voted in the open Indiana primary just to prolong the race. Conservative talk show host Rush Limbaugh urged his listeners to vote for Clinton to make it easier for McCain in November.
In the end, it wasn't enough. ``There just isn't much time left for Clinton to make up lost ground,'' said Barry Burden, a political science professor at the University of Wisconsin in Madison.
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