Wednesday, 3 October 2012

New Regulations for Old Sins

I do not know neither Michel Barnier nor Erkki Liikanen (the European Commissioner for Internal Market and Services and the governor of the Central Bank of Finland respectively), nevertheless I quite like their proposals. Here's what the latter's report stated:
"The group has concluded that it is necessary to require legal separation of certain particularly risky financial activities from deposit-taking banks within the banking group. The activities to be separated would include proprietary trading of securities and derivatives, and certain other activities closely linked with securities and derivatives markets."

I do not know how bankers may feel about this, yet still I believe its a good idea. Not so radical and effective as breaking up the banks into independent entities, but still good. What their proposal would do, is to "safeguard" depositors from banks which are willing to invest in forms of investment banking activities and not just the deposit-and-loan model. This would mean that both states and depositors are safer against any trades which end up bad. (You may ask the now bankrupted Barings Bank, once the greatest bank in the world, what may happen when a trader does something foolish. For a more recent example have a look at Société Générale's losses due a single trader's mistake last year)

Although, to be fair, it was not the traders who caused the 2008 sub-prime lending crisis. It was the banks themselves. Through debt securitization, banks are allowed to lend much more capital than they currently have. (for further details on how this works have a look at this). This would mean that they are more susceptible to prices of the assets they use as collateral than they were before.

The expert committee has also recommended that property lending should be underpinned with larger capital reserves than now and executives should receive part of their bonuses in the form of bonds to ensure that they contribute to any bailout of their bank. What would be even better is a solution Warren Buffett has proposed: No bonuses at all, just loans to the executives to buy ordinary shares. This would tie the executives to their firms, knowing that if the bank prospers they will prosper as well. 

On a different note, Mario Draghi is fighting a growing opposition (notably from the German side) about his OMT plan. Concerns about the feasibility or legality of such a move have been raging since the announcement. (For a review of Draghi's responses and his competitors' comments Der Spiegel has a very interesting article, found here). As for myself, I do believe that the longer we may go without using any of these plans, the better. Time allows economies to move from one end of the cycle to another. Yeah, fine, it may also be the case that they stay where they were or become even worse, but still, this does not seem to be the case with any nation in the EU (maybe except Spain). Although things appear bad now, they will be slightly better in 2013 for most countries (again here I exclude Spain and now Cyprus). Let's hope that Draghi will not have to use his guns to safeguard the Union.

P.S. On the Spiegel article mentioned above I read that people in Germany have a fond memory of the mark. No kidding! I bet the Spanish remember the peseta and the Italians the lira with a certain degree of fondness. And would someone guess why? Well, simply because things were better than they are now before the introduction of the Euro in both Germany and the South. Or at least that's how they remember them to be! They were not reminiscent of the mark 3 years ago when everything was fine.

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