The IMF has announced release of the March 2009 edition of Finance & Development.
One article caught my interest: What is to be Done:
What is clear from the latest crisis is that the perimeter of regulation must be expanded to encompass institutions and markets that were outside the scope of regulation and, in some cases, beyond the detection of regulators and supervisors.
Only in this way will dedicated and intelligent ex-regulators be able to compete for cushy jobs at shadow-banks.
To avoid overburdening useful markets and institutions it is important to identify carefully the specific weaknesses that wider regulation would seek to address (so-called market failures). This could be achieved by a two-perimeter approach. Many financial institutions and activities would be in the outer perimeter and subject to disclosure requirements. Those that pose systemic risks would be moved to the inner perimeter and be subject to prudential regulations.
I’ve argued for this all along: what we need is a rock-solid banking system, surrounded by a more exciting investment banking industry, surrounded in turn by a wild-n-wooly world of shadow banks and hedge funds.
There are several ways of [mitigating procyclicity], but a simple one would be to make capital requirements countercyclical—the amount of capital required to support a given level of assets would rise during booms and fall during busts. Ideally, these countercyclical capital regulations would not be discretionary, but built into regulations, becoming an automatic stabilizer that during upturns would enable supervisors to resist pressures from either firms or politicians to let things continue on their upward trajectory.
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it would also be helpful to apply a maximum leverage ratio—such as high-quality capital divided by total assets—including off-balance-sheet entities, as a relatively simple tool to limit overall leverage in financial institutions during an upswing.
This echoes today’s BIS release – not entirely by chance, I’m sure.
Although fair value accounting methods, requiring institutions to value assets using current market prices, serve as a good benchmark in most situations, the crisis made it apparent that in periods of deleveraging, they can accentuate downward price spirals. If a firm has to sell an asset at a low price, other firms may have to value similar assets at the new low price, which may encourage the other firms to sell, especially if they have rules against holding low-valued assets. Thus, accounting rules should allow financial firms with traded assets to allocate “valuation reserves,” which grow to reflect overvaluations during upswings and serve as a buffer against any reversions to lower values during downturns. Similarly, values of assets used as collateral, such as houses, also tend to move with the cycle. More room is needed in the
accounting rule book to allow the reporting of more conservative valuations, based on forward-looking and measurable indicators.
This will be somewhat controversial, to say the least. The SEC specifically went after hidden reserves in the first half of this decade, on the grounds that profit-smoothing, not prudential management, was the objective.
Any form of bookkeeping can be abused. What’s important is disclosure.
Many of the new structured credit products were supposed to distribute risk to those who, in theory, were best able to manage it. But in many cases, supervisors and other market participants could not see where various risks were located. What’s more, risks often were sliced and diced in ways that prevented the packagers of the risks and the purchasers from thoroughly understanding what risks they had sold or acquired. Moreover, the underlying information used to price such complex securities was not easily available or able to be interpreted.
Easy to fix. Repeal Regulation FD. A credit rating agency will, I’m sure, refuse to rate structured investments on the basis of what is currently public information. No Rating = No Sales. Repeal of the exemption allowing rating agencies access to material non-public information will … well, it won’t change anything, but at least there’ll be less whining next time.
Data on prices, volumes, and overall concentration in over-the-counter markets also need attention because they are typically not recorded in ways that allow others to see transaction information, limiting liquidity in periods of stress. A clearing system can be used to collect (and to net) trades, allowing participants and others to see how much total risk is being undertaken.
Ex-regulators will also be able to find jobs at clearing sytems – a major leap forward for prudential regulation!
The sooner markets can discern the direction new regulations are taking, the sooner investors can consider the new environment. Because many investors expect heavy-handed regulatory reforms, they are waiting before deploying their funds in various institutions and financial markets. The uncertain regulatory landscape makes it difficult to gauge which business lines will be productive and which may be regulated out of existence.
Hear, hear!