How Not to Solve a Crisis
…is the title of a useful contribution to the discussion from the International Policy Network in London and the Lion Rock Institute in Hong Kong. Their recommendations for finding a way out of the financial mess are worth attending to:
• Better mechanisms are needed to manage the failure of large financial institutions, some of which may now be both too big to fail and also too big to rescue.
• Open ended guarantees to depositors and other counterparties are expensive and unsustainable in the longer term.
• The rights and hierarchy of investors across the capital structure should be clear and honoured – not subject to arbitrary alteration by government.
• Closer attention to the rights of collateral providers and custodians in the case of failures can limit systemic risks.
• Hedge fund failures have not created systemic risks in this crisis and they should not be a target of policy action.
• Ad-hoc bailouts should be avoided, since they create ever expanding demands for further intervention.
• Much more thought needs to be given to the unintended consequences of over strict capital rules, rating agency privileges and rating based limits on pension investments.
As the authors say, “free markets thrive on creative destruction” and these recommendations would help in that respect. In fact, when it comes to free markets, creative destruction isn’t a bug. It’s a feature!
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Life’s two certainties (being sold out by the Swiss may be one of them)
As yesterday’s New York Times reports. Lost in the universal focus on the credit crisis, we have seen a somewhat troubling change taking place in Switzerland’s longtime bank secrecy laws.
Switzerland’s tax authorities, under pressure from a growing United States investigation into the Swiss bank giant UBS, are expected to hand over confidential data on wealthy American clients of UBS to the Justice Department, two people briefed on the matter said Tuesday.
The move would represent a significant shift in Switzerland’s banking secrecy laws, whose tradition dates to the Middle Ages.
Swiss neutrality (which is irritable to some) and stability has enabled its banking sector to become a source of prosperity for the nation. Reasonable exceptions to their secrecy laws for actual criminal activity should be allowed, but forcing banks to share private information on its clients merely for ’suspicion’ of tax evasion (something often disputable due to folks scrounging through the complicated tax code to reduce liability) seems quite dangerous. Especially since Swiss tax law has a different view of tax evasion than the U.S.
Swiss law makes disclosure of client data or names a crime unless the Swiss authorities think that the client has committed a serious crime, like money laundering or tax fraud. Unlike in the United States, Switzerland does not consider tax evasion to be a crime, though both countries have largely similar definitions of tax fraud.
And the Swiss are capitulating! In direct contradiction to their own legal view of tax evasion. Even though some may argue that this is moot because the U.S. does not consider a financial transaction as something beholden to privacy rights, the Swiss do–and besides, the U.S. view is wrong. A person’s financial records should be considered as sacred as their medical records.
Every citizen should maintain a healthy distrust of its government, after all, we have seen federal bureaucracies used to abuse the rights of citizens in many ways by many different regimes. If the government has the power to search through someone’s private financial dealings in another country solely on suspicion, where does our right to privacy stand? In terms of what constitutes law-breaking in one country as opposed to another, can the U.S. impose its view of a crime on another sovereign nation? Here, the U.S. Justice Department wants to see foreign bank records of thousands for the suspicion of committing an act NOT considered a crime in the country in which those records are held (I know, it happens).
Under pressure in recent months from the Justice Department, Switzerland’s justice ministry, taxing authority and banking regulator have adopted the view that some American clients of UBS may have committed tax fraud.
Note what this says, “Under pressure…[from the DOJ],” Swiss officials “have adopted the view…” that sees, contrary to their own law, these folks as criminals–because the DOJ ’suspects’ that they are.
So where does this lead? If the DOJ can pressure a foreign authority into ignoring its own legal views, where does this leave the U.S. on other issues, namely environmental and other laws that seek to usurp national sovereignty (there are a few)? What’s worse, under U.S. tax law, a U.S. citizen can still be taxed on income he earns outside of its borders and cannot renounce his citizenship solely to avoid taxes (how they’d find out who knows)–which is in my opinion just wrong–leaving you with the IRS and DOJ chasing down every red cent of your money they feel entitled to. Add to that some of the invasive banking provisions of the PATRIOT Act, and you have further intrusion into people’s lives and business by a government that knows no boundary. This is not a “pro-rich” or pro-tax cheat view, but a pro-civil rights and sovereignty view.
-GH
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CDS’s House of Cards
It’s been called a ticking time bomb by Investor’s Business Daily. CNNMoney asks if this will be the next disaster. Yet the Feds are delaying one key in bringing stability to our financial markets.
As a $62 trillion dollar over the counter market, CDSs need an exchange or central clearinghouse to provide transparency and collateral requirements. CME (formed from the Chicago Board of Trade and the Chicago Mercantile Exchange) and the Clearing Corp (formed from 17 financial players including UBS and Goldman Sachs) have stepped up to the plate. Clearing Corp could have had a clearinghouse up and running within a week or so; however, the Fed has pushed Clearinghouse to obtain a banking license which will probably delay its opening until next year. But with each bank that is removed from this house of cards the threat of meltdown is increased. The banks are falling one after another internationally, and with the CDSs so intertwined, its only a matter of time until when you take away one more card and they all fall.
According to Bloomberg, “Barclays analysts estimated in February that if a financial institution that had $2 trillion in credit-default swap trades outstanding were to fail, it might trigger between $36 billion and $47 billion in losses for those that traded with the firm. That doesn’t include the market-value losses investors face as the cost to protect companies against a default widens.”
Perhaps it would be a good idea for the Feds to speed their approval process?
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What Are Markets For?
There are all sorts of people today who normally talk about free markets but who have got themselves into a tizzy over the failed bailout. We need to get one thing straight - the bailout was the wrong answer to the wrong question. To begin with, the plan was merely postponing the inevitable, as a letter in the Wall Street Journal pointed out this morning:
The lesson of past financial inflection points is that we must let the markets reallocate capital from less efficient to more efficient uses. The sad fact is that we need to go through a brutal process of resizing down our financial and real-estate industries. Actions to try to recapitalize doomed financial companies only postpone the day of reckoning, which will make matters worse as the Japanese learned in the 1990s.
Secondly, we have to ask how to protect future viable assets and investments, not just what we should do about past failed assets and investments. The bailout plan is exactly the wrong approach. It puts in them in jeopardy because not only does it tread down the policy road that led to the Great Depression, as Martin Hutchinson powerfully argues, but because real capitalism provides strict disciplines that actually provide better protection than government regulation. We will not succeed in protecting our children from a future financial meltdown if we merely put in place the exact parameters for it to happen again.
Markets are all about the efficient allocation of capital. As has been demonstrated on this page repeatedly, government caused the market to misallocate badly. If we go further and have government misallocate the capital by design, then we will have made one of the biggest missteps in economic history, worse than FDR and co, because we will have completely ignored the lessons of the great depression. A market correction is, in a very real sense, necessary. Government cannot bring that about.
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Washington Post Blames Private Sector for Government Failures
On the front page of the Washington Post, writer Steven Pearlstein contradicts himself by writing that mortgage giants Fannie Mae and Freddie Mac are being “rescued from the harsh discipline of markets and the consequences of their own misjudgments,” undercutting arguments for “privatization, deregulation, and a faith in free markets.”
But the failure of Fannie Mae and Freddie Mac is hardly an indictment of the free market: Fannie and Freddie are “Government-Sponsored Enterprises,” not products of the free market or the private sector.
Moreover, mortgage lending is not exactly an unregulated, free market. Just a few days ago, Pearlstein himself admitted in his column that federal affordable-housing mandates deserved a “good chunk of the responsibility” for the Fannie and Freddie failures that he now blames on the free market. (Earlier, we noted that federal regulations promoting “affordable housing” and “diversity” helped cause the real estate bubble and the mortgage crisis). Continue reading this post »
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