Tuesday, 17 September 2013
5 years after Lehmans collapse, when the world came within a whisker of complete financial and economic meltdown its a good time to ask whats really changed in the world of finance since those dark days in September 2008?
Over the next few of weeks I'll look at the main positive and negative changes since 2008, starting firstly with regulation.
The last 5 years has seen lots of new financial regulation - some of it excellent and insightful, some of it awful and pointless. The time it has taken for large regulatory initiatives to take place is surprising but we have now seem wide-ranging requirements in relation to taxation (FATCA), consumer protection (Dodd Frank), banking (Basel & MIFiD) and hedge funds (AIFMD & Form PF).
Whether all this makes much difference long term is a matter for debate. There will likely always be financial crashes as the economic cycle of boom & bust/greed & fear merely reflects the human psyche.
The 30 period following WW2 was largely free of seismic economic shock. This period from the establishment of the Bretton Woods system till the US abandoned the Gold Standard in 1971 was remarkably stable by recent standards.
Many would put this down to the Glass Steagall Act in the US. This bill passed in the teeth of the Great Depression (which Clinton repealed in 1999 and has since regretted) forbade regular banks from becoming involved in investment banking. Banks lent far too much over the following decade and that house of cards came crashing down in a succession of the corporate, consumer and sovereign bailouts we have lived with ever since.
John Mc Cain wants to reintroduce a new Glass Steagall bill for the 21st century. This is great idea - despite bank lobbyists probably driving it to extinction.
Since 2008 banks aren't lending so naturally the shadow finance sector has become larger as companies seek new avenues to raise credit. This area needs proper regulation.
The EU have done a pretty good job regulating Hedge Funds (with AIFMD - and which I spend my days implementing!) but the current Chinese shadow finance system is a very expensive accident waiting to happen.
The Chinese authorizes need to urgently bring their shadow finance system under their regulatory remit whereby up to $6 trillion dollars sits in Off Balance Sheet vehicles and loans. We all know how this ended in Europe.
There is also growing pressure to properly regulate offshore finance.
This is a development worth watching. Personally I am very skeptical whether any headway will be made here, particularly when some critics would suggest that the US and UK are arguably the worlds largest offshore centers (The City & Wall Street/Delaware recycling money from warmer climes).
Some of the latest G20 proposals made the right noises but they also talked about leaving Trusts out of any new offshore financial rules. That's like bringing in Prohibition but excluding Guinness!
The current system whereby large technology and finance companies structure their corporate tax to reduce their liability to peanuts will probably be changed somewhat.
However it is important to note that Corporation Tax worldwide is on a long-term down trend and I expect this to continue, especially in the US. Even Sweden's company tax rate is below Americas (the highest in the Developed World).
Finally, one of the unintended consequences of all this new regulation is to make it so expensive to comply that the financial world has seen waves of consolidation with banks, hedge funds and finance companies all merging to becoming bigger, making the banks especially - and ironically - truly too big to fail.
10 banks dominate the American financial system and a lesser number in Europe and Asia. There is no credible plan for allowing an institution the size of Citi (quarter of a million employees) or HSBC (7,000 offices) to fail - they would have to be bailed out in all circumstances. Traders know this and have learned that if you're going to fail - "fail big"!
And that is exactly why finance needs to be tightly regulated worldwide.
The last 5 years have made some reasonable progress but plenty more still needs to be done in the years ahead.
Friday, 6 September 2013
Last week I wrote that the rest of 2013 would be dominated by 3 crises - Syria, Emerging Markets and the return of the Eurozone crisis.
Unfortunately it looks like next month we may have to add a fourth crisis to that list.
This week the US Treasury secretary Jack Lew fired a shot at Congress warning them the US would run out of money to pay its debts, if it did not increase the National Debt limit above its current limit of nearly $17 Trillion.
All of this happening in an economy showing solid recovery and whose recent growth figures keep being revised upwards.
So while the US may be a private sector success story, but it is a public sector disaster.
The forthcoming US debt and budgetary crisis is part of a multiyear (decade?) paralysis between Democrats and Republicans which has been, and feels, endless.
This legislative paralysis is mirrored across much of the country, where for years politicians have ensures re-election by promising elaborate public pension sector pensions and benefits - which will fall due long after politicians retire!
This reckoning is starting to happen now, as we saw in Detroit, with many other cities and states lined up behind it.
At the front of this queue is Illinois (which contains Chicago, the largest US city after New York and Los Angeles). Illinois spectacularly owes two and half times more in pensions that it has in its pension pot. There is not a snowballs chance in hell this can be paid. Its firemen, nurses and teachers face massive pension cuts in the years ahead.
The key point here is that the current US debt ceiling discussions do not contain any acknowledgment or provision for these enormous unfunded state and city pension liabilities (never mind solution). The federal government will, in all likelihood, suffer the bill.
As I have written elsewhere, the US is far from alone here. In fact, it in a better state that most of the G20 economies. In Ireland (where I live) the government has unfunded public sector pension liabilities equal to 4 times the country’s GDP! None of this is included in its already dire National Debt figures (of approx. 130% of GDP).
The US debt ceiling crisis will be played out against a background of imminent monetary tightening by the Federal Reserve. This will increase interest rates and while it was always going to happen sooner or later, higher rate expectations are already being reflected in higher US mortgage rates. This will slow down the rebound in the real estate market.
Though it is highly likely this game of financial chicken will be avoided, the first half of next month could very well be a repeat of August 2011, with its heart stopping moments of brinkmanship, as the world’s richest country teetered on the point of an unprecedented and unnecessary self-inflicted default.
The long term outlook for the American economy is by far the strongest of major economies, primarily due to its demography structure, entrepreneurial population and access to endless cheap energy and food supplies.
Needless to say Obama and Congress should put aside politician point scoring on this vital issue and increase the debt ceiling - while also agreeing a credible long term solution to curtail public spending.
Unfortunately the possibility of this looks remote.
No doubt a last ditch debt ceiling solution will be found in Washington by the end of October. Hopefully it won’t derail the US economy recovery.
The world economy is depending on it.