A New Regulatory America
-Alan Greenspan
Nothing captures the blind allegiance to laissez-faire economics and the dubious claims that the markets are always efficient than the above quote from the former Fed chairman. The credit crisis, combined with the near certain increase in Democratic power after next month’s election, will produce an increase in regulation and oversight of the financial markets and the economy. But what sort of re-regulation and oversight can we expect?
When it comes to regulation and oversight, there are two questions that stand above the rest:
- How effective will the effort be?
- How far will government go?
There are great risks tied to these two questions, and one to the other:
- Will the efforts produce a more efficient economic and financial America?
- Will the increased regulatory role go too far and, therefore, crimp American innovativeness?
The regulatory pendulum has swung away from laissez-faire and a blind faith in efficient markets and toward a new regime. Hopefully, it will not swing so far the other way that the actions will create more problems than they solve.
Investment Strategy Implications
One likely consequence of a new regulatory climate will be capital flows away from and out of the US to other parts of the global economy. Such capital flows are destined to occur anyway as US economic growth and profitability declines due to the forces of deleveraging and its impact on the US economy. This past Tuesday’s report on Consumer Credit (-$7.5 billion) is one of the first US consumer related signs that the credit crisis has begun to hit Main Street.
A sustained retrenchment of US consumer spending habits should result in a higher savings rate and a long overdue repair of the consumer balance sheet. This trend will be exacerbated by the reality that the wealth effect (real estate and financial assets) can no longer be counted on to satisfy future financial needs, most notably the retirement of millions of Baby Boomers – a fact made all the more true as Social Security benefits will not fill the lifestyle gap.
Higher savings and lower spending by the US consumer has worldwide ramifications. Domestic economic growth will slow with the slack being picked up by an emerging middle class in developing economies. These two factors will almost certainly drive investment capital out of the US and toward higher growth regions, an act made all the more imperative as capital seeks countries that have a less onerous regulatory climate.
The credit crisis will take a bit more time to resolve itself. But resolve itself it will. It is, therefore, prudent for investors to begin looking past the valley before us and to the new economic landscape that will be. And one central dynamic of the new economic landscape will be a changed regulatory and oversight environment. Let’s hope lessons have been learned and judgment and political courage does a better job than it has recently.
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The only regulation I would like to see would involve limiting leverage to reasonable levels.
Also they should limit banks to loaning money to people that have a reasonable chance of paying it back.
The biggest issue here was Freddie and Fannie buying bundling and selling bad paper. These social programs need to be regionalized and taken apart. Fre and FNM should be broken up. It is absolutely ridiculous that they are still allowed to trade on the stock market in their current condition.
What hope do we have of thoughtful, effective, or comprehensive regulation given the above statements ? Can the makers of rules demonstrate the diligence and humility to learn enough about this arcana to make wise ones ? Doubt it - thus the title.
Sane and reasonable regulation should be directed at increasing transparency, whether that is by mandating specific, plain-language disclosure of material facts or by banning practices that hide or confuse material information. Unfortunately today GAAP are more focused on hiding and confusing material facts from the public than they are on establishing transparency. Until accounting and its practitioners re-establish integrity, there is no hope whatever of creating free markets and no regulation ever conceived can alter that.
Effective and efficient free markets absolutely DEMAND transparency, honesty, and integrity. We may never achieve perfection in these areas but we can strive for it. Regulation isn't "onerous" on its face, and I would in fact submit that a well-regulated financial system would promote innovation and economic growth because it would restore, grow, and help to maintain trust between counterparties.
With everyone screaming about how markets are frozen because no one trusts any other counterparty, maybe it's time for us to look at ourselves again and ask "why?"
Great topic.
I think earlier discussions on Minyanville touched on this topic.
The SEC allowed banks to leverage from 12:1, up to 40:1 or even 50:1
And the derivatives people could leverage 100:1
This was simply too much risk. In hindsight, it was crazy.
What is needed is simple common sense. There were reasons why banks could only leverage 12:1
The problem was everyone got snookered by the illusion of easy wealth. And wealth that is not based upon the creation of real value, can disappear like dust in the wind.
We don't need much more regulation, just enforce some common sense rules.
It is always easier to create the illusion of value, than it is to create real value. And that is why these rules need to exist. Plenty of people can be illusionist, but few know how to create real value. It is by nature very hard work.
What if you where informed that all the cops would leave the city of chicago. In a very short time all the gangs and thugs would rule now wouldn't they.
Well, guess what de-regulation has done.
For past 8 years now, Bush with blessing of congress has pulled all the cops off of wall street.
It didn't take long for all the gangs and thugs to introduce their form of control, this time on the economy.
Guess what? Cops are now starting to enter the city and it will take time to clean out the mess that was created.
In the mean time, hang on main street, because the pendulum is swinging back towards socialism and with it the money infused to grow our economy is now leaving for greener pastures.
Good luck and keep your powder dry, that is if you have any left!!
