The US crisis proved that even strong fundamentals flounder against weak regulation. ?Lax oversight did indeed allow financial firms to borrow far more than was prudent (a leverage ratio of 30 or 40:1) to make bets that have gone sour. Tougher regulations might have prevented this. Alan Greenspan, extolled as the best US Fed Regulator for more than two decades has neither to regret nor explain. It is Bernanke’s unenviable task to alter this legacy. Now investment banks winding up in the US are entering virgin Indian financial markets. Unless safeguard measures of the global financial system are revisited and put in place, there could be a burn-out of emerging economies, before long. The time is more opportune now than ever and there are enough lessons to learn.
The much-abused and most-extolled market-led reforms are now strongly positioned against each other, with the US Fed rescuing Bear Sterns, nationalising the tainted Fannie Mae and Freddie Mac, the two giant mortgage-guaranteeing institutions, infusing capital of the order of $700 billion to rescue AIG Insurance to prevent the global contagion effect, after throwing Lehman Brothers to fend for themselves.
When the Asian meltdown occurred, the Council of Foreign Relations had set up a Task Force with Carla A Hills and Peter G Peterson as co-chairpersons to suggest measures for safeguarding the global financial system ? the future international financial architecture. Some of its recommendations are worthy of a revisit at this juncture as the content of that report seemed to have been put in archives, notwithstanding its pitch for market-related financial sector reforms that would ?create greater incentives for borrowing countries tostrengthen their crisis prevention efforts and for their private creditors to assume their fair share of the burden associated with resolving the crisis.?
Good housekeeping had its first ticket. Its advice to IMF: crisis-lending ? less will do more. For country crises, the IMF should abandon huge rescue packages. In this hour of crises in the US, the Washington trio is observing a golden silence, as its role has been taken by the US treasury secretary. The task force is tougher in the measures it proposes to reduce moral hazard and to induce private creditors to accept their fair share of the burden of crisis resolution. Triple ‘B’ rated mortgages were assigned triple ‘A’ ratings at counterparty derivative instruments by all the leading rating agencies like Fitch, Standard and Poor, Moodys, etc, with absolute impunity. Securities Industries and Financial Markets Association’s task force recommended wide ranging reforms of credit rating agencies and transparency in rating methodologies. It is not yet known whether such reforms would be part of the global financial architecture. In the context of implementation of Basel-II tri-pilloried risk management, heavily depending on external credit ratings, it is but essential that the credit rating agencies globally should conform to the new reforms suggested by SIFMA in August 2008. It is time to cry halt to the paymaster calling shots on ratings. Unlike in the East Asian Crisis, governments could not be blamed as involved parties although institutional and collateral contagion had their dark shadows in the post-crisis environment. When investment banks, mutual funds, advisory services, retail banking, etc are all under a single holding company with global franchisee/agency/networking arrangements. Decoupling these activities would appear at once imperative in countries like India that embraced the western model. Capital provisioning has proved beyond doubt its inadequacies when the moral hazard arises from institutional greed.
Briefly, the lessons:
* Development of speculative real estate markets and lax standards of credit appraisal are sure to bring economic catastrophe.
* Rating instrumentality is no substitute for independent due diligence by financing institutions. Instead of external ratings, depend upon internal ratings and scorings resting on the native culture of the clientele bases demonstrated over the decades
* Derivatives and hedging instruments have severe sensitivities
* Higher capital allocation, with or without Basel-I, II and the prospective III, is no insurance for bank failures triggered by the neglect of systems, peoples, and processes
* You will be better served to rely on native intelligence and conservatism that guided the robustness of financing institutions
* It is good to fall back on smaller banks and well-networked financial institutions, instead of running after the big banks and volatile markets
* The US has to keep a close watch on China as it now holds a key to its treasury markets
* Sophisticated mathematical models, inconsequential of back testing and stress testing, hardly forebode collapses. It is better that the modelling soothsayers exit the markets
* Like millions of private investors across the globe, Germany holds gold as a form of savings impervious to currency depreciation, systemic failure and geographical instability. By its example, it has delivered an important message. The average Indian investor too typically has a lesson or two to offer to the world in this hour of global distress.
* The current state of macro prudential analysis (MPA) requires a revisit.
* Efforts to develop better indicators of FIs’ exposure to the household and real estate sector should be stepped up, notably in the direction of more transparent information on credit outstanding to these sectors at shorter intervals.
* High degree of flexibility is required in the use of benchmarks, as they are often country-specific and change over time.
* GAAP is not enough.
* Moving towards a sound and robust financial system is an arduous task, it would appear.
* Appetite for mergers and acquisitions will move in a new direction ? distinct from the present market, driven by customers and shareholder-value.
* Currencies throughout the world weakened against the downturn of all the world’s stock markets in terms of the dollar. Several central banks injecting liquidity to help calm the nerves of the financial markets could at best be temporary palliatives.
* Strengthening the manufacturing sector ?particularly, SMEs, through the right type of financial instruments, holds the key for sustaining the annual growth rate of above 8%.
If there is a chill up one’s spine, can shivers be avoided through the rest of the body? Today, it is not just the chill; but it is the fire that is engulfing the entire financial world. Globalisation is no longer sweet music to the ears. It is time for revisiting the global financial architecture and make amends to the ills facing it.
?The author is regional director, PRMIA-Hyderabad and can be reached at yerramr@gmail.com