Sunday, May 16, 2010

(No.92) Financial executives: more nerve than a canal horse

As the experience in Canada compared with the U.S. in the last couple of years has demonstrated, strong and comprehensive government regulation of financial services (and not just of banks but also insurance) is necessary to protect the consumer and preserve the integrity and soundness of the financial system.

In Canada, as I have observed in previous columns on, the big banks have taken far too much of the public credit for their relatively favourable performance during the financial crisis compared to those in the U.S. and elsewhere. The bulk of the credit belongs to strengthened federal regulation in the 1990s and to strong federal regulators who have actually been the object of pissing and moaning by Canadian bank executives for getting in the way of their entrepreneurial creativity.

As we saw pre-crisis the American version of financial regulation and deregulation facilitated (among other subsequent problems) the sub-prime mortgage debacle and its contributing role in the crisis which overtook the U.S. financial system, the waves from which threatened to submerge the west's if not the world's financial system.

The U.S. did not benefit from the sort of financial regulation under which, as we now see so clearly, the rule in the financial business became: heads you win, tails the taxpayer loses. Nor is there any attraction left except to simple-minded and/or greed-driven adherents of 'market place freedom' in the actual 'unregulation' of aspects of the financial system (e.g., credit default swaps).

To be found in the serried ranks of big business executives in the U.S. and Canada have been the self-serving and the ideologically deluded declaring that 'free markets' are self-regulating. Obviously they were not and are not. As the chair of the U.S. Securities and Exchange Commission admitted post-crisis onset: voluntary regulation doesn't work.

U.S. financial regulation did not reduce risk; it allowed it to be hidden. Investors, including supposedly sophisticated ones, had no real idea of the implications of many of the financial products they were buying and how exposed they were to unacceptable risk.

My maternal grandmother was, for me growing up, a fountain-head of sayings which sprang from her old Ontario/United Empire Loyalist roots. One was: "He (or she) has more nerve than a canal horse". This was not meant as a compliment. It was that saying which came to mind as I saw the risible effort currently under way by the usual crowd of financial executives and their remaining groupies among the financial services paparazzi to fight off the imposition of genuine financial regulatory reform.

Many in the U.S. including within the Obama administration are entirely right to question the value of a financial regulatory system that did little or nothing to prevent or even impede (for example) the development of a huge sub-prime mortgage industry based on the promiscuous and sometimes illegal promotion of millions of residential mortgages to house buyers whose credit worthiness went unchecked, whose income levels were ignored and whose financial ignorance and gullibility was the basis of their signing of mortgage documents. The results have been dire and the crisis is far from over. For example: today in the U.S. there are more than 20 million unoccupied homes.

The reality was and (largely) still is that executive greed, incompetence and misconduct were central to the mess that much of the developed world as well as the Americans are in. There is no shortage of directions in which to look for causes. Indeed the big financial rating agencies are now coming under the U.S. congressional gun and why would they not? The public has learned that during pre-meltdown activity in the market financial companies could actually shop for a favourable rating among rating agencies -- as Lehmann Bros. did and received a AAA rating four days before it failed.

I have long resisted the siren call from within the financial services business for less regulation, as if its reduction constituted some sort of ideologically-driven vehicle to carry business to the promised land of market capitalism. If any demonstration was actually required that such a place can actually turn out to be a desert then we have had it.

Having sat for many years on the companies' side of the table dealing with regulatory issues in financial services I know that encouraging voluntary behaviour involving compliance and self-regulation by business as talking points is all very well but they need to be backed up by forceful regulation. The reality is, as the US. experience of recent years demonstrates so vividly, that while some companies will bend over backwards to do the right thing there are too many others which will not -- absent strong regulations and vigorous enforcement.

Alastair Rickard