Friday, February 12, 2010

Policy Intervention may be needed to Protect Investors

Author: David Schwartz J.D. CPA David Schwartz J.D. CPA

According to the Bank of England, “The lasting legacy of this crisis is too much debt held by too many sectors against too little capital.” A McKinsey study found that, since 2000, gross debt for the ten largest economies grew by US$40 trillion, or a rise of 60%. Bank leverage soared to as much as 50 times equity, as compared with a ratio of less than 10 at the start of the 20th Century.  This is not sustainable, say financial regulators.

Bank of England: It is said that the longest journey begins with a single step. Events of the past twelve months have been a first step – and a big one. But they are just the start of the journey for the financial system and economy as balance sheets are repaired. This adjustment needs to be fast enough to repair balance sheets, but not so fast as to risk a setback for the financial system or real economy. [1]

Bank for International Settlements: If a bank loses money from a risky investment, that is not systemic. But institutional failure, market seizure, infrastructure breakdown or even a sharp rise in the cost of financial services can have serious adverse implications for many other market participants. In these cases, there is a systemic dimension. It is such negative externalities and the significant spillovers to the real economy that are the essence of systemic risk and which make a case for policy intervention.[2]

IOSCO: The identification of emerging risks that are systemically important is essential if we are to have any chance of avoiding the mistakes of the past. … The financial crisis has focused us all on the importance of addressing systemic risk and the important role markets and market regulators can play in addressing this issue.  The new IOSCO principle will focus on the need for market regulators to identify, assess and mitigate risks and threats within and potentially even beyond the current perimeter of regulation.  It will also address the consideration of entities, regulated by market regulators whose failure may have systemic implications for the wider economy.[3]

[1] Mr Andrew G Haldane, Executive Director, Financial Stability, Bank of England, Liverpool, 27 January 2010.

[2] Mr Jaime Caruana, General Manager of the BIS, “Systemic risk: how to deal with it?”, 12 February 2010

[3] Jane Diplock, Chairman of the Executive Committee, International Organization of Securities Commissions, Basel, Switzerland, 8 October 2009