Crisis shatters myth of self-regulation

 

Bankers shoulder a heavy responsibility to society as banks are the main pillar of the economy. And from what has happened, they are far from being able to self-regulate.

IN THE end, we are now learning painfully that even in the developed economies, nobody was ready for self-regulation.

Ask bankers in America and Europe. They must dread picking up newspapers these days for they are being blamed, on a daily basis, for the present global economic calamity.

The US has especially been the number one promoter of self-regulation, for anything from banking, insurance, securities markets right up to the rights to own firearms.

At first, things looked all right, and with self-regulation, the American and European banks began to make more money in their trading rooms than in the banking halls.

Risks? No problem. Their financial analysts, investment bankers and rating agencies were all craftsmen in designing derivatives that could bring down risks to zero.

So, pack all those high-risk mortgages that otherwise would not qualify into derivatives, give them a good rating and sell them to the world. Americans are very good salesmen.

Regulators? Never mind. The bankers have successfully sold the Congress the idea of self-regulation since Ronald Reagan's presidency.

But even the most complex of derivatives could not bring risks to zero. The party must have ended at some point, just like the collapse of the Michael Milken-promoted money-making machine called the junk bond in the 1980s.

Or the crash of the reinsurance "spiral of death" in the old Lloyds insurance market in London around the same time.

In Lloyds' case, insured risks were reinsured several layers among the players there that in the end, nobody knew what exactly was the extent of their exposures. The Piper Alpha oil platform went down in the North Sea in 1989 and that big loss set a chain reaction which eventually broke Lloyds apart.

What had happened in the US subprime loan market was quite similar, with the collateralised debt obligations (CDOs) being sold over several times so much so it became difficult for the banks affected to gauge the extent of their exposures. Until now, nobody knows exactly the extent of the damage these particular derivatives have done to the global financial system.

Sure, those CDOs sounded sexy, but the underlying risks remained the same, that borrowers who in the first place should not qualify for loans are bad business, and when they don't pay up, the bough breaks.

Indeed, greed got the better of the American banking system and the banks believed every word the financial analysts, investment bankers and rating agencies had said about the magical potion called derivatives.

Clearly, everybody is now paying for their grossly misplaced beliefs.

The road back will be a long and difficult one and it may as well start with the banks in the US and Europe putting their feet back on the ground and acknowledge that running a bank is not about beating the system to ensure fat bonuses and pensions.

Bankers shoulder a heavy responsibility to society as banks are the main pillar of the economy. When the banking system collapses, everything else will go with it.

And from what has happened, they are far from being able to self-regulate.