Re-regulation in the aftermath of the financial crisis

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UNI Private Equity Group - Global Campaign for Private Equity Accountability, Nyon, 10 November 2008

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  • Re-regulation in the aftermath of the financial crisis

    1. 1. <ul><li>UNI Private Equity Group </li></ul><ul><li>Global Campaign for Private Equity Accountability </li></ul><ul><li>Re-regulation in the aftermath of the financial crisis </li></ul><ul><li>Nyon, 10 November 2008 </li></ul>
    2. 2. The crisis <ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul>
    3. 3. The crisis <ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul><ul><ul><li>Wage compression </li></ul></ul><ul><ul><li>Predatory lending & debt-financed consumption </li></ul></ul><ul><ul><li>Transfer of pension market risks onto workers </li></ul></ul>
    4. 4. The crisis: un-regulated products <ul><ul><li>“ originate and distribute” model of credit default risk </li></ul></ul><ul><ul><li>Lack of regulation </li></ul></ul><ul><ul><ul><li>no standardisation </li></ul></ul></ul><ul><ul><ul><li>No supply/demand price fixing </li></ul></ul></ul><ul><ul><ul><li>credit rating agencies. </li></ul></ul></ul><ul><ul><li>self-feeding asset depression process </li></ul></ul><ul><ul><ul><li>‘ pro-cyclical’ accounting rules </li></ul></ul></ul><ul><ul><ul><li>rigid prudential rules </li></ul></ul></ul><ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul>
    5. 5. “ originate and distribute” model of credit default risk <ul><ul><li>spreading risks </li></ul></ul><ul><ul><li>mitigates risks, </li></ul></ul><ul><ul><li>reduces the cost of capital </li></ul></ul><ul><ul><li>and therefore </li></ul></ul><ul><ul><li>enhances economic growth </li></ul></ul>hiding increases increases kills revisited Bankers made money on way up but didn’t lose on the way down Credit Rating agencies were paid to give over-optimistic ratings
    6. 6. Notional amounts of OTC derivatives outstanding (US$bn)
    7. 7. The crisis: lightly-regulated institutions <ul><ul><li>deposit banking vs shadow banking </li></ul></ul><ul><ul><li>blurring of the lines, off-balance sheet operations </li></ul></ul><ul><ul><li>regulatory gaps & arbitrage </li></ul></ul><ul><ul><ul><li>within groups </li></ul></ul></ul><ul><ul><ul><li>between jurisdictions </li></ul></ul></ul><ul><ul><li>risk management becomes an oxymoron </li></ul></ul><ul><ul><ul><li>Too big to fail, </li></ul></ul></ul><ul><ul><ul><li>be saved </li></ul></ul></ul><ul><ul><ul><li>be supervised </li></ul></ul></ul><ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul>
    8. 8. Deposit banking vs shadow banking <ul><li>Source: IMF, October, 2008, </li></ul><ul><li>via Crotty & Epstein 2008 </li></ul>
    9. 9. The crisis <ul><ul><li>Imperial CEOs </li></ul></ul><ul><ul><li>Weak risk management </li></ul></ul><ul><ul><li>Compensation & golden parachutes </li></ul></ul><ul><ul><li>Lying to the markets to protect shareholder value </li></ul></ul><ul><ul><li>&quot;Free cash flow” given back to shareholders is now badly missing </li></ul></ul><ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul>
    10. 10. The cost of corporate short-termism *purchased by BoA for 50bn; ** purchased 1.2bn by JP Morgan Chase following offloading of toxic assets valued at 29bn onto US gvt; *** 2007 only; **** entered into bankruptcy on 15 sep 5.3 4 Lehman Brothers**** 7.1 5 Morgan Stanley 1.7 1.7 1 Bear Stearns ** 8.2 12.1 25 JP Morgan Chase 11.8 16.8 10 Goldman Sachs 5 7.8 25 7.5 Citigroup 2.2 14.4 1.2 8 Merril Lynch* 1.3 17.5 25 Bank of America Debts to executives Buy-Backs 2006-07 US gvt injection Other funds Non-OECD SWF
    11. 11. The management of the crisis <ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul><ul><ul><li>Central banks did not prevent the bubble (but knew it would happen) </li></ul></ul><ul><ul><li>Self-market correction did not happen </li></ul></ul><ul><ul><li>Weak national & international governance </li></ul></ul><ul><ul><li>Regulatory catch-22 </li></ul></ul>
    12. 12. Re-regulation <ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul><ul><ul><li>Central banks did not foresee the bubble </li></ul></ul><ul><ul><li>Weak economic & financial governance </li></ul></ul>
    13. 13. Re-regulation <ul><ul><li>Strengthening financial safeguards & international cooperation </li></ul></ul><ul><ul><li>Diversifying finance & Protecting social development goals </li></ul></ul><ul><ul><li>Spreading responsibility throughout the investment chain </li></ul></ul><ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul><ul><ul><li>Central banks did not foresee the bubble </li></ul></ul><ul><ul><li>Weak economic & financial governance </li></ul></ul>
    14. 14. Re-regulation <ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul><ul><ul><li>Central banks did not foresee the bubble </li></ul></ul><ul><ul><li>Weak economic & financial governance </li></ul></ul><ul><ul><li>Strengthening financial safeguards & int’l cooperation </li></ul></ul><ul><ul><ul><li>Ensure fair prudential regulation for banks </li></ul></ul></ul><ul><ul><ul><li>Review the mandate and public accountability of central banks </li></ul></ul></ul><ul><ul><ul><li>Reign in int’l flows of capital </li></ul></ul></ul><ul><ul><ul><li>Offshore Financial Centres </li></ul></ul></ul><ul><ul><ul><li>Staffing of supervisory and enforcement authorities </li></ul></ul></ul><ul><ul><li>(Protecting social development goals) </li></ul></ul><ul><ul><li>(Spreading responsibility throughout the investment chain) </li></ul></ul>
    15. 15. Re-regulation <ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul><ul><ul><li>Central banks did not foresee the bubble </li></ul></ul><ul><ul><li>Weak economic & financial governance </li></ul></ul><ul><ul><li>(Strengthening existing safeguards and international cooperation) </li></ul></ul><ul><ul><li>Diversifying finance & protecting social development goals </li></ul></ul><ul><ul><ul><li>Protect households against predatory lending </li></ul></ul></ul><ul><ul><ul><li>Diversifying the financial sector & support community-based financial services </li></ul></ul></ul><ul><ul><ul><li>Protect workers’ pension schemes </li></ul></ul></ul><ul><ul><ul><li>International taxation </li></ul></ul></ul><ul><ul><li>(Spreading responsibility throughout the investment chain) </li></ul></ul>
    16. 16. Re-regulation <ul><ul><li>Unsustainable model of growth </li></ul></ul><ul><ul><li>The ‘structured finance’ business and the illusion of risk spreading </li></ul></ul><ul><ul><li>Investment banks, conglomerates and the cost of regulatory arbitrage </li></ul></ul><ul><ul><li>Shareholder value model of corporate governance versus market integrity </li></ul></ul><ul><ul><li>Central banks did not foresee the bubble </li></ul></ul><ul><ul><li>Weak economic & financial governance </li></ul></ul><ul><ul><li>(Strengthening existing safeguards and international cooperation) </li></ul></ul><ul><ul><li>(Protecting social development goals) </li></ul></ul><ul><ul><li>Spreading responsibility throughout the investment chain </li></ul></ul><ul><ul><ul><li>Reform the credit rating industry </li></ul></ul></ul><ul><ul><ul><li>Regulate credit risk transfers and derivatives </li></ul></ul></ul><ul><ul><ul><li>Regulate private investment funds and conglomerates </li></ul></ul></ul><ul><ul><ul><li>Ensure executives’ and intermediaries’ perverse incentives are reversed </li></ul></ul></ul><ul><ul><ul><li>Combat corporate short-termism </li></ul></ul></ul>
    17. 17. Re-regulation & private equity <ul><li>Financial safeguards & int’l cooperation </li></ul><ul><ul><li>Prudential regulation for banks </li></ul></ul><ul><ul><li>CB mandate and public accountability </li></ul></ul><ul><ul><li>International flows of capital </li></ul></ul><ul><ul><li>Offshore Financial Centres </li></ul></ul><ul><ul><li>Staffing of financial authorities </li></ul></ul><ul><li>Diversifying finance & social goals </li></ul><ul><ul><li>Protect households </li></ul></ul><ul><ul><li>Community-based financial services </li></ul></ul><ul><ul><li>Protect pensions </li></ul></ul><ul><ul><li>International taxation </li></ul></ul><ul><li>Spreading responsibility </li></ul><ul><ul><li>Credit rating industry </li></ul></ul><ul><ul><li>Credit risk transfers and derivatives </li></ul></ul><ul><ul><li>Private funds & conglomerates </li></ul></ul><ul><ul><li>Executive compensations </li></ul></ul><ul><ul><li>Corporate short-termism </li></ul></ul>
    18. 18. Crotty & Epstein 2008 <ul><li>A regulatory precautionary principle for new products and processes created by financial innovation </li></ul><ul><ul><li>Once the financial regulatory structure is extended to all important financial institutions, </li></ul></ul><ul><ul><li>similar to the US Food and Drug Administration to determine whether new drugs should be allowed on the market. </li></ul></ul><ul><li>Innovation in the financial sector is not like innovation in goods </li></ul><ul><ul><li>Has broad “externalities” and links to systemic risk </li></ul></ul><ul><ul><li>Systemic risk that are not taken into account by innovators </li></ul></ul><ul><li>A 180° shift in the regulatory approach </li></ul><ul><ul><li>Ensure overlaps, redundancies, multiple firewalls </li></ul></ul>
    19. 19. <ul><li>[email_address] </li></ul><ul><li>+33 1 55 37 37 38 </li></ul>

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