The Emperor’s New ‘Bear’ Hug

H.C. Anderson proved yet again that his classic tale, The Emperor’s New Clothes, will always come back to haunt people who do not pay heed to it. Ignoramuses acting as know-alls under the threat of ridicule by peers in a similar position are a very dangerous breed. And they have underlined that fact yet again. What Created This Monster? (NYT) attempts to figure out what the hell has been going on in the US financial sector over the past few months.

If the subprime mortgage crisis, and the Federal Reserve coming in with a huge bailout package for affected banks was bad idea, the Bear Stearns distress sale, underwritten by the Federal Reserve is worse. Conventional wisdom, and most pink papers, favors bailouts so that the overall banking system remains unscathed by such crises. But the fact of the matter is, bailouts fix the symptoms, not the cause. The main problem hardcore capitalists and libertarians (at least I do) have with bailouts is that those responsible for the mess don’t pay a financial price. If the tax payer has to pay for the financial jugglery done by employees of investment and commercial banks, and if the only thing that prevents people from losing their trust in banks is the backing of the government in the guise of the infallible Federal Reserve with an infinite credit rating, then a private banking sector makes no sense. In that case, nationalizing all banks should be the way to go. But that of course is unacceptable. How can a capitalist country go down the nationalization road? So, if the banks don’t want that to happen, as it will sometime in the future, if they don’t learn their lessons, they have to take responsibility for their actions and should not come running to mommy every time they face a crisis. Here lies another problem. It seems that it is mommy who is more worried about its children, and who in an attempt to save them, will probably end up killing them – through over regulation.

It is disgusting to see the way governments worldwide favor tight regulation of the banking industry. Consider these paragraphs from the above NYT article-

TWO months before he resigned as chief executive of Citigroup last year amid nearly $20 billion in write-downs, Charles O. Prince III sat down in Washington with Representative Barney Frank, the chairman of the House Financial Services Committee. Among the topics they discussed were investment vehicles that allowed Citigroup and other banks to keep billions of dollars in potential liabilities off of their balance sheets — and away from the scrutiny of investors and analysts.

“Why aren’t they on your balance sheet?” asked Mr. Frank, Democrat of Massachusetts. The congressman recalled that Mr. Prince said doing so would have put Citigroup at a disadvantage with Wall Street investment banks that were more loosely regulated and were allowed to take far greater risks. (A spokeswoman for Mr. Prince confirmed the conversation.)

It was at that moment, Mr. Frank says, that he first realized just how much freedom Wall Street firms had, and how lightly regulated they were in comparison with commercial banks, which have to answer to an alphabet soup of government agencies like the Federal Reserve and the comptroller of the currency.

This is precisely the problem. Most parliamentarians (there are a few sane voices among them, but not too many, unfortunately) will always blame every thing on insufficient regulation. Why couldn’t Mr. Frank of Massachusetts not think of loosening the noose around commercial banks so that they could take greater risks, instead of looking at things the other way round?

In conclusion, the financial sector needs to take a hard look at their practices. And governments worldwide need to rethink their financial laws. Regulation will only work when they are small in number and are enforceable. For, for (sic) every new law brought into being, ten new loopholes will soon be found. And gullible investors and depositors will not pay heed to the quality of their investments believing that the government is looking out for their interests, which in fact is not the case. If the people know that they and only they are responsible for the safety of their assets, only then will they take a deep hard look at their banking and investment practices. Putting all your eggs in the Federal Reserve’s (or any other US government agency involved in the financial sector) basket is a recipe for disaster. The next time a bank finds itself in a mess, the FR should let it sink. If it does not, people will never come to terms with the gravity of the situation.

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