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UNI Private Equity Group - Global Campaign for Private Equity Accountability, Nyon, 10 November 2008
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1
UNI Private Equity Group
Global Campaign for Private Equity Accountability
Re-regulation in the aftermath of the financial crisis
Nyon, 10 November 2008
2
The crisis
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
3
The crisis
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
– Wage compression
– Predatory lending & debt-financed consumption
– Transfer of pension market risks onto workers
4
The crisis:un-regulated products
– “originate and distribute” model of credit default risk
– Lack of regulation• no standardisation• No supply/demand price
fixing• credit rating agencies.
– self-feeding asset depression process
• ‘pro-cyclical’ accounting rules
• rigid prudential rules
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
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“originate and distribute” model of credit default risk
spreading risks
mitigates risks,
reduces the cost of capital
and therefore
enhances economic growth
hidingincreases
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
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Notional amounts of OTC derivatives outstanding
(US$bn)
29,289 31,081 31,360 38,127 40,271 48,645 56,238
190,502204,795 211,970
262,526291,582
347,312
393,138
8508.748999.768
6,396
10,21113,908
20,352
28,650
42,580
57,894
25,879
27,91529,199
35,997
39,740
61,713
71,225
46,59458,518 57,789
84,39870,444
96,70380,576 84,287
0
100,000
200,000
300,000
400,000
500,000
600,000
0
100,000
200,000
300,000
400,000
500,000
600,000
Dec.2004 Jun.2005 Dec.2005 Jun.2006 Dec.2006 Jun.2007 Dec.2007 Jun.2008
Bill
ions
of
US
do
llars
Unallocated
Credit default swaps
Commodity contracts
Equity-linked contracts
Interest rate contracts
Foreign exchange contracts
Memo: Exchange-traded contracts (futures & options)
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The crisis:lightly-regulated institutions
– deposit banking vs shadow banking
– blurring of the lines, off-balance sheet operations
– regulatory gaps & arbitrage• within groups• between jurisdictions
– risk management becomes an oxymoron
• Too big to fail,• be saved• be supervised
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
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Deposit banking vsshadow banking
Source: IMF, October, 2008,
via Crotty & Epstein 2008
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The crisis
– Imperial CEOs
– Weak risk management
– Compensation & golden parachutes
– Lying to the markets to protect shareholder value
– "Free cash flow” given back to shareholders is now badly missing
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
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The cost ofcorporate short-termism
Non-OECD SWF
Other funds US gvt injection
Buy-Backs 2006-07
Debts to executives
Bank of America 25 17.5 1.3
Merril Lynch* 8 1.2 14.4 2.2
Citigroup 7.5 25 7.8 5
Goldman Sachs 10 16.8 11.8
JP Morgan Chase 25 12.1 8.2
Bear Stearns ** 1 1.7 1.7
Morgan Stanley 5 7.1
Lehman Brothers**** 4 5.3
*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
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The management of the crisis
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
– Central banks did not prevent the bubble (but knew it would happen)
– Self-market correction did not happen
– Weak national & international governance
– Regulatory catch-22
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Re-regulation
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
– Central banks did not foresee the bubble
– Weak economic & financial governance
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Re-regulation
– Strengthening financial safeguards & international cooperation
– Diversifying finance & Protecting social development goals
– Spreading responsibility throughout the investment chain
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
– Central banks did not foresee the bubble
– Weak economic & financial governance
14
Re-regulation
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
– Central banks did not foresee the bubble
– Weak economic & financial governance
– Strengthening financial safeguards & int’l cooperation
• Ensure fair prudential regulation for banks
• Review the mandate and public accountability of central banks
• Reign in int’l flows of capital
• Offshore Financial Centres
• Staffing of supervisory and enforcement authorities
– (Protecting social development goals)
– (Spreading responsibility throughout the investment chain)
15
Re-regulation
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
– Central banks did not foresee the bubble
– Weak economic & financial governance
– (Strengthening existing safeguards and international cooperation)
– Diversifying finance & protecting social development goals
• Protect households against predatory lending
• Diversifying the financial sector & support community-based financial services
• Protect workers’ pension schemes
• International taxation– (Spreading responsibility
throughout the investment chain)
16
Re-regulation
– Unsustainable model of growth
– The ‘structured finance’ business and the illusion of risk spreading
– Investment banks, conglomerates and the cost of regulatory arbitrage
– Shareholder value model of corporate governance versus market integrity
– Central banks did not foresee the bubble
– Weak economic & financial governance
– (Strengthening existing safeguards and international cooperation)
– (Protecting social development goals)
– Spreading responsibility throughout the investment chain
• Reform the credit rating industry
• Regulate credit risk transfers and derivatives
• Regulate private investment funds and conglomerates
• Ensure executives’ and intermediaries’ perverse incentives are reversed
• Combat corporate short-termism
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Re-regulation& private
equity
Financial safeguards & int’l cooperation– Prudential regulation for banks– CB mandate and public accountability– International flows of capital
– Offshore Financial Centres– Staffing of financial authorities
Diversifying finance & social goals– Protect households
– Community-based financial services– Protect pensions– International taxation
Spreading responsibility– Credit rating industry
– Credit risk transfers and derivatives– Private funds & conglomerates– Executive compensations– Corporate short-termism
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Crotty & Epstein 2008
A regulatory precautionary principle for new products and processes created by financial innovation
– Once the financial regulatory structure is extended to all important financial institutions,
– similar to the US Food and Drug Administration to determine whether new drugs should be allowed on the market.
Innovation in the financial sector is not like innovation in goods
– Has broad “externalities” and links to systemic risk – Systemic risk that are not taken into account by innovators
A 180° shift in the regulatory approach
– Ensure overlaps, redundancies, multiple firewalls
