The financial system is broken – but we won’t tell you how to fix it | FT Alphaville

The financial system is broken – but we won’t tell you how to fix it

Paul Volcker and the Group of 30 are  none to0 impressed with banks, hedge funds, private equity, regulators, central banks, ratings agencies…you get the picture.

Why? Because as Arminio Fraga Neto put it at a press conference on Thursday, “There has been a failure of risk management to a point that is mind boggling.”

(FT Alphaville could not help but notice that Jacob Frenkel, chairman of the G30 and vice chairman of AIG, looked decidedly uncomfortable when Neto said that)

What ought  to be done, then, to prevent future breakdowns of the global financial system?

A few things, according to the G-30’s “Framework for financial stability“.

Take proprietary trading at investment banks. Or rather, take proprietary trading away from investment banks:

large, systematically important banking institutions should be restricted in undertaking proprietary activities that present particularly high risks and serious conflicts of interest

And more generally:

We propose that regulatory capital standards should be enhanced and that benchmarks for bank capital should be raised

There are also “compelling grounds for the regulation of hedge funds”. Money market mutual funds and other private pools of capital also need closer scrutiny, the G-30 said.

As for OTC derivatives and credit default swaps (aka Satan’s financial tools of choice), the Group proposes a move to an exchange-based system and for a harmonization of standards and practices across instrument markets and types.

Oh, and actual regulation:

For most of the past 30 years, the markets developed in something of a regulatory vacuum, being regarded legally as neither securities nor futures contracts…

The time has also come to move  beyond moral suasion and enlightened market self-interest to ensure that market practices develop in a time, healthy and comprehensive fashion.

Most of the recommendations in the report are concise, considered and suitably vague, given the nature and composition of the G-30, and there is very little in it that has not been said before. Moreover, not all of the G-30’s members necessarily agree with its conclusions.

Still, the report is worth reading, if only because it offers a reasonable indication of at least some of the policies the Obama administration will purse. (Volcker’s next job is chairman of the President’s Economic Recovery Advisory Board).

But – and this is a big but – none of these recommendations, even if implemented at this very moment, is going to get us out of the mess we’re in.

Volcker conceded as much in his opening remarks, and noted the report was decidedly “not a response to the things that have happened in recent months, although obviously it’s informed by what’s going on.”

For anything approaching policy proposals to deal with the current crisis, the markets will have to wait a little while longer; would-be Treasury Secretary Geithner’s confirmation hearings aren’t until January 21.

If Geithner doesn’t have something substantial to offer then – or if the Senate blocks his selection – that 777 point decline on the Dow back in September might look downright restrained in hindsight.

Related links:
Paul Volcker is back, and he warns of tough times ahead – LA Times