For every attempt at a financial overhaul, a similar method has been used: consultation of the financial community by the authorities, followed by negotiations towards a compromise between the demands of both parties.
The essential condition for such a method to succeed is that the financial industry would relate with the common good and recognize and promote the need to ensure a framework that maintains the sustainability of financial institutions without affecting the overall health of the economy.
Is there any evidence supporting the hypothesis that every financial institution will stand up for the common good at the expense of its own particular interest?
Alas, no: quite the contrary. What’s happened throughout the crisis of 2007 and 2008 has proven it instead as an unfounded belief.
The U.S. Senate report, released April 13, confirms what the auditions of executives at Goldman Sachs in April 2010 had already highlighted. Namely that the firm – and several others, including, foremost, Deutsche Bank – has not only betrayed the trust of some of its best clients by selling them financial products (collateralized debt obligations – CDOs) that were structured in such way as to be of the worst possible quality, but that it also developed new derivative products (“synthetic” CDOs) to wager on the downfall of the entire U.S. mortgage industry. It has doomed those who were naive enough to position themselves on the other side of the bet, but also it has hastened the fall of the global financial system as a whole!
We read in the Senate report that the head of the mortgage division at Goldman Sachs promised “ginormous” bonuses to anyone who would manage to sell these products. In the meantime, one of the bank’s executives in Australia said in an email, referring to a sucker who was ready to buy these toxic products: ” I think I found white elephant, flying pig, and unicorn all at once.”
The financial establishments in question are pursuing their business unhindered. None of their officers has been charged. Better yet, they can be found sitting at the negotiating table, objecting to propositions uttered by regulators representing the community as a whole.
The method needs to be changed. Regulators need to write rules that allow to dramatically lower systemic risk.
While hedging positions neutralize an existing risk in an insurance-perspective, speculative positions, because they are wagers, create a risk that didn’t exist beforehand.
The speculator puts forward his contribution to liquidity in order to justify his presence on the future markets. This argument should be ignored: a liquidity supply is pointless when offered at speculative levels of pricing and, and even more so, it doesn’t compensate for the increase in systemic risk that it causes.
Once the appropriate measures have been defined, they should be implemented without any further negotiations with the financial industry: the inability of its leading representatives to relate with the common good has been amply proved during the most recent three years.