Sunday, April 19, 2009


Washington keeps looking for quick and easy ways to get the economy back on its feet and return us back to the good old days. Some Americans think we can shop our way back to happiness. At least that’s what Washington would have us believe. As such, our national government is now spending like never before, forgetting that we are running up our collective credit cards to the limit and that the tab will ultimately have to be paid. But never mind they say, it feels good for now – and some would have us believe we need all this “stuff” are buying.

Between the U.S. Treasury and the Federal Reserve, Washington has committed well over $12.8 Trillion in new spending. The Europeans warned President Obama during this last round of G20 meetings that this is a dangerous course to take. The head of the European Union, which is always worried about inflation, warned that the spending of the U.S. Government is taking us down “the road to hell.” The French and the Germans have made similar warnings and have pressed for a repair to the regulatory system. Unfortunately, the Democratic Administration has brushed past these requests. While acknowledging that their arguments have merit, the Democrats called for even more stimulus spending.

One of the dangers of all this historically unprecedented spending is that it will spark a very dangerous new round of inflation. Never mind the spenders argue, before inflation can get started, we will pull the money out of the system. This of course sounds very much like the drug user who says that he is not hooked and can quit anytime. Washington does not work that way and never has; real spending cuts have rarely been seen. A brief history of the size of government as a percent of GDP shows that government never shrinks. At best, it plateaus from time to time.
Were this a run of the mill recession, where there was a mere imbalance in asset supply and demand, government spending might do the trick. But this is a deeper financial sector crisis that will require major structural changes. No amount of spending will fix the structural problems in the economy. We may very well pump up the economy into a short term sugar high. But there is an underlying illness that very much needs tending, lest we set ourselves up for a repeat of 2008. In some ways, the experience of the crash of Long Term Capital Management (LTCM) in 1998 was, in effect, a dress rehearsal for this crisis - from which we learned nothing.
First and foremost, the financial system will need to be repaired. There is almost certainly no going back to the old fashioned bank lending patterns. The capital markets will have to be stood up again – but they will need to be properly re-engineered to factor in what we have learned through this and other financial crises.
Overall, we will need to:

• Work to end the nation’s macroeconomic imbalances, particularly the current account and government budget deficits.
• Impose capital adequacy rules on all financial institutions. We inspect cars which travel our highways and insist they have insurance and safety inspections. Why not the banks which use the public markets?
• Restructure the rating agencies to prohibit the buyers of the ratings from “shopping” the agencies – all but bribing them for good ratings.
• Impose minimum hold requirements on securitization transactions so that packagers have some “skin in the game” and hence better monitor the risks associated with investment portfolios.
• Reorganize and streamline the financial regulators into one over arching organization
• Improve international regulatory reporting since most large financial institutions are now heavily international.
• Better compensate and incent regulators so that properly qualified and trained regulators can be attracted who understand the highly complex new finance.
• Stagger out executive compensation plans to better tie them to real performance
• Strengthen the role of corporate Board of Directors to prevent outlandish senior management compensation.

These excessive compensation packages are nothing more than major inducements to squeeze out short term earnings at all costs.
These measures will help restore the financial markets to proper health and help prevent some of the excesses we have just suffered through. In the end, these measures will be critically important.

But there is also an urgent need to re-examine the core principals and implementation of proper governance. One of the most glaring reasons for this crisis has been the almost complete breakdown in the most basic functions of good governance – in both the pubic and the private sectors. We thought we knew better. But we now see that we need to go back to the drawing boards and re-examine the entire system that anchors our institutions.

By Bob Bestani from Newmarket.

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