Our Take: Salvation, at a Price

When the smoke of crisis clears, will securities firms look much like commercial banks, forced to conduct business in Big Brother's shadow?

Some of the most powerful men in finance and government call that an unavoidable result of current and planned rescue efforts, which involve harnessing central bank and even taxpayer funds to bolster the industry's wobbly assets. If investment banks become subject to stiffer capital requirements, both risk-taking and profitability of Wall Street proportions will become a historical relic.

Market confidence has improved in the three weeks since the Federal Reserve stepped in to yank Bear Stearns from the edge of bankruptcy and began lending to securities firms on terms similar to those available to commercial banks. At the same time, U.S. Treasury Secretary Paulson issued a regulatory reform plan the media has painted as soft on Wall Street because it would cut the number of regulatory authorities and expand the powers of the Federal Reserve. The Fed is seen as broadly friendly to the financial industry, if only because its governance structure is insulated from lawmakers who think they're Robin Hood.

Summing up the Treasury's plan, Bloomberg News quoted University of Maryland professor Michael Greenberger: "It would be Congress and the president essentially giving a blank check to a regulator over which they have very little power. (It will) allow Wall Street to do whatever they want until a crisis occurs, at which point the Fed would intervene.'' Greenberger once worked for the Commodity Futures Trading Commission, which would merge with the Securities and Exchange Commission under Treasury's plan.

If we didn't know better, we'd think his words were meant to praise the reform plan. But then, what do we know?

Radical Measures Loom

Of course, the impetus for bailouts and re-regulation will fade if the turmoil in money and credit markets soon passes. But if new threats to stability emerge, solutions far different from Secretary Paulson's program are waiting in the wings. And they'll come at a price.

"Ultimately government programs which support private credit market assets may be required in order to prevent an asset deflation of significant proportions," wrote Pimco's Bill Gross, one of the world's most influential and successful bond investors, in his April monthly commentary.

Gross was calling on the government to support home prices, not bond or derivatives prices. He added, however, that since the Fed has opened its discount window to investment banks, "There seems no way that current reserve requirements for banks will not in some nearly uniform way be imposed on investment banks." Within a few years, Gross said, Goldman Sachs, Lehman Brothers, Merrill Lynch and their kin will have to slash leverage ratios, reducing profitability.

That dour vision of the industry's future was echoed by Mervyn King, the governor of the Bank of England. In a speech in Jerusalem, King called it "extremely likely" that a wide range of financial institutions that become eligible for "financial assistance, will be called upon to hold more capital and a greater quantity of liquid assets than hitherto."

Meanwhile, a laundry list of radical proposals emerged at a March 28 meeting of the Financial Stability Forum, a coalition of global banking regulators. Set forth as options for a "worst-case scenario," they run the gamut from suspending mark-to-market accounting and relaxing or suspending minimum capital requirements, to "using public money to buy credit instruments to unburden balance sheets," and even "buying new equity issues outright."

If any of this sounds like a free lunch at taxpayers' expense, consider the following sentence, also taken from the FSF options paper: "In the immediate term, supervisors can require that regulated firms conserve financial resources by suspending dividends and limiting bonus payments to staff."