Our Take: Brave New World

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Congress approved and the president signed legislation that will let the government spend up to $700 billion to buy banks' troubled assets. The measure also imposes clawback provisions for executive bonuses and authorizes the Treasury to take "ownership stakes" in banks that sign on.

What does this mean for your career? Opportunities will arise both within and outside the government for fixed-income professionals in creating, managing and administering the bad-asset portfolio that will eventually be purchased from private-sector institutions. However, in this column we will look at broader issues.

It's a commonplace that Friday's vote constitutes the largest U.S. government intervention in the economy since Franklin Roosevelt's New Deal of the 1930s. At this point, however, most chatter in the blogosphere evokes a less comforting image - that of a Communist takeover of the U.S.

Given what just went down in Washington and some of the major events that preceded it - the Treasury's takeover of Fannie Mae and Freddie Mac, the seizure of AIG and Washington Mutual, and the migration of the remaining U.S. bulge-bracket investment banks under the umbrella of commercial bank regulation - it is clear that a major portion of America's financial system will operate under a new set of rules for many years, if not decades.

Déjà Vu

Top policy makers in the U.S. and Europe, along with some finance industry leaders, foresaw the outlines of such a change at least six months ago.

Back on April 4, we published a column titled, "Salvation, at a Price." Inspired by pronouncements then emanating from diverse authorities on both sides of the Atlantic, many of its points accurately anticipated what has occurred since. We will quote from it at length.

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

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....

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, (radical solutions) 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." (emphasis added)

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."

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