Wednesday, November 05, 2008

Some Lessons of the Financial Crisis

Stephen Schwarzman, the co-founder and CEO of the Blackstone Group wrote an excellent editorial in the November 4, 2008 edition of the Wall Street Journal. Although I don't 100% agree with each of his seven principles, he makes a strong case for changes designed to mitigate a future financial crisis. The seven principles encompass the following recommendations:
  1. Finalize a common set of accounting principles across borders.
  2. Global financial regulatory regimes should be structured similarly. Each country needs a finance minister at the political level, a central bank and one single financial services regulator with a very broad mandate.
  3. Full transparency for financial statements - eliminate "off balance sheet" items (can you say Enron).
  4. Full disclosure of all financial instruments to the regulator - this includes esoteric creations like the $60 trillion market in credit default swaps (currently unregulated).
  5. A regulator should have oversight over all financial institutions that participate in the markets, regardless of their charter, location or legal status, i.e., hedge funds.
  6. Abolish mark-to-market accounting for hard-to-value assets (e.g., if your house does not sell after 120 days on the market are you forced to mark its value to $0?).
  7. Move to a principles-based regulatory system rather than a rules-based system.
That last point may be the most complex and compelling. The urge of young MBA's and talented financial engineers is to circumvent the rules in order to gain an edge. Regardless of how well a policy rule may be crafted, you can bet there will be someone that finds a "loop-hole" in the rule.

There is plenty of "blame" to go around for the mess we're dealing with; I want to communicate to our legislators that it will take some talent and CAREFUL consideration to move our system to where we will be safer in the future.

A system of rules and regulations is utterly incapable of dealing with the speed and complexity of the modern financial system. Current SEC and bank regulation was unable to stem the current crisis.

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