Politically driven post-crisis legislation must be avoided
A regulatory backlash is almost certain to follow the current trail of bail-outs and mortgage guarantees. Banks must ensure they have a say in any reform process or face the burden of further legislation.
The widespread use of public funds – in the US and other hard-hit countries – to end the credit crisis is inevitable. The first signs of the process are already there: central banks accepting a broader class of securities, including mortgages, as collateral in return for liquidity; US Federal Reserve guarantees provided in the rescue of Bear Sterns; and, in the UK, the takeover of Northern Rock.
It might be the right solution – the current aggressive monetary policy in the US is destined to cause as many problems as it cures, possibly stoking up inflation and risking the spread of further panic as investors perceive how panicked the authorities are. Anyway, monetary policy only impacts on the real economy about six to 12 months later.
Bailing out stricken banks, guaranteeing individual mortgages and even buying them up may be the only realistic route out of trouble, but it will come at the cost of a regulatory backlash (see regulation story).
As the debacle moves further into the political arena and Congress members work themselves up into a lather about profligate lending (most of which was not done by banks), a credit crisis version of Sarbanes-Oxley – the legislation that followed the Enron failure – is bound to appear on the horizon.
The challenge for the banking industry is to provide a well-argued case for appropriate, and where possible self, reform or risk getting tangled up in politically driven legislation that is devoid of good banking or even common sense.
The Institute for International Finance is engaged in just such an exercise now. It is expected to publish an interim report containing about 70 recommendations this month, chief among which is likely to be a review of fair value accounting that has turned out to be a catalyst in the current crisis and is presently occupying financial minds more than other factors, such as the role of the rating agencies and the pro-cyclicality of Basel II.
Ascertaining the best way of reforming fair value accounting and persuading the relevant regulators and politicians that it is the right course of action forms the mainstay of the painstaking but important work ahead. The banking sector must engage in this or suffer the consequences.
