A happy medium for marcroprudential supervision

In the dialogue of the past week or so, an interesting theme has emerged.

The theme is globally harmonised rules.

In fact, there appears to be a tectonic plate shift towards some form of global neutrality.

What I mean by this is that historically, the English have disliked the French and vice versa; the Americans have been wary of the Russians and vice versa; and the Chinese have not trusted most nations, and most nations have not trusted the Chinese.

I get a sense that this is changing.

With the last world war between nations a half a century ago, when we realised the loss of life was too intolerable to bear, we have had a tense but workable trading relationship worldwide ever since.

That trading relationship has been brought to a head over the past year though, as the credit crisis strained all cross-border trade and finance relationships.

America and China were rumoured to be starting trade wars; Russia clamped down on dissident bloggers and media reporting; Europe split into pro-banking and anti-banking blocks; and everyone has been on tenterhooks to see how the world and, more specifically, the G20, would work out these issues.

And there’s the rub: the G20 has to work out these issues and act in unison. Unilateral actions from one country, such as taxing bankers’ bonuses, will just result in banks and bankers moving to other financial centres to avoid the unilateral actions.

If this is the supposition, then we get into an interesting dialogue around the future.

For example, when Lehman Brothers collapsed, they had a leverage ratio of over 37:1. In other words, for every dollar of trading at their collapse, Lehmans had to find $37 of liquidity and, when that dried up, so did their collateral position which is why they collapsed.

On the other hand, as blogged about the other day, if you operate in a market with zero trust then you have to place too much collateral into the markets and get zero leverage or expansionism as a result.

There has to be a happy medium therefore between casino capitalism and collateralised communism.

Equally, the megalomania of the ego of a CEO who can leverage a bank so far that they burst is also coming under fire. Some form of checks and balance has to be in play. So maybe the Anglo-Saxon banking model has to move more towards the Asian consensual approach, where every decision is made by the collective rather than the individual. Mind you, that model is also flawed as consensual management means the loss of individual flair and dynamism, which hinders innovation and entrepreneurialism.

There has to be a happy medium between individual entrepreneurialism and team spirit.

Finally, we appear to be moving away from free markets and principles-based regulation to tightly controlled markets with Napoleonic law. The problem with the Napoleonic approach is that it means everything has to be written into the rules. That is because if it’s not in the rules, then it is assumed to be permissible. Hence, you end up with rule upon rule, and bureaucracy upon bureaucracy.

So there has to be a happy medium between free market disciplines with self-regulation and tightly monitored markets with strong regulators.

All in all, what the G20 movement seems to be moving toward therefore is global macroprudential supervisory structures that will strike a balance between leveraged collateral coverage, entrepreneurialism and individual innovation with appropriate market checks and balances, and free markets structures with tightly coupled regulations.

Although some of these drivers, structures, rules and procedures appear to be at opposites with each other, what it really means is that the G20 has to navigate towards a globally agreed approach that works for all.

Tough call but, if they can do it, a worthwhile goal to strive for.

The biggest danger is that we end up with rules that operate based upon the lowest common denominator. This is what we have ended up with in Europe, where all Directives are agreed to cater for the least sophisticated member state at the expense of the sophistication of the most developed states.

Or that’s what people are telling me in the banks, as they are forced to obsolete highly functional systems for ones that are less functional as a result of EU directives.

This game of macroprudential supervisory structures will be an interesting one to observe, and to discover whether we get the best or worst of all worlds ... or, most likely, something in between.