LEHMQ News DJ G30 Advises On International Financial Regulat...
Thursday, January 15, 2009 11:00 AM
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News for 'LEHMQ' - (=DJ G30 Advises On International Financial Regulation)
By Emily Barrett
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--International experts responded Thursday to the regulatory weaknesses exposed by the prolonged financial crisis with a plan to extend both the reach and the depth of financial sector oversight.
Former U.S. Federal Reserve Chairman Paul Volcker presented a hefty report from the steering committee he now heads for the Group of 30. It called for closer scrutiny of "large, systemically important banking institutions," whose distress could have a far-reaching impact on the health of the financial system.
Their oversight must meet "high and common international standards," the report said.
This recommendation is the clearest yet of the need to identify firms "too big to fail" - a need reinforced by the dramatic circumstances of Lehman Brothers' collapse and the $85 billion bailout of insurance giant American International Group. AIG Vice Chairman Jacob Frenkel, who also heads the Group of 30, said Thursday that "we believe that policymakers must adopt changes that improve prudential regulation and supervision."
The report also recommended bringing regulatory powers to bear on previously untouched areas of the financial community - it sees "compelling grounds" for regulation of hedge funds.
The G30 wants firms to take more responsibility for the performance of their products, by keeping on their books "a meaningful part of the credit risk." That could rile the securitization industry, which thrived in recent years by repackaging debt - including some risky mortgage deals - into so-called collateralized debt obligations, many slices of which have since become worthless.
Special measures for safeguarding markets also featured in the report - specifically the privately negotiated trades in derivatives. The G30 ventured further than most, advocating "legislation to establish a formal system of regulation" for these markets, currently valued at around $350 trillion worldwide.
These were the standouts among the 18 sets of recommendations in "Financial Reform - A Framework for Financial Stability." The project was launched in July last year by the G30, a nonprofit group comprising senior representatives of the public and private sectors and academia worldwide. It comes ahead of the Jan. 20 inauguration of U.S. President-elect Barack Obama, who has pledged a "21st century regulatory framework" for the country. How the new administration will use these recommendations is unclear, but the report will be presented formally to the Group of 20 industrial and developing nations in April.
The report didn't discuss the potential for further emergency action in a crisis that has stretched the mandate of central banks around the world. The Fed has drawn criticism for lending billions of dollars to financial institutions, under terms less exacting than some - including Volcker - deem appropriate.
Such actions, along with programs to buy securities backed by mortgages and other forms of consumer debt, helped push the Fed's balance sheet to a record $2.3 trillion as of the year end.
In a clause particularly relevant to the Fed, the report recommended that central bank emergency lending be kept in future for "highly unusual and exigent circumstances," requiring political authorization. Moreover, it rejected lending against or buying high-risk assets, or other forms of long-term capital support by the central bank, saying such measures are more appropriately taken by "directly accountable government entities."
The report made no recommendations on how to proceed in the current crisis, noting only that "difficult questions of weaning markets and financial institutions from official life support are sure to arise."
The report was more explicit about the duty of central banks to preserve financial stability. In what could be a rebuke for the years of easy credit under former Fed Chairman Alan Greenspan, the report said such concerns are relevant not only in times of crisis, "but also in times of rapid credit expansion and increased use of leverage."
In line with the European Commission's efforts to curb this use of leverage, or magnified borrowing, the G30 recommended that regulators cooperate worldwide to monitor and report on firms' unfunded liabilities.
Indeed, cooperation between central banks was a key theme in the report, which also recommended they strengthen their role in prudential regulation.
Strong U.S. Focus
In keeping with calls for an overhaul of the U.S.'s fragmented system of agencies and state departments, the G30 also advocated consolidation of the regulatory industry. It said countries should eliminate "unnecessary overlaps and gaps in coverage and complexity, removing the potential for regulatory arbitrage, and improving regulatory coordination." Moreover, the report said those authorities should be independent from "political and market pressures."
The federally chartered firms that are the biggest buyers of mortgages in the U.S. also received special attention in the G30 report. The future of Fannie Mae and Freddie Mac as quasipublic companies has been in doubt since their government rescue in September. The report noted that such entities should have explicit statutory backing and financial support, and "hybrids of private ownership with government ownership should be avoided."
"In time, existing GSE mortgage purchasing and portfolio activities should be spun off" to the private sector, "with the government, if it desires, maintaining a capacity to intervene in the market through a wholly owned public institution," the report said.
The report was less expansive on guidelines for risk management within principles put forward by the Counterparty Risk Management Group and the Institute of International Finance.
-By Emily Barrett, Dow Jones Newswires; 201-938-2248; emily.barrett@dowjones.com
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(END) Dow Jones Newswires
January 15, 2009 11:00 ET (16:00 GMT)
Copyright (c) 2009 Dow Jones & Company, Inc.- - 11 00 AM EST 01-15-09
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