[OPE] Regulation (one more)

From: GERALD LEVY <gerald_a_levy@msn.com>
Date: Wed Apr 28 2010 - 14:18:39 EDT


From: adsl675281@telfort.nl
Subject: Regulation (one more)
Date: Wed, 28 Apr 2010 19:06:38 +0200

Martin Wolff does a thought-provoking article on this in the FT ("Why cautious reform is the risky option", FT April 27 2010). The first point he makes I made previously on OPE-L in another way, i.e. that you don't know what capital reserves are sufficient, and indeed you often don't even know how much capital value there is, since what the assets are worth is conditional on expectations of future earnings. Indeed, as I mentioned and Costas Lapavitsas argued, the Basel ratios actually tended to promote securitization, "leveraging" and "off-balance sheet" operations, to the extent that ways were found to dodge the formal capital requirements.
Wolff writes succinctly:

"There are three difficulties. First, there is no sound basis for deciding how much capital is enough. Second, as the Bank of England’s Andy Haldane notes, “tail risk within the financial system is not determined by God but by man”. It is profitable to take risks whose upside accrues to oneself and whose downside accrues to others. So the safer regulators try to make the system, the more risk it can take on. Finally, it is easy to create the desired risk via regulatory arbitrage. That is precisely what the “shadow banking system” did. So what else might be tried? The answer is structural reform. Three proposals are on the table. The first, from Paul Volcker, is banning of proprietary trading by insured institutions. If this could be done (which I doubt), it should be. The second, from my colleague, John Kay, among others, is in favour of “narrow banking”, under which deposit-taking institutions would be safe but the rest of the system would be little regulated. I remain unpersuaded that government could ignore the way the credit-creation system as a whole works (or, rather, does not). Nobody planned to rescue money market funds. Yet, in the crisis, they were saved all the same. The third proposal, put forward by Laurence Kotlikoff of Boston University in his thought-provoking new book, is “Limited Purpose Banking”. I like this idea. In essence, it says that you cannot gamble with other people’s money, because, if you lose enough, the state will be forced to pay up. So, instead of having thinly capitalised entities taking risks on the lending side of the balance sheet while promising to redeem fixed obligations, financial institutions would become mutual funds. Risk would then be clearly and explicitly borne by households, who own all the equity, anyway. In this world, financial intermediaries would not pretend to be able to meet obligations that, in many states of the world, they simply cannot." http://www.ft.com/cms/s/0/cca02e40-522d-11df-8b09-00144feab49a.html
The last point I partly disagree with, and I really wonder how such an astute and erudite economist as Martin Wolff can say that in the FT. Wolff claims that "households own all the equity anyway". This manifestly untrue, since corporations and governments (quite apart from banks) own very large chunks of equity, quite independently of the "owners" of those corporations and governments (the ownership of stocks is of course highly concentrated (in the US, 10% of the households own in excess of 90% of all business equity).
You could of course argue that if e.g. Morgan Stanley owns vast equities, these equities are "ultimately" owned by the shareholders of Morgan Stanley. But in fact, most of these shareholders have little or no control over the corporation's equity deals at all. The ideology was that with more private ownership and private initiative, economic life would groove much better, because people would carry more direct responsibility and stewardship for resources, but in reality the "ownership", "control" and "use" of assets, apart from being highly concentrated, very often have become separate, independent functions, creating a problem of governance. With low interest rates, people owning sufficient capital could get rich by borrowing plenty capital and reinvesting it for profit, the snag being that a large chunk of those investments was very dodgy speculation, and added nothing or very little to net wealth, as indicated by lacklustre real GDP growth. And the more asset management has become disconnected from real production, the more uncertain the asset values have become; in a short space of time, trillions of dollars can vanish into thin air.
Even if the risks are formally "clearly and explicitly borne by households", the householders still don't have much effective control over what is done with their assets, because that is practically impossible; indeed many householders don't even want to bother with that control, they don't even have the time for that. So whereas you can institutionalize a "let the buyer beware", "invest at your own risk" policy, the householder still has to place trust in a fund manager of some type anyway, and has little control over fund management operations, except that he or she can divest if the profits are not to his/her liking (and even such divestment may be subject to all sorts of contractual conditions, since obviously few organisations can manage large funds on the basis that people can just take their funds out at a moment's notice).
Personally I "own" a (fairly paltry) bit of pension money in the Dutch ABP fund on account of being a public servant for a decade - the fund has a pretty good reputation - but the control I have over ABP operations is practically non-existent, and indeed I cannot even just withdraw my contributions, if I fancy doing so for any reason. Oodles of people, as Robin Blackburn among others has shown, are in the same boat, and Wolff's prescription doesn't really speak to our situation.
So I think Martin Wolff ignores that a large chunk of saving is, in reality, "compulsory saving". And obviously if I pay my taxes as a law-abiding citizen, I have practically nil control over that money either, except that I am allowed to vote every few years for parties who end up doing something different anyway.
So what's the conclusion? I think we'd have to admit for a start that the whole property system has become dysfunctional, and that there exists in truth no popular or democratic control over the assets we all helped to produce. The only thing us workers can do, mostly, is vote with our feet.

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Received on Wed Apr 28 14:20:34 2010

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