Thursday, April 29, 2010

US pushes for global capital reform

In an article in the online version of London's The Financial Times entitled, "US prepares to push for global capital rules," Tom Braithwaite wrote, "The US is preparing to pivot from domestic regulatory reform to a push for a tough new international capital regime after the weekend’s G20 and International Monetary Fund meetings glossed over differences between leading economies."

Candid Commentator (CC) is concerned that this is just another evidence of Obama's disdain for America's national sovereignty, and is a deliberate effort to subject America to international rules. This tendency, CC fears, will eventually lead our world to a global government.

In an effort to simplify the technical aspects of the article, CC called on guest writer Brian Bartsch (BB) to give his analysis of the developments.

CC: It almost sounds as though the US is pushing for banks to have a bigger capital reserve than they do now - 8% to 25%. That is a HUGE increase. What are your thoughts? What does the government stand to gain from this except more power through the regulatory door? (I don't trust the government.)

BB: Like you, I’m suspicious any time the government wants to increase regulation. I have a couple of thoughts:

First, if they raise the capital reserve requirement that much, there’s a progression that will be hard to stop:

  • Banks will be forced to call in loans in order to generate the high amounts of capital needed to meet the new reserve requirement.
  • The aggregate amount of liquidity will dry up as banks won’t have any money to lend.
  • Interest rates will skyrocket as the demand for financing will drastically outpace supply.
  • Businesses will be subjected to intense pressure financially; some will fail as they can’t afford their debt service and/or can’t find the financing they need to stay afloat.
  • At best, growth will come to a screeching halt as the creation of new businesses and the expansion/growth of existing businesses are discouraged by the high cost of capital.
  • The jobless rate will consistently edge upward as businesses tighten their belts and no new jobs are created.
  • Without something to change this equation, a recession seems likely at best.

Second, the schism between the USA/UK coalition on the one hand (pushing for the higher reserve requirement) and the France/Germany coalition on the other hand (against the higher reserve requirement) was very telling. France and Germany don’t have a problem with using public funds as a safety net (read: government bailouts) or are for interventionist policies as a whole. This means they see no need to (additionally) reduce risk because the government will step in if a situation ever gets out of hand.

The USA and UK, on the other hand, are trying to move away from the government intervention we just saw under Bush/Obama. They want to avoid the need for governments to step in by mitigating risk in two ways: by removing the riskiest loans from the table (since banks who can’t lend as much will only keep their safest loans) and by creating the cushion necessary to handle future crises without bailouts.

I guess that of the two, I’m more for the US/UK option, since that is ultimately the option that lets market forces determine financial activity, whereas the idea that the government will always step in (as recently with Fannie Mae/Freddie Mac here in the US) ultimately props up inefficient business practices, leading to bubbles.

However, events like this ultimately drive me to realize that the need for increased regulation (as is true with either option) only exists because of people who attempt to take advantage of others in their drive to satiate themselves. That is, if people instead made an effort to look out for the needs of others in all the arenas of business (rather than just looking out for themselves), they would act not only in their own interests, but also in the interests of their managers, employees, customers, vendors and shareholders; doing so would obviate any need for new regulation as decision-makers (by acting more responsibly) would mitigate their own risk, which would in aggregate, reduce risk as a whole.

A corollary is that rules exist because of rule-breakers, and increased regulation is ultimately a response to increased exploitation. Put another way, legislating morality only works if the people in the system are moral; if immoral people make up a significant enough portion of the system, no amount of increase in the rules will fix the problem.

A second corollary is that rules designed to help fix problems only undermine the freedom of those who don’t need the rules anyway; exploiters will find a way to take advantage of people no matter what rules are in place.

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