Investment Management Blog - Montague Capital

At long, long last we have a piece of fundamentally good news.  Unfortunately, this story is both too complex for the whitesocks to understand and won’t be reflected in events today, so markets have all but ignored it.  Nevertheless, if it comes off, this stands to be one of the most significant developments the global financial market is likely to experience for decades.  Better still, it is one that will go a very long way to ensuring that it is many years before we experience again what we have been going through over the last year (and will have to continue to endure for a year or more yet).

The news in question is the publication in the US of a report into the credit crunch by the Counterparty Risk Management Policy Group, led by Gerald Corrigan, former head of the Federal Reserve Bank of New York and managing director of Goldman Sachs.  This is not a repeat of the piece of limp flannel served up in the UK last week under the title of the Crosby Report.  For one thing, a raft of leading US banks have given the report and its conclusions their public support.  And those conclusions are striking.

Banks are voluntarily accepting tougher regulatory oversight and a deliberate restriction of their opportunities for growth in order to take risk out of the system.  Just compare this with the UK where Sir James Crosby only just resisted the bullying of our banks to plead for even larger state handouts to boost their coffers with no reciprocal concessions.  In the US, “sophisticated investors” will no longer be allowed to buy complex structured financial products unless they can demonstrate an ability and willingness to monitor what they are buying into.  Private clients can forget about this game altogether unless they are billionaires or above.  Banks will voluntarily submit to far tighter accounting treatment of structured products and transparent disclosure of “assets” that may still reside off balance sheet.  Risk-testing will be realistic and with reference to unthinkable catastrophes, rather than the less threatening exceptions to the daily grind that were favoured until 2007.  Bankers’ pay deals should no longer allow “patterns of behaviour and allocations of resources” which threaten “the basic goal of financial stability”.

In theory, all this makes a repeat of the present credit crunch far more difficult to take place.  Accounting policies will make it harder for banks to dream up “exotics”, there will be fewer customers to sell them to, risk-testing will ask really tough questions (and demand answers) and the whole thing will be transparent.  In other words, the problem will never grow as big again and we will know at-a-glance how big it could be.

But it is the size and lingering uncertainty about the present crisis which will prevent us from deriving any immediate benefit from this report.  It is not just reasons of “administrative complexity” that are preventing banks from signing up for tighter accounting and regulatory standards before 2010.  Do so earlier and the unspoken truth about just how bad things are will be laid bare for all to see and flee from in terror.  The banks will also need at least that long to identify and clear up what remains of today’s mess.  That is not a cost-free exercise.  Nor is the creation of the institutions – such as a grown-up clearing house for derivative products – which will be required to service the proposed new regime.  And, as usual in anything involving lawyers, the devil will be in the detail of any final agreement between the parties involved.  Lastly, the banks’ potential to make money on the same scale as in the run-up to August 2007 has gone, taking with it a big chunk of their future valuations.  But that’s a small price to pay in order to try to avoid the greed of a few supposedly intelligent men in suits from dragging down the entire global economy.  Mr. Corrigan deserves our thanks.