institutional changes are coming

Financial market volatility got you down?

As you know, I have been saying for some time that the markets will continue to be volatile until the actors that got us here are either gone or have legitimately changed. Additionally, there will be volatility for at least one quarter’s worth of earnings announcements from businesses. That’s because their results, affected by the financial industry meltdown and recessionary conditions, have not yet been baked into the financial markets. This is a point that I made a month ago but that continues to be demonstrated by the daily closings of the financial markets.

Not to beat a dead horse, but the actors that need to change are three:

• The institutions that got us here have to change. This includes financial institutions and their regulators
• The people who flubbed this whole thing up have to lose their jobs, or legitimately change. It is better for all concerned that they lose their jobs in my opinion
• The failed ideas about how to run a financial business and to regulate industry has to change.

Today’s Wall Street Journal has the first rumblings out of Democrats as to what financial industry changes can be expected from a legislative point of view. This directly addresses the first bullet point above.

Here is what is being proposed:

• House Financial Services Chairman Barney Frank said that he is weighing tougher rules on shareholder rights and stricter conditions on the $700 billion financial rescue package. This is a good thing. After all, shareholders have taken a backseat to the interests of executives for far, far too long. As a former institutional shareholder, I have to tell you that most businesses were run for the benefit of management and secondarily were run for shareholders. Ugh!
• One of the areas of interest here is to limit executive compensation at firms that are receiving large government payouts. And hopefully there will be a reform of, or elimination of, “pay for failure.” Again, this is something being discussed and that I insisted on earlier on the blog. Check out that archive!
• (Parenthetically, Senator Charles Schumer, who serves on the Senate Banking Committee is also committed to reforming the financial regulatory environment. So there is a powerful push in both houses of Congress for this movement. Trust me, this is a good thing!)
• Frank is also considering the creation of a “systemic risk regulator.” Systemic risk is the overall risk in financial markets, as opposed to the risks faced by a specific industry or individual business. This is one of the very things that I suggested would be a great fix for the finance industry in an earlier posting because right now, no one regulator has even good transparency into the whole system. That’s a bad thing. But what is being discussed is that the “systemic risk regulator” would have power over many financial institutions, from insurance firms to hedge funds. The idea would be to protect the soundness of the whole financial system, not just one sector. Hurray!
• Representative Frank likened the establishment of this new regulator to that of the Securities and Exchange Commission. As you may know, the SEC was created in the aftermath of the great stock market crash of 1929. In the aftermath of the great crash of 2008, new institutions are also going to be created. Hopefully these new organizations will be as successful in protecting our economy. Until the succeeding generations forget the lessons of our generation and need to create their own new institutions.
• Frank also talked about banning over-zealous selling of credit cards. That would again be a welcomed thing.
• Of course, I earlier commented on the SEC chairman’s wish to see his organization merged with the CFTC. That is still on the table as a possibility. Now there is additional talk about merging the Office of Thrift Supervision (OTS), the regulator of thrifts, with the Office of the Comptroller of the Currency (OCC), the regulator for banks. Again, this would be a good thing. More concentrated regulatory power allows for greater and more immediate application of power, as well as greater simplicity. Amen!

Lest my more conservative readers out there lose their laissez–faire minds, the Democrats are also talking about reforms that would benefit the finance industry, too. For example, it is currently the case that banks cannot hold greater than 10% of total U.S. banking deposits after the acquisition of another financial institution. Schumer has talked about eliminating this rule. The idea behind this is that in a future financial industry crisis that the stronger banks can take the role that the U.S. government has filled in this crisis by purchasing and absorbing weaker banks. The danger, of course, is that if the largest bank fails that the “earthquake” is an 9.0 on the Richter scale, instead of a 5.0. Could be a good thing, could be a bad thing. When it comes to money, conservatism is preferred.

Also, Senator Schumer as said that Democrats are, “very mindful of the fact that too much regulation will snuff out the hallmark of our economy, which is entrepreneurship.”

Additionally, President-elect Barack Obama, on the campaign trail echoed many of the financial-industry changes that are expected to be pushed by congressional Democrats. It’s my opinion that they have been working together to craft a policy even in advance of the Election. After all, Barack was ahead strongly for almost two months. So it can be assumed that Congress’s voice is also his voice.

Rather than commenting on the real specifics of this package of potential reforms, as the details will change, just note the most important thing: CHANGE IS UNDERWAY. We are still many months away from financial markets stabilizing.

Hang tough out there!

With my usual smile for all of you!

Jason