Monday, February 4, 2013

More rhetoric: UK's George Osborne and electrifying the ring-fence

Since the beginning of the financial crisis, global policymakers have been long on rhetoric describing how they will save the taxpayers  from a future bank bailout through yet another example of the combination of complex rules and regulatory oversight.  The latest example is an electrified ring-fence.

Regular readers know this is hot air as the global policy is "financial failure containment" and not "financial failure prevention".

The basic idea behind ring-fencing is that it separates investment banking from retail banking and makes it possible to let the investment bank fail.

Why is this separation necessary?

So that the failure of the investment bank doesn't drag down the retail bank too.

This is nice in theory, but given the global financial regulators' concerns with financial contagion there is no reason to assume it will actually be used in practice.  Does anyone think the global financial regulators will not use taxpayer money to bailout an investment bank that is larger and potentially more interconnected than Lehman Brothers?

Please note, ring-fencing is focused on financial failure containment, what happens should an investment bank fail, and not on preventing the financial failure in the first place.

Apparently, global policymakers have never heard the expression:  an ounce of prevention is worth a pound of cure.

The focus has to be on preventing the investment or retail bank from failing in the first place.

There is only one way to prevent failure and contain the fallout should failure occur.  The only solution is to require that the financial institutions disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants can exert discipline so that the financial institutions reduce their risk profile and therefore become less likely to fail.

Equally importantly, with this information, market participants can independently assess the risk of each financial institution and adjust their exposure to the financial institution based on the market participant's ability to absorb any losses on their exposure.  By limiting their exposure to what they can afford to lose, market participants contain the fallout from failure and eliminate the need for taxpayer funded bailouts.

George Osborne's rhetoric on ring-fencing as reported by the Guardian,

"My message to the banks is clear: if a bank flouts the rules, the regulator and the Treasury will have the power to break it up altogether - full separation, not just ring fence," ... 
"Any bunch of politicians can bash the banks, chase the headlines, court the populist streak. But what good would that do our country? The jobs, the investment, the banking system we all need would go with it. Let's take the anger we feel about the banks and turn it into change to build the banking system that works for us all," said Osborne.
The starting point is requiring the banks to provide ultra transparency.  Until this occurs, the bankers will continue to privatize the gains and let the financial regulators put the losses on the taxpayers.

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