Reforming the financial system
Gordon Nixon, the CEO of the Royal Bank of Canada, argues in favor of prudent reform. In his speech at the bank’s annual meeting on March 3, he made the following comments: “While new regulation in response to recent events is inevitable, it is critical that new standards not impede the ability of the market to operate efficiently…Any reforms must balance the need and urgency for change, with their impact on economic growth, the health of the financial services sector and the ability of companies to generate shareholder value.”
A day earlier, Paul Volcker was the key speaker at a Canadian Imperial Bank of Commerce event for its key clients. Gord Nixon does not favor the types of reforms proposed by Volcker and supported by President Obama. Volcker would move the U.S. financial system part way back to the Glass-Steagall era.
Let’s connect some dots in order to compare their positions. The U.S. Treasury likely will lose $80 to $100 billion on its assistance to AIG under TARP. The losses are the result of AIG’s sales of credit default swaps. The major buyers of these swaps were not the buyers of the debt “insured” by the swaps. The major buyers were hedge funds and other traders who used the swaps to bet on the deterioration of credit risks.
On February 23, Ben Bernanke, the Federal Reserve Chairman, announced that the Fed would look into the use by Goldman Sachs and other Wall Street firms of credit default swaps to make bets that Greece would default on its debt.
Goldman Sachs and JPMorgan have entered into the metal warehousing business, each one buying a major player in the business. Goldman and JP are astute investors, so their entry into this business suggests that they expect stockpiles of commodities to increase. Interestingly, the stockpiles are rising at the same time that commodity prices are rising. But commodity prices are rising because some speculators expect increasing demand as the global economy recovers. Goldman and JP are placing bets that the demand will not materialize.
What do we get when we connect these dots? A financial system that looks increasingly like a casino.
Let’s look at more dots. Eric Reguly reported (Globe and Mail Report on Business, March 4) that “In last year’s 263 trading days, Goldman Sachs lost money only 19 times.” What is the likelihood of this happening? Even taking into account the company’s superior talent and luck, the probability is extremely low. So what else can explain such phenomenal results? How about superior information?
Adding this dot to the others suggests that the odds in the casino are stacked heavily in favor of the house. The poor peasants have an even smaller chance of breaking even in this casino than they do in the ones in Las Vegas, and there are no free drinks either.
Now back to Nixon’s speech: Will Volcker type rules have a negative impact on economic growth and financial innovations?
Canada abolished its version of Glass-Steagall in the mid 1980s. If the greater flexibility permitted by this change enabled the banks to become more innovative and the financial system to become more efficient, thus contributing to higher rates of economic growth, where is the evidence?We should have seen some improvements in Canada’s productivity and economic growth rates between the mid 1908s and 1999 when Glass Steagall was repealed in the United States. Canada’s productivity levels did improve relative to the U.S. in the 1980s, but have since continued to decline in relative terms. Further, Canada’s economic performance over this 15 year period definitely was not superior to that of the U.S. when compared in terms of economic growth rates, unemployment rates or the rates of inflation.
The economic performance of the U.S. economy in the decade following the repeal of Glass-Steagall was inferior to the performance during the preceding decade. Of course, there are many other variables which impact the performance of the economy. However, there does not seem to be any obvious evidence to support the claim that financial flexibility has played a positive role.
Indeed, in Canada it would be difficult to make the case that small and medium size companies have been better served by the financial system since the mid-1980s.
So who is right – Nixon or Volcker? My money is on Volcker, and even he does not go far enough.
The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.