Wednesday, July 28, 2010
Leverage Is A Tool & It Can Be Abused
Recently, I have taken a break from writing almost every day about the political-economy. Perhaps, after the summer passes, I will feel like writing about the markets and what I think needs to be done. Although the Congress passed the new financial regulation legislation, the conflict of interest, between the investment bankers that underwrite the new bond issues and the credit rating agencies that rate the new bond issues, was not dealt with at all. This, in my opinion, is a serious omission, and I believe will lead us back to the problems that caused the bond market meltdown in the first place. I have suggested that the Federal Reserve Bank should take upon itself some role in the establishment of criteria for the triple-A rating because credit ratings and notes that qualify as reserves are tied together. When I was in Indianapolis a few weeks ago at an investment conference, another gentlemen suggested to me that the Federal Reserve Bank might monitor both the triple-A and double-A ratings. I have no problem with that. In fact, I think those two high grade bond ratings should have a "second signature" behind them. Without the Fed keeping a closer eye on the passing out of high grade bond ratings, the capital markets will find themselves in the same liquidity crisis that brought it to its knees and required the Federal Government to give it an influx of liquidity. Once more, this is not rocket science, these problems are man made and they are the direct result of greed. Leverage in the world of finance is a tool much like leverage is a tool in mechanical engineering, but leverage abused will bring down a financial system just as swiftly as leverage abused anywhere else.