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.

Stay tuned.

2 comments:

LceeL said...

Maybe it's much simpler than that - maybe what needs to happen is that the ruling which gave the Rating Agencies the rule of law needs to be reversed - and banks need to go back to being banks. Maybe we need to return to a time when it made sense to save money. Maybe we need to protect the value of the Dollar so that 'money in the bank' takes on its original meaning - that you HAVE money in the bank, that you're saving, that you're putting away for the rainy day.

winslow said...

Our political system is not set-up for making these types of simple decisions. There is always strong opposition even to good policy. What is the answer? I don't know, but it is destroying the country.