After the Election: Realities, Opportunities, and Challenges for Investors
The all-star cast of speakers during the University of Virginia’s Investing Conference — Jeremy Grantham, John Taylor, Kyle Bass, David Rubenstein, and Lawrence Goodman — presented mostly dire themes facing the US economy: extreme loss of confidence (both in the markets and regulators), the Central Bank assuming an unprecedented interventionist role (crossing the lines between setting monetary, to now fiscal, policy), an overvalued bond market, the far-reaching effects of uncertainty, convoluted new regulations that evade understanding, an exploding balance sheet — and let’s not forget that fiscal cliff that threatens to take each of us and whatever remains of global stability down with us.
While including threads of doomsday predictions in her address, keynote speaker Sheila Bair, former chair of the FDIC, had things to say on a number of levels about the future of financial services, in light of the current economic dilemmas, including possible solutions.
Problems in the Regulatory System
Noting that the system is fraught with acrimony, that banks have lost the trust of investors, and that there is almost constant push back against regulators, Ms. Bair, who chairs the CFA Institute co-sponsored Systemic Risk Council, pointed to four symptoms of regulatory dysfunction that have complicated meaningful reform:
- “Rubber band” regulation: Those believers in the former regulatory approach got burned and have now turned to the “other side” of endorsing new sets of regulations.
- “Genius” regulators: These consist of smart people who write complex rules that none can understand.
- Unbelievers: Those who don’t believe in regulation and that the recent crisis was of the “100-year flood” genre.
- Captive regulators: Those who lack the ability to separate their mindset from the mindset of those being regulated (an example being bank regulators who are too focused on making banks profitable).
And regulators are also influenced by Congress, notes Ms. Bair, which adds to the problem. The power of campaign contributions is but one example of related reform that needs to be addressed.
Possible Solutions to the Current State
To effectively address the economic state we’re in, Ms. Bair suggested four other areas that need close attention:
- Too-big-to-fail. Having approached this while chair of the FDIC through the creation of living wills and resolution authority, she wishes the Federal Reserve and Treasury Department would address this more, also noting that implementing certain rules and getting certain institutions to restructure would also help.
- Capital. She would like to see a 12:1 capital ratio and believes giving shareholders a higher stake brings greater market discipline.
- Risk retention. Bair prefers mortgage writing rules requiring lenders and bond issuers to keep a stake in home loans they securitize.
- Credit losses. She thinks credit default swaps (CDS) should be “shunned.”
Closing her presentation on a bigger picture note, Ms. Bair warned against taking a “rear view mirror” approach to analyzing what has happened and letting it dictate our future decisions for reform, as the next crisis will have different players.
The next exploding bubble? According to many of the conference’s experts, including Ms. Bair, the bond market is about to blow.
Photo credit: ©Shutterstock.com/Albert H. Teich