Most of the measures in the Senate’s version would be damaging, hike costs, reduce growth and jobs and do nothing to promote stability; a few, however, would actually help. Contrary to what most believe, artificial restrictions on what large firms can do – be it on operating private equity wings, involvement in derivatives or so-called proprietary trading – would have done very little to prevent the crisis. Northern Rock would still have gone bust – as would have Spain’s Church-controlled savings bank CajaSur, which was nationalised by the Bank of Spain at the weekend.
The proposal that firms that act as pure intermediaries between a buyer and seller should be saddled with a fiduciary duty towards both sides of the transaction is even more senseless. Sophisticated investors should have the right to ask a broker to conduct whatever transaction they wish, without being lectured on risk or told that the deal cannot be done for fear of a lawsuit.
But any move to eliminate the too-big-to-fail status, which applies to top banks, would be hugely positive. It would eliminate a crippling distortion in the market: Moody’s says that 17 US banks enjoy a better rating thanks to implied government guarantees. Some firms are enjoying a rating that is 3-4 notches higher than they truly deserve, allowing them to borrow money too cheaply. Several banking groups could be downgraded if the final bill introduces provisions for wind-down in the event of bankruptcy. While this will disrupt the money markets in the short term, making it trickier to raise wholesale finance, it is a good long-term reform which eliminates the competitive disadvantage suffered by smaller players.
We need real capitalism, not corporatism – it is by that metric that we should judge reforms. It is unclear what the final deal will be on ratings agencies but it is important their special privileges be revoked. The best news in this sphere is that Jules Kroll, founder of the eponymous corporate investigation firm, is planning a new, more sceptical credit rating agency.
The mainstream view on financial regulation – that just about any proposal that anybody comes up with must be implemented as quickly as possible, the more prescriptive and damaging to the financial services industry the better – is deeply flawed. To take just one interesting proof of this: research from Data Explorers shows that short-selling has played very little part in the recent market chaos, contrary to what everybody in Europe and especially Angela Merkel believes. Data Explorers’ long-short ratio provides the best data we have on this: if the relative volume of shorts go up, the index drops; if regular, long-only investing increases in importance, the index goes up.
The ratio is down 11 per cent from the 52 week high of 31 December 2009, but up 2 per cent from the 52 week low of 7 May 2010. So during the past weeks, as markets collapsed, shorting fell in relative terms; it was long investors that drove the decline. Facts have a funny habit of demolishing the received wisdom – something that US legislators are just as bad at understanding as our own politicians.