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FSA barks up wrong tree on guarantees

The Financial Services Authority has since the credit crunch had a bee in its bonnet about the incentives and rewards offered by financial firms and whether these encourage risky behaviour. It’s a perfectly reasonable concern. Big bonuses probably did skew behaviour towards excessive risk taking in some cases, although the crazy risks run by employee-shareholders at Bear Stearns and Lehman Brothers suggest it might be a more complex picture.

But the FSA’s latest campaign — against long-term bonus guarantees — simply doesn’t make sense. The regulator has written to more than 40 chief executives in the financial services industry warning them against offering bonus guarantees with a duration of more than one year. This is “inconsistent with effective risk management”, the letter states.
The whole idea of guarantees is of course a loaded one in the wake of the crisis. Some feel that bankers have come through it in better shape than their shareholders.

But one has to question whether the FSA is wise to stray into this area at all. Bonus guarantees are largely used to lure employees with special knowledge or skills to move their “practice” from one firm to another. The extent to which banks should invest in building up in a new area in this way is surely a commercial matter for them and their investors. It should only be a matter for the regulator if the level of investment is so big that it might imperil the whole business.

It is also very questionable whether guarantees do encourage risky behaviour. Arguably they do precisely the opposite. After all, employees who must earn their bonuses have an incentive to take risks. Their pay will be meagre if they do not. But a long-term guarantee, for all its shortcomings, actually encourages risk aversion. If employees have been promised the full rewards up front, their objective is to avoid being fired — not to shoot the lights out.

Obama treads lightly on Wall Street

President Obama, in a speech on the financial crisis at Georgetown University in April, spoke eloquently about the need to move away from a Wall Street-fueled “bubble and bust economy.” But Obama’s proposal for overhauling the financial regulatory system falls well short of his stated goal of making “sure such a crisis never happens again.”

In fact, another major crisis is all but certain if the administration’s plan is enacted as is. I can’t tell you when. Nor can I tell you which financial institutions will be hardest hit. But it will happen because Obama took the path of least resistance when it came to the thorny issue of handling financial institutions that are deemed too big to fail.

Mervyn King’s uncomfortable sermon for the City

Did Mervyn King miss his true vocation? Last night he compared the Bank of England to a church – with the Governor as the priest – as he took to the Mansion House pulpit to pour a rhetorical bucket of cold water over guests at the Lord Mayor’s banquet.

Headline writers predictably seized on King’s disagreement with Alistair Darling over Britain’s regulatory structure. But the more interesting section of his speech dealt with banks that pose a threat to the stability of the financial system.

The people not in the room

President Obama says he wanted a “light touch” in his adminstration’s approach to regulatory reform. And he certainly appears to have gotten that, after a quick read of a draft copy of the administration’s 85-page “white paper.”

Much of the meat of the reform package has been known for quite a while and some of it–like the plan to create a new consumer financial products protection agency–is good. But too much of the reform proposal seems more aspirational than anything else. I stopped counting, but the word “should” appears throughout the text far too many times.

It’s time to audit the Fed

The centerpiece of the Obama administration’s long awaited financial regulatory reform package is to give more power to the Federal Reserve to oversee any financial institution deemed too big to fail.

Team Obama seems to have decided that the Fed should emerge as the premier financial regulator, even though it has just as much egg on its face as the much-maligned Securities and Exchange Commission for failing to blow the whistle on Wall Street’s excesses.