Banker-author warns overseers to keep ‘extreme money’ in check

September 19, 2011

By Stuart Gittleman and Emmanuel Olaoye

NEW YORK, Sept. 19 (Thomson Reuters Accelus) – The “extreme money” and “voodoo banking” that are dominating the global financial system are too smart, too fast, too greedy, too self-absorbed and far too dangerous for traditional legislation and regulation, a veteran banker told Thomson Reuters.

Efforts to prevent another financial crisis are likely to fail unless lawmakers and regulators understand that the forces that drove the crisis of 2008 go back several decades. While keeping an eye on the past, the overseers should also look for the potential risks of proposals claiming to promote growth, and how they are disclosed, Satyajit Das says in his book, Extreme money: masters of the universe and the cult of risk (FT Press, August 2011).

“This is a process at the end of something that has been going on for 30 or 40 years,” said Das, an Australian resident who has worked in the banking industry, including derivatives, risk management and capital markets, for over 30 years. “When the economic history of this period comes to be written, what you will find is the global financial crisis, as wrenching and as traumatic as it was, is going to be a very small thing.”

Das said the causes of the crisis began as far back as the 1970s when modern economies like the United States and Britain suffered from low growth. Governments looking for a way to drive growth saw deregulation – the government policy of reducing controls from some sectors of the economy – as the best way to reach this goal.

Deregulation let institutions issue debt at higher levels than in the past. The institutions used financial engineering – using technology and quantitative methods to solve investment problems – because it let them pump “more and more debt” into the economy.

Moreover, deregulation and financial engineering “created a class of people whose particular ethos is the cult of risk, and they came to dominate lives,” Das said.

But lax regulatory controls, inadequately tested and monitored risk models and oversight practices, skewed incentives and poor governance let risks grow too much, too fast and too far. As a result, hidden risks were dispersed to investors who did not want to take on such high levels of uncertainty in which they had more to lose than they would likely gain.

Lawmakers and regulators started trying to prevent the next crisis before they understood what was behind the one they were facing, in many cases without addressing the impact of financial alchemy and the “Doomsday debt machine” on global finance, Das said.

U.S. lawmakers may have intended the Dodd-Frank Act to prevent banks from becoming too big to fail, but Das said the law mandates rulemaking that may itself be doomed to fail. Part of the problem, he said, is the power the banking lobbies have over regulators and members of Congress.

“The banking lobbies are among the most active and most powerful I have ever come across. They are also some of the cleverest that I have ever come across,” Das said.

Das pointed to the Basel Committee rules that require banks to hold higher levels of capital and use less liquidity to keep them financially sound, and said the banks will maneuver around the rules by arguing that their risks are minimized if they are bigger.

Das also said rules requiring central counterparties for derivatives are flawed because they will force derivatives traders to use swap execution facilities, which will tie the traders even more closely to the 12 to 15 derivatives dealers that dominate the market.

Asked for the most important lesson from the financial crisis, Das said lawmakers should focus on the drivers of the crisis.

“The way I look at it is its like having a Monet painting. If you stand too close to a Monet, all you will see are a few brush strokes. As you move back further and further a panorama emerges,” Das said. “I think it is important that if we are going to learn from this episode that we understand the panorama and the forces that drove it. Because if we don’t do that, we are going to make catastrophically incorrect changes.”

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus.  Compliance Complete ( ions/regulatory-intelligence/compliance- complete/) provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)

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