Financial reforms off target

Several industry commentators have expressed concerns in recent days that the financial reforms around the world will fail to deal with the real problems that led to the financial crisis and consequent corporate collapses.

Speaking at the Perennial Investment Partner’s Invest10 conference, Adrian Blundell-Wignall, deputy director of financial and enterprise affairs of the Organisation for Economic Co-operation and Development, said the reforms that governments were putting in place globally were “missing the point”.

The reform was fiddling at the edges of the system and not getting to the heart of the problems leading to the financial crisis, he said.

In 2004 at the Basel conference, the United States Securities Exchange Commission decided to supervise investment banks based on their entire consolidated entities. Blundell-Wignall said this decision left the broker dealer arms uncontrolled, and allowed the banks to grow their leveraging enormously.

That in turn led to an acceleration of mortgage-backed securities, which were ‘toxic assets’ sitting on the banks’ balance sheets.

There was also an explosion of credit default swaps (CDSs) from $3.4 trillion to $60 trillion from 2004 to 2006, which made securitisation easy and allowed banks to get around regulatory capital rules, he said.

Blundell-Wignall said that with the commercial banks’ involvement in the credit culture, combined with investment banks using CDSs to securitise toxic assets, the two hallmarks of the crisis became contagion risk and counterparty risk.

These were the real causes of the financial crisis, and remained unaddressed, he said.

“You’ve heard about the credit rating agencies and reforming those, you’ve heard about the underwriting standards — and they are all potentially important things — but in terms of what really mattered in this crisis ... you need to look at some of the clues,” he said.

Even now, the risks that the investment banks were taking on were simply being transferred to the insurance companies, while the Federal Reserve were also taking on toxic assets that were sitting on their balance sheets, he said.

In a recent address to the Australian Institute of Superannuation Trustees in Melbourne, the commissioner of the HIH Royal Commission, Justice Owen, echoed Blundell-Wignall’s comments.

He labelled Australian government reforms of the financial sector “reactionary” and said he was not sure that the move to add more levels of regulation would deal with the problems of corporate collapses.

Investment companies needed to make decisions because they felt right, not because of regulation, he said.

Australia needed to develop a culture of compliance instead (in which the first port of call would be your ‘gut instinct’) and to develop moral values that underpin that approach, he said.