Will Financial Regulation Make Us Safe?

Posted on Categories Business Regulation

It is with a bit of fear that I take over the podium as a guest blogger. The thought of coming up with enough substance to satisfy the cravings of an unnamed and faceless reader base is a bit frightening. So, please excuse me if my nervousness shows through in my writing.

So, first a bit about me. I have been very fortunate to have had a fantastic fifteen-year career in the hedge fund business (which does make me a bit of a dinosaur in the industry). Most recently, I was the President and Chief Operating Officer of Stark Investments (one of the oldest hedge funds in the world). During my career working in the business, I have done about everything – from providing legal counsel, to co-managing a large portfolio, to ultimately taking responsibility for the execution of the strategic vision and the overall administration of a large organization. I am a 1993 graduate of the Marquette University School of Law (and have to say that I am thrilled at all of the very positive developments at the Law School – kudos to Dean Kearney and his team!). All of that being said, I have had the fortune (or misfortune as the case may be) of having had a front-row seat throughout this period of financial crises.

It is with this background in mind that I will spend my month at the podium discussing the markets, the financial crises, financial regulation, and the evolving nature of some of the key players in the markets (investment banks, hedge funds, and other investors). 

I will start with some perspectives on the cause of the crises, the historic regulatory environment, and overall human behavior.

Earlier today (Thursday, September 2) – nearly three years after the first signs of instability became visible — Federal Reserve Chairman Ben Bernanke told lawmakers that a lack of regulation in the banking system was one of the key triggers in the 2008 economic and financial crisis. Speaking at a hearing before the Financial Crisis Inquiry Commission in Washington, D.C., Bernanke said that “the shadow banking system, as well as some of the largest global banks, had become dependent on various forms of short-term wholesale funding,” and that “the reliance of shadow banks on short-term uninsured funds made them subject to runs, much as commercial banks and thrift institutions had been exposed to runs prior to the creation of deposit insurance.” The Fed chief said that the Federal Reserve had no authority to regulate the shadow banks and address their liquidity problems until the crisis had already decimated the economic and financial system.

Although there is no doubt that the shadow banking system did act to exacerbate the instability in the markets, it is just one of many contributing factors (and, in my mind, was one of the more immaterial factors). The more significant factors, in my mind, were: (a) the policy decisions encouraging a low-rate environment in early 2000 (following the bursting of the tech bubble and the 9/11 attacks), which encouraged excessive risk-taking and speculation; (b) the corresponding development of bubble-like conditions in the real-estate market; (c) poor decision-making by consumers, underwriters, appraisers, and lenders, which allowed the real-estate bubble to continue to expand; and (d) Wall Street’s involvement in this party, which fueled the growth of new products (subprime mortgages and all of their derivative by-products which exploded on the scene) that magnified the consequences of the bursting of the bubble. This all resulted in a credit bubble of epic proportions — a bubble that will have lasting consequences for years to come.

To boil it all down, the primary culprit, in my mind, was a simple human behavioral characteristic: Greed.

Over the next few posts, we will explore the policy and purpose of our historic regulatory framework and that of the newly proposed environment. However, the question that we will come back to is: What is the best way of policing greed and excessive risk-taking?

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