Financial Regulation Is The Answer

In the 1970-ties before deregulation of the capital markets there were book keepers in every bank and corporation managing the effects of government administratively changing exchange and interest rates. There was no need to manage risk, no derivatives, no financial volatility (well apart from occasional devaluations and rate hikes). However with time this paradise came to an end with sky rocketing inflation and too little access to capital. It made it hard to build companies to create the jobs and prosperity we all expect from them. We were lucky having the now so celebrated Mr. Volcker keeping Fed rates so high it created such a deep recession, which later gave us good growth in the coming decades. Meanwhile our great leaders were spending much of their valuable time to figure out how we would get the economy going again. They came to the conclusion we needed many more loans. They launched a new buzz word: “Credit Expansion”. They explained to us, the common men and women, that we must deregulate the financial markets. Prices on financial assets and debt should be set in open market auctions organized through exchanges or on a bilateral basis. This would make the world strive and everyone being very happy creating easy credit flow to everyone wanting money.

Then there was a wake up call for all banks and corporations in the 1980-ties. Now suddenly the inherent positions from cash flows and balance positions could be marked to market in real-time. We were so happy and even so more when we also were blessed with the computer enabling us to expand on market information coverage and how to define and calculate financial risk. Meanwhile the always so clever leaders were worried since they felt we could loose control over the financial development. A special worry was what would happen with the financial system if a bank defaulted. “Oh no”, they so intellectually stated; “We cannot allow for any bank to go belly up.” So they created the Basel Framework in detail stipulating how the banks would measure and report risk. In this way they succeeded creating a solution to avoid the financial system to collapse for any reason. We felt safe and proud. The first crash happened not until the beginning of the 1990-ties when Sweden went through a PIIGS crisis and basically all but one bank got bust. But Sweden was so small and no one really cared (except the Swedes of course). Eventually they developed a very nice solution with even higher taxes and an expanded public sector hiring more bureaucrats than doctors and nurses. This was very clever since it created well paid employment with very low demand of output for our distinguished leadership.

In the 1990-ties we were blessed with sophisticated treasury systems, value-at-risk, and separation of duties. Now the field lay open for anyone to trade, regardless of underlying commercial position. Sometimes it popped up scandals with some sorry guy who had taken too big positions, doubling and doubling, even hiding trade tickets in the drawers. But that was all forgotten when he came out of jail and wrote a book. Some even earned more on books than trading. It was a wonderful time. We all continued to trade and sometimes we also hedged. We built portfolios of our financial positions; Trading, Strategic and Tragic were their names. Some positions even had so long duration that the traders were long gone when they expired. This did upset the auditors for the right reasons. They felt they had no control, which shall never happen. They therefore eagerly and faithfully started to lobby for new legislations for accounting. The most famous was Hedge Accounting. (Fair Value Accounting is also another valuable milestone in their careers, but unfortunately it came way later). One thing is clear; if you want to solve a simple problem ask an auditor and you will have plenty of valuable spend and bureaucracy to fill your time for at least a decade. We owe a lot to them.

The 2000-ties started a bit sour. We had a big crash. Who could have guessed that all those solid companies with p/e ratios in the millions would crash? It struck like lightning on a clear day. Anyway we had a great comfort in eagerly implementing Hedge Accounting in our spare time. A special treat was that if we had the assistance from a consultant to implement it, we surely would hear from our auditors they would not approve it creating ample opportunities for interesting and high energy creating discussions. And we were happy, hedge accounting created immense value for society and it was reaching our target of creating annual accounts leaving no question marks on the financial position whatsoever. In parallel we excelled the skills of defining policies that would eventually eradicate all financial risk for ever. The policies and hedge accounting combined was so successful that we would develop so robust procedures that we would be able to even control our future. Anyway that was what we believed. However something happened in 2008. Two very old brothers in the US (heard they were more than 150 years old) – the Lehmann Brothers – did something to interrupt the whole scheme of things. Somehow they managed to eradicate the water proof protection to financial volatility that hedge accounting and treasury policies and credit expansion so wisely had provided. The brothers even made banks go bankrupt. Poor central bankers having worked so hard for so long time to build up the perfect remedy for financial domino effects (the Basel framework). But the Lehmann brothers got what they deserved, I have even heard they are dead now – for real! And being America, they probably had it coming in the good, old fashioned way from a tree.

But now everything is back on the road again to full control and final eradication of financial risk. Our clever leaders have come to the divine conclusion that we must regulate again. I feel so much comfort in their common sense, high spirits and smart actions. I’m so grateful they borrow very much to ensure we can have our good standard of living forever. They have recently informed us that the good thing with government loans, regardless how many or how big, is the fact they create absolutely no financial risk what so ever. Only derivatives on loans do. This has made me understand the connection so clearly. I cannot understand why I have not realized this long ago. Probably that is why I’m not a bureaucrat.

Now it makes complete sense that our distinguished leaders want to regulate and even ban financial derivatives. That must be the very best way to eradicate financial risk once and for all so we can continue being safe and sound.

Hey, hey for a job well done.