Bank One Center[/caption]Jeffrey McKie----TARP and bailouts are the current administration’s idea of a solution to the economic and financial mess. It is time for the incoming administration to identify the real underlying causes. Here's a backdrop on what financial regulation means and what it means for everyone who wants to make the right financial decisions and know how this all works, in order to join with other Americans in asking politicians to do the right thing for all of us.
From my perspective after 35 years in the investment and financial services business, the solutions are obvious. Much of Main Street’s problem with Wall Street is a pervasive mistrust and a lack of confidence in the financial markets, consistent with the old saying “The problem with capitalism is capitalists.”
It is essential that “orderly financial markets” be restored and maintained, a primary function of regulation. The cause of the disarray in the marketplace goes back decades during which deregulation has allowed the various sectors of the financial services industry to cross over into each other’s territories.
Investment banks have been allowed to own commercial banks and, thereby, issue FDIC insured instruments to raise funds that are ultimately used to finance inappropriately aggressive investments. Even while this crisis was unfolding, investment banks were getting approval to become bank holding companies. Insurance companies have been allowed to create and sell proprietary products that clone securities. Banks have been allowed to engage in the insurance and annuity business. Securities broker/dealers have been allowed to charge management fees for “objective” investment advice in addition to commissions, and “guard” their own “henhouses” to prevent abuse. Investment banks have been allowed to control their own broker/dealers and registered investment advisers through which these banks can distribute their own proprietary products while charging commissions and/or fees.
The cause of this crisis has included the bipartisan failure of Congress, the various administrations, and the financial governmental and self-regulatory organizations to regulate creation of securities derivatives and the relationship between the different sectors of the financial services industry. This has led to abuse within the industry that is so flagrantly shortsighted as to be detrimental not only to the general public but also to the industry as a whole and its participants. No sector of this industry is untarnished by the current economic mess and both political parties have contributed generously to it.
Re-regulation of the financial services industry is necessary along the lines of resurrecting Glass Steagall, separating commercial banks from other investment functions. Similar regulation is vital to separate insurance/annuity products, banking, and securities from each other and from any other creations that would cloud their separation. Further regulation within the securities industry should separate the investment banking function from the fee-based investment advisory function wherein anyone licensed to charge a fee for advice would be prohibited from being licensed to sell securities for a commission. FINRA's jurisdiction should be strictly limited to broker/dealers, mutually exclusive from any fee-based advice or management, which are and should be regulated by the SEC and/or the individual states. Sponsors of securities products, including insurance related hybrids, should be restricted from limiting fee-based, non-commissioned product to the dually licensed BD/RIA market and make it available for recommendation by the exclusively RIA fee-based market.
Additional regulation needed is increased regulation of derivatives. Just as the insurance regulators in the states, the NYSE, and the options and commodity exchanges impose requirements that provide assurance that the trading and backing of securities, insurance, commodities, etc. are orderly and secure, derivatives of all kinds should be subject to similar requirements. Margin rules require that investors and clearing firms have the resources to stand behind their obligations, preventing financial collapse. The rules pertaining to short sales require that shares be available to short, preventing panic short covering when shares are not available to cover short positions. Options exchanges require that naked positions be adequately covered. Insurance companies are required to have the reserves necessary to cover potential claims. But now, it is possible for management companies to create structured investments committed to cloning specific portfolios without these protections. Derivatives now exist that are so complicated that even their creators have difficulty understanding or explaining them. Just as the SIPC provides protection to the investor in case a clearing firm runs into trouble, investors need protection from structured investments and other derivatives that can’t perform as promised. And now ponzi schemes have returned to the forefront.
The essence of such regulation would be separation of the different sectors, with no crossover except for specific hybrid products, providing assurance that investments would actually be what they are represented to be.
While I am under no illusion that these actions will address all of the problems they will establish a solid foundation within the industry towards repairing our damaged economy.
The difficulty in enacting these changes lies in the fact that each sector of the financial services industry has its own turf and special interests to protect. While these proposals will encounter mass resistance from within the industry, they are necessary to get the job done. I sincerely hope that the new administration can provide the necessary leadership.
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Jeffrey McKie has been an investment and real estate adviser for decades, knowing his way around many financial institutions and regulations. He has published in both local and national newspapers and journals, including the Financial Times and the Portland Oregonian. Consult with him at jamckie
