Floyd Norris is a business journalist who writes for the New York Times. His articles are interesting and insightful. His article in the April 26, 2013 Business Section of the Times was no less. In fact, it was rather chilling.
The article was about a proposed change in Federal Reserve policy the intent of which is to better insulate the U.S. banking system from other systems, particularly Europe. His point being that Central Bankers, and in particular, the Federal Reserve, no longer trusted other Central Bankers to effectively regulate their monetary system, and banks subject to it. In effect, the Fed would require higher standards. The European’s have objected and the Fed has not formally put the policy in place, but the message is clear. There is a lack of trust.
In a crisis there are two important assets. Capital requirements, liquidity requirements all are in important, but when they cannot stem a tide, when rules need to be bent or broken, it is trust and time that are critical. These are off balance sheet assets. There is no IFRS, GAAP, or STAT accounting policy for them. You only see them in legal documents when they have failed: default clauses; offsets; collateral; bankruptcy.
When there is less trust, you need more time. This was evident in the 2008 crisis, as first trust evaporated and contagion let time cascade away. The connectedness and speed of transactions became a nightmare. The game of quick trades and derivatives could not be unwound as the notional amounts were devoid of relative value. Regulation subsequent to the crisis was supposedly going to address institutions that were too big to fail, but they have only gotten bigger, and then our government leveraged themselves. Tier 1 capital- sovereign capital for the most part- which was supposed to be the most secure capital supporting these institutions (which by regulation banks and insurance companies must hold certain percentages of) became weak capital. Despite excessive debt, which temporarily can be managed, the U.S. has once again become the currency of choice. The Fed is now playing on this for competitive reasons and other countries have been compelled to play along.
The problem now is that economies are unraveling, because too many people are unemployed or under-employed. On a micro-economic basis corporations have temporarily protected themselves. This is not a long term solution for them. The finance ministers in Europe have belatedly realized the macro-economic effect of austerity is destablizing their continent, with spill-over effect. China, still a derivative economy, will not be a white knight, as they are leveraged and cannot withstand internal upheavel.
We are increasingly captivated by models, program trades and financial engineering in the hope that we can earn that little extra margin. It is time we forgot about momemtum, moved away from dark pools, and recognized once again that value is long term rather than immediate. We have a lot more time, and with more time, mistakes can be corrected; trust can be restored. In the end, what Germany practiced in 2008 must be absorbed globally. Corporations need to take a micro hit and retain and hire full time workers in there own country. This is particularly true for the U.S., because its consumer economy still drives the world, particularly when Europe has pulled off the road. China’s rising middle class will get there, but it is not there yet.
The truth is that most large businesses do not need tax breaks to do this. Their effective rates are not substantial and they have sat on piles of cash. For those who redomesticated to more tax efficient havens, they should start to bring the funds back to the U.S. regardless of the tax implications. They will ultimately recapture it in revenue as the world economy revives. The equities markets are a fiction of current unsustainable monetary policy. Trust and time is running out.