From sublime to subprime

Written on the 9 September 2009

From sublime to subprime

Griffith University professor of finance Michael Drew, is known for his research on superannuation investment models. He says issues such as integrity, trust and transparency need to be more than mere rhetoric; they must become an integral part of the daily life of a reformed global financial system.

THE spectacular growth in adventure-type tourism around the globe suggests that activities that incorporate a level of fear may fulfil some basic human need. And yet, sometimes tragically, we are often reminded of the very real risks of these adventurous pursuits.

The global financial crisis (GFC) has shown that the spirit of adventure has not been contained to the development of exciting new ways to spend our leisure time. A number of adrenaline-fuelled adventures, under the guise of financial innovation, have been the hallmark of the global banking system in recent years.

A heady mix of low interest rates, lax lending standards and the explosion of a number of innovative financial products (such as credit default swaps and collateralised debt obligations) saw the rise of new and largely misunderstood risks that brought the global financial architecture to its knees.

There is now voluminous commentary on the origins of the GFC, the international response to containing the crisis and Herculean effort to stop the global economy sliding into a depression. These are non-trivial issues that require a great deal of critical reflection in order to further our understanding of the crisis.

Recent data collected by the US Congressional Research Service suggests that, since late 2008, stimulus packages announced by governments around the world has now exceeded $2.7 trillion, or roughly three times Australia’s annual gross domestic product. But in the fast moving world of the GFC, the debate is now shifting to perhaps the most challenging question – how are we going to stop this from re-occurring?

Since March 2008, there has been no fewer than seven major international reports proposing various degrees of reform. The key contributors to the debate include various US agencies (Department of the Treasury, the Counterparty Risk Management Policy Group and the Congressional Oversight Panel), the UK’s Financial Services Authority and international statements from the Group of 30 and G20.

The over-riding messages from these reports are loud and clear: A more holistic approach to regulating the financial system (with minimum standards applied across borders) is mandatory; more stringent controls on banks (including heightened regulation of new financial products) are required; and reform of executive remuneration is needed to discourage excessive risk taking.

Given the size of the global stimulus bill, this doesn’t seem like an unreasonable set of demands to ensure a robust financial system for this generation of taxpayers (and given the length of time it will take to repay, perhaps the next generation as well).

The US sub-prime crisis, the Madoff scandal and the demise of Lehman Brothers has demonstrated multiple failures in the current system, with many investors hit by unfair, deceptive, and fraudulent practices.

In Australia, the Storm Financial fiasco, the temporary ban on short selling and the shift towards national consumer credit regulation reflects the imperfect structure of the Australian finance industry.
The bold initiatives announced by the Australian Securities and Investment Commission recently to further protect consumers reflects the community’s outrage at the current state of practices within the industry.

The regulatory challenge is to find an appropriate balance between the competing demands of consumer protection and financial innovation. While not a popular argument to make today, financial innovation in areas ranging from the provision of savings products, credit cards, home loans, ATM access, on-line banking and foreign exchange services, to name but a few, have provided more tailored solutions to meet our ever-changing financial needs.

The inability of the financial services industry and its regulators to keep the spirit of adventure in check and ensure that the interests of consumers are paramount in recent years suggest fundamental reform is warranted.

Issues such as integrity, trust and transparency need to be more than mere rhetoric; they must become an integral part of the daily life of the global financial system.

But while the push for more stringent regulation continues, the calls for continued financial innovation get stronger by the day.
How can we assist the growing pool of retirees managing longevity risk? How will the emissions trading scheme work?

We need to quickly discover how to walk the precarious tightrope between consumer protection and financial innovation; balancing the rewards of innovation with the risks that may arise for consumers.


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