Counterparties Are The First Line of Defense

Posted April 12th, 2010 by The Options Insider in Industry

Greenspan Says Financial World TooComplex For Regulators

During his testimony on April 7,former Federal Reserve Chairman Alan Greenspan made the kind ofadmission that may trouble those who assume that better regulators --rather than a wholesale rewriting of rules -- will better protectAmericans from a future financial crisis.

Regulators can't keepup with today's megabanks, he said. They're too complex. Regulators, inshort, don't have a chance. Greenspan, appearing before the panelconvened to investigate the roots of the financial crisis, said that the"ideal way" to supervise banks would be to go through its individualloan documents -- the way supervisors used to police banks and financialfirms before they grew so large.

But unfortunately, he lamented,that's no longer possible because firms are so complex. "We arereaching far beyond our capacities," Greenspan told the Financial CrisisInquiry Commission. "It's not a simple issue of 'Let's regulatebetter,'" he said. "It's a different world. The complexity is awesome."Instead, regulators need to rely on banks' counterparties -- those theydo business with -- as a first line of defense.

But that failedin 2008, Greenspan admitted. Counterparties were left holding the bagwhen the firms they did business with -- like Lehman Brothers and AIG,for starters -- nearly went belly up, with Lehman eventually declaringbankruptcy. Taxpayers were forced to bail the firms out -- money that inAIG's case went straight to its trading partners, like the billionsthat went to Goldman Sachs -- in what some members of Congress havecalled a "backdoor bailout."

"If you cannot depend oncounterparty surveillance," Greenspan warned, "regulators are much lesseffective."

So, in effect, it really doesn't matter who'sregulating -- the industry has to step up its self-regulation by keepingcounterparties in check.

Some experts have offered alternativesto this model, like strict rules calling for specific capital andleverage levels; banning certain activities; and breaking up themegabanks so they don't have such a stranglehold on the financialsystem.

The Obama administration has shied away from strictrules. Rather, the administration is pushing Congress to give regulatorsgreater authority to rein in the financial industry -- rather thanoutlining in law what is and what isn't allowed, what banks need to keepin their reserves, or other firm rules.

In essence, theadministration argues, it should be up to the regulators.

Whatdo you think? Discuss your views in the forum.
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