Think Twice Finance

The Coming Regulations For Financial Institutions: Don’t Worry. Be Happy.

It has been clear since the outset of the Credit Crisis (see “Mortgage Debt Crisis,” September 10, 2007 post, this blog.) that the investment banks were going to be regulated by the Federal Reserve. Secretary of the Treasury Paulson set a four year deadline to implement his then unspecified “update” of bank  regulation. He has obviously accelerated his plans. It has been clear since the bail-out of Long Term Capital that the Fed’s defacto regulatory umbrella covered far more than deposit-taking institutions.

While I oppose defacto regulation of investment banks by the Federal Reserve, given the moral hazard created by defacto Fed bail-outs, I want dejure Fed regulation. Dejure regulation, it is my hope, will eventually force the public to come to terms with the implications of cosseting the banks. To wit: Banks cease being creative and become unprofitable, requiring hidden government subsidies to survive. These subsidies are among the two or three important causes of The Credit Crisis.

In my opinion the deal to give the Fed the go-ahead to regulate the investment banks was sealed, interestingly enough, in far-off Australia. There, we find the two most profitable financial institutions on the globe (if I may be permitted not to count Moodys) Macquarie and Babcock & Brown. B&B, known down under as “Lil’ Mack,” has been the more profitable of the two since it went public in 2002. Its operations remind one very much of those of Macquarie, with one exception. It was never a commercial bank. Macquarie, on the other hand, was a bank.

Early in the crisis, Macquarie lost its patience with bank regulators. It simply turned in its banking license, taking the name Macquarie Group. Its motives were crystal clear. Macquarie stated that bank regulation reduced its profitability.  Macquarie also announced that it planned no operational or personnel changes. Interestingly, investors provided an additional $8 billion in financing to the new non-bank. More interestingly, most of the investors were large regulated banks.

Had that decision become a trend, it would certainly have left the Fed naked on the beach. So have no doubt. Investment banking, as a category of American financial institution, is dead.

Why, then, do I say, “Don’t worry. Be happy?” The reason is that I saw this coming long ago, and I adjusted. That means that any banker with half a brain saw this coming long ago and has also planned to adjust. “How?” you may ask. Ah… but that I cannot say. In the business of banking, one must stay one step ahead of the posse. The analogy between posses and bank regulators may not be apt. A posse is a blood-thirsty mob. Bank regulators are…, well….

So good bankers will not die. They will find someplace more opaque to do what they do. Maybe hedge funds. Maybe private equity. Maybe Australia.