Construct a universal system, later, to avoid the similar problems to occur again
When the dust settles and we are in a mood to move forward, we should get together and construct a system which will not invite the same mistakes to occur in the future.
We do know at this stage what that agenda should include, though not exhaustive, but sporadic. First, we should have some guidelines for the process of securitization. We have allowed too much freedom in mixing up the sub-prime loans with the good loans and call it an edible hamburger. Irresponsible insurance companies came in and guaranteed the content, so it seemed, at least until they failed. Then, the rating institutions came in and called the minced meat a triple A, or US Prime, which, with this golden label, was exported throughout the world. Freddies and Funnies were also labeled as if they were US Government securities, so did the Lehman bonds. We need to establish a much more rigorous process of rating the meat, and labeling of the mix. We need to have a more rigorous internationally agreed ASTM-equivalent in financial products as we have in industrial products. As to the housing loans, we should abolish the optimistic assumptions, such as property price escalation, at the time of constructing a collateral agreement. At a minimum, something like a 20% margin against the present value of the asset seems still a good old practice.
We might also think about providing a liquidity pumping station mentioned above as more of a permanent facility, if IMF does not stand up to this challenge now.
We need also to talk about short and long of the trading practice as we revive and allow the system to come back. If the liquidity facility I have proposed above were in place, we probably wouldn't have had to worry too much about the short-sell pressures that was really fatal to some institutions in September of 2008.
Then we need to establish a compensation guideline of public financial institutions, as most of the executives and traders are rewarded with the transactions at hand. If they turn sour years later, why should they keep the compensation in their pocket. The public anger and jealousy are not unfounded. But the question remains whether it is unique to the financial sector, or to the US. We, in Japan, do not have a marked skew of compensation between the financial institutions and manufacturing companies, except for the branches of the Lehmans and Morgans of the this world.
In the end we need to recognize the fact that the rest of the world is really dependent on the US dollars for their reserves and savings. So, it is acting as a deterrent against the falling reputation of the dollar and dollar-denominated US Government Securities. It will work once, but never twice, as the rest of the world will quickly realign their reserve positions to neutralize the impact of US financial conditions after this round of crisis is over.
So, while the US has the deterrent, they should call for the first order of the day, and that is to establish a liquidity facility by the world's "have nations" and avoid unnecessary casualties coming from one by one treatise of the troubled institutions, a la Paulson's instinct.
The US congress should not throw in revenge agenda which are socio-politically oriented. Their angers and concerns should be addressed in Phase 3. Before we get there, we will have a major challenge in Phase 2, because someone like the Citicorp has to sell $400 billion Tier 3 assets over the next few years, as its Chairman Vikram Pandit has already announced. We just don't know what that means to their already weakened balance sheet. Phase 2, therefore, will also be as careful as Phase 1.
The problem of the US approach is that they are not doing enough in providing liquidity in Phase 1, letting banks to fail one by one, and the Paulson package is on the table as if they were urgently needed while I think it is a partial remedy for Phase 2. And the Congress is throwing all the Phase 3 agenda on Paulson's misplaced package.
My advice to the American leaders, reflecting the expensive lessons we learned in Japan and miseries of now having to live with the arrogant mega-banks which have emerged, is very simple: Don't try to do all three Phases in a step. It will take time, and enormous sacrifice on the part of the American people. The rest of the world, with the proper message coming from the US leaders, will certainly share the sorrow and the burden of pains as well, as it is a matter of their going concern as well.
* Kenichi Ohmae is the author of "Borderless World", "The Invisible Continent" and "The Next Global Stage".
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