Banks Need More Disclosure, Not Regulation

Treasury Secretary Henry Paulson has gone to great pains to explain why boosting the Fed's powers to oversee financial institutions is a good idea.

I've read the particulars, but I have to say I still don't see how it makes sense.

It sounds like he's reviving the idea of a Drug Czar, only with a different brain-addling threat. This time it's the Greed Czar, which I think is going to work as well as the Drug Czar thing did.

Other recent banking crises suggest interesting ramifications for Paulson's proposal -- some encouraging, some not. According to the The Telegraph, during the near-collapse of Bear Stearns and anyone who dealt with it, Fed officials called central bankers in Nordic countries to compare notes on dealing with bank failures.

Those countries were hit back in the early 1990s, when U.S. commercial banks and investment banks were still on different tracks. It was also about the time that Japan was experiencing the all-time banking train wreck -- one that nearly two decades on we're still not confident has finished burning.

Compare Finland's -- or Sweden's or Norway's -- GDP since the early '90s with that of Japan's and you can see Japan underperforming. In short, any central banker or regulator with a preponderance of Viking DNA punished failed banks -- took them over and left stockholders dangling in the wind.

Japanese regulators bailed out banks and their shareholders -- and bailed them out, and bailed them out, and so on.

I was a financial reporter in Japan during the early '90s, so I can say, with the authority of any disinterested witness to a train wreck, that Japan's problem wasn't entirely bureaucratic stupidity. The latticework of cross-shareholding that took nearly half a century to weave into a tangled mess meant that failing banks would cause manufacturers' stock to fall -- which would pretty much put a bullet into the fabled Japanese economic animal.

There was talk in 1994 about securitizing bad bank debt in Japan -- a Tokyo version of Resolution Trust Corp. American investment banks like Goldman Sachs and Morgan Stanley pushed the notion, and after a month or so of consideration the idea was dropped.

Maybe securitizing Japanese loans would have worked (like in the U.S. in 1992) or maybe it wouldn't (like in the U.S. in 2007). But what the Japanese government chose to do instead would never have worked: it used public pension money to shore up stocks, banks or otherwise.

Here's why it didn't work: Foreign firms shorted stock-index futures, then arbitrageurs (again, largely non-Japanese firms) made sure the indices themselves matched the futures at expiration. So stocks fell anyway; and Goldman and Morgan made a fortune anyway.

Among the lessons of that mess: markets and nationalism don't mix; and in times of deep crisis, it doesn't pay to spare shareholders. Paulson has that first lesson down pretty well, but the Bear Stearns ten-buck-a-share plan really makes me wonder about the second.

Like Bear shareholders, investors of Enron have been seeking redress in the courts, with mixed results. But consider the cold-blooded response in Nordic countries -- and its subsequent results -- with the compassionate corporatism of Japan -- and its results. Messy as it can be, the court system offers a tidier boxing ring than the Fed does for angry shareholders.