Thursday, October 4, 2012

The defeater of Financial Markets – It's all about politics!

The man on the left is Peer Steinbrück, a German social democratic politician. He will be challenging chancellor Angela Merkel in 2013 when Germany will elect a new government.

As Germany's former finance minister, Peer Steinbrück has issued, on September 25, 2012, a position paper called “Regaining Confidence: A new Undertaking on Defeating Financial Markets”.

I confess, I was attracted by the title... Yes, this simplistic title, thousands of which we have already read in the past few years!

I printed the 30 pages of the paper last Sunday to read them on my way to work on Monday. So here I am, it is Monday 8 am and I wait for my train to La Défense. To get a seat, I let 2 or 3 trains pass by. This is actually enough time to read the introduction.

Peer starts off energetically:

  • The political repression of a finance-driven capitalism is a crucial political challenge of our time.”
  • The pleadings and concepts of a new banking culture of sustainability, long-run perspective, and customer focus are scarce and craven. The system of short-term return maximization paired with a distinctive risk-ignorance does not challenge itself but feels itself wrongly overwhelmed.”
  • The fundamentals of the social market economy are still repudiated, if the costs are born by the community whereas the [finance] industry holds on to its profits, dividend distributions, and bonuses. […] Responsibility and risk fall apart, the privatization of gains is opposed to the socialization of losses.”
  • Financial institutions and corporates are sitting on a branch that the crude financial capitalism and its promoters of market-radicalism are about to cut.”

I elbow my way through the train's door to get a seat. (This is usual in Paris. You only have to say “Pardon” before.) Once seated, I wonder whether I should really continue reading. After all, this seems to be more a pre-election party leaflet than a serious discussion paper. When the train leaves the station, I decide to continue reading, I have nothing else to read anyway.

Steinbrück discusses 6 topics:

  • Introducing a financial transaction tax
  • Abandoning government bail outs for banks
  • Separating corporate and investment banking
  • Supporting public information
  • Taking responsibility
  • Controlling banks

Introducing a financial transaction tax

Steinbrück appreciates the European Commission’s proposals but worries about possible loopholes regarding non-European trading and foreign exchange transactions.

Abandoning government bail outs for banks

To avoid future government bail outs, he suggests

  • bank liquidation funds, on a national level for small and middle sized banks and on a European level for systemic banks, and to be financed by the banks themselves;
  • a European liquidation authority for banks;
  • a liability waterfall in the order equity holders, debt holders, and liquidation fund;
  • a standard European liquidation regulation.

Separating corporate and investment banking

A first proposition relates to proprietary trading: A financial institution that puts proprietary trading into practice should not receive deposits or have access to central bank financing. This would also apply to financial institutions whose subsidiaries practice proprietary trading. However, Steinbrück specifies that trading for risk management purposes shall be exonerated from the scope of application.

A second recommendation relates to universal banks with complex business activities. Peer promotes the adoption of the financial services holding company structure for those institutions. More specifically, financial services shall be carried out by separate legal structures, each equipped with their own equity capital, management, and accounting system. In Peer’s view, this would strengthen not only the transparency of risk and return but also the stability of the financial institutions.

It is now 8h40 pm and I arrive at La Défense. Time to forget Peer’s position paper and to go to work...... on complex business activities of my universal bank!

Supporting public information

The title of Steinbrück's next chapter is „Illuminating the dark.“ This fits well my temper as it is already dark outside when I take the train back home after work.

Five fundamental points are made here:

  • The author suggests to make the regulation of the shadow banking system parallel to the regulation of the banking system itself. This applies especially to minimum capital requirements, due diligence and risk management standards, deposit insurance schemes, and liquidity risk management. This eventual goal of this proposal is to avoid supervision arbitrage.
  • Second, he calls for monitoring the links between the banking and the shadow banking system, namely with respect to refinancing arrangements backed by REPO transactions.
  • Third, the European legislation on OTC derivatives trading should be put in practice as soon as possible. In addition, incentives in form of lower capital requirements should be set for standardizing derivatives contracts and trading them via a central counterparty. In the same vein, commodity forward contracts should be limited to transactions touching on the real economy and credit derivative short selling bans should be extended.
  • Next, Steinbrück turns towards high frequency trading. He recommends a compulsory admission process for trading algorithms and a minimum time period for the validity of orders.
  • Finally, Peer addresses the statute of rating agencies: The conflict of interest caused by the remuneration scheme should be cleared by organizing CRAs as common welfare oriented foundations. Governments should set up a public European rating agency, financed for example by central banks' profits. Lastly, bank-internal rating systems are to be promoted.

Taking responsibility

In this rubric, Peer Steinbrück discusses a variety of topics, all more or less linked to the principle of responsibility banks should incur.

Controlling Banks

Systemic pan-European Banks can only be controlled effectively only by a pan-European supervisory body.”, writes Steinbrück, and refers to the European Central Bank as such supervisory body.

However, he feels that this shall not apply to small and middle-sized banks. They should be controlled by national regulators.

Towards the end of his discussion paper, Peer accelerates again

"Banks are service providers and not casinos, that gamble with other people's money, neglecting the interests of their customers and their capital base to realize extreme returns that flow in the form of bonuses to management and in the form of dividends to shareholders."

Reading Peer’s conclusion, I am almost back where I started off this morning. My train has still some stops to go, leaving some time to think about Steinbrück’s paper:

Save for the introduction and conclusion, I like his writing style. His paper is very clear and you can easily understand his positions.

On the merits, I haven’t noticed any pioneering idea in his position paper. Numerous of the above topics are already regulated or about to be regulated, mostly on a European level. In the end, I think that his initiative is first and foremost a tactical step of his election campaign.


  • Peer Steinbrück – Vertrauen zurückgewinnen: Ein Anlauf zur Bändigung der Finanzmärkte