Two years ago, the US financial crisis reached a tipping point with the crash of Lehman Brothers investment bank. Since then, governments have thrown billions of dollars at the problem. What lessons have been learned?
The collapse of Lehman Brothers had a domino effect on other banks
On September 15, 2008, Lehman Brothers investment bank filed for bankruptcy. As the global financial crisis unfolded, world governments spent vast amounts of money to prop up failing banks and cushion the economy from market shocks. All in all, they coughed up 15 trillion euros ($19 trillion) - a third of the world's annual economic output.
In the two years since then, politicians and financial managers have been busily debating new structures for a world financial system. Observers say some lessons have been learned - although the room for improvement is enormous.
"These lessons can be found in inner management, in strategy, and in the product design of the different banks," said Udo Steffens, the president of the Frankfurt School of Finance and Management.
Falling prices gave traders around the world headaches
But, he added, many concrete decisions are yet to be made. The problem, as he sees it, is that regulation needs to be global - which means few of the necessary changes can be effectively implemented using national laws.
Too little, and in the wrong place?
For example, Germany has prohibited the practice of so-called "naked short selling," a speculative style of investment that negatively impacted financial markets during the crisis. But that decision was largely symbolic, he said, because other financial markets haven't banned the practice. Indeed, the majority of naked short selling takes place in London.
What's more, the German cabinet has passed a restructuring law which says that, starting in 2011, all banks must contribute to a fund that could be tapped in the case of another crisis. Ideally, this would prevent taxpayers from having to cough up rescue money, he said. But in a best-case scenario, that fund would receive 1.3 billion euros a year. In comparison, the rescue package for Germany's wounded lender Hypo Real Estate was worth 142 billion euros.
On the European level, a set of new financial oversight rules agreed in early September are being heralded as the most important development since the financial crisis began. According to the regulations, starting in 2011, three new regulatory agencies for banks, insurers and stock exchanges will have the last word if an internationally active financial institution gets into serious trouble. However, this measure is more about crisis management than prevention, whereas the goal of the reforms was to do whatever it takes to prevent another vast financial crisis, Steffens noted.
'Naked short sales' are banned in Frankfurt - to little avail
Yet according to Max Otte, a finance professor at Worms University of Applied Sciences, it would be easy to regulate banks by concentrating on three particular instruments.
The first of these is capital reserves. Until it went bankrupt, Lehman Brothers had some $500 billion in obligations based on just $20 billion core capital.
"If you prescribe that a bank needs to have 8 or 9 percent capital for a product, then investors will use more of their own money. It will lead to people being more careful," Otte said. After all, the most important part of capitalism is capital, he explained, adding that "banks need to have enough of it set aside, or else we have socialism for banks, like we do now."
Basel III changes capital quotas
On Sunday, the Basel Committee on Banking Supervision, set higher capital quotas in an accord known as Basel III. Banks are currently required to have a Tier 1 capital ratio of 4 percent, with half of that dubbed "core" Tier 1 in the form of top quality capital such as retained earnings or shares, for maximum shock absorption. Under Basel III, the Tier 1 capital ratio is pegged at 6 percent, with core Tier 1 set at 4.5 percent.
In addition, banks would be required to keep an emergency reserve, known as a "conservation buffer," of 2.5 percent. They will have to begin building the buffer by 2015 and must have it fully in place by January 1, 2019. Tallied up, the amount of rock-solid reserves banks are expected to have by the end of the decade will be 8.5 percent of their balance sheets.
The Hypo Real Estate rescue cost taxpayers 142 billion euros
A second instrument could be a tax on financial transactions, Otte said. "If every transaction is taxed at 0.05 percent, that won't hurt investors like me, who might reassess their investments once a year." But hedge funds, which use computer programs to constantly shift investments around, "would be affected a hundred times over by a tax."
So far, only Germany and France have come out in favor of such a tax. The US, Great Britain and larger emerging markets remain staunchly opposed to the measure.
Derivatives markets still suspect
The third instrument recommended by finance expert Otte is more regulation of certain financial products, such as derivatives. The trading volume of derivatives is around $600 trillion - many times higher than the gross national product of all the world's economies. But for Otto, the derivatives market is nothing more than a gambling casino.
The EU wants to make this currently unregulated market more transparent. The US has already introduced stricter regulations for derivatives trading, although Otte considers the other US financial market reforms as mere "window dressing."
Taxpayers had to empty their pockets to finance the rescues
"A few minor areas saw small improvements, but the basic core of the problem has not been touched," he said.
So why is financial market reform taking place at such a snail's pace? According to Otte, the fault lies with banking lobbyists.
Meanwhile, banking expert Udo Steffens says he doubts that the much-touted new "finance-market architecture" will come to pass.
"It will remain an architectural sketch," he said. "The market won't allow itself to be set in cement and stone."
Author: Danhong Zhang (jen)
Editor: Sam Edmonds