Secretary Paulson Speaks To The Chamber of Commerce

Wednesday morning's speech by Treasury Secretary Henry Paulson to the US Chamber of Commerce contained several important points. But of all of the things he mentioned in his address, three stand out in my mind as crucial.


First, he explicitly spoke of the need to begin work on replacing today's crazy-quilt US financial regulatory scheme with a more simplified, streamlined, single-entity model.




Predictably, he began hinting that the Fed should assume this mantle. My own feeling is that it's unwise to overload the Fed with three missions. It should, ideally, still only have one, anyway- price stability/inflation.

Humphrey-Hawkins was a bad idea that has already brought the Fed under Congress' intimidation.


Assigning the Fed more regulatory duties in excess of what it has now is probably a bad idea. Should it be aware of a single regulator's findings and actions? Yes.


Second, he explicitly stated that he thought investment bank access to the Fed window was not meant to be permanent.


Nice try, Hank, but that's probably now irrelevant. Who among us, or, more importantly, investment bank CEOs, doesn't believe the Fed will do it again, when 'necessary?'


So much for enforcing moral hazard.

However, putting the first and second comments together, you can see the investment banks which want continued access to Fed funding being told they must look and act like a commercial bank, i.e., conform to the Basle accords on capital adequacy.

Oh dear. You mean de-lever an investment bank from 30x to a mere 12x capital? How will they ever make money that way? Underwriting commodity instruments, trading run-of-the-mill markets and doing some M&A advisory alone aren't going to make investors sit up and take notice of profits and growth.

As I contended in this recent post, I think you are looking at profound sector consolidation if the Fed window remains open to investment banks.


But to me, the most interesting and heartening message Paulson enunciated was on over-the-counter instruments, i.e., credit derivatives swaps. He called for an 'association' to be established with counterparty safeguards for clearing and settling.

That is, he means an exchange! He wants more transparency, counterparty capital adequacy, and fewer surprises among the participants in such markets.

As I suggested in two prior posts, including the one already linked, and this one, this month's action by the Fed concerning funding investment banks is an historic moment in our financial markets.

Every bit as significant and structure-altering as FDR's bank holiday and the 1914 establishment of our Federal Reserve System.