SERIOUS MONEY:The US has reached a tipping point with regards to its unfettered markets
RELATIVE CALM has returned to Wall Street after five consecutive months of decline following unprecedented measures by the Bush administration and the US Federal Reserve to alleviate the largest financial shock in decades.
Stock prices jumped by more than 3 per cent on the first trading day of April, causing diehard bulls and the majority of those amply rewarded analysts with nothing better to do than chart prices to declare that the worst is over and that the current rebound is not a fool's rally.
They may be right, but astute investors will be aware that the long-term ramifications of the current crisis are only beginning to unfold following the undeniable fact that the modern financial system has proved brittle in the face of challenging market conditions.
The bailout of Bear Stearns almost certainly means that Wall Street firms are no longer an endangered species. However, the same cannot be said of, and should not apply to, their largely unregulated business models.
The US's unfettered capital markets have failed on every count espoused by laissez-faire advocates. The notion that markets can properly assess risk has proved to be nonsense, as has the idea that risk can be hedged and shifted to those who are most able to bear it. The belief that the marketplace imposes discipline on decision-making is nothing more than a fantasy.
Of course, the US's capital markets are far from unfettered. The existence of the Federal Reserve, its manipulation of short-term interest rates and its willingness to underwrite financial markets in times of crisis - most notably in the Alan Greenspan years - mean that the deflation of one asset bubble will almost certainly beget another.
The latest crisis has seen the Federal Reserve, under current chairman Ben Bernanke, adopt unprecedented measures to reduce systemic risk. But Paul Volcker, a former Federal Reserve chairman who defeated the inflation spectre in the 1980s, is highly critical of this strategy and fears that investors are being sent the wrong message.
The idea that an investment bank can earn extraordinary profits in good times but be bailed out with taxpayers' money in bad times is a form of capitalism to which this author does not subscribe.
It is true that the Federal Reserve had little choice but to prevent the failure of Bear Stearns, given its important role in the $45 trillion (€28.4 trillion) credit default swaps market.
However, the idea that James Cayne, the chairman of Bear Stearns, can walk away with countless millions while ordinary folk are losing their homes leaves a sour taste in the mouth. This is not capitalism and the need for change is apparent.
US Treasury secretary Hank Paulson has outlined a plan for change, but those who have worked for a large organisation and sat through meetings about meetings will know that his outline is decision-making at its worst and will yield nothing. This is disturbing but completely in line with the Bush administration's track record of relentless vision followed by ineffective action.
The system is in need of change. Given that the Federal Reserve has allowed investment banks access to emergency lending via discount lending, it begs the question as to whether these non-banks should be forced to comply with the same regulations that apply to traditional banks.
As taxpayers' money is at stake, the answer must be yes, but the hit to non-banks' profitability would be material since their leverage ratios are three times higher than the regulated system.
It is unlikely to happen, but investors should question whether a business that requires high leverage to earn decent returns is a viable concern at all.
If regulation is not applied to non-banks, investors should and must question why so few are paid so much for delivering so little.
The compensation system is disturbingly short-term and pro-cyclical. Bonuses are paid on the basis of one-year results and there is no clawback should inferior performance follow.
Even more disturbing is the fact that substandard managers can and do survive despite several years of poor performance on a geometric basis. Vladimir Lenin would be proud.
The US has reached a tipping point with regards to its unfettered markets and a change of heart is required.
A decade ago Far East Asia suffered economic collapse and US academics offered their prescriptions for survival, which when adopted aggravated the downturn for many. The US is now implementing the very policies they previously argued against so vehemently.
Welcome to the US's crony capitalism.
