- No more Special Investment Vehicles (SIVs).
- No more sub-prime, no more "Alt-A" mortgages.
- No more CDOs.
- Higher underwriting standards.
On top of these changes, the Fed now wants to introduce 300 new regulations. Has anyone at the Fed studied the impact these regulations will have on credit? A fair question, to which Fed Chairman Bernanke stumbled, "It's complicated!" He then admitted no such study has been undertaken and that, indeed, tradeoffs have to be made and that the impact on credit will have to be carefully monitored.
For practical purposes, we believe we should expect more easy money; Dimon is correct that headwinds caused by upcoming regulations, as well as those already introduced since the onset of the financial crisis, are enormous. To keep the economy moving ahead nonetheless, more money may need to be printed than even the Fed expects.
Unfortunately, Bernanke misses the obvious—if it is so complicated, make it simple. Keep It Simple Stupid is a paradigm that should apply to not only monetary policy, but also to regulatory policy. In our humble opinion, regardless of regulation imposed, bankers will remain one step ahead of regulators. They simply have greater resources to find loopholes—introducing fancy terms like "macroprudential supervision of financial institutions" won't change that, either.
Regulators should embrace the challenge by working with market forces, rather than over-regulating the system, thereby stifling economic growth. There are simple levers that can be employed; for example, we believe that speculators should not be prevented from making dumb decisions, but processes should be in place to prevent dumb decisions from causing systemic risks. Such a policy is fairly straightforward to implement by imposing margin requirements on leveraged bets. Add transparency and mark-to-market accounting, and you have already achieved a more stable system with incentives to use less leverage. There are additional measures that can be implemented to force banks to deleverage their balance sheet, should the market—rather than regulators—believe banks engage in behavior that's too risky. For example, by requiring banks to issue substantial amounts of staggered, long-term subordinate debt should the cost of refinancing be unattractive, banks need to shrink their balance sheets, but can do so in an orderly fashion.
Some concluded from Bernanke's talk that there is no additional round of quantitative easing, QE3, in sight. Our view is that the Fed is simply baffled that all the money printed has not worked, and will wait and hope. . .for now. But because things are so complicated, sprinkling more money on the problem may be the weapon of choice in the not too distant future.
Axel Merk
President, CIO and manager
Merk Funds
