10 DAYS UNTIL BUDGET RUNS OUT - not healthy

Congress is behind schedule for passing the bills that authorise spending for the 2010 fiscal year, which starts on October 1st. Congress was to have been well through the process in early summer, but several factors intervened:
1) stress-tests of the major banks to see what capital requirements they will need that could involve some items on-budget (most bank aid being off-budget)?
2) vituperative partisanship over Health Care plans?
3) waiting to see if predicted end of recession has arrived?
4) Republican legislators testing their minority power to see if a possible re-run of Republican stymying of Clinton's 1995/6 budget that partially shut down Federal Government in November and December 1995. This was the culmination of a process that began in '93 around both budget and health care and is being repeated as the tactic against the Obama administration today. The risk today as then is that Democrats lose their slender majorities in one or both houses of Congress as they did in '94.
In 1993, when Clinton squeezed his budget through in June, Republicans were a minority in Congress, but by galvanising their revolt, they recaptured Congress in the '94 year's interims. By failing to pass the '95 budget, and by insisting on a constitutional amendment to enforce a balanced budget by 2000 (which Clinton achieved 3 years earlier much to republican chagrin) the US economy had some growth shaved off and this coincided in '95 with one of the coldest hardest winters on record. Globally, the effect was to panic many OECD countries into thinking another recession dip was imminent in 1995/6 and consequently many, especially, the UK, upped their fiscal stance to compensate. Balancing the US budget and the political power struggles in Congress forced other countries into higher deficit spending.
We may face this in the next 2-3 years again when recovery globally remains fragile! By May '09 it looked like Congress would complete budget appropriations on time. The House passed all 12 of its spending bills. But, then, the Senate passed only four, and all twelve had to go to conference, where House & Senate versions are reconciled. That cannot happen now in the next 10 days, and the struggle to get the budget passed may also be employed to topedo the health care reform bill, on which so much of Obama's political capital is invested!
What happened in the early '90s? In Spring '91 - Minority Whip Newt Gingrich, predicted the "next great offensive of the Left will be socializing health care." He called on hardline Republicans to position themselves to stop Democrats from winning on this. The same strategy has been re-conditioned for use against Obama. In November '91 - arguing that every American should have the right to a doctor, Harris Wofford defeated Dick Thornburgh to become the first Democrat to win a U.S. Senate seat in Pennsylvania in 30 years. In January '92, the Clinton campaign issued a health care white paper as its opening salvo for the 8-month long campaign. In June '92, Clinton began using a new jargon for health care reform called "managed competition." In July, Clinton accepted the Democratic nomination vowing to "take on the health care profiteers and make health care affordable for every family." (Obama, and also Hillary Clinton adopted similar platforms in 2008.) In August '92, when the election was in full swing, Clinton was warned by campaign aides that his position on health care is too unstructured; too unclear to be easily defended. The same has now been said to President Obama, 8 months into his presidency! By end of August '92, partly as a result of political pressures from incumbent George Bush and a deal negotiated between the two candidates (one that also included no prosecutions over Iran-Contra) and partly as a result of internal debates among rival advisers, a major effort was launched to reposition health policies, to merge Democratic left and right, and shed the "pay-or-play" label that was the focus of hysterical attacks. A policy-broker was Dem Sen Jay Rockefeller who argued against changing "pay-or-play", while warning that "Americans deserve or have a right to health care" (which is echoed today in Obama's current moral crusade that relies on the last public policy letter written by Sen Edward Kennedy). back in '92 Rockefeller said the policy presented problems in that "Although many Americans may initially react positively to this statement ("pay-or-play"), over time it can make them uneasy. Before long they will be asking: How would we pay for all that care for all those people? Won't it require a huge new government bureaucracy?"
Today, this dovetails with fanning flames of anxious ire about budget deficit spending (that also internationally encourages fiscal Conservatives to grossly exaggerate the lilihood of higher tax rates). Long term budget issues are being confused with short term crisis management. Long term health care reform in the USA is being sized up as if it it could be a burden long term similar to bailing out the banks, when in truth both matters rapidly become self-financing! But, opposition politicians are not averse to under-estimating voter intelligence about the long term in search for short term plitical advantages. Saving the Obama health reform bill may cost delay in passing his budget and in turn undermine economic recovery measures short to medium term. His response to being cornered is similar to Clinton's in '92 and '93. In September '92, Clinton pulicly revised his health reform, dropping the term "managed competition," to contrast his approach with the wholly private sector plan of President Bush. Obama did the same in '08. In November '92 and '08 Clinton and Obama respectively won the election. In both years, polls showed voters ranking health care far behind the economy behind the budget deficit. The majority of the public has only the fuzziest notion of what either Clinton or Obama had in mind for health care reform.
Clinton and Obama both addressed Congress a month after taking office.
President Bill Clinton's focus was on the economy, budget and taxes, he used the speech to make the policy link between health care reform and deficit reduction. The initial positive response bred false optimism in the White House. Advisers argued for a one-two punch: First, win a great budget victory by May; then follow up immediately with the introduction of the health care plan. But the consensus among Democratic congressional leaders was that there's not support for going to the well twice for difficult votes on health care and on budget cuts. Clinton then made the error of proceeding to put health care into the main budget bill.
President Barack Obama's focus was on the economy, budget and taxes, he used the speech to make the policy link between health care reform and deficit reduction, but not in a single budget appropriations bill. Obama is not doing this. The Health bill (650 pages) is hoping to get passed by year-end. He told Congress in February that an era of extravagant spending must end; the roots of the economic crisis is short-term gains prized over long-term prosperity. "And all the while, critical debates and difficult decisions were put off for some other time on some other day. Well, that day of reckoning has arrived, and the time to take charge of our future is here." He praised Congress for passing the economic stimulus plan, which he said would create millions of jobs and revitalise the US, and promised to deliver a tax cut to 95% of Americans by 1 April (that some said is April Fools Day). "We will recover," replaced "Yes, we can!" The recovery package, signed after compromises debated in both houses, was designed to channel federal money toward infrastructure projects, health care, renewable energy development and conservation programmes. The first month of Mr Obama's presidency also included a banking bail-out worth at least $1.5 trillion plus a plan to support "responsible homeowners" struggling with mortgages. He popularly told his audience that banks and bankers taking public money will be fully accountable, vowing that tax dollars would not be frittered away (bravery about hostages to fortune). "Those days are over... It's not about helping banks, it's about helping people." The speech came days before the unveiling of the first Obama budget, with a deficit at roughly $1 trillion. President Obama said the vast deficit and the "crushing cost" of healthcare made the need for wide-ranging reform more urgent than ever, and he pledged to reform and improve the nation's schooling and boost the numbers of students in higher education, restating a pledge to cut the deficit in half by the end of his first term, and to eliminate wasteful and ineffective schemes. Over 6 months later, President Obama had to address both houses of Congress again, after a struggle to pass his budget and serious obstacles in the way of health reform on which the Republican Opposition was now focuses much as it had been back in '93 against Clinton. Obama (9 Sept.) put the moral argument, which while gaining over 60% public support according to the pollsters, nevertheless has a hard climb to overcome medical insurers' and pharma companies' campaign contributions. His fighting talk called for serious proposals from Democrats and Republicans to address chronic health care problems and rising costs, warning that he would not "waste time with those who have made the calculation that it's better politics to kill this plan than improve it. I will not stand by while the special interests use the same old tactics to keep things exactly the way they are (to great applause from Democrats). If you misrepresent what's in the plan, we will call you out. And I will not accept the status quo as a solution. Not this time. Not now." In January '93, Clinton formed The President's Task Force on National Health Reform to "prepare health care reform legislation to be submitted to Congress within one hundred days of our taking office" with his wife, Hillary Clinton, heading it up. A blanket of secrecy was imposed on task force operations. Obama, like Clinton, has placed much of his political credit on Health Care. In both cases, such priority commitment instantly limits how far cabinet secretaries and White House aides can go in pressing alternate views.
In order to meet their hundred-day deadline and win swift congressional passage the Clintons sought to fit the health care into the presidential budget and pass it all in one gigantic package, seeking the advantage that under Senate rules the reconciliation bill can be debated for only 24 hours before it comes to an up-or-down vote.
Obama has even less time to try this, and has achieved little if any bipartisanship. Not one Rep legislator appears prepared to vote for Obama health care overhaul! Obama confronted the concern of opponents by pledging that any health care bill approved by Congress won't increase the federal deficit, repeating past statements that savings in the existing health care system will cover most of the cost of an overhaul bill. He also said, "not a dollar of the Medicare trust fund" would pay for the bill, but provided few details of exactly how, saying the plan will eliminate "unwarranted subsidies in Medicare that go to insurance companies" and create an independent commission of doctors and medical experts to identify further waste. In an emotional conclusion, Obama invoked the late Sen. Edward Kennedy citing a letter in which Kennedy called providing health care to all Americans "above all a moral issue." "'At stake are not just the details of policy, but fundamental principles of social justice and the character of our country...'". "I've thought about that phrase quite a bit in recent days -- the character of our country," Obama said to the hushed chamber. "One of the unique and wonderful things about America has always been our self-reliance, our rugged individualism, our fierce defense of freedom and our healthy skepticism of government." - adding that Kennedy recognised that with all of the drive of Americans to stand strong, there comes a time when government must step in to help. "When fortune turns against one of us, others are there to lend a helping hand," citing "a belief that in this country, hard work and responsibility should be rewarded by some measure of security and fair play; and an acknowledgment that sometimes government has to step in to help deliver on that promise." The opponents are claiming that while half of all personal bankruptcies in the US may be partially the result of medical expenses, the rising costs also mean the government is spending more and more on Medicare and Medicaid, and US government spending on the two schemes is expected to rise from 4% of GDP in 2007 to 19% of GDP in 2082, making rising healthcare costs one of the biggest contributing factors to the spiralling US budget deficit long term. This is similar to the hysteria that a Republican-dominated Congressional Budget office created in '94 about the long run cost of an ageing population, claiming, also very one-dimensionally, that the burden of old folk would absorb half of the Federal Budget and a quarter of GDP by 2050!
In March '93, the chairman of the powerful Senate Appropriations Committee, blocked the Clinton reconciliation bill strategy, calling it "a prostitution of the process" by pushing through "a very complex, very expensive, very little understood piece of legislation." We can expect the same tactic attempted now.
In April '93, media leaks were a problem, indicating that a value-added tax increase is under consideration. Hillary Clinton met with Republican and Democratic senators, imploring them to tell her what she is doing wrong and that she is having trouble getting dialogue with Republicans (Senate Minority Leader Bob Dole told Republicans not to meet with the First Lady). In May '93, a chart was leaked to the New York Times detailing health reform impact on national spending, altered to appear as if $150 billion is required in new taxes. private White House meetings are leaked to the newspapers. The Health Insurance Association of America (HIAA), restates support for universal coverage but complains of attacks on health insurance industry for "price-gouging, cost-shifting and unconscionable profiteering." Similar, brickbats were thrown this year in '09, also to diminish public support for reform. By the end of May '93 The Clinton Health Care Task Force is disbanded.
The health insurers started an advertising campaign with straplines "They choose, you lose" and "There's got to be a better way." And, the National Federation of Independent Business (NFIB) tried to kill a key element of the reform plan with mailouts and state by state meetings, to stop the "employer mandate" that would require all businesses to provide health insurance for their employees. This aspect is not in the Obama Plan.
In June '93, worried at having no effective political support team, the Clinton administration set up a "War Room" to monitor media, orchestrate responses to attacks on the Clinton health plan, and schedule administration and congressional visits to forums being held around the country. Obama may be doing the same today.
There was in '93 loss of left-wing Democratic support as the original principles were becoming less universalist.
In June '93, Clinton's budget got through only the Senate only with Vice President Gore's casting vote. Health care reform is therefore shunted off until another day. In early Summer '93President Clinton told the DNC (Democratic National Committee) to make grassroots efforts to support health reform. The DNC first tried to set up a tax-exempt "educational" foundation, separate from but allied to the DNC. When word of that leaked, critics said it will allow power brokers with their own agenda to curry favor with Clinton by secretly financing his pet project. The DNC backed off and offered to run the program itself, but they lacked a budget for any serious grassroots efforts, which was then junked in favour of a media campaign. Some called for the health care plan be delayed until '94, but others saw this as a death sentence for health care reform. Similar thoughts are the case today, for the next year means health care is a central part of mid-term Congressional elections.
Advisers are in disagreement, and President Clinton decided not to make any decisions until after his vacation. Obama did similarly, but returned to the fray with renewed vigour, except late in the Congressionl diary. In August '93 a plan is presented to a meeting of US state governors, but agreement is not found!
Ironically, while Clinton planners privately stress a conciliatory, middle-ground approach for reform, the public and many on Capitol Hill are beginning to gain an impression painted by opponents that the plan is a liberal, secretly concocted, Big-Government scheme to dictate how people get their health insurance and medical treatment. A rough draft of a plan embodying decisions on alliances, proposed price ceilings on insurance premiums, and Medicare cuts is used to brief members of Congress, but the supposedly secret plan is leaked to the press and to anti-bill lobbyists.
One difference this time is that number of congressional committees have been working on healthcare reform bills. The outlines of all competing bills are similar, and compatible with that of the White House. All favour tougher regulations for insurers, establish an individual mandate, set up insurance exchanges for those who do not have employer-provided coverage, offer subsidies for the less well-off (although the exact size of the subsidies varies from committee to committee), pay for most of the reforms by cutting waste in the Medicare programme. The major points of disagreement are on the "public option" and on how to pay for the remainder of reform. The Senate Health committee was the first to pass a healthcare reform bill
The House of Representatives bills propose to pay for reform by levying a surtax of up to 5.4% on families earning over $350,000 a year. In the Senate, the Health committee also backed the idea of a public option, but cannot rule on financial matters, the jurisdiction of the Senate Finance Committee, which has yet to produce a final bill. The Finance Committee has gathered together an informal, bipartisan group of senators - known as the "Gang of Six" - in an attempt to hammer out a compromise that will attract support from both parties. Will this work?
In September '93, President Clinton's advisers agreed on an explicit congressional strategy. Rather than start from the centre, writing a bill to appeal to conservative Democrats and moderate Republicans (while telling the liberals this is the best they can expect), they start from the left and moving as far to the centre only as needed to reach a majority. But, Newt Gingrich is determined there be no Republican support for any Clinton-designed reform and the whole effort be derailed.
The media ran stories describing and analysing Clinton's secret draft plan. Decisions are made, unmade, revised, and remade about what TV shows cabinet members and Democratic members of Congress will appear on. The result, according to one of those involved, is "piss poor planning and disastrous conflicts." Not unlike how fiscal policy and bank bailout schems are discussed today, back in September '93, opponents dismissed the economic calculations as "fantasy numbers" even to the extent of saying there is "no health care crisis."
Trying to replay the similar tactics in the run-up to next year's mid-term elections, not only health care bill but the general federal budget faces a struggle to pass in the Senate, for which very little time is left. That means Congress has to pass a “continuing resolution,” or a series of them, to temporarily fund the government, which would be a replay of '93, '94' and '95. That’s bad for a couple of reasons: One, a full federal budget for the year, federal agencies and sub-agencies can’t plan. They literally hold up recovery plans and programs because they don’t know if there’s money for them. Two, when Congress passes these bills in haste, lots of shenanigans will happen. Recall that it was in 2000, a provision was slipped into one of these big bills to remove Glass-Steagal that many claim ultimately helped cause the 2007-09 financial meltdown. That can be what Congress is playing with when it fails to get its work done on a regular schedule, and the rest of the world hanging on the economic and policy guidance teats of the USA!

US CORPORATE PERFORMANCE

As we know corporates are like households de-leveraging if they can to reduce their exposure to financial markets and cut costs especially investment, to defend margins and business models, and maximise profits to restore share values or push up their shares in the current rising market, which may prove a temporary centre of a W or double-dip. But in the interests of recovery, are US profit margins unsustainably high? FT's Lex argued that US corporate profit margins are too far above their long-run average and should "return to the mean relatively quickly", implying significant risk to current earnings path. US corporate profits before depreciation, tax & interest amounted to about 35% of corporate output in 2Q '09 compared with a long-run average (since 1947) of 29% (which seems at first glance very high?)
The margins are indeed odd (spotted by Simon Ward at Henderson) in that pre-depreciation profits have been compared with net corporate output after deducting depreciation i.e. inconsistency in treatment of depreciation between numerator & denominator of the ratio. Two credible measures of profit margins are:
1) profits before depreciation, tax & interest as % of gross output, i.e. before depreciation; and 2) profits before tax & interest as % of net output.
These gross and net measures are shown in the first chart. The gross measure behaves similarly to the series in the FT Lex column, but net margins are much less extreme relative to history – 19.4% in Q2 '09 versus an average since 1950 of 18.1%.
The widening gap between the two measures reflects a trend increase in depreciation as a proportion of output, related to a rising economy-wide capital-output ratio and a shortening average life-span (working life - at least in theory) of capital goods, whether or not simply for "tax efficiency", and alo pressure in many quarters of industry to replace systems (IT etc.) and processes.
If gross margins were to mean revert, as Lex thinks likely, net margins would fall to the bottom of their historical range. Economic theory suggests that the income share of capital-owners should be stable over the long run but this refers to return rewards after costing for the erosion in value of assets (argument for using net rather than gross margins).
The FT focused on domestic profits, ignoring 25% share of total US profits accounted for by foreign earnings. The first chart (also from Simon Ward) compares total profits net of taxes and adjusted for inflation with a log-linear trend. This suggests that profits were 8% below trend in the second quarter after a 10% first-quarter shortfall – similar to the 13% deviation at the bottom of the last recession. The slope of the trend-line implies real profits growth of about 3.5% per annum. Assuming 2% inflation, nominal trend profits will be about 18% above the second-quarter actual level by the end of 2010. Consensus hopes of a significant earnings recovery next year are therefore not irrational, providing a near-term economic pick-up can be sustained.

GEITHNER'S G20 AGENDA

Although analytically it is convenient to think of the real economy and financial sector as two subsets of capitalism, in reality, they are inseparable parts of the modern
political-economy, with a lot of two-way interdpendencies; finance sector is not just another boat bobbing up and down on the waves and tides of capitalism, but something as ubiquitous and powerfully a third as large in output but much larger in finabcial balances and cash-flows than government. The differences is of course that banking finances are private and dispersed and it is easy for bankers to duck political responsibilities. As we move into an era where banks have to be more macro-economic astute, they will become more politically active. At present that activism is weakened somewhat by needing government generosity of financial support.
The Credit Crunch has been a wake-up call to all to recognise that the interaction between the financial sector and the real economy is strongly influenced by
inter-government policies. The continuing financial turmoil is like a big stress test for theories on the interaction between the financial sector and the real economy and that stress-test is centred on the G20 agenda, about how our preconceptions about how the crisis will play out - the increasingly heard term "exit strategy". The US Treasury Secretary, Tim Geithner, other than Federal Reserve Chairman Ben Bernanke, may be the most important single person in the world of banking, if there is any such individual? At London's G20 agenda meeting the balancing trade-off (of private/public, individual star-players/ regulatory systems) seems to be between gaining France's agreement - and with Germany and ECB that of the EU and Euro Area - for the US & UK priorities in exchange for accepting a French (& EU) priority on reining in bankers' bonuses to pre-empt excessive remuneration from blinding bankers to excessive risk-taking i.e. a change in culture; a halt on where the 'star-culture' is leading, which is also about whether investment banking arms of large banks can continue to do competitive business with Hedge Funds and Goldman Sachs and attract and retain similar deal-makers. Do individuals or systems make the most difference to financial performance and social-economic benefits of banking, and can the governments who have saved banks from collapse dictate a new more macro- and micro- prudential banking culture? It is a perplexing question-of-judgment-balancing; do people or systems, private or public interests, animal-spirits or politics, count for most in how global finance works well or badly. Whose face should be on the dollar, Lincoln or Bernanke? The G20 meeting is therefore about whether the political leaders around the negotiating table can make a difference; collectively recognise the imperatives of what to do about the world's banking systems including the culture of star-player bankers or not? The crisis has eviscerated shareholders of banks and replaced private funding sources and capital reserves with state funding. But there is a mutual dependency and stand-off between banks and governments. Banks have various means to resist government controls, not least by the political insistence on behalf of capitalism as essentially a private matter that government intervention shoiuld be as temporary as possible. Governments are trying to ensure that before they exit their centrally supportive role that the banks are at least subject to new adjusted regulatory controls to ensure that banks recognise their macro-political-economic responsibilities and not simply return to 'business-as-usual'. There is a war being waged between politicians supported by angry general public and bankers on behalf of private finance. Does money or votes count for more in our democracies? The US finance sector as the world's most powerful is the benchmark against which everyone's else's banking sectors are defined, just as the dollar and the US economy dominate world asset values, trade and ouput and therefore G20 is about accepting or modifying or adding to the US agenda, Geithner's agenda:
US TREASURY STATEMENT WITH MY COMMENTS IN BRACKETS
The global regulatory framework failed (yet again for the umpteenth time) to prevent the build-up of risk in the financial system in the years leading up to the recent crisis. (Risk build-up is always inevitable. The global financial system, mainly following a US lead in dispersing credit risk internationally, but in debt markets of structured finance the originate-to-distribute model became an originate-to arbitrage model, with the effect of prolonging the peak of the credit/economic cycle by 2years thereby creating a stronger financial impact on the inevitable Anglo-saxon recession to produce a shock that became a brief Global Recession).
Major financial institutions around the world had reserves and capital buffers that were too low; used excessive amounts of leverage to finance their operations; and relied too much on unstable, short-term funding sources. (They were too low by being predicated on the recent past, not on future unexpected worst case - macro-model failure, ignorance or resistence to? Banks/bankers were not prepared to accept that they have collectively - and individually in the case of the biggest banks - a responsibility to be prudent by caring about the wider economy and their role in it a role that is not defined anywhere within the system except by the Basel II Accord issues on 'pro-cyclicality', something not taught by accademics, accountants or in Economics 101, and something that they are not motivated to care about by shareholders, by bonus remuneration, or by government tax & penalty-setting powers.)
The resulting distress, failures, and government bailouts of these firms imposed unacceptable costs on individuals and businesses around the world. (This is an inexact statement that is only believed by populaist political opinion. Bailouts removed half the pain so that individuals and businesses are in reality only having to cope with the equivalent of a relatively normal recession. The funding of bailouts is off-balance sheet of central governments that taxpayers' money so far is very little used. Furthermore, also rarely statd, the asset balloon build-up in credit-boom economies with massive trade deficits, US especially, that preceded the crash was a bonus to emerging market poor countries by giving them 2-3 years extra foreign investment inflows and trade surpluses, which were positively transformative, transferring from rich world to poor-world in a few years the financial equivalent of decades-worth of aid!)
Going forward, global banking firms must be made subject to stronger regulatory capital and liquidity standards that are as uniform as possible across countries. (This is already happening in a process preceding the Credit Crunch by 12 years). Today the Treasury Department set forth the core principles that should guide reform of the international regulatory capital and liquidity framework to better protect the safety and soundness of individual banking firms and the stability of the global financial system and economy. (This form of words is based on a perspective of banking and even government as merely large important cogs in the engineering machinery of the world economy, like water, transport and energy. Like any cog in a machine consisting working with other cogs, no cog can be allowed to spin at its own self-determined speed; it cannot have an agenda of its own. This is not a view of finance sector necessary restraint that appeals to the imperial egos of big bonus bankers. After all, the whole ethos of 'private' capitalism is that it should not need to take account of public interest, of the wider economy. The US Treasury proposes the following:)
1. Stronger capital and liquidity standards for banking firms:
Capital requirements should be designed to protect the stability of the financial system, not just the solvency of individual banking firms, including banks, bank holding companies, financial holding companies and large, interconnected firms. (We have minimum regulatory capital to cover worst case expected losses plus economic capital buffers for unexpected losses, which has been increased, and maybe now we may see a third category of systemic risk capital buffers? These should vary according to the too-big-to-fail relative size of banks.)
2. Capital requirements for all banking firms should be increased, and capital requirements for financial firms that could pose a threat to overall financial stability should be higher than those for other banking firms. (higher capital reserves means reduced leverage and reduced speed of asset growth).
3. The regulatory capital framework should put greater emphasis on higher quality forms of capital that enable banking firms to absorb losses and continue operating as going concerns. (This is saying that too much of banks' business models shifted from traditional funding from deposits to wholesale funding by borrowing and investment trading on the banks' own accounts rather than merely charging for services delivered to customers and clients.
4. The rules used to measure risks embedded in banks' portfolios and the capital required to protect against them must be improved. Risk-based capital requirements should be a function of the relative risk, including systemic risk, of a banking firm's exposures, and risk-based capital rules should better reflect a banking firm's current financial condition. (Giving systemic risk more prominence in the Basel Accord also means more prominence for liabilities, for liquidity risk, which were relatively under-played in the Basel Accords I & II, which are the basis for global banking regulation.)
5. The procyclicality of the regulatory capital and accounting regimes should be reduced and consideration should be given to introducing countercyclical elements into the regulatory capital regime. (These considerations are already there, but not systemetised in detail. Basel II authors and regulators repeatedly expressed concerns for sensitivety to pro-cyclicality risks i.e. banks knee-jerk responses to cycle downturns thereby making recessions deeper and longer. The risks are that while Government seeks recovery by deficit-spending to pump new circulating-money into the economy banks would be cancelling loans and not making new loans thereby sucking circulating-money out of the economy.)
5. Banking firms should be subject to a simple, non-risk-based leverage constraint. (This is the Comptroller of the Currency view that capital reserves should be a ratio to gross assets, not merely to risk adjusted assets net of risk-adjusted collateral and hegding. This leverage constraint could be a major restriction on derivatives generally though aimed specifically at arbitrage in credit derivatives.)
6. Banking firms should be subject to a conservative, explicit liquidity standard. (This will force banks to seek more government treasuries as part of their reserves and less reliance on shareholder equity. In consequence, banking growth will be constrained more by government deficits - bond issurance - and more controllable by central banks money market actions in dictating banks' CB deposits and short-end treasury bills - liquidity windows.)
7. Stricter capital and liquidity requirements for the banking system should not be allowed to result in the re-emergence of an under-regulated non-bank financial sector that poses a threat to financial stability. (The short end official money markets is essentially for unsecured short term lending & borrowing and is entirely for developed economy banks and governments only. Non-banks resented this and effectively created Money Market Funds and Credit derivatives to emulate siilar liquidity leverage, but by creating longer-lasting securities built up a massive credit derivatives inventory that became the focus of much leverage arbitrage that when it unravelled could bring down the world's banking system - the so-called ' financial weapons of mass destruction'. Hedge funds deny they are responsible for the Credit Crunch. There will be a major series of battles over the next few years o see how much that is unregulated & over-the-counter - off-exchange - and how much will become regulated & on-exchange.)
7. A comprehensive agreement on new international capital and liquidity standards should be reached by December 31, 2010 and should be implemented in national jurisdictions by December 31, 2012. (We may interpret this as the dates and therefore the announcement of Basel III Accord - or Basel II+?).