Checking the Street

The views expressed in this column are those of the author and not SVB Financial Group.  

 
Just got knocked clean off
No telling what it costs
But it sure feels right
- Radney Foster  

Last Thursday afternoon a natural gas main in a densely populated San Francisco suburb exploded, destroying dozens of homes and creating a fiery mess. Over one hundred homes were damaged, but fewer than 10 people were seriously hurt and only four deaths have been reported as of this writing.

It's interesting to imagine the tangled web of gas lines, power lines and who knows what that comprise a web that underlies our everyday existence. Although the tragedy was due to a failure in the existing system, the notable aspect of the story is the effectiveness of the safeguards that prevented an ongoing domino effect throughout the Bay Area.

The series of valves and safety triggers must be intricate, well-maintained, and in the end almost fail-safe.The alternative is nearly unthinkable.

One of the many lessons from the recent financial crisis is the revelation of weaknesses in the interconnectedness financial institutions of all stripes. Recall the logic behind the Bear Stearns bailout (along with AIG and many others) was the desire to avoid a systemic failure.

Financial contagion would have been disastrous, we were told.

Likely, that is a very true statement. However, there should have been a plan in place to deal with this problem before getting to the point of no return. Unfortunately, this was not the case.

So now, through the recently-enacted financial regulatory laws along with the Basel III conversations and other government activities around the globe, regulators the world over are attempting to build such fail-safe apparatus as that which saved many Bay Area communities last week.

The problem is we are getting a very late start.

Imagine if every home connected to a natural gas line decided to create offshoots for their own particular purposes. And these offshoots were not subject to code inspections or safety regulations.

Many would not install such safety measures, figuring the probability of danger is quite low. But taken together, the lack of automatic valve shut-offs across the system creates a greater danger — one that could be devastating to the entire society.

We got to that point in the financial industry because of little to no oversight from the regulators. The largest nodes in the system were allowed to create such intricate financial entities as CDOs, SIVs, and other valve-less entities living off the communal gas lines that, in the end, great systemic risk was created without regulation.

When Lehman went down, very few, if any, regulators knew about the so-called "REPO 105" transactions that allowed Lehman to understate their liabilities, thereby overstating the safety of the firm as a whole.

Why did they not know about these off-shoot gas lines lacking safety valves?

The debate about regulation, unfortunately, is developing into one of "more" vs. "less," pitting critics of capitalism and socialism against one another. This is absolutely the wrong debate. Instead, we should be discussing what regulation needs to accomplish (reduce risk to the system as a whole) and how we can achieve it.

Checks and balances are endemic to our governing bodies. But building these safeguards has lagged creativity in the private sector. We need creative, forward-thinking regulators who are not afraid to ask tough questions of Wall Street.

This will allow for the appropriate breakers to be placed in the system.

Key Developments
Consumer borrowing in the U.S. declined for a sixth straight month in July, indicating Americans are reluctant to take on more debt without faster job growth.

Borrowing dropped $3.6 billion in July, followed by a revised decline of $1 billion in June. Consumer spending is expected to be restrained as people pay down their debt.

Inventories in the U.S. rose in July by 1.3 percent, the most in two years as a rebound in demand prompted companies to add to stockpiles. Wholesalers make up about 30 percent of all business stockpiles. At the current sales pace, wholesalers had enough goods on hand to last 1.16 months in July, compared with 1.15 months in June.

The U.S. Treasury Department has received about $16 billion in dividends and interest on its investments in banks, insurance companies and automakers through the TARP. Programs such as the Public-Private Investment Program and asset guarantee program have accrued $140 million and $411 million in dividends and interests, respectively. In addition, 97 banks were behind on their quarterly dividend and interest payments to the government, with a total backlog of $455 million.