Due to current events, we are publishing this very special BriefLetter written by Dr. Thomas Schürrle. Dr. Schürrle is an attorney consulting globally operating businesses. It is due to this occupational activity that his point of view of the current situation is of particular value and interest.
Dr. Thomas Schürrle The Benefit of the Crisis A few years ago, the former president of the Federal Constitutional Court and Federal President Roman Herzog suggested suspending a percentage of all rules and regulations across-the-board with the reasonable expectation that the absence of numerous regulations would remain undetected. The criticism that this process has not been implemented quickly and noticeably enough has not yet faded away and the call for extended regulations and increasing legislative efforts already becomes loud again - to bring the financial market under control and to prevent systemic catastrophes within the global economic and fiscal system - which are currently dampening the future prospects.
Only at first glance there hides a paradox within the inconsistencies of both approaches. This is not a question of quality and quantity of regulation, but rather of market regulation as a whole.
Apparently, the freedom of competition and management is, from experience, a better guarantee of the supply with economic goods and services than the administered planning via a centralized government. That both exponents view each other as opposites of the integrated whole without ever representing competing alternatives we know since the heuristic discussions about the viability of the particular economic system. The position of the pendulum of regulatory measures between both exponents generally reflects ex-post-facto reaction according to the requirements of the control of markets. Within a regular framework, public administration can and should impact the markets through control to a very limited degree.
However, it would have to do so to a much more considerable degree in order to keep the markets from reaching their target functions.
If you examine the existing regulation of the financial markets under aforesaid premise, you will discover that the market for the supply with debt – with some regional distinctions – has been strictly regulated for the past few decades. Where as the market for the supply with equity is regulated only rudimentarily, either through private equity or hedge funds. Regulation of share derivatives and their trade, especially of those utilizing the leverage effect, is virtually non-existent.
Considering this background, it is fair to conclude that the markets and their instruments tend to develop into the area where they are subjected to the least limitations. Thus, the private equity / hedge fund business has grown considerably in the past two decades. The business with financial derivatives has exploded. Since the new development of products in unregulated segments was only profit-oriented and not controlled and it also was not subject to any self-regulating market conditions, fundamental principles were disregarded. One of these principles is that money cannot proliferate on its own. Appreciation of value which has a profit increasing affect on financial transactions based on derivatives must be generated by the underlying market economy. Furthermore, the extension of the derivative-chain does not simply increase the profit expectations but also the loss expectations and it simply defines the gradient of success or failure.
The increased dependence of the successful finance business on financial derivates does not square at all with the fact that banks, insurances and suppliers of proprietary capital have to primarily ensure the supply of external or proprietary capital. Trading with financial derivatives remains a secondary business, even if it speculates on the basis of short positions, unless strictly for hedging purposes only. If the financial leverage contingent on derivative trade typically leads to short term profits, it is at the same time inevitable that a market expanding in this direction will make out a draft on the future. Such drafts have been drawn in the past years and now it is time for payment: Since the market for financial derivatives inflated explosively, the bill is proportionately large.
This asks for more than drastic corrections. Trailing the runaway derivative market development with corrected touch-ups is doing too little. In view of the potency of this crisis and the magnitude of the dissipated finances, the main function of the money market to supply money has been jeopardized. In such a crisis, bans simply curtailing derivative trade or controlling managerial salaries do not work. In fact, approaches must be methodical and need to be all-encompassing.
This is exactly what the crisis provides space for: Legislature can and should, during a free-enterprise regulation, conceptually make the markets more expensive where limits need to be imposed, especially in secondary and tertiary derivative markets, which do not primarily serve the goal of supplying the population with economic assets, services and capital. In return, legislature will prevent economic main and primary functions – namely the supply of the population with economic assets, services and capital within the intergovernmental or domestic segment – from being curtailed. Internal and external barriers to trade need to be avoided at all costs. They were the main amplification factor in 1929. Any form of accelerators, which neither serve supply nor its basic principles, need to be strictly avoided. This includes not only derivatives from the financial sector but also other disruptive factors that could unduly amplify cyclical value fluctuations of products, services and businesses through leverage. Even a short term duty to supply information and reporting requirement should be taken out of the market to allow for long-term planning, where since such reporting requirements are verifiably not useful or used correctly. Long-term orientation has to be the basis for the entire market regulations to effect adequate self-regulation.
The awareness of what needs to be done is now forming in the crisis. Only the enormous pressure of a global economic crisis generates the necessity for clarity, thoroughness and strategy that is inherent to every great reform and creates the ability to get things done without endless debate. The industry has shown us the correct and successful path from a crisis jeopardizing ones existence in many cases, e.g. in the case of Siemens. Within a timeframe of just two years, the company was able to utilize a severe crisis in connection with dubious business practices and exchanged the entire top management and restructured nearly all internal control systems. Those familiar with Siemens before know that this equals the gutting of a building, and such a drastic restructuring would not have been possible without such a threat to the existence from the outside.
It is primarily the crisis that allows us to throw overboard pointless restrictions and enables the creation and installation of new and reasonable self-regulating market structures with a long term perspective. What proved to be imperative for the largest German industrial enterprise should also apply to the “site management” by political and administrative bodies, both on a Federal and a State level. |
