‘Poor Supervision of Investment Banks Led to U.S. Crisis’

Two economists say slack supervision of investment banks led to the U.S. financial crisis.

Danny Leipziger, the World Bank’s vice president for poverty reduction and economic management, and Park Yoon-sik, international business professor at George Washington University, talked to The Dong-A Ilbo on the U.S.-led financial crisis and its prospects.

The following is excerpts from their conversation.

Q: What was the fundamental reason behind the financial crisis?

Leipziger: When substantially low interest rates continue for a long period of time, investors tend to seek much higher profits despite risks. In a normal system, restrictions that limit risk-taking activities are in place. In certain markets, however, either supervision is often lacking or the practice of regulatory arbitrage, in which investors seek regularity loopholes when the severity of regulations is different from country to country or between regulators, becomes prevalent. That is the case of the United States. In America, various “players” participate in the financial sector. So it is difficult for regulators to accurately assess risks. When the economy slows down in this situation, risk control becomes out of the question.

Park: I agree with Leipziger. The financial crisis was due to the greed of financial institutions and the breakdown of financial supervision, with the latter being the main culprit. The U.S. regulatory system is unbalanced. Commercial and investment banks and insurance companies are supervised by different organizations, leading to different levels of regulations. For example, commercial banks are under stricter regulations. Though their required equity to debt ratio (leverage ratio) is 1:12.5, in practice it reaches 1:10. On the other hand, supervision for investment banks is slack. At certain points, the leverage ratio was 1:30.

Q: The mark-to-market account system is also considered one of the culprits.

Park: It sure is. Mark-to-market account, the act of recording assets to reflect market value rather than book value, aggravated the situation. Though real losses did not occur, astronomically growing losses in the account book caused banks to scramble to sell even blue chip assets to make up for losses. The U.S. Securities and Exchange Commission, which supervises investment banks, should have stopped the system when it detected a crisis.

Leipziger: The system is beneficial in theory, but is not effective in the event of a crisis.

Q: What is the fate of the 700-billion dollar bailout plan?

Leipziger: I think the rescue plan will be approved. The two political camps in the United States joined hands to reject the bailout plan. Those opposed to the bailout in the Republican Party think bailing out Wall Street is not the role of the government. In the meantime, Democrats think that it is unfair that when profits are made, Wall Street takes them and when losses incur, the government takes care of them. Average Americans, especially those who lost their homes due to adjustable mortgage interest rates, find the rescue plan gravely unfair. That’s the reason behind the House of Representatives’ rejection of the bailout plan. In addition, the rescue package paid no attention to how the effects of the bailout will trickle down to individual Americans. It only considered coming to the rescue of the financial system and big financial institutions. If the rescue plan considers all of these concerns, it will be implemented.