Financial regulation , a herculean task

• The parallel “shadow” banking system needs fixing: that should mean painful choices for money-market funds.
• If a film to be made with title “It’s a Wonderful Life” today, the hero would probably not be a banker—and not just because of the optimistic title. The shape of finance has changed radically in the past few decades.
• For every traditional bank clerk there are several sorts of financial intermediators. The character of George Bailey would today be as likely to manage a money-market fund as take in humble bank deposits. Or he might work at Fannie Mae and Freddie Mac, America’s housing-finance giants, buying home loans from banks and packaging them into mortgage-backed securities.
• India’s headline inflation should peak in March with demand-side pressures likely having a short-term impact on prices, the federal chief statistician said on Friday.
• This “shadow” banking system is huge, particularly in America—too big for the banks to be able to replace it. In the summer of 2007 assets funded through the capital markets were larger than those held by America’s banks. Only one-third of the country’s home mortgages were on banks’ balance-sheets. The bank bail-outs hog attention, but many of the government’s crisis measures were designed to prop up the shadow system. Even so, many bits of it, especially private mortgage-backed securities, remain moribund.
• The Reserve Bank of India (RBI) unexpectedly raised key rates last week to help tame inflation, which is at close to 10 percent, and warned of pressure from rising demand in the rebounding economy.
• The intellectual case for securitisation, the process of pooling lots of different loans and selling the cashflows to investors, remains strong. Done properly, it should enable banks and investors to diversify their exposures. In Europe, where bank lending is more important, it offers a useful, alternative source of financing. But the shadow system has to become far more stable. Great chunks of the crisis happened outside the banks. The rot started in the market for securitised subprime mortgages. Bear Stearns and Lehman Brothers were non-banks that were crippled by a silent run among panicky overnight “repo” lenders, many of them money-market funds uncertain about the quality of securitised collateral they were holding. Mass redemptions from these funds after Lehman’s failure froze short-term funding for big firms.
• Banks like JPMorgan Chase have found themselves the owners of a wide range of businesses, from distressed oil companies to hotels and newspapers, as a result of a recent wave of bankruptcies
• .So far the reformers of finance have neglected the shadow system. Some changes are on the way—new liquidity rules for money-market funds, for instance. But uncertainty about the long-term prospects of Fannie and Freddie has been a brake on the revival of securitisation. Congress started hearings on their future this week, but the White House has yet to put forward detailed thoughts of its own. Fiddlier issues require more clarity, too. Investors want assurance that securitised assets will be ring-fenced from claims if a lender fails, for instance.
• House of Representatives Speaker Nancy Pelosi on Friday formally signed and sent to President Barack Obama the final installment of landmark healthcare overhaul legislation.
• Financial organisation need attention. But what should be done? Two things stand out. The first is the need to project some light into the shadows. The pre-crisis securitisation markets were deeply murky. Efforts to get banks to retain more of the risk associated with securitised loans are well-intentioned, but the danger is that investors will regard this as a comfort blanket (as they previously saw gold-plated credit ratings) and skimp on due diligence. Investors need to have up-to-date information on the quality of the loans inside securities: central banks can help by mandating disclosure requirements for collateral that they accept at the discount window. And regulators need better data on obscure areas like triparty repo and stock lending.
• The other imperative is to make sure that the bits of the shadow system that act just like banks are regulated accordingly. That shift in thinking has already happened for investment banks, but needs to go further. Money-market funds are an obvious example. Investors in these funds expect to get their money back on demand, just like depositors in a bank. The post-Lehman run started after one fund “broke the buck”; it stopped when the government said it would guarantee investors against losses. So these funds should be forced to make a choice: keep the commitment to pay up and set aside capital and insurance funds (like banks have to do); or drop the commitment and put the burden of losses on investors.
• As Britain prepares to go to the polls, its sick economy is uppermost in voters’ minds. With good reason. There are fundamental doubts that it can ever recover fully from a banking crisis and recession that laid Britain lower than many other rich countries. In the short term, the worry is whether a feeble recovery reliant on fiscal and monetary life-support can develop its own driving force. Looking ahead, there are fears that the strong, steady growth rate in the 15 years before the financial crisis is no longer Britain’s default mode. And casting a dark shadow over the next parliament are public finances that have veered wildly into deficit and will need to be hauled back harshly from the brink.
• Yet the housing-market recovery has almost run out of steam. Sales of new and existing homes have fallen for three consecutive months. As a result inventories have grown, putting downward pressure on home values. According to some measures, prices are dropping again: the Federal Housing Finance Agency reported national declines in December and January.
• Standard & Poor’s Ratings Services on Thursday said that it revised the outlook on India to stable from negative. At the same time, S&P affirmed the ‘BBB-’ long-term and ‘A-3′ short-term sovereign credit ratings on India.
• For  bankers, the war is not yet over. Britain’s taxpayers are still sore. They blame the banks for pitching the country into crisis, and for hoarding their bail-out money rather than oiling the wheels of commerce by lending it.
• The surprise interest rate hike by the Reserve Bank of India (RBI) will not significantly dent property sales, but another widely expected rate hike in April may slow down sales marginally, developers and analysts said on Monday.
• World trade in merchandise goods is expected to rebound strongly this year as economic recovery takes hold, expanding by 9.5 percent, World Trade Organization Director-General Pascal Lamy said on Friday.
• Concerns that a gulf is opening between European Union countries that use the euro and those that do not resurfaced at an EU summit that saw euro zone states agree a plan to help debt-laden Greece.
• People must see their government play the role of an even-handed referee rather than be a dispenser of rewards or even a judge of economic merit or contribution.
• The U.S. economy grew at a slightly less brisk pace than previously estimated in the fourth quarter, while corporate profits slowed sharply from the previous quarter, government data showed on Friday.