Experts debate how to fix financial system

As stock markets grapple with the fallout from this week's turmoil on Wall Street, experts are asking what can be done to prevent a similar financial fiasco in the future.

But this time around the debate is what — not whether — changes should be made to the way Washington governs U.S. banks and other financial institutions.

"Lacking adequate regulation or oversight, our financial markets have become a snare and a delusion," Robert Reich, a former U.S. labour secretary and long-time academic, said Monday.

"Government only has two choices now: either continue to bail them out or regulate them in order to keep them honest. I vote for the latter."

Stock market woes are bringing calls for more government regulation.(Associated Press)

Within five days in September, Wall Street has seen the bankruptcy of brokerage house Lehman Brothers, the takeover of Merrill Lynch & Co. and a bailout of insurance giant American International Group Inc.

Global central banks have injected more than half a trillion dollars into the world's lending pools to make sure there is enough cash for firms to borrow.

Stock markets in Canada and the United States have tumbled precipitously during this process, all triggered by massive purchases over the past decade of mortgage-backed commercial paper that is now nearly worthless.

Banks, investment houses, insurers and even non-financial firms, such as oil companies, found themselves writing off billions of dollars in paper assets as the U.S. housing sector, which provided the repayment stream to this debt instrument, collapsed.

Eventually, supposedly savvy corporate investment types discovered they had no idea what was backstopping their holdings in this near-money asset.

"What were the people smoking who bought all this stuff?" said Don Drummond, chief economist with TD Bank Financial Group and a former senior official with Canada's Department of Finance.

SEC reacts on short selling

On Wednesday, the U.S. Securities and Exchange Commission dipped a toe into regulatory waters, instituting tougher requirements for so-called short sellers.

A short seller is someone who sells company stock that the investor does not actually own, believing that the price of the security will drop before he or she is required to deliver the certificate to the purchaser.

This activity is legal. But short sellers tend to be reviled on Wall Street and Bay Street since they benefit when securities markets drop in value.

The SEC now wants these players to disclose how many stocks they are "shorting" at the end of each trading day.

Tough rules needed, some say

Many expert observers want more regulations, mainly to prevent corporations from accumulating mountains of risky investments, the result of which could threaten a company's survival.

The trick is in finding the right set of rules without reducing the market's ability to raise cash.

"First, to correct the problem we need political leaders and policymakers who believe in regulation," Joseph Stiglitz, a Nobel Prize-winning economist, said in an interview with the Huffington Post earlier in the week.

"Beyond that, we need to put in place a new system that can cope with the expansion of finance and financial instruments beyond traditional banks."

He wants the government to install new rules that would limit the compensation of chief executive officers and other senior corporate officers.

Asset-backed commercial paper market fell with slumping U.S. real estate values.(CBC)

Stiglitz also said Washington should set up "speed bumps," or regulatory restraints, for financial markets enjoying spectacular popularity that is out of line with their underlying economic potential.

Many experts pointed to higher capital requirements for non-bank institutions as one way to dampen the ability of corporations, such as brokerage firms, to dabble in ultra-risky investments.

Other regulatory watchers, however, fear a heavy hand from Washington will slam capital markets.

"My bottom line right now is it's far too early to say what will happen," said Fred Gorbet, CIT chair in financial services in the Schulich School of Business at Toronto's York University and former deputy minister of finance in Ottawa.

"In the U.S., Congress will likely take the lead and the risk is that we have a knee-jerk reaction akin to Sarbanes Oxley after Enron — which was not well thought out, in my view."

In 2001, energy trading giant Enron Corp. slid into bankruptcy after it was disclosed that the company was artificially enhancing its income statements to boost its share price.

The U.S. government reacted by bringing in the Sarbanes-Oxley Act in 2002, a piece of legislation that many now concede was overly intrusive in trying to improve financial practices and corporate governance.

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