The surprise for me in the World Economic Forum’s report on global financial centres, presented by Nouriel Roubini at a media briefing in Manhattan this morning, was how badly France and Germany have suffered from the financial crisis.

The report, which ranks countries according to measures such as financial stability and the sophistication of their financial services, unsurprisingly found that New York and London’s lead had narrowed over financial centres in other countries. The US had dropped to third place, behind not only the UK but Australia.

Australia and Brazil were the two countries that rose fastest up the rankings, leading general strength among Asia and Latin American countries.

France and Germany, however, suffered disproportionately - both dropping out of the top 10 to positions 11 and 12 respectively. Since both governments have tended to present the crisis as an Anglo-American affair that had knock-on effects in their countries, this will probably not go down well.

I asked Prof Roubini about it and he replied, fairly enough, that “the idea that the eurozone institutions are OK is not correct” and argued that the Landesbanken sector - German regional banks -  is “semi-insolvent and needs restructuring”.

A related aspect of the financial crisis reflected in the rankings is the degree to which the financial crisis was one of developed rather than emerging markets. The macroeconomic stability and positive trade balances of countries such as Brazil gave them a buffer to withstand the crisis.

Is that a mea culpa I read from Michael Milken?

Not on the face of it. Mr Milken, pioneer of high-yield bonds and early backer of leveraged buy-outs, insists in an article in today’s FT that the old principles of financial markets still obtain, despite the upheavals of the past year:

Properly applied and regulated, the market innovations of the 1970s disperse risk and create jobs. The disruption of the past two years was caused by other factors, including unrealistic ratings that failed to reflect underlying credit risk, government encouragement of questionable investments, flawed underwriting practices and deployment of excessive leverage by financial managers who did not see the need for credit research.

Still, he acknowledges that companies can get over-leveraged at the peak of financial cycles and the ratio of debt to equity can affect a company’s value (despite Modigliani and Miller’s 1958 academic work which held that the value of a firm was independent of its capital structure):

. . . But markets’ future health requires investors to avoid errors that prolong and deepen global downturns. These include inaccurate assumptions that loans against real estate are high-quality assets, interest-rate movements can be predicted, capital structure has little effect on a company’s value, emerging-market sovereign debt is without risk and high leverage is best for maximising profit.

An example of the way in which over-leverage can have unpleasant consequences is reported in detail in today’s New York Times. It describes the likely bankruptcy of the Simmons Bedding Company after it was bought by Thomas H. Lee Partners, the buyout firm in 2003.

The NYT article is light on the competitive pressures behind the company’s problems and implies that all of its ills were to do with the rapaciousness of private equity, which I am not sure I believe. Incidentally, David Carr, an NYT columnist, also has a blast at private equity in his column this morning.

That said, Simmons does appear to be one of the companies that were over-leveraged at the peak of the cycle by private equity firms, which added debt to companies they already owned to finance dividend payouts to the equity holders.

That is one reason why, as this FT article this morning notes, private equity companies are finding it hard to raise debt from banks to take part in new acquisitions.

Even Michael Milken thinks that financial leverage can be taken too far.

There is a nice footnote to history in the revelation that the US government tried to force Morgan Stanley to sell itself for $1 a share to JP Morgan Chase at the height of the financial crisis last year.

Had the takeover gone through, it would not only have been a humiliating end to the career of John Mack, Morgan Stanley’s chairman and chief executive, but would also have reversed the enforced break-up of J.P. Morgan by the US government following the 1929 crash.

Morgan Stanley was originally the securities underwriting and trading arm of J.P. Morgan, and broke away in September 1935 after the Glass-Steagall Act separated commercial and investment banking in the US.

Andrew Ross Sorkin’s forthcoming book on last year’s crisis, Too Big to Fail, recounts that Hank Paulson, when he was US Treasury Secretary amid the financial turmoil, attempted to orchestrate deals between Goldman Sachs and Wachovia, and JP Morgan and Morgan Stanley.

Mr Mack, who will be succeeded at the top of Morgan Stanley by James Gorman at the end of the year, stood his ground more trenchantly than Ken Lewis, who has just announced his resignation as chief executive of Bank of America after being dogged by the ill-fated acquisition of Merrill Lynch.

This is a description of the event from Vanity Fair, which is carrying extracts from Ross Sorkin’s book:

Meanwhile, the government demanded Morgan Stanley merge with JP Morgan, an idea that both John Mack, Morgan Stanley’s CEO, and Jamie Dimon, JP Morgan’s CEO, did not want to pursue, but both held brief talks at the government’s urging.

Paulson, Bernanke, and Geithner told Mack that he should be willing to sell his firm to JP Morgan for $1 a share.  Mack, in an impassioned phone call with the three government leaders, rejected their demand: “There are 35,000 jobs that have been lost in this city between AIG, Lehman, Bear Stearns, and just layoffs. And you’re telling me that the right thing to do is to take 45,000 to 50,000 people, and put them in play, and have 20,000 jobs disappear? I don’t see how that’s good public policy.”

Morgan Stanley subsequently gained a $9bn capital injection from Mitsubishi UFJ, the Japanese bank, in exchange for a 21 per cent stake. Its shares were today trading at about $30, up from a 52-week low of $6.71, which shows that Mr Mack made the right call.

Of course, he also took a gamble for, without the help of the US government and Mitsubishi, Morgan Stanley might not be around at all, as Ross Sorkin notes in a Vanity Fair interview:

If the Mitsubishi deal had not gone through, I truly believe that Morgan Stanley would have either gone by the wayside like Lehman Brothers, probably putting so much pressure on Goldman that it may have toppled as well, and we would have seen even greater havoc in the marketplace. Now, there was always the possibility - it was never really raised that weekend, or at least not aloud - about whether the government at that point would have decided to step in itself and put capital into Morgan Stanley the same way they did AIG. But barring a capital injection, Morgan Stanley would have died, then Goldman Sachs - and then General Electric.

All the same, Mr Mack turned out to be doing a very good job for his shareholders by refusing to buckle to Washington pressure, or to nod to history.

My column this week in the FT is on OTC derivatives:

“We must not let daylight in upon the magic,” Walter Bagehot warned about the British monarchy. For the world of derivatives, however, more daylight is essential.

A year after the failure of Lehman Brothers, banks still make big profits from derivatives, particularly complex ones traded over the counter. US banks gained revenues of $15bn in the first half of this year on trading cash and derivatives, while the notional value of their holdings rose to $203,000bn.

OTC derivatives, used in everything from hedging balance sheets to tax arbitrage, are among the most profitable contracts that big banks offer. As the revenues from trading of equities and bonds have been squeezed, complex derivatives remain money-spinners.

It comes at a cost to the financial system, however. When American International Group failed, the US government spent billions of dollars to buy out its credit default swaps with institutions including Goldman Sachs. When Bear Stearns and Lehman Brothers hit trouble, others worsened their plight by rushing to close derivative trades.

The US government and the European Commission are trying to fix the most glaring problems in the OTC derivatives market. Both of them want the bulk of derivatives to switch from private OTC contracts to being cleared centrally, and perhaps traded on exchanges.

The banks that dominate the OTC derivative markets are fighting the most stringent proposals. They have allies in their campaign: industrial companies that are dismayed by the prospect of having to hedge currency, interest rate and credit risks through clearing houses.

European companies including Lufthansa and Rolls-Royce complained at a hearing last week about the financial risk posed to them by a clampdown on OTC derivatives. In the US, Delta Air Lines, Cargill and public utilities are protesting equally fiercely.

But companies should not be allowed to undermine reforms by forcing regulators and governments to retreat from the push for more transparency and less systemic risk. Their concerns can be addressed without letting the OTC market carry on as before.

You can read the rest of the article here and comment below.

How the world re-balances itself. The news this morning that Michael Geoghegan, chief executive of HSBC, is to move to Hong Kong, leaving the bank to be represented in London by Stephen Green, its chairman, reminded me of why HSBC put its chief executive in London in the first place.

HSBC, of course, once rejoiced in its full name - the Hong Kong and Shanghai Banking Corporation - which I regret that it dropped since it was one of the great names in finance. When it took over Midland Bank in 1992, it was told by the Bank of England that it had to move its headquarters to London.

HSBC, a bank run by Scottish expatriates who worked in  Hong Kong when it was part of the British empire, did not like that very much but it was forced to comply.

Now, 17 years later, and presumably with the approval of the Financial Services Authority, it is reasserting the arrangement it wanted in the first place - to run the bank from the expanding Asian markets and treats its UK subsidiary as just that.

To remind myself of all this, I looked back at the FT stories from the time, written by Robert Peston, my former colleague and now BBC business editor, and found something else interesting. This is from one story that he wrote in March 1992:

As for the Bank of England, it will examine any takeover proposals carefully, although it is expected to give its approval. The Bank’s primary aim is to protect the interests of Midland’s depositors. So it will seek guarantees that Midland’s deposits will not be used to make loans in the colony - just in case there is an economic calamity in Hong Kong after 1997 when it reverts to Chinese rule.

Ho, ho, ho is all one can say with hindsight. Not only was there no economic calamity but Hong Kong has been the model for China’s extraordinary growth since then.

However, the notion of ringfencing UK deposits to make sure they are not used for risky lending in far-off places is back in fashion as a way of handling future bank collapses. The difference is that the country from which UK depositors are supposed to be protected is the US, not China.

Paul Volcker is clearly too old and too independent minded to feel any need to avoid criticising the White House and the Treasury, although he has a role in Barack Obama’s administration as chairman of the Economic Recovery Advisory Board.

Mr Volcker has been agitating for some time about what he regards as an inadequate approach to dealing with large financial institutions that combine commercial and investment banking arms. He has called for some form of reinstatement of the Glass-Steagall Act.

In his evidence to Congress this morning, he zeroed in on the problem that a range of big institutions, now including investment banks such as Goldman Sachs and Morgan Stanley, as well as traditional commercial banks and hybrids such as JP Morgan Chase, are being designated as “systemically important”.

The clear implication of such designation, whether officially acknowledged or not, will be that such institutions, in whole or in part, will be sheltered by access to a federal safely net in time of crisis; they will be broadly understood to be ‘too big to fail’ . . .

In fair financial weather, the important institutions will feel competitively hobbled by stricter standards. In times of potential crisis, it would be the institution left out of the ‘too big to fail’ club that will fear disadvantage.

Compare that with the evidence of Tim Geithner, the Treasury Secretary, yesterday:

Identification of a firm as a Tier 1 financial holding company will not convey a government subsidy - it will be no guarantee of extraordinary governmental assistance in the event of financial distress. To the contrary, it will be a guarantee of substantially stricter supervision and regulation by the government - an intensity of government oversight that will serve as a strong disincentive for forms to become too big, complex, leveraged and interconnected.

On the whole, I agree with Mr Volcker and cannot help but think Mr Geithner is indulging in wishful thinking. As my column this morning noted, such institutions gain higher ratings and a lower cost of funding, as well as the comfort of a “heads I win, tails the taxpayer loses” implied government backstop.

In return for that, they merely have to suffer (or continue to outwit) their regulators. That will be irritating but it sounds like a good bargain to me.

The problem here, as Mr Volcker identifies, is that last year’s extraordinary events have made explicit what governments wanted to avoid disclosing - that large financial institutions will be propped up in times of trouble.

The only way to convince the market otherwise, and to reduce the obvious advantages of becoming a Tier 1 financial firm, is to let at least one of them collapse next time. That was what the Treasury tried to do with Lehman Brothers but could not hold the line.

Until then, being ‘too big to fail’ is going to be too attractive for most big institutions to resist. I would be surprised if any of them choose, as Mr Geithner suggests, to shrink themselves.

My column in the FT this week is on how to prepare for the next financial crisis:

Of all the suggestions since the financial crisis erupted to rein in banks and curb their incentives to become too big to be allowed to fail, the most cunning is the “living will”.

My view, however, is that enforcing wills could be both a sound discipline and help with the “too big to fail” problem by reducing the advantages of being big. If banks do not like it, they have to come up with another way to reassure British (and other) taxpayers that they will not be a burden again.

“Living will” is a misnomer, since the term means a plan drawn up by a bank for how it can be broken up if it is insolvent. It would be simpler and more accurate to use the term “will”, as Mervyn King, governor of the Bank of England, did when he coined the phrase in a speech in June.

“Making a will should be as much a part of good housekeeping for banks as it is for the rest of us,” said Mr King. Since then, that notion has been endorsed by Lord Turner, chairman of the Financial Services Authority, and Alistair Darling, the UK chancellor of the exchequer.

Put like that, it is uncontroversial. No one wants a repeat of last year’s scramble by governments to prop up all the operations of international banks such as Lehman Brothers and Fortis. The mess of assets and liabilities in different countries, not to mention a tangled web of derivative contracts, caused chaos.

Yet it is provoking resistance among some British banks. “If they [the regulators] want to turn the clock back and return to a world of national markets and small, simple banks unable to support global growth, they are going the right way about it,” says one banker.

They object to Lord Turner’s belief in wills as a means of forcing banks to simplify international activities and curb tax avoidance. Some fear they will be forced to set up ring-fenced subsidiaries in each country to make things simpler for regulators and governments.

You can read the rest here and comment below.

Senator Chris Dodd’s proposal to wrap together various US financial regulatory agencies into one “super-regulator” and squeeze out, or at least reduce the role of, the Federal Reserve, reminds me of something.

It is the decision by Gordon Brown, then the chancellor of the exchequer, in 1997 to strip the Bank of England of its role in banking supervision and to consolidate regulation under the Financial Services Authority.

Famously, Eddie George, the then governor of the Bank of England, threatened to resign over the issue but was mollified by the quid pro quo - that the Bank would gain independent authority over monetary policy.

It impresses me that Senator Dodd has the nerve to try to do what needs to be done in consolidating the fragmented and confusing array of US regulators - while others such as Barack Obama and Barney Frank,  chairman of the House of Representatives committee on financial services, have balked at the challenge.

Generally speaking, the loquacious Mr Frank gets better media reviews that Mr Dodd, who has faced controversy over whether, as a senator for Connecticut, he was too soft on Wall Street. In this case, however, Mr Dodd is displaying more political courage in defying Washington inertia.