tag:blogger.com,1999:blog-79538064413459738772024-03-08T15:13:41.780-05:00New Rules BlogJamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.comBlogger14125tag:blogger.com,1999:blog-7953806441345973877.post-42523222123423739762010-07-22T12:45:00.000-04:002010-07-22T12:46:22.494-04:00Dodd-Frank must be the first – not the last – step in a long-term restructuring of financial markets<div> <p class="MsoNormal"><span class="Apple-style-span" style="font-family:'Times New Roman';font-size:6;"><span class="Apple-style-span" style="font-size: 21px;"><br /></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">By Michael Prowse, Senior Visiting Fellow</span></span></p><p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><br /></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">After <st1:country-region st="on"><st1:country-region st="on">Britain</st1:country-region></st1:country-region>’s first military victory against <st1:country-region st="on"><st1:country-region st="on">Germany</st1:country-region></st1:country-region> in the Second World, at El Alamein in <st1:country-region st="on"><st1:place st="on"><st1:country-region st="on"><st1:place st="on">Egypt</st1:place></st1:country-region></st1:place></st1:country-region>, Winston Churchill cautioned against excessive optimism. “This is not the end,” he said. “It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” <a name='more'></a></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">The American public should regard the Dodd-Frank financial regulation bill rather as Churchill regarded Rommel’s defeat in <st1:country-region st="on"><st1:place st="on"><st1:country-region st="on"><st1:place st="on">Egypt</st1:place></st1:country-region></st1:place></st1:country-region> – as an encouraging sign of progress but as by no means guaranteeing that Wall Street will eventually serve the interests of the nation as a whole. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">The new law gives a network of new regulatory agencies greater discretionary powers over financial firms but it does not fundamentally alter the structure of the banking industry. There can be no guarantee that supervisors will possess the expertise or will to exercise their discretion wisely. Nor can we be certain they will be capable of predicting future crises soon enough to impose precautionary measures, such as increased capital requirements. Life looks set to continue pretty much as usual on Wall Street.<u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Dodd-Frank admittedly breaks new ground in several ways. It purports to solve the “Too Big To Fail” problem by creating an “orderly liquidation authority” which can seize failing banks, force creditors to accept losses and meet shortfalls with a retrospective levy on financial firms, rather than taxpayers. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">The new Financial Stability Oversight Council, chaired by the Treasury Secretary, will bring together the heads of the main regulatory agencies. The hope is that if information is pooled regulators will have a better chance of identifying emerging systemic risks. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">In addition Dodd-Frank will ban some proprietary trading by banks (but how much is not yet clear), It will oblige banks to spin off about a third of their derivatives business; standardised, but not exotic, derivatives will have to be traded on exchanges. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">The bill also creates a Consumer Financial Protection Agency to regulate the sale of mortgages and other financial products to consumers. In theory such an agency could reduce the information asymmetry that places such power in the hands of financial firms. But whether it does will depend on how it is led. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Dodd-Frank seeks higher capital requirements for banks but leaves the details blank because the <st1:country-region st="on"><st1:place st="on"><st1:country-region st="on"><st1:place st="on">US</st1:place></st1:country-region></st1:place></st1:country-region> is waiting for the outcome of international negotiations under the auspices of the Basel Committee on Banking Supervision (“Basel III”). The <st1:place st="on"><st1:city st="on"><st1:city st="on"><st1:place st="on">Basel</st1:place></st1:city></st1:city></st1:place> group has proposed counter-cyclical capital requirements –i.e. that banks strengthen their balance sheets during the boom phase of the business cycle so as to prepare themselves for the bust phase. But banks are already lobbying hard against the mooted <st1:city st="on"><st1:place st="on"><st1:city st="on"><st1:place st="on">Basel</st1:place></st1:city></st1:place></st1:city> reforms. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Dodd-Frank’s general philosophy (which reflects that of the Obama administration) is that the present structure of financial markets is basically sound. All will be well so long as a range of supervisory mechanisms is tightened up, and so long as modest restraints are placed on the most risky activities of the very large interconnected financial institutions – those that hitherto have been regarded as Too Big To Fail. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Although Dodd-Frank may represent the limits of the politically possible, even for a Democratic administration that controls both houses of Congress, it is fair to ask whether it is sufficiently radical. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Just consider what has happened. The financial industry extracted rent from the <st1:country-region st="on"><st1:place st="on"><st1:country-region st="on"><st1:place st="on">US</st1:place></st1:country-region></st1:place></st1:country-region> economy on a massive scale over several decades: the Financial Times estimates that financial sector profits rose 800 per cent in real terms between 1980 and 2005 against 250 per cent for non-financial firms. As a result of greedily agreeing risky contracts they did not understand, the largest banks around the world then succeeded in collectively bankrupting themselves. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Taxpayers rescued them at enormous expense – in many countries debt to GDP has doubled as a result of the bailouts. Meanwhile the financial turmoil caused the worst global recession since the 1930s. Although bankers’ bonuses are again at record highs, scores of millions of workers remain jobless. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Given the scale of the financial sector’s failure, on might have hoped for tougher action. Both equity and efficiency demand it. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">In the 1930s, the Glass-Steagall Act did not content itself with promises of vague future controls on some proprietary trading. It made financial firms choose irrevocably between commercial and investment banking, and it forcibly broke up the House of Morgan. Top bankers were not just summoned to testify before Congress; they went to jail. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">By contrast Dodd-Frank is imposing reforms that are expected to cut profits at Goldman Sachs and J P Morgan by just 9 per cent – and that will be temporary because their armies of lawyers will soon find loopholes in the legislation.<u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">The biggest weakness of Dodd-Frank is its pervasive reliance on unspecified discretionary interventions by regulators. History suggests regulators tend to internalise the assumptions of those they regulate. For instance, even if regulators have the power to impose significantly higher capital requirements during apparently good times, will they in fact do so? In practice they will do so only if they predict future trends better than financial firms <i><span style="FONT-STYLE: italic">and</span></i> if they have the support of their political masters. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Neither condition can be guaranteed. Banks are very effective lobbyists and will argue that more capital means higher borrowing costs for consumers. And suppose there is a Republican administration. Will regulators with a free market ideology use their discretion to impose tough restraints on top financial firms? <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Similar considerations apply to other aspects of the legislation. Suppose Citigroup gets into difficulties again. Can we be sure that regulators will use the new liquidation machinery? Will they seize its assets, impose heavy losses on creditors and wind it up, and then seek billions in compensation from financial firms that were well managed? <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Again it depends on political will. In practice a future administration will worry about contagion effects if it imposes losses on Citigroup’s creditors. And given that the White House was not willing to let General Motors fail would it really be willing to wave goodbye to a financial titan? Might not critics argue that Citigroup must be saved on national competitiveness grounds? After all, they will say, the German government would always rescue Deutsche Bank just as the Swiss would always rescue UBS? <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">The inescapable conclusion is that more radical restructuring is required. There is nothing special enough about financial transactions to justify the enormous salaries and bonuses on Wall Street and other financial centres. Adair Turner, chairman of the British Financial Services Authority (and a career investment banker), has said publicly that much financial activity is socially useless and exists only because it is highly profitable for those in the industry. He thinks finance should shrink as a share of GDP. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">The sector is also riddled with competitive distortions: chronic informational asymmetries; externalities and spill-over effects that create systemic risk; and reputational effects that prevent small entrants gaining market share. This is why remuneration is so out of line. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Financial services are oligopolistic rather than competitive, and the sector is dominated by very large conglomerates that are probably economically inefficient. There was no particular logic, for instance, in the bundling together of Citicorp (a retail bank), Salomon Brothers (an investment bank), Smith Barney (a brokerage) and Travelers (an insurance company) to create the gargantuan Citigroup – an institution that proved utterly dysfunctional in 2007/08. If it were not for the distortions of deposit insurance and the Too Big To Fail policy, each of these functions could be better performed by a specialist firm. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">Dodd-Frank is better than nothing. But what is needed now is a fundamental re-examination of the grounds rules of finance. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">In <st1:country-region st="on"><st1:place st="on"><st1:country-region st="on"><st1:place st="on">Britain</st1:place></st1:country-region></st1:place></st1:country-region>, the coalition government has established a high-powered Commission on Banking to undertake just such a radical analysis. It will consider proposals such as “narrow banking” under which the utility and casino aspects of banking are firmly separated, and “limited purpose banking” under which banks are effectively turned into mutual funds and prevented from gambling with their depositors’ money. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black"><u1:p> </u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;font-size:180%;color:black;"><span style="FONT-SIZE: 16pt; COLOR: black">The Obama administration should consider establishing a similar commission – with two crucial provisos. The majority of members should be independent of the financial services industry, and perhaps even of the present central banking/regulatory community. And they should be charged with restructuring banking so as to ensure it serves the public interest. The present goal of preserving “financial stability” is far from adequate. <u1:p></u1:p></span></span><span style="color:black;"><span style="COLOR: black"><o:p></o:p></span></span></p></div>Miranda Sturgishttp://www.blogger.com/profile/18182666149835587134noreply@blogger.com0tag:blogger.com,1999:blog-7953806441345973877.post-73092529736145158352010-07-15T14:48:00.003-04:002010-07-15T14:52:17.749-04:00Why the governance rules of the Financial Stability Board will not satisfy any true democrat<p class="MsoNormal"><span class="Apple-style-span" style="font-family:'Times New Roman';"><span class="Apple-style-span" style="font-size: medium;">By Michael Prowse, Senior Visiting Fellow</span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">Plato would have supported the Financial Stability Board (FSB) because he believed in rule by benevolent “Guardians”. He rejected democracy partly on the grounds that only an elite of knowledgeable experts can be trusted to make the “right” decisions for the rest of us. </span><a name='more'></a></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">If ever there was a sphere in which Plato’s principles might seem to apply, it would be financial markets. During the recent financial meltdown, we learned that boards of directors did not understand the derivatives and other complex products their traders were selling. In fact, it transpired that most of the traders did not understand them either. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">Should we, then, leave the task of regulating global financial markets to a body such as the FSB - a self-appointed committee of “experts” from leading financial centres – or should we place our faith instead in democratic principles and argue that all those affected by its decisions (the poorest as well as the richest nations) deserve representation at its table? <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">The answer matters: after the G20 itself, the FSB is the most significant innovation in global financial governance in decades. For the first time, the largest financial powers have a permanent mechanism for researching, debating and designing a regulatory structure for financial markets around the world. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">There is no doubt that a global economy needs common financial rules. If capital, people, and firms are free to move anywhere, different regulatory regimes imply “regulatory arbitrage”. Competition will be anything but fair and efficient because profit seeking firms locate subsidiaries wherever regulation is lightest (</span><st1:city st="on"><st1:city st="on"><span class="Apple-style-span" style="font-size: medium;">London</span></st1:city></st1:city><span class="Apple-style-span" style="font-size: medium;"> grew rapidly as a financial centre in the 1970s as </span><st1:country-region st="on"><st1:place st="on"><st1:country-region st="on"><st1:place st="on"><span class="Apple-style-span" style="font-size: medium;">US</span></st1:place></st1:country-region></st1:place></st1:country-region><span class="Apple-style-span" style="font-size: medium;"> banks moved offshore to escape onerous domestic regulations). The FSB’s attempt to take a global rather than national perspective thus makes a great deal of sense. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">The FSB’s members are the central banks, finance ministries and financial market regulators (where these exist and matter) of the G 20 nations plus those of </span><st1:country-region st="on"><st1:country-region st="on"><span class="Apple-style-span" style="font-size: medium;">Switzerland</span></st1:country-region></st1:country-region><span class="Apple-style-span" style="font-size: medium;">, </span><st1:city st="on"><st1:city st="on"><span class="Apple-style-span" style="font-size: medium;">Hong Kong</span></st1:city></st1:city><span class="Apple-style-span" style="font-size: medium;">, </span><st1:country-region st="on"><st1:country-region st="on"><span class="Apple-style-span" style="font-size: medium;">Singapore</span></st1:country-region></st1:country-region><span class="Apple-style-span" style="font-size: medium;">, </span><st1:country-region st="on"><st1:country-region st="on"><span class="Apple-style-span" style="font-size: medium;">Spain</span></st1:country-region></st1:country-region><span class="Apple-style-span" style="font-size: medium;"> and the </span><st1:country-region st="on"><st1:place st="on"><st1:country-region st="on"><st1:place st="on"><span class="Apple-style-span" style="font-size: medium;">Netherlands</span></st1:place></st1:country-region></st1:place></st1:country-region><span class="Apple-style-span" style="font-size: medium;">. Other members are trans-national institutions with financial responsibilities, including the IMF, World Bank, Bank for International Settlements (which houses the FSB), Basel Committee on Banking Supervision, and the European Commission. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">The G 20 established the FSB last year as a successor body to the Financial Stability Forum. Its mandate is to assess the vulnerabilities affecting the global financial system and to identify the regulatory actions needed to address them. According to its charter, its primary goal is to promote financial stability and a level playing field for financial institutions. To this end it hopes to coordinate policy actions across different jurisdictions and sectors. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">This bringing together of top regulatory minds is much to be applauded. Yet if the FSB is intended as a permanent addition to the global financial infrastructure, its governance and goals leave much to be desired. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">The first question to ask is whether such a body is sufficiently representative of a diverse global economy. Some will say the number of participants must be limited or serious debate will be impossible. In practice, the G 20 plus five extra nations provides sufficient breadth to ensure that the interests of all nations are taken into account. Moreover, in a sphere as complex as global finance, democratic niceties are irrelevant: what matters is whether the reforms are coherent and improve the functioning of financial markets. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">And to clinch this argument the FSB’s backers will remind critics that it is only an advisory body. Having no legal standing or powers of enforcement, its role is merely to make recommendations to the G 20 and other international bodies. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">At </span><st1:city st="on"><st1:place st="on"><st1:city st="on"><st1:place st="on"><span class="Apple-style-span" style="font-size: medium;">Toronto</span></st1:place></st1:city></st1:place></st1:city><span class="Apple-style-span" style="font-size: medium;">, for instance, the FSB submitted an interim report on the regulation of systemically important financial institutions – firms such as Goldman Sachs and J P Morgan. It sought the G20’s approval of the general thrust of its work programme. The FSB, therefore, can tell those worrying about democratic deficits that it is answerable to a higher authority: the G 20. If there are any worries about democratic deficits they should be addressed to the G 20, rather than to a group of experts charged with doing its spade work. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">The thrust of this argument is that so long as nation states are democracies, their citizens can overturn the decisions of unrepresentative international bodies. Lack of democracy at the trans-national level does not necessarily impair democracy at lower levels. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">This is a seductive but false argument. Nations cannot opt out of the global economy. If a group of the most powerful nations agrees on certain financial rules and institutions, smaller nations will have little choice but to accept them. If the smaller, poorer nations are to exert any influence, they need a voice at an earlier stage – when the proposed new rules and structures are being debated and designed. In the financial context that means they need a place at the FSB’s table. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">To say that the G 20 plus an extra five nations is sufficiently representative will not do. Few, for instance, would deny that </span><st1:place st="on"><st1:country-region st="on"><st1:country-region st="on"><st1:place st="on"><span class="Apple-style-span" style="font-size: medium;">Greece</span></st1:place></st1:country-region></st1:country-region></st1:place><span class="Apple-style-span" style="font-size: medium;"> has an interest in financial stability. Yet it has no voice in FSB proceedings. Nor do nations as diverse as </span><st1:country-region st="on"><st1:country-region st="on"><span class="Apple-style-span" style="font-size: medium;">Poland</span></st1:country-region></st1:country-region><span class="Apple-style-span" style="font-size: medium;">, </span><st1:country-region st="on"><st1:country-region st="on"><span class="Apple-style-span" style="font-size: medium;">Ireland</span></st1:country-region></st1:country-region><span class="Apple-style-span" style="font-size: medium;">, </span><st1:country-region st="on"><st1:country-region st="on"><span class="Apple-style-span" style="font-size: medium;">Venezuela</span></st1:country-region></st1:country-region><span class="Apple-style-span" style="font-size: medium;"> and </span><st1:country-region st="on"><st1:place st="on"><st1:country-region st="on"><st1:place st="on"><span class="Apple-style-span" style="font-size: medium;">Nigeria</span></st1:place></st1:country-region></st1:place></st1:country-region><span class="Apple-style-span" style="font-size: medium;">, let alone scores of poorer nations. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">The FSB’s charter calmly asserts that its “Plenary” (at which its members take decisions) will decide whether or not to admit other jurisdictions. Is it acceptable that a self-appointed club of nations can decide unilaterally whether any other jurisdictions can have a say in financial decisions which will affect the entire global economy?<u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">Regrettably, we do not today have any widely shared sound principles of global economic governance. We do not agree how to represent different national interests. For instance, there is no agreement on what weight to allocate to population, or to gross domestic product or to a range of other factors. The G 20 is itself an unrepresentative and self-appointed group of nations. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">The IMF’s governance structure is far from ideal but it at least attempts coherently to represent the interests of 182 nations. Through the quota system (now under review) nations have decision-making power that is loosely linked to various economic criteria. In order to avoid the problem of having too many seats at the table for serious debate, many of its 24 executive directors represent groups of smaller nations. At the very least the FSB should adopt a governance structure as representative as the IMF’s. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">A further unresolved problem has to do with the goals of international financial institutions. Bankers and regulators believe the FSB should have the narrow mandate of promoting financial stability, and doubtless support the nature of the demands placed on its members: that they commit themselves to financial transparency, acceptance of international regulatory standards and periodic peer review. Bodies such as the World Bank, they will argue, can be left to pursue other laudable goals such as economic development and poverty relief. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">Yet since financial markets have so powerful an influence on economic growth and the distribution of its rewards, there is a case for widening the goals of a body such as the FSB. Financial stability alone is barely credible as a goal. Stability for what? Stability can be consistent with all manner of inefficient and unjust economic structures. <u1:p></u1:p></span></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><u1:p><span class="Apple-style-span" style="font-size: medium;"> </span></u1:p></span></span><span style="color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;"><o:p></o:p></span></span></span></p> <p class="MsoNormal"><span style="font-family:Times New Roman;color:black;"><span style="color:black;"><span class="Apple-style-span" style="font-size: medium;">The FSB should be charged with promoting financial stability but subject to a proviso – that in creating new rules and regulatory standards for financial markets it must also seek to promote sustainable growth and a more equitable global economy. It needs to focus on ethical ends as well as technocratic means.</span><u1:p></u1:p></span></span><span style="color:black;"><span style="color:black;"><o:p></o:p></span></span></p>Miranda Sturgishttp://www.blogger.com/profile/18182666149835587134noreply@blogger.com1tag:blogger.com,1999:blog-7953806441345973877.post-24220576976996455752010-07-07T13:31:00.001-04:002010-07-08T13:35:02.953-04:00Moises Schwartz makes the IMF’s critics an offer they should not refuseBy Michael Prowse, Senior Visiting Fellow<br /><br />Moises Schwartz, the new director of the IMF’s Independent Evaluation Office (IEO), is reaching out to the Fund’s critics. At a briefing at New Rules last week he urged the non-governmental sector to propose topics for investigation. As Mr Schwartz is drawing up a work programme to present to the IMF’s Executive Board this is an opportunity that should be grasped.<a name='more'></a><br /><br />The IEO was established in 2001 to conduct “independent and objective” evaluations of Fund policies and activities. It operates at arm-length from the IMF’s Board and is fully independent of Fund management.<br /><br />Non-governmental organisations ought to make suggestions because the IEO exists in part due to the pressure they exerted in the late 1990s. See for instance “Policing the Policeman – the Case for an Independent Evaluation Mechanism for the IMF” by Angela Wood and Carol Welch of the Bretton Woods Project and Friends of the Earth, US, April 1998.<br /><br />Mr Schwartz takes up the post after serving as president of Mexico’s National Commission for Retirement Savings. He held many senior positions in Mexico’s central bank and finance ministry and is a former IMF executive director for Mexico and a group of other Spanish speaking nations. After decades as a top financial official, Mr Schwartz will need to work hard to convince sceptics that he does not share the prejudices and presumptions of those he is supposed to be monitoring – that he brings a genuinely open mind to his difficult task.<br /><br />In discussing the two projects he has inherited from his predecessor, Mr Thomas Bernes, his tone was decidedly balanced. The first is an evaluation of the IMF’s research effort. Mr Schwartz says the research department’s work is often excessively academic, not focused on the practical issues confronting the Fund and member countries. A further problem is that the operational departments have little or no say in the research department’s priorities. Nor do executive directors exert much influence. An external assessment conducted a decade ago - the Mishkin report – also concluded that the Fund’s research was insufficiently relevant to policy issues but it failed to bring about the required cultural and institutional changes.<br /><br />The second inherited project is an evaluation of the Fund’s performance in the years running up to the global financial crisis – 2004-2007. Did it provide sufficient advance warning? Were its warnings heeded? Again Mr Schwartz does not pull his punches. The Fund’s task is to prevent economic crises or, if this isn’t possible, at least to give early warning of emerging problems. He suggests the Fund failed in two different ways.<br /><br />The primary failure was that it did not connect the dots. It failed to give adequate warning of impending problems because it just did not anticipate the magnitude of the crisis. This was partly because its economists have traditionally regarded the financial system as of secondary importance. Fund staff did not know enough about derivatives, credit default swaps and so forth to evaluate the dangers. Although officials scattered across departments had concerns about different aspects of the emerging crisis, it seems there was no mechanism for centralising and analysing this data.<br /><br />The secondary failure is that the Fund tends to be most effective in its interactions with small low-income countries. A recent IEO evaluation noted “continuing strategic dissonance with large advanced countries about the Fund’s role”. Many large countries regard the surveillance process “as lacking value and/or even-handedness”.<br /><br />IMF officials can be diffident if not subservient when dealing with major shareholders such as the US. Thus even if senior staff had doubts about the stability of US financial markets, they probably would not have challenged the policies of Alan Greenspan (then Fed chairman) and other top US officials. In the same way even if junior Fund staff had doubts, they probably would have kept quiet rather than question the decisions of their superiors.<br /><br />So what are Mr Schwartz’s plans for future evaluations? Which of the Fund’s activities does he think are most in need of objective scrutiny?<br /><br />Broadly speaking, the IEO has two major fields for investigation: the effectiveness or otherwise of the Fund’s various policies; and the effectiveness or otherwise of its governance and relations with other key institutions. He is considering evaluations in both these fields.<br /><br />As regards Fund policies, surveillance is back on the agenda even though it was the subject of a previous IEO report. This reflects its centrality to the Fund’s mission: if surveillance had worked, the 2007-09 crisis would not have occurred. He is also looking at various design and technical issues: why, for instance is the Fund’s advice on inflation not even-handed (it tends to take a tougher line with smaller countries)?<br /><br />As regards Fund structure and external relations, he is considering evaluations of its internal governance and of its relations with external stake-holders, such as the World Bank and civil society. Why, he asks, is the Fund so often stigmatised – blamed for the implementation of harsh policies even when other institutions take a larger role, as for instance in Greece?<br /><br />In a previous study of Fund governance (2008), the IEO was highly critical of the role of the Board of executive directors – the body to which it is answerable. At New Rules, Mr Schwartz appeared sympathetic to suggestions that it should now scrutinise the structure of the Fund’s internal management. At present the various departments report to a very lean senior management team: the managing director and his three deputies. One shortcoming of this tight hierarchical structure is that horizontal relationships between departments are weak. This structure may partly explain why the Fund failed to join the dots and predict the 2007-09 crisis.<br /><br />Since Mr Schwartz’s is seeking suggestions for future evaluations, here are a few possibilities.<br /><br />First, the IEO could usefully assess the Fund’s performance as a development institution. Although the Fund intends its crisis support for low-income countries to be strictly temporary, in practice its interventions are often prolonged. This means that macroeconomic stability cannot be its only goal. It must also seek to promote equitable and sustainable development. How do its programmes measure up by these criteria?<br /><br />Second, it is ironic that the Fund (at the behest of member states) engaged in a brutal downsizing programme in 2007/08 just as the worst economic and financial crisis since the 1930s was brewing. The IEO should evaluate the reasoning behind this downsizing exercise. Did those responsible reflect sufficiently on the implications of economic cycles? The demands on the Fund will always fluctuate over time, but expertise and experience cannot be built up quickly in response to each new crisis.<br /><br />Third, Mr Schwartz should examine the Fund’s staffing policy. Traditionally it has hired PhD economists most of whom possess a rather narrow set of macroeconomic skills. Many of the Fund’s tasks require different backgrounds – the crisis revealed the shortage of senior staff with expertise in finance. But the problem runs deeper. The Fund needs generalists with negotiating rather than technical skills, and it needs staff with government and civil society experience and with qualifications in other social sciences. It also needs to have far more women in senior positions.<br /><br />NGOs and civil society groups should take Mr Schwartz at his word and put forward proposals for evaluations. He is likely to take any coherent suggestion seriously. Although he must submit a list of proposals to the Fund’s executive directors, he will make the final decision on the IEO’s work programme.<br /><br />It also is worth reflecting that governance and policy issues are intimately linked, as the current debate over quotas illustrates. What the Fund chooses to do in the field, and how it satisfies its mandate, will depend on the nature of its staff and the way it is organised internally. Proposals on governance reform could thus be just as significant as proposals for the evaluation of policies.Jamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.com0tag:blogger.com,1999:blog-7953806441345973877.post-79950873185897526072010-07-06T09:53:00.003-04:002010-07-06T13:43:21.657-04:00Korea's opportunity: the G20's Seoul summit is shaping up to be the most significant since London, 2009By Michael Prowse, Senior Visiting Fellow<br /><br />Toronto was just a holding operation for the G20. Amid signs of flagging growth in many countries, the assembled leaders agreed to disagree on the need for further fiscal stimulus. All the other important decisions – for instance on bank capital requirements, on IMF reform, on the broader financial regulation agenda, on the European sovereign debt crisis, and on what to do if the world economy does sink back into recession – were postponed until the Seoul meeting. <a name='more'></a><br /><br />This puts a heavy responsibility on South Korea, the host for the November summit – as Il SaKong, who is leading Seoul’s preparations, admitted at a briefing this week at the Peterson Institute for International Economics in Washington. Mr SaKong said he lost count in Toronto of the number of times decisions were postponed until November.<br /><br />Korea is determined not just to broker agreements on the key issues unresolved in Canada but also to introduce a “new agenda” that is of special relevance to emerging and developing nations. The main items here are how to promote economic development in poorer countries and how to protect emerging nations from capital volatility.<br /><br />Whether by luck or judgment, the G20 has picked the right nation to chair its next summit. If this steering committee for the global economy was to retain any credibility, it was essential that an Asian, and non G 7, nation take up the baton. Korea is ideally placed to serve as a bridge between industrialised and developing nations, and between east and west.<br /><br />The IMF classifies it as an advanced economy, but its per capita income is only about $20,000 a year which places it midway between the rich and poor nations. It has deep knowledge of both the US, its principal military ally, and of China, its principal trading partner.<br /><br />Politicians, pundits and the public have welcomed the G20’s emergence as the premier forum for debating global economic cooperation. Yet although the G20 is a much more representative body than the G7 or G8, it has so far focused almost entirely on the problems confronting advanced nations as a result of the meltdown of their financial systems.<br /><br />The old industrialised nations have invited others to their table but rather rudely are still monopolising the conversation. To some degree this is inevitable since most of the world’s leading banks are located in the US or Europe. If fire-fighters are to be effective they must initially focus their attention on the places where the fire is burning most fiercely.<br /><br />In order to inaugurate a new era of more enlightened global governance, the G 20 now needs to evolve in two complementary ways. It must adopt a longer time horizon and become more than a financial fire-fighter – in Fred Bergsten’s words it must become a “systemic manager” of the world economy. Equally important it must begin to address the diverse needs of a much broader range of nations. Its obligations extend not just to the developing and emerging nations that are members of the forum but also to the 172 nations that are not invited to its semi-annual meetings.<br /><br />Korea’s historic task at the G20’s summit in Seoul this November is to ensure that it does evolve in these desirable directions. Its new development agenda is a step in the right direction. Mr SaKong is not willing to divulge much detail, but Korea will certainly not be advocating the techniques that helped it grow so fast in the 1980s (high tariff barriers to protect infant industries and bureaucratic direction of economic resources). Instead, Korea intends to promote a development model centred on “private sector capital investment and human resource development”.<br /><br />Korea’s strategy has a logical corollary. If capital-intensive development is to be feasible in emerging nations, the rich industrialised nations must save more, and become capital exporters rather than importers. In the case of the US this requires a significant adjustment of national priorities.<br /><br />Mr SaKong also wants the G20 to address what he rightly regards as a major obstacle to growth in the developing world: the fear of capital instability that has prompted many nations to accumulate huge dollar reserves. This year emerging and developing nations will hold an astounding $6.1 trillion dollars worth of reserves, mostly in dollar assets. That includes $3.4 trillion in developing Asia, $1.0 trillion in the Middle East and North Africa, $600 billion in Latin America and $450 billion in Russia.<br /><br />When capital can flow out of small open economies as fast as it flows into them, and when every financial centre is potentially subject to speculative attack, one can understand the motive for building up such war-chests. But rather than filling bank vaults with dollars, it would make more sense to spend them on educational, health, transport and communications infrastructure – the prerequisites of equitable and sustainable development.<br /><br />Korea’s solution is the establishment of “global financial safety nets”. Again Mr SaKong is not willing to provide any details. But Korea appears to want the G20 to replace informal and bilateral currency swaps between central banks with a permanent international framework of swaps.<br /><br />If individuals have access to bank overdraft facilities, they do not need to hold such large precautionary deposits. Something similar could be true of developing nations: if they were confident of financial support to tide them over temporary market-induced difficulties, they would not be tempted to build up such enormous foreign currency reserves.<br /><br />Korea expects to spend 30-40 per cent of the Seoul meeting on these new agenda items. But it recognises the bulk of its effort will be on the issues unresolved after Toronto. And here Korea is fortunate that the timing of events favours progress this November. The first Asian Summit may thus be rated an historic success, further enhancing the authority of the G20 as the premier forum for economic coordination.<br /><br />For instance, on macroeconomic cooperation, the process the IMF initiated of “mutual assessment” of policies by G20 members will be entering its second stage. At Seoul there should be detailed discussion of what policies individual countries should adopt so as to ensure balanced global growth.<br /><br />On reform of international institutions, the G20 appears resolved that the vexed question of reforming member countries’ “quotas” at the IMF will be finally settled at Seoul. At Pittsburgh the G20 agreed in principle on a 5 per cent shift towards developing and emerging economies, but deciding who gains and who concedes ground has proved contentious.<br /><br />Given the speed at which Asia is growing, this is unlikely to be the last adjustment giving emerging nations greater clout. Korea will also push for a transparent selection process for the heads of institutions such as the IMF, with merit rather than nationality being the primary criterion for appointment.<br /><br />On the crucial issue of bank capital reserves, the Basel committee of regulators in Switzerland should have finalised their proposals – “Basel III” - in time for an agreement at Seoul. The most contentious issue is likely to be the transition period permitted rather than the standards themselves. Banks are arguing that raising standards too quickly will only increase the cost of loans to customers and further impair the fragile recovery.<br /><br />Mr SaKong argues that the G20 has distinguished itself from other forums by adopting a strictly pragmatic approach to problems. The London summit, for instance, successfully averted global depression by agreeing on practical measures to boost growth.<br /><br />Korea aims to be similarly pragmatic this November and has little interest in discussing a grandiose new global architecture. Where Seoul may differ from previous summits will be in showing greater sensitivity to questions relating to the G20’s legitimacy as a steering mechanism for the world economy, and in seeking to widen the range of issues under discussion.<br /><br />But in promoting its development agenda, Korea will be focusing only on “win-win” strategies –those from which all G20 members stand to benefit. It will not be in the business of promoting the interests of some regions or classes of economy at the expense of others.Miranda Sturgishttp://www.blogger.com/profile/18182666149835587134noreply@blogger.com0tag:blogger.com,1999:blog-7953806441345973877.post-33454764847611137572010-06-29T17:08:00.000-04:002010-06-29T17:09:29.755-04:00Toronto, the ghost of Keynes and the future of the international monetary systemToronto, the ghost of Keynes and the future of the international monetary system<br /><br />By Michael Prowse<br /><br />If Lord Keynes were alive today how would he have reacted to last weekend’s G20 meeting in Toronto?<br /><br />Like President Obama, he would probably have accepted the consensus view that fiscal deficits should be halved by 2013, while worrying that too much fiscal consolidation too soon could derail the global recovery. He would also have accepted the logic of delaying the implementation of more stringent rules on bank capital until the recovery is better established. <a name='more'></a><br /> <br />But Keynes would have criticised the assembled leaders for failing seriously to address the longer-term needs of the world economy. He would have argued that the measures agreed in Toronto were unlikely to solve two of the most pressing problems: large and persistent current account imbalances; and the inadequate flow of capital to the developing and emerging economies. He would have been frankly astonished that the global financial infrastructure he helped construct at Bretton Woods in 1944 was still largely unreformed, even though the global economy now faces entirely different challenges.<br /><br />As Joseph Stiglitz, among other economists, has argued, there are strong grounds for believing the US’s large and persistent trade deficit primarily reflects design flaws in the global infrastructure rather than the unfair trade practices of other nations. That said the perverse policies of the US’s trading partners, such as China’s deliberate undervaluation of its exchange rate and Germany’s implicit protection of its home market, certainly do not help.<br /><br />The basic structural problem is that the US supplies the world’s primary reserve asset. Following the Asian crisis in the late 1990s, emerging and developing countries’ demand for reserve assets (i.e. dollars) exploded because these nations wanted to protect themselves from global financial instability so as to avoid ever becoming wards of the IMF again. China today has $2.3 trillion of reserves which makes it immune from any kind of speculative attack in financial markets. Most other Asian nations have impressive dollar war-chests.<br /><br />But if poor countries are to accumulate dollar assets, such as US Treasury bills, the US must be induced to supply them. If US imports persistently exceed US exports, it will run a large current account deficit. Since the balance of payments in aggregate must always balance, this implies a large capital account surplus.<br /><br />In other words the US must be a net borrower from other nations, i.e. a supplier of dollar assets. If in addition it runs a large budget deficit, there will be a ready supply of US Treasury bills, a particularly safe dollar asset.<br /><br />If the global demand for reserve assets, which is really a demand for national economic security, accounts for all or part of the US’s persistent current account imbalance, then efforts by particular trading partners to reduce their surpluses with the US are unlikely to resolve the problem. If the structure of the reserve asset system is the primary factor driving the US trade deficit, surpluses will just pop up somewhere else.<br /><br />As Keynes argued 70 odd years ago, an international monetary system needs an international reserve asset. Regrettably delegates at the original Bretton Woods conference rejected his proposal for just such a synthetic asset – the bancor. Keynes would have tackled the problem of imbalances directly: deficit countries needing to acquire additional bancors would pay interest on them, but so would surplus countries that held unnecessarily large stocks of the reserve asset.<br /><br />Under Keynes’s rules, Germany would have to compensate the rest of the world for sucking demand out of the global economy and depressing world growth.<br /><br />But if the case against relying on the dollar as a global reserve asset was strong in 1944, it is infinitely stronger today. According to IMF figures, developing and emerging economies now account for 46 per cent of global production against 54 per cent for advanced economies. Since Asia is expected to grow much faster than the US or EU, these shares will soon approach parity.<br /><br />The US now accounts for only 20.5 per cent of global output, while China and India combined are not far behind with a share of 17.5 per cent. The eurozone’s share is just 15.5 per cent.<br /><br />Yet at present, the dollar accounts for about 67 per cent of global reserves and the euro for perhaps 30 per cent. Given the US’s dwindling share of global output, dollar assets are not going to remain the overwhelmingly dominant component of global reserves for the indefinite future. <br /><br />History suggests that suppliers of sovereign reserve assets can lose their market share surprisingly quickly. In 1914 the principal reserve asset was the pound sterling. The US dollar was a purely domestic currency: US exporters sought trade credit from London in sterling. Yet a mere decade later, the dollar was indisputably the world’s leading reserve asset.<br /><br />Partly because of the historical record, economists differ on what to do about the dollar today. Barry Eichengreen of the University of California at Berkeley argues that policymakers should sit back and allow market forces to determine the distribution of global reserves. He argues that a tripolar global economy (the US, the EU and China being the three poles) will naturally produce a tripolar distribution of global reserve.<br /><br />As China’s financial system matures and as it lifts restrictions on the use of its currency, the renminbi will take its place alongside the dollar and euro as a reserve asset. The renminbi will eventually be strongly in demand as a reserve asset among the Asian nations that trade heavily with China.<br /><br />Yet although the renminbi’s use as a reserve asset looks probable, it is not likely in the near term. Other economists – such as Mr Stiglitz - have followed Keynes and argued for the deliberate creation of a synthetic global reserve asset. Perhaps surprisingly, Governor Zhou of the People’s Bank of China has enthusiastically endorsed this position. In a much discussed paper published ahead of the London G20 summit last year, Mr Zhou argued that the US would be unable to set the dollar’s value appropriately or reduce its trade deficit significantly until a “super sovereign reserve asset” replaced the dollar in the portfolios of central banks around the world.<br /><br />Perhaps tongue in cheek he advocated the issue of a global reserve asset by a trusted international institution subject to clear rules and with the objective of sustaining global economic and financial stability. It was imperative, he argued, that the supply of the global reserve asset be disconnected form the needs and policy agenda of any one nation.<br /><br />In purely theoretical terms, Mr Zhou’s arguments, which echo those of Mr Stiglitz, make a great deal of sense. There is an international institution capable of managing the issue of a global reserve asset – the IMF – although whether it is universally “trusted” is a moot point. And the IMF has already invented a synthetic quasi currency – the Special Drawing Right (SDR) – which it uses as a unit of account in its dealings with member states. Central banks already hold some SDRs as reserves and there are informal arrangements whereby SDR’s can be exchanged for “hard” currencies such as dollars or euros – either by the mutual agreement of countries or through the IMF formally asking a member state in surplus to buy SDRs from a member state wishing to sell.<br /><br />Mr Stiglitz has argued that future incremental demand for dollar reserves be satisfied by the issue of SDRs. This would remove upward pressure on the dollar, thus helping the US to achieve external balance, and adding to global demand. With a costless supply of reserves, emerging nations could adopt more expansionary policies without fearing loss of autonomy as a result of financial crises not of their making. At the London summit, the G20 agreed a new SDR issue worth $250bn. This was big by historical standards yet still brought the share of SDRs in total global reserves to only 4 per cent, hardly sufficient to make any discernible difference.<br /><br />There remains a strong case for further issues of SDRs both to boost global growth and to reduce the strain on the US. Other possible reforms, such as changing the SDR’s composition to better reflect the distribution of global output and allowing its use as “private” money rather than only in dealings between central banks, also ought to be discussed. In general, the G20 needs to show that it can think imaginatively about longer-term challenges as well as respond to short-term crises. Otherwise Lord Keynes is going to continue turning in his grave.Miranda Sturgishttp://www.blogger.com/profile/18182666149835587134noreply@blogger.com0tag:blogger.com,1999:blog-7953806441345973877.post-82472720598419306662010-06-23T17:55:00.002-04:002010-06-23T17:56:40.406-04:00Austerity versus growth: why can’t Europeans be more like Americans?By Michael Prowse<br /><br />Debate at this weekend’s G20 meeting in Toronto is likely to focus on the rift that has opened between the US and Europe on macroeconomic policy. The US view is that governments should spend now, so as to create jobs and sustain economic growth, and save later. The European view is that fiscal consolidation is the urgent priority: governments must spend less, now and in the future. <a name='more'></a><br /><br />The US had been preparing to criticise the policies of both the major surplus nations: China and Germany. But by dropping its formal dollar peg just ahead of the meeting, and announcing that the renminbi will be managed against a basket of currencies, China has deftly taken itself out of the line of fire. It has given away very little since it says it intends to keep its currency “basically stable” but attention has naturally shifted to Germany which has made no concessions. Far from loosening fiscal policy, as many US economists recommend, it is cutting spending. <br /><br />Germany cannot be accused of engineering the 14 per cent depreciation of the euro in recent months. But the euro’s weakness reflects the severity of the European sovereign debt crisis. And that crisis erupted in part because Germany refused to help Greece early this year when the cost of a bailout might have been quite modest. <br /><br />The upshot is that German exporters are benefiting mightily from Berlin’s reluctance to accept its obligations to its EU partners. The weaker euro, moreover, is throwing in doubt President Barrack Obama’s strategy for boosting US exports and closing the US’s current account deficit. <br /><br />In normal economic times, governments that wish to stimulate economies can opt to loosen either fiscal or monetary policy. Most economists would agree that fiscal consolidation – spending cuts and/or tax increases – is not necessarily undesirable when growth is weak, provided it is compensated for with aggressive monetary easing. So in normal times, the US would not be second-guessing the Europeans’ choice of policy instrument. <br /><br />The trouble is these are not normal times. The interest rates that central banks can manipulate directly are close to zero, and cannot be reduced significantly. Long-term bond yields are also very low. Hence there is very little scope for monetary easing. If countries tighten fiscal policy in these circumstances, the US argues, economic growth will falter. <br /><br />It is too much of a leap of faith to believe that private consumption or business investment will spontaneously expand to fill the gap. Indeed in a climate of austerity, businesses and consumers may tighten their belts as well, sending the global economy into another recession. American policymakers recall that premature belt-tightening in the late 1930s produced just such a second dip.<br /><br />So what is wrong with Europeans? Why cannot they understand this simple logic? Why are they so fixated on austerity?<br /><br />At a meeting this week of the German Marshall Fund in Washington, Mr Janusz Lewandowski, the Commissioner who oversees the EU budget, offered a partial answer. In each national capital, preserving or regaining the confidence of financial markets is the absolute priority. If financial stability is not secured, they fear markets will push up bond yields, making public debts unserviceable. For the time being, therefore, job creation and economic growth are of secondary importance.<br /><br />This week’s British budget illustrates just how deeply these fears are felt. The UK’s public sector deficit is about 11 per cent of GDP, not far short of Greece’s. The ratio of its public debt to GDP has more than doubled since 2007. Since the UK is not a member of the euro zone, sterling has acted as a safety value, depreciating sharply against dollar in recent months. Even so the Conservative-led coalition government announced the deepest cuts in spending – a 25 per cent reduction for almost all government departments over the next five years – since the early 1980s. <br /><br />Greece, Spain and Ireland had no choice but to introduce austerity measures. The UK had greater room for manoeuvre, but chose austerity in a bid to win the confidence of financial markets and forestall the kind of short-selling of government debt that toppled Greece. Germany, even though far less vulnerable than the UK, has also opted to cut spending sharply. <br /><br />There is a second reason why Europeans can’t act like Americans. Although the EU is an economic bloc of roughly the same size as the US, most member states have not yet outgrown the attitudes they acquired as small economies that were heavily dependent on export markets. <br /><br />Germany is an economic power-house today but, like its smaller partners, still regards the world market as something that exists independently of its own policies. The German government is anxious to sustain the competitiveness of its own exporters. But it still does not accept that its policies will strongly influence the outlook for European growth and that this in turn will strongly influence world growth. <br /><br />When Americans call on Europeans to adopt more expansionary policies they forget that eurozone member states are trapped in an unpleasant institutional transition. They are no longer independent economies with control over their own interest rates and currencies. But neither are they sufficiently integrated with each other to face financial markets as a united bloc. There is, for instance, a series of individual bond markets rather than an integrated euro bond market, backed by the combined tax-raising powers of the eurozone members. Such an integrated bond market would have depth and liquidity comparable with the US bond market, but as yet it remains a distant dream. <br /><br />If the dollar were to lose its position as the principal global reserve asset, American policy makers would better understand the pressures that a still fragmented Europe faces. If the US were obliged to borrow in euros and renminbi to finance its vast public sector debt, it would be more fearful of the reactions of financial markets. In such an imaginary world, dollar depreciation would really hurt because it would increase the cost of servicing American euro and renminbi debt. Rather than blithely urging fiscal expansion, the US might then be cutting public spending just as furiously as Britain or Germany.<br /><br />So what can be done? In Toronto, the G20 leaders need to discuss ways of sustaining the world economic recovery. There is no harm in warning of the dangers of austerity in Europe and in urging Germany to adopt more expansionary policies. But in the absence of evidence of an imminent double dip recession, it would be unrealistic to expect a vigorous response in nervous European capitals. <br /><br />The G 20 can also usefully push for further regulatory and institutional reform. Germany has taken a lead in banning naked short selling of securities – one of the practices that put the Greek government under intense strain. The G20 should continue to search for ways to ensure more responsible behaviour in financial markets. In addition, it should throw its weight behind those in Europe who are urging deeper economic integration. If Europe is to have the capacity to respond more rationally in future crises, it needs to complete its project of creating an economic and political union. <br /><br />The lesson of the Greek crisis is that a monetary union and fiscal free-for-all is a dangerous combination. The eurozone has to become a fiscal as well as a monetary union, or else disband itself. At a minimum, this requires central oversight of national budgets and automatic penalties for failing to meet deficit targets. If, in addition, the euro were to become a more significant global reserve asset, Europeans could begin to act with the confidence of a large economic player on the world stage. <br /><br />Who knows: they might even begin to act more like Americans and adopt a “spend now, save later” policy, regardless of the misgivings of financial markets.Jamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.com1tag:blogger.com,1999:blog-7953806441345973877.post-81070363254771331902010-06-18T12:36:00.006-04:002010-06-21T12:03:47.371-04:00The significance of leverage in financial crises: what Shakespeare can teach economists and regulatorsBy Michael Prowse<br /><br />Who remembers the interest rate that Shylock charged Antonio in the Merchant of Venice? Nobody – but everyone remembers the pound of flesh that was agreed as collateral.<br /><br />John Geanakoplos, the James Tobin professor of economics at Yale, argues – only half in jest – that Shakespeare had a better understanding of finance 400 years ago than do most regulators today. Shakespeare understood that most loan contracts involve negotiations over two variables, rather than one. The borrower must worry not just about the interest rate demanded but also about the collateral that he has to put up to get a loan at all. Sometimes the collateral demanded is far more significant than the interest rate – as in Antonio’s case. <a name='more'></a><br /><br />Mr Geanakoplos prefers to talk about leverage rather than collateral, but they describe the same phenomenon from different perspectives. When banks are confident, they lend a very high proportion of the purchase price of assets. Investors become extremely leveraged because margin requirements are low – in other words investors can purchase real or financial assets with very small down payments. Equivalently, not much collateral is demanded because the value of the assets that banks can repossess in the event of default only just exceeds their loans. <br /><br />It might seem that Mr Geanakoplos is saying nothing new. Isn’t everyone these days is worrying about collateral or leverage? One of the main goals of the financial legislation now being reconciled in Congress is to raise banks’ capital requirements. International bodies such as G20 and European Union are equally committed to this goal. In fact European banks are complaining bitterly about the large increases in capital proposed by the Basel Committee on Banking Supervision in Switzerland. But an increase in capital requirements is surely simply a demand that financial institutions become less leveraged. <br /><br />And in the UK, Sir Andrew Large, a former deputy governor of the Bank of England, appears to be thinking along similar lines as Mr Geanakoplos. In a paper published this week by the Centre for the Study of Financial Innovation, he addresses the problem of “systemic risk”. Hitherto regulators have focused on the risk at the level of individual financial institutions, but have mostly failed to consider the inter-linkages between the decisions of seemingly independent institutions. Sir Andrew proposes a “Systemic Risk Committee” housed in the Bank of England whose task would be to prevent the build up of systemic stress. The only plausible instrument, he suggests, is the control of leverage – understood in terms of capital ratios - because this is measurable and closely related to financial instability. <br /><br />But while there is broad agreement on the role that inadequate bank capital played in the recent financial crisis, Mr Geanakoplos’s theories are less well understood. As he explains in a recent Cowles Foundation Paper*, economists have for decades systematically ignored investors’ leverage – or the adequacy of the down payments they make on asset purchases. The Federal Reserve and other central banks work hard at regulating the interest rate because they assume this is the key variable influencing the demand and supply of credit. But they should also be actively managing the “leverage cycle”, because this plays a crucial, and partly independent, role in the development of financial crises. <br /><br />During the expansionary phase of business cycles, down payments on asset purchases typically decline sharply as banks allow their borrowers to become ever more leveraged. (At the same time banks lend ever higher multiples of their own capital.) For instance from 2000 to 2007 the required down payment for home purchase in the US fell from about 14 per cent to less than 3 per cent. Financial risk exploded because the value of banks’ collateral exceeded their loans by ever smaller amounts. And progressively less credit-worthy borrowers were sucked into the market. But by 2008, after the bubble had burst, the required down payment had shot back up to about 16 per cent. <br /><br />Leverage swings are far more violent for financial assets than for housing, which is why Wall Street suffered a melt down. In 2006, says Mr Geanakoplos, it would have been possible for just two individuals – Bill Gates and Warren Buffett – to buy the entire $2.5trillion portfolio of toxic mortgage securities. This is because leverage was so staggeringly high at the peak of the business cycle: to buy the assets they would have needed to make a down payment of only $150bn. By 2009 the value of the toxic mortgage securities had halved. But permissible leverage had plunged: any buyer would have had to put up virtually the entire sum in cash. <br /><br />Mr Geanakoplos concludes that central banks will never prevent financial crises by managing interest rates alone – because at crucial phases of the economic cycle fluctuations in permissible leverage are far more significant. The fact that interest rates are at their lowest levels in decades does not mean that house purchase is easy because scared banks are demanding much higher collateral rates. People cannot find the cash for the required down payments. But today’s caution is the result of imprudently high leverage before the bubble burst. <br /><br />To avoid – or mitigate – the severity of financial crises the Fed and other central banks need actively to manage leverage rates throughout the economic cycle. Indeed, the active management must occur during the ebullient phase: although regulators can always impose lower levels of leverage, they cannot demand higher leverage during bad times. You can force a financial institution to make less risky deals but you can hardly force it to make more risky deals, even if that is what is needed during fragile recovery periods. <br /><br />A debate is underway as to whether the Basel III capital requirements will cripple the current economic recovery. The Institution for International Finance (which represents the world’s top banks) argues that regulators’ timing is wrong. Higher capital ratios will raise the cost of credit for industry and consumers, reduce economic growth and raise unemployment. It reckons that global growth could be cut by 3 percentage points between now and 2015, resulting in the creation of 9 million fewer jobs than if no reforms were implemented. Growth in Europe would be cut more because it depends more heavily on bank credit than either the US or Japan. <br /><br />The IIF may well be exaggerating the risks. Yet although everyone accepts the need for higher capital ratios in the longer-term, experts disagree over how rapidly they should be built up while confidence remains fragile. If leverage is to be taken as seriously as interest rates as a source of financial instability, the main priority ought to be regulatory discretion. When economies are booming, and banks are getting over-confident, regulators must have the power to force banks to raise more capital, thereby strengthening their balances sheets for the inevitable downturn. <br /><br />Mr Geanakoplos, in any case, is not just talking about bank capital ratios. He is demanding a comprehensive oversight of leverage in financial markets, so as to prevent systemic crises that arise because individuals and firms buying assets with ludicrously insufficient down payments. He wants the Fed to collect data on leverage for different asset classes from a broad spectrum of investors, including hitherto secretive hedge funds. He wants the actual leverage permitted in market transactions – including for credit default swaps – to become as transparent and public as the data on interest rates. Once the Fed has data on margins (or leverage) for different asset classes and investors, it will finally be able to monitor the evolution of financial risk. <br /><br />Ultimately, however, transparent data will not be enough. The Fed and other central banks, he argues, need new powers to impose limits on leverage for different classes of security. This is a radical reform proposal but one that governments everywhere ought to take seriously. <br /><br />*Solving the Present Crisis and Managing the Leverage Cycle. Mr Geanakoplos presented similar arguments at a conference in Washington held last month by the Institute for International Economic Policy, George Washington University.Jamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.com1tag:blogger.com,1999:blog-7953806441345973877.post-51006868104235499172010-06-14T18:49:00.000-04:002010-06-16T16:38:39.680-04:00The G20 and global finance: 20 ministers in search of a policyBy Michael Prowse<br /><br />In Luigi Pirandello’s famous play there were six characters in search of an author. Each had a story to tell but as yet nobody to relate it. The situation in global finance today is somewhat similar: a rather larger number of presidents and finance ministers are just as desperate for a script. They have the best opportunity in decades to redraw the ground rules of international finance. But so far they have no long-term strategy worth talking about.<a name='more'></a><br /><br />The fact that the world’s advanced economies got themselves into such a mess in 2007-08 was in some respects a blessing for the developing world. Without a financial shock of this magnitude, the rich western nations would have continued to dominate international economic policy-making for years – if not decades – through paternalistic groupings such as the G7 and G8. In principle at least a more diverse and representative body of national leaders now take decisions that affect the global economy. <br /><br />The G20 represents about two thirds of the world’s population and 90 per cent of global production. But it fails to represent Africa or the Islamic world properly. And, as in nearly every international forum, Europe is grossly over-represented: there is a seat for the EU as well as for Germany, the UK, France, and Italy. But at least the big middle-income and emerging economies – Brazil, Mexico, South Korea, China, India and Indonesia, among others - now have a voice. There are also seats for the chairs of the International Monetary and Finance committee of the IMF (an Egyptian) and the Development Committee of the World Bank, thus formally linking the G20 with the major Bretton Woods institutions. <br /><br />At its first meetings in Washington and London, the revamped G20 responded impressively to the global crisis. It agreed to prevent any further failures of systemically important financial institutions, it agreed a massive fiscal stimulus – a policy that many economists believe enabled the world to avoid another Great Depression – and it agreed in principle to regulate banks, hedge funds and rating agencies more rigorously. <br /><br />The issue today is whether the G20 can provide effective leadership in more normal times. Was it simply the severity of the perceived challenge in the fall of 2008 that enabled global leaders to put the collective good ahead of national interest? Or was this just one of those rare occasions when everyone’s national interest coincided? <br /><br />Last week’s preparatory meeting of finance ministers in Busan, South Korea, indicates that it will be far harder to reach a consensus on policies when the world economy is expanding, however unevenly. And the long-term challenge for the G20 is orders of magnitude more difficult than agreeing a fiscal stimulus at a time of crisis. It is to design global rules and institutions that meet the needs of the second decade of the 21st century – and these needs bear little resemblance to those in the aftermath of World War II when the IMF and World Bank were created.<br /><br />In the Busan communiqué it was hard to detect any input from the representatives of middle income and emerging nations. The document reads just like a G7 communiqué, and one that is patching over significant differences of opinion. The finance ministers abandoned support for concerted fiscal stimulus, despite the US’s misgivings, and agreed that fiscally challenged members should “accelerate the pace of consolidation” even though inflation is out for the count everywhere. <br /><br />There is a strong theoretical case for a global levy on banks and financial institutions, so as to ensure they pay the costs of any future bailout rather than taxpayers. The US, EU and UK accept this logic. Yet the G20 finance ministers retreated from a global levy, declaring that individual countries could adopt whatever policies suited them in the light of their national circumstances. <br /><br />This was nothing short of an agreement not to cooperate – and it reflects the desire of national leaders to support their own banking industries regardless of what might be in the global public interest. Perhaps the G20 will demonstrate more backbone in Toronto when it comes to the detail of financial regulation, but don’t hold your breath. <br /><br />Regrettably, groups such as G20 have natural limitations. The involvement of national leaders from emerging economies in global economic management was a watershed in financial diplomacy. But this forum meets infrequently and lacks a permanent bureaucracy of any significance. National leaders have numerous domestic challenges and can devote only limited time to it. We can expect the G20 to respond to crises and perhaps provide broad strategic guidance, but it is not a body that can itself design a new global financial architecture.<br /><br />Global economic cooperation today is far more primitive than, say, European political and economic cooperation under the auspices of the decades-old European Union. But one can perhaps still draw loose analogies. The European counterpart of the G20 summits would be the European Council meetings of EU heads of state. These are highly influential in determining the EU’s longer term goals. But the EU could have achieved nothing substantive on the ground without the European Commission, its large and powerful civil service. <br /><br />For the purposes of global economic rule-making and enforcement, there is only one bureaucracy of any significance: the IMF. And if the IMF is judged not fit for purpose, it would make more sense to reform it than to create a duplicate body. It appears, therefore, that the G20’s chance of achieving serious reforms will depend on its ability to use the IMF as a bureaucratic means for achieving its ends. <br /><br />In press briefings at Busan, Dominique Strauss Kahn, the IMF’s managing director, indicated that the G20’s emergence as a global economic forum had greatly improved his chances of achieving meaningful economic cooperation. He predicted the leading economies were more likely to adopt mutually consistent policies – and to recognise the impact of their policies on other member states – than was the case in 2006 when the IMF’s attempts to promote global economic coordination failed. <br /><br />But until China agrees to substantial revaluation of the renminbi, the US lifts its domestic saving, and Germany and Japan deregulate internally and boost domestic consumption, Mr Strauss Kahn is voicing aspirations rather than reporting solid achievements. <br /><br />If the IMF – for want of any other comparable agency – must undertake the serious work of designing a new financial architecture, the emerging economies may discover their “equal status” with the advanced economies at the G20 table is of limited significance. What will matter more are their quotas and voting rights at the IMF itself. But these are based on economic criteria such as GDP rather than democratic criteria such as population. It is best therefore to view the G20 as just the first step in the construction of a less paternalist system of global economic governance.Jamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.com0tag:blogger.com,1999:blog-7953806441345973877.post-19190168269210327292010-06-09T13:41:00.000-04:002010-06-16T16:39:03.633-04:00Incomplete globalization, human nature and the problem of current account imbalancesBy Michael Prowse<br /><br />One of the striking aspects of today’s global economy is a distribution of external surpluses and deficits seriously at variance with what textbook theory leads us to expect.<br /><br />The advanced economies ought to be running current account surpluses and the emerging economies current account deficits. As the counterpart to their trade surpluses the rich nations ought to be lending to, and investing in, the poor developing world. Why? Because returns on investment ought to be much higher in regions of the world where capital is scarce and labour abundant. In effect, young workers in emerging economies ought to be paying the pensions of the ageing populations of the developed world. <a name='more'></a><br /><br />Regrettably this is not happening. China, the world’s largest emerging economy, is running a current account surplus of more than 6 per cent of GDP and, via the purchase of US Treasury bills, lending on a massive scale to the US, the world’s richest and most technologically advanced nation. The US, meanwhile, is running a current account deficit of more than 3 per cent of GDP, having borrowed from poorer countries consistently for the past three decades. <br /><br />China is not alone. According to IMF projections, all the emerging Asian economies are running significant surpluses this year, with the exception of India and Vietnam. Japan, of course, is running its usual big surplus. Australia and New Zealand, although richer and technologically more advanced than emerging Asia, are busily importing capital to support domestic consumption, just like the US.<br /><br />One might have hoped that the European Union would follow the textbook model, generate a significant current account surplus, and invest its excess funds in the developing world. Instead as a bloc it is roughly in balance externally. But this overall balance masks bizarre internal differences. Every northern European economy is running a current account surplus (led, of course, by Germany which the IMF expects to run a surplus of 5.5 per cent of GDP this year, second only to China’s as a proportion of output). The UK, France and all of southern Europe, meanwhile, are heavily in deficit. Frugal Europeans are exporting capital but mainly, it seems, to their spendthrift partners. <br /><br />Elsewhere common sense mostly rules. In the former Soviet Union, Latin America, the Middle East and Africa, energy exporters are mostly running external surpluses whereas energy importers are mostly running deficits.<br /><br />Should we worry about this strange pattern of current account surpluses and deficits? What causes these apparently irrational discrepancies? And if they do matter, how can we create a better balanced world economy?<br /><br />To illustrate the range of opinions, one need only consider the disagreements among commentators at the Financial Times. Martin Wolf takes imbalances very seriously. In a pair of intriguing recent articles he drew inspiration from one of Aesop’s fables. Germans and Asians, in his view, are akin to industrious ants whereas the Americans, British and southern Europeans are lazy grasshoppers. The ants cannot stop saving and lending. The grasshoppers cannot stop spending and borrowing. Each feeds on the weakness of the other. Eager lenders play into the hands of eager borrowers. Spenders need savers. But given the ingrained characters of ants and grasshoppers, Mr Wolf appears sceptical that anything much can be done to resolve the problem.<br /><br />In an implicit rebuke, the FT’s other main economic commentator, Samuel Brittan, argues that imbalances are a non-problem. Adopting a staunch laissez faire line, Sir Samuel argues that individuals and families should be free to spend or save as they please – provided, presumably, that they bear the consequences of their decisions. It does not matter particularly if the aggregate results of these individual decisions lead to high or low national savings, or to current account surpluses or deficits. The whole point of having banks, investment managers and international capital flows is to allow spending to diverge from saving.<br /> <br />My own view is that although readers will find much of value in the articles of both Mr Wolf and Sir Samuel, neither pundit is entirely on target. For my taste both adopt too individualistic an approach and overlook the importance of social rules and institutions. Sir Samuel argues that individuals should be free to save or spend, borrow or lend, as they please. Yet as he would be the first to acknowledge, economic decisions are always taken against a backdrop of rules that influences the outcome of those decisions. “Free” choices will have very different outcomes depending on the institutional backdrop. Does one endorse “free” spending and borrowing decisions subject to American rules or subject to Asian rules? It makes a big difference. <br /><br />For his part, Mr Wolf appears to exaggerate the intrinsic differences between individuals. There is only one kind of human being with one kind of nature – at least this is what many evolutionary biologists now believe. But humans faced with one set of economic rules, institutions and practices will tend to behave like ants whereas those faced with different set of background conditions will tend to behave like grasshoppers. Again the salient issue is not so much individual choice as institutional background. <br /><br />There are several ways to see that it is differences in national rules and institutions – itself a reflection of incomplete globalization of markets – that mostly produces the different behaviour. When individuals from all over the globe settle in the US, they tend over time to behave like Americans rather than like the compatriots they have left behind. This is because they respond rationally to new rules and opportunities. It is much easier for individuals to borrow to buy houses and cars and to finance lavish spending on imports and vacations in the US than it is in either Asia or Germany. So ants transmute into grasshoppers – or at least the children of ants do. <br /><br />Equally the notion that Anglo-Saxons have a greater appetite for risk than Germans or Asians is not necessarily valid. When Germans and Asians operate outside their national frontiers – when they are free of domestic restraints, whether formal or informal - they can be pretty aggressive. Look at the huge volume of risky loans German bankers extended to Greeks. The counterpart to every risky borrowing decision is a risky lending decision. Greed is just as much a factor of life in Asia and Germany as in the deficit nations; it is just exercised differently – mainly by business people, rather than consumers, and mainly in overseas, rather than domestic, markets. <br /><br />I think the current pattern of imbalances does matter, for two reasons. First, the flow of capital to emerging economies is almost certainly smaller than it would be if the institutional playing field were levelled in the rich developed world. The north-south divide is thus entrenched. Second, imbalances tend to generate financial instability – capital inflows into the US kept interest rates low and contributed to the sub-prime mortgage crisis while capital inflows into southern Europe helped cause the sovereign debt crisis. Unsustainable debt invariably results in severe recessions in which nearly everyone loses. <br /><br />How can the G20 reduce future imbalances? Part of the answer, according to finance ministers in Busan, lies in fiscal retrenchment by the profligate, as this should reduce the gap between domestic saving and domestic investment. But this is a risky strategy while the global economy remains so weak. Where possible, appreciation of surplus nations’ currencies relative to those of deficit nations would be helpful. But whereas the renimbi can rise relative to the dollar, no currency adjustments are feasible within the EU. <br /><br />Longer term, the answer lies in more complete globalization, by which I mean convergence of domestic economic rules and practices. It is not helpful to think of the global economy as a set of sovereign domestic economies linked by trade and investment. Rather there needs to be common rules of the economic game internally as well as externally. Thus mercantilist Asia and Germany need to introduce more liberal rules for domestic borrowing and spending – for instance make it easier for young people to buy homes, which will generate much spin off consumption. By contrast the market-oriented US and UK need to impose tougher borrowing rules for consumption and home purchase, and introduce tax and other policies that favour saving and production. As structural policies converge imbalances will shrink.Jamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.com0tag:blogger.com,1999:blog-7953806441345973877.post-81124084738268159122010-06-04T21:25:00.000-04:002010-06-16T16:43:15.967-04:00Soros, bad economic theory and the origins of the financial crisisBy Michael Prowse<br /><br />Writers of detective fiction typically waste little time describing the murder. They reserve their ingenuity for the part that grips their readers. Who did it and how? Once the shock of the ghastly event has worn off, the focus naturally shifts to causes and motives.<br /><br />It is much the same with the financial crisis of 2007-09. We are no longer so much interested in what happened as in why it happened. Who or what caused it? Broadly speaking there are four competing views. <a name='more'></a><br /><br />The first is that advanced by many of those responsible for financial policy in the years leading up to the crash. For instance, Alan Greenspan memorably described the crisis as a “once in a hundred years flood” – i.e. something unexpected and unpredictable against which the US could not sensibly have protected itself. It was just one of those financial bubbles that occur from time to time – a product of irrational exuberance for which nobody (except perhaps God in designing us poorly) was responsible. I think we can all agree this is a self-serving and implausible explanation. <br /><br />The second, and slightly more credible view, is that it was a product of human error. The global financial system was fundamentally sound. But unfortunately the present generation of bankers – unlike their parents and grandparents - was not up to the job. Greedy and incompetent, they foolishly leveraged themselves to the hilt in pursuit of implausibly high returns that ultimately proved a mirage. Governments then had to spend hundreds of billions of dollars bailing them out to prevent the financial meltdown destroying the global economy. <br /><br />Greed and selfishness obviously played a part. But as Max Weber, the sociologist, observed long ago these attributes of human nature are not a unique product of capitalism. They appear in one form or another in every human society. It is pointless to blame recessions or bubbles on the frailties of human psychology. When we design social rules and institutions we should make due allowance for the flaws in our nature, rather than pretend they do not exist. <br /><br />This brings us to the third possible explanation. Although bankers and traders behaved badly, the origins of the crisis lie in inadequate regulation. It was the public not private sector that erred most grievously because it failed to establish sensible rules of the game, even when the evidence indicated the existing rules were not working. <br /><br />Ross Levine of Brown University makes this case as plausibly as anyone in a recent paper for the Institute for International Economic Policy in Washington. Using his own analogies from crime fiction, he argues the financial crisis was a product of “negligent homicide” – culpable carelessness on the part of agencies such as the Federal Reserve and SEC - rather than an “accident” or “suicide”. Accident corresponds to the Greenspan view; suicide to the view that it was all a product of banker greed and incompetence.<br /><br />Levine’s thesis is that policymakers caused the crisis: it was not just something that happened to them. He cites specific examples of irresponsible regulatory policies. <br /><br />One is the way that the SEC created the monopoly power of the private ratings agencies and then relied uncritically on their assessments of creditworthiness. Thus it endowed only a few agencies with the status of “nationally recognised rating organisation”, allowed these agencies to sell their ratings to the issuers of securities, and proceeded itself to rely on these assessments when establishing capital requirements. Regulators around the world followed the SEC’s lead in creating a system riddled with conflicts of interest – conflicts that became deadly following the explosive growth of structured financial products.<br /><br />The Fed’s stance on credit default swaps was another gross regulatory failure. It allowed banks that bought CDSs to reduce their capital reserves on the grounds they had insured themselves against possible losses. This was unwise, argues Levine, because the Fed did not have reliable means of assessing the credit risks of those who sold CDSs to banks. As the CDS market grew exponentially, the systemic risks multiplied, yet the Fed failed to intervene. It aided and abetted regulatory arbitrage.<br /><br />A third example is the SEC’s amazingly light regulation of the major investment banks. It allowed them to use their own risk models for calculating capital levels – unsurprisingly leverage soared. It then opted to supervise them as consolidated entities, despite their immense complexity, and allocated only seven people to monitor the parent companies of investment banks that controlled over $4 trillion in assets. Levine notes the SEC failed to complete a single inspection of a major investment bank in the year and half before they all failed or had to be bailed out at public expense. <br /><br />Levine’s paper is a rewarding study of regulatory failure. But it begs one question: why did regulators adopt so lax a posture? Regulators everywhere were lax, not just in the US. <br /><br />We finally reach the fourth and most profound level of explanation of the financial crisis – the one that George Soros emphasises: bad theory. Governments, central banks and financial regulators adopted a laissez faire stance because they believed in the “magic of the market”. On the whole they accepted the free market ideology of the past few decades, including offshoots such as the efficient markets hypothesis and rational expectations theory. They did not want to intervene much, or impose many rules, because they regarded the market, rather than themselves, as the repository of wisdom. <br /><br />Private rating agencies would naturally be better at assessing credit risks than mere bureaucrats. Who could know more about capital requirements than bankers: if they said credit default swaps were reducing overall risk, mustn’t that be true? And why supervise Goldman Sachs in more than a token fashion: its executives were the brightest and best – the incarnation of the market spirit. How could they do wrong?<br /><br />Soros has a particular theory of what went wrong in modern economics – for a brief summary see his paper for the Institute for New Economic Thinking’s inaugural conference. Broadly, it is that economics modelled itself too closely on theoretical physics and thus sought to establish timelessly valid laws that can be used to explain and predict events. Hubristic practitioners thought they had proved that markets always tend towards equilibrium. And in financial markets “quants” – often literally refugee physicists – were certain they could quantify all risks by means of complex mathematical formulae.<br /><br />This is all mistaken, argues Soros, because the phenomena of economics are entirely different from those of natural science: how people think influences economic events in a way that has no parallel in the hard sciences. His doctrine of “reflexivity” merely holds that the beliefs people have about what will happen influences what does happen, and, conversely, what does happen influences what people think. <br /><br />But since thoughts are unpredictable and need not correspond to reality, there is no natural tendency towards equilibrium. False beliefs – say about the sustainability of house prices – can appear valid for long periods (if they are shared by others) and thus create bubbles. Eventually the gap between thought and reality will become evident but by then it may be too late to prevent disaster – as in 2007.<br /><br />Soros is right to stress the differences in the subject matter of economics and natural science although his point is hardly new: German philosophers and historians raised precisely this objection during the 19th century. It also seems likely that bankers would have behaved more prudently if they had realised that risk cannot be quantified in a mathematically precise fashion. The truth is that the future is radically unknowable - how would one quantify, say, the risk of 9/11 occurring?<br /><br />But Soros is wrong to equate “bad theory” with physics envy. Some of the most committed market fundamentalists – Friedrich Hayek and the “Austrian school” for instance – were sceptical of the use of mathematics in economics. George Stigler, one of the founders of the Chicago School, was not into quantification. Nor was Adam Smith or any of the classical economists. Yet they all believed in laissez faire doctrines. Conversely, Paul Samuelson – one of the principal architects of modern mathematical economics – was a committed Keynesian who rejected free market ideology. <br /><br />The truth is that bad theory is the ultimate cause of the financial crisis because it lay behind the poor decisions of both regulators and bankers. But the bad theory was simply the notion that unregulated markets are efficient and tend to produce optimal outcomes. Keynesians – whether mathematical or unmathematical - have been arguing this for decades.Jamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.com0tag:blogger.com,1999:blog-7953806441345973877.post-62559407706374277082010-06-02T12:42:00.000-04:002010-06-16T16:40:16.727-04:00EU financial regulation: Michel Barnier’s chance to outshine Tim Geithner and Larry SummersBy Michael Prowse<br /><br />Don’t worry: I don’t expect Michel Barnier, the top European financial regulator, to come up with startlingly bold proposals this summer – proposals that would prove his critics wrong. But there is little doubt that the EU could, if it chose, take a tougher line than the US Treasury against what it calls “systemically important financial institutions” (SIFIs) – the likes of Goldman Sachs, Citibank, J P Morgan, Barclays and UBS. <a name='more'></a><br /><br />The US has opted to rely on stricter supervision and higher capital requirements. Mr Barnier, in his recent speech to the European Institute in Washington, rightly noted that other options are possible: size limitations and/or prohibition of risky activities. If he advocated breaking up the biggest firms, he would win the enthusiastic backing of a large segment of the academic financial community in both the UK and US.<br /><br />Mr Barnier is at least well aware of the economic inter-dependence of the US and EU. Forget China: the trade and investment links between these two economically advanced blocs are the most significant on the planet. <br /><br />It follows that the US and EU have a huge incentive to coordinate reforms of their financial systems. They need to head off regulatory arbitrage (especially significant between New York and London) and level their portion of the global playing field even if the rest of the G20 fails to follow suit. Yet while the shape of the US’s regulatory response to the 2007-09 financial crisis is basically history (the final details await reconciliation of the House and Senate bills), the EU’s is still a work in progress. So what can we expect from Mr Barnier, the EU’s financial architect in chief? <br /><br />Bear in mind, first, that France’s former agriculture minister is not part of that nation’s technocratic elite and not regarded as a man of ideas. He is known instead as a good-natured pragmatist – someone more comfortable negotiating deals than juggling abstract arguments. He is not a great admirer of Anglo-American capitalism but neither is he particularly hostile to it. <br /><br />What is encouraging is that his personal skills give him as good a chance as anyone of building consensus among disparate European nations. And such skills are vital given the cultural, institutional and legal differences between British and Continental European financial capitalism. In any case what the world lacks is not so much ideas as the political will to confront the powerful banking lobby and implement reforms that are in the wider public interest. <br /><br />So far the EU has agreed a new supervisory framework for financial markets and some modest regulation of private rating agencies. The ratings firms will now have to register and adopt more transparent methodologies. Tougher action is needed: it is far from clear that rating should be a private sector activity at all, given the conflict of interests when those rated pay for their ratings and can shop around for the best deal. Mr Barnier has hinted at a new pan European rating agency for sovereign debt. If publicly run, this would be good idea. <br /><br />Meanwhile, new European Supervisory Agencies for banking, insurance and securities markets are to work in tandem with national authorities, and with a new European Systemic Risk Board. A transfer of regulatory functions from national capitals to Brussels is highly desirable and long overdue. But how these proposals will work on the ground remains unclear: London and Frankfurt in particular are accustomed to regulating themselves, and in different ways. <br /><br />Mr Barnier expects to reach final agreement shortly on long-standing proposals for regulating hedge funds and private equity but is anxious not to put European based firms at a disadvantage relative to their American counterparts. And he has just announced proposals for a tax on banks to ensure that financial companies rather than taxpayers bear the burden of any future banking crisis. London andParis immediately raised objections, which suggests Mr Barnier will not readily achieve his longer-term goal of an integrated European banking resolution framework. But the goal is right nonetheless. <br /><br />These relatively modest achievements aside, EU financial regulation is mostly a list of aspirations. <br /><br />On derivatives the EU is dragging its feet. Mr Barnier supports US-style reforms aimed at bringing transactions onto regulated exchanges so as to increase transparency and protect the interests of consumers and non-financial users. Legislative proposals are due this summer. I hope the European proposals are at least as tough as those being discussed in the US. <br /><br />On bank capital requirements, Mr Barnier also promises legislative proposals later this year. But he is cautious for two reasons. Given the fragility of the European economy he does not want to choke off recovery by announcing too stringent requirements. He is also waiting on the outcome of discussions still underway in Basel on the calibration of capital and liquidity standards, proposed new controls on leverage, and rules to link capital requirements with the state of the economic cycle. The Basel rules are a key element in the jigsaw and the proposed direct control on leverage is encouraging. <br /><br />Mr Barnier is also promising action to strength the corporate governance of financial companies on the grounds that crisis prevention “starts from within”. The UK authorities are taking a lead here: they want to shift power to shareholders (who failed to curb the abuses of senior management in 2007-09) by making all directors stand for re-election at every annual general meeting. <br /><br />On governance, the Anglo Saxons may have something to learn from the Continentals: why not give rank-and-file employees some influence too, by electing them to supervisory boards alongside representatives of shareholders? Most ordinary employees were appalled by the excesses of their senior management in the recent crisis, but were powerless to prevent their risky behaviour. <br /><br />And, finally, what of those “systemically important financial institutions” (SIFIs) – those large financial companies with a finger in most pies that national authorities regard as “too big to fail”? After irresponsible risk-taking at such firms helped cause the worst recession since the 1930s and precipitated the biggest ever taxpayer bailout, one might have expected a Democratic Administration and Congress to break up such firms. Most financial experts agree there is little economic logic behind such conglomerates. <br /><br />The task of regulators would certainly be easier if different firms undertook different tasks requiring different skills. And a larger number of smaller, more specialised firms would mean more competition, which would benefit consumers and non-financial firms. Yet in the event, the conservative Geithner-Summers approach seems to have prevailed: the US is relying largely on a combination of stricter supervision and higher capital requirements. It cannot be expected to work<br /><br />Mr Barnier should put the US Treasury to shame and take on the SIFIs. He should recognise that size limitations and restrictions on multi-functionality do make sense. As pundits on both sides of the Atlantic have stressed, banks that are too big to fail are simply too big. It won’t be an easy argument to sell in Continental Europe, home of the universal bank, and where one-stop financial shopping is a way of life. On the other hand powerful voices in Europe – Mervyn King, the Bank of England governor, for instance – do favour a tougher line than the US has yet embraced. <br /><br />If Mr Barnier were to take on the financial titans, he might influence the G20 and via the G20, the US. And there are precedents of a sort: the European Commission has always run an aggressive competition policy: it has never hesitated to take on the largest companies, including Microsoft, when it concludes that their way of doing business is contrary to the public interest. <br /><br />But since no nation wants to be at a competitive disadvantage, size and function limitations in the financial sector will have to be imposed globally or not at all. This is Mr Barnier’s big chance to show that he is a capable of bold innovative thinking. Regrettably, I don’t count on him breaking out of the box.Jamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.com0tag:blogger.com,1999:blog-7953806441345973877.post-79383415370782330292010-05-27T19:19:00.000-04:002010-06-16T16:43:26.596-04:00Europe cannot agree with itself, let alone the US on financial market reformBy Michael Prowse<br /><br />If Tim Geithner, US Treasury Secretary, did any blunt talking in Europe this week, it was strictly reserved for off-the-record meetings. In public he was as diplomatic as he was optimistic. He failed to chide Germany for not adopting more expansionary macroeconomic policies and claimed that the US and Europe are “in a very good position to reach agreement on a global framework to implement common rules for regulating financial institutions”.<a name='more'></a><br /><br />If this were true, we could all sit back and relax. But actual events suggest caution. In the first place, there is no such thing, yet, as a common European position on financial regulation, let alone an agreement between Europe and the US. <br /><br />Secondly, the White House and Congress have pressed ahead with legislative reform for Wall Street without paying much attention to the competitive distortions that will arise globally if Europe fails to enact similar reforms. Although the US Congress deserves credit for grappling with these complex issues while other legislatures sit on the sidelines, the debate in Washington is depressingly insular. As so often before, US law-makers are behaving as though globalization were a fiction and US financial markets were entirely insulated from similar markets elsewhere.<br /><br />There are good reasons why Europe has been unable to act as quickly as the US. The responsibilities of the European Commission – the EU’s executive arm – have not traditionally included financial or banking regulation. Until the recent crisis, most national governments regarded financial regulation as a purely domestic matter – regardless of the obvious cross-border spill-over effects. The new Conservative-led British coalition government is likely strenuously to resist any attempt by Brussels to impose tough regulations on the City of London. <br /><br />The timing of the recent British general election also acted to delay financial reform. It was not in the interests of the outgoing Labour government to launch ambitious legislation ahead of an election it expected to lose. The Conservative-led coalition, meanwhile, is still finding its feet. <br /><br />To date tentative steps to reform financial markets in Europe have generated controversy rather than consensus. Germany’s unilateral announcement of a ban on “naked” short selling (naked because traders place bets on securities which they do not own) provoked irritation among both its fellow EU members and the US. Undeterred Berlin this week published a draft law expanding the ban to all shares with a primary listing in Germany, as well as government bonds issued by eurozone countries. It also intends to ban naked short selling of the euro and the use of credit default swaps to bet against European government bonds. <br /><br />Germany deserves credit for addressing some of the market practices that exacerbated the Greek debt crisis. By getting out front on this issue, it is putting pressure on the UK and other member states to clarify their own position. The European Commission appears broadly to support the thrust of the German measures but argues that such reforms can be effective only if adopted throughout Europe. The Commission is to present its own proposals on short selling in two weeks. But new laws might not take effect until 2013 – an unacceptably slow timetable by US standards.<br /><br />The other talking point in Europe is the Commission’s proposal to tax banks, unveiled on Wednesday by Mr Barnier, the internal market commissioner. He wants banks “to contribute to a fund designed to manage bank failure, protect financial stability and limit contagion”. The idea is that the creation of a network of national funds would be a first step towards more centralised governance of the European banking sector – ultimately the plan is for a single EU-wide fund to help banks in crisis no matter where they are located in the EU. The Barnier plan will be discussed at an EU summit next month ahead of the G 20 meeting in Toronto at the end of June.<br /><br />Britain and France, however, immediately rejected the plan, arguing it would create a “moral hazard”. In London officials warned that banks would regard the levy as an insurance premium which would entitle them to a bailout if they got into trouble. George Osborne, the new British finance minister, is planning a bank levy of his own, but it has nothing to do with financial regulation: he just wants to boost general tax revenue. In Brussels, the risk of moral hazard is understood, but Mr Barnier thinks it would be unfair if taxpayers were asked to bear the burden of future bailouts. <br /><br />The US view is that European governments are losing sight of the big picture. Last year the US Treasury subjected big US banks to “stress tests” and forced those that looked vulnerable to raise capital. This helped spur economic recovery by boosting investor confidence. US officials argue that European regulators should concentrate on stress tests and capital raising rather than new taxes on banks. While in China, Sheila Blair, the FDIC chairman, told Bloomberg that European regulators ought to force their banks to hold more capital to help stabilise financial markets. European governments, meanwhile, justify inaction by arguing they are waiting on the outcome of the “Basel III” discussions on capital requirements, which will apply internationally.<br /><br />US officials are uneasy because European nations have done so little to address the underlying causes of the banking crisis. They fear contagion if Europe suffers future banking crises. The unease is reciprocated but on different grounds: European officials complain that American law-makers have rushed to enact reforms without properly thinking through the consequences. For instance, many Europeans are worried by the Senate provision that forces banks to spin off their derivatives desks – since they frequently have a “one stop shopping” banking culture. Many also dislike the Senate’s embrace of the “Volcker rule” – the ban on proprietary trading. <br /><br />In practice, both worries are probably overstated: Blanche Lincoln’s amendment on derivatives is likely to be watered down during the reconciliation process since both Barney Frank in the House and Christopher Dodd in the Senate favour greater flexibility. And the Senate bill already creates wiggle room on proprietary trading since it allows regulators to amend or reject the provision if future study shows that it has adverse effects on financial institutions. <br /><br />I will assess the pros and cons of the US approach to financial market reform in a future blog. Suffice it for now to say that the focus of much European criticism is misplaced. The biggest shortcoming of the bills now to be reconciled is that they do not convincingly address the issue that many economists regard as pivotal to the crisis: the fact that many of the most powerful and diversified financial institutions have a bias towards risk-taking because they know they are too big to be allowed to fail, and because they have access to deposits which are federally insured. <br /><br />The Obama administration’s assumption – echoed by the House and Senate - is that the basic institutional structure of Wall Street is sound. The problem was simply inadequate capital and inadequate regulation. But if the fundamental problem is a chronic bias towards risk, these reforms may not prevent the next crisis – which regulators will likely miss because the strains will emerge in a new and unexpected way – just as they did in 2007. <br /><br />Will the European regulatory tortoise ultimately overtake the American hare and implement more coherent reforms of the financial sector? It seems unlikely because Europe will be unwilling to put itself at a competitive disadvantage to the US by doing more to restrain risk-taking. For instance, in Britain, the new government is setting up a commission to study whether big financial companies should be broken up to ensure they are not too big to fail. But even if the commission recommends dismemberment, it will never happen unless the US enacts similar reforms. <br /><br />The danger is thus that whatever emerges from reconciliation in Washington will set a ceiling rather than a floor for financial regulation in the rest of the world. The task for the G 20 next month is to prevent this happening.Jamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.com0tag:blogger.com,1999:blog-7953806441345973877.post-41810242069725765282010-05-26T18:12:00.000-04:002010-06-16T16:41:35.220-04:00Don’t write off the EUBy Michael Prowse<br /><br />From a US perspective Europe may appear to be self-destructing. Speaking on Tuesday Oli Rehn, the EU monetary affairs commissioner, warned of a “lost decade” in the wake of the financial crisis if member states failed to introduce structural economic reforms to boost productivity and innovation. The euro, meanwhile, seems in free fall with talk of parity against the dollar against $1.60 as recently as the summer of 2008. <a name='more'></a><br /><br />While the US and UK are enjoying a hesitant economic recovery, the eurozone is mostly stagnant. Germany appears to have no conception of its responsibilities as Europe’s anchor economy. Instead of expanding domestic demand, as the US undoubtedly would if in its place, it seems interested only in belt-tightening and the accumulation of ever bigger current account surpluses. <br /><br />Meanwhile many of the smaller southern economies are falling apart. Having run up an unsustainable national debt in recent years, Greece now faces a decline in gross domestic product of at least 10 per cent. Shut out of financial markets, it finally obtained an emergency loan from its EU partners only by becoming a ward of the International Monetary Fund – the first western European state in decades to face this humiliation. <br /><br />Few competent independent economists believe the IMF’s austerity plan will work: slashing spending and raising taxes is hardly likely to create the rapid growth needed if Greece is to have a chance of servicing a debt equivalent to 150 per cent of its GDP. But the point of the austerity plan was largely to convince Germany to cough up some money and appease the bond markets. It turned out not to be enough to prevent the threat of contagion. <br /><br />So, with the prospect of Spain, Portugal and Ireland going the way of Greece, the EU, together with the European Central Bank, finally decided a dramatic statement of intent was unavoidable. In one of the boldest policy moves since the Treaty of Rome inaugurated the Union in 1957, it announced its Euro750bn “shock and awe” rescue package. Flinging – or promising if necessary to fling - this much money at the problem seems to subdued the speculators, at least temporarily. Yet it raises more question than it answers.<br /><br />The IMF, for instance, has already bent its rules by lending Greece far more than its tiny quota technically allows. In contributing up to Euro 250bn of the broader EU support package, Dominique Strauss-Kahn, its French managing director, has effectively thrown away the rule book. A perfectly justifiable thing to do in dangerous times, but it will not necessarily prove popular with the rest of the IMF’s membership. And what of the contribution of eurozone governments to the EU support package. Who believes that Germany will actually lend what it has promised to lend? <br /><br />So, as I stated at the outset, Americans can be forgiven for believing that Europe is self-destructing. And, to be fair, leading US economists never were convinced the euro made any sense. Looking across the Atlantic all they could see was a patchwork quilt of economies, at differing stages of technical development, with differing attitudes to work, inflation and debt, and with dramatically different levels of productivity. It was insane, they warned, to expect one currency – the euro – to meet the needs of nations as diverse as Germany, Ireland, Greece, and Poland (in fact every EU economy differs substantially from those of its partners). The singe currency, their argument ran, was the invention of megalomaniac bureaucrats. It was certain to lead to disaster. <br /><br />Why in the face of this seemingly incontrovertible evidence am I nevertheless saying: don’t write off the EU? First, both markets and the media are apt to take a short-term view of events. Yes, the euro is weak – but not that weak. It has fallen sharply but remains well above its trading range in the early 2000s. The depreciation is necessary and will ease the strain on the weakest European economies. And although some EU members states such as Greece, have very high budget deficits, overall the eurozone is in better fiscal shape than the US. Its aggregate public deficit as a percentage of gross output is projected at about 6 per cent of gross output next year, well below most estimates for the US. The average unemployment rate in the EU is also far lower than in the US. And its member states mostly have more effective social support programmes for vulnerable groups. Both regions have challenges – they just happen to be different challenges. <br /><br />The more important reason for not writing off the EU is that this is a political project that cannot, and will not, be allowed to fail. The member states, especially the smaller ones, know that they could not survive alone in a globalized world economy, where capital flows freely and financial markets are lightly regulated. Imagine the Bank of Greece trying to defend a re-invented drachma from speculative attacks. But the issue is not just economic. The EU’s political integration is so far advanced as to be irreversible. And many Americans overlook the enormously significant role of the European Court of Justice which, since the early 1950s, has been developing a common legal structure that in many spheres now takes precedence over the national laws of member states. Even Germany’s constitutional court – long a renegade – has formally accepted that, where there is a conflict, EU law takes precedence over German law. <br /><br />Against this background, there is a silver lining in the recent financial turmoil. The EU always advances by fits and starts. The many passionate believers in political integration do what they can when they can. The single market programme of the 1980s (eliminating barriers to internal trade) led logically to the euro, since multiple currencies created endless headaches for businesses trying to establish pan-European operations. But although there was then political support for a unified monetary policy (except in the UK), it did not extend to fiscal policy. EU leaders went ahead with the euro anyway, knowing that the fiscal issues could be resolved only when the pressure of events made reform seem imperative. <br /><br />That pressure is now being applied and, as usual, the EU is rising to the challenge. The Euro750bn package is itself the beginning of a meaningful pooling of fiscal resources. It is supposed to be limited to three years, but in the nature of things such guarantees can never be withdrawn. We are almost certainly present at the birth of a new institutional structure that within a few years will seem so essential that Europeans will wonder why it was not created decades ago. Moreover, member states are finally negotiating seriously on rules for the effective joint oversight of national budgets. <br /><br />In a recent FT article, Romano Prodi, a former president of the European Commission and former Italian prime minister, detected the beginnings of “fiscal federalism”. That is provocative talk but there is no doubt that greater fiscal integration is coming: the EU is not going to allow a repeat of the Greek fiscal disaster which occurred not just because the Greek Conservative government (since ousted) borrowed far too much, but because it was also dishonest in reporting its data to the EU authorities. By the time its partners knew what had happened, it was too late to avert the crisis. <br /><br />The EU is holding a two day economic summit next month (June 17th-18th) to discuss ways to strengthen the eurozone’s governance, with the emphasis naturally on more robust fiscal cooperation. It will be fascinating to see what emerges from these talks. EU members are never quick to agree policy initiatives, still less institutional innovations. But their historical record is excellent: they do eventually succeed, because they have no alternative. Every sane observer now knows that fiscal anarchy in a monetary union is a recipe for disaster. Agreement on better fiscal controls will be reached. And when it is, the world’s first genuine transnational political community will be that much stronger.<br /><br />None of this, however, is deny that these are turbulent times. There is bound to be more bad news out of Europe. Share prices and the euro will probably slide further. And financial markets doubtless will target another southern economy, in the process testing the EU’s resolve. Europe is also further than the US from getting its act together on financial regulation, partly because this has hitherto been a responsibility of national governments. The important point to remember, though, is that the EU is a robust political entity that will stay afloat no matter how choppy the financial waters.Jamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.com0tag:blogger.com,1999:blog-7953806441345973877.post-21153850310277641192010-05-26T18:01:00.000-04:002010-06-16T16:42:48.719-04:00Introducing New Rules Blogger Michael ProwseDear Members of New Rules',<br /><br />It is my pleasure to introduce Michael Prowse, a volunteer with a background in journalism. Thanks to Michael, New Rules will be setting up a blog—which in turn requires an overhaul of our website. We should be operational in about a week.<br /><br />Michael’s first posting is copied below. He is a British citizen, so not surprisingly his first posting is on the financial situation in Europe. Please join me in welcoming Michael, and start writing your own submissions, or comment on Michael’s piece.<br /><br />Jo MarieJamiehttp://www.blogger.com/profile/00747959708933696033noreply@blogger.com0