Dani Rodrik
When US President Barack Obama announced in late January his intention to seek tough new rules for banks, he wasn't expecting to make friends on Wall Street. We will henceforth prevent banks from trading on their own account and from growing too large, Obama declared. The internal battle within the Obama administration seemed to have been won by Paul Volcker, the impressive and outspoken former Federal Reserve chairman who has long been a critic of financial innovation.
Unsurprisingly, Goldman Sachs and other Wall Street firms are dubious about the "Volcker rules". So, too, are the Republicans in Congress, along with some Democrats who feel that the scheme has come too late and may interfere with other reform efforts under way, as watered-down as those initiatives may be. Such domestic opposition weakens the prospect that Obama's proposals will ever become law.
But the international reaction was less expected. Obama's announcement received a decidedly unsympathetic reception from Europeans, who perceived his initiative as a unilateral move that would undermine international coordination of financial regulation. The announcement had come without international consultation. It also seemed to violate earlier agreements to cooperate with other nations through the G-20, the Financial Stability Board, and the Basel Committee on Banking Supervision.
At the World Economic Forum in Davos, US Congressman Barney Frank was surprised to discover that the greatest opposition to American plans came from international regulators. The Obama administration's proposed measures would simply create "regulatory confusion", one of them complained.
This is a widely-shared concern. Financial Times columnist Martin Wolf accused the US of injecting "new and unsettling ideas" into the discussion of financial reform. Continental European countries like big banks and, therefore, will never go along with the Volcker rules, he wrote. Accordingly, these reforms "are going to prove inapplicable outside the US and so create difficulties of international coordination".
Dominique Strauss-Kahn, the managing director of the International Monetary Fund, was uncharacteristically blunt for an international official. Taking direct aim at Obama's proposals, he argued that reform of the global financial system should not be driven by what each country sees fit for itself. "We need to have coordination," he said. "We cannot afford to have different solutions in different parts of the world."
The chiefs of major European banks, such as Deutsche Bank, Barclays and Societe Generale, were naturally also unanimous in their hostility. Regulation that is not globally coordinated, they warned, would create unnecessary uncertainty, prolong financial distress, and threaten economic recovery. And oh, of course, it would cut into their profits, too!
Global coordination, like global governance, sounds good. But the practical reality is that it cannot deliver the tough regulations, closely tailored to domestic economic and political requirements, which financial markets badly need in the aftermath of the worst financial upheaval the world economy has experienced since the Great Depression.
In a world of divided political sovereignty and diverse national preferences, the push for international harmonisation is a recipe for weak and ineffective rules. That is one reason why international bankers love international coordination.
Many scholars of international relations consider the Basel Committee on Banking Supervision, the international body of regulators charged with devising a new set of global standards, as the apogee of international rule-making. Yet it is surely telling that this will be the third version of its guidelines in as many decades.
The last big idea the Basel committee had was that large banks should calibrate their capital requirement based on their own internal risk models. But the dangers of permitting banks to police themselves were made amply clear in the latest crisis.
When financial regulations are devised by a coterie of global regulators in distant venues, it is bankers and technocrats who gain the upper hand. Returning the process to national capitals would shift the balance of power to domestic legislatures and national stakeholders. Bankers and their economist allies may rue this, but it is as it should be. Politicisation is the necessary antidote to technocrats' tendency to be captured by banks. Democratic accountability is our only safeguard against a return to light regulation.
Democratic accountability would also result in regulatory diversity - different countries doing their own thing - and that is not a bad thing, either. If the US wants to place size limits and tighter capital requirements on banks, it should be free to do so. If Europe wants to devise its own rules for credit-rating agencies and hedge funds, it should simply go ahead.
Naturally, regulatory diversity would require cross-border financial controls to ensure that banks do not evade national regulations by operating from foreign jurisdictions. The rule would have to be: if you want to serve my market, you must play by my rules.
It is easy to be swayed by arguments about how costly such market fragmentation would be. Deutsche Bank chief Josef Ackermann has gone so far as to warn that moving in this direction would "leave us all poor".
Regulatory diversity is indeed costly for bankers, who would have to adjust to differences in regulations across national borders. But the rest of us suffer from too much financial globalisation, not too little. Some financial segmentation is a price well worth paying for stronger regulations that are solidly backed by domestic politics.
