Global Policy Forum

By Carter Dougherty

Has the unthinkable become the utterly acceptable? At the last annual meeting of the World Economic Forum in Davos, Switzerland, a proposal at one discussion forum to create "a new sheriff to police global financial markets" was practically hooted off the stage. Participants voted the idea down by a 3-to-1 ratio. Even though economic troubles were clearly beginning to spread across the globe last January, the free-market reflexes of the Davos crowd trumped what was, admittedly, a proposal with a bit too much flash. But with the world economy in the grip of the worst banking crisis since the 1930s - in large part because of reckless lending spurred by financial innovations that went unsupervised for many years - the wisdom of a supra-national approach to regulation now goes virtually unchallenged.

"The world is too interconnected for nations to go it alone in their economic, financial and regulatory policies," Ben Bernanke, chairman of the Federal Reserve, said in a recent speech.

Under pressure from Britain and France, the United States agreed to a proposal for a "college of supervisors" at an emergency summit of the Group of 20 major in Washington in November. Britain, which leads the group, plans to push the idea further at a meeting in London in early April. Indeed, without some sort of global financial oversight, experts say, many nations will be tempted to protect their own banks at the expense of the larger whole, and banks will continue to profit from holes in the supervisory system to hide dicey transactions.

On the substance of regulation, the global consensus has gelled swiftly as well. Higher capital ratios, which would require banks to put aside more money to offset potential losses, are at the top of the list. Most institutions are already moving in that direction, though at the moment that is undermining efforts to revive lending. Reformulating accounting rules that allowed inflated gains while amplifying losses as the crisis gathered speed are also high on the agenda. Establishing greater transparency through open exchanges or clearinghouses for the trading of complex financial products, like credit-default swaps and credit derivatives, is now widely accepted, too. And tougher requirements that banks ensure access to ready cash seems virtually certain.

But for all the talk, it is still questionable whether the year 2009 will herald the birth of a world financial regulator with the power to peer across borders and into bank balance sheets. Plenty of skeptics challenge the notion that regulators are about to go global - and that elected officials will let them.

"There ain't going to be a new global financial architecture," said Charles Goodhart, a professor at the London School of Economics and a former top official at the Bank of England. "What has been shown up by this crisis is that the only people who can take up action are the nation states. I think the crisis has set back globalism and world federalism by a long way."

When the chips were down, he pointed out, a number of countries behaved with little regard for the international setting. The decision by U.S. officials to let Lehman Brothers go bankrupt on Sept. 15 intensified the financial crisis, and European officials have not been shy in arguing that the Bush administration did not consider the global impact when it let the bank go under. But Europeans did not always cultivate the European esprit de corps on which they pride themselves. The collapse of Fortis, a bank with operations in Belgium, the Netherlands and Luxembourg, resulted in a decidedly retrograde solution: The bank was dismembered into national parts, which the governments then rescued individually. For skeptics like Goodhart, the central question of who would pay to recapitalize insolvent banks creates a problem that the world is not politically prepared to solve. American taxpayers, in short, are not suddenly of a mind to underwrite the bailout of a German bank. The more optimistic argue that a global approach, even without a fat checkbook behind it, could improve the stability of the financial system by highlighting problems before they require taxpayer money.

Injecting fresh capital to the banks is a short-term fix. "We should separate this from the issue of supervision and regulation, which is not just a crisis framework," said Carmen Reinhart, a professor at the University of Maryland. The absence of a budget for financial intervention among the 27 members of the European Union prevented a border-straddling approach during the hottest phase of the financial crisis. This shortcoming, which was compounded by the absence of a pan-European banking supervisor, was remedied by the close coordination of bank rescues in early October. The EU is now pushing ahead with plans to revamp regulation at a regional level. A commission led by Jacques de Larosií¨re, a former head of the International Monetary Fund, is formulating a more detailed plan for presentation in February. Jean-Claude Trichet, president of the European Central Bank, recently pointed out that the treaties that created the euro suggested that the ECB could be given responsibility for banking supervision. "It's one thing to say who pays in the end," said Daniel Gros, director of the Center for European Policy Studies in Brussels. "But who makes sure that the banks are implementing rules that everybody agrees to at the EU level?"

Less debatable is that the financial services industry, with many of its big institutions only barely clinging to solvency even with the help of a government nursemaid, is hardly in a position to resist new regulation. That is a big change, as its once-mighty political clout forestalled such moves for most of the last three decades. "They were instrumental in creating this mess," said Kurt Lauk, a member of the European Parliament and an adviser to the German chancellor, Angela Merkel. "They have lost credibility in matters of regulation."

In a recent study, sponsored by senior executives from banking, insurance, private equity and asset management, the World Economic Forum concluded that "the positions taken by global regulators will significantly reshape the financial services landscape." A top priority, the study concluded, would be to limit the ability of banks to slip out of the reach of national regulators by basing their operations elsewhere. "Through global coordination, policymakers will attempt to present a united front and thus minimize regulatory arbitrage," the study said. How that is best done is another matter entirely, and much of the debate now brewing among experts is whether countries need to add another acronym to the alphabet soup of global institutions. Is the World Financial Organization on the way? Global regulation "does not mean somebody sitting in a single place and supervising authorities around the world," said C. Fred Bergsten, director of the Peterson Institute for International Economics. "That would require a global legal framework that does not exist and is not going to exist in the future."

Bergsten argues that the world needs something modeled on the regulatory principles that were hammered out in the wake of financial crises in Asia and Russia in the late 1990s. The International Monetary Fund was deployed to monitor their implementation. "Ten years on, they have enormously stronger banking systems," Bergsten said. "They have been substantially beefed up over the last 10 years and a lot of it came out of this process."

By contrast, Reinhart, the University of Maryland economist, contends that a new global institution - of which a college of supervisors could be "a kernel" - is necessary to avoid getting lost in the weeds, and preventing conflicts of interest. If the IMF takes up banking supervision, she said, it could be called on to lend money to alleviate a crisis that it was supposed to help avoid. And using other groups, like the Bank of International Settlements, or BIS, a kind of central bank of central banks based in Basel, Switzerland, risks spreading them too thin. It is time to start thinking of building a new institution "from scratch," Reinhart said, adding, "I don't think slapping additional responsibilities on the IMF or BIS is the way to go."