Idea ofglobal 'sheriff' to tighten regulation is seriously considered

ByCarter Dougherty

Tuesday,January 27, 2009

FRANKFURT: 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 policeglobal financial markets" was practically hooted off the stage.Participants voted the idea down by a 3-to-1 ratio.

Even though economic troubleswere clearly beginning to spread across the globe last January, the free-marketreflexes of the Davos crowd trumped what was, admittedly, a proposal with a bittoo much flash.

But with the world economy inthe grip of the worst banking crisis since the 1930s - in large part because ofreckless lending spurred by financial innovations that went unsupervised formany years - the wisdom of a supra-national approach to regulation now goesvirtually unchallenged.

"The world is toointerconnected for nations to go it alone in their economic, financial andregulatory policies," Ben Bernanke, chairman of the Federal Reserve, saidin a recent speech.

Under pressure from Britain and France,the United States agreed toa proposal for a "college of supervisors" at an emergency summit ofthe Group of 20 major in Washingtonin November. Britain, whichleads the group, plans to push the idea further at a meeting in London in early April.

Indeed, without some sort ofglobal financial oversight, experts say, many nations will be tempted toprotect their own banks at the expense of the larger whole, and banks willcontinue to profit from holes in the supervisory system to hide diceytransactions.

On the substance of regulation,the global consensus has gelled swiftly as well.

Higher capital ratios, whichwould require banks to put aside more money to offset potential losses, are atthe 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 rulesthat allowed inflated gains while amplifying losses as the crisis gatheredspeed are also high on the agenda.

Establishing greatertransparency through open exchanges or clearinghouses for the trading ofcomplex financial products, like credit-default swaps and credit derivatives,is now widely accepted, too. And tougher requirements that banks ensure accessto ready cash seems virtually certain.

But for all the talk, it isstill questionable whether the year 2009 will herald the birth of a worldfinancial regulator with the power to peer across borders and into bank balancesheets.

Plenty of skeptics challengethe notion that regulators are about to go global - and that elected officialswill let them.

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

When the chips were down, hepointed out, a number of countries behaved with little regard for theinternational setting. The decision by U.S. officials to let Lehman Brothers gobankrupt on Sept. 15 intensified the financial crisis, and European officialshave not been shy in arguing that the Bush administration did not consider theglobal impact when it let the bank go under.

But Europeans did not alwayscultivate the European esprit de corps on which they pride themselves. Thecollapse of Fortis, a bank with operations in Belgium,the Netherlands and Luxembourg,resulted in a decidedly retrograde solution: The bank was dismembered intonational parts, which the governments then rescued individually.

For skeptics like Goodhart, thecentral question of who would pay to recapitalize insolvent banks creates aproblem that the world is not politically prepared to solve. Americantaxpayers, in short, are not suddenly of a mind to underwrite the bailout of aGerman bank.

The more optimistic argue thata global approach, even without a fat checkbook behind it, could improve thestability of the financial system by highlighting problems before they requiretaxpayer money.

Injecting fresh capital to thebanks is a short-term fix.

"We should separate thisfrom the issue of supervision and regulation, which is not just a crisisframework," said Carmen Reinhart, a professor at the University of Maryland.

The absence of a budget forfinancial intervention among the 27 members of the European Union prevented aborder-straddling approach during the hottest phase of the financial crisis.This shortcoming, which was compounded by the absence of a pan-European bankingsupervisor, was remedied by the close coordination of bank rescues in earlyOctober.

The EU is now pushing aheadwith plans to revamp regulation at a regional level.

A commission led by Jacques deLarosière, a former head of the International Monetary Fund, is formulating amore detailed plan for presentation in February. Jean-Claude Trichet, presidentof the European Central Bank, recently pointed out that the treaties thatcreated the euro suggested that the ECB could be given responsibility forbanking supervision.

"It's one thing to say whopays in the end," said Daniel Gros, director of the Center for EuropeanPolicy Studies in Brussels."But who makes sure that the banks are implementing rules that everybodyagrees to at the EU level?"

Less debatable is that thefinancial services industry, with many of its big institutions only barelyclinging to solvency even with the help of a government nursemaid, is hardly ina position to resist new regulation. That is a big change, as its once-mightypolitical clout forestalled such moves for most of the last three decades.

"They were instrumental increating this mess," said Kurt Lauk, a member of the European Parliamentand an adviser to the German chancellor, Angela Merkel. "They have lostcredibility in matters of regulation."

In a recent study, sponsored bysenior executives from banking, insurance, private equity and asset management,the World Economic Forum concluded that "the positions taken by globalregulators will significantly reshape the financial services landscape." Atop priority, the study concluded, would be to limit the ability of banks toslip out of the reach of national regulators by basing their operationselsewhere. "Through global coordination, policymakers will attempt topresent a united front and thus minimize regulatory arbitrage," the studysaid.

How that is best done isanother matter entirely, and much of the debate now brewing among experts iswhether countries need to add another acronym to the alphabet soup of globalinstitutions. Is the World Financial Organization on the way?

Global regulation "doesnot mean somebody sitting in a single place and supervising authorities aroundthe world," said C. Fred Bergsten, director of the Peterson Institute forInternational Economics. "That would require a global legal framework thatdoes not exist and is not going to exist in the future."

Bergsten argues that the worldneeds something modeled on the regulatory principles that were hammered out inthe wake of financial crises in Asia and Russia in the late 1990s. The InternationalMonetary Fund was deployed to monitor their implementation.

"Ten years on, they haveenormously stronger banking systems," Bergsten said. "They have beensubstantially beefed up over the last 10 years and a lot of it came out of thisprocess."

By contrast, Reinhart, theUniversity of Maryland economist, contends that a new global institution - ofwhich a college of supervisors could be "a kernel" - is necessary toavoid getting lost in the weeds, and preventing conflicts of interest.

If the IMF takes up bankingsupervision, she said, it could be called on to lend money to alleviate acrisis that it was supposed to help avoid. And using other groups, like theBank of International Settlements, or BIS, a kind of central bank of centralbanks based in Basel, Switzerland, risks spreading themtoo thin.

It is time to start thinking ofbuilding a new institution "from scratch," Reinhart said, adding,"I don't think slapping additional responsibilities on the IMF or BIS isthe way to go."