G20 summit shows lack of resolve
The G20 summit must be considered a disappointing failure, even by the relatively low expectations set for the event. Leaders produced a long agenda of further studies, reports and work, but failed to provide a clear direction or tackle even the most fundamental decisions.
On the key issues, leaders displayed a worrying irresolution. Without unambiguous instructions from the top, discussions between finance ministers and officials will prove protracted and risk getting bogged down in detail. Negotiations between officials can fill in the details; they cannot make the kind of fundamental choices about strategic direction that leaders avoided at the weekend.
A SENSE OF HISTORY
The summit has been bedeviled by comparisons with the Bretton Woods conference in 1944. Intended as a rhetorical device to restore confidence by suggesting governments were taking bold action in an unprecedented spirit of agreement, the ghost of Bretton Woods has raised impossible expectations and distracted both leaders and officials from the real issues facing the global financial system:
(1) The three-week conference at Bretton Woods was the culmination of more than two years of detailed work at official level and more than a decade studying the issues. There was substantial prior agreement about the problem (poorly coordinated monetary and fiscal policies, leading to payment imbalances and protectionism) and the solution (a gold-exchange system, with multilateral surveillance of national policies, and national reserves supplemented by IMF drawing facilities on a conditional basis).
The system was buttressed by a new multilateral development bank to help fund infrastructure and post-war reconstruction, and later by the General Agreement on Tariffs and Trade (GATT) to prevent a slide back into protectionism.
Comparisons with Bretton Woods thus created unrealistic expectations of what top-level leaders would be able to achieve without detailed preparatory work.
(2) The more serious problem is that the comparisons frame the issue in the wrong way and encourage leaders to pursue the wrong solutions to the wrong problems.
Bretton Woods occurred against the backdrop of the Great Depression – when countries had tried to defend fixed gold parities by raising taxes, cutting expenditure, and hiking interest rates to deflate domestic demand and cut imports, while introducing trade barriers to reduce deficits and limit outflows of bullion.
The current crisis is very different. It is occurring under flexible exchange rates, not fixed ones. No one is suggesting governments raise interest rates, hike taxes or cut expenditure to maintain the external value of their currencies rather than support domestic demand. Most countries seem quite happy with depreciation and easy monetary and fiscal policies.
But the ill-conceived comparisons with 1944 have caused leaders to focus on the spectre of renewed trade protectionism and the need for international policy coordination – while more targeted but relevant proposals to improve financial regulation risk being lost in a sea of other ideas.
Like generals fighting the last war, the G20 leaders seemed more comfortable solving the problems of the 1940s than the 2000s.
FAILURE OF WILL
The summit made some progress agreeing on the nature of the problem and locating it in the financial system: “weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system”.
The communique went on to note: “Policymakers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications”.
However the real problem was not a failure of understanding but a lack of regulatory will:
(a) Long-Term Capital Management’s collapse highlighted the systemic risks posed by highly interconnected institutions as long ago as 1998.
(b) Enron’s demise in 2001 showed the risks arising from the use of off-balance sheet vehicles that were only independent entities in a narrow accounting sense but risked being consolidated back onto the parent company’s balance sheet in a crisis.
(c) The Commodity Futures Trading Commission (CFTC) warned about over-the-counter derivatives with poor transparency, limited oversight and unknown risk concentrations in the late 1990s, but was banned from trying to regulate them, partly at the behest of the U.S Treasury and Federal Reserve.
(d) With subprime mortgages, the Fed had been aware for several years about a relaxation of lending standards, but regulators did not nothing beyond issuing half-hearted warnings.
(e) Repeated warnings about serial asset market bubbles and the over-inflation of house prices were dismissed by the Fed as localised “froth”. Officials preferred to provide post-crisis relief rather than interfere with market mechanisms to prevent bubbles inflating in the first place.
Each time regulators attempted to quantify risk or force financial institutions to adopt more conservative practices, they were seen off by heavy lobbying from the major investment banks and insurance companies.
Top policymakers, from Greenspan downward, systematically dismantled regulatory safeguards that had been in place since the 1940s.
With no support from the top, junior regulators appear to have given up trying to enforce even the existing rules and were forced to adopt the interpretations most favorable to the institutions they were meant to be regulating. Wall Street controlled the regulators, rather than the other way around.
Adding to the pressure, the major financial institutions were able to successfully arbitrage among regulators in different countries, and even between different regulators within the same country. Tough rules-based regulation by the SEC was contrasted unfavorably with the light-touch principles-focused regulation adopted by the CFTC and Britain’s Financial Services Authority.
Regulators themselves seemed more anxious to promote the competitiveness of their local jurisdictions in a race to grab market share by offering the lightest touch – which often meant no effective regulation at all.
It was this regulatory arbitrage and capture of the regulatory authorities by the institutions they were supposed to regulate that lay at the root of the crisis. While G20 leaders seem to understand this, their response suggests a hesitancy that could be fatal to reform.
LITTLE THRUST FOR REFORM
There is a brief mention in the communique of the need to strengthen regulation and avoid regulatory arbitrage. But too many proposals in the document are either irrelevant or reveal a disinclination to challenge the status quo.
Proposals for a “college” of supervisors to assess risks in large cross-border institutions look like a solution to the lending crises of the 1990s (when institutions failed to understand their aggregate country exposure) rather than the 2000s (when the crisis largely stemmed from risk concentrations in a single country and a single financial system).
Proposals to examine the pro-cyclicality of regulatory policies and the valuation of illiquid securities suggest a willingness to accept industry efforts to blame accounting treatments and capital requirements rather than poor lending. Asking the Basle Committee to help firms’ new stress-testing models is a fairly ineffectual response to the wholesale failure of risk management processes the crisis has revealed.
Calls to avoid regulatory arbitrage were coupled with the need to “support competition, dynamism and innovation in the marketplace”. No one could argue against the importance of innovation, but the very mixed remit gives finance ministers and officials no real support for toughening regulation.
The communique lacks focus, with favorite but irrelevant themes about terrorist financing, uncooperative tax havens, voting reform at the IMF and completing the Doha round of trade negotiations all making an appearance. While these are worthy objectives, rolling them all into the communique has simply weakened it.
The G20 was timid and confused where it needed to be bold and clear. As ministers and officials sit down in a dozen working groups to discuss detailed reforms, they are more likely to tinker with a failed system than produce a successor to Bretton Woods.