Large Economies Move to Get at Roots of Financial Crisis

By Andrzej Zwaniecki

A group of large economies has signaled its willingness to get ahead of the global financial crisis as it pushed for reform of the financial system.

Opinions of American analysts about the outcome of the Group of 20 summit differ, ranging from "neither a disappointment nor a triumph" to "better than expected."

Barry Eichengreen's view is somewhere in the middle. Eichengreen, a professor of economics and political science at the University of California, Berkeley, told America.gov that expecting the leaders of 19 industrialized and emerging-market nations plus the European Union who gathered in Washington in mid-November to "solve all the world's economic problems in one day" would be unrealistic.

Wendy Dobson, the head of the Institute for International Business at the University of Toronto, said that, considering their minimal time for preparation, the leaders did what was needed: They launched a new process with defined priorities, an expert task force, deadlines and planned follow-up meetings. (See "Large World Economies Agree to Boost Growth, Tackle Crisis ( http://www.america.gov/st/econ-english/2008/November/20081115190815saikceinawz0.6696588.html).")

Some ideas on midterm regulatory reform endorsed by the meeting - such as strengthening oversight of complex financial products or enhancing regulatory cooperation - had been discussed before the summit. The summit, however, succeeded in institutionalizing a process to implement some of these ideas and broaden the reach and accelerate implementation of others.

"This is a measure of progress," although it may take months or years before changes actually happen, Eichengreen said.

The focus of the summit's recommendations is on the areas that have contributed to the market turmoil: complex financial products, hedge funds, over-the-counter trading, credit-rating agencies, off-balance-sheet accounting, and bank management. Whether the recommendations will lead to a financial system with fewer flaws or less chance of crisis will depend on the implementation details, according to analysts.

But progress can be made, Eichengreen said. He said that in the aftermath of a regional financial crisis in the late 1990s, Asian nations, with help from multilateral financial bodies, identified problems and implemented some reforms. As a result, Asia has been less affected by the current turmoil than any other region.

This time, finance ministers and regulators must tackle challenges that have arisen from financial markets becoming global.

The main issue is inadequacy of national regulation of cross-border financial flows and innovation, Dobson told America.gov. She said some G20 propositions, such as the creation of a college of bank supervisors, try to address this challenge by subjecting financial innovation to more scrutiny without stifling it. Whatever form enhanced scrutiny ultimately takes, "regulators have to work together more closely," Dobson said.

"That hopefully will be one of the big changes coming out of the crisis," she said.

Eichengreen said the crisis has shown that regulation at the national level indeed does not work for markets that are interconnected. For example, when U.S. mortgage-backed securities went bad, they ravaged the treasury of a small town in Norway, and the collapse of major banks in Iceland affected depositors in the United Kingdom and the Netherlands.

But because we still live in the world of sovereign states, Eichengreen said, radical attempts to reinvent the global financial architecture are not likely to be accepted. "We will have a global financial regulator at about the same time we have a global army," he said. A new financial order will simply be a strengthened version of the old one, in his opinion.

Making the Financial Stability Forum, an international standard-setting advisory body, a brain of the reform and expanding its membership to emerging markets puts the reform on the right path, according to many analysts. Eichengreen said the International Monetary Fund (IMF) can advance the reform of the global financial system farther along the path by fulfilling its statutory duties.

So far, the IMF has failed to play its prescribed role in the financial system because powerful member countries often have refused to abide by fund rules, experts say. Attempts made in recent years to make the organization more representative and effective have not produced much change.

Asking the IMF to be an enforcer of the existing rules and new standards set by the FSF in the future will come to the same effect unless member countries give the fund more legitimacy and independence, observers say.

The IMF will continue to be unwilling to criticize financial practices of countries that fund it unless it is more insulated from politics, according to Eichengreen.

Immediate steps agreed to by the leaders to address a severe economic slowdown were somewhat disappointing, according to some analysts. The G20 endorsed fiscal measures to stimulate demand in general, but failed to come up with a plan for coordinated action. The group also called for adequate funding at the IMF to support emerging-market and developing economies but did not recommend a specific level.

The most essential part of the agreed-to steps, some believe, is a pledge not to raise any new trade or investment barriers for 12 months and to give the stalled world-trade negotiations another try. "It is critically important that they keep that commitment," Eichengreen said.

More ideas on how to revive the world economy and reform its financial system are available on some universities' and research groups' Web sites, including the Centre for Economic Policy Research ( http://www.voxeu.org/index.php?q=node/2543 ) and Peterson Institute for International Economics ( http://www.iie.com/).

Source: U.S. Department of State

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