NEW YORK - A year after the panic that brought the world’s financial system to the brink of collapse, there is still no global regulatory framework to prevent another major market meltdown. As the leaders of the world's top industrialized nations gather in Pittsburgh, that will be another item on the menu while they sip wine and nibble on hors d'oevures.
The wine will be imbibed and the canapes consumed, but don't expect them to make any meaningful headway on financial regulations.
“There are always fine statements,” said Dan Price, a lawyer with Sidley Austin who specializes in global financial regulation. “Unfortunately, they’re followed by backsliding as leaders go home and feel domestic political pressure."
German Chancellor Angela Merkel warned Wednesday that officials gathering for the G-20 meeting should focus on the imperative of revamping the world's financial regulatory system and not get distracted by a U.S.-led drive to reduce global trade imbalances.
The United States has been pushing for nations such as China to reduce their dependence on exports and boost domestic spending. In return, the U.S. would increase savings and reduce its debt burden.
So far, individual G-20 countries have made little progress in getting their own financial houses in order.
In the United States, Congress is mired in health care reform and facing a divisive battle over carbon cap-and-trade legislation, making financial regulatory reform look less likely this year.
“Any global process is bound to be slowed down because the U.S. legislative agenda is so backed up now,” said Geoffrey Garrett from the University of Sydney's U.S. Studies Centre. “So we’re now talking about mid-2010 or later for any resolution on the U.S. side about what their reform is going to look like after the crisis.”
Meanwhile the global banking industry is still struggling to rebuild the capital that was destroyed by a lending spree that relied on huge leverage, producing huge gains on the way up and historic pain on the way down. Curbing the systemic risk that blew a trillion-dollar hole in the world financial system is a major goal of the G-20 financial leaders. But it’s not clear who will take the lead.
“Among the regulators it really has to be the U.S. and U.K. regulators who have a 30-year history of always leading from the front,” said Michael Foot, chairman of consulting firm Promontory Financial Group. “But one of the tragedies is that in both the States and the U.K. there are turf wars and uncertainties for what regulation will look like in two years' time.”
“We are absolutely at the levels of risk from 2004 or 2005,” said Simon Johnson, an MIT economist and former chief economist for the International Monetary Fund. “So it’s not imminent crisis, but the danger signals are there already in the amount of risk that the big banks are taking, and their attitudes towards risk and the controls they have over their derivatives (trading.)"
One likely scenario would require banks to keep more capital on hand and limit the amount of lending backed by that capital. But stiffening the rules now risks tightening credit just as the global economy is struggling to get back on its feet. That’s one reason regulators are in no hurry to force banks to keep more cash in the vault.
The discussion over requiring banks to hold more capital has also opened a major fault line among the biggest banking powers. Without a uniform set of regulations, countries that adopt easier capital requirements will hand their domestic banks a strong advantage over global competitors.
“The Americans don’t want to do enough on capital requirements, in my opinion,” said Johnson. “But the Europeans don’t even want to do that because their banks are so thinly capitalized."
In any case, bankers are in no hurry to play by a new set of rules on capital standards. Forcing them to lend fewer dollars for every dollar they hold in reserve means they’ll have less money to lend, and less profit to show for it.
“I think there’s no choice but that banks will have to expect much lower average returns on equity and returns on assets,” said Foot.
The discussion of restricting banks from relying on razor-thin capital reserves has also been overshadowed by a loud debate about capping lavish banker bonuses. Some critics have argued that excessive compensation contributed to the excessive risk-taking that produced the global lending bubble.
European leaders, lead by French President Nicolas Sarkozy, are calling for strict limits on bankers’ pay and bonuses. U.S. and British leaders, facing strong resistance from the global banking centers of Wall Street and the City of London, are pushing for more flexible oversight.
“We’re beginning to see some emerging consensus around a set of principles that ties compensation to performance, that discourages excessive risk-taking and that provides for claw-back in the event a firm’s performance suffers,” said Price. “What we’re moving away from — helpfully and sensibly — is talk of actual caps or ratios.”
The discussion over tighter bank regulation is being squeezed into a packed two-day agenda in Pittsburgh along with a long list of other pressing issues. Climate change, a perennial topic, has new urgency now that Congress is debating various proposals to cap carbon emissions.
The global recession has also increased pressure to protect domestic industries. Trade skirmishes between the U.S. and China over tires and chickens have brought those protectionist frictions to the front burner.
President Barack Obama's decision this month to slap tariffs on Chinese-made tires has been among the most visible signs of this growing friction. The rising risk is that as countries try to jump-start their economies, they will move to protect domestic industries. Any new barriers to international trade will only slow the weak recovery in the global economy.
“We have a series of skirmishes now, which we hope doesn’t escalate into a war,” said Mark Michelson, a Hong Kong-based consultant based with APCO Worldwide. “There’s going to be some of this tit-for-tat for a while. Some (are) not as obvious — in terms of regulations and barriers to trade that are not clearly stated.”
Global leaders also face the daunting task of winding down big budget deficits left behind as the industrialized world cranked up government spending to try to reverse the global downturn.
While it’s too soon to know just how effective those programs have been, the long-term impact of continued deficit spending is clear. Heavy government borrowing can squeeze credit in the private sector, eventually slowing growth and weakening the recovery.
“Obviously this isn't the time to start cutting those budget deficits,” said Martin Feldstein, a Harvard economist and chief economic adviser in the Reagan administration. “But it is the time to explain the plan and to make concrete promises about what's going to happen as the economy recovers.”