In a few days, the leaders of the Group of 20 nations will gather in Washington for a summit on the global financial crisis. European Union leaders pushed hard for the conference, expected to be the first in a series. The Europeans are angry about a meltdown most of them blame on the U.S., and they want major changes in the way global finance is regulated. British Prime Minister Gordon Brown has called for a "new Bretton Woods," a reprise of the 1944 conference where the World Bank, International Monetary Fund and postwar trading regime were born. French President Nicolas Sarkozy has said it's time to "build together the capitalism of the future."
It's not like they're making a fuss over nothing. No doubt that's why President Bush agreed to the summit in a meeting at Camp David last month with Sarkozy, who also holds the rotating EU presidency. The official agenda for the two-day meeting (sketched by the White House rather than the U.S. Treasury, which has otherwise led on these matters) calls for the leaders simply to review progress being made on the crisis, work for a common understanding of its causes and come to an agreement on a common set of principles for overhaul of the world's regulatory structures.
That still leaves room for big thoughts and high expectations, however. As German Chancellor Angela Merkel said after a European-Asian economic summit in Beijing on Oct. 25: "This is about no less and no more than the creation of a new financial constitution."
From an American perspective, the situation is complicated by the fact that there's a president-elect, Barack Obama, who has great interest in the proceedings and certainly a major voice, but, constitutionally at least, no real power. At press time, it was still unclear how the Obama team would interact with the White House or, indeed, who would be on that team.
So what are the chances Nov. 15, 2008, will go down in history as the date capitalism was reinvented?
Close to zero, according to some longtime denizens of the multilateral financial scene. These technocratic types don't dispute the need for significant, globally coordinated changes in financial regulation; on the contrary, they point to the work already accomplished or under way in settings such as the Financial Stability Forum, which convenes many of the world's top financial officials under the aegis of the Bank for International Settlements. Discussion of such measures as a clearinghouse for credit derivatives, tougher capital adequacy standards for banks and even possible changes to compensation practices in the financial sector is already well advanced, they say.
Nor do most people doubt that the politics of bailouts are important. With vast amounts of public money on the line in multiple countries, elected officials obviously need to exercise leadership.
What's cause for concern is the gulf between the work in progress on the world's financial plumbing and the lofty rhetoric of leaders facing severe domestic political pressure. Take, for example, Brown's suggestion that the IMF should become more like a global central bank. It's true that the IMF is back in the business of rescuing countries, and that many people, especially its managing director, Dominique Strauss-Kahn of France, think it can overcome past limitations and claim an important role in a revamped system. But as Brown, a former finance minister, is well aware, his remark glosses over some major political difficulties. "Pie in the sky," says Morris Goldstein, who worked for the IMF for 24 years before becoming a senior fellow at the Peterson Institute for International Economics in 1994. "There's not going to be any global central bank."
Turns out it's hard enough just strengthening a framework for financial regulation that's coordinated globally but administered nationally. As the G-20 leaders are reminded, this is a project in three dimensions, each of which complicates the other two. There's a geopolitical element, wherein the U.S. -- changing administrations but still vying for influence with the Europeans and developing countries -- finds itself arguing from a weakened position, but certainly not ready to cede control of its financial system. There's an institutional element, as all sides tussle over representation within international institutions, especially the IMF, and continue long-running arguments over what their missions should be and whose values they should reflect.
Finally, there's the work on actual policies and regulations, which brings an even larger cast of public and private-sector actors into play. The Financial Stability Forum, for example, includes not just representatives of central banks and finance ministries but also such groups as the International Organization of Securities Commissions, the International Accounting Standards Board and the International Association of Insurance Supervisors. Meanwhile the Institute for International Finance, a trade association representing the world's big banks and financial firms, puts out its own studies and position papers, and its members naturally wield influence in their home countries.
Bretton Woods dealt with a far simpler world -- and that's just one reason why it was a fundamentally different exercise than the Nov. 15 summit and any follow-on meetings will be. The 1944 conference came after years of economic depression and world war had focused the minds of the participants, observes Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley, and a former senior policy adviser to the IMF. It was also preceded by more than two years of preparation, and even the final gathering was led by financial figures (notably, John Maynard Keynes) rather than politicians. Not least, it was a trans-Atlantic rather than a global negotiation, anchored by a dominant power, the U.S., which had the unrivaled economic clout needed to make its vision of free trade and managed exchange rates a reality.
The geopolitics of the current discussions are quite different. For starters, there's that sense of vindication many Europeans feel in their long-running argument with Americans over how freewheeling financial markets should be. German Finance Minister Peer Steinbrück has called the U.S. "irresponsible" and predicted that in 10 years it will no longer be a financial superpower. Never mind that the exposure of a major German bank to Iceland's woes (to name but one example) would seem to indicate that the financial crisis had some collaborative aspects. "Their view is: We caused it and they're going to fix it," says Edwin Truman, a former IMF and Clinton Treasury official and senior fellow at the Peterson Institute.
Not a very realistic ambition, to be sure. Though the Obama administration will likely be more multilateral-minded than the Bush team, the U.S. isn't about to accept financial regulations imposed from the outside. Anyway, the picture became more complicated at that Camp David meeting when what the EU initially envisioned as a G-7 or G-8 meeting (adding Russia) became a G-20 summit. Established in 1999 as a result of the Asian financial crisis, the G-20 gathers the central bankers and finance ministers from the major developing economies as well as the developed ones. The grouping also includes an EU representative, plus the IMF and World Bank. (Alas, it leaves out Spain, which is lobbying to be invited anyway.)
Truman thinks the decision to make the summit a G-20 affair may turn out to be the most valuable thing about it. "It is a little dangerous because the other countries are not particularly friends of the Anglo-Saxon way of doing things," says Truman. "But it certainly does invite them to the table. And China, India, Brazil and South Korea have as much at stake in all this as we do."
What will the emerging economies bring to the table? For starters, growth. Though they're suffering in the current crunch, they'll still produce most of the world's expansion in the next few years. Then there are those foreign exchange reserves -- in the case of China, nearly $2 trillion worth. But it's not clear whether China's leaders, largely focused on Middle Kingdom concerns, would be willing to use any of that hoard for purposes other than domestic ones.
In the case of India, Prime Minister Manmohan Singh -- an economist and former finance minister -- has been vocal about his plans to lead a diplomatic initiative on behalf of the developing world. Chinese President Hu Jintao, who will also attend the summit, has agreed to coordinate with Singh. In fact, Brazil, Russia, India and China, the so-called Bric countries, have all agreed to work out a common position. Their finance ministers are scheduled to meet in São Paulo, Brazil, before the Washington meeting. A key topic at that preliminary meeting is bound to be the IMF, with all the wrangling to which it is heir. What should it be, and how should it be run? Truman and others think the IMF probably has a role as a diagnostician of national financial ills in a revamped regulatory setup. But that will involve both shoring up its credibility and giving developing nations a much greater say in its governance. Neither task will be easy. Traditionally run by a European, the IMF has also tended to reliably reflect the views of the U.S., its largest shareholder.
According to Eichengreen, the IMF's credibility problem was obvious earlier in the fall, when U.S. Treasury Secretary Henry Paulson unveiled the original, "deeply flawed" Troubled Asset Relief Program to buy toxic securities at around their market price. Eichengreen says that instead of raising its voice and recommending the recapitalizations and guarantees of interbank transactions that were eventually put in place, the IMF -- which knew better, having been behind the definitive work on how to resolve banking crises -- was notable for its silence. He explains that "it's a long-standing issue that the IMF has trouble being straightforward with its large shareholders."
But not with client countries. During the Asian financial crisis of the late 1990s (not to mention the sovereign debt crisis of the 1980s), developing nations had to come to the IMF for financial help, even though they deeply resented the painful conditions it imposed -- fiscal restraint, privatizations and other measures with a made-in-Washington feel. Determined to steer clear of the IMF, some developing countries went on to amass huge foreign-exchange reserves that could protect them from currency shocks like the ones that proved so devastating in the 1990s.
Broadly speaking, these pools (whether in the form of central bank reserves or sovereign wealth funds) figure in the current crisis in several ways. One is their contribution to the wave of liquidity that sloshed around the globe in recent years and, in the opinion of some economists, helped expand the credit bubble. Another is the way they raised questions about the raison d'être of the IMF, whose loan portfolio stood at a mere $17 billion on Sept. 30, having peaked at $110.2 billion in 2003. Last but not least, they represent capital that could shore up the world's financial systems through the IMF or perhaps another institution -- if terms could be agreed upon.
While the financial crisis has propelled the IMF back onto center stage, its role there is still being written. So far it has rescued four hard-pressed countries, including Iceland and Hungary, and will surely be asked to help others such as Pakistan, which first turned to China but was rebuffed. In late October, the IMF unveiled a $100 billion short-term lending facility for countries judged to be well managed but temporarily troubled. And Strauss-Kahn (cleared of wrongdoing, by the way, after an investigation of a brief romantic affair with an IMF employee) says there's more in store.
In an interview published in Le Monde on Oct. 30, the IMF's managing director said he'll propose a new global regulatory strategy at the G-20 summit. Strauss-Kahn -- who as France's hard-money Socialist finance minister helped to forge the euro and who may run for president of the republic in a few years -- also said he thinks the IMF can be an architect of a new regulatory regime, an idea that puts him in sync with his domestic rival, Sarkozy. DSK, as he's known, also expressed general approval of Brown's IMF-as-global-central-bank idea, and added that the IMF, which had only about $201 billion to lend at the end of August, needs more resources.
It was propitious, then, that on Nov. 4, Brown, concluding a four-day trip to the Mideast, announced he had found some of those resources. At the Nov. 15 summit, Brown said, the Saudis and other oil-rich states would put up some of the hundreds of billions the IMF will likely need. The IMF has borrowed from the Saudis and other individual countries before, and loans would seem the most likely form of infusion this time.
It will take more than loans, however, to give the IMF the credibility it needs to function as an effective monitor of global finance, let alone a quasi central bank. The problem -- and it's a big one -- is the IMF's governance, which despite the huge changes in the world economy since 1944, remains disproportionately European. Truman says the latest attempt to redistribute power, just last spring, "brought forth a mouse." He's clear about who's to blame.
"It was the British who led the charge not to change anything. It's a disgrace," he says. France and Britain, currently the fourth- and fifth-largest shareholders, should make way for China, which, given the size of its economy, clearly belongs in the top five. Truman adds: "To have these guys saying right now, 'We're going to fix global governance' -- it's hard for some of us to swallow."
The Great Power politics will no doubt continue, with officials of the Obama administration now entering the mix even as Bush officials serve as hosts for the summit. Since the whole thing must come together so quickly, preparations and politicking are proceeding at a rapid pace. European Union leaders were scheduled to meet Nov. 7, after this article went to press, to further develop their positions.
The work on the financial plumbing continues, too. Though less politically fraught, it has plenty of complications in its own right. One example is the prevailing view that the Basel II capital standards for banks -- which took years to negotiate, and which even now aren't fully implemented among banks -- are already obsolete.
Since Basel II rules are relatively new, they're not blamed for the epidemic of overleveraging. But the notion of letting big banks risk-weight their assets, an important feature of Basel II, is an intellectual cousin to the mania for structured finance that's now viewed with such regret. Another issue is the pro-cyclicality of current capital standards. Many now argue that banks should be held to higher capital standards during booms and lower ones during down cycles. Needless to say, neither of these ideas is popular with banks.
Still, the plumbers have already accomplished a lot. In April, the Financial Stability Forum, led by Italian central banker Mario Draghi, presented the G-7 finance ministers and central bankers with a package of specific recommendations for making markets and institutions more resilient. Among them: standardization and an "operational infrastructure" for over-the-counter derivatives; changes in the role and uses of credit ratings; and measures to improve risk disclosure by financial firms.
On Oct. 6, a group chaired by former Fed chief Paul Volcker -- who is also one of Obama's chief advisers -- issued a comprehensive study of financial regulation around the world. By showing in depth the strengths and weaknesses of various systems, the body (known as the Group of 30, even though it gathers individuals rather than governments) has probably helped pave the way for countries to modernize and improve their own systems and proceed with country-specific implementation of globally agreed-upon standards.
Will Obama send Volcker to the Nov. 15 summit in some capacity? Will the U.S. president-elect favor a path where the best of the technical recommendations so far are implemented locally and the IMF enhances its role as a monitor of how individual countries put them in place? There's no shortage of obstacles on that path. The Chinese have just begun to indicate that they want to participate fully in the IMF. Even within Europe, there's no united front among London (the hedge fund capital), Paris (where Sarkozy recently proposed a sovereign wealth fund to protect French companies from foreigners) and Berlin (France's partner but also its rival within the euro zone).
But with the right amounts of diplomacy and leadership -- not to mention, of course, luck -- it could still be the best road out of this mess.
Recommended reading on global financial regulation
What caused the financial meltdown? How do we prevent a recurrence? For more than a year various groups -- official, semiofficial and private -- have been writing reports that will provide the basis for reforms. Among them:
Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience
The FSF, associated with the Bank for International Settlements in Basel, Switzerland, convenes financial and market regulators, central bankers and officials from 26 countries, though it's light on developing-country representation. It published this key report in April and updated it in October. www.fsforum.org
Joint Forum Report on Credit Risk Transfer
Another BIS affiliate, the Joint Forum is a grouping of market regulators. The latest version of this report came out in April. Also available at www.fsforum.org
The Structure of Financial Supervision: Approaches and Challenges in a Global Marketplace
Issued in October by the Group of 30, an international body of central bank governors, economists and private financial-sector experts chaired by Paul Volcker. Analyzes regulation and its shortcomings in 17 countries, including the U.S. and the U.K. www.group30.org
Final Report of the IIF Committee on Market Best Practices
What the bankers think. Released in July by the Institute for International Finance, the global trade association for financial institutions. www.iif.com
Addressing the Financial Crisis
A 10-plank plan for regulatory reform presented in October by Morris Goldstein, senior fellow at the Peterson Institute for International Economics, a Washington think tank. Gathers Goldstein's ideas and synthesizes those of others into a highly readable mix of analysis and proposals. www.iie.com.