World leaders are talking bravely about fixing the global financial system. As the Group of Twenty heads toward an important summit in Pittsburgh on Sept. 24-25, they are vowing to bang out a regulatory structure that will keep rich, careless bankers from once again driving their firms to ruin and then getting bailed out by taxpayers. Finance ministers and central bankers who met in London earlier this month reported "substantial progress in delivering our ambitious plan."
But their plan is far less ambitious than what some voices were advocating as recently as last spring. Bank lobbyists have fought back hard, and recent improvements in the global economy and financial markets have robbed momentum from the reformers. What's more, truly ensuring change on a global scale would probably require a single international regulator with power to intervene in local affairs. Yet there is little appetite for that among the G-20, which includes the major industrialized countries as well as China, Brazil, and other developing powers.
The likely result? A package of worthy but lukewarm reforms that leave the global financial system—and taxpayers—exposed to another costly bust some years down the road. "We're not going to have a revolution," says Edwin M. Truman, a senior fellow at the Peterson Institute for International Economics who advised Treasury Secretary Timothy Geithner before G-20 meetings last spring. "The question is to what extent you're going to have, over the next year, a substantial evolution."
International and U.S. proposals on the table target the hot topics: increasing capital requirements, corralling the "shadow banking system" of nonbank lenders, and otherwise trying to ensure that risk doesn't balloon out of control. But in most cases they rely on the kinds of tools that failed the last time around, when supervisors proved less than vigilant, turf squabbles impeded regulation, and fears of foreign competition led governments to yield to industry demands for a lighter touch.
In the chaotic months following the bankruptcy filing of Lehman Brothers on Sept. 15, 2008, few ideas seemed too extreme for consideration. Break up the giant banks. Regulate the survivors like utilities. Ban casino-like bets on the possibility of default by corporate borrowers. Prohibit credit-rating agencies from being paid by the agencies they rate. Above all, build a mechanism so that even huge multinational banks could fail without jeopardizing other firms and national economies.
The G-20 plan doesn't do any of that. It focuses on bolstering the cushions of capital that financial firms must hold, making sure they have the liquidity to survive a cash squeeze, and strengthening the supervision over them. By the end of this year global regulators are supposed to come up with a plan for banks to build up capital buffers in good times that they can draw down in bad ones. That would discourage banks from overlending in booms and choking off credit in busts, as they tend to do. Unfortunately, experience shows that banks are good at getting around tougher capital standards or persuading regulators to ease them.
The G-20 nations aren't even seeking fundamental restructuring. Banking firms could continue collecting government-insured deposits with one hand and, in other subsidiaries, make risky bets on the market—though the cost of doing so could rise.
To succeed, rules also must be applied consistently around the world, but gaps are appearing in European and U.S. officials' united front. European regulators want to establish explicit boundaries for bankers' pay and tie capital requirements to the risk of an institution's underlying assets. U.S. officials, on the other hand, are resistant to strict pay limits and are focused on the capital requirements of the biggest and most important institutions.
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