Monday, November 17, 2008

Action plans (1)

This weekend's G20 meeting has produced a surprisingly long statement which departs somewhat from the usual anodyne assurances. Whether its bullet points and action plan will actually lead to any real coordinated efforts is anyone's guess, but it's hard to see much progress on any of these fronts being made before Obama is sworn in and the EU Presidency rotates.

Root causes?

Quasi-illiterate and question-begging, the statement's language on the root causes of the present crisis leaves much to be desired.
During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers, 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 of domestic regulatory actions.

Major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. These developments, together, contributed to excesses and ultimately resulted in severe market disruption.
From thirty thousand feet, the crisis is an "excess" created by a few market participants out of conditions of "prolonged stability" -- an anomaly, an outlier. Regulators failed to "keep pace" (it wasn't that they were incapable of doing so). Market participants sought higher yields (it wasn't that they were compelled to do so). The Pyrrhonism that has come to be associated with Nicholas Taleb -- the idea that the crisis was a "black swan" which no one could have anticipated, a reminder perhaps of eternal human frailty and the limits of cognition, but one without any more determinate consequences -- and the pensée unique reveal a hidden filiation: absent from either is any sense of structure.

In this world of mere phenomena, nothing concrete can be named. So "unsustainable global macroeconomic outcomes" -- but not the great actually existing polarities structuring the international economic system, the US as debtor of last resort and currency hegemon, the Chinese willingness to lend -- and inability to do otherwise. Nor the national policies in the advanced industrial countries which, whether nominally driven by the state (Britain, France) or the private sector (US), or transparently a result of rent-extraction (Norway), prop the standard of living of white people far above the global average in a futile attempt to postpone the equilibration of the most important economic disparity of our century, the vast concentration of capital in a few countries and labor in the rest.

Throw more money at it

On the way up, financialization is a necessary, virtuous symptom of industrial growth -- indeed, our great thinkers held not so very long ago, finance and other tertiary or even "quaternary" sector activities can replace manufacturing and agriculture as the roots of national wealth (thus the disastrous specialization of cities like London and New York in catering to the whims of transnational elites). On the way down, monetary disintermediation and debt deflation are perverse, unintended, unnecessary, and to be halted at all costs. Money and finance as essential social functions when they yield rents for politicians; as inessential mere appearances when they inconveniently refuse to extend more credit to the bankrupt.

Which is when government steps in.
* Recognize the importance of monetary policy support, as deemed appropriate to domestic conditions.
* Use fiscal measures to stimulate domestic demand to rapid effect, as appropriate, while maintaining a policy framework conducive to fiscal sustainability.
* Help emerging and developing economies gain access to finance in current difficult financial conditions, including through liquidity facilities and program support. We stress the International Monetary Fund's (IMF) important role in crisis response, welcome its new short-term liquidity facility, and urge the ongoing review of its instruments and facilities to ensure flexibility.
The ongoing coordinated bailout is likely the largest single government intervention in economic affairs in history. No surprise that it's likely to continue until either markets yield before it (certainly possible) or a genuine catastrophe ensues (sterling crisis, a sustained run on the dollar, sovereign debt crisis of an EMU member, revolution in China).

In the mean time, the temptations of beggar-thy-neighbor policies will only grow. Here that will mean fiscal stimulus that supports national champions -- like automakers -- in a deadly race to the bottom to subsidize global overcapacity, legacy costs, and inefficient production methods. So too the risk of unintended consequences from uncoordinated policy interventions -- as market participants learn the structure of bank recapitalization programs and new lending facilities and their quirks, and start to arbitrage one monetary authority against another. The spectre of the IMF as a global monetary authority is a hopeful one -- but relies on commitments to fund its operations which may well be withdrawn in the face of bigger problems at home.

Globalization tested
We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports. Further, we shall strive to reach agreement this year on modalities that leads to a successful conclusion to the WTO's Doha Development Agenda with an ambitious and balanced outcome. We instruct our Trade Ministers to achieve this objective and stand ready to assist directly, as necessary. We also agree that our countries have the largest stake in the global trading system and therefore each must make the positive contributions necessary to achieve such an outcome.
Leave aside the unhappy word "modalities" (it's a technical term of WTO negotiation). This is the strongest statement yet from a global or quasi-global body on governments' commitments to free trade and a globally interconnected economy -- even recognizing that those commitments will entail near-term costs for at least some of their domestic economies. And it is the strongest and most important single pledge in the G20 document. Unfortunately it is strong just because it is testable -- and whether new trade barriers are erected in the next year will be the biggest test of whether governments understand the importance of their interconnections. A Detroit bailout would be an inauspicious start to meeting this commitment.
Regulation is first and foremost the responsibility of national regulators who constitute the first line of defense against market instability. However, our financial markets are global in scope, therefore, intensified international cooperation among regulators and strengthening of international standards, where necessary, and their consistent implementation is necessary to protect against adverse cross-border, regional and global developments affecting international financial stability. Regulators must ensure that their actions support market discipline, avoid potentially adverse impacts on other countries, including regulatory arbitrage, and support competition, dynamism and innovation in the marketplace.
All true -- and nothing is weaker than truisms. Informed observers agree that this language is thanks to the US's unwillingness to tie its regulatory hands in any way -- a repetition in another key of our Queen of the May behavior towards other international institutions (the International Criminal Court, the Kyoto Protocol, and, oh, just fill in your favorite example). Whether the SEC, which has trouble implementing the XML standards it writes itself, is even capable of doing much in the way of "international cooperation," is another question.

The reality is that the current state of international financial regulation is the result of an ugly race to the bottom, the pigheadedness of individual regulatory bodies, and the galvanic reflex-arc of politicians stuck with scandals they don't understand. So Sarbanes-Oxley in the United States (because of "Enron"), even as the key provisions of Glass-Steagall are repealed; landgrabs for new regulatory territory (the NY State insurance regulators announcing unilaterally that they would regulate CDS) when old rules aren't being enforced. Or individual nations with strong traditions of securities regulation that refused to bow to trends -- and find themselves back in fashion (Canada). The blatant example of Britain, whose Labour governments rode on the back of a booming financial services business attracted by deliberately low taxes and lax regulation, designed to suck financial business away from other countries: the Gulf States hoping to follow the example of London. Within the EU, no one is clear on jurisdiction or on the Byzantine (and seemingly unwarranted) complexities of individual countries' securities law: witness the Volkswagen debacle, which caught investors from all over the world who didn't realize that in Germany it was possible to take vast stakes in a company through cash-settled swaps without ever announcing it.

Is there any regulator willing to take the lead? Which means not only to set out a clear, efficient, professional system of market regulation -- and then to enforce it, with all the costs (including the recruitment of talent) that entails -- but also to show the markets a path forward where financial "competition, dynamism and innovation" means something aside from tax evasion (sorry, "optimization"), regulatory and legal arbitrage, and structured obfuscation?

The innovation required is on the scale of the original invention of 1933 and 1934 -- the creation of the SEC. We may be excused for failing to see where the personal authority and the political will of a Franklin Roosevelt or a Joseph Kennedy (or even, in a much more muted key, a Carter Glass or a Henry Steagall) is to be found.

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