Posted: 25 Sep 2009 05:25 AM PDT
The IMF Should Move To Europe
The headline news from the G20 summit in Pittsburgh is that progress has been made on “IMF reform,” meaning increased voting power for emerging markets relative to rich countries – remember that West Europeans are greatly overrepresented at the IMF for historical reasons. But further change in a sensible direction is being blocked by the UK and France – because they have figured out that this logic implies they would lose thei individual seats on the IMF’s executive board.
The way to break this impasse is (1) for the European Union to consolidate into a single seat or membership, and (2) for the Union to assert its right to be the headquarters of the IMF (under the Articles of Agreement: “The principal office of the Fund shall be located in the territory of the member having the largest
quota…”).
The US will push back hard – arguing that only countries can be members of the IMF. But what’s a country for these purposes? The UK, for example, has
elected assemblies in constituent parts of its union (and different soccer teams), but can still belong to the IMF: “Membership shall be open to other countries at such times and in accordance with such terms as may be prescribed by the Board of Governors. These terms, including the terms for subscriptions, shall be based on principles consistent with those applied to other countries that are already members.”
Ultimately, this kind of decision is more about high politics than international law. The only part of the world where the IMF currently has the legitimacy to make a difference is in Eastern Europe, and most of the additional resources for helping that region should come from Western Europe – after all, Brussels had the not-so-good idea that “convergence” through EU accession meant that running massive current account deficits was somehow a good idea.
Europe still insists on the right to nominate one of its own to be managing director of the IMF, which is an awful anachronism at this point. The New IMF could be based in London with a French boss, or in Paris with a British boss. The EU would have a powerful voice and the US would keep its veto.
The emerging markets, outside of Eastern Europe, would still be annoyed and with good reason – but they should really stop complaining and just set up
their own fund (building on the Asian Chiang Mai initiative);
China, India, Russia, Brazil, and Saudi Arabia have more than enough financial firepower to make this happen.
By Simon Johnson
More on Managing Systemic Risk
Posted: 25 Sep 2009 04:00 AM PDT
David Moss wrote a good article in Harvard Magazine about systemic risk and regulation; it’s based on an earlier working paper of his. The problem statement is not particularly original, but very clearly put: Depression-era regulation brought an end to recurring financial crises because deposit insurance was combined with strict prudential regulation to guard against moral hazard. Half a century of stability, however, was undermined by a philosophy that regulation was not only unnecessary but harmful in financial markets, at precisely the same time that financial institutions were becoming dramatically larger in proportion to the economy as a whole. For example, as Moss points out, “the assets of the nation’s security brokers and dealers increased from $45 billion (1.6 percent of gross domestic product) in 1980 to $262 billion (4.5 percent of GDP) in 1990 to more than $3 trillion (22 percent of GDP) in 2007.”
The problem today, in Moss’s words, is that “implicit guarantees are particularly dangerous because they are typically open-ended, not always tightly linked to careful risk monitoring (regulation), and almost impossible to eliminate once in place.” The solutions he outlines basically boil down to renewing that tradeoff, so that government guarantees are explicit and financial institutions pay for them through more stringent regulation and cash.
On stricter prudential regulation:
“[A]n important advantage of the proposed system is that it would provide financial institutions with a strong incentive to avoid becoming systemically significant. This is exactly the opposite of the existing situation, where financial institutions have a strong incentive to become ‘too big to fail,’ precisely in order to exploit a free implicit guarantee from the federal government.”
On making systemically important institutions pay for their guarantees:
“One option for doing this would be to create an explicit system of federal capital insurance for systemically significant financial institutions. Under
such a program, covered institutions would be required to pay regular and appropriate premiums for the coverage; the program would pay out ‘claims’
only in the context of a systemic financial event (determined perhaps by a presidential declaration); and payouts would be limited to pre-specified
amounts.”
Moss thinks there needs also needs to be a receivership process in place as a backstop should both prudential regulation and capital insurance fail. I think this all makes sense in concept, although I still prefer the idea of simply breaking up the large financial institutions and preventing them from reassembling, either through size caps (yes, I know, this is a complicated issue) or new antitrust laws. One problem I see is that better regulation is based on the premise of better regulators, and until that problem is solved (pay them more? inspect them more closely?) nothing else follows. Moss favors a new agency dedicated to systemic risk regulation (read: not the Fed). However, I previously referred to this as the “posit a good regulatory agency” premise. I prefer the idea of just having smaller financial institutions because it doesn’t require this particular can opener.
By James Kwak
Neal Wolin And The Bankers
Posted: 24 Sep 2009 07:47 PM PDT
Deputy Treasury Secretary Neal Wolin addressed the Financial Services Roundtable today. His prepared remarks included the following key paragraphs, “The days when being large and substantially interconnected could be cost-free – let alone carry implicit subsidies – should be over. The largest, most interconnected firms should face significantly higher capital and liquidity requirements.
“Those prudential requirements should be set with a view to offsetting any perception that size alone carries implicit benefits or subsidies. And they should be set at levels that compel firms to internalize the cost of the risks they impose on the financial system.
“Through tougher prudential regulation, we aim to give these firms a positive incentive to shrink, to reduce their leverage, their complexity, and their interconnectedness. And we aim to ensure that they have a far greater capacity to absorb losses when they make mistakes.
“…… Leading up to the recent crisis, the shock absorbers that are critical to preserving the stability of the financial system – capital, margin, and liquidity cushions in particular – were inadequate to withstand the force of the global recession.
“While the largest firms should face higher prudential requirements than other firms, standards need to be increased system-wide. We’ve proposed to
raise capital and liquidity requirements for all banking firms and to raise capital charges on exposures between financial firms.”
There is nothing wrong with this statement of principles, although I would prefer a much blunter statement of “Too Big To Fail is Too Big To Exist”. But where are the numbers? How much is the administration proposing to raise capital requirements, and how will these steepen as banks and other financial firms move into the “red zone” above $100bn total assets? Without specific figures on the table, it is simply impossible to evaluate whether
this is a good proposal or window dressing.
Don’t tell me leading administration figures don’t have a view on the numbers – with the lobbyists and behind the scenes with journalists they are happy to provide more specific briefings, and you know that Treasury/Federal Reserve Board guidance or “input” into the regulatory process will have huge weight. And all the background information – including Treasury’s recent actions vis-à-vis big banks, this week and last – point in the same direction: window dressing.
Mr. Wolin, for your proposals to have credibility and to win support, you must answer the question: in the view of the administration, how much capital is “enough”?
By Simon Johnson