Wall Street’s embrace of foreign markets makes it nearly impossible for national regulators to keep watch over what’s being sold abroad and to whom.
This sentence comes from one of the most important stories BusinessWeek has run this year, “The Perils of Global Banking,” by David Henry and Matthew Goldstein. The story lays out, in precise detail, just how a globespanning financial firm like Lehman escapes the grasp of national regulators during good times—and how it leaves behind an almost indigestible global mess for regulators when things turn bad.
The Henry-Goldstein story helps explain just why Obama’s new financial regulation proposal feels so..unsatisfying. Basically, the Obama proposal calls for beefed-up national regulation, in an increasingly global world. The proposal makes a nod to international coordination, but it’s weak, weak, weak.
Here’s the problem, or rather two problems: First, the U.S. has no way to require other countries and regions—EU, Japan, Russia, China, India—to tighten up regulation enough to really make a difference. Every region has their own interests. That gives plenty of room for financial institutions to search “high and low for the most beneficial legal environments for particular lines of business,” as Henry and Goldstein put it. In fact, the tighter regulation gets in one country, the more incentive there is for financial institutions to spread themselves around the world.
Second, the Obama proposal simply doesn’t deal with a Lehman-type problem—how can national regulators deal with the failure of a global financial institution? To put it most bluntly, who pays when disaster strikes? The Obama folks know they have a problem. They write:
Currently, neither a common procedure nor a complete understanding exists of how countries can intervene in the failure of a large financial firm and how those actions might interact with resolution efforts of other countries. For instance, countries differ on close-out netting rules for financial transactions or deposits. National regulatory authorities are inclined to protect the assets within their own jurisdictions, even when doing so can have spillover effects for other countries.
The Obama folks offer suggestions for more study and more international cooperation, including:
further work on the feasibility and desirability of moving towards the development of methods for allocating the financial burden associated with the failure of large, multinational financial firms to maximize resolution options
To translate: The only way to truly solve this problem is for countries to give up some national sovereignty, and allow a central global board to allocate the global losses during a crisis to different countries.
The fact is, it’s not going to happen anytime soon, no matter how much sense it makes. Can you imagine the U.S., Europe, Japan, China, Russia, and Saudi Arabia, say, allowing a global board to control multitrillion (perhaps) spending decisions during a crisis? Cue the black helicopters, boys.
Even in Europe, there’s no political will for central management of the next crisis. There’s agreement on a new European Systemic Risk Council, but according to a WSJ piece, “European Union leaders have agreed that a new financial-market overseer won’t be able to force countries to pay for bank bailouts.” Of course not. No one wants to give up any sovereign control.
This time around, the financial crisis was contained, because the U.S. government was still large enough—barely—to take on the burden of being the lender of last resort for the world at the moment of truth. Taking over AIG—and pouring billions through the insurer into European banks—was an astounding case of the U.S. doing “the right thing,” at large cost to itself.
It won’t happen again. The U.S. will never again be large enough, relative to the size of the global economy. And by the time the next crisis rolls around, the dollar will no longer reign supreme as the world reserve currency, significantly reducing the Fed’s maneuvering room.
I’ve got some more thoughts about the Obama proposal, and what it tells us about the shape of the next crisis. In particular, will tighter national regulation force financial institutions to turn themselves into true transnationals—global networks of affiliates which borrow and lend to each other. But that’s for another post. For now, I suggest reading the Henry-Goldstein story, and ask yourself this question: Does the Obama proposal really give regulators the firepower they need to deal with a repeat of the global Lehman disaster?