Can a global financial system be made safe without creating a global regulator?
Hoping to avoid future crises, the Obama Administration released its plan for financial regulatory reform on June 17. The proposal, loaded with good ideas, would help U.S. regulators monitor financial stresses during good times and give them new powers to deal with troubled U.S. financial institutions.
But the reform proposal is unsatisfying, precisely because in an increasingly global economy it focuses mainly on beefing up U.S. regulation. Until now that was a workable strategy. Even globe-spanning giants like Citigroup (C) and Goldman Sachs (GS) got the bulk of their income and revenue at home, enabling them plausibly to be regulated by the U.S. government. For example, in 2006, Citigroup received 56% of its income from the U.S., roughly matching the location of the company's loans.
In the future, however, the successful big financial players will expand beyond the reach of a single national government. Rather than being concentrated in New York or even London, they will go where the growth is. As a result, they will have their revenues and assets spread more or less equally across the U.S., Europe, and Asia.
The current crisis already has given us a glimpse of the damage that can be done by financial institutions operating beyond the reach of U.S. regulators. A recent BusinessWeek story, "The Perils of Global Banking," (BW—May 18) described in detail how Lehman Brothers was able to issue $35 billion in complex bonds from a small office in Amsterdam—bonds which might have raised a lot more questions if they had been issued in the U.S.
Globalization also makes it more difficult to figure out which government will lay out the big bucks to support a mammoth financial institution in the event of a crisis. Until now the U.S. had enough economic heft to serve as the global lender of last resort. For example, when the U.S. government threw enormous sums at American International Group (AIG) to keep the embattled insurer afloat, at least $58 billion went to banks and other creditors based outside the U.S.—an altruistic move that helped contain the global crisis. In the future the U.S. may no longer be able to afford to spend in this way.
The Obama officials who wrote the financial regulation proposal are aware of the problem. In a section on international cooperation, the report calls for "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."
But that's just talk. In theory, what's needed is a global board with the power in a crisis to decide how much each country will contribute to financial bailouts and guarantees. But be serious—can you imagine Barack Obama, President Hu Jintao of China, Chancellor Angela Merkel of Germany, and other G-20 leaders allowing a global authority to control trillion dollar spending decisions during a crisis? In early June, Merkel publicly criticized U.S. policies, saying : "I view with great skepticism the powers of the Fed."
True, Europe is also moving towards imposing stricter regulations and creating new European financial supervisors. But the new agencies won't have the power to force European countries to pony up money to bail out failed banks.
As strange as it may sound, it may be that this crisis was not bad enough to force nations into the difficult step of giving up some sovereignty. Remember that in the U.S., the Federal Reserve was created only after the Panic of 1907 frightened Wall Street bankers. With the global economy seemingly on the mend, we will have to live with reform proposals which only go partway.