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How far is the ability of emerging markets to assert themselves in international financial deliberations?(Reuters photo) |
The fall of Lehman Brothers, the largest US institution ever to declare bankruptcy, opened a new chapter in the global financial turmoil that had started in the summer of 2007 and that seemed, originally, to be confined to a small segment of the US housing market.
Every day new figures on the impacts of the financial crisis reveal the depth and severity of the crisis, even as governments have put aside long-held monetarist beliefs and resistance to state intervention in the market.
And, most countries have taken strong expansionary measures to mitigate the impacts of the crisis.
In the face of this situation, the leaders of several countries started talking about the need for a "Bretton Woods II", in reference to the "foundational" character of the reform that the crisis should trigger.
Bretton Woods was, indeed, the conference that established, right after the Second World War, the multilateral economic institutions that have overseen the world economy up to these days.
In Nov. 2008, the G20— a group of several emerging market countries and was created after the East Asian financial crisis as an informal forum to broaden the discussion on international economic affairs— was vested with a new mandate.
G20 usually meets at Finance Ministers level, but Heads of State were summoned to the United States by then-president Bush for an unprecedented G20 Summit on Financial Markets and the World Economy where they agreed on Principles and an Action Plan for reform.
Bretton Woods II?
| Rather than empowering the country regulators, the existing international framework for banking supervision sets constraints on them. |
Many observers concur that major reforms usually come after major catastrophes, so given the seriousness of the crisis, we may be about to witness a radical transformation of the international economic system.
Looking at the problems that plague the Bretton Woods system, there is no shortage of fixes one could envision for what is left for the Bretton Woods system.
The growth in unsustainable global imbalances— that almost everybody warned about, but nobody was able to prevent— underscores the definitive failure of the IMF as a forum to provide credible coordination of macroeconomic policies among the world's major economies.
A new monetary system would have to depart from the unhealthy over-reliance on the currency of one country for cross-border transactions, as well as the storing of reserves.
The destabilizing effect of sudden capital movements can only be addressed with effective, emergency-financing mechanisms.
Since the unfolding of the Asian crisis at the end of the 1990s, the IMF has been working, unsuccessfully, on the development of one aspect.
The Contingent Credit Line, an attempt that lasted four years, was so ill-designed that no country ever made use of it.
The Short Term Liquidity Facility that the IMF put together in haste in Oct. 2008— amidst the heat of the crisis— may prove a temporary fix, but uncertainty clouds its future role.
The diminished resources that the IMF counts on— as well as the continued flawed conditions utilized to pre-select beneficiary countries to lend them—undermines the utility of IMF.
After a protracted internal debate on the need to increase voting power of developing countries, the IMF— not the World Bank, where the discussion is still incipient— agreed to touch its anachronistic voting system.
The distribution of votes in these institutions— which responded to geopolitical demands in the wake of World War II— needed dramatic reform to take into account more than five decades of developments in world economy and politics.
But the meager agreement that was reached, when fully implemented, will see a meager 2.7 percent of voting power switch from developed to developing countries.
Besides the dramatic failure of the global financial institutions, the crisis brings unquestionably into the debate the role played by ungoverned private capital flows.
This is a portion of the global financial system over which there is little or no regulation whatsoever and whose increased size and importance make them necessary candidates for a regulatory overhaul.
The example of international banks is very indicative. Rather than empowering the country regulators, the existing international framework for banking supervision sets constraints on them.
The Basel Accord, a document developed by the Basel Committee on Banking Supervision in the 1970s, establishes minimum capital requirements for banks.
Vicious Cycle
| The international financial agencies, in turn, searching for increased profits had their own incentive to overlook or be negligent about drawbacks of the instruments they were rating. |
In the 1990s, large international banks complained that they have more sophisticated methods for risk management that were better tailored to deal with the ever-growing complexity of financial instruments.
Subsequent reforms of the Basel Accord progressively gave more weight to these banks’ internal mechanisms for managing risk.
The logic of the Basle Accord presumes banking crises will be avoided by letting each individual bank manage its own risk-taking, a tenet called into question by a crisis whose effects were only magnified by a large number of banks pursuing similar behavior.
Critics also call for reforms of the very process to set such international standards on banking supervision, the Basel Committee.
The archaic governance of Bretton Woods Institutions looks modern, if compared to this committee of the governments of the Group of 7 where there is no developing country participation whatsoever.
But banks are, overall, the most regulated actors in private finance.
The increased opportunities for profit-making and the search for ever higher returns opened the door to the enormous growth in number of hedge funds, private equity funds, and investment banks whose extreme leverage and lack of transparency also contributed to magnify systemic risks.
As more complex financial instruments were designed, credit-rating agencies became more important.
Banks and investors aiming at a pre-specified risk had to rely on credit-rating agencies to find out about the risk grade of these instruments, even asking them to design instruments that would match their desired risk level.
The international financial agencies, in turn, searching for increased profits had their own incentive to overlook or be negligent about drawbacks of the instruments they were rating.
All of these actors are, in the current system, largely left to self-regulatory devices such as codes of conduct and "market discipline" supposedly provided by the investors’ monitoring of their activities and performance.
A More Skeptic Scenario
| As for the Basle Accord, there is no evidence that it will be the subject to more than some tinkering. |
Just as there is no shortage of agenda items for a Bretton Woods II, skeptics point out that drastic reforms of the international financial system will be successfully resisted by those who profited from the status quo. So, only cosmetic changes can be expected.
The quick "mea culpas" and adoption of "tighter" self-evaluation mechanisms by banks, credit-rating agencies, hedge funds and others are, indeed, indicative of their intention to deflect the potential for far-reaching reforms.
The same organizations,whose legitimacy and governance are criticized, have been quick to take the helm of analysis and crafting of reform proposals.
Judging by the tenor of the proposals that have been championed by official actors — whether in governments or intergovernmental bodies where discussion reforms are taking place— there are, certainly, more basis to side with the skeptics.
The program emerged from the G20 Summit in Nov. 2008 does little to address risks posed by continuing global imbalances— let alone their likely deepening as the United States borrows in a massive scale to finance its bail-out program.
The dangerous reliance of the global economy on US dollar and the need to search for alternatives deserve no reflection.
In response to the need of rapid access to crisis liquidity, official consensus seems to be content with the marginal IMF reform of lending facilities.
The G20 statement speaks about increasing the voice and vote of developing countries, but it is worded in a way that may merely be interpreted as implementation of the recent decisions, rather than carrying the reform further.
Enlarging the membership of the Financial Stability Forum and "other major standard-setting bodies " deserves also a reference.
Even if this is done, the mere incorporation of a few countries on an ad hoc basis will not redress the self-appointed nature of these bodies and their profound representational deficit.
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| Obama affirmed that only the federal state has the key to shore up US economy, (Reuters photos) |
As for the Basle Accord, there is no evidence that it will be the subject to more than some tinkering as its basic approach, which is reliant on banks' internal risk management systems as the best tool to achieve systemic stability, is reaffirmed and strengthened.
That "colleges of supervisors" may come as the most far-reaching reform, but within a context where the supervisors are supposed to monitor implementation of a flawed Basel agreement, it will have little meaning.
Some European officials have expressed their intention to insist on broadening regulation to include leveraged institutions, regardless of whether they are banks, hedge funds, or other types.
However, the language of the G20 declaration is rather tentative, reflective of the misgivings that major countries, such as the United States, continue to dominate regulation of these leveraged institutions.
Also, from Europe comes the attempt at imposing some degree of public regulation on credit-rating agencies.
For example, the European Commission’s recent attempt at intra-EU regulation shows already the potential scope of such reforms that may give teeth to provisions embedded in the IOSCO Code of Conduct.
But compared to the initial proposal, credit-rating agencies are successful in stopping major proposals of "reform".
Other Scenarios?
| Oil-producing countries may force their way into the deliberations and agenda-setting for a new global economic system. |
So, the much-touted Bretton Woods II may look very much like Bretton Woods I. But one cannot entirely rule out factors that could prompt the emergence of a different scenario.
One such factor is the action of developing countries themselves. The move towards emerging regional financial architectures, that were gaining momentum before the crisis hit, could be resumed.
In this context, regional cooperation may be seen as a necessity in the face of unjust system whereby developing countries that have managed their economies in the soundest of ways will still suffer from the mistakes of the most developed economies.
Strengthening and setting up regional reserve systems, regional development financial institutions, and regional currency arrangements is a logical way to shield the economies of the developing world from the turmoil.
A second factor is the sway of oil-producing countries that— by the sheer power of having liquid resources very much in need in the hitherto financial centers— may force their way into the deliberations and agenda-setting for a new global economic system.
The recent drop in oil prices has made this scenario less likely, but it cannot be discarded, because longer term projections anticipate that oil prices will not remain low for long.
Thirdly, the mind-changing power of a further aggravation of the crisis should not be discarded. What is unthinkable today may be common wisdom tomorrow as the crisis wreaks further havoc.
Finally, the imponderable human factor cannot be neglected. Indeed, major reforms come after major catastrophes, but one should hope a major catastrophe does not always need to precede major reforms.
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