With the London Summit rapidly approaching, I urge
participants to take bold steps to address the fundamental structural issues in
global finance that have, in part at least, led to the current economic crisis.
I recognize that there remains a debate between those who believe that the
current economic environment compels a dramatic rethink of the foundations,
systems and structures upon which the global economy operates, and those who
believe that such sweeping reforms are both unnecessary and politically
impossible. In short, there are those who seek to begin the process of crafting
a ‘new Bretton Woods’ and those who seek to ban the use of that phrase
altogether.
I fall into the former camp.
The global financial sector is in need of structural reform.
I believe that the current economic crisis provides an opportunity to reshape
the global financial system in ways that more accurately reflect the global
nature and risks inherent in 21st-century banking, finance and capital flows.
The leaders at the London Summit should collectively announce one or more bold
steps to demonstrate that this will not be an exercise in ‘kicking the can down
the road’ but rather a recognition both of what is at stake and that now is the
time to frame a global collective response.
Participants at the London
summit are widely representative. Given the unofficial nature of the London
Summit and the G20 – a group with no formal voting rules, enforcement power or
vetoes – the gathering represents a true ‘free market’ where there is
competition for ideas, creativity and leadership. It provides the perfect
opportunity for a 21st-century successor to the intellectual and creative
leadership of John Maynard Keynes to emerge.
To be successful, it is imperative that the United States
play an active leadership role at the London Summit. The US has a unique
role. It is the world’s largest economy and the incumbent provider of global
economic stability and ballast – through the size of its market and the reserve
currency status of the US dollar, and as the world’s leading financial centre
and capital market. The failure of the US to assume a leadership role, especially
with the presence of President Obama, would undoubtedly be seen as an
opportunity missed.
Thus far, publicly at least, the most innovative and bold
structural proposals have come from Europe, where a recent report by the High
Level Group on Financial Supervision in the EU, under the direction of Jacques
de Larosière, contains some very worthy, realistic and detailed
recommendations. Unofficial groups, such as the G30 Financial Reform Working
Group chaired by Paul Volcker, have similarly issued reports which I urge
summit participants to review carefully and consider seriously. While I will
not take up space here to repeat the specific recommendations of these two
reports, I point to them as examples of the type of thinking that should be in
evidence at the London Summit. In particular, I note the EU recommendation for
the creation of a European Systemic Risk Council. The proposal is important
because it seeks to address the systemic nature of risk, which underpins the
existing financial system, and also because of its inherent inconsistency –
which, in this instance, I consider a virtue. It is inconsistent because if the
risk is systemic, then, by definition, it cannot be limited to Europe but must in fact encompass the global ‘system’.
That is a virtue, because it is a proposal which can be scaled to include a
commitment by all London Summit participants – not just those who are members
of the EU.
I urge participants to expand the possibilities for
cross-border, global structural initiatives to address a crisis, the scale of
which is already beyond anything considered possible only months ago. Failure
to do so may well be seen in the future as a failure of imagination. While not
attempting to put forward comprehensive recommendations for such bold reforms,
I would nevertheless like to propose certain areas for consideration. I believe
that Summit
participants should embrace a deeper exploration of how ‘risk’ is integrated
into the global financial system. Risk is the cornerstone of our financial
system, but how it is treated is one of the most misunderstood aspects of what
is at the very core of needed reforms.
As governments play an increasingly large role in the global
financial system, it is imperative that those proposing reforms consider the
enormous differences between those who approach risk as lawyers, politicians
and policy-makers – for whom, in general, risk is something to be avoided
and/or mitigated – and those in the financial sector, for whom it is something
to be valued and managed. That distinction is of enormous consequence. Any
proposals to reform the global financial system must take into account these
fundamentally different approaches to risk.
This may ultimately result in a bifurcated financial system
in which the more risk-averse are drawn to a more traditional banking model,
and where the systemic nature of the banking sector makes it worthy of
government intervention and taxpayer support. Those entities that seek to take
on more sophisticated financial-sector activities, wherein risk is valued and
managed, would be excluded from the banking sector and would fall into a
non-bank financial services sector. As proposed in the G30 report and
elsewhere, there are a number of different proposals to ensure that this sector
is regulated on a globally coordinated basis to ensure that innovation is not
destroyed but systemic threats are kept under control. These proposals need to
be considered in great detail.
A further observation is that, to be truly effective,
supervision of the global financial system requires not only coordinated
supervision but coordinated enforcement. The global nature of capital flows and
the risk of regulatory arbitrage require that specific and enforceable
sanctions are coordinated on a global basis. This is not a call for a ‘super-regulator’,
but it is a call for individual countries to recognize that sophisticated
financial professionals are paid to execute transactions to create revenue and
profit from the opportunities that such arbitrage presents. To expect the
individuals or the firms that employ them to do otherwise is to misunderstand
their fundamental job description.
I recommend consideration of the recognition that those who
engage in the provision of banking services are acting in a capacity that is crucial
to the successful functioning of national and international society.
It is for this reason that governments around the world have
been compelled to provide enormous amounts of capital and other support to the
banking sector in the recent turmoil and trauma. In this regard, it should not
be unrealistic to expect those who provide these crucial services to be
individually licensed (not just regulated) to do so – as is the case with
lawyers, doctors and other professional service providers. As part of this
reconsideration of the role of financial professionals, I recommend
consideration of a code of professional responsibility for those engaged in
certain banking and financial activities.
As the system is currently constituted, the responsibility
for risk management rests primarily with the institution, not the individual.
When combined with individual incentive structures that virtually invite
risk-taking beyond what might be considered prudent for the institution or,
ultimately, the financial system as a whole, the structure provides limited
personal responsibility with enormous potential reward. Executive compensation
caps do not fully address this.
While I strongly support much needed reforms to existing
incentive and compensation structures, I further recommend the adoption of a
set of basic, but binding, professional guidelines with which individual
financial services professionals’ behaviour should comply. This would at least
begin to address a fundamental structural weakness in the current financial
system, which is riddled with inherent conflicts. Unless we change the
individual’s responsibilities as well as incentives, the reforms necessary to
the financial system may well fail to address fundamental issues.(1)
The global economic climate has deteriorated significantly
since the November 2008 G20 summit. The issues become more serious by the day.
I fully recognize how difficult these issues are and further how complicated it
is to coordinate even a simple meeting of world leaders – much less one as
crucial (and large) as the London Summit. An enormous task has been set before
the countries that will be participating and leading the effort. But it is
precisely because the global economic crisis has become so severe that bold
action is required. Countries must seek to find common ground.
Given the magnitude and scale of the issues now confronting
summit participants, those officials tasked with its preparation should not
feel bound to adhere strictly to the agenda and working groups created four
months ago. Those seeking to take an active leadership role in solving this
crisis, in particular the United
States, should consider bold steps and
proposed revisions to that agenda to more comprehensively reflect the current
global economic crisis.
Now is not the time for caution, but rather the time for
bold assertion of leadership, ideally by the United States, but hopefully with
the collective support of the global community. There is much at stake.
Endnote
1. Unless the regulation, incentives and responsibilities of
the financial services industry are changed, then even a return to economic
growth and a restored housing sector will not fundamentally address the causes
of the current crisis. Financial professionals are paid enormous sums to structure,
sell and trade complex financial products. The fact that housing was the
underlying asset upon which many of these structures were based does not mean
that a similar bubble could not occur with another underlying asset. Clearly
the size of the housing market made this crisis worse than it might otherwise
have been, but fixing housing will not fix the financial system. Had it not
been housing, it could have been consumer debt, credit cards or possibly
something else that would have been ripe to serve as the underlying asset
around which an unregulated culture of derivatives and securitized products
would have been created.
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