Time to Stop the Regulatory Circus and to Steer the Ship to Safe Ground

The real issue for regulators around the globe is a serious definition of the financial world we want to live in. The current focus nearly exclusively on the banking sector could cause authorities to miss the broader picture.
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Writing from Istanbul October 6, 2009

After the G 20, the annual assembly of the International Monetary Fund and the World Bank in Istanbul has been a theater (in the true sense of the word) of the most confusing and disparate cacophony of opinions on the issues of the day. The world's financial regulators and Ministers of Finance need to stop their internal competitions and find a different way to reform financial regulation, make the economy grow, ensure that the systemic risk is eliminated and define an exit strategy.

Last year, this same assembly was starting to realize the magnitude of the disaster created by the bankruptcy of Lehman Brothers, the rescue of Bear Stearns and Merrill Lynch, the transformation of Goldman Sachs and Morgan Stanley into a bank, and of course the bloodbath of AIG. This week's meeting in Istanbul is the first assembly after three G 20 meetings, loads of summits and meetings around the world.

Foreign delegations were not amazed to hear, read or see the cacophony of opinions emanating from the U.S. administration and its focus on short term measures, completely missing the global and long-term perspectives. Emerging markets in particular had a field-day explaining that they coped very well with the crisis, did not suffer from a collapse of their financial institutions and were not plagued by greed as the Western Hemisphere has been.

However, this is not an excuse to continue business as usual. Somebody has to rein in the various parties and call them to focus on the work at hand. Yes, they can congratulate each other for the way they managed to stop what could have been a true financial earthquake, but the current landscape is not exactly pretty and it is urgent to make some sense of the current disorder of financial markets. On top of that, they should not ignore their own responsibilities in the crisis.

While all of this is happening, the derivative market's gross exposure is approaching its pre-crisis levels or in the words of NYU Professor, Nouriel Rubini, it is nearly ten times the world's Gross Domestic Product. With $ 1.5 trillion, the fixed income markets (and related bonuses) are at record levels.

The real issue for regulators around the globe is a serious definition of the financial world we want to live in. The current focus nearly exclusively on the banking sector, could cause authorities to miss the broader picture: the non-banking financial sector and global capital markets. By adding charges and equity requirements to the banks' balance sheet and cash flows, we are substantially shrinking the ability of banks to keep loans on their balance sheets and setting up the potential for days of scarce and expensive credit that could threaten the fragile economic growth we currently enjoy.

The United States has demonstrated that unless it reorganizes its regulatory apparatus to make it coherent and to give the Federal Reserve a coordinating role at the Federal and State levels, it will have no credibility. Only president Obama can empower the Federal Reserve Bank to play an essential leadership role, since it has the financial means to act and oversee the systemic financial risks.

Creating a special regime for financial institutions representing a systemic risk could effectively giving them control of banks to the public sector and creating a scenario where institutions that are "too big to fail" will enjoy quasi-Government guaranteed funding.

At international level, three institutions have the credibility to tackle these issues, provided that they closely cooperate: the International Monetary Fund for macro imbalances, the Financial Stability Board (acting effectively for the G 20) and the Bank for International Settlements where central banks coordinate their actions and clear funds between them. The time has come to stop talking and holding high level meetings. Let us see what these institutions will propose. In the mean time, the banks do not remain idle. They already are well under way in their restructuring, even at compensation level.

Now is time to identify a captain to steer this ship to safe ground by giving this person or institution the powers needed to implement a coherent new financial architecture and define the financial world in which we want to live.

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