od-G20-communique

Before the crash, much hope was placed in "decoupling" -- essentially the belief that we were not _so_ globalised that a fall in demand from Americans rebuilding their savings would be contagious everywhere else. One view of the most sensible reflation policies -- pump prime demand in China -- is to create by policy the decoupling we did not have automatically.

This one is interesting from the p.o.v. of the UK and other highly-leveraged small open economies. Gordon Brown wants to have government spending and tax cuts in the UK to make up for the lack of spending from households and the rest of the world. But there is real trouble for a small open economy "going it alone": much of the stimulus leaks abroad in imports; interest rates have to be raised to attract lending to the government; or money has to be printed, increasing inflationary expectations and so forcing government to pay higher rates on debt to avoid a run on the currency. (The Shadow Chancellor is in trouble for pointing out this particualr difficutly of being small). Mitterand's attempted 1981 reflation was the classic case of an open economy that could no longer operate Keyneisanism in 1 country. If everyone reflates together, the worry about import leaks disappears; also, the exchange rate worry disappears, since there is little relative difference between currencies. Viewed in this light, Gordon Brown's emphasis on the international coordination aspects of the crisis is in the UK's narrow interest.

There was a certain allignment between the "Washington consensus" of the immediate post cold war and the neo-connery that followed. The Washington consensus was that pro-free trade, pro-market reforms (and maybe democratic reform also) would rapidly end poverty in the less developed economies. Neo-connery was frustrated at the slow-pace of reform and added institutional change by force to the list of medicine that might be needed, Now, if the World Bank starts to lend more freely and has more capital to hand out, will the questions of control over the spending be refashioned? Or do tanks eventually follow where World Bank money has blazed the trail?

States vote against "regulatory arbitrage" like turkeys against Christmas ... my sympathies tend to lean towards the turkeys.

Delivering on this will require regulation of bonus contracts. Good.

Credit rating is at the heart of what went wrong. Banks paid agencies to rate their complex products. Surprise - the rating agencies gave good clients good ratings, even if they understood nothing about -- or worse, overlooked -- the risks they were supposedly judging. Have a multilateral institution like the BIS provide public credit ratings. Levy a tax on financial institutions to pay for it (yes, even a Tobin tax). Make the jobs incredibly attractive - as good as being a civil servant in Signapore. A code of conduct sounds like the kind of thing that monetary incentives will pervert in no time.

I agree. The right assessment of credit risk is so strongly in the public interest that it cannot responsibly be left in private hands - especially when the temptations to do it badly are so strong, the track record of the agencies shameful, and the consequences of it's being badly done such a high public cost.

If they are serious about this, the "basic vote" in the BWIs (250/country in the case of IMF), which has served primarily to facilitate a feeling of equality among states, must be given higher authority at the cost of the weighted elements, "the quota", and the principle of running the fund and the bank as private business corporations. USA will probably be skeptical, but legitimacy restoration of the BWIs must perhaps go beyond rhetorics. Countries like Saudi Arabia and China may be able to increase their financing and thus quota. But will the basic votes be given higher authority?

Jesper - Can you give us a brief overview of the current basic votes versus weighted votes in the Bretton Woods Institutions (... and, by the way, does that apply to the WTO too...)? Thanks, Tony

Jesper has added his clarification on the weighted versus basic votes in the comments section at the bottom of the communique.

This work has partly been counterproductive and harmed poverty reduction in so far as it has harassed people who sends legitimate remittances to friends and relatives in poor countries through informal channels (e.g. hawala systems).

Jesper, can you give us a brief bit of background on what the FATF is and when it arose. Thanks, Tony

FATF is an international body initiated 1989 by the G7. Its aim is to develop policies to combat money laundry and terrorist finance. It also composes black lists and names and shames of countries who doesn't follow its recommendations/requirements in regard to transparency on financial flows etc. This have had effects on credit ratings. I don't know the details of either FATF or remittances. Combating money laundry and terrorist finance is all good but critiques argue that FATF and others have been "over ambitious" in the post-911 era. For instance, FATF and the developed countries perceive all informal money flows as illegitimate. Its widely acknowledged that ex-patriots from developing countries sends large sums to their friends and relatives in the home countries. While it may not be panacea for development -- in fact there can be several problems -- remittances to developing countries account for up to 3 times global ODA. But, it's hard to find and ATM in for example Nanga Tarbat. Therefore people often send money through informal and reciprocal "fei qian" or "hawala" systems. I know that Somali-Swedes in Sweden which is a FATF member who have sent money through such channels have been arrested and harassed but no evidence have been produced to suggest that they have done anything illegal. "Informal services as well as some of the smaller MTOs, however, do not readily comply with international standards of transparency and accountability, which are also becoming tighter as the Financial Action Task Force (FATF) and other stakeholders seek to ensure better control and security through regulations and their enforcement... [C]lamping down on informal services regarding the effect on flows of remittances and the cost of transfers, on the other hand. ... can have strongly felt effects on livelihoods. The latter is underlined, for instance, in the case of Somalia." (Cerstin Sander 2003 Migrant Remittances to Developing Countries http://www.dai.com/pdf/Migrant_Re

What I missed to write is that to be fair FATF has aknowledged the importance of remittances even though they naively believe that all informal remittance channels shall be registered. Daunting task. Anyway, I don't understand why FATF is even mentioned in a top leader communiqué on the global financial crisis. Can imagine there are some tough agenda setting struggles. free trade, regulation, climate change, war on terror...

At least a part of the difficulty with figuring out how bad things are in the financial sector has come out of the habitual use of opaque offshore "Special Investment Vehicles" to build complex financial products. I take it that this clause says: "we'll clamp down on the Cayman Islands Financial Authority". I wonder how you credibly threaten to do that. Assume there'll always be a jurisdiction out there that carves a niche out of off-shoring. You have to say: "if your financial product is contaminated with off-shore structures, we will stop you from benefiting from lender-of-last resort protection from the international and national institutions." But the SIV's were meant to be off balance sheet until it turned out they were too big to fail. Remember, the UK taxpayer is now the proud owner of Granite, a huge tax-dodge in Jersey that is attached to Northern Rock. The problem with "too big to fail" is enforcing regulatory threats. So I think that very serious anti-trust needs to be part of this re-working of banking to stop size becoming an excuse for turning a blind eye to suspect behaviour.

I agree with your anti-trust point, but I don't believe your threat will work. The last-resort lending would have to be withdrawn in advance of a problem, or the bank can carry on at full speed until it crashes. For that, you would need continuous audit and disclosure to the last detail of every transaction, which is hardly practicable though it would be wonderful for accountants. I think you have make it personal. Any director of a bank that engages in off-balance-sheet finance is criminally liable. Fine, prison, disqualification, the works. Just like directors of insolvent companies defrauding creditors. Wait a minute....

or ease up on limited liability, maybe - as in http://www.opendemocracy.net/globalization-institutions_government/corporate_responsibilities_4605.jsp and http://www.opendemocracy.net/audio/admin/corporate_liability_and_social_interest I guess that didn't prevent Lloyds...

Interesting leadership group. Note that the Fed extended swap lines to Korea and Brazil of the same type that it had extended to the UK. So everyone in that group is already part of the solution that effectively allows non-US central banks to create dollars.

This kind of control over agenda is important. Gordon Brown is in a good position to promote the interests of the small, over-leveraged open economy....

This is the criticism made of the Bank of International Settlements capital adeqacy definitions. When times get tough, asset values fall; so banks' capital is worth less, so they have to scale back on their lending. Of course, the problem was more that the banks got around the BIS rules by creating off-balance sheet vehicles. If only they had followed BIS rules.

This is the argument about mark-to-market accounting. When regulating bank capital and leverage, it is very important to be able to define what the value of the assets and liabilities are. Mark-to-Market rules are based on the idea that the market knows best, so market prices should be used to value assets and liabilities. But when markets disappear for certain products in time of crisis, price goes to zero and, if they are part of banks' capital reserves, banks would have to corepsondingly cut lending. An alternative proposal is to value capital "at maturity" -- what will this loan be worth in 5 years when it needs to be paid back? You can be sure that all measures will be manipulated.

"Over the counter" markets are bilateral markets in tailor-made financial contracts. The trouble with these contracts is that no one has an overview of what everyone's positions are, so it is impossible to tell what the system-wide risk is if any one party defaults. Exchange-traded contracts, on the other hand, get system-wide information because they act as a clearing-house -- they record all trades and often offer settlement and other infrastructure services. It is therefore easier to regulate exchange-traded markets.

allign the incentives -- this could end up being a very powerful mechansim for policy. You want green investment? put it into the compensation metrics. The financial crisis has certainly shown us that the banking sector responds fast and massively to incentives. Youjust have to make sure they're the right ones.

I agree. In an ideal world, this is an opportunity to steer the market toward longterm oriented, socially and environmentally sound development.

There's a lot of talk about directing all kinds of activities and decisions, including pay. But is this going to happen without nationalising everything? Targeting banks looks unfair. Targeting high pay for 'really' superb performance also looks unfair, certainly unnecessary. How high is too high, anyway? Do we want to spawn an industry of avoidance vehicles (off balance sheet pay)? Or yet more lawyers in the boardroom? Isn't it cleaner to define prohibited activities for authorising which directors are severely punished? We already have a few: fraud, environmental damage, health and safety at work, insolvent trading... Fear is the other great motivator.

I don't think it requires full-scale nationalisation. externalities really need to be identified and an institutional form for them has to be found -- or the power of incentive will lead the system to dangerous excess. There are real externalities in compensation practices -- specifically that shareholders all try to free-ride on the supervision of boards and executives. I don't know what my favourite solution is, but what we know is that externalities can no longer be papered over by "gentlemanly behaviour" (http://www.opendemocracy.net/article/globalisation/institutions_government/end_of_capitalism)

International Financial Institutions

These are the centers of "moral hazard": they are too big to fail, so they take advantage of it. These are the ones that need to become regulated like utilities. (http://www.spectator.co.uk/email/the-magazine/business/642796/say-farewell-to-gentlemanly-capitalism.thtml)

So now they are telling us that the decade of the war on terror that opened with the destruction of the Wolrd Trade Centre in New York, no less, and included the invasion of Iraq was a period of "prolonged stability"! Was the continuous economic growth in no way connected to a military bubble as well?

Good point, Anthony. One of the troubling aspects of the depression we're entering is that government spending and borrowing have been so high going into it (and military spending has been a good chunck of that) that we are in real uncharted territory. The notion of UK sovereign default is not outlandish. Anyone warning us of US sovereign default yet?

I had the privilege of attending last year's "progressive governance summit" at which Gordon Brown, Pascal Lamy (WTO head), DSK (IMF head) and Peter Mandelson (then EU Trade Negotiator) all agreed that we needed an IMF that will be a real financial Early Warning System, a UN that will be a real resolver of conflict and a World Bank that will be a real promoter of the environment and a WTO that actually delivers the Doha round. You can see this G20 setting the scene for that vision, except on the conflict side (naturally, this is about economics), but more strangely, there has been no mention of greenery at all so far...

OK .. here is climate change. A sort of footnote that says: "poverty and growth are not the only problems we have ..."

This analyses the problem as mechanical: bad practice and regulation. But when real growth and profitability are in the region of 2%, a 25% return on capital, as routinely demanded by investors, cannot be sustainable. This demand led to leverage and financial engineering. The implication is that with 'better underwriting' etc. we can go back to 25% returns, but more safely. Instead, we may have to get used to the idea that a 4-5% return on investments is really quite good.

You're right, although the 2% growth number may well under-state what you can expect from private enterprise. After all, the 2% GDP growth includes 40% of government spending on sectors where growth is notoriously hard to measure. So 2% GDP growth might actually be consistent with corporate growth of 5%

-- though nominal UK govt spending has increased by 6% p.a. on average for the last 20 years, which might suggest corporate growth has not been that different. But this doesn't affect the wider point about demand for financial returns in the 20-30% range.

The basic mis-allignment of interests in accounting exercises must be recognised: accounting is always about monitoring, and the monitored would almost always prefer to be left alone. Reading this section on accounting standards, I do woner: "weren't we exactly here just recently with Enron and WorldCom? So why didn't that regulatory change fix these things?" Because the conflict of interest is stronger than any standard can be.

What's the argument for this linkage?

This is Buiter's complaint -- that the UK has no special bankruptcy mechanism that makes it _possible_ to bankrupt banks, even ones that are not sytemically important but just politically important. See http://blogs.ft.com/maverecon/2008/11/could-the-uk-face-a-sterling-crisis-or-are-we-in-one-already/

This has to mean public provision

I'm puzzled by this one.... Anyone care to elucidate? Who is the intl org of securities regulators? and how can they have the competence to review compliance?

Looks like http://www.iosco.org They have a €2m budget.

so this clause was put in by the credit rating agencies, do you think? this is not the foxes in charge of the hen-coop, but rather the foxes putting the tortoises in charge of the hen-coop :)

so i see that thte credit rating agencies must have inserted this :) €2m, less than 10 low-level banking jobs (before bonus) to check the credit rating agencies??

I am a bit puzzled at the heavy weather made of the exchange traded point. OTC makes it sound as if this market happens with bits of paper - contracts - traded. But not at all -- participants' positions are in sophisticated electronic form ... they are just dispersed. Centralising that daat is a regulatory question, not a "platforms" question.

I agree this is overdone. And the logic is that banks, unlike other institutions, should expect ALL their transactions to be recorded in some central place(s). If not, then as soon as anyone thinks of it, trades will take place off market: that's what innovation - which everyone is still in favour of - implies.

I wonder whether SPVs are actually a bit of a scapegoat. Clearly regulators and governments had no data to aggregate global liability positions. (Would it have made any difference if they had?) But the originators of SPVs knew what they were doing, presumably knew that all their trading partners were in the same game, and were selling paper to buyers who knew what they were buying. So either the SPVs were not in the end off-balance-sheet - and it's hard to believe they were generally faulty - or they were off-balance-sheet, in which case it's the buyer of the security, not its originator, who has the problem. The issue is really whether the _assets_ have value, not whether a heap of liabilities are suddenly going to re-appear on the balance sheet. It was AIG, who among other things provided the credit guarantees for SPVs, who really copped the liabilities when it became clear that the assets were worthless. Since insurers had been badly burned as recently as the 1990 property crash and have form here. The circle turns back to the credit rating of debt instruments and the aggregation of risk in the companies that support them with guarantees. To summarise, it seems the task is less to define off-balance-sheet as really on-balance-sheet, as implied by calls for more and more disclosure, but to ensure that the rating of debt instruments takes place outside any bubble surrounding the underlying assets and liabilities.

but surely you cannot rate anything if you do not have an accurate picture of assets and liabilities - which the balance sheet is meant to provide?

but how can anyone measure the value of assets and their riskiness if you don't know that the balance sheet contains all assets and liabilities? So it is not just whether the assets have value -- if they are not measured, the temptation will be to create more assets that have risky values. How you measure influences what you end up with --- (a sort of financial version of Heisenberg, maybe?)

'Cost of capital' arbitrage - where business is moved to the industry with the lowest reserving requirements against that particular risk - is certainly a feature of insurance-guaranteed mortgage-backed securities. The case would still have to be made that having the same capital reserve requirements everywhere would be better than having different ones.

isn't the point in principle quite clear: the risk is not different depending on what institution insures it; so the minimum capital to set aside against it should not differ?

Interesting - presumably different reserve requirements for different types of businesses (banks vs. insurance companies, for example) came about beacuse they were thought to operate on different points of the risk/return frontier. But once everyone could engineer their way onto any point of the frontier, the argument for different requirements _overall_ requirements goes away, no?

This seems to be the only mention of the state actually using the data it proposes to collect, and it's largely backward-looking.

Fine. They should also be public.

The Keynesian stimulus shoudl clearly go to the "well-run" emerging economies and create export demand in the developed west. this will avoid a resumption of the over-consumption and silly investment in houses, SUVs etc.

the specific mention of infrastructure investment here is encouraging.