Friday, October 17, 2008

To Grandmother's House We Go

. Friday, October 17, 2008

If banks are the bridges of the financial industry, and world governments are able to prop them up sufficiently well as to avoid any more major collapses, then where do we find ourselves? According to Gordon Brown, the next step is the development of a new Bretton Woods system. Nevermind the poor historical analogy; if Bretton Woods I was formally constructed as an international security measure while WWII was still raging, and if Bretton Woods II was informally constructed by the U.S. running current account deficits in order to finance cheap current consumption, which in turn boosted export-biased growth in developing countries (with the U.S. dollar as the de facto reserve currency for the world), then I'm interested in what Bretton Woods III would look like. What formal or informal structure will emerge in the coming years as the controlling mechanism for the world economy? Or, more specifically, what institutions might be developed which would prevent future crises from resembling the present one? I see several possibilities, none of which strike me as being especially likely.

1. The development of a new international agency, with the scope and resources of the IMF, dedicated to providing short-term liquidity directly to major banks (or investment firms with large counter-party obligations?) in any country, without the approval of that bank's host country. This agency would have the authority to demand structural changes to lending or investment practices of the banks they aid. In other words, the loans would be tied to some actions. These demanded actions may include things like higher reserve requirements, equity stakes in the banks in exchange for the capital, preclusion from engaging in credit default swap markets or taking on other investments with large exposure to system risk. It's possible that this could be done under the auspices of the IMF if certain changes were made to its charter, tho considering the P.R. problems facing the IMF, it may be better to develop an entirely new agency.

2. The development of a global version of the Securities and Exchange Commission, which closely regulates the balance sheets of major banks, and has strict restrictions on what types of investments certain banks may make. Although, given that these sorts of regulatory agencies had no real positive preventative effect on the current crisis, it seems unlikely that a global agency would've done much better. There are also corruption problems in many countries. And would countries with a nationalized banking system accept foreign control? Of course not.

3. The development of a global FDIC, which guarantees depositors in traditional bank accounts and money market funds. This, however, is a rather mild symptom of the global contagion; it isn't the disease itself. And many countries in the developing world have incredibly corrupt banking systems. It would require a massive reform of a corrupt political culture in order to make such a plan feasible in those countries; that, obviously, would be quite hard to do.

What else? In my opinion, #2 and #3 would have little effect on the international financial system, plus enforcement would be mostly impossible even if enaction weren't. #1 is essentially the same as recapitalization of banks, and this can already be done by private investors or local governments in most cases. When that proves problematic, the IMF (see: Hungary, Ukraine) or neighboring countries (see: Iceland, Pakistan) are capable of pitching in.

Perhaps I'm missing something obvious, but Bretton Woods I picked the low-hanging fruit in a time when the Western economic powers were capable of forcing the agenda. Bretton Woods II was an informal mechanism in which the world voluntarily tied its sails to the fortunes of the dominant economic powers by organizing their economies to sell to the world's biggest markets. I don't really see a realistic place for a third organizational system at present. If folks have ideas, put them in the comments. Or, if folks have things they'd like to see in a BWIII, even if they aren't realistic, put those ideas in the comments also (I'm looking specifically at you, Emmanuel).


JMax said...

Kindred: I wonder if GB, in his comment about Bretton Woods, actually was advocating a new international organization to back up the international financial system. I'd argue that it's impossible - given intl. financial flows, the amount of money one would have to have on tap would dwarf Chinese FX reserves. I don't think governments are going to pony up for that. That leaves the international banks... but again, I don't think they'd be too keen either.

You touch on sovereignty issues in point 2, but it's not just countries w/nationalized banking systems that would be loath to cede control to a global body. Can you imagine what the black helicopter crowd in the US would say about a global body regulating banks?

I suspect GB would agree that the Basel Accords offer a better framework for thinking about these issues. Way back when, the G10 got together to agree on voluntary capital requirements. No serious bank can afford not to follow Basel recommendations now(at least not for long). Obviously, more countries could be involved now and the products are more complex now, but the same principles of international voluntary standards could apply. While that kind of a solution doesn't address the liquidity problems of the moment, it does create a framework that could be helpful in avoiding the loss of confidence that is the underlying cause of the current crisis.

To Grandmother's House We Go




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