THE FINANCIAL CRISIS AND REFORMING GLOBAL FINANCE Problem

THE FINANCIAL CRISIS AND REFORMING GLOBAL FINANCE Problem Statement, Recent Developments, and Contours of a Reform Agenda Leonardo Burlamaqui l. burlamaqui@fordfoundation. org Chennai, India, January 25 -27 , 2010

THE VISION “Public institutions need to be the vehicles by which leaders take public responsibility for the public interest. Otherwise, markets determine the public interest, which manifestly does not work, especially in finance. ”

THE PROBLEM STATED PROPERLY “I believe that the root cause of the present crisis lies in the intellectual failure of economics. It was the wrong ideas of economists which legitimized the deregulation of finance which led to the credit explosion which collapsed in the credit crunch” ( Lord Skidelsky, 2009 – Keynes: The Return of the Master )

THE FAILURE EXPOSED… “I found a flaw in the model I perceived as the one explaining how the world works. That’s precisely why I was shocked…I still do not fully understand why it happened” (A. Greenspan – Congressional testimony, October 2008) ONE YEAR LATER……. Banking regulators should consider breaking up large financial institutions considered "too big to fail. " NYT: 10/16/09 !

THE PROBLEM STATED PROPERLY ONCE MORE “At a deeper level, the crisis of 2008 -09 and our continued dangerous financial system are very much the fault of our regulators. Bank executives are supposed to make money. They pursues profits – and rent extraction from the government. “It is the government’s responsibility to prevent people like Jamie Dimon from creating massive social costs. The failures here – and they were colossal – were on the part of the people who ran the Federal Reserve, the Treasury, and associated agencies over the past 20 or so years. ” (S. Johnson. Jan/2010)

THE PROBLEM IN A NUTSHELL (1) We’re facing a big trade-off between corporate sponsored globalization and democracy.

THE PROBLEM IN A NUTSHELL (2) CAPABILITIES REQUIRED: Unique knowledge of business firms competences; strategies and of their competitive ecology Creative destruction Late 19 th Century trough the end of Financial Bretton-Woods Schumpeterian Long-term Funding & Venture Capital innovation financing productive Investment Development/ Structural Change RETURNS Sorosian Hedge Funds, Securitization & Leverage Post-Reagan Financial innovation financing Washington-Consensus speculation CAPABILITIES REQUIRED: Knowledge about the regulatory/legal loopholes and how to structure bets on the formation & evolution of prices in currency, commodities & securities markets PONZI/ MADOFF CAPITALISM Destructive creation

THE CHANGING FINANCIAL LANDSCAPE

Burlamaqui The Global Financial System: Multilateral and Public DC and Geneva BIS (G 20 Central Banks) SEC FED IMF WB OECD EUROPE WTO GATS IOSCO Int Org of Sec Comm. IFAC Int Fed of Accountants Fin Stability Board Credit Rating Agencies BRICS South Bank IAIS Int Ass of Insurance Supervisors Mortgage Funds Credit card Companies WFE World Fed of Export Credit Agencies Fiscal Shelters Hedge and Private Equity Funds SIVs Global Corporations Chang Mai Init Exchanges Banking System RMBS National Fin Reg Agencies Reg Dev Banks IASC Int Acc Standards Board Insurance Companies LAW FIRMS ACC FIRMS Bilateral Int. Trade & Arbitration Investment Tribunals Treaties SWFs European Central Bank FSB Multilateral and Public Asia, Russia, Middle East and Latin America GLOBAL PRIVATE Pension Funds COUNTRIES & NATIONAL STATES

The financial landscape: new developments in 2009 The G 20 leaders’ summit in November 2008 urged that the FSB “must expand to a broader membership of emerging economies, and that other major standard setting bodies should promptly review their membership”. In January 2009, the IASB expanded its members and guaranteed geographical diversity on its Board for the first time. In February 2009, IOSCO invited securities regulatory authorities from Brazil, India and China to join a body that previously included mostly G 7 countries.

The financial landscape: new developments in 2009 In March, the BASEL COMMITTEE expanded its membership by inviting Australia, Brazil, China, India, Korea, Mexico, and Russia to join the existing members (who had previously all been from developed countries). Most dramatic of all was the announcement that same month to expand the FSB to include all G 20 countries. The American Recovery and Reinvestment Act (5. 8 % GDP) starts to impact the non financial sector. Depression avoided (? )

The financial landscape: new developments in 2009 Aggressive calls from European regulators for a comprehensive Mr. Turner is daring to ask the very question that many Britons, overhaul the financial system. Will it last (? ) and of indeed, many Americans, are asking themselves: What good are banks if all they do is push money around and enrich themselves? As he sees it, the City takes too much The Chinese stimulus package kicks in (13. 5 % of GDP). Asian from British society and gives back too little. growth reassured (? ) too big and too powerful. It has grown And, he contends, the bankers have co-opted many of the regulators who watch over them Asian and Latin American emerging economies surface as better ( A. Turner: Chief British Financial Regulator, quoted in NYT 9/24/2009) equipped the weather the financial storm than Europe or the US. A structural change (? ) The “Return of the State”: Public ownership of financial assets “ Banks should be split into separate utility companies and risky ventures…. and financial institutions skyrockets. A new form of capitalism It’s a delusion to think tougher regulation [alone] would shaping up (? ) prevent future financial crises” ( Mervyn King. Governor of the Bank of England, quoted in FT 10/21/2009)

ON THE DOMESTIC FRONT (US): The underlying roots of the crisis remain n n Toxic assets are still in hidden in bank’s balance sheets (which the Fed refuses to disclose). A year after Washington rescued the banks considered too big to fail, the ones deemed too small to save are approaching a grim milestone: the 100 th bank failure of 2009 (NYT – October 10, 2009). Economic conditions in the real economy continue to deteriorate – unemployment has climbed to almost 10 % (not seen since 1983) and could reach 11% in 2010. The mortgage crisis far from solved:

Serious Delinquency among Mortgagors

Number of Foreclosures Started

ON THE DOMESTIC FRONT: The underlying roots of the crisis remain n Financial concentration has increased: the top 3 US banks "And – hard (up to believe now control 30 % of the all banks deposits, from 20 %). in a time when we're facing a banking crisis that many of the banks created - are still the mostbig powerful lobbygot on Capitol Hill. And they frankly own the place. “ n Or…“Too to fail” worse… -Senator Dick Durbin (D-IL), April 27, 2009. n Investment banks are back in business ( JP Morgan: +11. 9 B in 09), but credit is not flowing… “Lobbyists Mass to Try to Shape Financial Reform” “The financial services industry has poured than ropes $220 million into lobbying n And other jumbo banks are stillmore on the (BOFA: -5. 9 in 2009” B in 4 th Q, Citigroup: -1. 6 B in 09). -NYT, October 15, 2009. n The “Volcker Plan” (1/2010). Will it succeed? Is it enough ? “The Obama administration’s proposal for a new Consumer Financial Protection Agency risks being watered down by lawmakers in Congress after lobbying from banks” n The elephant in the room: the political influence of finance. -FT, October 16, 2009.

THE COUNTOURS OF A REFORM AGENDA

THE COUNTOURS OF A REFORM AGENDA - GLOBAL Re-regulate the financial system: a Glass-Steagall for the 21 st Century n n n Establish a new division of labor among banks and financial institutions in general: traders should not be deposit takers and vice versa. Credit and liquidity: limit leverage and raise capital requirements (Banking and non-banking institutions). Subject OTC custom made derivatives to pre-approval (like prescription drugs…). Begin with a “positive list” for new derivatives.

THE COUNTOURS OF A REFORM AGENDA - GLOBAL n n Access best regulatory practices outside the US and UK and incorporate them. Bring all bank assets and liabilities onto bank balance sheets, subject to reserve & capital requirements. After a “grace period”, all off-balance sheet assets and liabilities declared null and void, unenforceable contracts. Create an adequate incentive system for regulators.

THE COUNTOURS OF A REFORM AGENDA - GLOBAL Reform the BIS/BCBS: make it transparent assure broad representation and coordination capabilities. Replace Basel II in the direction of more intense macro -prudential regulation and an early-warnings risk assessments system. Make rating agencies a public utility. Prevent “too big to fail”: restore the distinction among financial institutions and regulate by functions. Use competition policies to prevent excessive concentration.

THE COUNTOURS OF A REFORM AGENDA - GLOBAL Develop a global financial governance for development agenda based on regional financial cooperation and enhanced representation by non- G 20 countries (The UN back at the negotiating table). Create a “global financial governance body” (GFGB) where national regulation would prevail, but would be supplemented by international supervision, regulatory coordination and enforcement power (Housed where? ). Establish a mechanism for coordinated capital account control under this GFGB. Reform the GATS agreement under the WTO.

THE COUNTOURS OF A REFORM AGENDA - US Resolve the mortgage crisis through the homeowners side – not the banks - & demand complete transparency of mortgage lending, Rationalize the regulatory “maze” (ex. Dodd proposal), Establish a broad Financial Products Safety Agency, Realign compensation schemes to ensure “skin in the game” for fund-managers, traders, and CEO’s, Address financial industry political influence peddling – stop revolving door and reform campaign finance.

Thank you

Appendix

THE SYSTEM IN MOTION MINSKY’S MODEL AND THE NEW FINANCIAL SYSTEM : MAD MONEY INSTITUTIONAL FRAMEWORK: MARKETS AS WEBS OF CREDIT AND DEBT CONTRACTS Long Expansion: Δ credit + Fin innov. Lax monetary policy Δ Debt financing Derivatives , & Securitization Reckless finance Trade Imbalances (Δ liquidity) PONZI FINANCE Asset price inflation Bad debt/ Losses Financial fragilization Exc rate fluctuations ∆ interest rates PONZI SQUARE FINANCE Asset price deflation Financial meltdown Liquidity & solvency problems Δ Profits Hedge & Private Eq Funds Policy Change Δ Leverage ∆ Debt Exc rate volatility ∆ Overshooted expectations SIVs, ∆ Fin Deregulation: Δ liquidity + Opaqueness Profits interest rates MADOFF FINANCE

A few interesting books on the crisis, Keynes and Minsky

Governance Failure : Financial Regulation in the US: A Very Inefficient Maze Commercial banks Thrifts Industrial Loan Companies Bank Holding Companies Securities and Exchange Insurance Credit Unions Futures

Burlamaqui The Fin Governance Grant’s Cluster: Multilateral and Public LEVY DC and Geneva LEVY SEC FED NEW RULES WB BIC IMF OXFORD (GEG) PUBLIC CITIZEN WTO TWN GATS IOSCO Int Org of Sec Comm. IFAC Int Fed of Accountants FORUM DEM Center. Bilateral Int. Investment Arbitration Treaties Tribunals Multilateral and Public Asia, Russia, Middle East and Latin America BIS (G 7 Central Reg OXFORD Banks) Dev BRICS (GEG) SWFs IBASE European Banks EURODAD CEDES ERF/ OECD Central IDEAS Bank National Chang EUROPE SIENA IPD CEPR Fin Reg South Mai Agencies TWN Init Bank FSF South IAIS Fin Int Ass of Center Credit Rating Stability Insurance IASC Supervisors Forum Agencies Int Acc Standards LEVY WFE Board World Fed of Insurance Companies LAW FIRMS ACC FIRMS IPD CEPR Mortgage Funds Banking North System South LEVY Hedge and Private Equity Funds RMBS Credit card Companies CUUS Fiscal CFIShelters. TJN SIVs Global De Corporations Justicia Exchanges GLOBAL PRIVATE Pension Funds Export Credit Agencies IPD COUNTRIES & NATIONAL STATES