Global Trends by Martin Khor

Monday 17 November 2008

Finance summit ends with menu of mild actions

Last Saturday a summit of 20 political leaders ended with a Declaration listing mild actions to improve regulation of some financial institutions, which may prove inadequate for dealing with the financial crisis.


Leaders of 20 countries met at the Finance Summit in Washington last Friday and Saturday and agreed to take a wide range of actions to counter the world economic recession and prevent future financial crises like the one that almost engulfed the developed countries’ financial system.

It was quite striking how some of the actions proposed – especially about the need to regulate financial speculation and cross-border capital flows – are similar to the proposals that Malaysia had made ten years ago in the midst of the Asian financial crisis.

At that time, Malaysian leaders were heavily criticized for the then unorthodox policies  such as lowering interest rates, boosting government spending, fixing the exchange rate and imposing controls over the outflow of portfolio capital.

Malaysian officials also advocated international financial reform, especially control over currency speculation, regulating the activities of hedge funds and credit agencies, and reducing he leverage that banks give in loans to speculators.

These proposals were made at the meetings of the International Monetary Fund and at the United Nations financing-for-development summit process.  But the proposals were rejected outright.

For the next decade, the activities of the hedge funds multiplied, further deregulation took place and more and new financial instruments and products were introduced, such as the mortgage-backed securities that turned sour and sparked the problems that snowballed into the greatest financial crisis in 60 years.

Now that the crisis has taken place in the very heart of the financial system – the United States and Europe – the Western political leaders at last are paying close attention to its causes and to the solutions.

Egged on by the France, the United States President George W. Bush hosted the Group of 20 to the two-day summit to discuss the crisis.  The group comprises the major Western countries, Japan, and several developing countries including China, India, Brazil, Indonesia, South Korea and South Africa.

This G20 had been created during the Asian crisis as a forum to discuss necessary actions.  It is not known how the countries were selected.  Malaysia did not made it due to its outspoken reputation and unorthodox policies at that time.

Many developing countries are unhappy that an exclusive and unelected small group of countries have been invited to make global financial policy.  They have advocated that the reform discussion be held within the United Nations instead. 

But the US and Europe have so far rejected this role for the UN, despite its holding an international financing-for-development conference at the end of this month. 

And so it was the G20 which were convened for last week’s summit.  The Summit Declaration identified the root cause of the crisis as the market players seeking higher yield without appreciating the risks nor due diligence.  Other causes were weak underwriting standards, unsound risk management practices, complex and opaque financial products and excessive leverage.

Policy makers, regulators and supervisers in some advanced countries did not appreciate and address the risks building up in financial markets, keep pace with financial innovation or take into account the systemic ramifications of regulatory actions, said the Declaration.

It then listed a set of principles to guide future policies.  These included strengthening transparency and accountability, enhancing sound regulation, promoting integrity in financial markets, reinforcing international cooperation and reforming international financial institutions.

The leaders also pledged their commitment to an open global economy, to reject trade protectionism and to try again to make progress in the WTO’s Doha negotiations.

The Declaration comes with an action plan for reform. Its proposals include revamping accountancy standards, a review of present national regulations in banking, securities and insurance and proposals to improve them.

It added that credit agencies must abide by high standards and avoid conflict of interest.  Banks must have adequate capital while new standards for capital requirements for their structured credit and securitization activities.

Under international cooperation, the Declaration also asked supervisers to set up “supervisory colleges” for all major cross-border financial institutions, and to strengthen cross-border crisis management arrangements.

On reforming international financial institutions, the Declaration said the IMF should take the leading role in drawing lessons from the crisis and must review its lending instruments. 

Developing countries get a mention here.  The leaders said they would explore ways to restore access to credit and resume capital flows for emerging and developing countries, which in turn should have greater voice and representation.  The advisory role of the IMF is also to be strengthened.

The Summit’s missing leader was Barrack Obama, who cleverly stayed away as after all this was Bush’s show.  Thus, the summit and its Declaration had the feel of being tentative, as it will have to wait for President Obama to take actions for the United States.

Thus this was only an initial Summit.  Some actions agreed on are scheduled to complete by 31 March next year while other actions have only been proposed but when they are to be implemented is not stated.  There is thus to be a follow-up Summit – a more important one – around April next year.

By then it will be clear how much deeper in recession the world will be in.  The actions listed in the Declaration are mild – for example, measures to regulate hedge funds and to stabilize exchange rates of different countries are missing – and will likely prove inadequate for dealing with the crisis.