A better G-20 agenda (Part 5)

By Philip Zelikow

The next step toward a better agenda for the G-20 summit is this:

On financial regulation, don’t fall for the dumb dichotomy of global vs. national; adopt a smart synthesis, a global framework for coordinated national regulation.

The papers are playing up an issue for the G-20 summit of Europeans emphasizing the need for new financial regulation vs. Americans talking up stimulus. This would be a truly terrible way for the debate to evolve. The Europeans would be all about attacking bad bankers (like the Wall Streeters they want to scapegoat) while the Americans would seem wedded to their preferred panacea. And the biggest issues get lost both ways.

Fortunately, the U.S. side has moved adroitly to develop an agenda for future regulation (important but not critical right now) that should help answer the European mail. Geithner laid out a set of ideas on this point in the statement he issued last week. They seemed plausible. But Bernanke did an even better job of discussing this issue in an address he delivered to the Council on Foreign Relations on March 10. Here is his four part outline:

First, we must address the problem of financial institutions that are deemed too big–or perhaps too interconnected–to fail. Second, we must strengthen what I will call the financial infrastructure–the systems, rules, and conventions that govern trading, payment, clearing, and settlement in financial markets–to ensure that it will perform well under stress. Third, we should review regulatory policies and accounting rules to ensure that they do not induce excessive procyclicality–that is, do not overly magnify the ups and downs in the financial system and the economy. Finally, we should consider whether the creation of an authority specifically charged with monitoring and addressing systemic risks would help protect the system from financial crises like the one we are currently experiencing.

Bernanke added, crucially, that it is "self-evident that, in light of the global nature of financial institutions and markets, the reform of financial regulation and supervision should be coordinated internationally to the greatest extent possible." In other words, the U.S. side is clearly developing a constructive approach toward the topic of regulation.

One red herring, though, is the "mark to market" issue. The SEC and others are being pressured by Congress (e.g. Barney Frank) to revise these accounting rules. Conservatives like Steve Forbes have jumped on this too, arguing that this is a relatively recent deviation from good old traditional accounting rules. Well, the problem is that in the good old days accountants weren’t being asked to sign off on the asset value of hundreds of billions of dollars in collateralized debt obligation derivatives whose asserted value was based on statistical modeling rather than the ability to assess the quality of individual loan performance. These CDOs were also being traded in, shall we say, a rather murky marketplace. As the trading of these derivatives skyrocketed in the last decade, honest accountants tried to cope.

Here again the administration’s instincts seem right to me. Geithner in particular has resisted devices to cheat on assessing the asset value of troubled banks, while everyone acknowledges being open to smaller adjustments in the ways the rules work. My only footnote is to observe that, here again, the United States would be well advised to coordinate its regulatory framework with the one being developed by other leading states, like the participants in the G-7’s Financial Stability Forum.