The G20 pushes on a string

By Phil Levy

The G20 leaders meeting wrapped up in London with a long list of promises of virtuous behavior in the future. Close followers of global summitry may remember back to the last such meeting in November, when solemn vows of fealty to open trade were broken in short order. If a skeptic were to set aside the more nebulous statements of intent and dismiss the self-congratulations on policies already adopted, what did the meeting really accomplish?

The headline number was $1.1 trillion of new money, with most of that flowing through the International Monetary Fund and some through the World Bank. According to the Financial Times,

When all the sums are added together, rather than $1,100bn, the new commitments appear to be below $100bn and most of those were in train without the G20 summit.

Even if one were willing to credit the G20 with the much larger figures, there was an oddity about their IMF ardor. It seemed to suggest that one of the key difficulties so far has been a shortage of resources at the IMF. In fact, the IMF just had to rework its loan offerings since a recent attempt at a no-conditions loan facility attracted not a single customer. When the IMF assessed its own likely needs prior to the London meeting, it requested $250 billion. So the G20 promised $500 billion.

This seems like a new twist on John Maynard Keynes’s "pushing on a string." The phrase usually describes a situation in which monetary policy cannot work anymore. Central banks drive interest rates to zero and then have real challenges getting more money out the door. The exhaustion of traditional monetary policy is the rationale behind the rediscovered passion for fiscal stimulus, as well as unorthodox measures by the central bank.

In the case of the IMF, the problem is that many countries are determined to avoid these measures. In Asia, after the financial crisis of the late 1990s, this has been a major motivation for the large buildup of currency reserves: no reserve crisis, no IMF. There is similar antipathy in Latin America and Africa. Traditionally, countries have complained about the policy conditions the IMF has attached to its loans. Now, there is a sufficient stigma that even condition-free loans are a hard sell.

This is not to argue that all of the IMF money will go unused. There seems to be enough trouble looming in central and eastern Europe that the IMF will find some takers. That, in turn, should help western European banks that made extensive loans to the region. But doubling the IMF’s request is unlikely to double the impact.

Increasing regulation was the other key focus of G20 attention. It has its own string-pushing issues. The fascination with regulation stems from a belief that the current crisis was caused by either a lack of regulatory power, or through wild American deregulation over the last 8 years. There are some oddities about this belief. As my colleague Peter Wallison has argued, the major financial deregulation that is cited, the repeal of restrictions on mixing regular and investment banking, was undertaken at the end of the Clinton administration. The only important role it seems to have played in the crisis was to allow Bank of America to take over a troubled Merrill Lynch.

Poor regulation was certainly an important cause of the crisis. There is a fascinating story in the Washington Post about the regulation of major banks such as Citigroup. The key U.S. financial institutions were under the supervision of the New York Fed, run at the time by now-Treasury Secretary Tim Geithner. The Post concludes:

A confidential review ordered by Geithner in 2006 found that banking companies could not properly assess their exposure to a severe economic downturn and were relying on the "intuition" of banking executives rather than hard quantitative analysis…

Records and interviews show that Geithner and his colleagues did not employ some of the harsher tools at their disposal to bring the banks into line. From 2006 through the start of the credit crisis in the summer of 2007, they brought no formal enforcement actions against any large institution for substandard risk-management practices. The Fed also did not use its confidential process during that period to downgrade any large bank company’s risk rating, according to two people familiar with the process, a step that could have triggered costly consequences for the firms.

At least Mr. Geithner knew enough to worry. In the context of mortgage regulation, former Senator Phil Gramm writes: "It was not that regulators were not empowered; it was that they were not alarmed." Nor is this a uniquely American problem. The troubled European banks that relied heavily on dubious AIG credit default swaps to avoid capital requirements were under the watchful gaze of European regulators.

Poor regulation and inadequate regulation have very different implications. If our difficulty was that regulators were human and fallible and unwilling to use the tools at their disposal, it is not clear how expanding the tools at their disposal will solve the problem. We can at least be grateful that President Obama resisted French and German attempts to go even further on the regulatory front.

Thus, it appears the G20 did little harm, but did little to save the world either. At the core of the current global crisis lie failed banking systems. As the communiqué noted, "Our actions to restore growth cannot be effective until we restore domestic lending and international capital flows." The leaders promised to work on that in unspecified ways.

Perhaps it’s better not to examine these things too closely. We can be happy that the whole thing went off without walkouts or fisticuffs (at least not inside the meeting hall). It can be reassuring just to close one’s eyes and try to believe the leaders’ grand proclamations that they are taking dramatic joint action and that we are swiveling around at an historic turning point.