Stephen R. Ganns

Over the weekend of April 15th, the G-20 finance ministers and central bank governors, comprised of some, but not all, of the 20 largest developed economies, met in Washington D.C.    This was a continuation of the dialogue which was promulgated by the G-20 document of April 2009 namely: Declaration on Strengthening the Financial System.   The Declaration vested “enhanced capacity” to the former Financial Stability Forum–now re-named the Financial Stability Board (FSB).   For clarification, the FSB is a group which is housed and is functionally a part of the Bank for International Settlements (BIS), in Basel, Switzerland.  The BIS acts as the central bank for other sovereign central banks, such as the Federal Reserve System, Bank of England, Bank of Japan, Bank of China, Reserve Bank of India, etc.  The BIS currently has fifty three central bank members, comprising the vast majority of global economic activity. The Declaration also appointed the IMF with an enhanced role in the arena of financial and regulatory monitoring.   Additionally, a G-20 Communiqué was issued after the meeting. *

 According to Euro News, one of the stated intentions was expressed as: 

 “… to avoid a repeat of the global financial crisis the G20 nations have decided to put the policies of seven of its members, the US, China, Britain, Germany, France, India and Japan under the microscope. The IMF will seek out imbalances in debt, trade, and budget deficits, although its conclusions will not be binding on members.”

 “The guidelines operate a little bit like a net which actually holds those of the countries that violate or do not respect the guidelines and the net is a little bit tighter for those countries that are considered of systemic importance because they represent more than five percent of the GDP of the G20”, said French Finance Minister Christine Lagarde.

 This regime or set-up raises questions here in the U.S.   Question one: Why are these particular entities, the BIS and FSB (which are made up of various central bank representatives) being vested with so much latitude and—when the central banks themselves exist to be of service to their States of origin?   Additionally, the central banks in many cases are owned by their private commercial banking members.    Question two: Although the IMF is performing better work than it did in the past (even though that past is quite checkered), is it really an organization in which we want to abdicate our faith to in terms of monitoring our own economy or in their parlance, “put… under the microscope” so as  to be judged?

 We see that the conclusions won’t be binding.    However, notice Minister Lagarde’s language above, “…the net is a little bit tighter…”   Is that the non-binding net for “violators” and “disrespectful” participants?    Would there be embarrassment or moral suasion (persuasion and pressure) for non-compliance?  What influence will this have on buyers of sovereign debt or on cross border trade agreements?   How does it affect the dollar as a reserve currency?   How will the Rating Agencies react to these analyses since they have had very little a priori vision (ability to analyze beforehand) in the past?   There could be many other serious unintended consequences.

 And so in the final analysis, principles of sovereignty could be being bypassed by international entities and coalitions, and without the approval of the United States Congress.  It’s an interesting system being put into place which has the force of a treaty, and yet does not need ratification.

On 2 April 2009, the G-20 issued the: Declaration on Strengthening the Financial System. The Declaration vested “enhanced capacity” to the former Financial Stability Forum–now re-named the Financial Stability Board. It also seems to have appointed the IMF with an enhanced role in the arena of financial regulatory reform. Several reports and articles have since been produced, many of which are quite comprehensive.

The G-20 document references many component parts; one of which deals broadly, with compensation. This is the subject of the post by Professor Ferrarini and Ms. Ungureanu.

However, before I turn attention to my comment, I would like to make an observation. We still live in a world which subscribes to a Westphalian system (well discussed by Padoa-Schioppa in his intellectually breathtaking Per Jacobsson Lecture). Much of the declaration reads as if it were some form of treaty by sovereign governments. As these types of issues do not garner much press or interest for that matter, and are not very well understood by legislators (empirically evident in the U.S.), the liability extant is that it will meet with opposition when finally understood by those with responsibility. Surveying several legislators, economics and business professors, bankers and business chieftains in the U.S, it is interesting to note that 99 out of 100 have never heard of the BIS–much less one of its secretariats the FSB.

The idea of misalignment of compensation being a central cause (of the Turmoil of 2007) is a “red herring” of immense proportion. It’s tantamount to a medical doctor chasing the symptoms of a patient rather than dealing with the source of the illness.

The turmoil and consequent damage caused globally was primarily a failure of sovereign governments and central banks to monitor and understand what was occurring under their charge. This primarily was a U.S. problem of faulty legislation and poor use of regulation; but most importantly, monitoring in an holistic fashion. Putting forth the idea that “greed” (let’s call it what it is) can be regulated is unrealistic and counter-productive–as well as counter-intuitive.

It is a fact that Wesphalian systems are dirigistic and need to set rules and guidelines–especially in the insured banking sector. Yes leverage requirements, yes de-construction of too big to fail institutions offering too many diverse products and services, yes prudential supervision, yes reform of CRA’s, etc. But the attempt at moderating compensation from outside of the internal entity or organization by an authority that is not part of the actual Sovereign is a non-starter and will not gain traction.

The turmoil developed over a 25 year period; very specific events occurred in the timeline which led up the collapse. It’s time to revisit those events.

Comment by Stephen R. Ganns — April 13, 2011 @ 7:04 pm