President Barack Obama made an unexpected concession to Europe by embracing a relatively strong regulatory role for a Swiss-based body that will create standards for financial institutions around the world.
For the past several weeks, the U.S. and Europe debated how to grapple with the global financial crisis. Ahead of the Apr. 2 summit of leaders of the world's 20 largest economies, Washington steadfastly urged across-the-board fiscal stimulus spending of 2% of gross domestic product in order to reignite growth.
But Europe, in particular France and Germany, said they were already spending enough, and insisted instead on tight new regulations to show bankers and markets a resolve to prevent a recurrence of out-of-control bubbles. The consensus among analysts was that neither would get what they wanted, and that the Group of 20 summit would end by papering over the differences.
No Policing Powers
The G-20 leaders, however, announced potentially far-reaching new powers for the Basel (Switzerland)-based Financial Stability Board, or FSB, which previously existed under another name. The board consists of central bankers and financial regulators from major economies, from the U.S. Treasury Dept. to the Monetary Authority of Singapore, as well as international financial standard-setters such as the World Bank and the International Monetary Fund (IMF). It will set standards to govern hedge funds, tax havens, executive compensation, and capital requirements in financial institutions, among other areas.
The board won't itself possess policing powers, which perhaps was Washington's greatest objection to outside financial regulation. It will monitor compliance through the IMF. Its recommendations, released on Apr. 2 and detailed in a 12-page summary in addition to four thick annexes, must be approved by the legislatures of all G-20 countries, which make up the board's membership.
The broad outlines of the G-20 regulatory proposals resemble those suggested by U.S. congressional leaders and Obama Administration officials. It remains to be seen, however, how similar they will be in the details. It is also a real question whether Congress will agree to such extensive oversight. If the FSB finds that U.S. regulations aren't up to its standards, European regulators could block access to their financial markets, as they threatened to do to U.S. investment banks earlier this decade, prompting marginally stronger oversight by the Securities & Exchange Commission. Of course, the giant U.S. financial multinationals may retain enough clout to head off such efforts.
Little Agreement on Hedge Funds
In its recommendations, the board didn't spell out rules on hedge funds or tax havens because the U.S. and Europe are still far apart on what they are seeking. Among the major recommendations are that executives be paid according to a company's profitability; that banks be forced to set aside a large reserve of capital in good times to tide themselves over in bad times; that risk assumed by financial institutions be restricted; and that credit rating agencies be better regulated.
Analysts said it is too early to know whether the FSB will be effective. Yet the reaction to the board's new powers verged on astonishment, particularly considering Washington's strong views against extraterritorial regulation. "It is much more serious than we anticipated," said Douglas Rediker, director of the global strategic finance initiative at the New America Foundation in Washington.
Gary Hufbauer of the Peterson Institute for International Economics said the regulatory effort is embryonic, comparing it to the inception of the global trading system in 1948. "It's a good step, but we are at least a decade away in terms of it being effective."
But, in a note to clients, Federal Financial Analytics, a Washington (D.C.) financial consulting firm, called U.S. agreement to the board "a major concession" to the European Union, and suggested that it could bring swift change to global finance. "Their intention is to give the board more weapons, more tools and instruments," said Uri Dadush, the World Bank's former director of international trade, who runs the international economics program at the Carnegie Endowment in Washington. "A lot of the regulation will be done at home, and the FSB will provide an overall umbrella to make sure this is happening."
LeVine is a correspondent in BusinessWeek's Washington bureau.