Outside Shot

Financial Reform: No Time to Pull Back


One year ago, Lehman Brothers filed for bankruptcy, and the world fell into the worst economic crisis since the Great Depression. A few weeks after the bank failed, the Heads of State and Government of the Group of 20, representing 85% of the world's wealth, met in Washington to assess the task that lay ahead. In April 2009, they met again, in London, to draw up a road map for the steps to be taken to prevent such a crisis from ever happening again.

To use another metaphor, at this point, after intensive care (a set of coordinated stimuli), the patient seems to be out of danger. Now comes the second phase of the treatment: lancing the wound that still infects the markets and sickens the global economy.

When the G-20 emerges from its Sept. 24-25 meeting in Pittsburgh, its goal must be to fully implement the decisions we made back in April: to improve supervision and standards of prudence to prevent excessive risk-taking by financial operators; to regulate hedge funds and credit-rating agencies; and to address the issue of securitization, one of the contributing factors of the onset of the crisis.

This is not just a matter of being true to our word. It is the best guarantee of moving forward to recovery.

Already there are signs of improvement on the economic front and in financial markets. In Europe, some countries—France and Germany among them—enjoyed positive growth in the second quarter. The Chinese economy is increasingly showing signs of renewed dynamism. Confidence is returning to the banking sector.

At the same time, this upturn has led some to think we can go back to business as usual, that financial-sector reform can wait for another day. Such an attitude cannot be tolerated. It deliberately ignores the fact that public authorities around the world—taxpayers, in other words—stepped in with massive injections of capital when the crisis was at its height. It also ignores this fact: We will be able to put the economy on the path to sustainable growth only by dealing with the roots of the crisis, through a profound reform of the financial system.

And if we are to reconstruct international financial regulation, we must do so quickly and forcefully. With so much at stake, "It can't be done" is not an acceptable response.

At a meeting in London in early September, G-20 finance ministers unanimously decided to present two recommendations to the Pittsburgh gathering. The first: to continue to support the global economy as long as the recovery has not fully taken hold, while beginning discussions about exit strategies. The goal should be to successfully complete recovery efforts so that 2010 can be—as the International Monetary Fund has given us to hope—a year of positive global growth. Suddenly pulling away needed support and prematurely claiming victory would dash this hope.

The second recommendation: to implement all of the G-20's April 2009 decisions with respect to financial sector regulation— and even to strengthen them in certain areas.

When it comes to bonuses, the ultimate symbol of a possible return to past excesses, our shared goal is not to reward excessive risk-taking but to restore a legitimate search for product innovation and to do away with the reckless conduct of some traders who put our financial system in jeopardy. In The Wealth of Nations, Adam Smith argues for something similar, noting that moderation is necessary for the market to function in the long term.

At the end of last month, France unveiled a series of rules on compensation for market players. These include a provision for bonuses to be stretched over three years (so there is time for performance to be taken into account), the payment of one third of a bonus in shares, and a way to "claw back" a bonus in the event of a bank's negative performance. In Pittsburgh, France will argue for strict, globally accepted, and universally applied rules on compensation to put an end to the excesses and greed that once characterized the financial sector.

I know that points of view among G-20 members may differ when it comes to bonuses. But I also know that since we share the same objective—to rebuild a financial system on a sound basis—tackling the bonus-culture issue is unavoidable.

Whether we are talking about enhanced requirements for financial prudence or fighting offshore tax havens, we have accomplished a lot since the last G-20 meeting. Washington 2008 was the G-20 summit of principles. London, that of decisions. In Pittsburgh, we must show that we can change the system for the better because, ultimately, it is in everyone's interest. Transparency, responsibility, and supervision are the keys to avoiding another financial meltdown.

Business Exchange: Read, save, and add content on BW's new Web 2.0 topic networkGood Intentions, Bad OutcomesFrom Pittsburgh to Washington to Paris, a debate is raging on how to tame excessive executive pay. But compensation expert Graef Crystal reminds advocates of government regulation that in the U.S., at least, some attempts at reform have fallen flat or even backfired. Specifically, he cites the introduction in 1993 of a rule that limits the corporate tax deduction for executive pay to $1 million. Yet salaries have climbed. Crystal found that of the 355 CEOs at U.S. companies with market caps of $5 billion or more, 55% collect a salary of more than $1 million. What's more, the Clinton-era legislation—which applies only to base salaries—may be partly to blame for the trend in recent years toward oversize bonuses for chief executives.For Crystal's and others' insights on the topic, go to http://bx.businessweek.com/executive-compensation/
Lagarde is the managing director of the International Monetary Fund.

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