Finance

Meet our new regulatory structure, almost as bad as the old one.

By David Andrew Singer

Last week, the administration of U.S. President Barack Obama released a wide-ranging plan to reform the regulation of financial institutions and markets. Pundits and economists, pleased by the attempt to control "too big to fail" institutions and systemic risk, met the plan with guarded caution.

Harsher criticism would have been warranted. The proposal falls short, as it fails to address a crucial problem: the United States' fragmented, and thus broken, financial regulatory structure. Indeed, rather than emulating the world's best regulatory systems -- which are streamlined and unitary, like Canada's -- the United States has simply dusted off its current Balkanized system and tried to pass it off as new. American companies and investors deserve better.

Of course, Obama's proposal includes many sensible reforms. For example, all nationally chartered banks would be supervised by a new national bank supervisor, rather than multiple agencies. Financial holding companies would be subject to strict capital and other prudential standards, thereby closing the loophole that AIG, Bear Stearns, and other institutions exploited for enormous financial gain (but which ultimately led to their downfall). And hedge funds and other private pools of capital would have to register with the Securities and Exchange Commission (SEC) and open themselves to monitoring.

However, as the biggest regulatory overhaul since the Great Depression, the proposal leaves much to be desired. It would abolish just one regulatory agency -- the Office of Thrift Supervision (OTS). Accountability for financial stability, whether of individual firms or the entire system, would continue to be spread thinly across the Federal Reserve, Treasury Department, and an alphabet soup of bank, securities, and insurance regulators.

The national bank supervisor would not have jurisdiction over thousands of state-chartered banks, which could still choose to be regulated by either the Federal Deposit Insurance Corporation (FDIC) or the Fed. Fifty separate state regulators would still oversee insurance companies, with only a new token Office of National Insurance to "coordinate" their disparate regulatory regimes. The Commodity Futures Trading Commission and the SEC would remain institutionally separate, despite the clear overlap in their jurisdictions. Complex financial institutions such as Bank of America would continue to face a multitude of masters, including the new national bank supervisor, the Fed, and the SEC.

This regulatory hodgepodge inevitably creates loopholes to be exploited. In the past, banks and other financial institutions have been able to to play regulators off one another. For instance, in 2007 OTS actually courted Countrywide Financial away from another agency by offering more-flexible oversight. There's too little in the Obama proposal that promises to stop such malfeasance.

Another troubling part of Obama's proposal is the creation of a Financial Services Oversight Council to "identify emerging systemic risks and improve interagency cooperation." In place of regulatory consolidation, the new council would give the full gamut of regulators a seat at the table and no doubt invite the very turf wars and blame shifting that contributed to the financial crisis. The need for such a council reflects the underlying fragmentation that should be rectified -- and not by committee.

The United States has much to learn from other rich countries -- Australia, Canada, Finland, and South Korea, for instance -- that have simplified their regulatory structures. Financial institutions in these places, from the largest holding company all the way down to the smallest subsidiary, have a single regulator. Requirements are clearer and better enforced as a result.

Moreover, central banks in these countries are focused solely on keeping prices stable and monitoring systemic risks. The Fed currently has a dizzying array of responsibilities, from administering the White House's distressed-asset programs to determining if a company is overleveraged. It is difficult to imagine it will succeed, particularly with other Balkanized agencies muddying the waters.

The time has come for the United States to rationalize its regulatory structure by simplifying it. The rest of the world is waiting.

David Andrew Singer is assistant professor of political science at the Massachusetts Institute of Technology. He is the author of Regulating Capital: Setting Standards for the International Financial System.

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The International Monetary Fund now has $750 billion to lend to needy nations during the Great Recession. But will the additional capacity hurt the IMF's mission? 

By Martin Edwards

Two years ago, global economic consensus held that the International Monetary Fund -- the lender of last resort for ill-managed countries with a desperate, immediate need to borrow -- was dying or dead. Its bungling of the Asian financial crisis in 1997 harmed its reputation; the availability of foreign capital made it obsolete.

But global economic consensus now holds that the IMF will play an integral part in alleviating today's crisis. The "Great Recession" has created a strong demand for its lending, and the G-20 countries tripled its resources to $750 billion at their latest conference. Once a black sheep, the IMF overnight became the world's economic shepherd.

Yet the reforms undertaken to expand the IMF dramatically alter its modus operandi and fundamental purpose. They might even make the fund less effective over time.

At the latest G-20 conference, the IMF announced two major changes in response to the global economic crisis: It eased the conditions on its standard loans and created a new lending facility for approved countries. Standard IMF loans now have negotiable installment schedules and easier conditional restrictions. Countries were once required to make big changes -- rewriting their tax codes, for instance -- in order to receive loans. Now, the fund is much less aggressive in cleaning up governments' acts. Second, the IMF created the "Flexible Credit Line" (FCL) program to provide loans to countries with strong macroeconomic fundamentals. FCL loans have essentially no conditions whatsoever -- and Poland, Mexico, and Colombia have already received them.

Thus, the IMF has greatly expanded and turned itself into a provider of loans to prevent crises, not just alleviate them. The amount pledged to fund borrowers is now twice as much as was committed at the height of both the Asian crisis in 1998 and the Latin American crisis in 2002. That is all well and good for the Polands and Colombias of the world. Their IMF loans will surely help them avoid economic catastrophe. But it isn't necessarily good for either the developing countries that may be worst hit by the crisis, or for the IMF itself.

Indeed, with its much-heralded unveiling of the FCL, the IMF placated G-20 countries unwilling to provide loans to struggling countries themselves. Industrialized countries, such as the United States, pledged to lend directly to the fund to meet the $750 billion goal. But middle-income emerging countries, like Brazil, Russia, India, and China, proposed to provide resources in the form of purchases of IMF-issued bonds, rather than permanent lines of credit. These new resources will help the fund better meet the challenges of the economic crisis in the short term. In the long term, however, they mean that Brazil, Russia, India, and China will have a greater procedural voice within the fund. The golden days of the IMF being autonomous and distant from the desires of developing countries has surely reached an end.

Second, the fund's easing of conditionalities stemmed from a perceived need to reduce the stigma associated with seeking a loan from the IMF. But many countries value these conditions and tolerate the stigma. In a weak state, politicians might not want to take vital steps that will be electorally costly, such as cutting government spending or raising taxes. The fund plays a valuable role as a scapegoat, providing political cover for policymakers and ensuring changes are made. Making conditionality "cheaper" by reducing the stigma, then, may net the IMF more loans as states with weak commitment seek fund programs, but it is not likely to produce the reforms many of these countries urgently need.

These developments should temper our enthusiasm about the reemergence of the IMF. A more responsive fund is not necessarily a better one. Having a degree of autonomy from member states allows international organizations to be influential. The conditionality reforms, combined with the likely exchange of bond purchases for more voting power, by diminishing this autonomy, may make the fund's new prominence brief indeed.

Martin Edwards is assistant professor at the John C. Whitehead School of Diplomacy and International Relations at Seton Hall University and the author most recently of "The International Monetary Fund, Conditionality, and the World Economic Crisis: New Beginning or False Dawn?" (pdf).

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