Financial Follies and the Future

by Kent Hughes, Program on America and the Global Economy, written for Centerpoint, December 2010

Dec 06, 2010

The Woodrow Wilson Center is increasing its focus on the aftermath of the global financial crisis and on the domestic and international debate over how to prevent another economic debacle.

The issue is not new to the Center. Last year, David Wessel, the economics editor of The Wall Street Journal, researched and wrote his In Fed We Trust: Ben Bernanke's War on the Great Panic while a public policy scholar at the Wilson Center. Working with the Center's regional programs, the Program on America and the Global Economy (PAGE) has explored how other countries and regions dealt with the crisis.

As part of the renewed focus on finance, PAGE and Wilson Center on the Hill hosted a meeting on Capitol Hill to discuss The Squam Lake Report: Fixing the Financial System, co-authored by 15 leading financial economists. On November 9, PAGE hosted David J. Lynch to discuss his just published When the Luck of the Irish Ran Out: The World's Most Resilient Country and its Struggle to Rise Again. Lynch, who covered the global economy for USA Today and is now a senior writer for Bloomberg News, wrote his book while a public policy scholar at the Center.

On December 8 and 9, the Asia Program with its partner in Tokyo, the Sasakawa Peace Foundation , will host a conference to explore the future of the Japan-U.S. partnership in strengthening the international economic and financial system.

The United States, Europe, and much of the world are still struggling with the aftermath of the global financial crisis. Individual governments are working to stabilize their economies, to adopt new financial regulations, and to seek some broader agreement on global financial flows and the large, current account imbalances that contributed to the recent economic calamity.

The Group of 20 or G20, a group of the major world economies, at its November meeting in Seoul, South Korea, failed to adopt firm guidelines on current account imbalances or settle on key standards for global banking. The G20 continues to look to the Financial Stability Forum and the Basel Committee to develop guidelines for major banks and to the IMF as both observer and potential referee on global imbalances.

The Squam Lake Report
Like many other countries, the United States has adopted a series of new rules and standards in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, signed into law on July 21, 2010 by President Barack Obama.

On October 26, 2010, PAGE and Wilson Center on the Hill hosted Professor Rene M. Stulz, Everett D. Reese Chair of Banking and Monetary Economics at the Fisher College of Business at The Ohio State University, and one of the 15 co-authors of The Squam Lake Report. He was joined by Mark F. Oesterle, Republican chief counsel and deputy staff director of the Senate Committee on Banking, Housing, and Urban Affairs.

While some disagreements persisted, Stulz reported on broad agreement over flaws in the current system and a number of proposals to fix the system going forward. Some, but not all, paralleled the Dodd-Frank bill.
Stulz noted that the 15 agreed that bankers suffered from conflicts of interest, the inadequacy of traditional bankruptcy laws for failing financial institutions, the development of a "modern form of bank runs," and the inadequacy of the current financial structure. Each identified flaw was followed by a consensus recommendation.

There was broad agreement that financial institutions needed to report on their asset and risk positions to regulators on a quarterly basis. They proposed that the Federal Reserve take on the new responsibility of monitoring systemic risk, coupled with the requirement of making an annual report to Congress. Systemically important firms would need to have greater capital reserves and reserves that would increase along with investments in riskier assets. They pointed out the advantage of having one or a very few clearing houses to facilitate the settlement of derivatives contracts but argued that barring nonstandardized contracts would be counterproductive. Instead, the nonstandardized contracts should require a higher degree of reserves.

Oesterle, speaking off the record, added a historical perspective by noting past efforts at banking reform. He also described different aspects of the Dodd-Frank Bill and the sheer complexity of the challenge of dealing with such a wide-variety of financial institutions. Because of the congressional committee structure, there must have been regulatory elements that will have to be considered by other committees in the future.

Where President Harry Truman longed for a ‘one- handed economist' who could give clear advice, The Squam Lake Report is notable for having found 15 top economists who could agree on causes, regulatory weaknesses, and specific recommendations for reform. Stulz did remind the audience, however, that the one hand involved in the report involved ‘left hands and right hands' making the agreement all the more remarkable.

When the Luck of the Irish Ran Out
On November 9, PAGE sponsored a book launch with David J. Lynch on his just published When the Luck of the Irish Ran Out. Irish luck was still in question in mid-November as the entire Eurozone feared a possible Irish default that would have implications for the future of the Euro.

Lynch tells his story through five different individuals who highlight the initial rise of the Celtic Tiger, its ability to attract high-tech firms from the United States and elsewhere, and the early success in exporting goods and services. What started as an export success turned to a dependence on what was first seen as an unending property bubble and a construction boom that went with it.

Irish banks borrowed internationally and then lent to developers, too often with little due diligence on the quality of the borrower or the soundness of the proposed project. As the bubble burst, the Irish government stepped in to guarantee the soundness of the banks at the cost of draconian cuts in public spending, cuts that are far from over.

Lynch embeds his story in the history and culture of Ireland. He sees the demand for home ownership – reaching an 80 percent level, far above the 65 percent found in America—as rooted in the many centuries where the Irish could not own the land they tilled. There was, he reports, a great Irish pride as they watch English laborers come to build Irish homes—just the opposite of a history that saw people as Ireland's leading export.

Japan-U.S. Economic Partnership in the Post-Lehman World
On December 8-9, the Asia Program and the Sasakawa Peace Foundation will co-host the 2nd Japan-U.S Joint-Public Policy Forum. The forum will explore the potential for Japanese-U.S. economic partnership in the post-Lehman world.

There will be a heavy Wilson Center presence at the conference. Former Wilson Center scholar David Wessel, now economic editor of the Wall Street Journal will give one of the two opening keynotes. The first panel on the future of the dollar-based financial system includes , Paul Blustein, formerly with The Washington Post and a Wilson Center public policy scholar. Kent Hughes, director of PAGE, will participate in the final panel on the future of global governance and the U.S.-Japan relationship.

The second keynote will be given by Eisuke Sakakibara, former vice minister of finance, who is often referred to as Mr. Yen for his impact on global financial markets. Andrew Ross Sorkin, columnist with The New York Times and author of Too Big to Fail, a best-selling book on the financial crisis, will join the first panel.

The Financial Crisis and the Future at the Wilson Center
The United States has not fully recovered from the financial crisis nor have many other parts of the world. At home, there is the ongoing problem of home foreclosures, personal bankruptcies, and small bank failures. Overseas, a financially unstable Ireland has spread uncertainty to Portugal and, potentially, to the much larger economies in Italy and Spain.

The longer-term challenge will be to develop an international agreement that finds common ground for newly established or strengthened national regulatory regimes. Just as challenging is the effort to reduce and then eliminate the large current account imbalances. The challenge is particularly acute for the United States whose record trade and current account deficits have weakened the industrial base, left the United States deeply indebted to overseas creditors, and weakened the international standing of the country.

Going forward, the Wilson Center will continue to examine the evolving nature of U.S. financial regulation, the effort to balance its current account, and the evolution of old and the development of new, international financial organizations and agreements.

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