October 9, 2008
There is only one issue of concern these days in Brussels and other capitals: the widening of the financial crisis into a recession! The speed at which the crisis, which has started some 15 months ago in US mortgage financing, has accelerated in the last three weeks is awe-inspiring. Governments have failed to realise the depth of the crisis and its ramifications beyond the USA and the financial sector proper.
The US government – FED and Treasury – should have known for long the full extent to which toxic mortgage certificates have invaded the banking sector. If not, it proves the incompetence of the banking supervision, fragmented among FED, SEC and States. Most probably, the government was more or less aware of the gigantic volume of necessary write-downs but did not dare to admit the truth while hoping for the best.
The ongoing crisis in Europe is mostly due to the infection from toxic US debt. Without the bad debt imported from the USA, Europe would have been able to weather the storm much better than it did. Indeed, countries like France and Spain, much less exposed to US debt and under strict banking supervision, find themselves hardly affected, while Germany has taken several big hits.
So, what policy consequences?
First, in the short term there is nothing but restoring confidence and preventing a credit crunch from disabling the economy.
Most EU governments have rushed raising the ceilings for deposit/savings guarantees, Unfortunately, this has happened in disarray creating nasty tensions between Ireland and other member countries. It is time for the EU to step in and try to achieve a minimum of harmonisation. Never late than never.
The ECB has played a vital role in injecting liquidity into the system. It must continue to do so as long as the inter-bank market fails to function for lack of confidence among operators. This is its primary function, much more important than a possible lowering of the interest rate, say to 4 percent. The ECB should keep its powder dry and prepare a well-orchestrated operation with member states, in case the pessimistic forecasts for the economic development were to be confirmed.
Second, it is good that the heads of government of the four major EU countries met in Paris last Saturday. Thanks to it, governments feel committed to prevent a collapse of one of their major financial institutions.
The idea of a € 300 billion EU rescue fund was still-born from the moment of its conception. It must have been invented by someone lacking basic knowledge about the functioning of the Union and the delicate sense of intra-EU solidarity reached far. One only had to look at the huge difficulties for the USA, a full-fledged federation, getting its $ 700 billion rescue passed in a dramatic second act.
Third, in the medium term, the EU has to tighten the regulatory framework for banks and insurance companies and – in parallel- strengthen and banking & insurance supervision.
An integrated EU financial market is not conceivable with 27 odd regulatory frameworks and supervising mechanisms. These need to be streamlined and strengthened as a matter of urgency.
The Commission has submitted a few disparate proposals in that direction, e.g. banks trading debt certificates should take some 5 percent into their portfolio, organising group supervision for the 30 major trans-national banks operating in the EU, more independence for rating institutions. But that will not do. We need a comprehensive review of the way in which banks function today. Banks have assumed more and more functions that go beyond their proper role of financiers of business. They engage in too much trading with complex instruments. Their risk assessment has proved inadequate. There is need for more accountability.
The EU would be well advised to take its time and not go ahead with fragmented measures. To that end, the EU should rapidly appoint a “Committee of Wise Persons” for listing the main shortcomings in financial regulation and supervision and making proposals how to address them.
The Commission seems insufficiently equipped to undertake such complex work in a short time. It should, of course, be associated as well as the ECB, whatever its future role in banking supervision.
One conclusion seems evident. The EU will not escape a unified centrally guided financial supervision that may be structured like the EU monetary authorities, with a central institute directing and coordinating 27 national agencies. The Commission proposal for group supervision may be at best a first step on the road towards “federal structures”.
One should expect staunch opposition from member states against a more federal organisation of banking and insurance supervision. It may well take 10-15 years to reach the final stage, provided at the end it will be more than loose coordination among groups of national supervisors.
Fourth, it is not clear what the French Presidency expects from the scheduled international conference on financial markets to be held before the end the year. It is bold for the EU to take such an initiative and demonstrate global leadership in an area in which it has a lot of expertise.
But to be successful the conference will need to focus on specific points and come to terms. Without painstaking preparation it risks being counter-productive.
Among the points to be addressed might be: stricter capital/debt ratios, accountability of bank executives, changes of penal codes and stricter prosecution of executives infringing on supervision rules, stricter rules concerning trade in stocks and derivates, prior authorisation for any new “bank products”.
All these are urgent topics for international coordination. They raise complex questions and strong opposition from main financial centres.
But in the age of global financial flows it is not possible to engage in cross border trade without the participants adhering to identical standards.
Ideally, the outcome of this work should be a new institution, say WTO+BIS. Hopefully the USA and others will realise that the world has suffered major damage due to lax banking regulation. Humanity needs a better protection than in the past against bankers engaging in excessively risky operations at the expense of millions of citizens across the world. They need to be reigned in by stricter regulation and control. Banking and Credit are public goods. The market cannot be left to itself. It requires strict rules and their full respect by the banking community.Author : Eberhard Rhein