THE FINANCIAL CRISIS

AND REFORMING GLOBAL FINANCE

Problem Statement, Recent Developments, and Contours of a Reform Agenda

Leonardo Burlamaqui l.burlamaqui@fordfoundation.org

New Delhi, India, January 29-30,2010

“Public institutions need to be the vehicles by which leaders take

public responsibility for the public interest. Otherwise, markets

determine the public interest, which manifestly does not work,

especially in finance.”

THE VISION

“I believe that the root cause of the present crisis lies in the intellectual

failure of economics. It was the wrong ideas of economists which legitimized the deregulation of finance which led

to the credit explosion which collapsed in the credit crunch”

( Lord Skidelsky, 2009 –

Keynes: The Return of the Master )

THE PROBLEM STATED PROPERLY

“At a deeper level, the crisis of 2008-09 and our continued

dangerous financial system are very much the fault of our

regulators. Bank executives are supposed to make money.

They pursues profits – and rent extraction from the

government.

“It is the government’s responsibility to prevent people

like Jamie Dimon from creating massive social costs. The

failures here – and they were colossal – were on the part

of the people who ran the Federal Reserve, the Treasury,

and associated agencies over the past 20 or so years.”(S. Johnson . Jan/2010)

.

THE INSTITUTIONAL IMPLICATIONS

We’re facing a big trade-off between corporate sponsored globalization and democracy.

THE POLITICAL ECONOMY DIMENSION

THE ANALYTICAL DIMENSION

RETURNS

Financial innovationfinancing

productive Investment

Financial innovationfinancing

productive Investment

Schumpeterian Schumpeterian

SorosianSorosian

Long-termFunding &

Venture Capital

Long-termFunding &

Venture Capital

Hedge Funds, Securitization &

Leverage

Hedge Funds, Securitization &

Leverage

Development/StructuralChange

PONZI/MADOFF

CAPITALISM

CAPABILITIES REQUIRED:Unique knowledge of business

firms competences; strategies and of their competitive ecology

CAPABILITIES REQUIRED:Unique knowledge of business

firms competences; strategies and of their competitive ecology

CAPABILITIES REQUIRED:Knowledge about the regulatory/legal

loopholes and how to structure bets on the formation & evolution of

prices in currency, commodities &securities markets

CAPABILITIES REQUIRED:Knowledge about the regulatory/legal

loopholes and how to structure bets on the formation & evolution of

prices in currency, commodities &securities markets

Financialinnovation

financingspeculation

Financialinnovation

financingspeculation

Creative destruction

Destructivecreation

Late 19th Century trough the end of Bretton-Woods

Post-Reagan Washington-Consensus

THE CHANGING FINANCIAL LANDSCAPE

Fiscal Shelters

BIS (G20 Central

Banks)

Credit Rating Agencies

Burlamaqui

IMF

WBChang

MaiInit

WTO

BankingSystem

SouthBank

RegDev

Banks

Multilateral and Public

Asia, Russia, Middle East and Latin America

The Global Financial System:

SECFED BRICS

OECD

ExportCredit

Agencies

Int.ArbitrationTribunals

BilateralTrade &

Investment Treaties

Multilateral and Public

DC and Geneva

COUNTRIES&

NATIONAL STATES

Mortgage Funds

EUROPE

EuropeanCentralBank

LAWFIRMS

InsuranceCompanies

SWFs

IOSCOInt Org of Sec Comm.

IFACInt Fed of

Accountants

WFEWorldFed of

Exchanges

FSBFin

StabilityBoard

IAISInt Ass of Insurance

Supervisors

Credit cardCompanies

SIVsRMBS

IASCInt Acc

StandardsBoard

Global Corporations

Hedge andPrivate Equity

Funds

ACCFIRMS

GLOBAL PRIVATE

Pension Funds

GATS

NationalFin Reg

Agencies

• Much broader than the banking system

• Totally interconnected

• Mostly unregulated

• Structurally changing as we speak

The financial landscape: new developments in 2009

The G20 leaders’ summit in November 2008 urged that the FSB “must expand to a broader membership of emerging economies”.

In January 2009, the IASB expanded its members and guaranteed geographical diversity on its Board for the first time.

In February 2009, IOSCO invited securities regulatory authorities from Brazil, India and China to join a body that previously included mostly G7 countries.

The financial landscape: new developments in 2009

In March, the BASEL COMMITTEE expanded its membership by inviting Australia, Brazil, China, India, Korea, Mexico, and Russia to join the existing members (who had previously all been from developed countries).

Most dramatic of all was the announcement that same month to expand the FSB to include all G20 countries.

Summing-up : the emergence of G20 as a new – potential- source of power in global financial governance.

BUT also: the emergence of the G2. G2 overriding G20 ?

The financial landscape: new developments in 2009

Aggressive calls from European regulators for a comprehensive overhaul of the financial system. Will it last (?)

Asian and Latin American emerging economies surface as better

equipped the weather the financial storm than Europe or the US. A structural change (?)

The American Recovery and Reinvestment Act (5.8 % GDP) starts to impact the non financial sector. Depression avoided (?)

The Chinese stimulus package kicks in (13.5 % of GDP). Asian growth reassured (?)

The “Return of the State”: Public ownership of financial assets and financial institutions skyrockets. A new form of capitalism shaping up (?)

Mr. Turner is daring to ask the very question that many Britons, and indeed, many Americans, are asking themselves:

What good are banks if all they do is push money around and enrich themselves? As he sees it, the City takes too much

from British society and gives back too little. It has grown too big and too powerful.

And, he contends, the bankers have co-opted many of the regulators who watch over them

( A. Turner: Chief British Financial Regulator, quoted in NYT 9/24/2009)

“ Banks should be split into separate utility companies and risky ventures….It’s a delusion to think tougher regulation [alone] would

prevent future financial crises”

( Mervyn King. Governor of the Bank of England, quoted in FT 10/21/2009)

Toxic assets are still in hidden in bank’s balance sheets (which the Fed refuses to disclose).

A year after Washington rescued the banks considered too big to fail, the ones deemed too small to save are approaching a grim milestone: the 100th bank failure of 2009 – 400 on the watch list .(NYT – October 10, 2009).

Economic conditions in the real economy continue to deteriorate – unemployment has climbed to almost 10 % (not seen since 1983) and could reach 11% in 2010.

The mortgage crisis far from solved:

ON THE DOMESTIC FRONT (US):

The underlying roots of the crisis remain

Serious Delinquency among Mortgagors

0

5

10

15

20

25

30

35

40

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Prime FRM Subprime FRM

Prime ARM Subprime ARM

Number of Foreclosures Started

0

50000

100000

150000

200000

250000

300000

350000

400000

450000

500000

550000

600000

65000019

7919

8019

8119

8219

8319

8419

8519

8619

8719

8819

8919

9019

9119

9219

9319

9419

9519

9619

9719

9819

9920

0020

0120

0220

0320

0420

0520

0620

0720

0820

09

Financial concentration has increased: the top 3 US banks now control 30 % of all deposits, (up from 20 %).

Or…“Too big to fail” got worse… Investment banks are back in business ( JP Morgan: +11.9

B in 09), but credit is not flowing…

And other jumbo banks are still on the ropes (BOFA: -5.9 B in 4th Q, Citigroup: -1.6 B in 09).

The “Volcker Plan” (1/2010). Will it succeed? Is it enough ?

The elephant in the room: the political influence of finance.

ON THE DOMESTIC FRONT:

The underlying roots of the crisis remain

"And the banks – hard to believe in a time when we're facing a banking crisis that many of the banks created

- are still the most powerful lobby on Capitol Hill. And they frankly own the place.“- Senator Dick Durbin (D-IL), April 27, 2009 .

“Lobbyists Mass to Try to Shape Financial Reform”“The financial services industry has poured more than $220 million into lobbying

in 2009”- NYT, October 15, 2009.

“The Obama administration’s proposal for a new Consumer Financial Protection Agency risks being watered down by lawmakers in Congress after

lobbying from banks”- FT, October 16, 2009.

THE COUNTOURS OF A REFORM AGENDA

THE COUNTOURS OF A REFORM AGENDA - US

Resolve the mortgage crisis through the homeowners side – not the banks - & demand complete transparency of mortgage lending,

Rationalize the regulatory “maze” (ex. Dodd proposal),

Establish a broad Financial Products Safety Agency,

Realign compensation schemes to ensure “skin in the game” for fund-managers, traders, and CEO’s,

Address financial industry political influence peddling – stop revolving door and reform campaign finance.

Governance Failure : Financial Regulation in the US:A Very Inefficient Maze

Commercial banks

Futures

Industrial Loan Companies

Thrifts

Bank Holding Companies

Credit UnionsInsurance

Securities and Exchange

THE COUNTOURS OF A REFORM AGENDA - GLOBAL Re-regulate the financial system: a Glass-Steagall for the 21st Century

Establish a new division of labor among banks and financial institutions in general: traders should not be deposit takers and vice versa.

Regulate credit and liquidity: limit leverage and raise capital requirements to banking and non-banking institutions(from Ponzi to Hedge units).

Subject OTC custom made derivatives to a pre-approval process (like prescription drugs…). If regulators don’t fully understand them, don’t allow. If they do, establish a trial period.

THE COUNTOURS OF A REFORM AGENDA - GLOBAL

Access best regulatory practices outside the US and UK and incorporate them.

Bring all bank assets and liabilities onto bank balance sheets, subject to reserve & capital requirements.

After a “grace period”, all off-balance sheet assets and liabilities declared null and void, unenforceable contracts.

Create an adequate incentive system for regulators ( unless we want “good regulation under bad regulators”).

THE COUNTOURS OF A REFORM AGENDA - GLOBAL

Reform the BIS/BCBS: make it transparent assure broad representation and coordination capabilities.

Replace Basel II in the direction of more intense macro-prudential regulation, less leverage and an early-warnings risk assessments system.

Make rating agencies a public utility.

Prevent “too big to fail”: restore the distinction among financial institutions and….

Use competition policies to prevent excessive concentration.

THE COUNTOURS OF A REFORM AGENDA - GLOBAL

Develop a global financial governance for development agenda based on regional financial cooperation and enhanced representation by non- G20 countries (The UN back at the negotiating table) .

Create a “global financial governance body” (GFGB) where national regulation would prevail, but would be supplemented by international supervision, regulatory coordination and enforcement power (Housed where?).

Establish a mechanism for coordinated capital account control under this GFGB.

Reform the GATS agreement under the WTO.

QUESTIONS FOR DISCUSSION:

1. The tensions between recovery and reform.

2. The political influence of the financial industry versus democracy.

3. The need to overcome the Anglo-American intellectual hegemony.

4. The need to evolve from criticism towards building a coherent alternative.

Thank you

Appendix

THE SYSTEM IN MOTION MINSKY’S MODEL AND THE NEW FINANCIAL SYSTEM : MAD MONEY

INSTITUTIONAL FRAMEWORK: MARKETS AS WEBS OF CREDIT AND DEBT CONTRACTS

LongExpansion:Δ credit +Fin innov.

Overshootedexpectations

Laxmonetary

policy

TradeImbalances(Δ liquidity)

Recklessfinance

Asset priceinflationΔ Debt

financing

Exc ratefluctuations

Financialmeltdown

PONZI FINANCE PONZI SQUARE FINANCE

Asset pricedeflation

Liquidity &solvency problems

Δ Profits

Fin Deregulation:Δ liquidity +

Opaqueness Δ Leverage

∆ Debt

∆ interestrates

interestrates

∆

MADOFF FINANCE

SIVs, Derivatives ,&Securitization

Hedge &Private Eq

Funds Exc ratevolatility

PolicyChange

Bad debt/Losses

Financialfragilization

Profits

∆

A few interesting books on the crisis, Keynes and Minsky

Fiscal Shelters

BIS (G7 Central

Banks)

Credit Rating Agencies

Burlamaqui

IMF

WBChang

MaiInit

WTO

BankingSystem

SouthBank

RegDev

Banks

Multilateral and Public

Asia, Russia, Middle East and Latin America

The Fin Governance Grant’s Cluster:

SECFED BRICS

OECD

ExportCredit

Agencies

Int.ArbitrationTribunals

BilateralInvestment

Treaties

COUNTRIES&

NATIONAL STATES

Mortgage Funds

EUROPE

EuropeanCentralBank

LAWFIRMS

InsuranceCompanies

SWFs

IOSCOInt Org of Sec Comm.

IFACInt Fed of

Accountants

WFEWorldFed of

Exchanges

FSFFin

Stability

Forum

IAISInt Ass of Insurance

Supervisors

Credit cardCompanies

SIVsRMBS

IASCInt Acc

StandardsBoard

Global Corporations

Hedge andPrivate Equity

Funds

ACCFIRMS

GLOBAL PRIVATE

Pension Funds

GATS

NationalFin Reg

Agencies

IBASE

SIENA

CEPR

TJN

LEVYLEVY

NorthSouth

LEVY

LEVY

CUUS

ERF/IDEAS

CEDES

IPD

IPD

OXFORD(GEG)

FORUM

CFI

NEWRULES

DEMCenter.

IPD CEPR

Multilateral and Public

DC and Geneva

BICPUBLICCITIZEN TWN

EURODAD

TWN

DeJusticia

OXFORD(GEG)

SouthCenter