It has been nearly six months since G-20 leaders last met in London, when, in the midst of a global financial crisis, they adopted a $1.1 trillion global liquidity package aimed at increasing the International Monetary Fund’s lending capacity, restoring confidence, and unfreezing global credit.
Since then, with many analysts declaring the worst of the crisis over, attention has been turned to reforming the way the global economy is run and implementing rules to prevent a future crisis. Among the thorny issues on the table: how to regulate hedge funds, oversee derivatives markets, curb tax havens, set adequate capital standards for banks, and place limits on executive compensation.
In the months leading up to the summit, varying levels of philosophical differences between key countries have emerged on nearly every issue set to be discussed.
Writing in the New York Times today, economist Simon Johnson wrote, “In terms of the economic agenda — and this meeting is supposed to be about the global economy — the likely deliverables look thin.”
On the issue of executive pay, France and Germany have proposed strict limits, citing the idea that excessive risk-taking by bonus-seeking bankers played a large role in bringing financial institutions to their knees. Last month, French President Nicolas Sarkozy summoned top French bankers to the Elysee Palace and unveiled a series of measures that would defer traders’ bonuses over several years, impose long-term criteria on performance in order to receive a bonus, and install government watchdogs at banks that have received aid.
At a press conference announcing the new rules, Sarkozy vowed to fight for similar rules to be implemented across the G-20 countries so as to retain competitiveness. “If we limit bonuses only in France, everyone will leave,” he said.
The French finance minister, Christine Lagarde, echoed that sentiment when she told the BBC this month that “we are determined to change the [global] rules.”
The Obama administration has so far appeared resistant to changes to executive pay on the scale proposed by France and Germany. But President Barack Obama has called for greater responsibility and prudence on Wall Street, saying in a speech in downtown Manhattan last week that “[w]e will not go back to the days of reckless behavior and unchecked excess at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses.”
It was a speech that no Wall Street CEOs actually attended, but the Wall Street Journal recently reported that the Federal Reserve is close to proposing reforms that give it the power to reject broad compensation policies that it feels create incentives for excessive risk at major financial institutions.
Under the reported plan, the Fed would not have the power to govern individual salary amounts, but the proposal suggests that the government is prepared to have a hand in deciding how bankers are paid, if not how much.
European leaders, however, may move ahead with a cap on executive compensation with or without U.S. support. The president of the European Commission, Jose Manuel Barroso, said last weekend that the European Union should limit bonuses regardless of whether the United States agrees to a cap.
The United States has largely focused on reforming the issue of bank capital requirements — requiring a certain ratio of capital on hand to assets as a cushion — as its proposal of choice for the G-20 summit. Increasing the amount of money banks must have on hand is intended to insulate them in the future from catastrophic losses — and ideally prevent future government-funded bailouts.
But so far, the Obama administration has not been specific about what those requirements might look like, and if they would be dramatically different from the capital standards to which many American banks voluntarily submit.
Capital requirements in Europe tend to be lax and diverse across the continent, and it is unlikely that they will embrace new rules, particularly any that dramatically change the way their banks have operated. Similarly, Japan and China appear cool to any proposal that dictates how their domestic banks may function.
“Each government is trying to figure out what kinds of regulation would cause the least pain for its banking system and the most pain for its rivals,” according to Joseph Stiglitz, the Nobel-winning economist, in an interview with the NewsHour.
A key complaint about increasing capital standards is that it would inhibit banks’ ability to lend at the precise moment governments are demanding that they unfreeze credit. In a recent letter to British Prime Minister Gordon Brown, the chairman of the British Bankers’ Association wrote, “The simple fact remains that financial institutions cannot take steps to further increase the amount of capital they hold and at the same time lend that capital to businesses and consumers.”
But an increase in capital requirements may not have a negative effect on banks’ ability to lend, according to a new report released Thursday by the Brookings Institution and commissioned by the Pew Financial Reform Project. The cost of loans will likely increase only modestly even if capital requirements are hiked dramatically, writes the report’s author, Brookings Fellow Douglas Elliott. The results “strongly suggest that tougher capital requirements can powerfully aid the stability of the system without doing excessive damage to lending or the economy,” Elliott writes. They will “not wreak havoc on the system.”
Also up for discussion will be whether the governing structure of the IMF will be reformed. Emerging countries, including China, India, and Brazil, are demanding more voting power, which has historically been concentrated in the hands of Western countries. Currently, more than half of IMF votes are held by just fourteen member nations, while the remainder is divided between 172 members.
Offering emerging economic powers like China and India a larger role in the system of governance, particularly if growth in those countries is helping to lead others out of a global recession, is seen as essential to restoring the IMF’s legitimacy. But few observers expect smaller Western economies, such as Switzerland or the Netherlands, to concede much ground. And with a deadline of January 2011 for new proposals, little progress is expected this week in Pittsburgh.
Far more impressive has been the global community’s progress on curbing tax havens, a key issue at the April summit. Since then, 13 jurisdictions, including Belgium, Austria, and the Cayman Islands, have agreed to enact international tax standards. More than 30 other jurisdictions, including Switzerland, Singapore, and Liechtenstein, have committed to reform.
Far less has been done on regulating hedge funds, a key point of contention among many countries. Several European countries, with Germany leading the charge, seek to regulate hedge funds similarly to banks. They blame hedge funds for causing — and profiting from — instability in the market. But so far, the United States and the United Kingdom have avoided strict regulation. They propose that hedge funds should simply be more transparent and provide more data to government regulators.
With much yet to be done, the pace of reform has itself become a contentious issue. Last week, the Financial Stability Board, the G-20’s policy coordinating body, released a statement admitting that “challenges in maintaining an appropriate balance and pace of regulatory reform” remain. Momentum from Pittsburgh may be required to keep many of the thornier reforms on the table.
Editor’s Note: This story was updated on Sept. 25.