Wednesday, 16 March 2011

Mark Sobel: Top US official discusses financial regulation and rebalancing the global economy

Ben Bernanke (Federal reserve chairman),
Tim Geithner (US Treasury Secretary) and Mark Sobel
On Tuesday morning I attended an intimate round table with thirteen other academics and Mark Sobel, US Deputy Assistant Secretary for International Monetary and Financial Policy. The discussion addressed the broad topic of US policy after the financial crisis, and it was fascinating to hear the American perspective from a top US official.

Numerous questions were addressed by Sobel and the group of academic attendees, whose interests lay mainly in global governance and financial markets. In my mind, the two most interesting issues raised were 1) whether new financial regulation had introduced any significant change, and 2) the US priority to rebalance the global economy.

(Please note that, in order to respect the fact that the discussion was "off the record", my summary will be quite general.)

Financial regulation

In the aftermath of the 2008 financial crisis US Treasury Secretary, Tim Geithner (pictured above with Sobel), believed that low capital requirements were at the core of the problem. This opinion is reflected in the BASEL III accord, yet to become legally binding in individual countries, which sets the minimum target for common equity capital at an increased rate of 7% or risk-weighted assets. 

Some at the meeting were skeptical that Basel III significantly altered the workings of financial markets. I think that, compared to the US, the sentiment in the UK is that regulatory action needs to address more than just capital requirements. The governor of the Bank of England, Mervyn King, warned that we have not yet addressed the "too important to fail" issue, and the Independent Commission on Banking is looking into breaking up the banks, and separating more risky investment activities from the saving accounts of normal citizens.

Others at the roundtable thought that Basel III had significantly strengthened the system both quantitatively and qualitatively. It was their opinion that the increased capital requirements, and a tightened definition of capital are significant changes and that, importantly, they are regulations that can be agreed upon globally. One attendee mentioned that Basel III requirements were 50% more robust than Basel II.   

It is understood that the increased capital requirements are not going to stop financial crises occurring; Merrill Lynch would have needed a 23% capital requirement to have stopped it from going under in 2008 (three times what Basel III is asking for)! In order to strengthen the proposed system we need to also design resolution mechanisms for failed banks that clear up the mess at minimum cost to the rest of the financial system and economy. Under the Dodd-Frank Act there is a presupposition that when a bank goes under, someone else will be there to buy it. One attendee suggested that it might be desirable to have legislation so that banks can be reorganised back into shape without needing to sell it on.

Those satisfied with the latest financial regulation also pointed to the widening net of regulation that now covers non-banks (like hedge funds) and credit rating agencies. Policy has reacted slowly in this area though, and is probably incomplete; the first paper on the shadow banking sector, which is apparently larger than the regulated sector, was published by the G20 and Financial Stability Board just this February. 

Rebalancing the global economy

A large part of the discussion focused, unsurprisingly, on global imbalances and exchange rates. The US imports much more than it exports, which, translated into the jargon of economics, means that the US has a large current account deficit. US officials would argue that this is, in part, because the currencies of South East Asian economies are undervalued, and so US consumers import too many goods from abroad, and export too few goods. This is bad news for American jobs. It has a less obvious impact too; I mentioned in my previous post that the low interest rates in Western economies (stemming from cheap import prices which led to low inflation expectations) gave rise to the "search for yield" that made risky assets with high returns so attractive in the run up to the financial crisis.

Chinese reserves of dollars went up from $5 billion to $3 trillion in just the last five years! As China buys more and more dollars they become more scarce and so are worth more, making US goods more expensive relative to Chinese goods. Is it no wonder, then, that the US points to China's actions as a cause of it's current account deficit? Well, actually, I now understand that revaluing the Renminbi alone would not actually rebalance the US economy. In fact, it was said at the meeting that revaluing all South East Asian currencies would create only a small effect on the US current account deficit! 

The other way to rebalance and economy, namely to reduce spending, is internationally problematic too. As the US saves, the rest of the world's growth will slow, and countries from which the US buys goods will need to encourage domestic demand to maintain growth. 

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