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. 

The Story of Economics

I've just listened to Michael Blastland's The Story of Economics on radio 4. This first of three episodes, 'Gods', addresses the role of morality in economics. The next episodes, 'Cogs' and 'Monsters', will consider economics from very different perspectives; as a science, and as the study of many animal spirits. Looking forward to them!

Inside Job: a collaborative review by Antonia Jeans and Marloes Nicholls

This week Mervyn King stated that he was surprised at the lack of public anger following the 2008 financial crisis. When Antonia and Marloes went to see Inside Job yesterday evening, we felt that our fellow cinema goers would strongly disagree. As we watched the crisis unfold with the rise of deregulation under the Reagan administration, Clinton's ratification of the Gramm-Leach-Bliley act and the collapse of subprime mortgage lending, the audience recoiled as if we were watching a horror film.

Christopher Ferguson's documentary doesn't just scrutinise the banking and finance industry, it pieces together the events that lead to the crisis with a gripping narrative and all the drama of a Hollywood blockbuster. Ferguson succeeds in making the complex world of CDOs and CDSs understandable to a layperson, without patronising the audience's intelligence.  This is in great part due to the minimal use of jargon in Matt Damon's narration, and clear use of diagrams to explain how financial instruments work.  

By focusing on first person accounts of the key players in the upper echelons of the finance and economics profession, the viewer personally identifies with the story and characters involved. Ferguson cleverly includes outcuts from the interview tapes, catching the interviewees off guard. There are some particularly intimate moments where his frank questioning leaves certain guilty parties embarrassingly (and sickeningly) exposed.

We did feel that a focus on US companies and politics, but an insistence on the relevance of the film globally highlighted a US-centric standpoint. The inclusion of French finance minister, Christine Lagarde, would have been welcomely accompanied by a UK representative such as Alistair Darling. Ferguson also chose to neglect the role of Globalisation in contributing to the financial crisis: 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 like CDOs so attractive.

Having said this, it is widely acknowledged that the crisis of 2007/8 began in the US, and Ferguson couldn't include everything! What the film does best is to reveal the corruption and cronyism within the top tiers of the banking system. It is the same men who sit on the boards of banks who form US financial policy. President Obama's decision to continue the trend is worrying, but it's clearly difficult to find others with the expertise to do the job who are not subject to a conflict of interest.

Above all the film's cinematography remains most vivid. Striking images of Iceland's natural beauty, juxtaposed with the modern industry of the New York skyline, we felt, underpinned the difficult and depressing point that in the UK, as in the US, we are dependent on the banking system to drive the economy.  It provides the basic and essential services of looking after our savings and providing loans. During the boom years we enjoyed the successes and excesses of a system which seemed indestructible. It is left to current governments to negotiate banking reform for which, despite King's opinion, the public are clearly impatient.

A and M

John Redwood: The Future of the Euro

The Rt. Hon. John Redwood, Secretary of State for Wales under the leadership of John Major, prides himself for playing a role in the UK's decision to not join the euro. He recently came to All Souls College, Oxford, to present his ideas on "The Future of the Euro". Find my report on the seminar, written for the Oxford Institute for Economic Policy (OXONIA), here.

Rt. Hon. John Redwood, Old Library, All Souls College

Interview with Sir John Vickers

See my article 'Can we bank on the future?' printed in the Oxford Student Newspaper here.

Gordon Brown and the Transition we Face

For the first time in 200 years Western Europe and the US are being out-produced, out-invested and out-exported. It has been forecasted that the Chinese economy will be the largest in the world in 10 years. This is astounding given that just 20 years ago China was one of the least productive economies. The figures in a paper I was reading for one of my classes yesterday [Hall and Jones 1999] highlight the point - they estimate that China's productivity in 1988 was a mere 6% of that of the US! 

It was this shift in economic power to Asia and the group of countries known as the BRICs (Brazil, Russia, India and China) that the Rt Hon. Gordon Brown addressed when he came to Oxford this week.

The shift poses many problems for the West. How can we compete with these emerging economies? We are no longer a great manufacturer, and our financial services are toxic. It is not just a question of what we can sell but where we will find work; we are going to increasingly face competition for jobs from the increasingly educated global labour market.

On the other hand, with rising production there will be a rise in consumption, and a huge new middle class (about 2bn people), which Gordon believes we can turn to our advantage. Gordon fears, however, that we may face an unnecessary 'lost decade' of low growth and high unemployment. For how can we export our culture (music, wine, film), our medicines, our education and our science (particularly brain surgery and small satellite technology) if we are cutting investment in education, science and the arts? (This is where Gordon condemned the current UK economic policy but he didn't mention they who will not be named once!)

(Sorry for the poor quality - taken on my phone)

Gordon's opinion that the government should continue spending now is controversial. The Conservatives might argue that they will be in a better place to address the global imbalances once they have put "their house in order" (see previous post). Either way, it would be encouraging to hear the current government talk about this issue more. President Obama made it clear in his recent 'sputnik moment' speech that he is aware of these issues. He is preparing a budget to take to congress in order to fund investment in industries that he believes the US has a competitive advantage, namely biotechnology and clean technology.

Two further warnings Gordon gave were that 1) the mistakes which caused the 2008 financial crisis are not being addressed and will be made again, and 2) while we can expect a rising level of living standards in the rising economic powers, there will remain the very poor in Africa and island states that are suffering from climate change. It is striking that Africa is not benefiting from globalisation; whilst it has 15% of the world population, it receives just 1% of the total investment.

The free capital flows which enabled countries like China to grow, and the US to consume so much, have also created an interdependence which means that we can no longer define countries as economic regions. And this leads to Gordon's final point that effective decisions about the economy can be made less and less at the national level. Rather, we will have to use international institutions like the International Monetary Fund (IMF), the World Bank, and the G20. 

We are currently using these institutions as a way to make global decisions in the wake of the 2008 financial crisis. At a meeting with an IMF official earlier this week I was told that, after 10 months, the G20 could still not decide on what indicators, let alone the limits, to use as warning signals for future crises! It is easy to see why people are cycnical that compromises can be made on a global level. They certainly take more time. (We have seen this with climate change too.)


Gordon believes that it is in our interest to make decisions on a global level, and that we can achieve global accord. Perhaps he is being optimistic. Thankfully, though, he is not following some other leaders in Northern Europe who are becoming more nationalistic and presenting xenophobic views. It is understandable to feel insecure as a citizen of a developed economy, but Gordon's message is that the answers lie in looking out, cooperating, and developing imaginative new ways to participate and compete on the world stage. 

The Future of Banking? A roundtable discussion

Gulbenkian Lecture Theatre, 

St Cross Building, Manor Road, Oxford (see map)

Friday 4th March 5pm-7pm

Chatham House Rules may apply (i.e. you are free to use the information, but cannot identify who said it).

There will also be time to ask questions, and a drinks reception in the economics department will follow.

You can find the Facebook page here.

Professor David Miles has been a professor of finance at Imperial College London since 1996. His research focuses on the interaction between financial markets and the wider economy. From 2004 -2009 he was Chief UK Economist at Morgan Stanley. He has acted as a specialist economic advisor to the government and is currently a member of the Monetary Policy Committee at the Bank of England. 

Professor Peyton Young is the James Meade Professor of Economics at the University of Oxford and a Senior Fellow at the Brooking Institution. He is an expert on social norms and how they affect the design of policy, and has written on hedge funds and gaming of performance fees, in academic journals as well as in the financial press. 

Angela Knight is chief executive of the British Bankers Association - "the voice of banking and finance". She has a high profile in the city, having been economic secretary to the treasury and chief executive of the Association of Private Client Investment Managers and Stockbrokers . She was also a Conservative MP from 1992 to 1997.

Ben Dyson is a specialist in money and banking. He has spent 4 years researching and identifying flaws in fractional reserve banking-the current business model used by banks globally-and getting an understanding of the wider impacts of this business model on the economy and society as a whole. He now spends his time working on the the Positive Money campaign. Ben has also worked on proposals and draft legislation that would apply Irving Fisher's full-reserve banking solution to a modern, digital banking system.

David Vines is a professor of economics at the University of Oxford, and Director of the Centre of International Macroeconomics. His work spans international macroeconomics, the reform of international financial architecture and monetary economics. Whilst studying at the University of Cambridge, Professor Vines worked with Nobel Prize-winning economist James Meade, who was deeply influenced by Keynes. In 2002 Professor Vines was a Houblon-Norman Senior Fellow at the Bank of England.

Chair: Professor Alan Morrison is an academic at the Said Business School, Oxford. He first studied in Oxford as an undergraduate when he read mathematics at Brasenose College. After seven years working for management consultancy, Accenture, he decided to go to Imperial College in order to pursue an academic career. His research interests are banking regulation, corporate finance and corporate governance.