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Reforming International Financial Regulation

University of Pennsylvania's Wharton School professor David Zaring filed this guest blog post:

Any vision of financial reform must grapple with the globalization of both finance and the regulation of it. 

Consider the current financial crisis.  In 2008 alone, the insolvency of Lehman Brothers occupied both British and American courts.  The collapse in value of American housing assets threatened the European economy because of the many buyers of those assets among European financial institutions.  AIG wrote most of the credit protection that felled its American operations out of its London office.  Capital adequacy is handled by the multinational Basel Committee on Banking Supervision, and accounting standards come increasingly from the International Financial Reporting Standards process, which is administered by the mostly private, but public-minded International Accounting Standards Board, which is based in London. 

The international dimensions of the financial crisis are inescapable.  Finance has globalized, the oversight of it has increasingly gone international, and transnational spillovers have become the part and parcel of financial crises.  While the right scope of domestic financial regulatory reform is debatable, I think there is little question that better international coordination is needed before we are confronted with the next crisis.

How should American regulators coordinate their efforts with their foreign counterparts?

An effective system of international financial oversight would perform three distinct tasks. First, it would provide the capacity to harmonize basic global rules, so that minimum levels of oversight and transparency are available in all of the major markets, the inclination to regulatory arbitrage is minimized, and the capacity of emerging market regulators is developed. Second, it would serve as an early warning system that could coordinate quick responses to brewing crises with systemic implications. And third, it would provide some sort of capacity to resolve international differences in regulatory approach – particularly when those differences lead to jurisdictional and other disputes, as they have in the context of multinational insolvency proceedings and antitrust enforcement.

The current repository for harmonization is the informal network of all sorts of financial supervisors known as the Financial Stability Board. Both the Obama administration and the G-20 have endorsed the development of the board and vowed to make it more effective. (It has operated quietly, and none too promisingly, for about a decade, and has had little to say about the current crisis.) A newly strengthened Financial Stability Board may be a good idea. It may be flexible and expert enough to harmonize baseline rules for the regulation of international finance while still taking a broad view of all of the markets in which modern financial conglomerates participate. But the question presented by this international committee (and it is one presented by all of the regulation-by-committee proposals) is whether a committee of experts is the right institution to help harmonize global rules. It might be, but the devil in effective international committee composition lies in the details.

As far as early warning goes, the renewed mission of the G-20, and commitment to the International Monetary Fund, are both promising developments. The G-20 has been the international vehicle most capable, at least in this crisis, of responding to financial shocks. It has done the most policymaking, even as other international institutions have been silent. And its meetings have resulted in real substance, rather than the nostrums and platitudes that can characterize many international gatherings of heads of state. Foremost among its accomplishments is the reinvigoration of the IMF as monitor of the global economy on the lookout for shocks to its system. No early warning system will be perfect, but with the IMF tasked to do the early identification, and with the G20 committed to rapid response, international financial crisis response may be in with a chance.

Effective dispute resolution is hard to find in international economic law. The gold standard for dispute resolution is the World Trade Organization, but practical observers may suspect that there will be little political appetite for a financial regulatory analog to the WTO. So what can one country do if it suspects that another it letting its undercapitalized banks roam free in the global marketplace? No solution is perfect, but one strategy that could help lies in the regulatory dialogue. These semi-formal meetings have done a great deal to reduce tensions between the United States and European Union; there is no reason why the dialogue process could not be implemented more widely, both quickly and easily.

I expand on these observations in the final chapter of the broader Committee on Capital Markets Regulation report and proposals for regulatory reform. You can download the full report here.

--David Zaring is an assistant professor of legal studies at the Wharton School of Business. He also blogs at the Conglomerate.

By Terri Rupar  |  July 2, 2009; 12:30 PM ET
Categories:  Regulation  
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I found: A Sick Economy Can Be Hazardous to Your Health, Tuesday, March 31, 2009; Page HE05 in the Post archives. I can't criticize the scholarship of these articles attempting to untangle the economic Gordian knot, but I can add to the knowledge of the problem through reference to other sources. History is a favorite since much of problematics have precedence in origin and persistence in subsequent concurrency. In 1968 Garrett hardin, an ecologist, published a study he called, "Tragedy of the Commons" See:-

Essentially we have and will always have a complex of threads in the line of the Gordian knot of economics, but just as stars explode when they run out of fuel to burn, so do economics contribute to war and deprivation.

Posted by: hillhopper | July 9, 2009 9:41 PM | Report abuse

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