G-20 Risks ‘Catastrophe’ as Push Ebbs for Regulation

By Rich Miller and Simon Kennedy

Sept. 2 (Bloomberg) -- Economic policy makers from the Group of 20 nations gathering this week in London are finding that their drive to prevent the next financial crisis may be jeopardized by their success in countering the current one.

Stock markets are rebounding, with the MSCI World Index of 23 developed nations gaining 59 percent since March 9, when it reached its lowest level since 1995. Signs of economic revival are also appearing in countries such as the U.S. and the U.K. after the worst slumps since World War II.

The rally is sapping the political push to impose tougher regulations on financial-services companies. While that might help earnings for New York-based Citigroup Inc., the third- largest U.S. bank, and Barclays Plc, the U.K.’s second-biggest lender, it may also leave the global economy susceptible to a fresh cycle of boom then bust.

“We’re getting a recovery, so dealing with the true problems is going to be more difficult,” said Raghuram Rajan, a former chief economist at the International Monetary Fund who is now a professor at the University of Chicago. “The risk is that we’re just going to tool around until the next crisis.”

U.S. Treasury Secretary Timothy Geithner, Bank of England Governor Mervyn King and other G-20 finance ministers and central bankers meet Sept. 4 and Sept. 5 to prepare for the Pittsburgh summit of leaders three weeks later. They are convening five months since their governments blamed “major failures” in supervision as one of the “fundamental causes” of the worldwide credit crunch and vowed to “strengthen financial regulation to rebuild trust.”

Global Growth

That drive is now in jeopardy as the crisis ebbs. The IMF plans to raise its global growth forecast to “just below” 3 percent for 2010 from its 2.5 percent estimate of July, Jorg Decressin, a division chief in the lender’s research department, said yesterday. Banks are regaining lobbying strength, and other political goals such as health-care reform in the U.S. have captured the attention of legislatures. International differences, including over how to restrain bonuses, are also undermining the G-20’s united front.

Central bankers are already pressing governments not to slow the pace. “It would be a catastrophe not to draw all the lessons from the present crisis in terms of regulation,” European Central Bank President Jean-Claude Trichet told a symposium in Jackson Hole, Wyoming, on Aug. 21.

‘Radical Restructuring’

“Much remains to be done,” Bank of Israel Governor Stanley Fischer told attendees the same day. The former Citigroup vice chairman suggested the global banking system may need to undergo “radical restructuring,” perhaps by imposing limits on the size of individual financial companies.

Fischer also recommended that banks be forced to set aside more capital and central banks be given the power to monitor financial systems.

“What I’m very worried about is the recovery is going to come and the political will is going to disappear to actually repair the system,” said Stephen Cecchetti, head of the monetary and economic unit at the Bank for International Settlements in Basel, Switzerland, which serves as a bank for central banks.

Financial institutions may be the winners of a regulatory impasse because their profits would be spared, said Simon Johnson, a former chief IMF economist who is now a senior fellow at the Peterson Institute for International Economics, a Washington-based research organization.

Sweeping Overhaul

President Barack Obama in June proposed the most sweeping overhaul of the U.S. financial-regulatory system in 75 years, calling for the creation of an agency to monitor mortgages and other consumer products and tighter oversight of the country’s biggest banks and institutions.

Congressional passage of his revamp would have a “material” effect on bank earnings, said Andrew Laperriere, a Washington-based managing director at International Strategy & Investment Group, an institutional brokerage. The MSCI World Financials Index has jumped 132 percent since its low of 35.01 on March 9.

Unless steps are taken to reduce complexity and leverage in financial markets, “we’re going to have a replay of what has just happened over the last few years,” said Richard Bookstaber, a former trader at New York-based Morgan Stanley, the sixth-biggest U.S. bank by assets.

Fastest Pace

He warned in 2007 that risks in the markets were becoming unmanageable. Since then banks, brokers and insurers have racked up more than $1.6 trillion of writedowns and credit losses, data compiled by Bloomberg show, and the world economy fell into recession.

Financial firms are showing signs of reverting to their old ways, Johnson said. Zurich-based Credit Suisse Group AG, Switzerland’s second-largest bank, and Scotia Capital, the investment-banking unit of Bank of Nova Scotia, Canada’s third- largest bank, are among those increasing lending to buyers of high-yield company loans and mortgage bonds at what may be the fastest pace since the crisis began.

Still, stocks fell around the world this week on concern that their rally has outpaced the prospects for earnings and economic growth. U.S. stocks dropped for a third day yesterday, the longest losing streak for the Standard & Poor’s 500 Index since June, amid worry banks will post more losses.

In the U.S., Obama’s plans face resistance from lawmakers, overseers and the banking industry.

Risk Regulator

Federal Reserve Chairman Ben S. Bernanke, Federal Deposit Insurance Corp. Chairman Sheila Bair and other regulators have opposed giving up their consumer-protection powers under an administration plan to set up a new agency to police financial products. Banks have also opposed the new regulator, arguing it would add a layer of expense to their operations and raise borrowing costs for customers and companies.

“The industry has gotten really organized since the crisis began to ease,” said Johnson, who is also a professor at the Massachusetts Institute of Technology in Cambridge.

A number of lawmakers, including Christopher Dodd, a Connecticut Democrat and chairman of the U.S. Senate Banking Committee, have voiced unease about another administration proposal to give the Fed powers overseeing systemic risks. Dodd has said he is leaning toward giving that power to a council of regulators.

“There’s no chance reform gets done this year,” said Laperriere, noting the breadth of changes proposed by the administration. “It’s not very likely it gets done in the current Congress,” which concludes at the end of 2010, he said.

National Money

It also may take more than a year for the European Union to unify market oversight in its 27 nations. While leaders agreed in June to sharpen scrutiny of banks, the EU’s executive arm must now draft legislation that then goes to the European Parliament and individual governments.

The risk watchdog the EU has proposed will lack powers to enforce its warnings and won’t automatically be run by the ECB as originally planned. The U.K. has won a compromise to prevent the panel from making decisions involving national money.

Executive pay is an area of disagreement that may become a point of contention at this week’s meeting of financial officials from China, India, Canada and other G-20 countries. German Chancellor Angela Merkel and French President Nicolas Sarkozy are urging the G-20 to impose tougher limits on bank bonuses.

Bonus Pools

France will suggest curbing bonus pools as a percentage of a bank’s revenue, imposing a ceiling on payments or taxing them, a finance ministry official told reporters yesterday. U.K. Prime Minister Gordon Brown sees a cap as difficult to enforce, the Financial Times reported yesterday, citing an interview.

“Bonus payments are the thing that quite rightly drives a lot of people up the wall,” Merkel said in Berlin on Aug. 31 with Sarkozy beside her. The two leaders said they want the G-20 to limit the size of banks and tighten capital rules.

France drew criticism from U.S. analysts and investors last week by announcing it won’t hire financial firms unless they follow their French counterparts and apply rules that include a three-year deferral on two-thirds of bonus payments.

“We’re in a tug of war between national political pressures and the desire to coordinate,” said Charles Dallara, managing director of the Washington-based Institute of International Finance, which represents the world’s biggest financial firms. “Right now the nationalist forces have the upper hand.”

Regulatory ‘Fragmentation’

He said that may lead to regulatory “fragmentation,” with supervisors trying to “protect their own backyard” and making the global system less stable in the process.

The longer the delay in adopting reforms, the more likely the drive will be dominated by politicians as opposed to “technocrats,” said Mohamed El-Erian, chief executive officer of Newport Beach, California-based Pacific Investment Management Co., manager of the world’s largest bond fund. In that case, reforms may end up being too “blunt,” he said.

“The run-up to the Pittsburgh G-20 meeting has attracted little attention,” said El-Erian, a former IMF official. “There is a risk that, after a successful London meeting in April, the G-20 process may lose momentum.”

To contact the reporters on this story: Rich Miller in Washington rmiller28@bloomberg.net;