Nov. 10 (Bloomberg) -- This week's economic-crisis summit will pit U.S. and Canadian support for free markets against European demands for greater state control.
In the middle will be developing nations that hold increasing sway over the future of the global economy and don't want the trade-off between regulation and economic expansion to come at their expense.
The leaders of the Group of 20 industrial and emerging countries, gathering Nov. 14 and 15 in Washington, will consider steps ranging from raising bank-capital standards to regulating hedge funds.
Their goal is to prevent any repeat of the irresponsible risk-taking that led to the worst erosion of credit since the Great Depression. ``Necessity is the mother of invention, and there's a real necessity now for more regulation,'' says former U.S. Treasury Secretary John Snow. The hard part is figuring out how much growth they are willing to sacrifice in exchange for greater economic security.
``Whatever changes are made will be long-standing, and so policy makers must be careful to make sure they are a net positive overall,'' says Tim Adams, a former U.S. Treasury official and managing director of the Lindsey Group, an economic-advisory firm in Washington.
G-20 Focus
The G-20 leaders' focus will fall squarely on banks and investment houses that ignored evidence they were miscalculating risk. That led them to lend to unqualified borrowers and place too much reliance on derivatives such as credit-default swaps, a financial instrument that functions as a kind of insurance for bondholders, to protect against losses.
Finance ministers and central bankers from the G-20 yesterday concluded talks in Sao Paulo by blaming ``excessive risk taking and faulty risk management practices in financial markets'' for starting the crisis, while acknowledging ``deficiencies in financial regulation and supervision in some advanced countries.'' The officials said they are prepared to act ``urgently'' to bolster growth.
Global Slump
So far, banks worldwide have been forced to write off about $691 billion in bad assets, creating a global credit crunch as they suddenly shut down lending, wary of losses. The International Monetary Fund last week predicted the economies of the U.S., Japan and euro region will simultaneously contract in 2009 for the first time since World War II.
While Adams is among those predicting a ``regulatory backlash,'' there's little agreement on what kind of or how much oversight would be needed to prevent another crisis.
French President Nicolas Sarkozy, who pushed U.S. President George W. Bush into convening the summit, is calling for increasing government control -- reaching across international borders -- over lending practices and investing.
``We don't want to move from an absence of regulation to too much regulation, but we want to change the rules of the game,'' Sarkozy said in Brussels on Nov. 7 after European leaders finalized their proposals for the summit. He demanded the Washington talks deliver ``ambitious, operational decisions'' and a plan for officials to reconvene by the end of February.
Financial Constitution
The Brussels meeting concluded with calls for stiffer regulation of credit-ratings agencies, hedge funds, and urged a crackdown on risk-taking and executive pay.
The French leader has support from German Chancellor Angela Merkel, who seeks regulation of hedge funds and curbs on bonus packages for bankers as part of a new ``constitution'' governing financial markets.
U.K. Prime Minister Gordon Brown has lobbied for improving cross-border oversight of the global financial system by placing the world's top 30 banks under the supervision of a panel of regulators.
Such ideas will find little favor with the lame-duck Bush administration. With little more than two months left before President-elect Barack Obama takes office, the administration has signaled it opposes any movement toward a global authority overseeing financial markets.
While European leaders have called for a ``new Bretton Woods'' -- a reference to the 1944 conference that established the post-World War II global economic system -- Canadian Finance Minister Jim Flaherty cautions against overreaching.
``We don't need to recreate the world right now,'' he said in an Oct. 31 interview.
Basel Accords
In any event, international supervision has its limits, says Charles Calomiris, a professor at Columbia University in New York who studies the global financial system. He notes that most major banks already subscribe to the so-called Basel accords, developed in 1988 and 2004 to create international standards for regulation, risk management and disclosure -- and those failed to prevent the recent crisis.
``We don't want more cooperation through the global apparatus,'' Calomiris says. ``We just want to regulate our banks more effectively.''
Subjecting financial institutions to more checks would rebuild confidence among investors, says Willem Buiter, a professor at the London School of Economics and former Bank of England policy maker. ``If it's done well, we can get greater stability. The risk is of doing too little.''
Trade-Dependent
There is also the risk of going too far, with regulation that stifles innovation and raises costs. Requiring banks to hold more capital, for example, would mean less money available to lend to companies and consumers. Tighter regulation is one reason why ``potential growth is likely to be very subdued and substantially lower than in the past decade,'' said Joachim Fels, co-chief economist at Morgan Stanley in London.
That's a concern for the leaders of trade-dependent developing nations, which benefit when industrialized countries are growing and buying their products.
``The prospect of regulation slowing a return to trend growth, and so hurting exports, is a worry,'' says Tim Condon, head of Asia research at ING Groep NV in Singapore. As for imposing tougher rules at home, countries such as China will want to maintain ``regulatory forbearance and flexibility as their economies slow,'' he says.
So far, the Chinese aren't taking sides. After meeting with European leaders Oct. 24, President Hu Jintao, who will attend the summit, said his country ``must first and foremost run our own affairs well.'' Premier Wen Jiabao, who also attended the meeting, said while more oversight may be required, ``we need to handle correctly the relationship between financial innovation and regulation.''
Chinese Investment
The Chinese are acting in other ways to gird their economy. The biggest contributor to world growth yesterday unveiled a 4 trillion yuan ($568 billion) plan to sustain growth. China's cabinet pledged ``fast and heavy-handed investment'' in housing and infrastructure through 2010.
Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong, says leaders of most emerging-market nations see little reason for stricter rules because their banks didn't make the same lending mistakes as western rivals.
That, along with their increased economic power, may give emerging countries more influence over the global regulatory response to the market turmoil, Maguire says. ``Whatever the solution to the crisis is, they are going to have a significant role.''
Global Solutions
``This is a global crisis and demands global solutions,'' Brazilian President Luiz Inacio Lula da Silva said Nov. 8. The Group of Seven rich nations ``alone is not in conditions to conduct the world economy. The participation of the developing world is essential.''
Jeffrey Sachs, director of Columbia University's Earth Institute and an adviser to governments around the world, says regulation should take a back seat to helping countries navigate the economic crisis. Developed nations could use the IMF or their own central banks to help provide safety nets for banks in emerging markets, he says.
``We need financial institutions that make sense for the challenges we're facing, not just an effort to fight the last war, which is what financial regulation would do,'' he says.
Given the divided goals -- and the timing -- this weekend's meeting is mostly a chance for the Europeans to make their case and for officials to agree to meet again next year, after Obama's administration has taken over in Washington.
That means the summit isn't likely to be much more than the beginning of a debate -- let alone a modern version of Bretton Woods.
``This will be long-term,'' says Michele Fratianni, who studies the international financial system as a professor of economics at Università Politecnica delle Marche in Ancona, Italy. ``When you start talking about fixing things, with so many countries having different objectives, this will take some time.''
To contact the reporter on this story: Simon Kennedy in Paris at Skennedy4@bloomberg.netMichael McKee in New York at mmckee@bloomberg.net
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