Dani Rodrik had a provocative “blogpost”:http://rodrik.typepad.com/dani_rodriks_weblog/2008/11/what-a-surprise.html a little while back:
Here is the dilemma we cannot evade. If we want a truly global financial system, we need to acquiesce in a global regulator and a global lender of last resort. If we do not want the latter, we cannot have an integrated global financial system, so we must acquiesce in–gasp!–capital controls.
The counterargument that I’ve been hearing from people (well, one significant person anyway) involved in the Obama transition process is twofold. First – that it would take far too long to create any global regulatory structure, given differences in national level regulatory schemes. Second, that we don’t need any binding global regulations anyway, and that everything we need to do can be done through dialogue between the national regulators that already exist. Maybe the best way to think this through is to look at the best example that we have of a transnational regulatory system with teeth – the European Union.
The EU’s experience reinforces the claim that it is really difficult to get national regulatory systems to play nicely with each other, and it is _especially_ difficult to get them to play nicely in the realm of banking and financial system regulation, because these regulations are (a) really important, (b) reflect genuinely different national priorities and banking systems, and (c ) also reflect the desires of strongly embedded interest groups in the national systems that like things the way they are (the Italian central bank, for example, is effectively beholden to a number of national banks inside and outside the _salotto buono_ and unsurprisingly these national banks want to keep the current system unchanged).
However, it also provides strong evidence of the problems of weak regulation. One of the major reasons why the European financial system is finding it hard to cope is exactly the lack of a Europe level regulatory backstop and lender of last resort, that could deal with banks that are effectively playing in a Europe-wide (if not worldwide) market. National governments are trying to do what they can, but their efforts are sometimes pretty wobbly. And the EU experience completely belies the claim that regulatory dialogues are a good substitute for comprehensive supranational regulation. If there is one thing that Europe does to a fault, it’s regulatory dialogues. But they do diddly-squat to stop countries defecting when they are in hard situations (e.g. the Irish offer to guarantee bank deposits when its credibility came under attack, Germany’s follow-up behaviour etc). This isn’t to say that one can easily create a global regulator with teeth and genuinely binding regulatory power – building one would be somewhere between very difficult and effectively impossible. It is to say that Rodrik’s conundrum is a real one – and the claim that governments can muddle through with a little more coordination and talk among themselves is almost certainly wishful thinking.
{ 30 comments }
lemuel pitkin 11.19.08 at 4:03 pm
But you only talk about one horn of the dilemma here. What about capital controls, then? — what’s so bad about them?
Henry 11.19.08 at 4:14 pm
Like (I suspect) Dani, my silence on the topic is tactically significant …
Ginger Yellow 11.19.08 at 4:54 pm
The thing is, there really doesn’t seem to be a Europe-level will for a Europe-level regulatory institution/framework. Ultimately member states want control over (and the ability to save) their own institutions, while reaping the benefits of cooperation and harmonised standards.
Take the proposed regulations for credit rating agencies published last week, for instance. These came about amid lots of talk of the need for a European rating agency (never mind that Fitch is French) and the need for a consistent approach to fit with regulations depending on ratings like the Capital Requirements Directive. Yet still responsibility for registration and supervision lies with the individual member state in which the agency has its registered office. CESR is supposed to provide a “mediation” function between the home state and other states in which the agency operates, but it’s all very vague and there’s enormous potential for fights between different states’ competent authorities.
If they’d wanted to have Europe level regulation, they could have just set up a new body under the auspices of CESR, but they didn’t.
virgil xenophon 11.19.08 at 5:15 pm
The EU is a fiction that ultimately won’t work. Same for the WTO. “What we have here”
is the playing out of the dream of a bunch of French socialists from the Gene Monet school of economic bliss that has always believed that a plethora of regulations and “agreements”
in the economic sphere would ultimately “spill-forward” into the political one and force world government driven by the logic of the underlying financial and economic structure
that had grown to emesh the political ones. But as the Irish have shown, when push comes to shove, national identities and priorities will always come to the fore. What everyone is wishing for is a Chimera that leads to false hopes.
ajay 11.19.08 at 5:34 pm
One of the major reasons why the European financial system is finding it hard to cope is exactly the lack of a Europe level regulatory backstop and lender of last resort, that could deal with banks that are effectively playing in a Europe-wide (if not worldwide) market.
I’m a bit puzzled by this statement, because Europe not only has an EU-level regulatory backstop – the European Commission, which produces things like the Markets in Financial Instruments Directive and the Capital Requirements Directive – and an EU-level lender of last resort – the European Central Bank, which has been expanding lending to European banks just as the Bank of England and the Federal Reserve have been doing.
alarob 11.19.08 at 5:53 pm
“Not only” implies a “but also.” Is there more to the comment?
Henry 11.19.08 at 8:02 pm
Ajay – the relevant regulatory backstop here isn’t the European Commission which issues regulations, but a body that could actually supervise banks. And this is lacking on the EU level. I’m unaware of the ECB acting as a LLR (although it has surely played an informal role in coordinating national central bank operations). Could you point to the specific operations? (e.g. stuff beyond interest rate cuts). Could be that there have been initiatives taken that I am unaware of, but the effective inability of the ECB to do this kind of stuff has been the focus of controversy since the system was initiated (see e.g. this “Aglietta paper”:http://webu2.upmf-grenoble.fr/curei/strucfi/agliLLR.pdf (PDF).
John Quiggin 11.19.08 at 8:43 pm
Another way of looking at the EU case. If a global regulator is to emerge, it will have to start out as a joint initiative of the EU and US. But that can only happen if the EU itself takes a unified position.
There are pretty good reasons to think they will be forced along this route. First, to stop the kind of competitive defection we’ve just seen, and second because it seems unlikely that anything much, even of the regulatory co-operation kind, is going to be negotiated in forums like G7 if Europe is represented by four separate countries (and, at G20, the EU aw well).
Ginger Yellow 11.19.08 at 8:44 pm
“Europe not only has an EU-level regulatory backstop – the European Commission, which produces things like the Markets in Financial Instruments Directive and the Capital Requirements Directive – and an EU-level lender of last resort – the European Central Bank”
The UK and other European states are not covered by the ECB, while interpretation and enforcment of MIFID, MAD, the CRD and all other EU financial market regulation is done by national authorities, which often take very different approaches.
PersonFromPorlock 11.20.08 at 12:34 am
Ah. All believers here in Intelligent Design, then, and none in Evolution? There is a spontaneous system which allows for negative feedback (and therefore stability). It’s called the free market and it will work if you can keep the businessmen from buying the politicians; not easy, with the politicians working the streetcorners and the businessmen cruising the neighborhood.
But economic regulation is just a cathouse to a streetcorner; it makes it easier for commerce and politics to get together without changing the underlying nature of the transaction at all. It’s not that I have any idea of how to make people act better, but I’m pretty sure that a formal structure that can and will be corrupted isn’t it.
Righteous Bubba 11.20.08 at 1:20 am
But economic regulation is just a cathouse to a streetcorner; it makes it easier for commerce and politics to get together without changing the underlying nature of the transaction at all.
Sounds quite okay to me as commerce left alone clearly breeds corruption anyway.
alarob 11.20.08 at 6:21 am
@Person, to go with your analogy, there’s a reason why natural selection is not the guiding principle in a civilized society; it’s because humans prefer not to live in a world that’s “red in tooth and claw.” It doesn’t mean we want to stamp out competition is an evil. We just don’t take a naive view that all of its effects will ultimately be good. I guess you don’t either, given your other analogy of street corners and cathouses.
Maybe it’s time we faced the fact that the pure “free market” only exists in our imaginations. In reality, maintaining some kind of stability and prosperity is always a balancing act. Sometimes you lean left, sometimes you lean right. If your ideology tells you to always lean the same way, you soon fall on your face.
dsquared 11.20.08 at 7:36 am
I think we might want to try and get a single financial regulator for the USA (as opposed to two national banking regulators, a securities regulator with powers over several banks, a completely separate insurance commission, a deposit insurance scheme with substantial regulatory powers and 50 state banking, insurance and securities regulators) before we started on Europe; let’s walk before we run here.
Alex 11.20.08 at 10:00 am
The EU is a fiction that ultimately won’t work
Eppure si muovo. Hilariously, this is just the argument of the stereotype French official who says “we know it works in practice, but does it work in theory?”
Frankly, all my life Very Serious Right-Wing People have been blathering on about how the EU can’t possibly work, just as they blathered on about how I was an unserious, unpatriotic hippy for not supporting the invasion of Iraq, just as they blathered on about the end of ideology and how nobody serious believed we needed financial market regulation, just as they blathered on about Sound Money and IMF even years after they gave up on monetarism in practice. I therefore conclude that, in this as in other things, they are full of shit.
ajay 11.20.08 at 12:18 pm
Ajay – the relevant regulatory backstop here isn’t the European Commission which issues regulations, but a body that could actually supervise banks. And this is lacking on the EU level. I’m unaware of the ECB acting as a LLR (although it has surely played an informal role in coordinating national central bank operations). Could you point to the specific operations? (e.g. stuff beyond interest rate cuts).
a) no, there was no “but also”, that was merely an error. Sorry about that.
b) the ECB has been collaborating with the Fed and the other central banks on coordinated liquidity provision operations – check its website for details, but, for example, see the announcement of unlimited short-term dollar lending on 13 October and its earlier expansion of lending in mid-September. As for it coordinating “national central bank operations” – there aren’t really any national central banks in the eurozone, not in this context. The ECB runs eurozone monetary policy. That’s what it’s for.
c) 13 is very wise. The US system is a horrible conglomeration of entities. You could also have mentioned the separate commodity futures regulator and the Office of the Comptroller of the Currency. It makes the British Constitution seem like the cleanly rational product of an eighteenth-century philosopher.
d) And I think that saying “the Commission isn’t really a regulator, it’s just something that produces regulations that other people enforce in their own way” is a bit of a quibble.
e) How long, incidentally, does the EU have to keep working before the people who say “the EU ultimately won’t work” shut up?
A. Y. Mous 11.20.08 at 1:02 pm
>> How long, incidentally, does the EU have to keep working before the people who say “the EU ultimately won’t work†shut up?
How long? Until there is a unified EU foreign policy.
Carts and horses. Globalisation of finance and its consequent regulations, without a public, albeit purported, globalised political establishment is not going happen. At least not without collapses now and then. The current Letters of Credit crisis is already taking its toll on many exporters. But only to nations that aren’t that very pally with the exporting nation. Govts. and their functionaries making phone calls to their counterparts in other countries has fortunately not gone out of fashion. Bankers talking overseas to each other has, unfortunately, gone. A poltical establishment is a pre-requisite to a financial establishment. Unification of Germany happened because of a express will to unite. The modality of that unification happened with economy, finance, travel arrangements taking precedence over flag hoisting. But flag hoisting was the purpose.
A one-world polity is preferrable to some. Most here on CT. But anathema to a very very large number of people across the world.
Dave 11.20.08 at 1:08 pm
“It makes the British Constitution seem like the cleanly rational product of an eighteenth-century philosopher.”
Tee-hee. That’s actually really funny if you know anything about the debates on the US Constitution…
Ginger Yellow 11.20.08 at 1:22 pm
“And I think that saying “the Commission isn’t really a regulator, it’s just something that produces regulations that other people enforce in their own way†is a bit of a quibble”
Well, only if it’s a quibble to distinguish between, say, the Fed and Congress.
Alex 11.20.08 at 2:43 pm
Further, the EU actually pulled closer together in the crisis. Yes, “everyone went their own way”, but by the end of the week there was a full dress European Council/Eurogroup in progress which finished by adopting a coherent policy. This policy has now been adopted by essentially everybody else as well.
ajay 11.20.08 at 4:22 pm
16: I’m not sure whether I can’t follow this entry because it’s written. In a very staccato style. With full stops in places. Where you would not normally expect. To find them, or if I can’t follow it because it’s simply a collection of unrelated assertions that don’t actually assemble into any sort of argument.
Henry 11.20.08 at 5:27 pm
Hi Ajay
I think we are talking at cross-purposes here. The “lender of last resort” function, as best as I understand it (open to correction from Real Economists if I am wrong), _doesn’t_ refer to generic liquidity operations. It refers to a central bank’s willingness to lend money to _specific_ institutions whom nobody else will lend to, in order to keep the system propped up. The operations that you are referring to are quite different. What the ECB _has_ done, ex post, is to issue opinions on the circumstances under which central banks/national governments can offer deposit guarantees etc. And the distinction between regulator/issuer of regulations is a _really important_ one. The European Commission can issue broad rules governing how actors ought to behave in the marketplace. It _can’t_ regulate the specific behaviour of financial institutions in national markets (it has neither the authority nor the capacity).
a. y. mous 11.20.08 at 5:30 pm
Re: 20,
Ajay, that is quite true. While you may not follow it as intended, it is quite very parse-able. If only you get used to comprehension of content. As opposed to form. Insofar as punctuation is concerned, much of my experience is with condensation of academic gobbledygook . Policy makers prefer, and in my opinion are competent (and only to that extent) to comprehend, precis. It is unfortunate that I carry that experience along with me. Wherever I go. Plus, I have this really confused apprehension of the distinctions among the usage of colon, semi-colons, hyphens. As the Americans are wont to shrug, my bad. Too bad.
With regards to the content, my point in #16 was a response to your Q. regarding a frustrated statement of that fact that many keep insisting on the imminent failure of the EU. I agreed with the professed fact and informed you of a possible end to such insistence, viz., when there is unified foreign policy for the whole union.
The references to Germany was a response to the OP, which is, characteristic of many posts on CT, mum about the undeniable fact that politics beats economics. Always. It is a heavy burden on society at large to indulge in such fancies (the keeping mum part. Not the fact. May I wink? Or must I be Sarah Palin to warrant such indulgence?)
As with most of my comments, perhaps all, I make no arguments. I state facts as I see them. You are most welcome to dispute my observations or dismiss them with total disregard or whole-heartedly agree with them. Your choice. No compulsion. And if I may make a comment as to potential impact, no matter whatsoever.
ajay 11.20.08 at 5:52 pm
21: you’re quite right. The ECB is not officially a lender of last resort – it doesn’t have that as part of its mandate, unlike the BOE and the Fed. In fact as far as I know there are no eurozone lenders of last resort. But there is certainly a damn good argument that the ECB is now acting as a lender of last resort – to the entire eurozone banking industry, all of which is having difficulty raising money on the interbank market.
Your definition of a lender of last resort – “It refers to a central bank’s willingness to lend money to specific institutions whom nobody else will lend to, in order to keep the system propped up” – is correct – and this is what, for example, the BOE did with Northern Rock. Normally, bank liquidity operations are intended to affect the money market as part of general monetary policy, not to keep the entire system from collapsing. So your definition – and your argument that the ECB isn’t a lender of last resort – would be correct, in normal times.
But these are not normal times. The problem, at present, isn’t that there is one specific bank which can’t raise money for idiosyncratic reasons – there is a systematic lack of interbank liquidity and therefore a need for a system-wide lender of last resort, and I would argue that, by expanding its liquidity programmes and relaxing its capital criteria, this is exactly what the ECB has turned into.
I’m afraid I don’t see the distinction that you are trying to draw w.r.t. regulation. “The EC issues regulations on how banks should behave, but it doesn’t actually regulate how banks behave?” I suppose in a very narrow sense that’s true – it’s up to the national regulators. But in the same sense, the UK Parliament doesn’t regulate, say, British drivers. It produces laws on how drivers ought to behave, but those laws are actually put into effect by the police and the courts, both of whom have quite a bit of latitude on how they enforce the law – just as national parliaments and regulators have a bit of latitude about how they deal with, say, the Capital Requirements Directive.
Henry 11.20.08 at 6:51 pm
Hi Ajay
There is still a distinction – and it is an important one. The ECB lacks certain tools that its US equivalent has – and these tools are important and helpful in general crises as well as in ‘normal’ times. That’s the issue. And the regulator issue is very, very important (as someone who writes on delegated powers and the Commission, this may be a particular hobby horse of mine, but I think it is objectively a very important distinction). As I said in my original post, _there is no actor at the EU level_ – neither the European Commission, nor the ECB, nor anybody else, which regulates what national banks do on a day-to-day basis. This aspect of central bank functioning is still reserved to the national level central banks, who are jealous of their powers and independence. This means that there are important loopholes in supervision, esp. wrt the activities of banks which cross national borders, and consequent questions about who deals with the wreckage when things go wrong (see e.g. Fortis disaster). This is a real problem with obvious and substantial consequences. Nor is the European Commission the happy dispenser of regulations from on high that you suggest. It had been _trying_ to expand its authority vis-a-vis national regulators in areas such as competition policy (Charlie McCreevy’s various initiatives), but had been facing some very stiff headwinds indeed. You are really underestimating the power of existing national institutional arrangements here, and as a result not understanding the underlying politics very well, as best as I can see.
virgil xenophon 11.20.08 at 7:15 pm
I’m with Henry on his last post@24–a quite succinct outline of the state-of-play. And it is always good to remember that, as usual, Henry’s “underlying politics” of the thing, as I and
a.y.mous have been at pains to point out, always trumps all–until the day when when the aliens arrive, take over, and rule with an iron fist–but not before.
Alberto Ugas 11.21.08 at 3:25 am
Maybe I’m completely out of my turf here, but please indulge me. Seems to me that if there is a lesson to be learned from this crisis, it ought to be that the global over-reliance on the US dollar has been a complete disaster, and not just in purely economic terms. Doesn’t it stand to reason that was is needed is diversification away from one central currency for global trade? The euro is certainly a step in the right direction, though admittedly in need of some fine tuning. Asia should develop a common currency of their own, and probably Latin America as well. Let the market forces, through the winds of competition, dictate the required levels of regulation across the common currencies nations’ borders. We will never rid the world of national self interests, but clearly, the day has arrived when it should be plainly obvious to these nation-states, that competing global currencies are in their own self-interest.
Jan 11.21.08 at 8:50 am
Martin Wolf and others have argued that the crash was caused in substantial part by a world savings glut. Wolf says the largest fraction of the recent glut was generated in China and its neighbors. A reader of Wolf might well get the impression that the glut was an Oriental mystery, a mere historical accident.
But accidents offend my mechanistic sensibility.
Perhaps the glut is symptomatic of a collective action problem among nation states. Observing the volatility of international capital flows, each state aims to save enough to guard against disastrous capital flight. (The savings policy might take a variety of concrete forms: rents collected by state controlled banks, for instance, or regressive tax cuts. ) In short, the combination of multiple sovereign states and a single capital market always will produce a savings glut. The glut will cause investment volatility, which will strengthen each state’s propensity to save. You can see where I am going with this. Widening gyre and all that.
And if economic competition among states is unstable, because of a glut or for any other reason, will the international system revert to military competition? Is that what happened in 1913?
So far as I know, the professional economists in my country (USA) have not written about this problem. It is not the sort of problem closeted anarchists like to write about.
ajay 11.21.08 at 10:27 am
24: Assertion /= argument.
Also, Bank of England /= regulator of UK banks. Similarly for Ireland, Germany, Belgium, Sweden, Luxembourg…
John Quiggin 11.21.08 at 11:50 am
Henry, it seems likely to me that the crisis will producing a sharp switch in the attitudes of national governments, from fiercely defending their freedom of action to eagerly seeking to give it up in return for collective security. We’ve already seen the captains of capitalism rushing for the safety of the regulated banking sector, and Iceland scrambling to join the EU – these are indications of a broader change, I think.
Henry 11.21.08 at 6:12 pm
Ajay – you’re right that I should have said central banks _and_ national regulators (although NB that I did mention the national regulators later in the argument) but your claims simply aren’t empirically correct. What the ECB is doing now isn’t the same as acting as lender of last resort (more precisely, it shares the same rough relationship to acting as lender of last resort as firing a howitzer does to using a stiletto – both aim to kill people, but there are circumstances where you clearly want a stiletto rather than a howitzer, and vice-versa). The European Commission isn’t a regulatory backstop in the sense meant in the post – and that has important consequences for how European banks work, and for the ability of authorities to respond effectively to cross-national crises. Efforts of the Commission to try to increase its authority vis-a-vis national banking systems (through competition law etc) have had only partial success – this is an ongoing battle. National level regulatory authorities have been, and continue to be jealous of their authority (see Aglietta etc – the literature on this is unanimous on this point). You seem to have come into this assuming that this was an EU-bashing post. It isn’t. It’s a set of _specific_ claims about a particular aspect of EU governance, claims which are pretty well rehearsed in the relevant literature (I make no claims to being original here). And your claims just aren’t right.
John – you may well be right 0ver the l0nger run, and your arguments are obviously the sensible ones, but so far we have seen rather less coordination among national authorities in the EU than one might have liked to have, and no consensus emerging on a shared supranational regulatory system (this has been floated, but as best as I can tell, has been shot down for the moment at least).
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