International Financial Architecture: Dumb Chills and Opportunities

I am grateful to Adam, Bob and Credit Slips for scheduling this guest stint on the eve of what is billed as the Grand Global Rethink of All Things Finance. This Saturday, November 15, the leaders of the Group of Twenty rich and developing economies will meet in Washington to talk about crisis and reform. Regrettably, the organizers’ absurd pretensions to the legacy of Bretton Woods have diverted public attention away from the substance of what is surely an important international effort at coordinating economic, financial and regulatory policy.

Why should legal academics and debtor-creditor folk care?

In the middle of the Asian Financial Crisis a decade ago, a similar group of countries launched a series of initiatives under the rubric International Financial Architecture. The name was much mocked, deservedly so. But the effort marked a period of unusual policy openness and innovation at the national, transnational, regional and international levels. Examples of crisis-driven “architectural” contributions include corporate and sovereign bankruptcy reform, regulatory networks and bodies such as the Financial Stability Forum, a quantum leap in transparency at central banks and international institutions, regional currency arrangements and high-level policy coordination fora such as the G-20, which is fast eclipsing the sad old G-7. Many innovations, especially on bankruptcy, had extensive input from academics. So – this could be our time … and since everyone has something to say on the right agenda for reform, here are my four cents.

•  Poverty and Inequality. It would be a mistake to make this all about aid flows. The crisis comes at a time when poor people and poor countries are increasingly integrated in global finance. Migrant remittances are shifting to formal banking and payments channels; funds for microfinance in Bangladesh – and subprime mortgages in Ohio – come from the global capital markets, and even the poorest states, such as Ethiopia, have begun to develop domestic financial markets. To the extent such integration is desirable or at least unavoidable, what special protections, if any, should come with global finance for the poor? Who should insure the poor from financial volatility, and how?

• Regulation. By now, it is trite to say that the crisis has exposed regulatory failure in banking, capital markets, and insurance, along with persistent shortcomings in national bankruptcy regimes. Yet Europe and the United States are at loggerheads over how regulation fits in the Rethink. There may be good political reasons for stalling, and reasonable arguments about the right scope and locus of state intervention, but skipping regulation altogether is bizarre. Agenda items should include a Basel re-do, the way forward for cross-border banking after U.K v. Iceland, revisiting resolution of global financial conglomerates in a big way for the first time since BCCI, harmonizing accounting standards, and revisiting derivatives regulation, including their treatment in bankruptcy post Lehman and AIG, as well as central counter party clearing. Apropos resolving conglomerates, see here a fine look at the end of Lehman Europe. We are all transnational now.

• Institutions. Just yesterday, the International Monetary Fund was laying off staff; now it is lending up a storm. Whether the old Bretton Woods institutions are adequate to the day is an open question with a financial and a political dimension. On finance, the challenges are size, speed and complexity – the IMF is not a true global lender of last resort, and it is far from clear that it should be, absent real regulatory underpinnings. On politics, developing countries are still underrepresented in the Fund’s governance. Recent reforms have not brought about a major shift in public perception/legitimacy. The ascent of the G-20 marks the recognition that these countries are indispensable, and boosts the prospects of real change. Change may mean a bigger, better IMF, or a brand new set of institutions/fora weighted substantially to the erstwhile periphery. The fate of technocratic and regulatory fora such as the BIS and the FSF also bears watching; their lot can only grow in importance.

• Investment. The effort to craft global norms for foreign direct investment collapsed in the mid-1990s with the OECD-based and dominated Multilateral Agreement on Investment. At the time, capital flowed from wealthy states in Europe and North America to poorer states in the South and East. Since then, the flows and roles have reversed. The rise of sovereign wealth funds is but one symptom. Is it time for a new, more equitable and legitimate, formal international regime? Should private and regional norms continue to evolve informally? What role for public-private hybrids, such as sovereign wealth funds, nationalized banks, and other latter-day inventions?

Most architecture agendas also include a coordinated stimulus package. It is an important and sensible idea (though China has preempted some of the discussion), but strikes me as an item wholly apart from long-term financial reform – unless, of course, we see the establishment of new mechanisms for this sort of coordination going forward.  Finally, look here for a nice mainstream take on what should happen this weekend.