Global Finance After The Crisis

Taken together, European nations have put together a bailout for financial institutions three times bigger than the U.S.--$2.25 trillion vs. $700 billion. The goal, though, is the same: recapitalization of troubled banks to improve liquidity and help boost interbank lending.

Coordination across the Atlantic is growing--and may do so further after this weekend's meeting at Camp David between Presidents George W. Bush and Nicholas Sarkozy of France. Sarkozy will press the case for a summit on global financial regulation on behalf of the E.U., which France currently chairs.

His host will probably politely decline and say the U.S. must put its financial house in order first, and that won't happen before he leaves the White House in January.

The meeting takes place against a backdrop of weakening economies that look set to continue to decline over the next few months regardless of the success of the recapitalization of the global banking system, a result that still isn't assured.

Economists at the international monetary fund now predict that the growth in world output will slow to 3.9% this year and 3% in 2009. It hit its cyclical peak in 2006 at 5.1%.

More gravely, the IMF forecasts that global-trade growth will slow even more rapidly--to 4.9% this year and 4.1% next, from its 2006 rate of 9.3%--as barely growing developed economies lessen their appetite for imports and commodity prices fall. Continuing, albeit slower, growth in emerging economies won't make up the shortfall.

This general global gloom will reinforce policy shifts in the developed economies that the financial crisis has already got underway, particularly in Europe. But on both sides of the Atlantic, the culture of light-touch regulation and corporate self-regulation has given ground to firmer government-driven regimes.

The clearest example of this shift is in the financial sector, where governments are taking ownership stakes in firms and injecting new capital. But this new regime brings with it new expectations and requirements regarding a broad range of corporate governance issues from risk-tolerance to reserve ratios to executive compensation.

Even countries that haven't taken stakes in banks have taken initiatives to put themselves on banks' boards. Ireland, for example, made the appointment of two government-nominated directors a condition of banks getting deposits fully state insured.

This is being matched by more national and international coordination among fiscal and monetary authorities. How far this will go remains debatable. Intergovernmental and supranational institutions still seem far from reach, despite Europe cheering on the International Monetary Fund's desire to play global financial cop.

America isn't anywhere close to being ready for that, and maybe never will be--just as it isn't ready to accept global accounting standards. There are too many vested domestic interests at risk.

But some of the coordination across international borders seen during the current crisis will continue in a more formal way, particularly between central bankers and bank regulators. Also likely: consolidation of regulatory agencies within countries to give governments a more holistic view of the risks to their financial systems.

In Europe, certainly, this financial crisis will have advanced the cause of harmonization of fiscal policy. Monetary policy, too, is changed, with European central bankers becoming more pragmatic and less single-minded about fighting inflation. They will take on a broader remit, much like the Federal Reserve.

Other changes, more embryonic at this point, include an intent to re-couple Wall Street with Main Street, getting financial institutions to return to focusing on financial services for real investment, production, distribution and consumption, instead of on speculative financial engineering.

That may prove less than lasting once profits return and capital is flowing freely again.

$Boopathi$, October 21, 2008