Cross Border Aspects of the US Treasury Department’s White Paper on Financial Regulation Reform
Update, July 3, 2009. The Economist of July 4, 2009 has a useful, short article on the EU’s proposals for reforming global finance, “Divided by a Common Market.” I will put up a separate post with some excerpts from the piece.)
I spent the plane flights back and forth to Prague over the weekend mostly reading, uninterrupted and straight through, the Treasury Department’s new white paper, Financial Regulatory Reform: A New Foundation: Rebuilding Financial Supervision and Regulation (June 2009). (I’ve linked here to the 88 page pdf, which curiously seems to be undated; a useful resource overall is the new Treasury Department website, financialstability.gov.) I’ll comment on the US-specific aspects of the proposed regulatory reform (which cuts across a wide range of regulatory matters) over at Volokh, but here I wanted to comment briefly on the international and cross border aspects of the Obama administration’s reform proposal.
The specifically transborder aspects of the reform proposal are one of the five fundamental principles for regulatory reform underlying the proposal. They fall into broad categories that approximately mirror what that the proposal says domestically:
- raise common regulatory standards for financial institutions, particularly capital standards and liquidity buffers;
- raise common regulatory standards for supervision of banking institutions but also any other financial institution systemically connected to the financial system, particularly with regards to leverage, but also with regards to compensation and attendant incentives to risk-taking and moral hazard;
- undertake financial markets regulatory reform, particularly to create conditions for the emergence of central exchanges for credit derivatives, regulation of securitization, and other financial markets reforms;
- raise and develop common standards for accounting and measurement of financial indicators, including fair value (‘mark to market’) accounting; and
- various other matters, such as the role and regulation of rating agencies (some of these other matters appear to be quite unrelated to financial regulation reform as such, e.g., terrorism financing).
As far as the proposals go on their own, probably the most striking aspect to those who follow the international debates is the lack of a position on the so-called “rules” versus “principles” debate. This was almost certainly a deliberate agnosticism on the issue. Reduced to a sentence, this is the fundamental question of the approach to regulation – go with specific rules (the historically American approach, and which tends to mean rules that get more and more specific over time) or a more discretionary-based use of principles that leave much flexibility to regulators, and which relies in part on the willingness of regulated parties to respond to regulatory “signals” short of a court order or the threat of legal action. The issue is not addressed as such in the white paper, although the thrust of the reform proposals seems to indicate more specific rules that would be common standards for all leading participants; perhaps this is compatible with either a rules-based or principles-based approach, but perhaps not. (Steve Schwarcz has a useful paper from 2008 on this topic, “The Principles Paradox“; it serves both as an introduction to it and an intervention in the debate.)
As to implementation, the white paper is striking for not offering or endorsing any kind of binding international mechanism. Recall that for many governments and world leaders – Sarkozy, for example – the two previous global economic summits were opportunities to press for new, or newly-empowered, economic institutions able to enforce common standards and rules in matters running from accounting standards to (at the most ambitious) a common global reserve currency. The US Treasury position embraces none of that. Instead, it endorses what has been discussed a lot here at OJ in a variety of contexts – international regulatory coordination, regulatory cooperation, accomplished largely through networks of national regulators.
That seems to me the right approach as a matter of policy and not just practicalities of politics, but it is striking that there is not even a nod in the direction of any kind of binding regime or even genuinely binding common standards. The proposal does embrace the commitment from the last 2008 global economic summit for a “college” of financial supervisors – in effect, a network of national financial regulators – but the proposal for this “college” as finally adopted is a pure “network” one, not one with any binding powers. The Treasury white paper embraces a substantive transnational cognate for each of the essential proposals for internal US reform, but then treats them as common, or homologous, standards to be worked out by leading economies internally – presumably on the assumption that each will conclude that a roughly common standard is in its interest – without suggesting any kind of binding regime, let alone binding governing body.
Given that general “network” and “common standards” approach, it is unsurprising that the white paper does not address the role of the Bretton Woods institutions. It does not discuss proposals for the IMF to take on new roles, for example. Perhaps least surprising of all, nothing in the proposal suggests that the IMF or anyone else offer something besides the US dollar as the global reserve currency. The white paper does not address issues specific to the developing world, nor does it address issues specific to the so-called “BRICs” (Brazil, Russia, India, and China). Again, this is unsurprising in a paper that is about financial institution and market regulation, not monetary policy. However, a question I suppose many outside the United States will have is whether the ‘networks’ approach for elaborating and persuading countries to adopt roughly common, or at least “homologous,” regulatory standards will be enough to avoid regulatory arbitrage by financial institution and financial market players among global economies.
My own view is that the white paper takes the right approach to the transborder question by adopting the networks approach. The fundamental differences of economic conditions for leading players – China, the United States, Europe and its various key economies, Japan, etc. – mean that they will not share common ground on some core issues. But arguably most of those core issues are monetary policy, rather than financial regulation, thus leaving sufficient room for common, or at least homologous, standards in this area. And if there were not sufficient agreement for common standards, it seems quite unlikely that the solution to that would be the creation of a highly defection-prone, purportedly “binding” standard.
The leading risks posed by the networks approach are:
- First, the “common” standards reached by the networks turns out to be a little of this and a little of that, but not a consistent approach with respect to any particular leading economy, so that the common standard is so much a common denominator among unlike economies that it serves well no one in particular.
- Second, the elaboration of a networks-based common standard promises more than it can actually deliver in the way of implementation – but it leads to a sense that all is well because a network has pronounced common standards, whereas in fact, regulatory arbitrage among countries is rife, yet it is hard to say so without giving political offense to one’s network partners.
- Third, the collective of regulators might simply get it badly wrong, as George Soros noted in a recent op-ed in the Financial Times (to which we might add, Basel II capital adequacy standards have not exactly come out unscathed from the current crisis).
That said, and leaving aside other kinds of criticisms of the Treasury approach (which are far from insignificant, but not taken up here, as being about domestic US policy), the networks approach taken by the Obama administration seems to me the right one. Both politically right and right as a matter of the correct policy approach.