Think Twice Finance

Should Gordon Brown Lead World Financial Reform?

Following the US general election in November, Gordon Brown will become the only leader of a G7 country who can read a bank balance sheet. That and his reputation as a dour Scotsman may make him the person most qualified to carry Britain’s standard to the front rank in the current global charge to reform financial markets and institutions.

The thought has apparently occurred to Prime Minister Brown, who has spent the past week in New York, persuading leadership of U.S. financial institutions of the need for global financial reform.

London has indeed come to the world’s rescue in the past: opening and expanding markets for foreign exchange when the dollar floated, ending the Bretton Woods era; then encouraging the development of an active market in dollar deposits when the United States strangled on Regulation Q interest rate ceilings during the OPEC crisis. In both instances British initiative forced a recalcitrant Wall Street to break the fetters of convention by applying the pressure of global competition. The Street was forced to choose between loss of global dominance and following London’s lead in letting market forces prevail over reactionary regulation.

That was then; this is now.

Then, global regulators in general and US regulators particularly were intent on preventing financial institutions from taking risk. They prevented competition among financial institutions by setting prices and fees by fiat and segmenting markets. This system proved unstable. When fixed exchange rates or rampant inflation drove real financial yields to wildly inconsistent levels, the government most heavily influenced by the concerns of financiers over those of rank-and-file labor and non-bank commercial interests was needed to break regulatory logjams. Appearances to the contrary, Britain has always filled the bill.

Now, however, the problem is not popular reaction against matters financial. The problem is that financial regulators have been co-opted by the bloated, uncreative, unprofitable large institutions that have emerged as the product of governmental fear of financial failure. As the banks have lurched from misadventures in Latin America and other emerging markets to domestic misadventures, bank regulators have sought and discovered ways to subsidize and support the large banks’ penchant for passing off risk as creativity.

When banks teetered on the brink, they were merged with other banks at fire sale prices. Laws were changed to facilitate the burial of unseemly losing operations in resulting gigantic regulation-abetted managerial morasses. The regulators’ mantra was Large Complex Financial Institutions, a class that called for special treatment, it was averred.

As it turned out, the subsidized behemoths were not complex. They were all playing the same simple duplicitous game of hide-the-risk-off-balance-sheet. The bank regulators did whatever was necessary to cloak the risk in the guise of respectability, fiddling with accounting rules and overlooking inconsistencies until the next disaster struck.

As a result of the growing power of U.S. financial institutions over their regulators, Britain’s regulatory system is no longer the enlightened alternative to the reactionary American norm. It has become the epitome of the norm, blessing every American regulatory subsidy and even competing with America in laxity, as when America nearly eliminated mortgage conduits in the wake of the Enron scandal, but saved them to avoid losing the commercial paper market to London.

The reality is that the tools of the banking system in the public domain have changed very little from those that were built in the wake of deregulation in the 1980’s. But the system has slowly been dividing itself into two components - the inefficient banks that depend on regulation and “regulatory reform” for their survival, and the efficient banks that avoid regulation as though it were a plague of locusts. The “innovations” that bankers talk about publicly are window dressing for the latest risky scam. The real innovations are hidden by other profit-making bankers with imagination and the sense to avoid imitation as long as is possible.

Whoever “leads” the coming regulatory reform will not need to be able to read a balance sheet. He will need a group of spin doctors and a place to hide when the next “regulatory reform” is necessary. If Gordon Brown wants the job, so be it.