Prime Minister Gordon Brown of the United Kingdom asserted
earlier this week that the financial crisis revealed the need to
"rebuild our fractured financial system." The European Union echoed
this sentiment in a call for "a genuine and complete reform" of the
world's financial architecture. The heart of Brown's proposal
is to enhance the power and authority of the International Monetary
Fund (IMF) and the World Bank (known collectively as the Bretton
Woods organizations) to create an unprecedented level of global
governance to supervise financial institutions, impose universal
standards for accounting and regulation, and serve as an early
warning system for future crises.
The financial crisis certainly is serious, but Mr. Brown's
suggested solutions would, for the most part, do little to prevent
future crises; on the contrary, they could do great harm.
Brown's proposal coincides with ongoing meetings between the
Bush Administration and European officials and the announcement of
a special G-8 summit as early as next month to focus on the global
financial crisis. The Bush Administration should not make the
creation of a powerful new international regulatory authority a
part of its legacy.
A New Financial Architecture?
Prime Minister Gordon Brown authored an op-ed in the Washington
on October 17 suggesting that the current international financial
crisis requires a radical expansion of global governance over
international financial institutions and transactions. Brown's
op-ed is a study of internal contradictions and confusion and
should not be taken as a serious proposal.
Brown opens his argument with the false statement that "We are
living through the first financial crisis of this new global age."
The numerous banking and financial crises in Latin America over the
past few decades, the Asian financial crisis in the late 1990s, and
the Russian financial crisis in 1998 were all international in
scope and precipitated calls for massive interventions. Indeed, the
crises resulted in substantial lending from the IMF and World Bank
to ward off fears they would spread to the U.S., Europe, and other
parts of the world. Perhaps Brown means that this is the first
financial crisis to arise in the U.S. and Europe in the new global
age? If so, he should state it.
Brown's criticism of an alleged deficit of international
cooperation in addressing the financial crisis is undermined
several times in his own piece. A good example is his statement
that "The global problems we face require global solutions....
There are no Britain-only or Europe-only or America-only solutions
to today's problems. We are all in this together, and we can only
resolve this crisis together." Yet Brown acknowledges that this
cooperation is already ongoing and robust. Several examples laid
out in his op-ed include the following:
- "French President Nicolas Sarkozy and European Commission
President José Manuel Barroso will meet with President Bush
to discuss the urgent reforms of the international financial system
that are crucial both to preventing another crisis and to restoring
- "When President Bush met with the Group of Seven finance
ministers last weekend, they agreed that we all had to deal with
not only the issue of liquidity in the banking system but also the
capitalization and funding of banks. It was clear that national
action alone would not have been sufficient. We knew we had to send
a clear and unambiguous message to the markets that governments
across the world were prepared to act in a coordinated manner and
do whatever was necessary to stabilize the system and address the
- "Over the past week, we have shown that with political will it
is possible to agree on a global multibillion-dollar package to
recapitalize our banks across many continents.
Indeed, international coordination in financial regulation has a
long history, including the Basle I and Basle II international
agreements on bank capital standards. The recent crisis
demonstrates the importance of internationally consistent
regulation of financial markets. But any international effort
should be consultative and advisory, engaged in such matters as the
development of best practices standards, rather than bent on
establishing new international regulatory authorities possessed of
dictatorial or coercive powers over such matters.
Brown's problem seems less that cooperation is not occurring
than that it is occurring in a way that is led by national
governments rather than being directed by an international
authority. He specifically notes that:
At the end of World War II, American and European visionaries
built a new international economic order and formed the
International Monetary Fund, the World Bank and a world trade body.
They acted because they knew that peace and prosperity were
indivisible. They knew that for prosperity to be sustained, it had
to be shared.... The old postwar international financial
institutions are out of date. They have to be rebuilt for a wholly
new era in which there is global, not national, competition and
open, not closed, economies.
The problem is that the Bretton Woods institutions have been
struggling for years to find a role precisely because the world has
been increasingly open and globalized. For instance:
- IMF. Under the rules established for the Bretton Woods
system, each currency was assigned a value in gold that was to be
maintained within a narrow range. The IMF was the mechanism that
kept this system running smoothly and, for the first quarter
century of its existence, the IMF had a clear mandate. However, in
the late 1960s and early 1970s, the system of fixed exchange rates
that the IMF was set up to oversee began to break down and ended
entirely when the U.S. abandoned the gold standard. This rendered
irrelevant the primary function of the IMF. Instead of reducing its
activities, the IMF sought out new missions to justify its
continued existence. As successive crises erupted, the IMF
reoriented its focus to deal with them to greater and lesser
degrees of success.
- World Bank. The World Bank was originally established to
rebuild Europe after World War II. Once that need passed, it
shifted to providing financing and economic advice to poor
countries with the purpose of catalyzing development. Despite the
best of intentions, many World Bank recipients today remain just as
poor--if not poorer--than they were before receiving hundreds of
billions of dollars in World Bank loans and grants.
Brown is offering a false hope by pointing to the IMF and the
World Bank as the saviors of the international financial system.
They simply do not have enough money to resolve serious financial
crises in the U.S. or the EU. Global markets facilitate the flow of
trillions of dollars in private capital. In 2006, international net
capital flows totaled more than $4 trillion. Global trade of goods
and commercial services exceeded $14 trillion in 2006. The U.S. and
the EU countries have allotted well over a trillion dollars to
address their financial crises.
By contrast, the IMF and World Bank each control roughly $300
billion in resources. Moreover, their readily available resources
are far less than this amount because much of their resources are
tied up in existing loans and grants. Solving serious financial
crises through the IMF and World Bank is simply not possible unless
these institutions are granted substantially greater resources--an
increasingly unlikely scenario considering the financial
constraints in which countries currently find themselves.
Moreover, Mr. Brown assumes that additional resources will not
be made available through other outlets. In response to growing
panic over the tightening of trade finance--the credit, insurance,
and trade guarantees used to keep the wheels of international trade
turning--the WTO has called for a meeting of World Bank, IMF,
regional development banks, commercial banks, and trade insurance
agencies to lay out a plan for improving the availability of trade
finance to developing countries. Of the five commercial banks
invited, Citigroup, JP Morgan, and the Royal Bank of Scotland are
receiving government support and Britain's HSBC and Germany's
Commerzbank may accept public bailouts in the future. With
these and other commercial banks increasingly holding hands with
interventionist governments, a successful "public-private" solution
to tightening trade finance could drive momentum for a misguided
approach to bailing out global financial markets--at significant
expense and risk to taxpayers everywhere.
Mr. Brown's proposal to have the World Bank or IMF serve this
function is also naïve and ill-informed. These institutions
are cumbersome, slow, and lack the expertise and standing to
fulfill this role effectively. They should not be granted the
sweeping authority proposed by Brown, especially when other
organizations such as the Organisation for Economic Co-operation
and Development and the Bank for International Settlements arguably
have more experience and expertise with central bank supervisory
Nor do Brown's proposed solutions seem on target. For example,
he calls for
root[ing] out the irresponsible and often undisclosed lending at
the heart of our problems. To do this, we need cross-border
supervision of financial institutions; shared global standards for
accounting and regulation; a more responsible approach to executive
remuneration that rewards hard work, effort and enterprise but not
irresponsible risk-taking; and the renewal of our international
institutions to make them effective early-warning systems for the
At the base of Brown's proposal is an assumption that national
and regional financial regulators were inadequate and the rules
governing accounting and transparency of private and non-private
financial institutions need to be strengthened by an international
regulatory authority. This is far from clear.
In the U.S., both the Federal Reserve and the U.S. Treasury
warned repeatedly of pervasive risks posed to the U.S. financial
system by unsound lending practices at Fannie Mae and Freddie Mac.
Congress rejected measures proposed by the Bush Administration and
some members of Congress to rectify or constrain these practices.
It is this situation--a political failure rather than a regulatory
failure--that triggered the financial crisis in the U.S.
Few can dispute the need for increased transparency in financial
markets. But there is no such thing as perfect information and risk
cannot be eliminated. That said, improving standards and the amount
of information available to the market would not only make them
more efficient, but would also improve accountability and reduce
the risk of future crises. However, there is no need for such
standards to be imposed through an international regulatory
authority lacking the intimate knowledge of national financial
markets that national regulators possess--and which failed to deter
the current crisis.
Accounting standards are increasingly congruent internationally
and can be tweaked on the national level to best fit domestic
markets. Moreover, to a great extent, the World Bank and the IMF
already provide sound advice to countries in improving transparency
and accountability. Indeed, it was a key condition for their
assistance during the Asian Financial Crisis. Unfortunately,
countries do not always adopt sound advice. Few lawmakers are--or
even should be--willing to blithely yield their authority to set
policy at the urging of the IMF or the Bank and that is unlikely to
change in the future. Similarly, the IMF and the Bank already
provide frequent warnings and assessments of financial conditions
internationally and in individual countries. These early warnings
are accurate as often as they are wrong--an inevitable condition
given the nature of imperfect information. It is hard to see that
they would be more "effective" simply by granting the institutions
As to Mr. Brown's notion that pay for CEOs be set by
international financial regulators in a "more responsible" manner
"that rewards hard work, effort and enterprise but not
irresponsible risk-taking," it is simply beyond comprehension why
remuneration in private companies should be determined by
governments or supranational institutions rather than the
companies' stockholders or the board of directors, both of which
are more likely to have the best interests of the company in mind
when making such decisions.
Preventing A Future Crisis
Gordon Brown's proposal to create a new Bretton Woods system
with greatly enhanced powers over international financial markets
may be aimed at boosting his flagging popularity in Britain, but it
will not make global financial markets more sound or a future
crisis less likely. On the contrary, to the extent that it promises
to remove risk by backstopping financial crises, his proposal could
arguably increase market volatility and the likelihood of crisis by
creating a moral hazard that encourages imprudent risk-taking.
There are undoubtedly steps that can and should be taken to make
future crises less likely or severe that President Bush should
entertain and suggest during his meeting with French President
Nicolas Sarkozy and European Commission President José
Manuel Barroso or at the upcoming G-8 meeting. But creating an
additional layer of international regulation and oversight with
unprecedented authority and power--especially one charged with
"ensuring that globalization works not just for some but for all
hard-pressed families and businesses in all our communities" as
suggested by Mr. Brown--will more likely retard international
investment, financial transactions, and other economic aspects of
globalization that contribute to long-term economic growth in the
developed and developing world.
Brett D. Schaefer is Jay
Kingham Fellow in International Regulatory Affairs in the
Margaret Thatcher Center for Freedom, a division of the Kathryn and
Shelby Cullom Davis Institute for International Studies, at The
Bretton Woods is the New Hampshire location where leaders met to
establish these institutions in 1944.
"U.S. bank bailout comes at steep price,"
Reuters UK, October 14, 2008, at http://uk.reuters.com/article/stocksAndSharesNew
edName=stocksAndSharesNews (October 17, 2008); "Royal Bank of
Scotland Chiefs to be Forced Out Under Bailout Deal,"
Telegraph, October 8, 2008, at http://www.telegraph.co.uk/finance/financetopics/
iefs-to-be-forced-out-under-bailout-deal.html (October 17,
2008); "HSBC has 'No Plans' to Use Government Funds,"
Telegraph, October 13, 2008, at http://www.telegraph.co.uk/finance/newsbysector/b
plans-to-use-Government-funds.html (October 17, 2008);
"European banks in no rush forbailouts," International Herald
Tribune, October 17, 2008, at http://www.iht.com/articles/2008/10/17/europe/banks.php
(October 17, 2008).