RE-REGULATING FINANCE IN THE LIGHT OF THE GLOBAL CRISIS

Tsinghua UniversityBeijing, China.

9-11,2009

Leonardo Burlamaqui

l.burlamaqui@fordfound.org

““Public institutions need to be the vehicles by which leaders take public responsibility for

the public interest. Otherwise, markets

determine the public interest, which manifestly

does not work, especially in finance”

A SUGGESTED DEPARTURE POINT

“In finance, everything that is agreeable is unsound, and everything that is sound is

disagreeable”(W. Churchill, 1926)

“When the capital development of a country becomes a

byproduct of the activities of a casino, the job is likely to be ill

done” ( J.M.Keynes, 1936)

SOME OLD ADVICE

“I made a mistake in presuming that the self-

interests of organizations, specifically banks and others,

were such as that they were best capable of protecting

their own shareholders and their equity in the firms.”

(A. Greenspan – Congressional testimony, October 2008)

SOME SCARY NEWS

I’ve never seen financial insiders this spooked — not even during the

Asian crisis of 1997-98, when economic dominoes seemed to be falling all around the world. This

time, market players seem truly horrified — because they’ve

suddenly realized that they don’t understand the complex financial

system they created.”( Krugman: December 2007)

EVEN MORE SCARY ….

“To a remarkable extent we have got into the current economic and

financial crisis because of a wrong economic theory – an economic

theory that itself denied the role of the animal spirits in getting us into

manias and panics.”( R. Shiller: March 2009)

A WINDOW OF OPPORTUNITY FOR GETTING ECONOMICS RIGHT ?( AND, THEREFORE, A BETTER ROADMAP TO FIX THE ECONOMY)

Pressing Questions on the Crisis: First, despite some agreement on the proximate determinants

of the crisis, there is substantial divergence of opinion on “root” causes, in particular the role of post-liberalization changes in regulatory structures in creating the environment that led up to the crisis

Second, there is disagreement on the appropriate set of policies — injecting liquidity, recapitalizing or nationalizing banks, the size and shape of the fiscal stimulus packages (for example) — that would prevent the transition from a recession to depression and trigger a recovery .

Third, while there is a consensus that changes in the regulatory structure that governs finance are needed nationally and globally, with the concomitant creation of a new global financial architecture, the specific nature of these changes are hotly contested issues.

Pressing Questions on the Crisis:

Fourth, while the gap between the global nature of financial markets and the national character of regulation is acknowledged everywhere, the institutional framework needed to fill that gap is mostly terra incognita.

Fifth, although there is huge consensus on the urgent necessity for a radical change in the incentive system inbuilt in financial compensation packages, there is very little discussion on what incentives should be in place on the regulator’s side of the equation (e.g. What are the essential measures to enable effective regulators once we have effective regulation ?).

Taking a Step Back:

What’s wrong with the Global Governance System ?

It’s undemocratic:

Global Governance organizations lack the political legitimacy that is produced by the participation of all

interested political and economic actors.

Their decisions not only reflect the preferences of a few rich nation states, but a highly skewed subset of the interests within those states. This further erodes

their legitimacy and efficacy.

What’s wrong with the Global Financial Governance System ?

It’s ineffective:

It evolved from a productive orientation towards an exclusively speculative configuration.

More concretely: now we have….

An extremely opaque, unregulated and unaccountable system that is completely unfit for the task of bringing financial stability for both North and South .

A financial system that has lost, almost completely, the basic objective of financing productive investments.

Maps and Facts:

Fiscal Shelters

BIS (G7 Central

Banks)

Credit Rating Agencies

Burlamaqui

IMF

WBChang

MaiInit

WTO

BankingSystem

SouthBank

RegDev

Banks

Multilateral and Public

Asia, Russia, Middle East and Latin America

The Global Financial System:

SECFED BRICS

OECD

ExportCredit

Agencies

Int.ArbitrationTribunals

BilateralInvestment

Treaties

Multilateral and Public

DC and Geneva

COUNTRIES&

NATIONAL STATES

Mortgage Funds

EUROPE

EuropeanCentralBank

LAWFIRMS

InsuranceCompanies

SWFs

IOSCOInt Org of Sec Comm.

IFACInt Fed of

Accountants

WFEWorldFed of

Exchanges

FSFFin

Stability

Forum

IAISInt Ass of Insurance

Supervisors

Credit cardCompanies

SIVsRMBS

IASCInt Acc

StandardsBoard

Global Corporations

Hedge andPrivate Equity

Funds

ACCFIRMS

GLOBAL PRIVATE

Pension Funds

GATS

NationalFin Reg

Agencies

Toxic finance at its best: Global markets for derivatives: UNREGULATED

Note: world GDP ~ 42 trillion

Governance Failure (1) Financial Regulation in the US: A Very Inefficient Maze

Commercial banks

Futures

Industrial Loan Companies

Thrifts

Bank Holding Companies

Credit UnionsInsurance

Securities and Exchange

GOVERNANCE FAILURE (2): “MARKET DISCIPLINE” AND RENT-SEEKING IN FINANCE

RETURNS

Financial innovationfinancing

productive Investment

Financial innovationfinancing

productive Investment

Schumpeterian Schumpeterian

SorosianSorosian

Long-termFunding &

Venture Capital

Long-termFunding &

Venture Capital

Hedge Funds, Securitization &

Leverage

Hedge Funds, Securitization &

Leverage

DEVELOPMENT/StructuralChange

PONZICAPITALISM

CAPABILITIES REQUIRED:Unique knowledge of business

firms competences; strategies and of their competitive ecology

CAPABILITIES REQUIRED:Unique knowledge of business

firms competences; strategies and of their competitive ecology

CAPABILITIES REQUIRED:Knowledge about the regulatory/legal

loopholes and how to structure bets on the formation & evolution of

prices in currency &securities markets

CAPABILITIES REQUIRED:Knowledge about the regulatory/legal

loopholes and how to structure bets on the formation & evolution of

prices in currency &securities markets

Financialinnovation

financingspeculation

Financialinnovation

financingspeculation

Creative destruction

Destructivecreation

To bring the financial system back from its current “rent-seeking” configuration to a

“productive” fit.

What has to be done ?

The answer to that question, I leave to you all to figure out

in the next three days…

Thank you.

HOW ?