In an absolutely fascinating reconstruction of the events that led to the near collapse of the global financial system last September, the New Yorker’s James B Stewart describes an extraordinary exchange between the Bank of America’s Christopher Flowers and Hank Paulson, then US Treasury Secretary.
As they discuss the imminent collapse of Lehman Brothers, Flowers turns to Paulson and says, “By the way, have you been watching A.I.G.?”
“Why, what’s wrong at A.I.G.?”
“Well, you should take a look at this.” Flowers handed Paulson a spreadsheet he had received from A.I.G.
“Oh, my God,” gasps Paulson and the rest is history.
April’s first G20 Summit in London, was a stunning success. It locked in a critical fiscal stimulus, began the process of agreeing a basis for financial reform, significantly provided a better financial insurance policy for developing countries, and began to shine a light on the dark corners of tax havens.
The risk then was global economic collapse (not a risk that has entirely receded incidentally). The challenge in Pittsburgh this time around was to build on that foundation and go further in creating a new and less risky global system of financial regulation. In other words, will the G20 usher in regulatory changes that prevent another ‘oh, my God’ moment?
First, the good news: this second G20 Summit cements the shift in global power from the G8 to a wider group of nations. This is significant – China, India, Brazil, Saudi Arabia, Argentina, Turkey, Indonesia, and South Africa now have a formal voice where before they could just protest. This formalisation of the G20 was proposed by the Center for American Progress in a report written earlier this year by the editor of this site with others and that has been delivered.
But on de-risking global finance less has been achieved. Banks are required to have greater capital reserves, greater liquidity and there is some talk at the Summit about reducing their lending to capital ratios – something that, ironically, the French and Germans are stalling (though this does actually make economic sense anyway in the short-term). New restrictions on bonuses – to be monitored by the Financial Stability Board – are a further improvement. However, the notion that our financial system is shielded from ‘oh, my God’ is fanciful.
Despite common action in London and Pittsburgh, there are still a great many financial institutions that are too big to fail. As Terry Smith, Chief Executive of Tullett Prebon, pointed out on the Today programme this morning, the casino elements of the City are still conjoined to the boring, utility bits, i.e. the bits that look after cash in our personal, savings, and business accounts.
For a country such as the UK, which has a large financial sector, the risk to the taxpayer and the economy is enormous. It is in our interests to have some form of firewall against major financial failure. An enormous fiscal deficit and the loss of 4 per cent of our output in a year is testament to that.
The sense is that the G20 leaders have ducked these more structural questions. If a large bank, which jeopardises the financial system, is failing do we have any choice but to save it? Knowing that we must, how does that inspire prudential financial management in these institutions? This is the reason the US passed the Glass-Steagall Act in the 1930s. It was repealed in 1999 but there must now be a case for such a casino-utility separation effective for the modern financial environment.
So the concluding assessment of this G20 must be that in governance terms there has been progress but in terms of building more solid structural resilience for the financial system, little significant change has been achieved.
A future Hank Paulson is less likely to intone ‘oh, my God.’ But I wouldn’t bet the cash in a sock at the back of your wardrobe against it.
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