What of the Financial Reform?

by Inya Ivkovic, MA

Governments worldwide are still baffled about how to monitor systemic risk in an efficient manner to ensure that the build-up of hidden risks does not go unnoticed again. Not surprisingly, policy-makers are still having nightmares after missing all the red flags that popped up during 2006 and 2007. However, those fears have yet to germinate past the proposal stages. As the markets race, investors open themselves up to risk again, and banks give out bigger loans and larger paychecks, the G20 are still only talking about what needs to be done to prevent new bubbles from creating.

In their defense, governments have been plenty distracted lately. The U.S. is all wrapped up in the healthcare debate. Canada appears to be going towards the fourth election in five years, while the economy is still focusing more on economic stimulus than on the reform of the financial sector. Granted, there is still too much anger aimed at financial scoundrels; anger that has created a strange state of political indifference towards reform of the financial markets, which, if it were not tragic, would be quite maddening. People’s ability to forget unpleasant things can be truly amazing.

This is why it is of paramount importance to accomplish one major goal and that is to create omnipotent financial regulators in key developed countries. The idea is to make sure these regulators work in concert and make sure there are no blind spots left in global financial systems, the likes of which we have seen in the past year. If there was such a body in the U.S., for example, it would have seen the potential risks of AIG nearly abandoning its core insurance business in favor of selling complex derivatives the insurer knew so little about.

At the moment, the Obama administration seems to be in favor of the Federal Reserve taking that role, but Congress is not exactly playing ball, because it believes that it was the Fed that let the country get into this mess in the first place. In Canada, the Conservative government wants to retain this function under the responsibility of the federal finance minister, but little has been offered in lieu of any specifics.

I should say that there are new capital rules on the table that would require banks to hold more capital to help them weather future downturns better, but these have not been finalized yet. So, whichever way you look at it, it seems the best window for regulatory reform is closing, or at least the will to fix whatever can be fixed seems to be evaporating.

Nevertheless, the events of the Great Recession and what caused it scream with the need to return the financial reform on the global macroeconomic and political agenda. The agreement among the G20 exists on a set of solid principles upon which to build a stable global financial system. But these principles need to be translated into a viable framework sooner rather than later. And as for fears that more regulation will mean stumping the financial innovation, those are the fears of old schoolboys. The financial reform is not about stifling innovation; rather, it is about creating the environment in which
innovation will be sound, transparent and thriving, because investors will be able to trust it and promote it. This financial reform should be about learning the lesson and moving forward in a productive way.