It’s been more than a year since Lehman Brothers Inc. collapsed and leaders of both political parties agreed that we needed to fix financial regulation to avoid future large-scale bailouts and economic peril.
But nothing much has happened. Why? This problem is global. And while everybody sees the problem with an unsustainable financial industry that’s coddled by national too-big-to-fail policies, no elected officials want their unsustainable, government-subsidized financial industry going somewhere else.
The best regulations would make each nation’s financial system and economy more robust to inevitable financial-industry failures. Such regulations include stronger, uniform borrowing limits for financial firms and markets, so that firms cannot make hundreds of billions of dollars worth of promises with negligible cash down.
But global politics is obscuring this reality. The French and the Germans long ago determined that the financial crisis had sprung from “Anglo-Saxon” recklessness. “The U.S. will lose its status as the superpower of the world finance system,” said Germany’s finance minister in October 2008. French President Nicolas Sarkozy promised that la crise would bring an end to financial “laissez-faire.” It seemed inevitable that the world would get much more regulatory “harmonization.”
But there’s no harmonious world, only a collection of competing nations. The biggest problem with the most sensible financial-regulatory fixes (and this is true of the not-so-sensible ones, too) is that each hurts one nation more than it hurts others.
To wit: In May, the European Parliament unveiled its first ambitious postcrisis proposal, and it seemed designed not to fix the conditions that led to the financial crisis but instead to aggravate Britain’s fear of disadvantage through blunt regulation.
The proposed “directive” would closely regulate hedge funds, private equity funds and other management funds, but exempt funds owned by big banks.
London has the most to lose from such a rule. The city is Europe’s No. 1 asset manager, with more than a third of such business across the region. London is also home to hundreds of stand-alone hedge funds that could find themselves competing at tremendous disadvantage against bank-owned funds on continental Europe.
Other uniform regulations — whether the right ones or the wrong ones — could disproportionately disadvantage France and Germany. A recent JPMorgan Chase report estimated that, were the eight most commonly suggested regulatory reforms enacted, profitability at the investment-bank division of Germany’s Deutsche Bank “would be the most impacted,” with French banks’ investment-banking units next in line.
No self-respecting American politician would admit to waiting around to see what Europe does before we act. But surely Larry Summers and others are counseling President Barack Obama, as well as congressional leaders, that in the short term, imposing unilateral regulations, such as a requirement to hold significant capital against credit default swaps, would send much of that business to a willing country that’s a 5½-hour flight away.
Yet absent adequate regulation that makes markets robust enough to withstand failure, European nations — and the United States — are competing, not healthily on subtle differences but unhealthily on how much implicit government subsidy they can offer an inadequately regulated, too-big-to-fail global financial system the next time it needs an inevitable bailout.
Continuing to subsidize the financial sector with implicit guarantees carries long-term costs. A government-supported financial sector competes with other, perhaps more productive, areas of the economy for resources.
The U.S. should not allow a global regulatory stalemate to prevent it from creating a credible way in which lenders to its financial institutions can take their losses, including smarter capital requirements and rules for unregulated financial instruments to make the system more robust to failure.
As usual, it’s a question of short-term trade-offs versus long-term principle. The political class is good at making the short-term trade-offs. There is no perfect solution, but it doesn’t hurt for the rest of us to direct the politicians’ view toward the principle, creating the conditions for a competitive financial sector, not a government-coddled one.
Nicole Gelinas is author of “After The Fall: Saving Capitalism From Wall Street — and Washington.” Adapted from the autumn 2009 City Journal.