G20: Was the Summit Actually Dangerous?

By Simon Johnson

It is easy to dismiss the G20 communique and all the associated spin as empty waffle. Ask people in a month what was accomplished in Pittsburgh and you’ll get the same blank stare that follows when you now ask: What was achieved at the G8 summit in Italy this year?

Perhaps just having emerging markets at the table will bring the world closer to stability and more inclined towards inclusive growth, but that seems unlikely. Should we just move on – back to our respective domestic policy struggles?

That’s tempting, but consider for a moment the key way in which the G20 summit has worsened our predicament.

There is broad agreement that capital requirements need to be increased and a growing consensus that very large banks in particular should be required to hold bigger equity cushions. This is a pressing national priority – if our financial system is to become safer – and reasonable people are starting to put numbers on the table, ever so quietly: Joe Nocera is hearing 8%, but Lehman had 11.6% tier one capital on the day before it failed and the US banking system used to carry much more capital – back in the days when it really was bailout free (think 20-30% in modern equivalent terms (see slide 40 here).

Obviously, raising capital standards in the US is going to be a long and drawn out fight. The G20 could help, if it set high international expectations, but the opposite is more likely. As Nocera suggests this morning, the inclination of the Europeans – largely because of their funky “hybrid” capital, but also because they have some very weak banks – will be to drag their feet.

Why should we care? This administration seems to think that we need to bring others with us, if we are to strengthen capital requirements. Our progress will be slowed by this thinking, the glacial nature of international economic diplomacy, and the self-interest of the Europeans.

Instead, the US should use its power as the leading potential place for productive investments to make this point: If you want to play in the US market, you need a lot of capital. If you would rather move your reckless high risk activities overseas, that is fine.

It’s time to get past the thinking that our economic prosperity is tied to the “competitiveness” of the financial sector, when that means doing whatever finance wants and keeping capital standards low.

As we discovered over the past 12 months, undercapitalized finance is not a good thing – it is profoundly dangerous and expensive. Other countries should be encouraged to raise capital standards also, but if they can’t or won’t, then their financial institutions will (a) not be allowed to operate in the United States, and (b) be allowed to interact in any way with a US bank only to the degree that the US entity carries an extra (big) cushion of capital in those transactions. Any US entity found circumventing these rules will be punished and its executives subject to criminal penalties.

Of course, this process needs to be WTO-compliant and the G20 is as good a place as any to manage the high politics of that. But stop worrying about what other countries might or might not do. Establish high capital requirements in the US, and make this a beacon for safe and productive finance.

And prepare for the crises that will sweep undercapitalized parts of the world financial system in the years to come.

Comments

[secmaven]

And where are the banksters going to get the required infusion of capitals. Perhaps they can recover the bonuses paid to their executives for the nefarious work they have performed?

2009 Sep 26 10:33 AM

[Michael Clark]

Bonuses are a good place to start.

Obama, you need Simon Johnson instead of Bernanke.


On Sep 26 10:33 AM secmaven wrote:

> And where are the banksters going to get the required infusion of
> capitals. Perhaps they can recover the bonuses paid to their executives
> for the nefarious work they have performed?

2009 Sep 26 10:39 AM

[isurfmb]

We seem to have evolved an international banking system that has the current capacity to shuttle funds between the various central banks in order to abritage all key markets ie: large Comex positions being covered for delivery by foriegn bank sales, failed USTreasury auctions being saved by late in the day by foreign bank purchases, direct Fed Reserve capitalization of foriegn central banks, and countless funding operations held in secret as Barney Frank says would cause ruinous market runs if they were unveiled. Well the point of all this is the US dollar carry trade as needed with zero interest rates allowing for funds dispsement wherever and whenever the Fed and Treasury want. The FDIC is a govt. funding mechanism masquerading as an insurance company at the beck and call of the Fed Reserve and USTreasury and will be used and funded by them to support their best intersts.

2009 Sep 26 11:47 AM

[User 353732]

Undercapitalized banks are primarily a threat to the bonuses of Wall St predators and the power of entrenched incumbents in Wash Dc who ,incidentally, are very well financed indeed by their fellow kleptocrats on Wall.

In a free and fair financial market and a genuinely capitalist economy(the US has neither by any reasonable definition of these terms), undercapitalized banks would never have been allowed to become "too big to serve" and they would have been allowed to fail early and often. There would have been, in parallel, massive entry of new, untainted, capital that would have backed multiple new banks and bought the worthwhile assets, technological infrastructure and management contracts of the truly talented and clean executives and professionals of the failed banks. The tainted capital would be extinguished; overpaid, vain and hugely corrupt executives and traders would be denied the opportunity to commit more serial financial crimes; and fake assets and the complicity of the US Govt in creating and then hiding these fake assets would be exposed to the scrutiny of all.

The purpose in "saving " Big Banks is to rescue, reward and even further embolden the Bosses that control Big Govt, Big Money and Big Media.; this vast, ongoing and vile rescue has been and continues to be at the expense of free and fair markets, US global stature, scores of thousands of American businesses and scores of millions of American households and the American Constitution.

2009 Sep 26 11:51 AM

[CautiousInvestor]

Instead, the US should use its power as the leading potential place for productive investments to make this point: If you want to play in the US market, you need a lot of capital. If you would rather move your reckless high risk activities overseas, that is fine
______________________...
Club Med (Europe) has been fixated on compensation as it allows them to avoid more serious issues and we have been making a big stink out of global imbalances in savings and investments to shift the discussion completely away from financial reform as the elites of the cartel are adamantly opposed to anything but the status quo. After all we survived the storm.

I would like to see reform that increases the amount and quality of capital banks must carry and specific curbs on the activities of the large banks. In the event risk activities are not curbed, then the capital ratio should be adjusted for both the size of the institution and its scope of activities; larger banks engaged in risky activities would need to carry more capital than smaller banks involved only in intermediation.

In light of the weanesses in Basel II and much needed reform, Basel II must be redrafted to reflect current realities and the need to avoid another financial meltdown where taxpayers monies are at risk. Given the differences between the US and Club Med, there may be unifying and overarching language but regional policies are likley to vary.

While highly unlikley, everyone in the US shoulld stand tall with hard resolve and not flinch when the bankers and their pygmie lobbyists remind legislators how much they contribute to congressional campaigns; basic reform is essential to avoiding a reprise of what we just experienced. At a minimum we need higher capital ratios, risk weighted capital requirements, higher quality capital, counter cyclical capital rquirements and greater transparency; in my mind the jury is still out on the oversight of systemic risk and the proposal for a consumer financial products agency.

And as Simon notes in the paragraph that precedes this comment, if Club Med wants to play in our economy they can only do so with banks that meet or exceed the likely reforms in capital requirements. We cannot afford anything less.....because the possibilities are so dire.... and this would be an example of much needed leadership in a world in desparate need of leadership.

2009 Sep 26 12:43 PM

[Michael Clark]

This is an even better place to start.

"While highly unlikley, everyone in the US shoulld stand tall with hard resolve and not flinch when the bankers and their pygmie lobbyists remind legislators how much they contribute to congressional campaigns; basic reform is essential to avoiding a reprise of what we just experienced. At a minimum we need higher capital ratios, risk weighted capital requirements, higher quality capital, counter cyclical capital rquirements and greater transparency; in my mind the jury is still out on the oversight of systemic risk and the proposal for a consumer financial products agency."

I do think bonuses are an issue (a psychological issue for many Americans -- and also a psychological issue for the bankers themselves, telling them they are not the law, not the tip of the pyramid -- they cannot do whatever they like). But reforms like those listed by Cautious Investor will go a long way toward ending the Era of Obscene bonuses.

Another way of ending the Era of Obscene bonuses is to tax them at an obscene rate. If superbankers who 'deserve' these bonuses leave the country to go to Switzerland instead, then let them go. Superbanking is really greased by the banks owning the government, not by super-educated individuals who are taught how to apply the grease to the wheel. The rule of life is that EVERYONE can be replaced.


On Sep 26 12:43 PM CautiousInvestor wrote:

> Instead, the US should use its power as the leading potential place
> for productive investments to make this point: If you want to play
> in the US market, you need a lot of capital. If you would rather
> move your reckless high risk activities overseas, that is fine<br/>_______...
>
> Club Med (Europe) has been fixated on compensation as it allows them
> to avoid more serious issues and we have been making a big stink
> out of global imbalances in savings and investments to shift the
> discussion completely away from financial reform as the elites of
> the cartel are adamantly opposed to anything but the status quo.
> After all we survived the storm.
>
> I would like to see reform that increases the amount and quality
> of capital banks must carry and specific curbs on the activities
> of the large banks. In the event risk activities are not curbed,
> then the capital ratio should be adjusted for both the size of the
> institution and its scope of activities; larger banks engaged in
> risky activities would need to carry more capital than smaller banks
> involved only in intermediation.
>
> In light of the weanesses in Basel II and much needed reform, Basel
> II must be redrafted to reflect current realities and the need to
> avoid another financial meltdown where taxpayers monies are at risk.
> Given the differences between the US and Club Med, there may be unifying
> and overarching language but regional policies are likley to vary.
>
>
> While highly unlikley, everyone in the US shoulld stand tall with
> hard resolve and not flinch when the bankers and their pygmie lobbyists
> remind legislators how much they contribute to congressional campaigns;
> basic reform is essential to avoiding a reprise of what we just experienced.
> At a minimum we need higher capital ratios, risk weighted capital
> requirements, higher quality capital, counter cyclical capital rquirements
> and greater transparency; in my mind the jury is still out on the
> oversight of systemic risk and the proposal for a consumer financial
> products agency.
>
> And as Simon notes in the paragraph that precedes this comment, if
> Club Med wants to play in our economy they can only do so with banks
> that meet or exceed the likely reforms in capital requirements. We
> cannot afford anything less.....because the possibilities are so
> dire.... and this would be an example of much needed leadership in
> a world in desparate need of leadership.

2009 Sep 26 02:21 PM

[Rokjok777]

Huge bonuses are fine for investment banks. Take the govt safety net out from under them; and split off commercial banks. Those are the ones that need salary caps: they're critical to keeping the economy moving. Let the i-bankers fail (or succeed spectacularly) by putting only their shareholder's money on the casino table. Not the taxpayer's money...

2009 Sep 26 05:07 PM

[Dave Wrixon]

What are you on? So the Europeans are now totally to blame?

2009 Sep 26 06:09 PM

[a. palmer jr.]

Any foreign entity now playing in the U.S. market will in the future need to be cash-rich. The reason for that is: we need to borrow it!

2009 Sep 27 09:44 AM

[Gold_Investor]

Buy Physical Gold and get it outside the US the dollar will be worthless says Marc Faber also known as Dr Doom:
Source : MarcFaberchannel.blogs...
Speaking at the CLSA Asia Pacific Markets investor conference in Hong Kong. Mr. Faber told the audience to put money in Asian equities and commodities. He said gold is important, but buy real gold, not derivatives, and keep the gold outside the U.S. The U.S. confiscated gold during the Great Depression, he noted.
He, like Warren Buffett, Nouriel Roubini and others, thinks the dollar is destined to erode, though Mr. Faber said it could rebound over the next few months as signs of deflation stick around. “The dollar in the long run is a doomed currency,” he said. “This is the short of the century…The government’s policy is to make it worthless.”

2009 Sep 27 01:12 PM

[Harry Tuttle]

Bear Stearns was about to report a profitable quarter right before it failed.

If Google can massage their numbers with "ex-items" imagine what a bank can do.

What about the regulators? as Bernie said, they really want to be hired by those whom they regulate.

2009 Sep 28 11:00 AM