G-20 gridlock leaves global financial system at risk

NEW YORK—

A year after the panic that brought the world’s financial system to the brink of collapse, the Group of 20 nations will now assume the role of a permanent council on global economic cooperation. But there is still no global regulatory framework to prevent another major market meltdown. As the leaders of the world's top industrialized nations gather in Pittsburgh, that will be another item on the menu while they sip wine and nibble on hors d'oeuvres.

The wine will be imbibed and the canapes consumed, but don't expect them to make any meaningful headway on financial regulations.

“There are always fine statements,” said Dan Price, a lawyer with Sidley Austin who specializes in global financial regulation. “Unfortunately, they’re followed by backsliding as leaders go home and feel domestic political pressure."

The heads of state will announce Friday that the G-20 will become the permanent council for international economic cooperation, eclipsing the G-8, The Wall Street Journal reported. The proposal is aimed at improving coordination of global economic policymaking, and would reduce global reliance on U.S. consumers.

German Chancellor Angela Merkel warned Wednesday that officials gathering for the G-20 meeting should focus on the imperative of revamping the world's financial regulatory system and not get distracted by a U.S.-led drive to reduce global trade imbalances.

The United States has been pushing for nations such as China to reduce their dependence on exports and boost domestic spending. In return, the U.S. would increase savings and reduce its debt burden.

So far, individual G-20 countries have made little progress in getting their own financial houses in order.

In the United States, Congress is mired in health care reform and facing a divisive battle over carbon cap-and-trade legislation, making financial regulatory reform look less likely this year.

“Any global process is bound to be slowed down because the U.S. legislative agenda is so backed up now,” said Geoffrey Garrett from the University of Sydney's U.S. Studies Centre. “So we’re now talking about mid-2010 or later for any resolution on the U.S. side about what their reform is going to look like after the crisis.”

Meanwhile the global banking industry is still struggling to rebuild the capital that was destroyed by a lending spree that relied on huge leverage, producing huge gains on the way up and historic pain on the way down. Curbing the systemic risk that blew a trillion-dollar hole in the world financial system is a major goal of the G-20 financial leaders. But it’s not clear who will take the lead.

“Among the regulators it really has to be the U.S. and U.K. regulators who have a 30-year history of always leading from the front,” said Michael Foot, chairman of consulting firm Promontory Financial Group. “But one of the tragedies is that in both the States and the U.K. there are turf wars and uncertainties for what regulation will look like in two years' time.”

“We are absolutely at the levels of risk from 2004 or 2005,” said Simon Johnson, an MIT economist and former chief economist for the International Monetary Fund. “So it’s not imminent crisis, but the danger signals are there already in the amount of risk that the big banks are taking, and their attitudes towards risk and the controls they have over their derivatives (trading.)"

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One likely scenario would require banks to keep more capital on hand and limit the amount of lending backed by that capital. But stiffening the rules now risks tightening credit just as the global economy is struggling to get back on its feet. That’s one reason regulators are in no hurry to force banks to keep more cash in the vault.

The discussion over requiring banks to hold more capital has also opened a major fault line among the biggest banking powers. Without a uniform set of regulations, countries that adopt easier capital requirements will hand their domestic banks a strong advantage over global competitors.

“The Americans don’t want to do enough on capital requirements, in my opinion,” said Johnson. “But the Europeans don’t even want to do that because their banks are so thinly capitalized."