In Beyond the Crash, his curious testament (part unreliable memoir, part tract), Gordon Brown argues that we need
a redefinition of the relationship between states and the financial markets. His case is that since governments, and their taxpayers, were obliged to bail out banks – and indeed, in Europe, continue to do so – we cannot sustain the status quo ante. Wall Street and the City of London have tasted the forbidden fruit of public subsidy; there can be no return to that paradise garden in which traders and rain-makers could leverage their balance sheets without limit, play unmolested with financial weapons of mass destruction, and pay themselves whatever they liked.
That may be right, but why is there still a need for a new social contract? Surely in the two years since Gordon Brown himself saved the world there have been G20 summits a go-go, the Financial Stability Board has reported not once but many times, and even the normally slow-moving Central Bankers have raced to produce a new set of rules: Basel 3? Dodd and Frank have produced Dodd-Frank, the European Parliament has got in on the act with new rules on pay, and governments around the world have huffed and puffed to produce their domestic versions.
But still there is a sense that we have not yet reached a new equilibrium. Many people in the centre or on the left of the political spectrum (and for this purpose we can include most British Conservatives in that definition) think more fundamental reforms to the structure of banks and markets are needed in order to resolve the “too big to fail” problem, together with tough and permanent controls on remuneration. While on the right, and in the banks themselves, there is growing nervousness that the controls already imposed on leverage will restrict the future availability of credit, with adverse consequences for economic growth. And brave voices are beginning to ask if it is the business of the state to interfere in private sector pay decisions. Might that not be the thin end of a very dangerous wedge?
Furthermore, there are signs that the global consensus that informed the early G20 summits in Washington and London is beginning to fray at the edges. When the crisis was at its peak, governments around the world felt the need to keep each other close: in the aftermath of the collapse of Lehman Brothers it was understood that they would all hang together, or hang separately. Now that is not the case. The new year brings very different dilemmas for the key participants. China is dealing with the problems of overheating and an asset price bubble. Brazil is worried by the effect of capital inflows. The US economy, by contrast, is still trying to achieve escape velocity, and in the eurozone the issue for 2011 is existential: will the currency union survive a sovereign debt crisis? And hanging over all of them is the fear that currency wars may erupt, and spill over into protectionism.
President Sarkozy, now chair of the G20, wants a new currency accord and a reconfigured Bretton Woods. That is an ambitious endeavour. But it will not deal with the continuing regulatory problems, or address the signs of regulatory arbitrage that we are already beginning to see. As the US and the EU pursue their own agendas to control financial risks, Switzerland and the Gulf centres are warmly welcoming hedge funds and the trading arms of investment banks. Low personal tax rates, and (in the Gulf) no pesky rules on bonuses are proving a powerful attraction.
In spite of all the post-crisis summits we still lack an effective mechanism to ensure the consistent application of global financial regulation. G20 ministers look to the Financial Stability Board for answers. The FSB was renamed in London in 2009, but given no new powers – indeed, it has no powers at all beyond moral suasion. In the trade arena there is the World Trade Organisation, with a mediating role in trade disputes and some authority to ensure that commitments entered into are kept. There is no equivalent in financial markets. The IMF may inspect its members and assess their compliance with the codes and accords in place, but it can do nothing if it finds gaps.
So the future of the world’s financial architecture will once again be an important agenda item this year at Davos. There is a risk that the momentum of reform has been lost and that we are moving back to a world in which financial centres compete aggressively to attract mobile financial business. Banks themselves are ambivalent about that: they will take advantage of the opportunities on offer, but there are many voices arguing for greater co-ordination and consistency. Incompatible and conflicting rules from country to country create new risks for companies, and fail to produce a new settlement that will provide the certainty about future practices which the markets would like to see.
Is it realistic to hope that governments will recognise that their long-term interests might lie in some concession of sovereignty to a global body like the FSB? I do not see why not. It would be a concrete recognition that the world has changed. The crisis showed that systemic risk was contagious, and that national financial markets could not be looked at in isolation. Academics and central bankers have begun to use network theory, and to adapt techniques from epidemiology, to understand the way risks are transmitted from node to node. What we need now is a body that can use that work and draw lessons from it. That should include global guidance on remuneration, on capital, and on the role of governments and central banks in the future. The new settlement that Gordon Brown suggests is conceivable, but we will not reach it by accident.
Howard Davies is director of the London School of Economics and a former chairman of the FSA. His latest book is “The Financial Crisis: Who is to Blame?”