Focus on the meat and two veg of reform

By Howard Davies

Published: August 31 2010 22:04

The French take over the leadership of the Group of 20 this autumn, a prospect that must be exciting Downing Street and the White House already. Last week Nicolas Sarkozy, France’s president, set out his priorities, initially to a complaisant audience of French ambassadors in the safe environs of the Quai d’Orsay.

He proposes to be an activist chairman. Who could have imagined otherwise? France’s leadership will be energetic and effective. In particular, it will promote fundamental reform of the international monetary system, a theme Mr Sarkozy broached in his address to the World Economic Forum in Davos in January. Instability in financial markets, he argued, “is a threat to world growth”, adding: “We need new instruments to prevent excessive currency volatility.” What the full range of those instruments might be was not set out, but he did call for a new reserve currency “not issued by one country alone”.

There are the germs, here, of yet another narrative explaining the financial crisis and its aftermath. Mr Sarkozy has already been fertile in his explanations. Initially, we may recall, the French focused on hedge funds and on offshore centres, known more colourfully in French as “fiscal paradises”. In the run-up to the London G20 last year, indeed, Mr Sarkozy insisted on measures to clamp down on them – threatening not to show up at all if Gordon Brown, Britain’s then prime minister, did not concede the point. We hear little of those concerns now: the caravan has moved on.

Indeed, it is striking how, fully three years after the crisis began, we are still no nearer to a consensus about the underlying causes and the most effective remedies. Normally, when a disaster strikes, whether man-made or natural, we begin with a range of theories, some less plausible than others. Then, as more is learnt, we tend to converge on one, or perhaps a small number of competing explanations. This time, the old saw that success has a hundred fathers but failure is an orphan has been turned on its head.

Far from opinion converging on one theory, views have tended to diverge, with a range of competing narratives articulated, from the grand macro explanations focusing on global imbalances, loose monetary policy and the savings glut, through regulatory failings – too little capital, feckless supervisors, gaps in oversight in the US – to a whole series centred on the outrageous behaviour of banks themselves, fuelled by greed and dangerous incentives. I have catalogued 38 distinct theories in a new book, The Financial Crisis: Who is to Blame?

Politicians have become more attracted by the wicked bankers line as time has passed and elections have had to be surmounted. But now it is the dollar, the International Monetary Fund and the currency markets that are coming under the spotlight, as underlying factors which contributed to the crisis. The American (and British) belief in pure currency floats, broadly supported by the IMF, is seen as creating the conditions for “excess” volatility. These are, of course, long-held concerns in Paris, where the role of the dollar in international markets is widely resented and part of the attraction of the euro was its potential role as a “competing” reserve currency, so perhaps we may count this new narrative as one that slots under “never waste a good crisis”.

Does this lack of consensus matter? Maybe we should welcome a comprehensive overhaul of the financial and monetary system, even of those parts that can hardly be blamed for the meltdown. Perhaps, but the risk is that the G20 gets bogged down in a morass of initiatives. Already the initial sharp focus on remedial measures evident at the London summit last year has dissipated, and different countries have focused on domestic reform programmes that have little to do with each other and which will not make international co-ordination easier in future. The Dodd-Frank debates over US financial reform proceeded with almost no discussion of the global dimension of securities markets. The recently announced UK plan to carve the Financial Services Authority into four pieces, whatever its internal merits, will make it harder for British regulators to play their part in international forums, as their structure will not match those of other countries. European parliament proposals on pay sit uneasily with reforms already agreed under the auspices of the Financial Stability Board.

A better approach for the G20 over the next year would be to give the Federation of Small Businesses the job of producing its own summary of the principal malfunctions in financial markets in 2007-09, together with an assessment of how far the reforms we have seen already offer the prospect of correcting those malfunctions. I suspect that exercise would produce a different agenda from the one sketched out by Mr Sarkozy last week. There is still much work to do on the capital framework for banks and brokers, there is an unfinished agenda in the derivatives markets, and the thorny issues surrounding cross-border insolvencies need resolution.

Grappling with these tough technical questions, which do need political focus to overcome national resistance, is not such a glamorous menu for world leaders. The meat and two veg of bankruptcy arrangements is less appealing than the foie gras and soufflés of international monetary reform, but more nourishing in the longer term.

The writer 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?

Copyright The Financial Times Limited 2010.