The United States has blown Europe’s plans for tougher market rules right out of the water.
It has chosen the day of the London Group of 20 summit of world leaders to loosen the most important accounting rule affecting US banks.
At the London showdown, the US was demanding other countries do more to stimulate the world economy. On banks alone, the US has already spent half as much again as the whole of Europe combined.
However, Europe’s leaders preferred to focus on preventing future crisis, by discussing new rules to regulate the financial markets.
In fact, the most important issues facing the leading economies, the cost of the massive banking bailout and the trillions of dollars of toxic assets burning a hole in their balance sheets – were not even on the London agenda.
Why European leaders preferred to talk about future crises, instead of the economies melting beneath their feet, is a question I asked in yesterday’s blog.
US PLAYED HARD
France and Germany pushed hard for stronger regulation of the financial markets - but even that was softened in the final communiqué.
Now the US has stolen the limelight from the G20, by deciding to loosen, not strengthen, bank regulation in the key area of mark-to-market.
This is the banks’ most-hated rule, which forces them to account for the losses they have made as assets plunged in value.
Now the Financial Accounting Standards Board will let banks be more creative with how they value assets which may have a higher value in the long term.
In a healthy market, banks never hold assets like bonds to maturity. It’s more profitable to trade them. While credit default obligations and mortgage backed securities were booming in value, banks were happy to account for their market value.
Now that many assets are trading well below face value, removing the obligation to mark-to-market will improve their balance sheets.
The US played hard in London, too.
“It was a very big win for the United States,” says John Kirton, Director of the G20 Research Group. “You start reading the communiqué: Open markets, growth, jobs, that comes first. Regulation comes second and here it’s effective regulation, not stronger regulation, regulation for itself, but regulation to restore trust.”
SHORT ON DETAIL
Financial market players concede that the derivatives market in particular does need regulation.
Derivatives are a way of trading or betting on the value of commodities, shares, currencies without owning the underlying product, say a barrel of oil. They give the chance of earning much more - or losing much more - than you do by owning the actual product.
Derivatives boosted bank earnings when the markets were rising but now they are amplifying their losses.
This needs regulating, says Kevin Dougherty, Moscow based fund manager with Pharos Financial Group, “specifically the over the counter derivatives market. Quite frankly it is a place where banks, investment banks and hedge funds go hide risk”.
However he said derivatives risk is really only an issue for the biggest financial centres. In Russia the derivatives market is both smaller and more tightly regulated.
The summit was short on detail, with no explanation of how politicians proposed to regulate banks or ratings agencies.
“This is a prudent recognition by leaders that with a few exceptions they really don’t know enough about how credit rating agencies and credit markets really work.” says John Kirton.
“So broad principles, yes, that ratings agencies must be registered, that they must be overseen when they are used for regulatory purposes but to get the details right, that’s the job of the new Financial Stability Board which they created and I think we will see those details coming in a sensible way over the next six months.”
REVERSE MARSHALL PLAN
By the end of the summit it was not clear whether the G20 really exists.
On the one hand, countries like Russia had a platform to push ideas like a supra-national reserve currency. On the other hand, the major players largely ignored the proposal.
As Barry Eichengreen argues in The Daily Telegraph, there should be a G7/8, but not today’s. “Rather it means a 21st century G7/8 made up of the US, the EU, Japan, China, Saudi Arabia, South Africa, Brazil and maybe Russia.”
Ultimately the measures the G20 called for, to revive the global economy, depend on domestic governments.
Above all, solving the crisis depends on the US fixing its broken banking system. The summit fell short of delivering a new world financial order.
However, the politicians snuck a kind of reverse Marshall Plan into the communiqué. The London summit agreed to refinance the International Monetary Fund and the World Bank to the tune of $1 trillion.
Much of the money will go to indebted East European countries that need to repay their creditors - the Western banks.