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More From IMF's Lagarde — Part III

By    |   Wednesday, 09 October 2013 03:11 PM

In this final installment of the Oct. 3 speech by International Monetary Fund Managing Director Christine Lagarde at George Washington University on the theme of transitions in global economic and regulatory policy, Lagarde set forth her vision of reforms under the Dodd-Frank Act in the United States and companion agreements among G20 regulators.

Not only are the largest, globally significant financial institutions at risk due to a buildup of complex, unregulated risks embedded in hundreds of trillions of dollars of derivatives trades, with only a tiny percentage traded on exchanges where reliable values can be determined, but this market also lacks supervision and will continue to until "speedy reforms" are made.

Lagarde then turned her attention to what she called "another danger zone" — the shadow banking system, which she said has been attracting "a lot of riskier activity." She estimated that the shadow banking sector is twice the size of traditional banking and charged that it receives very little supervision and regulation, although she found progress in the proposals of new regulations for money market funds, securities lending and repurchase agreements.

She hastened to add that she does not recommend that the shadow banking sector be eliminated altogether, because it can be an alternative source of financial services. Rather, it needs to be made a lot more transparent and better overseen.

I would offer a different perspective, that the entire banking system can be considered "shadow," because the entire system qualifies as lacking transparency and effective regulation and supervision. Moreover, many of the traditional banks have connections to shadow banking through their myriad affiliates. Finally, using the money fund proposal as an example, proponents of tougher regulation have criticized the Securities and Exchange Commission's latest proposal, and the industry is still in denial that money funds pose systemic risk, as the Financial Stability Oversight Council has found. At best, it is highly premature to conclude that the risk from this industry is finally under control.

Already, she noted, discrepancies have shown up in the application of the capital rules by different jurisdictions, and the same is in store for the Volcker rule, which exists in three different versions among the leading financial centers. Therefore, Lagarde has already concluded that putting it all together will be "a bit of a headache," but she would exhort the regulators that "Nothing less than global financial stability depends on it." Going into whisper mode, she considered whether this state of affairs is a comment on the performance of regulators and policymakers, but concluded it is not.

Rather, it is the financial sector that Lagarde exhorted, because it "has to make some serious decisions. It is their responsibility because it is the survival, the continuation and the growth of their activities [at stake]." She went on to predict that the business of banking and even the size of banking enterprises could change.

Her vision holds that "What is ultimately important is that the financial sector stays focused on what it is expected to do for the economy. It should serve the economy. It should provide the financing, it should mature money, it should move it around, it should finance investment and innovation."

But back in whisper mode, she cautioned, "Old habits die hard."

This is the point where the flight with Commander Lagarde gets a bit turbulent as it prepares to land. She acknowledged that reform will take time, and expressed hope that "it can be managed, particularly if all participants unite around shared goals. This means the industry and its regulators accept core responsibility for the public good that is financial stability."

Here it gets good: "It means countries working in harmony, so that the new financial framework looks more like a mosaic, rather than a clash of unmatched colors — a Monet rather than a Pollock."

She tried to refute the notion that this is a Mission Impossible and warned against responding by "retiring to your own turf, less opening of markets, more protections, more restrictions," a response that she realizes could occur, because the financial crisis has shaken faith in "the virtues of being open and engaged with the world."

She closed with a stirring quote from Albert Camus that can choke up even a confirmed cynic.

A more realistic view, albeit a cynical one, is that policymakers have learned nothing from the four plus decades of the financial crisis if they do not realize that the largest financial institutions are run by incorrigible rent seekers, not by strivers toward a common goal of improving the living standards of mankind.

It is utterly fanciful to think that an industry that avoids capital as Superman recoils from Kryptonite is going to finance investment and innovation.

Fortunately, there is a Camus quote for this circumstance: "The evil that is in the world almost always comes of ignorance, and good intentions may do as much harm as malevolence if they lack understanding."

If policymakers continue to "extend and pretend" in their dealings with bankers, they will continue to serve as useful foils for bankers bent on extracting all that they can from the new, improved bailout engine banking lawyers have build from the wreckage of 2008.

The most optimistic view of the speech is that enough words are there to show that at some level, Lagarde realizes that nothing has changed in the cult and culture of the banking industry; only the number have changed, and they're bigger.

However, to reform such a dysfunctional financial system will take more than exhortations. It would have to come from an activist element that would arise from within the industry, but it is nowhere to be found.

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In this final installment of the Oct. 3 speech by IMF Managing Director Christine Lagarde on the theme of transitions in global economic and regulatory policy, Lagarde set forth her vision of reforms under the Dodd-Frank Act in the United States and companion agreements among G20 regulators.
Wednesday, 09 October 2013 03:11 PM
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