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Global effort to regulate ‘too big’ fails

Tepid economy, banking lobbyists hamper progress

Five years after the collapse of Lehman Brothers, a global push to tighten financial regulation around the world has slowed in the face of a tepid recovery and a tough industry lobbying effort.

Important progress has been made. Banks in the United States and Europe have socked away capital to guard against a fresh economic downturn, and evolving rules may force them to split off some of their riskier operations.

But the post-Lehman goal – of a global plan that would immunize the financial system from another large-scale shock – remains incomplete. Big banks, insurers and other financial giants remain intact and arguably “too big to fail.” Tools to guard against dangerous bubbles in the value of property or other assets are not yet in place.

There is no agreement on how countries should coordinate the failure of a globally important financial company. Implementation of basic banking rules in major nations has fallen behind schedule.

Finishing the job “is going to take many years,” International Monetary Fund chief economist Olivier Blanchard said. “It is conceptually very difficult, politically very difficult.”

In their effort to overhaul the global system, regulators have been confronted by a number of head winds. The world’s economy has been unexpectedly slow to recover, making governments leery of doing anything that might make banks cautious to lend and invest. The financial industry has pushed back hard, warning that aggressive regulation might undermine growth. And regulators are simply limited in their understanding of how modern finance can be made safe while still supporting economic activity.

The result: Some of the proposals once considered core to a safe, post-Lehman system have been delayed and weakened, and others have been played down, at least for now, as too politically complex. In other cases, the world is heading toward a patchwork. Some major European nations, including Germany and France, are preparing to impose a tax on every financial transaction, while Britain and the United States have rejected the idea. There is a growing divergence, as well, over how involved banks should be in securities trading and investing.

“The global economy is such a complex animal, there is a lot of structural work to be done. We are discovering that there is still a fault line here, a fault line there,” said World Bank chief economist Kaushik Basu. “As this gets mitigated, there will be a period of difficulty and danger.”

The complexities are such that even basic questions remain in dispute among the international bankers, regulators and political officials involved in the process.

In the wake of the 2008 Lehman collapse, there was a seeming groundswell behind the idea that no institution should be so important to the economy that taxpayers would have no choice but to provide a bailout if the company faltered. The concept of “too big to fail” prompted the United States to rescue American International Group, the insurance giant known as AIG.

A follow-up move, a committee of central bankers and regulators operating out of the Bank for International Settlements in Basel, Switzerland, agreed that the most globally important banks should set aside extra capital as a cushion against losses, raising their cost of doing business and possibly acting as a break against growing too large.

But the broader issue – how to prevent institutions from becoming too big, or how to guard taxpayers against a bailout – “is not yet satisfactorily addressed,” Blanchard said. Industry figures such as JPMorgan Chase chief executive Jamie Dimon, meanwhile, have disputed the concept that size and complexity in itself is a problem.

In the United States, regulators have proposed limiting the funding banks use to finance themselves as a percentage of the nation’s gross domestic product, but they would need congressional support to pursue the idea. Given the polarized political climate in Washington, analysts say it is unlikely that Congress will address the issue soon. Even if legislation cleared Capitol Hill, there would be a battle to get all global stakeholders on the same page.

“It would make sense to work through the debate over large banks” before imposing other rules proposed by the Basel committee, said Phillip Swagel, who served as assistant secretary for economic policy in the George W. Bush administration. “It seems like a waste to have banks spend lots of money figuring out how to deal with rules that would become irrelevant if they are broken up.”

There also is no comprehensive global approach for addressing bank failures. Individual members of the Basel committee, including the United States, have established resolution plans in case their own lenders become insolvent. And the United States and Britain in December released a set of guidelines to handle a major insolvency – a potentially important agreement between two world financial centers.

But determining how to coordinate the collapse of a major multinational bank is an area where the IMF and others have had limited success in pushing for a broader global agreement.

The issue is important because a method to share the fallout of a bank failure across national borders would probably make countries more willing to let institutions go out of business, rather than propping them up with taxpayers’ money.

Policymakers, however, seem unable or unwilling to rid the global financial system of weak banks, said Anat Admati, a Stanford University professor who calls for even tougher capital regulation in the forthcoming book “The Bankers’ New Clothes.”

“Some banks in Europe, even in the U.S., are very weak, with a lot of overhanging debt and unrecognized losses. But regulators do not face up to this,” she said. “Prompt corrective action, to prevent banks from becoming distressed, would improve the system. We need better ways to handle insolvent banks.”

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