Comments on the Draft Outcome Document dated May 8, 2009 for the United Nations Conference “World Financial and Economic Crisis and its impact on Development”
H.E. Mr. Miguel d'Escoto Brockmann
President of the 63rd session of the United Nations General Assembly
1. Sir, what is going on? The Basel Committee officially endorsed the capabilities of the credit rating agencies’ to identify for the whole world the whereabouts of “risk-free” investments and then, through their minimum capital requirements for the banks, they provided additional incentives for those “risk-free” AAA signs to be followed… and there, right in front of our eyes, over just a couple of years, about 2 trillion dollars were diverted to finance an almost useless and clearly risky housing and consumption boom in the USA, instead of financing the creation of sustainable decent jobs; the elimination of many infrastructure bottlenecks that exists especially in developing countries; or the adaptation and mitigation efforts that the climate change threat requests...and the Draft Outcome Document says basically nothing at all about that!
2. I am one of the very few who can evidence a track record of having in a timely fashion criticized the current financial regulatory framework that originated with the Basel Accord, both in terms of that it doomed the world to a horrendous financial crisis and in relation to the negative impact it has on development. In fact, on the latter issue, I might even be the only voice. Just as an example the following is a letter to the editor titled “Credit ratings for developing nations are just a new breed of systemic error” that I wrote and that was published in Financial Times, January 11, 2003
“Sir, Except for regulations relative to money-laundering, the developing countries have been told to keep their capital markets open and to give free access to all investors, no matter what their intentions are and no matter for how long they intend to stay. Simultaneously, the developed countries have, through the use of credit-rating agencies, imposed restrictions as to which developing countries are allowed to be visited.
This Janus syndrome – “you must trust the market while we must distrust it” – has created serious problems, not the least by leveraging the rate differentials between those liked and those rejected by our modern-day financial censors. Today, whenever a country loses its investment grade rating, many investors are prohibited from investing in its debt, effectively curtailing the demand for it just when that country might need it the most.
Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”
3. In this respect and notwithstanding that I agree with much of what is said therein I wish hereby to record some fundamental objections to the Draft Outcome Document dated May 8, 2009 (the Draft) and which relates to the G192 Conference on World Economic Crisis and its impact on Development. Many of these comments are extensive to the Recommendations of the Commission of experts of the President of the General Assembly on Reforms of the International Monetary and Financial System (the Recommendations).
Regulation
4. Paragraph 55 of the Draft states “The collapse in confidence in the financial sector is widely recognized as central in the economic crisis; restoration of confidence will be central in the recovery. But it will be hard to restore confidence without changing the incentives and constraints facing the financial crisis”
5. Of course restoration of confidence is central for economic recovery but for the recovery of confidence to happen a full understanding of what happened is a must. That a Bernard Madoff can cheat does not affect confidence in the markets because the markets are much aware that cheaters have always been around and are in fact themselves a part of the market.
6. But, if the credit rating agencies who were so recently officially bestowed with so much power in the surveillance of risks, and therefore must be the best, sort of an “Appointed Risk Surveyor to the Majesty” managed to fail so miserably, then that is of course a tremendous blow to confidence. That loss of confidence can only be cured by fully acknowledging that the mistake was in the creation of an oligopoly in risk surveillance and that this oligopoly will now be eliminated… not strengthened.
7. Paragraph 55 also states “It is imperative that the regulatory reforms be real and substantive, and go beyond the financial sector to address underlying problems in corporate governance and competition policy, and in tax structures, giving preferential treatment to capital gains, that may provide incentives for excessive leverage.”
8. The above says that not taxing the profits is at fault and so that presumably we now must tax profits? Not really so, the problem is not that the profits had tax incentives but that the profits proved to not be profits at all. The “incentives for excessive leverage” those were in fact provided by the regulators and thank God the maximum authorized financial leverages were never even reached by any bank before the crisis. This does of course not preclude that there might be many other valid reasons to tax profits, but that is a quite different matter.
9. Paragraph 55 also states “Even if there had been full disclosure of derivative positions, their complexity was so great as to make an evaluation of the balance sheet position of the financial institutions extraordinarily difficult”.
10. First the crisis was not caused by “derivative positions” and second, the “complexity” argument is irrelevant because the instruments that were so complex that they were not even understood by those who generated them, would never even have reached the balance sheet of a bank, or an investor, had they not been granted the triple-A rating which substituted for the understanding, unfortunately in a much imperfect way. There is of course a need for a better management of the exposures though central clearing houses but that is a quite different matter.
Purpose and objectives of the Financial System
11. Paragraph 57 of the Draft states: “Financial policies, including regulation, have as their objective not only ensuring the safety and soundness of financial institutions and stability of the financial system, but protection of bank depositors, consumers and investors and ensuring financial inclusion - such as access to all banking services including credit, and the provision of financial products which help individuals and families manage the risks they face and gain access to credit at reasonable terms. It is also imperative to make sure that the sector is competitive and innovative.”
12. First, the world needs to set as an explicit objective that individuals should be sufficiently gainfully employed so as not having to use debt except for the acquisition of long term capital goods or in the case of very special emergencies. Most current consumer debt does only help to advance current consumption, at interest rates higher than the risk-free rate and therefore, as a norm, only help to impoverish even more the poor consumers.
13. Second the real purpose of our financial policies should be to advance growth, the creation of decent jobs and to help society to confront special challenges such as climate change. If, in doing so, the financial sector remains stable that is of course a much welcome result, but little is gained from making stability per se the ex ante overriding objective, such as is currently the case. In fact I have even argued that a regulatory system that is much more “trigger-happy” and therefore allows financial institutions to fold much faster, would lead to more satisfactory and stable results.
14. Third, it is of course imperative that the financial sector remains competitive, but this only as long as the competition is carried out in a competitive way and not by assigning special favorable treatment to any parties. That said there is absolutely nothing that requires it to be innovative per se and much less so when the innovations, in this case regulatory innovations, can generate crisis like the current.
15. In this respect there is a need for a banking system that does not substitute bankers staring at monitors for bankers knowing their clients’ business, looking into their clients’ eyes or feeling the firmness of their clients’ handshake. It is indeed of extreme concern to see parents in developed countries giving almost more importance to some opaque credit scores than to the school grades of their children.
16. Therefore paragraph 57 should be rephrased placing as the primary objective of financial policies and regulations the development of the real economy in a sustainable and in a just way. The paragraph 28 of the Recommendations, though incomplete, reflects much of what needs to be stated.
The systemic risks of global arrangements
17. There are continuous references made to the need of “global institutional arrangements for governing the global economy” and this is all well, as longs as it comes with the absolute recognition of the systemic risks such global governance can produce. We should be aware that an objective analysis of the current financial regulations would have to conclude that the world would have been much better off without any of that global public common good we were told that the Basel Committee was, and which has now sadly revealed itself as a real global public common bad.
18. The worst regulator ever, in a small village, will produce harm of little aggregate significance. An extremely good regulator, globally connected, is a monumental menace. In this respect we need to value some of the diversity that different regulatory environments can bring and never underestimate the dangers of the rigidities that global regulations can introduce
Risk as the oxygen of development
19. According to the minimum capital requirements for banks established by the Basel Committee if a credit of $100 is given to a borrower who does not possess a credit rating, the banks need $8 in capital, but if the banks lends to a borrower that has an AAA to an AA- rating, the loans are risk-weighted at 20% and therefore the banks needs only $1.6 in equity. This is equivalent to an authorized 62.5 to 1 leverage.
20. That difference of $6.4 in required equity, especially in times when bank-equity is expensive, costs real money and acts like a de-facto tax on risk. This tax is laid as a surcharge tax on all the different risk spreads that the market already demands. Since the lack of development, just by itself normally generates in the market a perception of additional risk which has to be paid for, and since risk-taking is in so many ways the oxygen of development, it is clear that the developing countries are being especially discriminated by the current regulatory framework.
21. Now if you want to know the real extent of how the minimum capital requirements favored those able to dress up as risk free read paragraph 615 of the Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework - Comprehensive Version of June 2006 which refers to investment in securities that are risk weighted at only 7% and therefore signify an authorized leverage of 179 to 1.
22. The importance that risk-taking has for development and the need to avoid imposing de-facto taxes on risk as has been done with the minimum capital requirement for banks risk-weighted structure and much less introducing artificial incentives to direct funds to real or fictitious low risk investments is completely absent in the document.
23. Paragraph 14 of the Draft argues correctly that “Financial subsidies can be just as detrimental to the efficiency of a free and fair trading system as tariffs. Indeed, they may be more inequitable, because rich countries have more resources to support subsidies” and yet, neither the Draft nor the Recommendations mention even once the current minimum capital requirements for banks and which are as previously explained a real tax or a real tariff on risks, of which the developing countries have the most… at least as perceived by the markets.
24. For a more detailed comment on this I reference a document that I was honored to see posted in October 2007 in the Finance for Development site.
http://www.un.org/esa/ffd/hld/HLD2007/UN_FFD_Statement_Basel_Accord.pdf
Restructuring of International Institutions
25. There are many proposals related to the need of better more transparent and more democratic global institutions. They are all correct but missing from that is the following:
26. First it is not sufficient in structures like for instance the Financial Stability Forum (a name that in itself you might understand that I find much lacking) to have a representation of developing countries as this might not by itself guarantee diversity of thought. What is foremost needed is to avoid that the discussions of vital global issues are hijacked by clubs of mutual admirations and which, due to often strange ying-yang relations sometimes even include representatives from civil society.
27. Second in order to be able to introduce a more global perspective there is also need for more representatives who are not wedded to very local interests. As a former Executive Director of the World Bank I have often held that the least represented entity in the bank is planet earth itself.
Financing for Restructuring and Survival
28. Though I agree with some of the proposals made in paragraphs 21 trough 35 I just cannot comprehend how in paragraph 27 one finds room to mention minor initiatives such as PetroCaribe without even mentioning in the Recommendations or in the Draft the importance of remittances. Given that the enormous sacrifices of many migrants is what is holding many economies afloat it is truly an embarrassing omission.
29. Also and given the current role of the dollar as a kind of borrower of last resort, as a sort of last perceived safe-haven I certainly miss efforts to discuss the possibilities the US recycling some of those dollars to developing countries with perhaps some partial guarantees from other developed economies that also have a vested interest in it.
30. Paragraph 28 speaks of “efficient mechanisms for mobilizing the funds available in countries that have accumulated large reserves” and this could create the false illusion the existence of funds that have not already been deployed. In fact these reserves have one way or another already been invested and their divestment signifies by itself a major challenge.
31. Finally if there is a possibility for a Global Stimulus Fund, then now, in the midst of a crisis, this is not the best of times time to delay its workings by trying to also ascertain the voice of recipient countries.
Sincerely,
Per Kurowski
A concerned citizen and that while being an Executive Director at the World Bank 2002-2004 had little luck in having his voice heard on this issue.
H.E. Mr. Miguel d'Escoto Brockmann
President of the 63rd session of the United Nations General Assembly
1. Sir, what is going on? The Basel Committee officially endorsed the capabilities of the credit rating agencies’ to identify for the whole world the whereabouts of “risk-free” investments and then, through their minimum capital requirements for the banks, they provided additional incentives for those “risk-free” AAA signs to be followed… and there, right in front of our eyes, over just a couple of years, about 2 trillion dollars were diverted to finance an almost useless and clearly risky housing and consumption boom in the USA, instead of financing the creation of sustainable decent jobs; the elimination of many infrastructure bottlenecks that exists especially in developing countries; or the adaptation and mitigation efforts that the climate change threat requests...and the Draft Outcome Document says basically nothing at all about that!
2. I am one of the very few who can evidence a track record of having in a timely fashion criticized the current financial regulatory framework that originated with the Basel Accord, both in terms of that it doomed the world to a horrendous financial crisis and in relation to the negative impact it has on development. In fact, on the latter issue, I might even be the only voice. Just as an example the following is a letter to the editor titled “Credit ratings for developing nations are just a new breed of systemic error” that I wrote and that was published in Financial Times, January 11, 2003
“Sir, Except for regulations relative to money-laundering, the developing countries have been told to keep their capital markets open and to give free access to all investors, no matter what their intentions are and no matter for how long they intend to stay. Simultaneously, the developed countries have, through the use of credit-rating agencies, imposed restrictions as to which developing countries are allowed to be visited.
This Janus syndrome – “you must trust the market while we must distrust it” – has created serious problems, not the least by leveraging the rate differentials between those liked and those rejected by our modern-day financial censors. Today, whenever a country loses its investment grade rating, many investors are prohibited from investing in its debt, effectively curtailing the demand for it just when that country might need it the most.
Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”
3. In this respect and notwithstanding that I agree with much of what is said therein I wish hereby to record some fundamental objections to the Draft Outcome Document dated May 8, 2009 (the Draft) and which relates to the G192 Conference on World Economic Crisis and its impact on Development. Many of these comments are extensive to the Recommendations of the Commission of experts of the President of the General Assembly on Reforms of the International Monetary and Financial System (the Recommendations).
Regulation
4. Paragraph 55 of the Draft states “The collapse in confidence in the financial sector is widely recognized as central in the economic crisis; restoration of confidence will be central in the recovery. But it will be hard to restore confidence without changing the incentives and constraints facing the financial crisis”
5. Of course restoration of confidence is central for economic recovery but for the recovery of confidence to happen a full understanding of what happened is a must. That a Bernard Madoff can cheat does not affect confidence in the markets because the markets are much aware that cheaters have always been around and are in fact themselves a part of the market.
6. But, if the credit rating agencies who were so recently officially bestowed with so much power in the surveillance of risks, and therefore must be the best, sort of an “Appointed Risk Surveyor to the Majesty” managed to fail so miserably, then that is of course a tremendous blow to confidence. That loss of confidence can only be cured by fully acknowledging that the mistake was in the creation of an oligopoly in risk surveillance and that this oligopoly will now be eliminated… not strengthened.
7. Paragraph 55 also states “It is imperative that the regulatory reforms be real and substantive, and go beyond the financial sector to address underlying problems in corporate governance and competition policy, and in tax structures, giving preferential treatment to capital gains, that may provide incentives for excessive leverage.”
8. The above says that not taxing the profits is at fault and so that presumably we now must tax profits? Not really so, the problem is not that the profits had tax incentives but that the profits proved to not be profits at all. The “incentives for excessive leverage” those were in fact provided by the regulators and thank God the maximum authorized financial leverages were never even reached by any bank before the crisis. This does of course not preclude that there might be many other valid reasons to tax profits, but that is a quite different matter.
9. Paragraph 55 also states “Even if there had been full disclosure of derivative positions, their complexity was so great as to make an evaluation of the balance sheet position of the financial institutions extraordinarily difficult”.
10. First the crisis was not caused by “derivative positions” and second, the “complexity” argument is irrelevant because the instruments that were so complex that they were not even understood by those who generated them, would never even have reached the balance sheet of a bank, or an investor, had they not been granted the triple-A rating which substituted for the understanding, unfortunately in a much imperfect way. There is of course a need for a better management of the exposures though central clearing houses but that is a quite different matter.
Purpose and objectives of the Financial System
11. Paragraph 57 of the Draft states: “Financial policies, including regulation, have as their objective not only ensuring the safety and soundness of financial institutions and stability of the financial system, but protection of bank depositors, consumers and investors and ensuring financial inclusion - such as access to all banking services including credit, and the provision of financial products which help individuals and families manage the risks they face and gain access to credit at reasonable terms. It is also imperative to make sure that the sector is competitive and innovative.”
12. First, the world needs to set as an explicit objective that individuals should be sufficiently gainfully employed so as not having to use debt except for the acquisition of long term capital goods or in the case of very special emergencies. Most current consumer debt does only help to advance current consumption, at interest rates higher than the risk-free rate and therefore, as a norm, only help to impoverish even more the poor consumers.
13. Second the real purpose of our financial policies should be to advance growth, the creation of decent jobs and to help society to confront special challenges such as climate change. If, in doing so, the financial sector remains stable that is of course a much welcome result, but little is gained from making stability per se the ex ante overriding objective, such as is currently the case. In fact I have even argued that a regulatory system that is much more “trigger-happy” and therefore allows financial institutions to fold much faster, would lead to more satisfactory and stable results.
14. Third, it is of course imperative that the financial sector remains competitive, but this only as long as the competition is carried out in a competitive way and not by assigning special favorable treatment to any parties. That said there is absolutely nothing that requires it to be innovative per se and much less so when the innovations, in this case regulatory innovations, can generate crisis like the current.
15. In this respect there is a need for a banking system that does not substitute bankers staring at monitors for bankers knowing their clients’ business, looking into their clients’ eyes or feeling the firmness of their clients’ handshake. It is indeed of extreme concern to see parents in developed countries giving almost more importance to some opaque credit scores than to the school grades of their children.
16. Therefore paragraph 57 should be rephrased placing as the primary objective of financial policies and regulations the development of the real economy in a sustainable and in a just way. The paragraph 28 of the Recommendations, though incomplete, reflects much of what needs to be stated.
The systemic risks of global arrangements
17. There are continuous references made to the need of “global institutional arrangements for governing the global economy” and this is all well, as longs as it comes with the absolute recognition of the systemic risks such global governance can produce. We should be aware that an objective analysis of the current financial regulations would have to conclude that the world would have been much better off without any of that global public common good we were told that the Basel Committee was, and which has now sadly revealed itself as a real global public common bad.
18. The worst regulator ever, in a small village, will produce harm of little aggregate significance. An extremely good regulator, globally connected, is a monumental menace. In this respect we need to value some of the diversity that different regulatory environments can bring and never underestimate the dangers of the rigidities that global regulations can introduce
Risk as the oxygen of development
19. According to the minimum capital requirements for banks established by the Basel Committee if a credit of $100 is given to a borrower who does not possess a credit rating, the banks need $8 in capital, but if the banks lends to a borrower that has an AAA to an AA- rating, the loans are risk-weighted at 20% and therefore the banks needs only $1.6 in equity. This is equivalent to an authorized 62.5 to 1 leverage.
20. That difference of $6.4 in required equity, especially in times when bank-equity is expensive, costs real money and acts like a de-facto tax on risk. This tax is laid as a surcharge tax on all the different risk spreads that the market already demands. Since the lack of development, just by itself normally generates in the market a perception of additional risk which has to be paid for, and since risk-taking is in so many ways the oxygen of development, it is clear that the developing countries are being especially discriminated by the current regulatory framework.
21. Now if you want to know the real extent of how the minimum capital requirements favored those able to dress up as risk free read paragraph 615 of the Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework - Comprehensive Version of June 2006 which refers to investment in securities that are risk weighted at only 7% and therefore signify an authorized leverage of 179 to 1.
22. The importance that risk-taking has for development and the need to avoid imposing de-facto taxes on risk as has been done with the minimum capital requirement for banks risk-weighted structure and much less introducing artificial incentives to direct funds to real or fictitious low risk investments is completely absent in the document.
23. Paragraph 14 of the Draft argues correctly that “Financial subsidies can be just as detrimental to the efficiency of a free and fair trading system as tariffs. Indeed, they may be more inequitable, because rich countries have more resources to support subsidies” and yet, neither the Draft nor the Recommendations mention even once the current minimum capital requirements for banks and which are as previously explained a real tax or a real tariff on risks, of which the developing countries have the most… at least as perceived by the markets.
24. For a more detailed comment on this I reference a document that I was honored to see posted in October 2007 in the Finance for Development site.
http://www.un.org/esa/ffd/hld/HLD2007/UN_FFD_Statement_Basel_Accord.pdf
Restructuring of International Institutions
25. There are many proposals related to the need of better more transparent and more democratic global institutions. They are all correct but missing from that is the following:
26. First it is not sufficient in structures like for instance the Financial Stability Forum (a name that in itself you might understand that I find much lacking) to have a representation of developing countries as this might not by itself guarantee diversity of thought. What is foremost needed is to avoid that the discussions of vital global issues are hijacked by clubs of mutual admirations and which, due to often strange ying-yang relations sometimes even include representatives from civil society.
27. Second in order to be able to introduce a more global perspective there is also need for more representatives who are not wedded to very local interests. As a former Executive Director of the World Bank I have often held that the least represented entity in the bank is planet earth itself.
Financing for Restructuring and Survival
28. Though I agree with some of the proposals made in paragraphs 21 trough 35 I just cannot comprehend how in paragraph 27 one finds room to mention minor initiatives such as PetroCaribe without even mentioning in the Recommendations or in the Draft the importance of remittances. Given that the enormous sacrifices of many migrants is what is holding many economies afloat it is truly an embarrassing omission.
29. Also and given the current role of the dollar as a kind of borrower of last resort, as a sort of last perceived safe-haven I certainly miss efforts to discuss the possibilities the US recycling some of those dollars to developing countries with perhaps some partial guarantees from other developed economies that also have a vested interest in it.
30. Paragraph 28 speaks of “efficient mechanisms for mobilizing the funds available in countries that have accumulated large reserves” and this could create the false illusion the existence of funds that have not already been deployed. In fact these reserves have one way or another already been invested and their divestment signifies by itself a major challenge.
31. Finally if there is a possibility for a Global Stimulus Fund, then now, in the midst of a crisis, this is not the best of times time to delay its workings by trying to also ascertain the voice of recipient countries.
Sincerely,
Per Kurowski
A concerned citizen and that while being an Executive Director at the World Bank 2002-2004 had little luck in having his voice heard on this issue.
