17 December 2008

December 2008

Graham Bishop’s Personal OVERVIEW -

As historians look back at 2008, it will be seen as an extraordinary year that defined the end of an “age”. The list of failures seems to be lengthening by the moment. It began with the unfolding of the true magnitude of the sub-prime crisis that demonstrated that a significant number of bank managements had not understood the risks that they had built up.

But AIG/Fannie Mae/Freddie Mac showed this management failure was not limited to banks’ risk management. The Soc Gen trading loss showed that control systems could still be evaded by rogue traders. However, the final blow to any thought that regulators could be trusted as the backstop to keep the financial system on the straight and narrow road of probity was finally delivered by the revelations of the Madoff “Ponzi scheme”. Where were the thoughtful and diligent analyses by the investors, the ethics of the staff, the forensic skills of the auditors and the rigorous checks by the regulators?

What is to be done about all this? The average citizen might well ask this question – given the unfolding grimness of the economic picture for 2009. The answer provided so far by the G20 Heads of Government is that “no market segment, no territory, and no financial institution should escape proportionate and adequate regulation or at least oversight”. Self-regulation by the financial system has been seen to fail but public regulation has fared no better. Will more of the same ensure that such a crisis does not recur?

Perhaps the key will be found in the governance arrangements that must align the long-term interests of the individual employee, the corporation and the public good. But the stick in such arrangement probably lies in the ease with which a defective corporation can be compelled to exit the market – together with those employees who brought about the problem. A multitude of smaller, actively competing players is more likely to produce this discipline than a series of behemoths that are believed to be too big to fail. The thoughtful reviews scheduled by the Commission for the period after the current rush of legislation should provide the breathing space to consider different models.

The legislative rush is certainly visible as one glances at the up-dated roadmap from the Dec 2 ECOFIN meeting. The immediate focus is on preparing positions for the next G20 meeting set for April 2. The report from the de Larosiere group at the end of February will be an important step towards proposing solutions to the EU’s supervisory difficulties. Already proposals are multiplying but the concept of a European System of Financial Supervisors seems to be gaining traction. CEPS published a study that laid out a possible mechanism for this and EP President Pottering’s speech to the European Council also seemed to envisage something akin to the European System of Central Banks.

But any such schemes are likely to meet a fundamental difficulty: a significant transfer of powers to the EU level would require a change in the Treaty, and the appetite for further changes is minimal. The December meeting of the European Council attempted to deal with the problem of Ireland’s rejection by offering a series of categorical assurances on all the points that were thought to have precipitated the No vote in the Referendum. If this is all done, then the Irish Government has committed itself to seeking ratification by the end of this Commission’s term of office – October 2009. That leaves open several tricky issues as the Treaty of Lisbon would change the number of Commissioners and Members of the European Parliament.

Yet this will not be known when the EP elections take place in June and the Commissioners are selected. Most importantly, the new President of the Commission will be selected immediately after those elections from within the “political family” of the largest party then in the new Parliament. For the first time, the combination of a planned withdrawal by the British Conservatives from the centre-right EPP and the possibility of an electoral backlash against governing parties in the Member States could make the Socialist Party the largest group. A Socialist President would then look to the Member States to propose like-minded Commissioners.

Such a set of developments would represent an earthquake in the regulation of financial services in the EU, as the new Commission would be shaping the regulatory framework that must evolve after the catastrophic failures of private and public regulation witnessed in 2008.

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Graham Bishop
 

© Graham Bishop