RE-REGULATING FINANCE IN THE LIGHT OF THE GLOBAL CRISIS Tsinghua University Beijing, China.

1. RE-REGULATING FINANCE IN THE LIGHT OF THE GLOBAL CRISIS Tsinghua University Beijing, China. 9-11,2009 Leonardo Burlamaqui l.burlamaqui@fordfound.org

2. A SUGGESTED DEPARTURE POINT “Public institutions need to be the vehicles by which leaders take public responsibility for the public interest. Otherwise, markets determine the public interest, which manifestly does not work, especially in finance”

3. SOME OLD ADVICE “In finance, everything that is agreeable is unsound, and everything that is sound is disagreeable”(W. Churchill, 1926) “When the capital development of a country becomes a byproduct of the activities of a casino, the job is likely to be ill done” ( J.M.Keynes, 1936)

4. SOME SCARY NEWS “I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.” (A. Greenspan – Congressional testimony, October 2008)

5. EVEN MORE SCARY …. I’ve never seen financial insiders this spooked — not even during the Asian crisis of 1997-98, when economic dominoes seemed to be falling all around the world. This time, market players seem truly horrified — because they’ve suddenly realized that they don’t understand the complex financial system they created.” ( Krugman: December 2007)

6. AWINDOW OF OPPORTUNITY FOR GETTING ECONOMICS RIGHT ? ( AND, THEREFORE, A BETTER ROADMAP TO FIX THE ECONOMY) “To a remarkable extent we have got into the current economic and financial crisis because of a wrong economic theory – an economic theory that itself denied the role of the animal spirits in getting us into manias and panics.” ( R. Shiller: March 2009)

7. Pressing Questions on the Crisis: • First, despite some agreement on the proximate determinants of the crisis, there is substantial divergence of opinion on “root” causes, in particular the role of post-liberalization changes in regulatory structures in creating the environment that led up to the crisis • Second, there is disagreement on the appropriate set of policies — injecting liquidity, recapitalizing or nationalizing banks, the size and shape of the fiscal stimulus packages (for example) — that would prevent the transition from a recession to depression and trigger a recovery. • Third, while there is a consensus that changes in the regulatory structure that governs finance are needed nationally and globally, with the concomitant creation of a new global financial architecture, the specific nature of these changes are hotly contested issues.

8. Pressing Questions on the Crisis: • Fourth, while the gap between the global nature of financial markets and the national character of regulation is acknowledged everywhere, the institutional framework needed to fill that gap is mostly terra incognita. • Fifth, although there is huge consensus on the urgent necessity for a radical change in the incentive system inbuilt in financial compensation packages, there is very little discussion on what incentives should be in place on the regulator’s side of the equation (e.g. What are the essential measures to enable effective regulatorsonce we have effective regulation ?).

9. Taking a Step Back:

10. What’s wrong with the Global Governance System ? • It’s undemocratic: • Global Governance organizations lack the political legitimacy that is produced by the participation of all interested political and economic actors. • Their decisions not only reflect the preferences of a few rich nation states, but a highly skewed subset of the interests within those states. This further erodes their legitimacy and efficacy.

11. What’s wrong with the Global Financial Governance System ? • It’s ineffective: • It evolved from a productive orientation towards an exclusively speculative configuration. • More concretely: now we have…. • An extremely opaque, unregulated and unaccountable system that is completely unfit for the task of bringing financial stability for both North and South . • Afinancial system that has lost, almost completely, the basic objective of financing productive investments.

12. Maps and Facts:

13. The Global Financial System: Burlamaqui Multilateral and Public DC and Geneva Multilateral and Public Asia, Russia, Middle East and Latin America BIS (G7 Central Banks) SEC FED BRICS Reg Dev Banks SWFs IMF OECD European Central Bank WB WTO EUROPE Chang Mai Init South Bank National Fin Reg Agencies FSF Fin Stability Forum IAIS Int Ass of Insurance Supervisors GATS Credit Rating Agencies Toxic finance at its best: Global markets for derivatives: UNREGULATED Note: world GDP ~ 42 trillion IOSCO Int Org of Sec Comm. IASC Int Acc Standards Board WFE World Fed of Exchanges IFAC Int Fed of Accountants Insurance Companies LAW FIRMS Banking System ACC FIRMS Export Credit Agencies Credit card Companies Bilateral Investment Treaties Int. Arbitration Tribunals Fiscal Shelters Mortgage Funds Hedge and Private Equity Funds Pension Funds RMBS SIVs COUNTRIES & NATIONAL STATES Global Corporations GLOBAL PRIVATE

14. Governance Failure (1) Financial Regulation in the US: A Very Inefficient Maze Commercial banks Thrifts Industrial Loan Companies Bank Holding Companies Securities and Exchange Insurance Credit Unions Futures

15. GOVERNANCE FAILURE (2): “MARKET DISCIPLINE” AND RENT-SEEKING IN FINANCE CAPABILITIES REQUIRED: Unique knowledge of business firms competences; strategies and of their competitive ecology Creative destruction Financial innovation financing productive Investment Long-term Funding & Venture Capital DEVELOPMENT/ Structural Change Schumpeterian RETURNS HedgeFunds, Securitization & Leverage PONZI CAPITALISM Financial innovation financing speculation Sorosian CAPABILITIES REQUIRED: Knowledge about the regulatory/legal loopholes and how to structurebetson the formation & evolution of prices in currency & securities markets Destructive creation

16. To bring the financial system back from its current “rent-seeking” configuration to a “productive” fit. What has to be done ?

17. The answer to that question, I leave to you all to figure out in the next three days…Thank you. HOW ?