Thursday, 25 March 2010

Obama’s health reform success hands global financial regulation to Europe

And now onto financial regulation? Europe is poised to win from stalemate of the US Senate.

The fallout from the success of the US health care reform bill might just determine the fate of the emerging global regulation. The Volcker-Obama-Dodd initiative will never see daylight as a law without all the teeth are pulled out: the Republican’s strategy of obstruction makes any meaningful financial reform rather unlikely. The consequences for the global capital markets may be far reaching.

First, obviously, the US market staying relatively regulation loose will make the domestic banking sector super-profitable again. Score one for the US.

Second, this will also turn the battle over the emerging global financial regulation to a European victory. Score one hundred for Brussels.

The reality is that there is no truly global regulatory framework emerging: the much promised intergovernmental cooperation towards creating such an umbrella is all but dead. The only two initiatives that have any chance of manifestation are that of the EU, and that of the US. Clearly, you cannot have global financial regulation without these two. More importantly, if the US and EU settled on a solution, that would be it. In practice that would be the global framework from its first hour.

The battle over the regulation dominance between Brussels and Washington has its core at radically different approaches to the problem. In philosophy, in ideology, in fundemantal beliefs about the role of economy in the society.

(Onegin and Lensky's Duel by I.Y. Repin. Pushkin Museum, St. Petersburg)

US. The US is pushing for a market self-regulation, where the authorities’ job is to ensure that the self-management works. This solution is rooted in the belief that market solutions tend to outperform bureaucratic rules, and while there clearly were market failures in the crisis, these were due to the information bottle-necks, rather than anything inherent in the system. Thus most elements of a would-be US solution are aimed either at increasing transparency or enhancing market competition.

EU. The European approach is the opposite. The solution pushed by Brussels is based on the belief that markets, and financial markets especially, tend to yield socially suboptimal outcomes whatever the transparency is, whatever the market structure is. The assumption or observation (depending on which side of the debate you are) is that self-regulated financial markets will reduce the systemic risks for the sector given the systemic buffers of the rest of the economy. Hence, the self-managed banking sector will always be too risky, and it is the job of the government to manage the market directly.

As a consequence of the opposing philosophies, although many of the elements of the two alternative would-be global reform approaches are similar, the devilish details are radically different.

The early row between the two regulators (some of it played as a proxy fight between the City of London and the Brussels bureaucracy) led to a regional limitations: if we can't agree, no problem, we will just focus on European / American only regulation. For what is better than an isolationist solution right after what was the first truly global financial crisis...

Yet, separate rule may work for local banks. However, for global ones -- if the past is any guidance here -- it will not. Historically, there have been areas where international behaviour of financial companies has been regulated differently in the EU and the US: the prohibition of bribery of foreign officials was one, for instance. Surprisingly, the US laws have been stronger than that of the EU in this area. If you were a Europe-only player, then you’d have to abide by the weaker regulations only. But, if you wanted to be international, there was no other way than follow the rules of the stronger US rule. It is unlikely to be different in the case of upcoming financial regulation reform: local US financial companies will operate within the weaker US framework, but one with global presence will have to follow the toughening EU rules. (If you want to know what this feels like, just ask Microsoft...)

The extent to which Obama will be able to achieve anything in terms of financial regulation in the coming months will determine where the balance between the European and US regulation will end up. Despite all the sovereign-will-always-dominate-the-global speak, the local politics and institutional constraints of two regulatory superpowers have become global politics global and constraints.

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