By Michael Pomerleano

I was in Chicago last week to participate in the 12th Annual International Banking Conference sponsored by the Federal Reserve Bank of Chicago and the World Bank. The answer to the question posed — have the rules of the global financial game really changed? — is a resounding no.

This was my first week back in the US after being away for three years, and the conference gave me an opportunity to gauge the state of the debate there. Compared to my two years at the Bank of International Settlements in Basel and my year at the Bank of Israel, the openness of the debate and the quality of the discussions in Chicago were refreshing. However, in the US — the epicentre of the crisis and the country that is supposed to lead the world toward reform and out of the crisis — I expected a far more forceful articulation of remedial measures.

Considering the number of luminaries attending — Christina Romer, head of the Council of Economic Advisers, and Kevin Warsh, a member of the board of governors of the Federal Reserve System, among others — I expected to find a strong shared sense of direction and a determination to take the correct steps following the financial carnage. I did not.

First and foremost, it was striking and disappointing to realise that there is still debate in the US over what happened, what was accomplished, and what needs to be done. US policymakers and economists are still debating the causes of the crisis and trying to defend the old ways and means of achieving bank safety and soundness. Christina Romer and Governor Warsh each offered a cheerful view of what the Obama administration and the Federal Reserve have accomplished.

Second, while there were calls for “reform” of regulation, policymakers did not offer any advanced thinking about bank safety and soundness. The current Basel II framework is a bad joke, but the official community is determined to salvage it for reasons of reputation, proposing to “refine” once again the Basel II Accord to address capital and liquidity.

Foreign participants free of official shackles or self-imposed loyalties to past institutional affiliations were  forthright. Andrew Sheng of the China Banking Regulatory Commission reproached us for thinking that throwing debt at a global problem of insolvency will succeed. He presented striking data. The subprime losses of $150 billion in 2007 required US government aid of $13.2 trillion as of 19 June 2009. In 2008, salaries of the top 10 banks reached $75 billion (up from $31 billion in 1999), while cash dividends to shareholders were only $17.5 billion. Management took 4.3 times more than shareholders at a time when shareholders were injecting capital and government was guaranteeing deposits. He pointed to the critical principal-agent fiduciary problem. Essentially, financial sector losses will be paid for by future taxation (large fiscal debt) or inflation. To this I add that the US Treasury “stress tests” led to an injection of roughly $67 billion in 2009. This year alone, the committed bonuses are more than $75 billion.

Charles Goodhart of the London School of Economics provided a sobering reminder about the situation facing global banks and regulators: “The outcome of current [international] efforts to re-regulate remains obscure. The most likely outcome will be a generalised introduction of a leverage ratio, adjustable at local discretion, the promulgation of some form of [internationally agreed] liquidity ratio, and a tightening of capital adequacy requirements, though whether with, or without, countercyclical characteristics remains to be seen.”

In the most recent issue of the Institutional Risk Analyst, Chris Whalen reminds us that while governments in the EU may think they have thoroughly regulated their markets, bad acts still flourish in public sector banks. In Germany, for example, a recently-elected coalition plans to make the Bundesbank the sole bank regulator, providing access to off-balance-sheet guarantees and ensuring that the government will not need to restrict spending to deal with the banking crisis. In other words, the official sector is creating its own version of a “shadow banking system”.

Francesco Papadia of the European Central Bank observed at the conference that in Europe there is no debate about the ECB. I can only conclude that both the EU and the US are tolerant, naïve societies prepared to accept the loss of our future to regulators and financiers. Sadly, the indifferent attitude in Europe and the debate in the US are leading to a path of no reform, and the financial system will game the taxpayer again.

The rules of the global financial game have not really changed. By the end of the year, the US federal government will stand behind 59 per cent of the mortgage market, and the Big Bad Bear of huge and growing federal debt driven by the guarantees and entitlement programs will loom large. This is a large source of instability and shows why another crash is all too possible. Basically, “Plus ça change, plus c’est la même chose”.

Michael Pomerleano has worked at the Bank of International Settlements and at the Bank of Israel. He returns to work at the World Bank next month.

September 30, 2009 4:20pm in Banks, Crisis, Economics, Eurozone, Recession, Regulation | Comment