David Wright talks about repairing the financial system and the consequences of failure
“It is hard to imagine any other event, except for war, that could have caused more economic damage”. It was with these words that David Wright, former Deputy Director General, Internal Markets at the European Commission, described the recent financial crisis.
David Wright was guest speaker at the 11th monthly finance lunch organised by the Luxembourg based Institute for Global Financial Integrity (TIGFI). No fewer than 7 ambassadors were present, alongside TIGFI president Jacques Santer, to hear David Wright tackle the theme: “Repairing the global financial system: are we are on track? If not, what are the consequences of failure?”
Fired by the liberty of his new position as Visiting Fellow of St Antony’s College, Oxford, David Wright gave a forthright speech that left few market participants with somewhere to hide and suggested clear priorities for the future.
Where we are now
David Wright began by declaring that simultaneous failure at all three levels: regulatory, supervisory and within firms themselves, had caused “near meltdown” with no fewer than 200 state aid cases. The rescue bill amounted to a total of EUR 4.6 trillion in direct aid and guarantees, or 10-15% of GDP for a sector that adds only 8% of value to the economy. He spoke of “utter failure of risk management in major firms”, lack of regulation (of derivatives and OTC markets, rating firms and the whole shadow banking system) or unsuitable regulation (capitalisation rules) and failures in supervision: the “light touch” method had failed, and available sanctions had proven themselves to be inadequate to force behavioural change.
At a philosophical level, the interventionist view of financial regulation is gaining popularity. Within the EU, three new supervisory authorities have been set up alongside a Systemic Risk Board chaired by the ECB governor. In the US, the supervisory system has collapsed and remains highly fragmented – a fault line that contributed to the fatal lack of “early warnings”. This provides an opportunity to create a new system.
2011 is the critical year
In David Wright’s view, 2011 is a critical year. The new global Financial Stability Board, a product of the G20, will start monitoring global systemic risk. Will we succeed in bringing about convergence of capital market rules or will regulatory arbitrage get worse? Can we reach a position where any financial institution, however large, can be wound up before bringing in public money? Will the US adopt international auditing standards? This sort of bold reform can only come from the politicians.
“There is no alternative to the convergence of rules” believes this experienced European. “It is the best we can hope for.”
Will the European Systemic Risk Board dare to rock the boat?
“The best brains in the world did not understand the connectivity of the markets” observes David Wright. The ESRB must have data and must understand it. He compares the situation to a nuclear power station: without transparency, risk management is impossible. “The ESRB must rock the boat and its warnings must be acted upon”. Companies will listen, he believes, because of the composition of the Board.
What are the consequences of failure?
What if global convergence fails? From a political point of view, David Wright says, the statements made by political leaders will be shown up as empty. And success is not guaranteed: “The BRIC countries may choose not to follow, on the grounds that they did not cause the mess”.
Long term, the consequences of failure are “very serious indeed” he concludes, adding the resonant warning: “It is hard to imagine any other event, except for war, that could have caused more economic damage. People have been incredibly tolerant this time round. If it happens again, there will be riots in the streets. It could signal the end of capitalism.”