U.S. Proposal to Extend Financial Regulation Breaks New Ground
| Author | IMF Survey |
"In one sense, the task is to catch up with three decades of financial innovation," said the IMF on July 31 in a paper issued as part of the Fund's annual review of the U.S. economy, known as an Article IV consultation, which is the annual assessment process for the IMF's 186 member countries.
Other issues covered in the report include potential growth after the crisis, fiscal risks, and the effects of debt issuance on emerging markets.
The reforms are part of the U.S. plan to monitor risks across the financial system, which emerged as a critical regulatory gap in the current economic crisis; evident first in the U.S. subprime mortgage market in mid-2007.
"Systemic risk and the moral hazard it creates are economic spillovers, like pollution," said Charles Kramer, chief of the IMF's North American Division. "Environmental policy addresses pollution by regulating it and financial policy should do the same with systemic risk."
Prior to the global economic crisis, U.S. regulatory philosophy was focused on the "core" institutions, especially traditional banks and their holding companies. Despite these measures, the lack of rules and authority to resolve a failing non-bank institution, such as Lehman Brothers, in part contributed to the catastrophic nature of its failure.
The change in approach proposed by the United States would introduce a new category of financial firm, called a Tier I Financial Holding Company (FHC), which would come under group supervision by the Federal Reserve. A firm's designation would be made based on size, leverage, and its interconnectedness in the financial system, to be set out in legislation. The firms would be subject to higher capital and risk management standards, as well as a special wind-down mechanism in case a firm fails.
Acknowledging that a primary cause of the crisis was lax financial regulation in the United States, the IMF said in its paper that a major test for financial reform will be to force systemically critical firms to control risk taking and moral hazard, and strengthen crisis management.
Observers said the IMF did a good job laying out the main issues that need to be addressed, but questions remain.
"How do you go about internalizing risk?" said Michael Mussa, a senior fellow with the Peterson Institute for International Economics, a think tank in Washington, D.C. "That's a...
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