Wednesday, March 11, 2009

G20 to Develop Early Warning System

If someone had told me all the banks in the UK would be owned by the government only 6 months ago, I would have laughed really loud….a long-term corporate strategic planning tool is becoming mainstream for world’s governments to establish early warning systems to spot new disasters before it is too late.  An interesting article from today’s FT is as follows:

“Why did no one see this coming?” is the $50,000bn dollar question about the global financial crisis asked by more or less everyone – perhaps the most celebrated inquisitor being Queen Elizabeth of England during a visit to the London School of Economics late last year.

As policymakers from the Group of 20 leading developed and emerging economies struggle to combat the immediate effects of the crisis with fiscal stimulus packages and financial bail-outs, their forthcoming summit will also look at designing early warning systems to spot new disasters.

The problem, experts warn, is that, like much of the G20’s agenda, it is a question of implementation rather than technical improvement. It is not just that any attempt to design such a system inevitably misses crises that do happen and falsely predicts crises that do not, but that policymakers tend either to ignore such warnings or try to suppress them so they are not made public.

Early warning systems used by institutions such as the International Monetary Fund are focused at national level on individual emerging markets and generally look at current account deficits, large public debts and currency mismatches – government and the private sector borrowing abroad heavily in a foreign currency – particularly for countries committed to defending a fixed exchange rate. But for a crisis centred in the US, which ran a large deficit but had a floating currency and relatively low public debt and borrowed in dollars, it was not so straightforward.

“Too many people, including the IMF, bought into the idea that securitising debt had made the US financial system robust,” says Morris Goldstein, senior fellow at the Peterson Institute in Washington. “This was a different kind of crisis.”

Gordon Brown, the UK prime minister, has been talking about early warning systems for about a decade and has recently said such mechanisms could have prevented the crisis. But officials from other countries and from financial institutions say he never gave details of what he meant.

Brad Setser, a former US Treasury and IMF official now at the Council on Foreign Relations, says the UK’s financial service industry itself acted as a huge conduit for dollar-denominated borrowing – unlike the US, which maintains detailed data on capital flows. Mr Setser says it was not clear until afterwards just how much dollar debt was being funnelled through London via the so-called “shadow banking system” outside the reach of regulation.

“Given how much trouble has emerged from the shadows, a bit more transparency about what goes on in the UK might have helped the world’s regulators (and the IMF) do a better job of providing a bit more early warning of budding problems,” he recently wrote.

What will emerge from the G20 is likely to be a less than cataclysmic shift. Institutions such as the IMF and the Bank for International Settlements, the central bankers’ central bank, will step up their co-ordination with each other and aim to produce reports of potential flashpoints in the whole system as well as individual countries.

What they do with the results remains an open question. Publishing them – or even giving them to the IMF’s executive board, from which they could leak – could invite runs on the currency or debt of countries identified as being at risk. Reza Moghadam, head of the IMF’s strategy, policy and review department, says: “We need to combine country risk with cross-cutting risk and think carefully about with whom these analyses are shared.”

IMF officials say they were subjected to repeated attempts by many governments – in particular the UK, when Mr Brown was chancellor of the exchequer – to tone down warnings about instability in individual countries. Mr Goldstein recalls the enormous pressure he was put under to keep quiet about problems in the Japanese banking system in the 1990s. “Fundamentally, early warning systems come down to being willing to make the call in public,” he says. “It is about balls as much as brains.”

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