Out of Bretton Woods

With much of the world — at least apart from French President Sarkozy — presenting a united front at the World Financial Summit in Washington, D.C. in mid-November 2008, the big question now is what concrete steps toward an international financial regulatory system will be taken in time for the next meeting in late April 2008.

Amidst a continuing global financial and economic crisis, the issue of real follow-through matters a great deal.

Without such steps, the United States will hardly be the last country in the world to impose huge costs on its partners by allowing excessive risk-taking in its own market. And yet the United States could be the one to break the deal.

The Bush Administration, for its part, expressed strong doubts about an international regulatory regime.

While that seems to be in line with its long-term philosophy, it would be naïve of other participants to hope that the arrival of an Obama Administration will change everything or make America cooperative for the pure sake of being cooperative.

Indeed, even setting aside its ideological concerns, the Bush Administration has reason to be skeptical about international regulatory and institutional solutions to the challenges posed by new-to-world risks.

Looking ahead, there are nevertheless two good reasons for the United States to say more than "no" to the Europeans. First, the United States needs to offer Europe something in exchange for European help avoiding a deep and dangerous economic slump.

And second, the United States must avoid the appearance of close-mindedness as the world's traders and producers decide where they are going to take their future business.

Perhaps the most effective solution for the new administration would be for the United States to propose an international regulatory peer review process — one that would let countries shape their own regulatory systems, while strongly encouraging continuous improvement.

Instead of relying on international legal sanctions, such a process might take advantage of the wisdom of "crowds" (crowds, that is, of national regulators) — as well as the power of shame.

Suppose the financial regulators of every major trading nation met several times a year at a supervisory summit. The main order of business would be voting on criticisms that any national regulator or group of regulators leveled against the rules or procedures of another national regulator.
If an appropriate super-majority of regulators agreed with the criticism, the summit would publish it.

No further action would be needed — international market participants would be on notice to protect their balance sheets from the identified regulatory or governance weakness. They might even avoid doing business with counterparties from the criticized country — until it took steps to meet the criticism.

Viewed in that light, a U.S. step toward international financial regulatory coordination must be considered a universally attractive step to take.

The idea of peer review involves no new system of international law, no new multilateral institutions and no sacrifice of sovereignty — a problem for conservatives everywhere, not just in America.

What it does involve is ongoing multilateral criticism of financial regulatory rules and procedures that may deserve it. No one has a monopoly on wisdom — and an international regulatory peer review system puts that plain truth in practice.

Ultimately, financial markets depend on confidence. And confidence depends on evidence that market authorities are pragmatic.

Refusal by U.S. authorities to take any steps toward meaningful financial regulatory coordination could seriously erode confidence in U.S. economic and financial markets.

Such an erosion of confidence got under way with the collapse of Enron — and required all the rigors and cost of the Sarbanes-Oxley law's new system of financial controls to be stopped.

Saying "no" would put U.S. authorities in the un-pragmatic position of seeming to believe they know everything about the regulation of markets continually evolving in ways that are, in fact, unknowable. Regulators must change with innovation or either the regulation or the innovation will seriously disappoint us.

Chinese producers and Brazilian financiers know this. A little flexibility will show that the United States knows it, too.