Paris: Banks, bonuses, tax havens and under-regulation caused the financial crisis and are the keys to reform. Not so, the OECD warns as the G20 takes steps in such areas.
Compromises on action to deal with symptoms, such as bonuses, rather than action on real causes could even end up doing more harm than good, the OECD said in a report and remarks to an agency.
The Organisation for Economic Cooperation and Development says that progress on new rules to strengthen the capital base of finance companies and related regulations does go in the right direction.
But, in the words of the author of the report, Adrian Blundell-Wignall, much of the focus in other areas, such as on bonuses, tackles "symptoms instead of causes" and "puts the cart before the horse."
Instead the focus should be on matters which are scarcely being discussed. Among these issues are:
- Preventing the spread of failure, or "contagion", by erecting "firewalls" within financial companies;
- Requiring the company risk manager to be on the main board with freedom to speak out without fear of the chief executive. This would ensure that boards were fully informed, and would focus more on the interests of shareholders rather than on their own incentive pay;
- Ensuring that directors of financial companies are competent and understand their business, instead of meeting a requirement merely to have no criminal convictions as is the practice now;
- And reforming national tax regimes in leading countries. This is because onshore tax incentives encourage the legal use of offshore entities and complex instruments to take best advantage of onshore tax allowances.
The Organisation for Economic Cooperation and Development is a policy forum for the 30 leading industrialised economies, and participated in the G20 talks on reform of the global system.
The report said: "A widely held myth about the current crisis is that it has occurred in a regulatory vacuum."
Although deregulation had been a factor, the crisis broke "within an overall framework of complex rules" and supervision.
Regulatory arrangements should be updated and streamlined, the report argued.
On bank bonuses, Blundell-Wignall said: "Excessive bonuses come out of excessive profits from excessive risk-taking.
"If you just cap bonuses without dealing with excessive risk, the problem is not solved. If you get the corporate rules, structures and governance right, you will deal with the bonuses.
"Governments have no place sitting in the boardrooms setting wages."
The report argued that if boardrooms came under increased pressure to work for shareholders, the budgets for bonuses would be contained. A pivotal step would be to free the chief risk officer from fear of sanction by the chief executive.
"If the chief executive loses direct control of high risk activities because of firewalls, and if the risk officer has to be a director reporting to the chairman and board, the balance of power and risk-taking changes. This is the key," Blundell-Wignall said.
He said another central issue was the spread of damage when a financial entity in a group failed. "The concept of contagion of risk is about the structure of companies, but it isn`t being addressed," he warned.
Blundell-Wignall, who is deputy director of finance and enterprise affairs at the OECD, told an agency that the causes of the crisis lay with policymakers in many fields and in many countries.
"At the root of all this is public policy," he said. "On the macro economic side, the global problem lies at the door of misaligned exchange rates.
"This is not a US or European policy matter. They have no control of this. It is mainly driven from Asia, the Midddle East and parts of Latin America where they have pegged their currencies to the dollar."
The report "Reform and exit strategies" implies that the main causes of the global crisis were borrowing by governments and unduly low interest rates by central banks.
Official distortion of exchange rates then prevented markets from absorbing the global trade and savings imbalances which resulted.
In the West, a social bias towards "easy money policies" led to "excess liquidity, asset bubbles and leverage."
The report says: "The reform of global exchange rate regimes and the dollar reserve currency problem is extremely important, but is also unlikely to be achieved any time soon."
On the fuse that blew, the US subprime home-loan market, Blundell-Wignall said the system became overloaded because of a coincidence of events in 2004.
Among these were a decision by the US financial watchdog, the SEC, to allow financial companies to pool their businesses, thereby removing walls between risk activities.
The SEC did so partly to comply with European rules which had permitted such arrangements for years.
Another was the so-called "American dream" vote by Congress to push out zero asset-backed home loans to low income households. "Banks respond to the signals they are given," he said.
The OECD report points to the risk that mortgage tax relief, of the type associated with subprime loans, could result in households falling into excessive debt.
Another main cause of the crisis, given little or no public attention, was national tax systems in leading economies. These unduly favour corporate risk and debt leverage and were the main force behind much-criticised structured financial instruments.
But the issue of domestic tax reform "needs to be on the long-run agenda," Blundell-Wignall said.
The focus on bonuses "misses the point," he warned.
And three more factors in the crisis were a degree of incompetence in bank boardrooms, the pooling of businesses within financial groups which ensured contagion if part of the group collapsed, and unduly complex or overlapping rules and supervision.
In view of these causes, Blundell-Wignall said: "By partly fixing symptoms, for example by just focusing on pay caps, you may do more damage."