Financial reform efforts pit US against Europe

NEW YORK – U.S. policymakers are struggling to agree on new rules to avoid another financial crisis.

A global consensus? Even harder.

Efforts are raging on three continents, with at least as many ideas about the proper fixes. Unless the U.S., Europe and Asia adopt uniformly strict regulations, banks and high-risk traders will shift operations wherever rules are loosest. Experts warn another crisis could follow.

The global proposals are clashing on several levels. Among the differences:

• The Obama administration wants to restrict banks' size and ability to take risk. European officials have called that plan unworkable in a region with roughly 40 cross-border banks.

• European Union officials want to crack down on financial derivatives, which they blame for worsening Europe's debt crisis. Derivatives are instruments whose value depends on underlying assets, such as mortgages or currencies. U.S. regulators favor making derivatives trading more transparent. But they've resisted calls to restrict it.

• In Asia, Chinese regulators are forcing banks to set aside more reserves to prevent a U.S.-style credit binge. And India has maintained rules that were already stricter than many in the West.

A report last week on Lehman Brothers' 2008 collapse reminded the world of the matter's urgency. The report said regulators missed Lehman's accounting tricks, which made the firm appear stronger than it was. Lehman's bankruptcy, the biggest in U.S. corporate history, shocked global markets and triggered the $700 billion financial bailout.

But 18 months later, no deal on stricter rules is in sight — domestically or globally. Senate Banking Committee Chairman Christopher Dodd proposed his own bill Monday — without Republican support. And the U.S. and Europe seem far apart on such issues as how to oversee bank accounts and mortgages and whether banks can do proprietary trading. That's when they use their own money to make high-risk bets. If those bets go bad and a bank goes under, taxpayers could be on the hook.

The Lehman disaster underscores the "enormous imperative" to tighten international rules, said Kenneth Rogoff, a Harvard professor and former chief economist of the International Monetary Fund. Yet he doubts countries can agree.

"You're dealing with different accounting standards, different political systems and different banking systems," Rogoff said. "It will be very hard to create one-size-fits-all regulations."

A lobbying blitz by Wall Street banks has helped drive the sides apart. Banks argue that some U.S. proposals would give overseas rivals an unfair edge. Especially in their sights is a proposed Consumer Financial Protection Agency to oversee consumer products.

The House and Senate plans would create a council to monitor threats to the financial system. Both would also set a "resolution authority" to close large failing firms. But key differences remain. One involves the proposed consumer agency. The House favors a freestanding agency; the Dodd bill would place it inside the Federal Reserve.

Europe is weighing some similar reforms. The economic bloc would create three authorities: to govern banking, insurance and markets in all 27 member nations. A watchdog would monitor financial stability. It would also look for any financial-asset bubbles or banks embracing too much risk.

But trans-Atlantic discord is flaring. The Obama administration wants to bar the biggest banks from using their own money to make high-risk bets. It would also limit the size of banks.

The European Union has rejected that plan. In Europe, banks already have been getting smaller. Regulators insisted they shrink to compensate for government aid.

"Trying to apply sweeping rules about the structure, content and range of activities of banking entities is too difficult," British Business Secretary Peter Mandelson said this month.

In addition, European officials have threatened to restrict trading of certain derivatives linked to government debt, called "naked" credit default swaps. Naked swaps are a type of insurance in which investors don't actually hold the insured bonds. European officials argue the swaps have worsened Europe's crisis by magnifying bets that Greece and other indebted nations will default.

Many experts disagree. They say ballooning deficits — not derivatives — have weakened confidence in Greece and other EU nations.

Still, EU officials want the U.S. to help crack down on those swaps. The House and Senate bills would likely require most derivatives trades to go through clearinghouses to make them more transparent. But they wouldn't limit their use.

Another conflict is over hedge funds, which are lightly regulated private investment vehicles. Treasury Secretary Timothy Geithner has voiced concern that disclosure rules that Europe is weighing could block U.S. hedge funds and private equity firms from Europe's market.

EU proposals would likely require big funds operating in Europe to regularly disclose their trades and risk exposure. The idea is to prove they don't threaten the financial system.

By contrast, the Senate bill would require only that big hedge funds pay into a resolution fund to pay for dismantling failing firms.

Andrew Busch, a global strategist at BMO Capital Markets, warns that firms would exploit any differences in countries' rules. Risky activities banned in one country could shift to another with friendlier rules.

"You would invite regulatory shopping — really, country shopping," Busch said. "It's as easy as flipping a switch."

Even the banking industry acknowledges the risk.

"You could have a race to the bottom to those countries and jurisdictions that have weaker protections," said Scott Talbott, chief lobbyist for the Financial Services Roundtable, which includes the largest banks.

The banks argue that the U.S. effort risks stifling financial activity and are fighting elements of it.

"There has to be a balance in how you regulate, or you make banks less competitive," Talbott said.

For a model on how to tighten rules, U.S. and European officials may look East. Asia's banks were relatively unscathed by the West's crisis. In part, that was because China wasn't deeply integrated into the global system. In other cases such as India, regulation was already stricter than in the West.

Some Asian countries have further intensified efforts to reduce risk. Chinese regulators in 2008 required banks to hold more reserves to guard against loan failures.

In addition, China wants to increase oversight of banks that were ordered to boost lending last year to back Beijing's stimulus.

"We used to learn from Western developed countries, but later we found their systems had problems, so we'll have to amend our system and hope it will develop in a healthy and steady way," said Wei Tao, an analyst for China Securities Research.

Gary Gensler, head of the U.S. Commodity Futures Trading Commission, has struck an optimistic note about a global accord on derivatives. He said last week that U.S. authorities are "working well" with overseas regulators.

Others say some disagreement is helpful. Banking analyst Bert Ely said a diversity of regulations can point to flaws in a country's rules and to better solutions elsewhere.

"If everyone adopts the same rules and we're wrong, then we all go running off the cliff together when the next crisis hits," Ely said.