March 30, 2009
Raymond Baker
This article was originally published in the Diplomatic Courier.
Increasing transparency has become an uncertain element in the laundry list of reforms, regulations, agreements, and actions expected to be discussed when the G20 meets this week. Of the original three solutions proposed to be addressed by the G20 process: stimulus, regulation, and transparency, it is the first two: stimulus and regulation, which have emerged as dominant themes for Thursday’s meeting. This is a critical misstep as transparency represents the most reasonable and effective means for strengthening and revitalizing the global financial system.
The communiqué following the November 15th meeting of the G20 in Washington was bold and comprehensive, with “strengthening transparency and accountability” well argued and placed ahead of “enhancing sound regulation.” But transparency did not appear in the elements paper preceding the April 2nd meeting in London. Nor did it appear in U.S. Treasury Secretary Timothy Geithner’s statement following the March 14th finance ministers meeting in Horsham. And it appeared only glancingly—“transparency of exposures to off-balance sheet vehicles”—in the general communiqué following that meeting.
Improved regulation of global finance is certainly included in the elements paper and the finance ministers’ statement—regulation of banks, rating agencies, financial instruments, cross-border activities, etc. However, regulation is couched within the overriding aim of returning to stability in financial operations. Does “stability” mean getting back to the status quo ante before the crisis, i.e., retaining central elements of the shadow financial structure that permeates global economic activity?
Current emphasis is on strengthening regulation within the existing structure rather than requiring transparency to alter the structure. This is misguided. Tweaking of controls applied to financial institutions and multinational corporations or more intrusive oversight by authorities cannot work effectively in the current structure of secrecy and opacity that characterizes our global economic system. Transparency on the other hand is much more difficult to circumvent, as it gives multiple players—citizens, investors, watchdog groups, and authorities—access to information and opportunity to react to improprieties. UK Prime Minister Gordon Brown, host of the G20 meeting, said before the U.S. Congress as well as on other occasions that the shadow banking system must be curbed. Yet there is reason to worry that this may not happen.
Transparency, not tinkering around the regulatory edges of existing arrangements, can rein in the shadow financial system. An elaborate and integrated fabrication growing exponentially over the last 30 years, this system comprises tax havens, now more than 90 across the globe; secrecy jurisdictions where nominees and trustees can front for activities of unknown beneficial owners; disguised corporations numbering in the millions; “flee” clauses enabling such disguised entities to relocate quickly from one secrecy jurisdiction to another; anonymous trust accounts; and fake foundations. The most frequently used mechanism for shifting money through these channels is falsified pricing in international exports and imports of goods and services, that is, abusive transfer pricing in multinational corporations and manipulated pricing in arms-length transactions. Some estimates suggest that perhaps half of global trade and capital movements pass through this framework somewhere between initiation and completion.
This shadow financial edifice lies at the heart of the global economic crisis, hiding much of the enormous accumulation of bad paper held by banks, hedge funds, and other collective investment schemes and obfuscated in credit default swaps, derivatives contracts, and sliced up packages of subprime mortgages. Interbank lending has dried up because banks don’t know the quality of assets in potential borrowers’ and even their own portfolios. Witness AIG on its fourth and Citibank on its third rescue effort, with unknown billions of dollars likely still needed. With interbank lending down, corporate, trade, housing, consumer, and student lending have fallen as well.
Achieving greater transparency in the global financial system should include confirmation of beneficial ownership in all banking and securities accounts, curtailing trade mispricing, automatic exchange of tax information especially by tax havens, and eventually country-by-country reporting of sales and profits by multinational corporations and financial institutions. None of this is rocket science; it is a matter of political will.
The documents now circulating are weak on the broad topic of transparency. If the outcome of the April 2nd meeting is to approach the ambitions of the November 15th meeting and deal with bedrock issues to prevent future crises, strong political leadership will be needed in the immediate days ahead to correct its impending shortfalls.
Raymond Baker, author of Capitalism’s Achilles Heel: Dirty Money and How to Renew the Free-Market System (Wiley 2005) is director of Global Financial Integrity in Washington, DC.
This article was originally published in the Diplomatic Courier.