Financial Crisis - Looking for the Magic Bullet

UNCLAS SECTION 01 OF 03 GENEVA 000220

SIPDIS

STATE FOR IO/EDA and EEB/OMA
USUN for JLAWRENCE

E.O. 12958: N/A
TAGS: EFIN ECON EINV UNGA ECOSOC
SUBJECT: Financial Crisis - Looking for the Magic Bullet


1. SUMMARY: The global economic downturn was the focus of several
meetings in Geneva March 9-12. The UN Commission on Financial
Reforms (the Stiglitz Commission) slammed U.S. regulatory failures,
and promoted greater institutional power and money for lesser
developed countries. The UN Conference on Trade and Development
released a report focusing on the triple crises in financial,
commodity, and currency markets. The UN apparently has grand
ambitions leading up to a June Ministerial, as outlined in detail
below, but we suggest the USG focus on garnering multilateral
support for practical ways countries can pool their resources to
lessen the impact of the economic downturn. END SUMMARY.

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UN Commission on Financial Reforms
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2. The commission of experts of the President of the United Nations
General Assembly on reforms of the international monetary and
financial system held its second, closed-door session in Geneva
March 10-11. Joseph Stiglitz, Professor at Columbia University and
Nobel Prize laureate, who leads the Commission, presented some of
its key findings to member states at both the UN Conference on Trade
and Development (UNCTAD) and the International Labor Organization
(ILO) on March 12, 2009. He argued that the United States and the
United Kingdom are largely responsible for the world financial
crisis, mainly due to their failure to regulate risk properly.
Nevertheless, the crisis is harming all countries, so all countries,
not just the G20, should have a voice in its resolution.

Causes of the crisis
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4. Stiglitz attributed the crisis to three underlying problems.
First, markets were built on a theory of market fundamentalism,
namely that unfettered markets work perfectly and are
self-correcting, and this theory failed in practice. Second,
management of the Asian financial crisis taught developing countries
that they should create large foreign currency reserves. Countries
built huge reserves, but this dampened aggregate demand and
aggravated global imbalances. Third, in the absence of sufficient
global demand, central banks pursued loose monetary policies,
allowing debt accumulation by entities that had no capacity to repay
that debt. In response to the ensuing global financial crisis, the
world needs a global economic stimulus package, and institutional
and regulatory reforms.

Global Stimulus Package and Financial Reforms
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5. Stiglitz proposed a new issuance of Special Drawing Rights
(SDRs) and the auctioning of carbon permits and other global goods
as a source of new funds for global economic stimulus packages. He
stated that one percent of all developed country stimulus packages
should be allocated to developing countries to stimulate their much
smaller economies. There should be no conditionality on that
stimulus money, because conditionality has forced countries to
pursue pro-cyclical policies and lose sovereignty. Stiglitz added
that there should be "a new international lending facility that
could deliver aid in a way that is better for donors and
recipients," but did not elaborate further.


6. Stiglitz also encouraged member states to address competition
policy at the global level to resolve the problem that some banks
supposedly have become too big to fail. He said there should be a
"financial product safety commission" that could provide guidance
about the efficacy, use and risk of financial instruments. There
also should be some global financial regulation, to avoid regulatory
arbitrage.


7. Stiglitz advocated the establishment of a new global reserve
system. He said small changes in voting rights in the Bretton Woods
organizations (the international financial institutions, IFIs, such
as the IMF And World Bank) will not make a difference; what is
needed are big changes in voting rights and the way Executive
Directors are chosen. The world needs better global economic and
financial surveillance, and central banks need a broad reform of
their policies because central bankers need to address long term
growth not just inflation.


8. Stiglitz encouraged the issuance of GDP-linked bonds by
developing countries to mitigate risk. He said this global
financial crisis will be followed by a sovereign debt crisis and
that we need to agree upon a sovereign debt restructuring mechanism
now to deal with it.

Protectionism and Moral Hazard
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9. Stiglitz warned that the current stimulus policies can be

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protectionist, singling out the United States and its cosmetically
amended "Buy America" provisions. Stiglitz opined that the "Buy
America" provisions will harm poor developing countries. Stiglitz
criticized U.S. and European subsidies, saying they create an uneven
playing field that is insurmountable for the developing countries.
Stiglitz suggested a framework of global regulation to curb these
subsidies and criticized the Doha Development Round as falling
short. Stiglitz also recommended that the developed countries open
their markets further to the least developed countries (LDCs),and
particularly extend the "everything but arms" tariff relief to more
countries.


10. Stiglitz expressed deep concern about the impact of the US and
European bail-out packages in terms of moral hazard. He said that
the knowledge companies have that they may be bailed-out changes
their perception of risk. "The level playing field has been
destroyed. We need to compensate developing countries for the huge
advantage bail-outs provided to developed countries."

Reforms and New Institutions
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11. Stiglitz suggested the establishment of several new
institutions and mechanisms: a financial product safety commission;
a new international lending institution; a sovereign debt
restructuring mechanism; and a Global Economic Coordination Council
(GECC). Stiglitz said the Commission was still debating the role
of the GECC and whether it should be created as a global regulator,
promulgating rules, or as a coordinator, overseeing rules which
would not touch on sovereignty issues. He explained that government
regulations do not operate across borders, but we need an entity
that looks at competition and regulations globally to avoid
regulatory arbitrage across countries by companies and to address
the challenges posed by this crisis. Stiglitz said along with
regulatory coordination, the GECC could take the IMF's surveillance
function. According to Stiglitz a lender, like the IMF, has a
conflict of interest when it conducts surveillance since it looks at
the world from the standpoint of repayment, so will have an inherent
bias to promote pro-cyclical policies, while what we need are
counter-cyclical policies.

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Next Steps at the UN
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12. After Stiglitz presented his oral report, Paul Oquist, Senior
Advisor from the UNGA President's office, stated that the
Commission's written report, along with consultations between the
UNGA President and the G-20, G-7 and G-8, will feed into an outcome
document drafted by the UN Department of Economic and Social Affairs
(DESA) that delegates will negotiate in New York, starting April 12,
leading to a Ministerial meeting June 1 and 2 to deal with
contentious issues, and then a heads of state and government meeting
June 3 and 4. He provided the following time line for the
Commission's work and its usage. He noted the schedule was
compressed because some countries are running out of reserves and
need help now. (COMMENT: Oquist presented the schedule and actions
to occur as accepted facts. However, after the meeting, several
delegates told us they were unaware of member state agreement on
this schedule or plan. END COMMENT).

-- March 20: UNGA president will have received input from the
Commission, G-20, G-7 and G-8.

-- March 25: UN agencies and regional commissions will provide their
view on the financial crisis.

-- March 26 and 27: the Commission chaired by Stiglitz will present
its conclusions and then the four working groups under the
Commission will present their findings and have a dialogue with
member states.

-- Early April: the UNGA President with DESA will produce a report
on the financial crisis.

-- April 13: intergovernmental negotiations on a proposed draft
outcome document will begin in New York.

-- June 1-2: Ministerial meeting in NY to deal with contentious
issues.

-- June 3-4: Heads of State and Government meeting in NYC.


13. Oquist put the Stiglitz Commission, and plans for negotiating a
document on the financial crisis at the UN, in a broader context.
He said the Monterrey Consensus was a breakthrough, since it was the
first time that the UN had a financial and economic-focused meeting

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with a Ministerial Declaration. Up to that point, conventional
wisdom had been that only the IFIs and US Treasury had expertise to
deal with financial and economic issues. Monterrey changed that
attitude. Now, he opined, the Stiglitz Commission is another
breakthrough for the UN to give further voice to the world community
on these issues.


14. Oquist stated emphatically that the final solutions to the
global financial crisis need to come to the UN for approval as a
matter of legality. The G-7 and G-8 are totally ad-hoc and have no
basis in international law. International solutions affect
everyone, so everyone should have a voice in them for them to be
legitimate. Oquist concluded that trillions are being spent to
reinstate credibility in the global financial system, but to have
credibility we must have equality and justice where everyone feels
their interests are represented.

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UNCTAD takes a stand
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15. On March 9, in part as input for the Stiglitz Commission, the
UNCTAD Secretariat produced a paper on the economic crisis,
identifying crises in the financial, commodity and currency markets.
In his paper, Dr. Heiner Flassbeck, Director, Division on
Globalization and Development Strategies at UNCTAD, suggested three
possible solutions to the economic crisis. The first suggestion was
a regional currency system with 'planets' and 'satellites,' and a
managed floating exchange rate with the satellite countries'
currencies tied to the planets' currencies. Second, Flassbeck
proposed establishment of a body for global oversight of financial
institutions, to identify and restrict usage of financial
instruments that do not have any social benefits. The final
solution Flassbeck offered was debt inflation by developed
countries, to compensate for insufficient private demand.


16. In a March 10-11 UNCTAD Experts' meeting on Gender and Trade,
in the context of the financial crisis the USDel suggested UNCTAD
should monitor trade data to identify which sectors in which
countries were hardest hit by the global financial crisis, and to
apply gender analysis to those hardest hit sectors to determine if
women and men were impacted differently, and finally to inform
member states of that research and analysis on a timely basis, so
states could develop gender-aware policy responses. This suggestion
was supported by delegates from all regions and NGOs, who all opined
it would be a practical and constructive way to help limit the
negative impact of the financial crisis on women and children.

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COMMENT
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17. In our view, the various reports accurately report the causes
of the economic downturn and the interrelationship between the
financial, commodity, and currency crises. Some dispute remains
regarding proposed solutions. The real question is how to get past
economic modeling for ideological purposes, and put into practice
the widely-accepted view that countries need to act in concert to
deal with the economic downturn. For example, the U.S. Treasury
recently announced it is developing a method for the USG to join
with private investors to begin buying the mortgage-backed
securities and other complex financial instruments whose resumed
trading is so important to the stability of the financial system.
To address the multilateral dimension of this economic problem in
concrete terms, the Department might wish to explore the possibility
of convincing other governments to contribute to that effort to
attack the financial crisis at its roots. Ultimately, we will need
to find ways to deal with overly broad ideas about reforming the
world's financial architecture, as proposed by Stiglitz and others,
and develop practical multilateral solutions to global market
instability.
STORELLA#