New rules for finance at last

Christine Lagarde is France’s Minister of Finance.

By Christine Lagarde

PARIS – The World Monetary and Economic Conference took place in London 76 years ago, in June 1933, with 66 countries meeting to put an end to the unfolding monetary disorder and trade wars while trying to draw the lessons of the Great Depression. When it was over, the negotiators admitted failure.

On April 2, 2009, world leaders will head to London again to find a solution to a financial and economic crisis as dire as that of 1929. We cannot let history repeat itself. If collective inaction prevails, we risk a return to the political and economic woes of the 1930’s, which paved the way to a devastating world conflict.

Of course, we must respond to both the weakening economy and financial instability in a virtual state of emergency. This is why stimulus packages and financial rescue plans were for the first time adopted concomitantly in Europe, the United States, and some large Asian countries.

At the G-20 finance ministers meeting on March 14, all of our countries did their best and made massive efforts to repair their economic machinery as fast as possible. The policies chosen are different, but all states favour solutions that seem most appropriate to them. All are daring and realistic regarding the tasks that await us.

Like its partners, France has launched significant stimulus measures, with a plan announced by President Nicolas Sarkozy last December, as well as public investments and early repayment of government debt. If we also take into account the strengthening of social services and legal policies launched last month, France’s stimulus in 2009 totals more than 2% of its GDP, with committed future outflows equaling the US.

Moreover, the impact of automatic stabilizers – which enable the government to mobilize more or less fiscal resources, depending on economic conditions – is more powerful in Western Europe than in most of the Anglo-Saxon countries. Yet America’s macroeconomic situation seems worse than Europe’s in terms of consumption, banking, or employment and housing markets.

But, as both Sarkozy and US President Barack Obama have insisted, we must go further. Economic stimulus will work efficiently only if confidence is restored. And confidence can be restored only if the financial system is fully overhauled.

We obviously need to strike at the root of the problem, which requires us to redefine the basic principles of the system. It would be counterproductive to focus on treating the symptoms, only to realize later that the unprecedented budgets for structural policies are neither economically efficient nor politically acceptable.

At the Washington Summit last November, the EU suggested a basic principle: all markets, all territories, and all actors putting the global financial system at risk should be monitored. This principle, to which all agreed, must be enforced even if it upsets old habits and comfortable incomes. I am especially convinced that we must closely monitor actors in financial markets such as hedge funds. Although hedge funds sometimes account for 50% of market transactions, they are not registered or subject to rules on transparency. This is not sustainable.

Fighting for transparency also implies confronting states that refuse to collaborate on financial issues at a global level or to combat money laundering or prevent financial risks. We cannot build a safer system if we do not raise global requirements and if we tolerate non-compliance with the rules. Together with Germany, France intends to draw up a list of uncooperative countries and to design a tool kit of appropriate sanctions.

New auditing standards must reflect an overhauled financial architecture that focuses on transparency. The aim of such standards must be to attenuate the impact of financial failure, not amplify it, as has occurred in the crisis.

Indeed, the rating agencies, whose malfunctions contributed to the crisis, must be regulated. We demand an easy policy: stricter rules (especially when fighting conflicts of interest), a specific rating scale for complex products, and regular publication of their returns. Europe followed this path when preparing, under the recent French presidency, a European regulation that will soon be adopted. We expect all of our partners to do the same.

Responsibility must be put back at the heart of a system that has sunk into excess. The methods used to pay market operators reflected our collective mistakes. We yielded to short-term incentives, and everything seemed to conspire to push us to accepting excessive risks. We must revise compensation schemes and delay bonus payments until the long-term profitability of a firm’s investments is known.

Finally, we must express our solidarity for emerging and poor countries. Weakened by this crisis, they are the first to suffer from the cuts in financial flows. The international financial institutions must support them massively, and also have the resources needed to foresee global unbalances and prevent crises, rather than respond only when events become urgent.

France and its European partners, in particular Germany, with which we worked in tight collaboration, will suggest all these points to the G-20. Indeed, just as a national fiscal stimulus is less efficient than a coordinated effort, strengthening financial regulations without combating the laxity that prevails elsewhere makes no sense in a globalized world.

We should not delude ourselves; we cannot solve all the problems of this crisis in the coming days. We must, however, reach several objectives and give clear signs of a true collective ambition. History has shown how risky it is to miss some opportunities. On April 2, France and Europe will be present.