THE BLOG

G20 Fails to Fix Global Finance. Again.

09/12/2013 12:08 EDT | Updated 10/30/2017 19:46 EDT

It's a wonder that the heads of state and heads of government of the G20 who just met in Russia spent any time at all talking economics. Seriously, how could they pull themselves away from discussing Syria (or Sochi, or Snowden) long enough to actually focus on the international financial system? Sure, that's the explicit purpose of the G20 meetings, but still, let's give credit where credit is due.

For starters, Russian, Indian and Chinese officials expressed concerns over the US Federal Reserve's expected reduction of monetary stimulus, which has already prompted a selloff in emerging market currencies and a flight to the dollar. Stephen Harper, meanwhile, threw down the debt-reduction gauntlet, committing Canada to a debt-to-GDP ratio of 25 percent by 2021 and prodding other leaders to set their own targets. And everyone agreed on the need for a coordinated crackdown on individual and corporate tax evaders.

But although they did address some economic issues, the G20 leaders failed to get at the root causes of the sputtering global economic recovery: the ethical rot in our financial system.

A recent book, The End of Ethics and a Way Back: How to Fix a Fundamentally Broken Global Financial System, tackles this problem head on. Authors Theodore Roosevelt Malloch and Jordan D. Mamorsky paint a depressing picture of a system that remains very flawed. Five years after the failures of several major banks and the bailout of many others, we have not made the changes that they believe we need to make to stop rewarding economic vice and punishing innocence and virtue.

To take just one example, the authors remind us that the big three credit rating agencies (Moody's, S&P, and Fitch) provided unrealistically high ratings to subprime mortgage assets, which helped banks inflate the housing bubble. They did so because banks paid them to do so -- a conflict of interest if ever there was one. Think about it: Would you trust Car and Driver's reviews and ratings if they were paid by Ford, GM, and Chrysler?

The big three CRAs can get away with being paid by the very people who issue the bonds they rate because they have had a virtual lock on the ratings business since the 1970s, thanks to government-granted privilege. As the authors of The End of Ethics write, "The conflict of interest in rating a bond issuer and receiving a profit from them for that rating coupled with literally no competition in the market creates a disastrous situation where rating agencies abdicate their duties to investors."

Despite new regulations like the Dodd-Frank bill, systemic failings like these persist. Indeed, the New York Times raised the alarm just a month ago regarding CRAs. One of the big three, S&P, has reportedly been winning back market share by offering more favourable ratings for certain mortgage-backed securities. This kind of competition -- to win bankers' business instead of investors' -- is not the kind of competition that makes for a stable, healthy economy.

The G20 leaders had a lot on their minds, it's true, even just in terms of economics. But if the global financial system is to perform properly, it needs to be purged of the kinds of serious flaws that allowed the housing bubble to inflate in the first place.

According to Theodore Roosevelt Malloch and Jordan D. Mamorsky, unless we reform the system so that it starts rewarding virtues like prudence and hard work and punishing vices like excessive risk-taking, we will just keep going from boom to bust, with all the hardships that implies. You'd think that might have been something worth talking about in Russia.