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U.S., European countries at odds over regulation, stimulus spending

Lefteris Pitarakis / AP London's Excel centre will be the venue of the G-20 leaders' meeting on the global economic crisis on April 2.

By John W. Schoen | There's widespread agreement among the world's biggest countries that the current global financial and economic crises require global solutions. But as leaders from twenty of those countries gather this weekend in London, that may be about all they can agree on.

The upcoming meeting is the last of a series of preliminary sessions before an April 2 summit that was called to try to reverse the downward spiral in the global economic and financial systems.

There’s little debate over the scope and urgency of the problem. And all parties have called publicly for a unified approach to economic stimulus programs, coordinated efforts to bail out the battered financial system and tougher, comprehensive rules to prevent the global financial system from running off the rails again.

When the time comes to work out the details, the limits of global harmony quickly become apparent.

“I think they’re pretty disunified,” said Simon Johnson, a professor at MIT’s Sloan School of Management and former chief economist at the International Monetary Fund. “But they don’t obviously want to present that too publicly.”

After months of preliminary work, several major fault lines have opened, largely between the U.S. and European countries, say analysts. The Obama administration, represented this weekend by Treasury Secretary Tim Geithner, has been pressing European countries to boost spending. For their part, the Europeans have been urging quick action on tightening financial regulations.

Officials on both sides of the Atlantic have been teeing up the issues this week. On Tuesday Federal Reserve Chairman Ben Bernanke outlined the issue facing U.S. financial regulators, but pointedly lowered expectations for the April G-20 summit.

“I think it's asking too much for a meeting like that to come out with detailed proposals in many different areas,” he said.

Bernanke focused much of his speech on the need for a more centralized approach to U.S. regulations that could more closely monitor increased risks to the entire financial system, not just the risks faced by individual banks.

But so far, no one has figured out how to pull that off.

“The fact that the best idea they can come up with is a 'college of regulators' — which essentially means air miles for the regulatory industry — suggests that we are not seeing any coordinated action,” said Tom Vosa, head of economics research for nabCapital in London. “That’s not surprising because different countries have different histories of their banking system. The structures are entirely different.”

Given the complexity of those different regulatory systems — not unlike the multiple federal and state financial regulations in the U.S. — it’s hard to envision a single global regulator with the sweep and authority to undertake the kind oversight being discussed, according to Sebastian Mallaby, a senior fellow at the Council on Foreign Relations.

“This G-20 meeting in April 2 is not going to resolve financial regulation,” he said. “It’s just too difficult and too complicated. There’s been some noise from the Europeans saying, ‘Gee, we’ve got to regulate hedge funds’ and so forth. That’s because they want to change the subject from the fact that they ought to have more fiscal stimulus.”

In response to U.S. calls for more government spending, the EU has said it is doing its part with a package that amounts to between 3 and 4 percent of Europe’s gross domestic product. The $780 billion amounts to about 5.5 percent of the U.S. GDP, but is spread over two years.

While the U.S. is expected to continue to urge European countries to spend more, that will likely be a tough sell. With the exception of Germany, Great Britain and France, most European governments’ finances are already stretched to the limit.

As the EU’s largest economy, Germany is expected to play a critical role in propping up Europe’s economy and ailing banks. But analysts say that with lingering memories of the hyperinflation that gave rise to Nazi Germany, there’s a strong cultural aversion to easy-money policies. The current coalition government also faces an election in September that has dampened enthusiasm for a big spending package.

“People are divided on whether the Germans are posturing while preparing sensibly for these very difficult and increasingly likely contingencies or whether they’re totally asleep at the wheel,” said Johnson. “I guess we’ll find out.

Smaller Eurozone countries that have been slow to boost spending have another reason to drag their feet, say analysts. Some would rather let other, bigger countries do the spending, as long as it boosts demand for everyone’s exports.

“The risk at the moment is that if one or two countries do fiscal packages, that’s simply going to boost the export market for countries which haven’t,” said Tom Vosa, head of economic research at nabCapital in London. “That’s why in the U.S. they’ve put in those 'Buy American' provisions to stop those leakages from happening.”

Those “buy local” restrictions on stimulus spending could backfire if they open a round of trade retaliation that could further slow the global economy.

All politics are local
Much of the conflict is being driven by politics back home, say analysts. The European focus on regulation, said Johnson, plays well among voters who believe the crisis was caused by excessive spending and risk-taking by American.

“The story they want to tell about the crisis — that American finance got out of control and they’ve now got to be reregulated and the initiative of the Europeans and that (Europe) saved the day. Of course nothing could be further from the truth,” he said. “Their banks were just as much involved in causing the problems as were the U.S.”

While the response to the crisis in the U.S. has occasionally bogged down over bickering between two political parties, the Europe Union faces the much more daunting task of forging consensus among its 27 member countries. Fault lines are already opening. Heavy borrowing by eastern European countries with weaker economies, for example, has left them saddled with debts they can’t pay to banks in richer countries that now face heavy losses.

Local conflicts also loom as Europe tries to develop a unified approach to shoring up its financial system, said Mallaby.

“When taxpayers put money into a bank they tend to want to say ‘In return you’ve got to start lending in our country to stimulate demand so we don’t lose too many jobs,’” he said. “If everybody says that to their banks, then it just exports the credit crunch to other places in Europe. This is the financial sector equivalent of ‘Buy American’ or ‘Buy France’ instinct.”

The debate over European banking bailouts is further complicated by the scope of the resources that each country can bring to bear. Despite the staggering cost of the $700 billion U.S. TARP bank bailout, that figure is still a relatively small portion of the roughly $14 trillion U.S. economy. Some European countries now face the prospect of bailing out banks that are substantially bigger than their entire economies.

One solution being proposed is a doubling of the International Monetary Fund’s emergency account to $500 billion. That’s forced the G-20 countries to look to newer, emerging market countries like China for help. But that’s revived a contentious debate over giving those countries more IMF voting power.

While expanded IMF funding could provide an important financial backstop, it’s not the most appealing solution for the countries that end up tapping the fund for a bailout, according to MIT's Johnson.

“It’s the complete failure of a country and of a system of government if you have to go to the IMF,” he said. “It’s the most humiliating experience you can imagine, having these faceless bureaucrats, many of whom are my good friends, tell you what to do. It’s horrible.“