G-20 Summit: Five Ways to Tame the Financial Market Monster

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The failure of the three largest ratings agencies, Fitch, Standard & Poor's and Moody's, is beyond dispute. They awarded their highest ratings to junk securities and assigned Lehman an A+ credit rating shortly before its bankruptcy.

Ratings agencies are exposed to several conflicts of interest. They help banks structure securities that they subsequently rate. This has to be prohibited!

They are also paid by the same banks that seek to market the securities they rate. Clearly this can cloud their judgment, which is why ratings agencies should be paid by the buyers of financial products in the future.

Besides, a system of competition among the three main agencies should be developed. Peter Bofinger, a member of the German Council of Economic Experts, is calling for a government-run European ratings agency which the EU would have to establish and partially fund, at least at first.

Even this type of agency could be vulnerable to being influenced -- in this case, by politicians seeking to prevent their countries from being downgraded. But a European ratings agency would be only one voice among the ratings agencies. It could act as a counterbalance to its commercial competitors.

The banks are lobbying hard against many of these proposals. The bankers who are fighting back against overly stringent rules for their industry argue that they would weaken banks, slow growth and prevent job creation.

But politicians should not allow themselves to be deterred by such arguments. Even the chief economist of the Bank for International Settlements, Stephen Ceccheti, characterizes such doomsday scenarios as blatant exaggeration.

According to Ceccheti, the banks' dire warnings are based on the assumption that the maximum impact of the biggest possible change in the rules will coincide with the smallest possible change in the banks' behavior -- a worst-worst-worst-case scenario, in other words. In fact, says Ceccheti, the effects of the proposed reforms on worldwide growth would be "negligible."

Nevertheless, the G-20 summit is likely to produce minor advances at best. Jörg Asmussen, state secretary in the finance ministry, will be Germany's chief negotiator at the summit. He has a special history when it comes to financial market reforms. In a former job as senior official under former Finance Minister Hans Eichel, a Social Democrat, Asmussen was in favor of Germany emulating the Anglo-Saxon model and permitting hedge funds.

Asmussen does not deny that he supported the zeitgeist of the moment, which paid homage to market liberalization. Today, as a state secretary under Christian Democratic Finance Minister Wolfgang Schäuble, he takes a different view of the world. His change of thinking began after the Lehman bankruptcy, and now Asmussen strongly supports better regulation. But he is not overly optimistic.

His skepticism stems from the fact that there are too many competing interests. The emerging economies, which make up half of the G-20 group, see the financial crisis as a problem for the Northern Hemisphere. But even the established economic powers are not all on the same page. On the one side are the continental Europeans, who want to see tighter regulation of hedge funds. But Great Britain, seeking to protect London as a financial center, opposes such regulation.

The Americans, most of all, are determined to impose stricter regulations and a banking tax on their financial institutions in the future. Australia and Canada, whose financial systems have survived the financial crisis virtually unscathed, come down on the other side of the regulation debate. Why should they burden their banks now, they argue?

All signs point to the Toronto closing communiqué being as vague as usual. One of the concrete efforts being proposed so far is to prohibit the providers of high-risk financial derivatives, like banks, from trading directly with customers, like hedge funds. Instead, the trade in such securities would take place through exchanges, the goal being to increase transparency. A bank tax to pay for the burdens of financial crises seems as unlikely to succeed as an international tax on financial transactions.

US economist Nouriel Roubini, who predicted the financial crisis, warns of the consequences of inadequate reforms. If the international community does not intervene now, says Roubini, even bigger and more dangerous speculative bubbles could develop. "If that happens, what we are experiencing now would only be a taste of what is to come."

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• Part 1: Five Ways to Tame the Financial Market Monster
• Part 2: Control the Banks!
• Part 3: 2. More Equity Capital!
• Part 4: 3. Quality Controls for Financial Products!
• Part 5: 4. Monitor the Hedge Funds!
• Part 6: 5. Control the Ratings Agencies!