The Finance Ministers and Central Bank Governors of the Group of Seven industrialized countries met Friday, April 11, in Washington D.C. as is the established practice before the annual meetings of the IMF. Very often the public statements released at the conclusion of such G-7 meetings are highly predictable, containing support for established policies, papering over issues where positions are known to differ and rather little that is particularly newsworthy. Friday’s G-7 Statement was an exception. The reason was evident in their frank admission that “The turmoil in global financial markets remains challenging and more protracted than we had anticipated.”
Faced with this situation, the G-7 decided on a very ambitious action program, endorsing all the recommendations in a report the G-7 tasked the Financial Stability Forum to produce, identifying the underlying causes and weaknesses in the international financial system that contributed to the current financial problems. The Financial Stability Forum (FSF) was established in 1999 to “promote international financial stability” by bringing together on a regular basis senior representatives of national authorities responsible for financial stability in major international financial centers (e.g., the Treasury Department, the Federal Reserve and the SEC in the case of the US), international financial institutions, and international groupings of financial sector regulators and supervisors. The FSF Report recommends 65 actions in five areas:
- · Strengthened prudential oversight capital, liquidity and risk management
- · Enhancing transparency and valuation
- · Changes in the role and uses of credit ratings
- · Strengthening the authorities’ responsiveness to risks
- · More robust arrangements for dealing with stress in the financial system
The G-7 Finance Ministers and Central Bank Governors not only were able to reach consensus on strongly endorsing the report and committing to implement its many recommendations. They uncharacteristically went further to set priorities and a very ambitious time-table, identifying some actions for implementation within the next 100 days and other for implementation by the end of the year. We will point out just several important examples here. [The full report of the Financial Stability Forum is not longer available at the original site.]
The G-7 called for financial institutions in their upcoming mid-year 2008 reporting to “fully and promptly disclose their risk exposures, write-downs and fair value estimates for complex and illiquid instruments…consistent with leading disclosure practices”. Also within the next 100 days, the International Accounting Standards Board and other standard setters are asked to “initiate urgent action to improve the accounting and disclosure standards for off-balance sheet entities and enhance its guidance on fair value accounting, particularly on valuing financial instruments in periods of stress.” Despite the validity of this request, rapid progress in this area will be very difficult to achieve.
An important and controversial call by the G-7 is the request that by end-2008 the Basel Committee (a grouping of Central Banks) should raise bank capital requirements for complex structured credit instruments and off-balance sheet vehicles. This would reduce the attractiveness to banks of these assets, which recent events have shown to be more risky than previously thought. Earlier in the week the Institute of International Finance, an organization of the world’s largest banks, warned that increasing regulatory capital requirements would add too much “conservatism” to banking practices and proposed instead a voluntary code. Evidently, the financial officials believe self-regulation would not be an adequate response.
Another noteworthy action is the call for the International Organization of Securities Commissions (IOSCO) to revise its Code of Conduct Fundamentals for Credit Rating Agencies and for these agencies to improve the quality of the rating process and manage conflicts of interest in rating structured products. The FSF Report concluded that poor credit assessments by credit rating agencies contributed both to the build-up and to the unfolding of recent events.” One specific recommendation is that ratings of structured risk products should be differentiated from traditional corporate bond ratings. There is also a call for investors to improve their due diligence in the use of ratings.
In addition to the action program for strengthening the global financial system, the G-7 set a new tone in its brief reference to exchange rates. They said “Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability.” This modest statement marks a first time in recent years that the G-7 has agreed to express such a concern, although some individual G-7 participants have made such statements, fear the effects of a possible further slide in the US dollar. The IMF’s sharply lower forecasts for the US economy likely have strengthened such fear. This expression of concern by the G-7 could possibly signal future policy changes to draw a line under the dollar, but none have been announced.
A resumption of growth in the US in the second half of this year would be the best counter to these concerns about a destabilizing further fall of the dollar. Unlike the IMF, we are projecting such a pick-up in economic activity (albeit a modest one) with the US leading the Euro-zone in this change in direction. For this reason, we believe the US dollar is probably at or close to a bottom with respect to the euro and a number of other currencies, the main exception being some of the Asian emerging market currencies, where strong economic growth is continuing and stronger currencies are being used to counter inflationary pressures. Cumberland’s US, International and Global equity ETF portfolios are fully invested.