U.S., Europe fall out of step on global financial reform

By Anthony Faiola and Brady Dennis
Wednesday, May 26, 2010; A01

LONDON -- The global campaign to harmonize rules for financial firms is swerving off course, threatening efforts to curb the risky bets that rocked the world economy two years ago.

As U.S. Treasury Secretary Timothy F. Geithner lands in Europe on Wednesday, differences are growing among world leaders over how to keep the promise they made at the height of the financial crisis: that they would work together to reshape how finance is governed. Their aim was to avoid another upheaval by making financial rules consistent across borders and closing loopholes.

But the United States and Europe are increasingly pursuing their own -- sometimes clashing -- paths to reform, potentially undermining the regulatory overhauls taking shape on both sides of the Atlantic.

If this continues, a resulting patchwork of reforms could allow companies to continue exploiting national differences by moving operations to countries where conditions are most favorable and thwart the efforts of regulators to spot financial threats early on. The outcome, for instance, could be very different ways of banking in New York and the financial capitals of Europe, prompting leading American firms to shift their riskiest activities overseas beyond the purview of U.S. regulators.

The evolving divide, analysts say, is spooking investors and contributing -- along the European debt and euro crisis -- to the sharp losses in recent days on stock markets from New York to Frankfurt to Tokyo.

"Each nation has said to the other they would work together on this," said Angela Knight, chief executive of the British Bankers' Association, "but in fact, we don't see that happening."

As Geithner arrives for talks with his counterparts in Britain and Germany, for instance, Europeans are expressing dismay about parts of the regulatory overhaul bill approved by the U.S. Senate last week.

European diplomats are alarmed by a measure, introduced by Sen. Susan Collins (R-Maine), that they say could force European financial companies to shift significant amounts of capital to their U.S. subsidiaries to cover potential losses.

Dispute on derivatives

The Europeans are also worried about a provision that could force U.S. banks to spin off their lucrative trade in financial instruments known as derivatives. The Europeans, who have a one-stop-shopping banking culture that allows firms to conduct a vast array of businesses under one roof, are ready to resist any effort at setting a global precedent excluding banks from the derivatives business. Even in the United States, the derivatives provision sponsored by Sen. Blanche Lincoln (D-Ark.) has powerful adversaries in government and industry, and it may be eliminated from the final bill.

The derivatives rule, along with a separate provision that would restrict financial firms from trading with their own money, could encourage U.S. firms to shift some trading overseas. Although the Europeans could win jobs and market share in financial services, "the U.S. would be exporting its risk to Europe or Asia," said a European diplomat involved in the reform effort.

U.S. officials, in turn, are upset by a German move last week to crack down on a form of speculating known as naked short selling. In unusually harsh terms, a senior U.S. Treasury official on Tuesday described the German action as damaging to the markets and counterproductive. U.S. officials are also taking issue with Europe's push to increase oversight of hedge funds and say this could impede American funds from courting European clients.

In addition, U.S. officials are accusing the Europeans of failing to force banks to beef up their balance sheets with more capital. The United States has made this demand on its banks.

European officials should be "making it clear to the markets and the international community they have good strong rules in place to ensure the capital base of the banking system going forward, which would help their economic recovery, which in turn would help the rest of the global economy," Federal Deposit Insurance Corp. Chairman Sheila C. Bair told Bloomberg News while in Beijing on Tuesday. "There have been a lot of concerns about what will happen in Europe and to what extent it could impact the Chinese economy and the U.S. economy."

Points of commonality

In principle, U.S. and European leaders have found much common ground. For instance, they agree that markets and banks need more oversight and that investors, depositors and the financial industry more broadly -- rather than taxpayers -- should pay the tab for future crises. On Wednesday, Geithner is set to lay the groundwork for an agreement on common goals to be signed at an economic summit in Toronto next month.

Officials on both sides of the Atlantic say the divergence in practical approaches reflects cultural and legal difference that can be resolved. "It doesn't mean that if we take one structural measure and the others don't follow, that we're hitting a major bump in the road or that we aren't pursuing our common agenda," said an Obama administration official who spoke on the condition of anonymity.

The world's largest economies have agreed to let a committee in Basel, Switzerland, set international standards for how much money banks should hold in reserve to protect against unexpected losses.

Geithner has said that new capital standards are at the heart of reforming the global banking system, and the financial overhaul bill on Capitol Hill largely defers to the Basel committee to set the standards. Some Europeans complain they have found it hard to coordinate with the United States over the Basel process.

In striking out on a different path than the Europeans, the United States could force them to rethink their approach.

In Britain, for instance, the coalition government elected this month is setting up a commission to study whether big financial companies should be broken up to ensure that they are not too big to fail. But the British, who don't want to be at a competitive disadvantage, are unlikely to adopt this approach if the Americans don't. The U.S. legislation would leave banks largely intact, instead bulking up federal oversight.

"If the Americans don't do it, let's face it, we won't do it, either," said Ray Barrell, director of macroeconomics at the National Institute of Economic and Social Research in London.

Dennis reported from Washington.

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