Central Bankers Frustrated at Their Lack of Influence

OK, the headline may be exaggerating, but not by much. A Bloomberg article titled, “,” discusses how central bankers are finding the Bank of International Settlements an increasingly important forum for exchanging ideas and intelligence.

What is distressing yet not surprising is the central bankers’ acknowledgement of their lack of understanding of what is happening. This situation is the inevitable result of the lack of regulation of private equity funds and hedge funds. If these firms had reporting requirements, say a detailed version for the regulators, only a subset of which was made public, the powers that be would have a more informed understanding of where the risks lay.

As the Fed’s limited influence is becoming more apparent (see “Toothless Fed” “Part 2” and “Part 3“), it means that it and its counterparts are left trying to devise emergency plans for a problem that may be beyond their capacity to manage. Sort of like being on the Titanic without enough lifeboats.

From Bloomberg:

Six decades ago, the U.S. Treasury wanted to shut down the Bank for International Settlements, saying it helped finance the Nazis. Today, Jean-Claude Trichet and Ben S. Bernanke are transforming the organization into one of the world’s most powerful networking clubs.

With hedge funds and private equity firms pumping record sums of money around the world economy, central bankers fret that investors are taking on too much risk. As a result, the bankers are increasingly turning to the Basel, Switzerland-based BIS, the oldest international financial institution, for research and advice, and to coordinate damage-control plans.

The bank’s most important role may be in providing a venue for swapping information and ideas among those charged with maintaining the stability of the global economy. “If the BIS didn’t exist we’d have to invent it,” said Laurence Meyer, 63, vice chairman of Macroeconomic Advisers LLC in St. Louis and a former U.S. Federal Reserve governor.

The “central banks’ central bank” now performs many of the functions of a monetary authority, churning out research on everything from derivatives to inflation-targeting. It also holds about 6 percent of central banks’ currency reserves on their behalf.

`Unbelievable Speed’

“Funds are flowing across the world with unbelievable speed, and central bankers feel they are in uncharted territory,” Meyer said. “Central bankers want to talk to each other about this, and the BIS is the best vehicle.”

European Central Bank President Trichet, 64, and Fed Chairman Bernanke, 53, will meet about 250 of their colleagues from around the world on June 23 and 24 at the BIS’s copper-colored, cylindrical headquarters after a year in which investors ignored their calls for prudence.

While market blowouts such as the Asian crisis of 1997 are always hard to spot in advance, policy makers say, the increasing popularity and complexity of the derivatives used by investors to hedge their bets are making the task even tougher.

Fed Bank of New York President Timothy Geithner argues that the danger that new crises will be harder to manage should be the “principal preoccupation” of central bankers.

“The rapid development of global financial markets points toward the importance of strengthening the cooperation within the worldwide community of central banks,” Malcolm Knight, 63, general manager of the BIS, said in an e-mailed response to questions.

Providing a Forum

Providing a forum for central bankers to discuss financial globalization is only the latest incarnation of an organization founded in 1930 to manage Germany’s World War I reparation payments. In the interim, it handled gold looted by the Nazis, helped oversee the global currency system set up after World War II, bailed out a Communist government during the Cold War and midwifed the ECB.

During World War II, the bank transferred Czechoslovakian gold to Germany after the Nazi invasion in 1939. It later emerged that Czech officials were held at gunpoint as they placed the order.

U.S. Treasury Secretary Henry Morgenthau tried to shut down the bank at the 1944 Bretton Woods conference; only intervention by John Maynard Keynes saved it. The U.S. soon saw the usefulness of the BIS as an arena to fine-tune the Bretton Woods global currency regime, with Fed officials attending regularly from 1960.

Cold War Divides

The BIS also straddled the divides of the Cold War, giving central bankers from both sides of the Iron Curtain a rare forum. In the early 1980s, it helped bail out Yugoslavia’s government after a debt crisis hobbled the country’s ability to meet its international obligations.

The first foundations for European currency union were laid at the BIS and in 1994 the European Monetary Institute moved from Basel to Frankfurt, where it became the ECB.

As barriers to capital flows fell in the 1990s and countries such as China and India become more integrated into the global economy, BIS membership has swelled to 55 from 36 over the past decade.

“Markets are increasingly global, and central banks are not,” said Willem Buiter, 57, a former member of the Bank of England’s Monetary Policy Committee. “So there’s a huge vacuum to be filled.”

The agenda for this year’s annual meeting may already have been set by a report published last month. The Financial Stability Forum, which is based at the BIS and brings together regulators and central bankers, argued that hedge funds should “enhance sound practice” methods for improving risk management and preventing potential shocks to the international financial system.

Perceptions of Risk

Investors’ perception of risk is near historic lows. The gap between the yield demanded by investors to hold high-yield, high- risk U.S. corporate debt and government bonds fell to the lowest ever on June 5. European companies have borrowed a record $284.7 billion in loans and bonds rated below investment grade since the start of the year.

Growing concern about the extent of investors’ risk-taking comes as a global cash glut swamps the ability of central bankers to set policy. New Zealand central bank Governor Alan Bollard said in March that “cheap international money” has stymied his efforts to curb a housing boom, a sentiment echoed by Bank of England Governor Mervyn King.

Buiter, now a professor of political economy at the London School of Economics, says liquidity and new financial instruments are pouring across borders so quickly that the BIS’s ability to analyze financial markets is struggling to keep up.

`Fighting the Last War’

“The problem is that you will inevitably end up fighting the last war,” said Buiter. “The global reality is they have to agree on everything, so things become very, very slow.”

The BIS’s advocates nevertheless point to its power as a magnet that brings together the world’s most powerful central bankers and their officials.

“The BIS has more influence than you might think,” said Ernst Welteke, 64, who headed the Bundesbank between 1999 and 2004. “It’s a very informal exchange of opinions, which I found very important.”

The BIS’s meetings, which usually take place every two months, give central bankers an opportunity to meet face to face. Policy makers typically arrive on Sunday evenings and governors from the Group of 10 nations dine together.

The next morning, the likes of Trichet, Bernanke, King and China’s Zhou Xiaochuan can be seen taking breakfast together in the restaurant of the Basel Hilton before they stroll across the street to the BIS’s 20-story building, which was designed by Martin Burckhardt.

`Uniquely Valuable’

There, policy makers share ideas and experience on everything from the state of the global economy to derivatives to currency management until late into the evening. “Governors find these discussions uniquely valuable,” said Knight. “They have the chance to really hear others’ news.”

Central bankers also get time to relax. At last year’s annual gathering, policy makers crammed into the bar of the Basel Hilton to watch the World Cup soccer match between the Netherlands and Portugal, smoke cigars and exchange banter.

“There’s a wonderful camaraderie among central bankers that means they really get to know each other very well,” said Meyer, who sometimes represented Alan Greenspan during his time at the Fed between 1996 and 2002. Traveling to Basel “was unbelievable fun.”

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