Crisis Talk - The World Bank Group

Too Specific to Fail

The FPD Forum opened this morning with a not-so-cheerfully titled plenary The End of the World As We Know It?. The panelists were Daron Acemoglu of MIT, Alan Rosling of Tata Sons, Tim Harford of the Financial Times, and Michael Klein of FPD/World Bank. Perhaps my favorite line from the plenary: Too specific to fail. Acemoglu was discussing the bailout of banks in the U.S., and pointed out that the moral hazard problem isn't so much an issue of "too big to fail" as "too specific." The human capital and knowledge contained in investment banks is highly specific, and it's exactly during a crisis that it's needed. The upshot? It's very difficult to punish the managers of these banks for taking excessive risks in the good times when they're needed to help halt a systemic crisis during the bad times.  

Lessons on Risk Management

What has the financial crisis taught us about risk management? The answers seemed obvious, yet murky at a spirited afternoon session moderated by Michel Maila of the IFC at the FPD Forum.

Mark Carey of the Federal Reserve Board and Martha Cummings of Banco Santander agreed that a fundamental change of "bank culture" was needed everywhere to bring about change. Cummings believed the crisis stemmed from an excess at every level - from the individual, the institution, to the government, as Carey insisted on the technical experitise of knowledgable committee members on the board of every bank. "But those are serious challenges we are aware of," he said.

The High(er) Probability of the Improbable

There was a bit of tension in the room as Nassim Taleb got up to speak at the FPD Forum. In his book the Black Swan, Taleb seems to take no small pleasure in insulting economists. As it turns out, the World Bank probably has the highest density of economists per square foot anywhere in the world on a weekday. What might he have to say to this audience?

Fortunately for us, Taleb saved most of his ire for the kings of finance who seemed to be on top of the world prior to the financial crisis. The chiefs of investment banks got their due of course; Ben Bernanke also came in for particular criticism for using the phrase "The Great Moderation." (Taleb explained (tongue-in-cheek) his investing strategy - he shorts the market every time he sees Bernanke on the television.)

In Taleb's view, Bernanke made the mistake of assuming that an environment of low volatility is equivalent to an environment of low risk. Nothing could be further from the truth according to Taleb. In a networked and globalized world, the likelihood of a low probability, high impact event - a black swan - is greatly increased. Globalization tends to reduce volatility but increases the chances that a crisis will turn into a mega-crisis. So much for Bernanke. I heard laughter all around me as Taleb criticized, but I think I noticed a tinge - was this nervous laughter?

Trading Places: China and the US

World Bank President Robert Zoellick gave opening remarks at the FPD Forum, and much of it recapped the work of the World Bank so far in relation to the crisis. One-forward looking remark really caught my attention, though. Zoellick noted the variety of stimulus packages out there - in broad brush strokes, the US is favoring consumption, while China is favoring investment. In the long run, these two countries will have to trade places, with the US switching to greater levels of investment and China switching to greater consumption.

Update: Zoellick, along with World Bank Chief Economist Justin Lin, expands on this idea in an op-ed in the Washington Post.

Sobering Numbers

The FPD Forum opened to a packed auditorium this morning - all the seats were filled in the main auditorium, and I heard that the overflow rooms were left with standing room only. Probably the star power of the keynote speaker Nassim Taleb was the reason that so many World Bank staff showed up promptly at 9am. Michael Klein, the Vice President of Financial and Private Sector Development, provided some sobering numbers in his welcoming remarks. Most sobering of all - corporations in emerging markets face a requirement of rolling over somewhere between $1.25 and $2 trillion in foreign exchange exposure in 2009. It's not clear where that financing will come from.     

Markets and Crises: Live-Blogging the FPD Forum

Over the next three days (the 24th through the 26th), the World Bank will be hosting the Financial and Private Sector Development Forum. The theme this year (how could it be otherwise?): Markets and Crises. Although it is an internal World Bank event, we'll be bringing you highlights from the many sessions, including the opening plenary with Nassim Taleb, author of the Black Swan, and Tim Harford, a columnist at the Financial Times.

Corporate and Government Transparency: Hong Kong (China)'s Experience

In January, Hong Kong (China) extended disclosure requirements for corporate executives. “Braving the financial storm with good governance” is the proud title of the January issue of Hong Kong (China)’s Independent Commission against Corruption Newsletter. In addition to remuneration disclosure, new rules made it mandatory for directors of listed companies to disclose all their current and past (during the past three years) directorships. Stricter disciplinary and possibly criminal sanctions for providing false information were introduced.

Hong Kong (China) also does well on disclosure by politicians - extensive financial and business interests’ declarations by its legislators are available online.

Hong Kong (China) owes its successful transformation from highly corrupt in the 70s to today being one of the most corruption-free societies to the activities of its anti-corruption watchdog. The Independent Commission against Corruption (ICAC) is mandated to deal with both public and private sector corruption. On the one hand, ICAC is empowered to conduct investigations up to searching and arresting suspects; on the other, it carries out a lot of advisory and guidance activities.

A robust system of checks and balances to ensure there will be no abuse is a major element in the success story of Hong Kong (China)’s ICAC. Crisis-stimulated empowerment of watchdog agencies should include building in stronger checks and balances. The checks and balances might include reporting to the executive, control by the legislature, prosecution separated from investigative powers, procedural guarantees by independent judiciary, media scrutiny and an open complaints channel.

Lessons from Past Financial Crises

Can the past teach us anything about the current crisis? Two reports imply as much. A recent report from the Independent Evaluation Group (IEG) of the World Bank looks at Lessons from World Bank Group Responses to Past Financial Crises. According to the folks at IEG:

Experiences with past crises bring out substantial differences in the effectiveness and results of Bank Group crisis support. With important modifications to reflect contextual differences between present and past events, these lessons can inform today’s response and help improve results.

And what can the past tell us about the response of the World Bank, particularly its lending operations?

Effectiveness of Crisis Support. World Bank loans were generally successful in supporting financial and some public sector reforms, but the poverty focus was insufficient. There were attempts to protect pro-poor spending and reduce the poverty impact of the crises (Brazil and Thailand), but overall attention to this area was insufficient. There were also disagreements with the IMF on exchange rate policy (Mexico and Russia), on the scale of macroeconomic adjustment (Indonesia and Thailand), and on what balance to strike between short-term crisis management imperatives and measures to alleviate corporate distress (Thailand). Evaluations also found that the loans were excessively ambitious in the range of problems they tried to tackle and in the large number of conditions they included. In addition, there were problems in several aspects of the Bank’s institutional response to crises. These included poor cooperation between the Bank and the IMF (and with regional banks), as well as among several units within the Bank.

Will the Currency Board Survive in Bulgaria?

Yes, we can. But since this is a lively topic in Bulgaria these days, it is useful to go through the reasons. A new Citibank report entitled CBA likely to ride out financial turmoil does just that.
 
Before going into the report, let me just say why the alternatives are bad. During crises, the common argument for devaluation is that your exports become more competitive. Italy has used devaluations successfully now and then, and more recently Russia, Belarus, Ukraine and Kazakhstan have all devalued their currencies. Other currencies like the Mexican peso, the Czech krony, the Polish zloty and the Korean won have depreciated by 30% or so too. It is not clear, however, that this has helped their exports. The December export numbers show a universal decline of 25-30%. The collapse in demand in many sectors is so great that depreciations are just not cutting it. In addition, for a country like Bulgaria where banks have borrowed in euros or dollars or Swiss francs and have given some credit in lev, a depreciation would be bad news. In sum, exiting the currency board arrangement won't pay off.

The Walmart Effect

Fourth quarter sales at Walmart went up 6 percent in the U.S. market. This suggests that as the financial crisis spread people substituted toward lower cost goods. The substitution effect can also be seen in U.S. imports of textiles and apparel. While imports of textiles and apparel fell 10 percent in November and 4 percent in December (relative to the same month the previous year), not all exporters were equally affected. Of the top 25 exporters, only exports from the low cost producers, Bangladesh, China, and Vietnam, grew in both months. In contrast, Canada, Hong Kong (China), Italy, Korea, Macao, Turkey, and Taiwan (China) all experienced declines over 20 percent in both months. The remaining large exporters, nearly all in Latin America and Asia, are struggling somewhere in between.

As the recession deepens, it is likely that there will be increasing substitution toward cheaper goods.  This offers a small silver lining to the low wage countries that produce them.

Revising the Balance of Consumption

Marinus Verhoeven, a lead economist in public sector governance at the World Bank, raised an interesting question to my earlier post, Living in a Madoff World:

I am not sure excess provides a good framework for thinking about the crisis...It may have had something to do with inadequate control of the money supply, misguided legislation, and an unequal distribution of wealth, but excess consumption--no, I don't think so...The second issue is more controversial...is there a moral dimension here?.

This got me thinking.  So, here's my response. I was using excess as metaphor for bubbles we have had in real estate, in consumer spending, in leveraging, and so on...and excess consumption too.
 
Like most economists, who first look for a phenomenon and then go find a theory to fit it, let me try the same here…
 
Over the last decade, many countries became frugal, some by their demographics such as Japan, others by choice like the middle income countries (MICs), which, afraid of exchange-rate volatility, ran precautionary current account surpluses and accumulated large stocks of foreign reserves. And yet others like China where a combination of demographics, exporting more and spending less, induced large savings.

A Second Chance for Abandoned Construction in Ukraine

Kyiv has a long history of abandoned construction, with some objects dating back as far as the beginning of 20th century. However, most of it has accumulated in the city (and throughout the country) within the two last decades. We can find at least several groups here:

1. Unfinished construction from perestroika times – mostly huge administrative buildings that were started in the eighties and abandoned just before or soon after the collapse of the Soviet Union, when public spending on construction was cut off;
2. Buildings that were started after 1995, with the rise of private building companies – mostly apartment blocks – and dropped at different stages of construction for several reasons. The builder may have gone bankrupt or due to frauds with funds collected from individual investors;
3. Construction frozen as a consequence of the current financial crisis and lack of liquidity. This last group includes both residential and commercial real estate.

Fortunately, the Ukrainian language has a word for this phenomenon: dovgobud. Some of these are lucky and eventually get finished; others are forgotten, and in some very rare cases ruined. Dovgobudy in the third category, however, may be getting a second chance. Overall, as for apartment blocks, around 75-80 percent of objects have been put on hold, and as for commercial real estate – it’s close to 30-40 percent. Just before the end of 2008 the Ukrainian Parliament adopted a special law aimed at mitigating the influence of the financial crisis on building construction. The Government will now allocate UAH 3 billion (roughly USD 375 million) to help finish the objects built by at least 70 percent in 2009. Those built by 50-70 percent will be covered by the program in 2010.

World Crisis Index

Intrade, one of the most popular prediction markets out there, has put together a world crisis index that aggregates markets that indicate the probability of recessions, unemployment, falls in the stock market, and the like. The index opened at 50.0 on January 27. Unfortunately, Intrade hasn't published a graph to track the index over time, but as of 2pm GMT today, the index had creeped up to 51.0, meaning that propsects for 2009 have gotten just a little bit worse over the last two weeks.

Enforcing Transparency

The financial crisis gave new impetus to demands for more transparency and more accountability. “The global financial crisis [is caused] in part by greed and corruption,” was the announcement last December by the United Nations Secretary General Ban Ki-moon. How to enforce transparency? 
 
There might be a few good ideas to learn from the American experience of setting up a transparency watchdog. These ideas were presented by Walter M. Shaub of the US Office of Government Ethics (OGE), the main speaker at a brown bag lunch at the World Bank last week.
 
The work of the OGE is focused on prevention. Assets and interests disclosure is the main tool to identify conflicts of interest among government officials. If a conflict of interest is apparent from the declaration, the agency works with the official on resolving such conflict before it creates prejudice. Increasingly complex conflict-of-interest legislation increases the probability of inadvertent violations. The right advice is important - independent from law enforcement bodies and tax authorities, the ethics agency is conscientious of the trust that its clients place in it.
 
Promoting transparency comes before fighting corruption. It is generally true that a psychological stance of promotion creates acceptance while struggle against something incites resistance. Transparency might be just like healthy food and a healthy lifestyle – it requires steady effort to build up the right habits.

A Return of the Investment Banks?

Not likely, or at least not very desirable, according to a new working paper from Asli Demirguc-Kunt and Harry Huizinga. In Bank Activity and Funding Strategies, the authors look at an international sample of 1,334 banks to get a handle on the risk-return tradeoff of various activity and funding strategies. Their findings suggest that the failure of investment banks in the U.S. was not really a statistical outlier or a once-in-a-century event:

The main contribution of this paper is to provide evidence on what bank income and funding strategies perform well in terms of producing profitable and stable banks. In particular, we examine how a bank’s income and funding mixes affect the rate of return on its assets and Z-score or distance to default. Our basic regressions suggest that at low levels of non-interest income and non-deposit funding, there may be some risk diversification benefits of increasing these shares, although at higher levels of non-interest income and non-deposit funding shares, further increases result in higher bank risk...

...The evidence presented in paper suggests that traditional banks – with a heavy reliance on interest-income generating and deposit funding – are safer than banks that go very far in the direction of non-interest income generation and funding through the wholesale capital market. Our results provide a strong indication that banking strategies that rely preponderantly on non-interest income or non-deposit funding are indeed very risky.

Figure 2: Trend of the fee income share

(The fee income share is the share of non-interest income in total operating income. This figure displays the trend of the fee income share from 1999 to 2007. The fee income share data are yearly averages. The data are from Bankscope.)

Increasing University Enrollment as Crisis Response

My friends in economics departments around the United States tell me that applications to PhD programs have trippled this year relative to last year. Some law schools have also reported a large increase in applications. This is because the unfolding crisis is putting lots of young people - particularly Wall Street types - out of jobs. What better time to get a graduate degree?

Even business schools report higher demand, even though one wonders what they really teach students there. Some "modesty" courses may be in order.

Increasing university enrollment is a good anti-cyclical device. In a country like the United States, this happens naturally as people with dimmed work prospects upgrade their skills. In smaller countries, this may be trickier as universities may be less prepared to meet increasing demand. Especially if they depend on government subsidies for financing a share of their operations. Hence, the need for a possible public policy.

Georgi Angelov, a senior economist at the Open Society Institute in Sofia, and I have just written a short paper on this topic, using data for Bulgaria as an example. The policy proposal is relevant for any country, however.

We develop a proposal for expanding university enrollment in Bulgaria by 30,000 students (or about 12% over 2008 enrollment). This is done by creating a student loan program guaranteed by the government. Student loans, offered competitively by commercial banks, would cover up to 50% of the cost of education. The remainder is covered by direct government subsidies (as is currently the case) and household income. The proposal is budget neutral – the government spends as much money on university education as in previous years.

Trade Still Weak but Not Worse in December

More than 60 countries have now reported trade data for November and they are uniformly weak, with imports on average down 14 percent and exports down 17 percent, as compared with the same month last year. In addition, 22 countries have now reported December data. While trade continues to be weak, there is little change since November, and nearly half of the countries show some improvement. So, while conditions did not improve in December they did not worsen significantly either.

Another indicator that the trade situation did not deteriorate further in December comes from the Baltic Dry Index. (The BDI is issued daily by the Baltic Exchange, which canvasses brokers around the world about the cost of shipping cargo of raw materials on various routes.) After a 93 percent drop since the early summer, November is the month when the Baltic Dry Index (BDI) appears to have bottomed out, suggesting that demand for shipping was at a low in that month.   

While this is not exactly positive news, it could have been a lot worse.

The Man with the Two Trillion Dollar Plan

On Monday, World Bank Chief Economist Justin Lin proposed the establishment of a $2 trillion Global Recovery Plan. A new Marshall Plan, of sorts. You can listen to his presentation and read about it here.
 
The issue is that the United States of today is in a different position than the United States after the Second World War. It is hard to imagine Congress giving much money for causes abroad when the domestic economy is hurting. The same applies to the other rich economies. If anything, one may expect some lean years in development aid.

Trained to Be Dull

Nassim Taleb, author of the bestseller The Black Swan, doesn't have a very high opinion of bankers:

...think of a bank chairman whose institution makes steady profits over a long time, only to lose everything in a single reversal of fortune. Traditionally, bankers of the lending variety have been pear-shaped, clean-shaven, and dress in possibly the most comforting and boring manner, in dark suits, white shirts, and red ties. Indeed, for their lending business, banks hire dull people and train them to be even more dull. But this is for show. If they look conservative, it is because their loans only go bust on rare, very rare, occasions. There is no way to gauge the effectiveness of their lending activity by observing it over a day, a week, a month, or...even a century!

Taleb will be speaking at the opening session of the upcoming Financial and Private Sector Development Forum at the World Bank, along with Tim Harford, a columnist at the Financial Times, and World Bank President Robert Zoellick. I expect the discussion will be lively. 

Remittances: Not as Bad as Predicted

Writing on the World Bank People Move blog, Dilip Ratha points out that not all the dire predictions about the crisis have come to pass. At least in the cases for which we have data, remittances have proven resilient. Mexico - one of the most important recipients of remittances and a country for which there is good data - is a case in point:

Remittance flows to Mexico dropped 10 percent year-on-year in December 2008, bringing the 2008 12-month total to $25 billion, a 3.6 percent decline compared to $26 billion registered in 2007. This decline is much smaller than the 8 percent decline projected by Mexico in August 2008.

As long as this is not a blip on the screen, remittances should help cushion the blow of the retreat of other forms of private capital flows. The Institute for International Finance warned late last month that "the outlook for private capital flows to emerging economies has deteriorated significantly in recent months." The fate of stimulus packages in rich countries consequently becomes all that more important for the rest of the world, as migrants will have a hard time keeping or finding jobs in the face of rising unemployment rates. 

Russia: Corruption Prevention during the Financial Crisis

Editor's Note: Larisa Smirnova is a consultant at the World Bank and is currently working with the Transparency indicator team. She previously worked with the United Nations High Commissioner for Refugees in Russia and Japan.

Experts at Troika Dialogue Group, a Russian investment company, estimate that the financial crisis may naturally decrease corruption in the country due to… lower oil prices! As the Russian economy is largely dependent on oil exports, lower oil prices means less money and therefore… less bribes?

Among fears that government anti-crisis money may become another easy prey for corruption, Russia adopted a new anti-corruption law in December 2008. After heated debates, financial disclosure requirements were extended to family members of government officials. However, the content of the declarations is confirmed to be not just publicly unavailable but constituting a "state secret".

The conclusions of a recent paper, Disclosure by Politicians, which compared financial disclosure procedures in 175 countries, suggest that Russia’s corruption prevention measures might not be the most effective ones. Analysis showed that family members’ disclosure does not correlate with lower perceived corruption. Publicity of disclosure, on the contrary, appears to be the crucial imperative for political accountability.

Creating Jobs for Ukraine’s Migrant Workers

It seems that Ukraine won’t be seeing a massive return of its migrant workers due to the economic downturn, as was predicted last fall. At least, not from EU member states. Officials from the state employment service say the migrants who have returned from abroad due to lay-offs are mostly construction workers that were employed in neighboring Russia. Overall, the migration experts estimate between 200,000 and 250,000 Ukrainian migrants returning home.

The data on Ukrainians working abroad are very ambiguous. According to the official statistics, slightly over 2 million Ukrainians are currently employed abroad, with around 48 percent in Russia and almost the same in EU countries, mainly Spain, Poland, Czech Republic, Italy and Portugal. Alternative estimates that include illegal migrants reach figures that are almost three times as high. There are also different assumptions as to amounts sent home by the migrants in remittances, ranging from Euro 2 to 8 billion annually.

In the mid-1990s it was common to hear politicians and social workers complaining about “brain drain” – the mass emigration of Ukrainian scholars, technicians, doctors and other highly qualified staff. The profile of Ukrainian migrant workers has changed significantly during this last decade. A few are leaving with the intention to settle for a lifetime, while most people seek to earn money and come back. Now it’s mainly construction and agricultural workers (mostly men) and also women employed in the area of household and nursery services. Ukrainians with advanced degrees and sufficient work experience are often ready to accept much lower-skilled jobs than they occupied at home. One example is a teacher of physics who is now working as a hotel maid in Italy.

Competitive Devaluations?

Kazakhstan’s central bank devalued the tenge by 18 percent yesterday. The central bank is letting the tenge weaken for the first time since it started managing the currency in 2007. Kazakshstan joins Russia, Ukraine, and Belarus in abandoning attempts to prop up exchange rates as currency reserves dwindle and economies stagger. A number of other resource-rich countries have also seen their currencies fall substantially against the dollar over the last few months, including Brazil, Mexico, and South Africa. 

Maintaining a currency’s value under pressure is costly. Kazakhstan spent $3.5 billion, or 16 percent, of its foreign-exchange reserves supporting the tenge. Russia spent between $7 and $8 billion in one day last month defending the already weakened ruble. And the longer the process lasts, the more money that goes down the drain. Argentina’s net reserves fell by $20 billion in 2001 before the currency board eventually collapsed the following year. 

Some countries attempt to maintain currencies because of a history of inflation. Sudden and large depreciations can be destabilizing, leading to inflation and higher interest rates. Depreciations also increase the cost of foreign currency debt. But depreciation is not necessarily bad for growth. Depreciation mimics an export subsidy and import tax, boosting exports and consumption of domestic goods. This can help countries to grow when domestic demand is weak or declining. 

But what happens if many currencies collapse simultaneously? This puts downward pressure on import prices, fueling deflation in foreign markets. Kindleberger has argued that such competitive devaluations are part of what led to the Great Depression. 
 
Volatile currency movements are already aggravating uncertainties in global financial markets. But at least so far, most of the these currency declines are understandable. Sharp declines in commodity prices have worsenened the terms of trade of the resource exporters at the same time as western capital has dried up. If depreciations spread to the large manufacturing countries then there could be real trouble.

Guerilla Trade Tactics

In 1930, the Smoot Hawley tariff was implemented in the United States, raising tariffs on nearly 900 goods. The Europeans retaliated with similar tariff hikes. World trade fell by two-thirds from 1929 to 1934 largely as a result of declining demand during the world depression, but also because of the increased tariffs. Such conventional trade warfare finally came to an end with the advent of the GATT in 1947.

Thanks to the rules provided in the WTO, the successor to the GATT, a conventional trade war is now unthinkable. But as demand is plummeting, countries are seeking ways to shift it to domestic goods. This is where guerilla trade tactics come in. The WTO Secretariat reported that in the first half of 2008 (the most recent data available) there was a 39 per cent increase in antidumping investigations among members as compared with the same period in 2007. Subsidies around the world are being directed at specific domestic industries. Now, the U.S. stimulus package appears likely to include a “buy American” clause. 

Such guerilla trade tactics may be just as dangerous as a conventional trade war. A key issue is the non-transparency of these antidumping duties, countervailing duties, and targeted domestic subsidies. If these modes of discrimination explode it will take a long time to disentangle them and reopen the trade system. Not to mention the resources wasted and uncertainty they generate for importers (for example, in the United States, it takes the ITC and ITA between 235 to 390 days to reach a final conclusion in an antidumping investigation!). 

The WTO has been among the most successful of the international institutions. The ongoing Doha Round—with all its promises—may be able to claim victory after all if it can simply prevent protectionism from surging during the global recession.

Share Prices and Accounting Reclassifications

Editor's Note: The following post is a joint contribution by Costas Stephanou and Haocong Ren.

As some may recall, Deutsche Bank (DB) took advantage of the change in IFRS rules (under pressure from the EU Commission) and reclassified almost Euro 25 bn. of hard-to-value (toxic?) securities from its available-for-sale portfolio to the held-to-maturity portfolio in October 2008. This allowed it to improve its reported net income for 2008Q3 by more than Euro 500 million and to report a quarterly profit, as opposed to the loss that analysts were expecting. Its stock price shot up 15% on the day of the announcement (October 30, 2008) vs. 1.2% for the relevant benchmark index (S&P 500 financials), and similar behavior could be observed for its 5-year CDS spread vis-a-vis the relevant benchmark (iTraxx Europe senior financials).

This jump in the share price washes away (based on a preliminary statistical analysis - see the attached Excel file) when looking at the evolution over a longer time period vis-a-vis the benchmark. It may also be due to a perceived market relief that DB's reported tier one capital adequacy ratio (partly as a result of the accounting changes) exceeded 10% and therefore DB had no apparent need for more capital raising  that would lead to shareholder dilution. However, it is instructive to see how - at least anecdotally - accounting rules have real effects on share prices since DB's accounting reclassifications represented the main reason why analyst expectations were exceeded, as was pointed out explicitly in the financial press. (See here, here, here, here, and here.) 

Kaufmann Takes Aim At Corruption

Dani Kaufmann, one of the pioneers of the governance agenda at the World Bank, discusses the role that corruption played in the financial crisis:

There are multiple causes of the financial crisis. But we can not ignore the element of "capture" in the systemic failures of oversight, regulation and disclosure in the financial sector. Concrete examples abound.

First, the way Freddie Mac and Fannie Mae spent millions of dollars lobbying some influential members of Congress in exchange for, among other things, lax capital reserve requirements for these mortgage giants.

Second, how AIG's "small" derivatives unit located in London managed to obscure its accounts, be governed by lax regulatory oversight, and take inordinate risks that effectively brought down AIG's empire of 100,000 employees in 130 countries, accelerating the global financial crisis...

Third, how giant mortgage lenders such as Countrywide Financial switched regulators so to fall under the lax oversight of the Office of Thrift Supervision, which was funded by fees paid by the regulated banks (and which also supervised AIG's derivative unit).

Fourth, how in April 2004, during a 55-minute-long meeting at the Securities and Exchange Commission, the largest investment banks persuaded the SEC to relax its regulatory stance and allow them to take on much larger amounts of debt.

Finally, Madoff's giant Ponzi scheme, some of which appears to be plain fraud, though system-wide irregularities also point to subtler forms of corruption and capture. Years ago the SEC knew that Madoff, who had served on the commission's own advisory committee, had multiple violations and was misleading it in how he managed the funds of his customers. Yet the SEC failed in unmasking the Ponzi scheme.

Worse yet, more governance challenges are yet to come, as fiscal stimulus packages present all kinds of opportunities for the ethically challenged. Kaufmann recommends far-reaching measures to improve transparency as an antidote. I agree with that but doubt that's enough.

Disclosure by Politicians

After three years in the making, we have just completed a large research project on the disclosure of conflicts of interest and business dealings by politicians in 175 countries. The resulting paper, Disclosure by Politicians, a joint effort with Rafael La Porta (Dartmouth), Florencio Lopez-de-Silanes (EDHEC Business School) and Andrei Shleifer (Harvard), is the first to look at what disclosures are required by law, which of these are made public, in which countries someone actually checks whether the disclosures are made or not, and what penalties exist in the event of faulty or incomplete disclosures.
 
The topic will undoubtedly raise heat in countries that don't do well. More relevant for the current crisis, however, one can imagine a call for similar types of disclosures by CEOs of publicly-traded companies and perhaps even privately-held financial companies. The scandals starting to emerge from the crisis - take Madoff and Satyam - suggest there is considerable sleaze in the private sector too.
 
The good news is that the methodology now exists and can be adapted to the captains of industry.