Global financial reform needed, but not in the works

The nation’s state legislators, meeting in Philadelphia this week, may have hoped to hear two economists tell them the recession is ending, the stimulus package is working, and things will be better next year.

One out of three ain’t bad.

The U.S. economy could be a few months from bottoming, but David Wyss, of Standard & Poor’s, and Simon Johnson, of MIT, provided many reasons why federal stimulus efforts have lagged and unemployment will remain a challenge in 2010.

Worse, given the trillions committed to financial bailouts, we haven’t fixed anything yet, they warned.

All of Washington’s efforts on financial reform are aimed at patching a U.S. system built in the 1930s. With today’s interconnected financial giants, leaders of the developed and developing nations need to adopt global accounting standards and regulatory mechanisms, Wyss said.

But “it’s not even being discussed,” he said.

Johnson was more blunt about the potential for new financial crises: “We’re going to be just as vulnerable going forward.”

The two were part of a panel discussion on the economy at the National Conference of State Legislatures at the Convention Center yesterday. (Comcast Corp. executive vice president David L. Cohen also took part.)

Moderator Kathleen Hall Jamieson, of the University of Pennsylvania, asked what states can do to address financial-sector reform. “States are doing their best to make it worse,” Wyss said.

How? Insurance regulation is still done at the state, not federal, level. AIG, rescued with a $180 billion federal bailout, had 200 regulators, Wyss said, noting, “When anything has 200 regulators, you have no regulator.”

In effect, the states are giving companies “the ability to do regulatory arbitrage,” Wyss said.

Johnson agreed. “Big companies are gaming you,” he told the state legislators and staffers in the crowd. Under the current system, states are pushing “risks down the road.”

He also emphasized that the U.S. must make its largest financial institutions smaller. “You can’t prevent failures or bubbles. But when they occur, you must make sure the damage is less than” what the world has experienced in this crisis, he said.