Debt Crisis Demands Strong Financial Regulation in West

The near-epidemic sovereign debt crisis draining the vitality of a number of eurozone economies is trumpeting the need for greater financial regulation in the western world.

It's true the United States and other western countries have been tightening their grip on financial markets after over-stretched derivatives and irresponsibly greedy financial institutions lured the world deep into the abyss of a global financial crisis not experienced since the Great Depression.

It's also true, and unfortunate, that these life-saving reforms have increasingly lost momentum since the world economy showed signs of recovery in the second half of 2009.

Old enemies always die hard. Massively hurt in the crisis and trying to sabotage the rising government oversight, the surviving vested interests in the financial sector have strongly opposed reform and stalled legislation in Western countries.

Opportunities for rooting out the sources of the global financial crisis were pitifully lost and, in exchange, we have zero substantial reform progress and have opened another Pandora's Box, unleashing the current debt crisis.

The deliberately complex financial derivatives have retained their omnipresence in the soul of the financial markets, including credit default swaps (CDS). Basically insurance against the default risk of debt issuers, the CDS have become more like financial gambling.

Many investors, who might not directly invest in the Greek Government bond markets, could buy or sell Greece-related CDS while financial companies are more than willing to sell CDS to make a commission fee.

The CDS market has become a barometer of investors' sentiment towards the default risk of the Greek Government. When more investors are betting Athens will go "bankrupt," the price of a CDS contract could rise considerably.

The borrowing costs of the Greek Government could accordingly also surge, making it harder for Athens to meet its debt obligations.

The most problematic element is that the CDS market is not centralized. Its over-the-counter nature means investors and regulatory bodies have not sufficient information to understand what is going on. In other words, the market can be manipulated by major financial companies to turn their bets on government debt into large profits.

The role of international credit rating agencies is also dubious. Firms such as Standard & Poor's, Moody's Investors Service and Fitch are given too much power with no effective review or supervision in deciding who is creditworthy and who is not.

They have accumulated enormous authority over the years to the point where their decisions, which carry such gravity, go unquestioned and unchallenged.

Abusing the blind trust of investors, debt issuers and regulators, credit raters have turned financial products into a pool of toxic waste, leading to the outbreak of the subprime mortgage crisis in the U.S. in 2007.

If left unchallenged, this kind of authority will ensure their decision-making continues to escape objective assessment and the turbulence in the financial markets will spread from the eurozone to the entire world.

Developing countries, which have always been persistent and full-throated advocates for greater international financial regulation, are also the victims of the cascading economic turmoil, whose epicenter is found in the developed world.

In retrospect, the Asian financial crises in the 1990s were also created by excessive speculative behavior of some Western investors, who had not been properly regulated back in their home countries, not to mention at the international level.

Without comprehensive financial reform and a tighter regulatory system, the next round of economic chaos will be the next in a line of dominoes, the first block of which has already been knocked down.

(Xinhua News Agency May 12, 2010)