Will “It worked” come back to haunt G20?


The G20 may face a “mission accomplished” moment akin to former President George W. Bush’s premature declaration of victory in Iraq unless leaders quickly make good on pledges for substantive financial reforms.

Leaders from the Group of 20 rich and developing nations were so confident they had succeeded in tackling the global financial crisis and recession that they included in the preamble of their final statement on Friday this bold, two-word declarative sentence:

“It worked.”

“It’s hubris,” said Simon Johnson, a former chief economist of the International Monetary Fund.

Johnson, who is now a senior fellow at the Peterson Institute for International Economics in Washington, listed possible pitfalls including growing losses on commercial real estate loans, the need to recapitalize European banks, and stubbornly high unemployment in most developed countries.

Any of those has the potential to trigger an economic setback serious enough to force a re-thinking of policy.

Even though G20 leaders insisted they were on guard against complacency, Johnson said they may have assumed success too soon, much like Bush’s infamous May 2003 Iraq speech on an aircraft carrier in front of a banner that read “mission accomplished.”

“What can you point to in terms of real regulatory reform since April?” Johnson said, refering to the last G20 leaders’ summit in London.

The G20 acknowledged there was considerable work to be done to make the global economy less susceptible to crises, and said they would work toward “growth without cycles of boom and bust and markets that foster responsibility not recklessness.”

Mustering the political will back home to put in place the necessary rules won’t be easy, particularly in the United States where the contentious issue of reforming healthcare holds the attention of Congress and regulatory overhaul seems to have been relegated to the back burner.

Anil Kashyap, an economics professor at the University of Chicago‘s Booth Graduate School of Business, said he would give the G20 an “incomplete” grade.

“It’s too early to tell whether they’ve got a reasonable exit strategy for unwinding some of the things they’ve done, and it’s really unfortunate that they haven’t attended to some of the gaps in the regulatory arrangements,” he said.

The G20 leaders have won plaudits for the estimated $5 trillion they have collectively injected into their economies to revive growth. Cross-border cooperation among central banks helped to ease a credit crunch, as did emergency loans and guarantees put in place to restore the flow of credit to consumers and businesses.

But big questions remain about how healthy the global economy will look once those crutches are removed, which the G20 acknowledged when it committed to keeping supports in place until sustainable recovery is assured.

Kashyap was most concerned that the United States had yet to come up with a way of safely shutting down large financial firms in danger of a disorderly collapse so that they don’t trigger a global panic as did the failure of investment bank Lehman Brothers in September 2008.

“If some other large institution got into trouble the same way, they’d have no better set of options than they had a year ago, and I think that’s pathetic,” Kashyap said.

The U.S. Federal Reserve and Treasury Department have been pushing Congress to pass legislation giving regulators authority to wind down firms in trouble, much like the Federal Deposit Insurance Corp — or FDIC — can shut failing banks.

U.S. Representative Barney Frank insisted this week that Congress would indeed establish “death panels” for firms deemed too big to fail so that taxpayers won’t be on the hook.

The G20 set a 2010 deadline for big firms to put in place contingency and resolution plans, but because these companies operate in many countries with differing bankruptcy laws, finance experts think international rules are necessary.

The International Monetary Fund warned earlier this year that European banks need to raise hundreds of billions of dollars in capital to cushion against future losses, although many European leaders objected to the Fund’s methodology.

Another concern is the potential political problem that governments and central banks will have when the time comes to remove economic supports.

One of Kashyap’s worries is that the Fed will get push-back if it tries to dismantle its special lending programs and raise interest rates while unemployment remains high.

Raising rates tends to slow the economy, and that means fewer jobs are created, which doesn’t sit well with voters — or with members of Congress facing 2010 elections.

“The exit problems are all political,” Kashyap said.

The G20 made it clear it was not ready to deal with that problem until the economy is in better shape.

“The leaders at the G20 meeting all agreed that the crisis is not over yet,” South Korean President Lee Myung-bak said in an interview on Friday. “That is why we are not in a position to talk about exit strategies quite yet.”

South Korea hosts the G20 summit next year, and is poised to become the first in the group to raise interest rates. If the global economy takes a turn for the worse by then, it may be an uncomfortable meeting.