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OECD says US, EU market supervision changes needed

Overhauls of US market supervision and European policy coordination are needed to plug regulatory gaps highlighted by the market crisis, the OECD said in its latest economic outlook.

Initially billed as a first step to refound post-war Bretton Woods financial institutions, a Group of 20 meeting in Washington earlier this month already agreed to pursue reforms that respond to some of the OECD concerns.

“The reform agenda is comprehensive and the many complex issues involved will take time to address,” OECD Chief Economist, Klaus Schmidt-Hebbel, said in the outlook.

“It will be important, therefore, to remain focused on the objective of strengthening the global financial architecture,” he said.

The OECD backed a US Treasury plan to shake up domestic market supervision divided among several agencies that oversee different segments such as stocks, derivatives and insurers.

“This system is no longer well suited to supervise financial institutions that increasingly operate across the traditional sectoral boundaries,” the OECD said.

“No single regulator has all the information to monitor systemic risk or the authority to take coordinated action throughout the financial system,” it added.

Unregulated institutions such as hedge funds and private equity have not yet been a feature of the market crisis, the worst since the Great Depression, but it was time to look at how to limit risk from these two sectors.

“At a minimum, the market stability regulator should foster counterparty-risk management that discourages regulated institutions from becoming excessively exposed to highly-leveraged institutions outside the regulatory framework,” the OECD said.

The US Administration also had little choice but to bail out the country's two government sponsored enterprises, Freddie Mac and Fannie Mae so that mortgage lending continued.

“However, the longer term advantages of these GSEs are doubtful,” the OECD said.

The two GSEs imply “huge financial risks” for the taxpayers and unfair competition for the private sector and in the longer term the securitization of mortgages should be turned over to the private sector, it said.

The bailout of Fannie Mae, Freddie Mac and several banks showed the “too big to fail problem” was widespread in the United States and regulatory changes will need to tackle this.

In Europe governments cooperated swiftly to bail out major banks but rules for preventing, managing and resolving financial crises in the region needed beefing up to deal with the major cross-border operations, the OECD outlook said.

Europe's ad hoc approach to banking failures will most likely lead to an under provision of recapitalization because of the unclear nature of who bails out a cross-border group.

“The absence of an explicit burden sharing arrangement for dealing with banking crises with cross-border dimensions could lead to potentially damaging delays,” the OECD said.

The OECD said a centralized store of prudential information on banks would also improve supervision. (Reuters)