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The global financial crisis that began in 2007 marked the failure of an ambitious experiment in financial diplomacy. Since the 1970s, officials from the world's leading economies have worked together to regulate financial institutions with the aim of making the international financial system safer. When the collapse of the U.S. subprime mortgage market triggered a cascade of events that put that new international regime to the test, the results were disastrous. International agreements on the regulation of banking and securities did little to protect against a financial meltdown that severely damaged the world economy.
Inevitably, painful experience has fueled a drive to get financial regulation right. The G-20 presidents and prime ministers who met in Pittsburgh last September found themselves discussing such arcane matters as bank leverage ratios and over-the-counter derivatives. A bevy of obscure multilateral organizations, from the Bank for International Settlements (BIS) to the International Accounting Standards Board, are now advancing proposals intended to prevent crises in the future. The G-20 finance ministers and central-bank governors are set to discuss international financial regulation in Berlin in May, and regulation will be on the agenda when the presidents and prime ministers convene again in Toronto in June. Meanwhile, some prominent bankers are proposing an international fund to insure against the collapse of any institution deemed "too big to fail." Regulatory cooperation is clearly a growth industry.
But that growth is not necessarily good for the global economy. Over three decades of experience have shown that international cooperation in financial regulation brings as many risks as benefits. The attempt to harmonize standards across borders has led many countries to make the same mistakes, adopting misguided rules in some areas and none at all in others. National governments have deferred important regulatory changes while waiting for multilateral agreements that may not be signed for years, if ever. Meanwhile, truly critical international issues, such as allocating responsibility for the oversight of banks operating across borders, have been addressed inadequately or not at all.