* U.N. agency calls for overhaul of financial system rules
* State intervention and oversight of markets, forex urged
* Market prices of vital goods should be regulated - UNCTAD
By Jonathan Lynn
GENEVA, March 19 (Reuters) - Tough international rules are needed to regulate currency, commodities and other financial markets and “close down the big casino” to prevent more economic crises, a U.N. agency said on Thursday.
The United Nations Conference on Trade and Development (UNCTAD), in a report prepared ahead of next month’s G20 summit, called for comprehensive reform and regulation of markets to weed out trading that has no “social return”.
“We have learnt now that financial market participants not only have no idea about the equilibrium, but they tend to drive financial prices systematically away from the equilibrium,” said the report, “The Global Economic Crisis: Systemic Failures and Multilateral Remedies”.
“Governments do not know the equilibrium either, but at some point they are best-positioned to judge when a market is in disequilibrium.”
UNCTAD has long warned of the dangers of speculation and imbalances, and in the report it said the United Nations must play a central role in market reform because of its global membership and capacity for impartial analysis.
Financial systems are intrinsically unstable and prone to boom and bust cycles, so they need close oversight, it said, saying the present crisis arose from unregulated speculation in assets from housing to complex trading instruments.
Regulation must span all markets, because for instance controlling foreign exchange alone could drive speculative investors into commodities instead, UNCTAD said, arguing: “Nothing short of closing down the big casino will provide a lasting solution.”
Highlighting the problems of patchwork rules, the agency said the introduction of capital ratios to control risk in banks led to the creation of a “shadow banking system” as money was moved off balance sheets or outside the regulated sector.
At its peak, the U.S. shadow banking system held assets of about $16 trillion, about $4 trillion more than regulated deposit-taking banks, UNCTAD estimated. While regulation focused on banks, it said it was the collapse of the shadow banking system that kick-started the crisis.
Regulators must weed out unproductive financial instruments that increase risk without providing a “social return”, it said, using as an example credit default swaps that provide a useful hedging service but have drawn 10 times more investment than what is needed.
Financial instruments that do not contribute to long-term economic growth or facilitate household consumption do not provide any true social return, the Geneva-based agency said.
Such instruments that generate high returns for a while without social utility act as a casino superimposed on the real economy, according to UNCTAD.
In the United States, it said policymakers and regulators should have been suspicious of a financial industry that constantly aimed at double-digit returns in an economy that naturally grew at a much slower rate.
The report called for more transparency in futures markets for commodities such as food and petroleum.
Regulators should have more power to step in when futures speculation which is aimed at profits for arbitrage investors, rather than as a hedge to protect producers against normal price swings, drives up prices for vital goods such as food, it said.
Investments in commodities to diversify portfolios or hedge inflation risks may have contributed in the past few years to sharp food price fluctuations, creating hardship for millions of poor people around the world, it said.
In confronting the next wave of the crisis, it will be critical to stabilise exchange rates with direct and coordinated government intervention, supported by multilateral oversight, the report said.
Exchange rate adjustments should not be left to market forces alone, according to UNCTAD, which argued changes in nominal exchange rates should reflect differences in rates of inflation between trading countries. (For the full report go to: here ) (Editing by Alison Williams)