World economic leaders, bankers and economists now believe that the imbalanced global economic structure and the lack of a more rational approach to the international monetary system are to blame for the global financial crisis. As one of the economists who are doing their best to diagnose the crisis and offer remedies, Wu Xiaoling, former Vice Governor of the People's Bank of China and Vice Chairwoman of the Financial and Economic Affairs Committee of the National People's Congress, elaborated on her ideas about international financial reform in an article in Economic Information Daily. The following are edited excerpts of her article.

The blame

The low savings rate in the United States and twin deficits in fiscal and current accounts at the macro-economic level should take the blame. The U.S. Government and households have relied on debts to maintain their high spending rate. The ratio of household debt to disposable income has increased from 101 percent in 2001 to 138 percent at present, while the U.S. debt-to-GDP ratio stands at 73 percent, up from 60 percent in 2000.

Apart from the debt-fueled spending spree, the blame also belongs to the U.S. real estate bubble caused by sub-prime mortgage lending and the drastically loose monetary policy that led to global excess liquidity. The U.S. Federal Reserve has lowered the benchmark interest rate 13 times since 2001, reaching a record low of 1 percent in 2003.

At the micro-level, commercial banks and derivatives traders such as investment banks, hedge funds and private equity corporations were responsible for the crisis. Easy profits lured financial institutions to betray the principle of serving the real economy and recklessly develop financial derivatives through asset securitization, which created credit-fueled asset bubbles.

On the risk monitoring and supervision front, the U.S. banking regulator failed to put major investment banks' leverage ratios and derivative innovations under effective control. Merrill Lynch and Lehman Brothers, for example, were leveraged up to 30 times over.

The financial crisis that originated in the United States has had a profound impact on the rest of the world because of the imbalanced global economic structure and the lack of a more rational approach to the international monetary system. While developed countries save less and spend more, developing countries spend less but save more; while developed countries specialize in the production of knowledge-intensive, high value-added goods and services, developing countries engage in low-end, low value-added manufacturing activities. Developing countries have accumulated huge U.S. dollar-denominated foreign exchange reserves by exporting goods to the United States. By purchasing U.S. treasury bonds and securities, they backed up debt-fueled spending by the U.S. Government and households.

Boost market confidence

The financial crisis triggered the credit crunch. Commercial banks had to undersell large quantities of derivatives for liquidity support, which further squeezed asset prices, entailed more losses and weakened their lending capabilities. Besides, these banks didn't know who would be the next to fall apart and thus became too cautious in their lending.

Efforts should be made first to address the risks with credit default swaps (CDS) transactions in order to restore the function of financial institutions as credit referencing agencies. Most derivatives including CDS are sold "over the counter" (OTC) through private trades rather than on public stock or commodity exchanges. As the deals are secret, they do not help other investors assess risk, and often investors, regulators and other analysts do not know what liabilities a company has taken on. This private transaction pattern could magnify distrust between trading partners when the market turns bad and result in overestimation of risks. If a central settlement system could replace the OTC system, it would help enhance the transparency of CDS transactions and effectively lower the credit risk through multilateral netting arrangements, which involve net settlements among more than two parties conducted by a central counterparty. The Intercontinental Commodity Exchange was approved by the U.S. Securities and Exchange Commission (SEC) to begin clearing CDS on March 9, but the CDS clearing mechanism has yet to cover all bilateral transactions to serve the global market.

Serve the real economy

Financial innovations have deviated from their purpose of serving the real economy. Some derivatives evolved from tools that help shun risks to speculation tools that court high returns, and circulated only within the financial industry. Excess liquidity, sophisticated risk management models and banks' profit-driven incentive schemes all accounted for the deviation.

Banks should not sell or buy complica-ted derivatives allowing investors no access to the information of their underlying assets. If investors can only depend on the rating and review of a certain derivative and their faith in derivative brokers in decision-making, they can easily be cheated. Financial derivatives should be prohibited from being reproduced many times over to limit their risks and prevent over-speculation.