The Global Financial Crisis: A Plan for Regulatory Reform
About This Event

The Committee on Capital Markets Regulation has issued a comprehensive report on the causes of the financial crisis and recommended regulatory remedies in "The Global Financial Crisis: A Plan for Regulatory Reform." The committee identified four objectives of improved regulation: reducing systemic risk, improving disclosure, unifying the existing regulatory structure, Listen to Audio

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and encouraging international regulatory cooperation. In line with these objectives, the report outlines fifty-seven specific recommendations for restructuring financial regulation, covering such issues as credit default swaps, capital requirements, regulation of nonbank financial institutions, resolution of failed financial institutions, credit rating agencies, and accounting standards.

Hal S. Scott, director of the Committee on Capital Markets Regulation and Nomura Professor and director of the Program on International Financial Systems at Harvard Law School, will present the report's findings. Peter J. Wallison, the Arthur F. Burns Fellow in Financial Policy Studies at AEI, and Douglas J. Elliott, an economic studies fellow at the Brookings Institution, will discuss the feasibility and efficacy of these recommendations. AEI's Alex J. Pollock will moderate.

This event is cosponsored by AEI, the Brookings Institution, and the Committee on Capital Markets Regulation.

Event Summary

WASHINGTON, SEPTEMBER 22, 2009 -- At a conference at the American Enterprise Institute, resident fellow Alex J. Pollock convened a panel to debate the recommendations set forth in the Committee on Capital Markets Regulation's (CCMR) recent report, "The Global Financial Crisis: A Plan for Regulatory Reform." The panelists discussed the appropriateness and efficacy of the committee's recommendations, and the debate expanded to consider the more philosophical question of whether reforms can be prescribed before the causes of a crisis are known.

The CCMR report identified four objectives of improved regulation, explained Hal S. Scott, director of CCMR and a professor at Harvard Law School. He highlighted the reduction of systemic risk as the "central problem" and "most important objective" of any meaningful regulatory reform. Specifically, Scott advised that revising capital requirements, improving resolution procedures for failed financial institutions, extending regulation to nonbank financial institutions, and expanding the use of clearinghouses and exchanges for derivatives would help reduce the threat of systemic risk.

Scott argued for raising capital requirements as the "chief ex ante measure for reducing systemic risk," but he cautioned that such revision does not necessitate increased regulation, noting that while capital ratios have been highly regulated for a long time, they proved to be quite inadequate when the crisis hit. "More regulation doesn't necessarily translate into less systemic risk." Douglas J. Elliott, an economics studies fellow at the Brookings Institution, agreed with Scott's analysis, adding that the capital is meant to "protect you against mistakes and accidents," and that the current requirements were obviously not high enough to cover the mistakes that sparked the current crisis. Elliott acknowledged the concern that increasing capital requirements would make loans more scarce and expensive, but he believed that this negative impact would be relatively insignificant. Peter J. Wallison, the Arthur F. Burns Fellow in Financial Policy Studies at AEI, supported Scott and Elliott's general position, but advocated that any systemic-risk-related regulation apply only to commercial banks. "Nonbank financial companies should not be regulated and should be allowed to fail," he argued.

If capital requirements are insufficient and a systemically-important firm is on the verge of failure, the government must be prepared with a "comprehensive and unified resolution process for all financial institutions," argued Scott. If such a plan is not created, the continued "avoidance of bankruptcy for financial institutions can create a zombie financial system." Unlike the current administration's regulatory proposal, Scott believes this resolution process should be applicable to all financial companies; otherwise, counterparties will be uncertain about what would happen to a partner institution if it failed.

Wallison opposed this recommendation, arguing that "any resolution authority set up for this purpose will create a permanent TARP… [as well as encourage] moral hazard and competitive inequities." He questioned certain details of the committee's proposals, asking how the committee would identify a "financial firm" when many companies that are not typically thought of as financial in nature--like sales or manufacturing firms--engage in financial activities as an essential part of their operation. Moreover, he was skeptical that anyone could identify in advance which firms would cause a systemic breakdown if they collapsed. Despite Wallison's questions, Elliott endorsed Scott's plan, saying that "markets believe that the government will bail out any large institution now.… We're stuck with moral hazard." Given this assumption of moral hazard in the market, Elliott argued that the government should focus on creating a standardized regime for resolving the seemingly too-big-to-fail institutions.

Wallison's overall criticism of the CCMR report was that it "talks about the severity of the crisis, but not about the causes, which are just as important." In his analysis of the data, the crisis was caused by the housing policies of the U.S. government, specifically the affordable housing mandates of Fannie Mae, Freddie Mac, and the Community Reinvestment Act. "If the crisis was caused by government housing policies, it was not caused by regulatory and market deficiencies," said Wallison, "[so] there is little point in designing policies [like those outlined in the CCMR report] that assume that the crisis will happen again."

Elliott agreed that it is important to know the cause of the crisis, because it can dictate your perception of the need for regulation: "if you believe that this is unlikely to occur again, then you care most about the negatives of all financial regulation." However, he disagreed with Wallison's conclusion that similar future financial crises are unlikely. Although he concurred that the government-created housing bubble was a unique incident, he believed "there were [also] so many imbalances and excessive risk-taking in the financial system that something was bound to blow up." It was the latter causes that Elliott advocated designing regulations to address. Scott added that we may never agree on the causes of the crisis, so it is "prudent for policymakers to rescue [or regulate] anyone who might create a systemic collapse."

Finally, Scott asked the audience to remember that "reforms cannot fix the current crisis nor speed economic recovery; they are to prevent future problems…. [We] must thoroughly discuss, debate, and vet these proposals" to make sure we are making the right decisions for the future.



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Speaker biographies

Douglas J. Elliott is a fellow in economic studies and a member of the Initiative on Business and Public Policy at the Brookings Institution, where he focuses on the federal government's role in dealing with the current financial market crises. He previously served as president and principal researcher for the Center on Federal Financial Institutions, a nonpartisan think tank he founded in 2003. For the bulk of Mr. Elliott's career since 1985, he has been a financial institutions investment banker, most recently a managing director at J. P. Morgan, where he worked for fourteen years. Mr. Elliott has also worked as an investment banker with Sanford Bernstein, Sandler O'Neill, and ABN AMRO. Throughout his professional career, he has researched financial institutions or worked directly with them as clients in a range of capacities. Mr. Elliott has testified before both houses of Congress and participated in numerous policy forums as an expert. His analyses have been quoted frequently in major publications, and he has made many appearances as an expert on The NewsHour with Jim Lehrer and other news shows.

Alex J. Pollock has been a resident fellow at AEI since 2004, focusing on financial policy issues, including housing finance, government-sponsored enterprises, retirement finance, corporate governance, accounting standards, and the banking system. Previously, he spent thirty-five years in banking, including twelve years as president and chief executive officer of the Federal Home Loan Bank of Chicago. He is the author of numerous articles on financial systems and the organizer of the "Deflating Bubble" series of AEI conferences. In 2007, he developed a one-page mortgage form to help borrowers understand their mortgage obligations. He is a director of Allied Capital Corporation, the Chicago Mercantile Exchange, the Great Lakes Higher Education Corporation, the International Housing Union for Housing Finance, and the chairman of the board of the Great Books Foundation.

Hal S. Scott is the president and director of the Committee on Capital Markets Regulation and the Nomura Professor and director of the Program on International Financial Systems at Harvard Law School, where he has taught since 1975. He teaches courses on capital markets regulation, international finance, and securities regulation. Mr. Scott is also an independent director of Lazard, Ltd., a past president of the International Academy of Consumer and Commercial Law and a past governor of the American Stock Exchange. Mr. Scott’s books include International Finance: Transactions, Policy and Regulation (16th ed., Foundation Press, 2009) and International Finance: Policy and Regulation (2nd ed., Sweet & Maxwell, 2007). His recent articles include “International Finance: Rule Choices for Global Financial Markets,” in Research Handbook in International Economic Law (2007) and with Martin F. Grace, “An Optional Federal Charter for Insurance: Rationale and Design,” in The Future of Insurance Regulation in the United States (2009).

Peter J. Wallison holds the Arthur F. Burns Chair in Financial Policy Studies at AEI, where he codirects the Institute’s program on financial market studies. He is also a cochair of the Pew Financial Reform Task Force and a member of the congressionally-authorized Financial Crisis Inquiry Commission. Mr. Wallison previously practiced banking, corporate, and financial law at Gibson, Dunn & Crutcher in Washington, D.C. and New York. During 1986 and 1987, Mr. Wallison was White House counsel to President Ronald Reagan. From 1981 to 1985, Mr. Wallison was general counsel of the Treasury Department, where he had a significant role in the development of the Reagan administration’s proposals for deregulation in the financial services industry. He also served as general counsel to the Depository Institutions Deregulation Committee and participated in the Treasury Department’s efforts to deal with the debt held by less-developed countries. Between 1972 and 1976, Mr. Wallison served first as special assistant to New York governor Nelson A. Rockefeller and, subsequently, as counsel to Mr. Rockefeller when he was vice president of the United States.

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