What Ought to Be Done Now...

Gary Gensler Chair, Commodity Futures Trading Commission (2009-present)

The financial system … terribly failed the American public. And the financial regulatory system failed the American public. And there are many parts of that failure, but one of the failures is that we have not been regulating the over-the-counter derivatives marketplace. …

The people in [the CFTC] are thinking nearly every day about the derivatives marketplace, whether it's the derivatives marketplace we call futures or the derivatives marketplace we call swaps or over-the-counter derivatives. They're thinking about both.

And if I can just use a term -- the reason it's called "over the counter" is because it's not on an exchange. It's as if you walked into a store and you just personally bought something over the counter. In this case you go to a large Wall Street firm and do a transaction, currently not regulated. It wasn't regulated in the 1990s; it's not regulated now. We should regulate them.

What should be and not be on the exchanges?

I believe strongly that we need two complementary regimes. We need to regulate the dealers, these 20 or 30 large global financial firms that issue these derivatives. How should we regulate them? We should make sure there's a lot lower risk, and we do that by capital and having margin requirements. Capital means money put to the side in case of crisis and so forth.

We're going to enhance the integrity of markets by business conduct standards, protecting the public against fraud and manipulation, and lastly, [promoting] transparency by record keeping and reporting. …

But I don't think that's enough. I think we also need to mandate that the standard product, the product that can be put onto an exchange and put onto what's called centralized clearing, be done.

Why is that? An exchange, just like the New York Stock Exchange or the Chicago Board of Trade for agricultural commodities, brings transparency. That means anyone in the public could know what the price is, what somebody is willing to buy or sell this risk contract [for]. And even though they're very complicated contracts, if it's a small hospital in your township, if it's a small school, or even a large business in your state, they could then look to this exchange and say, "This is where it's priced." They'd get the benefit of that.

Some people will argue … that these deals are being done between two very savvy organizations. These are not private citizens; you don't need the government overview. Your point of view on that?

… Every end user, every institution, even if they're big and savvy, would benefit from knowing what some other institution just paid for just one of these things. We would promote economic activity, I believe, if we brought a lot of sunlight into this area. ...

Why is this important?

It's very important because we can't let this happen again. … You could be living in Iowa as a farmer, or you could be living in Maryland as a doctor and have no relationship with a company called AIG, and wake up one day and $180 billion of your money -- this is the American public's money; this isn't Wall Street's money -- had to go into an insurance company that was so lightly regulated that the system might have come down if they failed.

Brooksley Born Chair, CFTC (1996-1999)

I think we have to close the regulatory gap. ... We need to take a lesson from the existing futures markets where exchange trading has been safe. As much as possible of the over-the-counter (OTC) derivatives market should be traded on a regulated derivatives exchange. The transaction should be cleared on a regulated clearinghouse. There should be robust federal regulation of any remaining OTC derivatives market. And personally, I think that remaining market should be limited as much as possible to no more than the customized contracts that are needed for specific businesses to hedge particular business risks. ...

If this moment passes again, the consequences are what from your perspective?

I think we will have continuing danger from these markets and that we will have repeats of the financial crisis. It may differ in details, but there will be significant financial downturns and disasters attributed to this regulatory gap over and over until we learn from experience. …

Do you think most people know there's no government regulation in this territory?

I don't know if they do or not. All other financial markets have some kind of government oversight protecting the public interest.

But not this?

Not this one. This one had very good lobbyists. The very same entities that are lobbying today to limit the effectiveness of a new regulatory reform are the people who in 2000 and 1999 deregulated these markets entirely. ...

Michael Greenberger Director, CTFC Division of Trading and Markets (1997-1999)

It's ironic, because Obama has essentiality brought back many of the actors who were unsympathetic to our point of view in 1998, 1999, 2000.

However, from my perspective, and I believe from Brooksley's perspective as well, the lessons have been learned. Recently, the Treasury proposed a white paper (PDF). It's confused and not as clear as one would like, but embedded within it is a program that comes in the direction of where Brooksley and I were 10, 11 years ago. ... My view is, I believe Brooksley's view is right now, that they have put forward proposals that are meaningful and strong. ...

The benefit now, and the difference now, for Obama and the Treasury is, a, the understanding of what just happened; b, people like [CFTC Chair] Gary Gensler, who was a Goldman Sachs partner and a protégé of Bob Rubin, have come back into power, and they have given every evidence of the fact that they have learned their lesson. They are advocating the kinds of things that we advocated 10 or 11 years ago.

Right now, all I can tell you is that the battle is evenly matched. You would think after everything we've been through there shouldn't be a battle; it should be understood. No, no, the financial services industry has organized itself and will pitch very, very hard for continuing to have these markets be unobserved by anybody outside of the banking system or their customers. No capital requirements, no fraud controls, no manipulation controls and no regulation of the intermediaries. It's going to be a close-fought battle.

Ron Suskind Author, The Price of Loyalty

We only have a few people here in Washington. I mean, look at the mismatch. For every thousand of them, we've got one person. Every 10,000, we have one person. They're big; they're well funded. They're moving at lightning speed. There's innovation and ingenuity. They're just exploding with the new thing every day. And sometimes they don't even know it inside of the big golden temple. How are we going to know it here in Washington?

And frankly, most of the people who go through this part of public service, they're in and they're out the other side, because my God the riches are vast. If you spend time in the SEC, or the CFTC, or one of those buildings in Washington, you are a person of value. You did your public service and God bless you. But now, you can make some real money, because that's what this country's about. Don't you forget it. And so it is a mismatch.

Blythe Masters CFO, JPMorgan; in 1997, she was part of a group at JPMorgan who created credit derivatives

The fact is, the regulatory framework … is one that is very much defined by either products or corporate entity charters. So, even though your activity may look the same irrespective of whether you're an insurance company, a banker, a broker/dealer, hedge fund, a private equity company, your regulatory framework, your restrictions, your legal powers are utterly different depending on what your corporate charter looked like. …

As we ran into this financial crisis, you had mortgage originators that were non-banks that were operating with one set of rules. You had insurance companies operating with another set of rules. You had broker/dealers under SEC supervision under another set of rules. You had banks under another set of rules. You had hedge funds under no rules. You essentially had a mish-mash, a patchwork quilt with some large holes in it, of regulation and yet actors within the financial markets who often had very similar business models.

That is what needs to be tackled through regulatory reform. We need to reduce the number of different regulators that are accountable for addressing these issues. We need to empower a smaller number of regulators on a consistent basis to govern activities as a function of the risk they create, not as a function of what label they bear.

And if you can fix that, then there will no longer be the notion that there is a black box. If you are actively engaged in the derivative market, if your activity is above a certain level or size or significance, then you must be subject to oversight by the following regulator and subject to the following capital requirements. That is the type of approach that we need to develop. …

… Could the over-the-counter derivative market actually operate if there was transparency, if there were exchanges, if everybody knew what everybody else was doing nowadays?

… Yes, absolutely. The over-the-counter derivative markets can exist with transparency. The biggest, most transparent market in the world is the market for U.S. government securities, is an over-the-counter market, just for the record. And there is no inherent conflict between having a degree of transparency and the ability of those markets to function.

One of the important features of over-the-counter derivatives is they are not standardized to the point that you have a one-size-fits-all approach. You need a one-size-fits-all approach to trade something on an exchange.

So, the question is, can you have non-exchange-traded activity that is still sufficiently transparent to address the regulatory and systemic risk issues? And the answer to that is yes. There are a number of tools for achieving that. One is the use of central clearing for those products which are sufficiently standardized to be amenable to that. And the other is regulatory reporting. You put in place a framework … that says your activity will be transparent to a regulator that is tasked with the management of systemic risk. Then you have the transparency that you need from a regulatory point of view to know whether there's someone out there that has accumulated an undue quantity of risk without the adequate capitalization. …

By and large, there's already a tremendous amount of price transparency in the over-the-counter derivative markets. It's not something that the man on the street would access, but it is something that institutional investors and market participants have plenty of visibility around. …

What's important is that we don't impose costs on activity that don't achieve societal benefits. So, insisting on real-time price transparency so that every transaction every second has to be transparent to the whole world? Well, certainly that might have inherent benefits of being transparent. But at what cost? At what cost to liquidity? At what cost to the providers that have to carry the burden of making that degree of transparency available? …

So the key here is that there needs to be intelligent regulation, not brute-force regulation that essentially destroys the benefits of these products. And destroying over-the-counter derivatives, or legislating them out of existence, would hurt the world. It would hurt growth. It would hurt liquidity in all markets. It would hurt the ability of people to borrow, the man on the street and the corporation. That would be a bad thing.

So, we need to not overreact. It's important that we react, don't get me wrong. The notion that things need to change is very clear, but it's got to change sensibly and it's got to be clear what we're trying to tackle.

Joseph Stiglitz Council of Economic Advisers (1993-1997)

The challenge we have right now is, are we going to create a financial system that actually does what a financial system is supposed to do? Provide credit to small and medium-sized enterprise? Manage risk? Help homeowners manage the risk of owning their home? Provide capital to new enterprises, money to the venture capital firms? -- these basic core functions of the financial markets.

Our financial markets failed, and they failed massively. Take even one simple idea: electronic payment mechanism. Modern technology allows for us to have an efficient electronic payment mechanism. It shouldn't be the case that when you go to a store and you want to pay with a debit card that that merchant has to pay 1 percent or more to the bank. It should cost a couple of pennies.

The financial market would like to go back to the world as it existed before 2007 because they did very well. But our financial markets were too big. They were garnering over a third of all corporate profits. What should be a means became an end in itself. And, remarkably, it didn't even do what they were supposed to do.

So this is a dangerous moment, because if we don't get it right, we are likely to wind up with an even more politically influential financial system, banks that are even bigger, more too big to fail, too big to be financially resolved, and so the risk of another crisis some years down the line is going to be greater. The risk that our economy's performance will be weaker, the risk that there will be greater inequalities and a sense of injustice in our society will be higher.

So I think this is really a moment. I was very hopeful that in the aftermath of the crisis we could see what had gone wrong and say, "Let's fix it." But it may be that we are passing that critical moment. ...

Harvey Pitt Chair, Securities & Exchange Commission (2001-2003)

If government really wants to correct the deficiencies, a lot of the specifics that we're seeing now are not really as well directed toward getting the problems under control. They really are directed at answering last year's crisis.

And I think there are certain things that need to be done.

First, there has to be a universal requirement that anyone that takes money from the public that can have an impact on the economy must provide a continuous flow of significant data. The nature of the data will change over time, because as things evolve you get smarter, and nobody is sufficiently prescient to figure out all the data we need today for the rest of time. It won't happen. But there ought to be power in the government to require people on a regular and continuous basis to provide significant data.

Second thing you need is for government to be obligated to analyze that data and disseminate the data back out to the marketplace.

Some folks are concerned that, for example, their proprietary trading activities and other things may be compromised. But we've had a long history of being able to deal with those kinds of concerns. And they can be dealt with either by aggregating data, or by having some delays in what gets published -- but nonetheless getting the data out. The government has to know what is going on. That's critical. In essence, that is a very easy cure. …

And ... there has to be a clear assignment of responsibility.

When the subprime crisis arose, and I met with every government agency I could think of that had or should have had some interest in the matter, I found that the first question I was asked by virtually every agency was, do we even have any authority to deal with this?

What was the answer?

My answer was, yes, there is authority, particularly to deal with the types of things we saw evolving. But that takes a lot of effort to persuade the government to act, particularly in the face of affirmative legislation saying you shouldn't regulate certain areas. So I think there has to be a grant of authority.

The third thing that I think is absolutely critical is what I call residual regulation.

I think that government has to have the ability to set tripwires, to set so-called circuit breakers. And when those circuit breakers are tripped, government then should have complete authority to stop the trend dead in its tracks before it becomes a problem, and even before the problem becomes a crisis.

So even if you're not going to regulate specific areas in detail up front, that isn't the same as saying that government shouldn't have the ability to stop trends it believes are destructive, and so on. …

With respect to how you then regulate, I guess what I would say is, I think that you need a truly independent body. I think the Federal Reserve is the appropriate body to do two things, but only two things. One is monetary policy. And the other is to regulate systemic risk.

The reason you need an independent regulator is because if the political side of government, any administration, has control over what is deemed to be systemic risk, then you can have the wrong types of criteria directing whether government acts or doesn't act. And that, in part, is a major concern I have with the current proposal.

I think there's a lot of good in what the administration is proposing, but trying to put all of this under the Treasury, in my view, is a mistake. An independent Fed, and a truly independent Fed, could do those two functions. And I think those two functions would consume an enormous amount of energy.

So I think that all of the bank regulatory functions should be alleviated. That is, the Fed should cede those, along with all other financial regulatory powers from other agencies into one overarching agency or entity, like a Financial Services Authority in London, or what have you, that would maintain the independence of various functions.

For example, the SEC has very critical functions and those should continue to be independent. But I think by combining the regulatory apparatus, you can avoid what I like to refer to as regulatory arbitrage, where people try to figure out who will be the lightest regulator, the easiest regulator, what have you.

What you really want is a regulatory system in which everyone performing the same types of functions or dealing in the same types of instruments, whatever they're called, is subject to the same types of restraints and restrictions. That would be the way that I would try to deal with the current crisis.

Henry Kaufman Director, Lehman Brothers (1995-2008); author, The Road to Financial Reformation

From my viewpoint, what ought to be done is supervision ... should be centralized, as I indicated in my book, with the Fed -- but after we have taken another look at the Fed and re-examined its strengths and weaknesses.

The head of supervision of our financial system should be a vice chairman of the Federal Reserve. He should have under him the responsibility of a substantial staff that supervises closely the 15 to 20 largest financial institutions in the United States. He should be required, in conjunction with the president of the United States, to render a report annually on the strength and well being of the largest financial institutions in the United States, that they should certify.

That would bring a far greater discipline into the process. It would give the chairman of the Federal Reserve Board and this chairman of this new supervisory authority a much greater responsibility from which they cannot withdraw if something goes wrong.

And we've got to fight hard to have a more centralized supervision over major institutions outside the United States in the industrial world. By major institutions, we're not talking about hundreds and hundreds and thousands of institutions. All it requires in the United States is 15 to 20 financial institutions, which are conglomerates.

Now, the dilemma in dealing with those is the big fight.

If you keep them as they are, they have to be too good to fail. And if they're going to be too good to fail, they're going to have to be constrained on their capital requirements; in other words, capital requirements would have to be raised significantly, and their profits have to be constrained. That is an extraordinary change from where we are today.

They will become, and should become, financial public utilities; that they have a responsibility far beyond anything that they've had heretofore. The fact is, the financial institution is different than an industrial company. It deals with our savings, with our temporary funds. These institutions have major roles to play in the well-being of our financial system and in the American economy and the global economy.

But is there any likelihood that the 15 major institutions like that in America are going to yield? Has the problem been bad enough? Have they been scared enough? Have they been warned enough?

Well, they're not in a good position. Many of them are indebted to the U.S. government; quite a few of them have shares that are owned by the U.S. government today. And therefore, their bargaining position, so to speak, has been diminished. But it's still very powerful in the public arena in terms of trying to influence political people in Washington, undoubtedly. That's where the battle will be fought.

Joe Nocera The New York Times

I don't think the impulse to regulate has completely abated, even though the dust has settled a little bit on the crisis. What I do think is that a, banks have recovered enough to feel that they can push back. I mean, it's pretty incredible that they are pushing back against the new consumer protection agency. …

The other thing is that the regulations that have been proposed and that may soon be law, they kind of accept certain things that don't seem particularly acceptable, i.e., there is such a thing as too big to fail. Or that there should be only limited clampdown on derivatives; that derivatives are still going to be a huge part of the financial world.

To me, it feels as if they are trying to change things on the margin rather than trying to make wholesale, substantive changes in the way the system works, the way Franklin Roosevelt did during the Depression, where he created the SEC, and they passed the Glass-Steagall Act, and they separated banks from investment banks. There is nothing remotely in the Obama administration's regulations that would suggest anything as bold as that.

Why?

It's hard to know why. I think part of the reason is they are moving too fast. As much as we need re-regulation or better regulation, nobody in government has really taken the time to really examine what went wrong and what needs to be done. They are moving on the fly. They are trying to get this behind them. The administration has other priorities. President Obama didn't come to office with a lifelong ambition to solve a financial crisis. He came to office to solve health care. So the sooner they can get this behind them, the happier they will be.

Sheila Bair Chair, Federal Deposit Insurance Corporation (2006-present)

I think both the Treasury and the Fed are very much committed to regulatory reform. There may be different views about how to achieve that. But I think the regulatory community at least does want reform, will push aggressively for reform, and hopefully, we'll all try to provide the technical expertise and drafting help and arguments pro and con to assist Congress in making the decisions that they will need to make.

… What's at stake and what's the worry?

We're not out of the woods. And I think in some ways, the situation has become worse because government did have to come in and stand behind a lot of very large institutions. The implicit too-big-to-fail doctrine has now become explicit. And so longer term, if we don't have a good exit strategy and a more robust regulatory regime coming out of this, we're going to have the same incentives for high risk-taking that we had before, perhaps even worse now because investors and creditors will figure: "Well, maybe I can make a lot of money if I can encourage high-risk behavior, high-return behavior on the part of these institutions. If it doesn't work out, well, I'm just limited to my investment, and the government's probably not going to let them fail anyway. So let's bring the punch bowl back to the party." …

We need to end too big to fail. We need stronger regulation of these very large institutions. We need to give them incentives to downsize. Those are certainly at the top of my priority list, I think at the top of the administration's priority list, everybody in the regulatory community. And I hope Congress will maintain the will to get that done.

… What are the obstacles? …

The complexity of these issues and the complexity of the legislative solutions weighs against them. There are lots of different things that need to be fixed. There's no one silver bullet here.

Though we can agree on broad objectives. We need a resolution authority, first of all. If an institution gets into trouble, it needs to be allowed to fail, and there needs to be an orderly mechanism to let that happen.

We need better regulation and stronger regulation of any systemic institution, regardless of whether [a firm voluntarily] comes in and wants to become a bank holding company or not. We need stronger consumer protections across the board.

There's broad agreement on those priorities. There are different ways to achieve those. And I think people of good will can work together to a common solution.

But there is a lot of industry resistance still to a lot of these proposals. But I am heartened. We are very actively engaged in both the House and Senate. And I think that frankly, the Hill's not really listening to them. I think Congress understands that this is a very dire situation, there was not enough regulation, and that it needs to be fixed. And it's really core to the future of our economic health and the preservation of our capitalist system to fix this and make it right.

So I'm actually optimistic. I think Congress does want to do the right thing.

Roger Lowenstein Author, When Genius Failed

The whole regulatory system wasn't bad, but there were some holes in it, and you want to patch them. You don't want to unnecessarily restrain speculation, although there's some areas -- you know, do we need a credit default swap market? Do we need a market where people can gamble on whether or not companies are going to go bankrupt? Most people still say yes. I would say no.

But not every new drug is approved. We have an agency that looks and says, "This one, on balance, looks like it could do more harm than good." So we might think about that financially. Not every financial innovation does more good than harm.

Where would those decisions reside? At a sort of super-powered Federal Reserve?

One proposal … is to limit derivatives to exchange-traded contracts, and then if someone exchanged, the exchange and its regulator has to approve that. So if someone comes out and says, "I want a new contract where we can gamble on companies going bankrupt," some worry, well, maybe that's not such a great idea. You laugh, but that's what we have. It's called the credit default swap market. Maybe that's not a great idea.

[Economist] Bob Shiller wants a housing futures market. So is it necessarily a good idea to allow people to speculate on the price of center-hall Colonials in Indianapolis so that, you know, oil traders lose money and they got to get out of something, suddenly housing markets crash.

Actual liquidity in trading is not always a good thing. It's a very hard thing for people to grasp. But we had enough capital raised in this country, enough stock sold, enough capital raised before we ever had stock index futures, before people could trade a million shares in 500 different companies in a second. In those days people had to take it and make an individual decision about it: "Do I want the stock? Do I not want the stock?"

And now we have this great innovation so that people can sell zillions of shares without thinking about any them. Well, does that sound smart to you? It doesn't to me.