Stanford Report, March 13, 2010

White House adviser Lawrence Summers outlines 'six imperatives' for financial regulation

Top White House economic adviser says we should take "considerable satisfaction" in the progress the country has made toward recovery – but financial regulation has proven "manifestly inadequate."

By Cynthia Haven

In the face of daunting unemployment and hardship for millions of Americans, White House economic adviser Lawrence Summers was upbeat Friday night: The economy is looking up, he said, and we should take "considerable satisfaction in the progress that has been made."

"We have a long way to go," said Summers, speaking at the annual Economic Summit of the Stanford Institute for Economic Policy Research, an event that gathers key players in the U.S. economy. He noted that "unemployment is at unacceptable levels, and will remain at unacceptable levels for a substantial interval." Moreover, "the amount that our economy is producing is more than a trillion dollars short of potential."

"But I would say to you that the sense of free fall – like a ball rolling off a table – is not our situation today," said Summers, director of the National Economic Council and a former Harvard president. "The prospects for success look rather better than they did a year ago."

He noted that 15 months ago many people reasonably feared we were heading for a depression: "The economy was losing more than half-a-million jobs a month; GDP declined as rapidly as it has in 50 years in the first quarter. The stock market had fallen to the same level in real terms, after correcting for inflation, that it reached in 1966."

Steve Castillo Lawrence Summers told the audience that he 'rejects the view expounded by some in the financial sector that crises are an inherent part of economic life that one has to accept and plan for.'

Lawrence Summers told the audience that he "rejects the view expounded by some in the financial sector that crises are an inherent part of economic life that one has to accept and plan for."

He said the debate would continue about what factors spurred a recovery. However, "I don't believe anyone can credibly assert it would not have happened without strong government intervention," he said.

"There are moments when strong public action is necessary to preserve economic stability," he said. "We have been reminded of a central lesson: For all its tremendous virtues, we cannot rely on markets to always be a self-sustaining system."

Summers said he "rejects the view expounded by some in the financial sector that crises are an inherent part of economic life that one has to accept and plan for – things that happen every five to seven years and it's just the way it is, just as hurricanes happen occasionally."

Recalling that "John Kennedy took arms control more seriously after the Cuban missile crisis," Summers said we must continue to rethink "a system of financial regulation that has proven manifestly inadequate."

Summers outlined six "imperatives" for financial regulation:

  • He advocated "comprehensive regulation of all systemically important institutions." He said that any institution that is "big enough and interconnected enough so that its failure can bring down the financial system" should be subjected to "comprehensive regulation by an accountable regulator."
  • He called for "resolution authority," with procedures for managing failure: "Our system will not be fail-safe until it is safe for failure."
  • For capital and liquidity requirements, "we need to seek a regulatory regime that applies pressure to level standards up rather than to win races to the bottom."
  • Taxpayers should be compensated for the financial assistance they gave to institutions.
  • Summers suggested requiring the use of clearinghouses and exchanges for over-the-counter derivatives and swap transactions. 
  • Summers favored the "Volcker Rule," which would place limits on banks' trading activities, putting "appropriate restrictions on activities on those who benefit from the safety net."

"I suggest that these six principles provide criteria for whether an approach followed domestically in the United States or globally is doing what can be done to reduce risks of crisis," said Summers.

"We are under no delusion that we have seen the last financial crisis. Under no illusion that these [crises] are fully understood."

Keeping the current system "is to court excessive risk," said Summers. "To build a house too close to an ocean beach that may surge is foolish," but after a surge floods the house out, "to build another house is far more foolish."

He said that is precisely what will happen, in wake of the these events, if "we do not act to strengthen systems of financial regulation."