“The Future of the Global Financial System”—an ambitious agenda for a 90-minute talk, but in this case the people sitting on the stage had a good chance of covering the topic. They included people who had led many of the most influential financial organizations in the world, including the Federal Reserve, the World Bank, the Treasury Department, Goldman Sachs, and the FDIC. The conversation was part of the Business + Society conference, a three-day event marking the opening of Yale SOM's new campus, Edward P. Evans Hall.
Three broad themes stood out in this high-velocity flyover of the challenges in the world’s banks, markets, and regulatory agencies.
The need for global coordination
Former Fed chair Paul Volker started the conversation with the assertion, “We have a financial system without a monetary system in my view.” By this he meant that there are few rules or standards guiding the world’s policymakers, as compared to the days of the gold standard or the Bretton Woods regime. At the same time, cooperation and collaboration are needed. “Any individual country is not independent in what it does [with its currency] because what it does affects others.”
Robert Rubin, who served as treasury secretary in the Clinton Administration, picked up on this theme, and pointed to the important role the U.S. plays in global markets. The global system needs confidence that the U.S., as the world’s largest economy and the issuer of the reserve currency, has a stable fiscal system, he said. This means that any apparent instability in the U.S. has major ramifications for the global system. “We haven’t addressed in any way the structural issues in our fiscal situation,” said Rubin. He argued for strong moves toward long-term fiscal discipline, which could then provide the context for short-term investments in public infrastructure and other stimulus.
Gary Gensler joined the panel only days after stepping down as chairman of the U.S. Commodities Futures Trading Commission, a key regulator in the response to the 2008 financial crisis. He also spoke about the importance of improving global regulation of what is certainly a global industry. “Capital and risk know no geographic border. None,” he said. He pointed to how financial crises, such as the Latin American debt crisis, the Asian crisis, and the crisis in U.S. housing, all quickly spread across borders, in large part because the companies involved operated across borders. Since most regulators are based in individual nations, he pushed, during his tenure, for more effective use of international forums and standard-setting bodies. It’s critical to cover the worldwide operations of today’s financial institutions, he said, and not take a territory-by-territory approach.
Adding to the challenge, the global economy is in the midst of a major structural shift with the rise of developing economies, pointed out Robert Zoellick, the former World Bank chief. He argued that future regulatory regimes will have to grow out of a much larger collection of nations than the G7 and the G20.
The challenge of crafting effective regulation
In her role as chairman of the FDIC, Sheila Bair was one of the key decision makers in the government’s response to the 2008 financial crisis. Her assessment of how things stand more than seven years later: “About 50% of what we know needs to be done as a result of 2008 still hasn’t been done.” As a result, she added, “We’re still looking in the rearview mirror. We’re not looking ahead.” In her view, the core threat to the financial system is leverage. Increasing capital requirements can increase resilience by enabling firms to withstand unanticipated shocks. But she pointed to the difficulty of enacting rules in this area, particularly when they are opposed by the financial industry.
Rubin illustrated the notion that it’s hard to get the industry behind regulation by telling an anecdote about his time at Goldman Sachs, before he started his government service. He wanted to organize an industry group that would voluntarily adopt capital requirements in derivatives markets. However, the pushback was fierce. “It’s very hard to get people to take an enlightened self-interest,” he said.
Roger Altman, former deputy secretary of the U.S. Treasury, considered where we stand in mitigating the risks posed by “too big to fail” financial institutions. On the one hand, he said, regulatory changes and increased scrutiny by government had made the odds of a major bank failing much smaller. “The [financial] system is in a safer condition that it has been in many years,” he said. On the other hand, “In the unlikely event that one of these institutions would get to the edge of the cliff, particularly in a crisis situation, I don’t think we’d see an outcome other than the regulators organizing a rescue.”
Zoellick shared one lesson for regulatory rulemaking that he’s learned after watching how decisions get made in a crisis. He described how during the 2008 crisis, he was forced to pull the World Bank’s deposits out of Wachovia due to a regulation enacted many years before for very different purposes. “I’ve learned that one has to be careful about unintended consequences; it’s very important to build flexibility into the system.” He thinks the regulatory design process should be ongoing and should “[contain] feedback loops, keep learning from experience, and build in flexibility.”
The financial system’s connection to the rest of the economy
A theme throughout the discussion was how what happens in the financial system ends up affecting the broader economy. Moderator Jeffrey E. Garten described the financial system as being like the circulatory system in a body. When that system stops working smoothly, the whole body is harmed.
All of the speakers mentioned the antipathy that has developed toward the finance industry since 2008. Altman argued that there’s a gap between financial institutions and the rest of the economy. “The leadership of the financial community could do a much better job than it has done in trying to bridge the gap.”
Rubin, Zoellick, and Bair all pointed to the role that education could play in informing policy decisions. “We need vastly greater public understanding,” said Rubin. Zoellick also argued that part of the solution depends on financial decisions made by individuals. “Individuals still have to choose and at the end of the day I’m wary of pushing this too far away from individual responsibility,” said Zoellick.
Rubin also argued that the finance industry shouldn’t ignore issues like unemployment and inequality. These issues are important in their own right, but are also important for the future of the financial system. To get political support for trade liberalization, free markets, and other policies favored by the finance industry, he said, “people have to believe this works for them.”
Volker argued that the financial system remains out of whack and that bringing it more in line with the rest of the economy is important for future stability. He pointed to the incentives for risky behavior that led to so much trouble in 2008. He also argued that financial industry profits have grown to be too large in comparison with the rest of the economy. “We’ve got to get back to something that’s normal… There’s much more acceptance of sensible regulation.”