National Journal

The Current Health of Financial Market Reform

"A crisis is a terrible thing to waste." - Stanford economist Paul Romer (November 2004)

Paul Romer’s pithy and somewhat cynical observation was not inspired by the recent financial crisis. It surely applies to that crisis, however. The fallout from last year’s financial meltdown was so widespread and severe that sensible people hoped poplar revulsion would provide an opportunity for legislators to overhaul financial regulation. Such an overhaul would be especially important in the United States, but reform is needed in other rich countries as well. Fundamental reform now seems increasingly less likely.

Since last winter asset prices have partially recovered and the immediate threat to the financial system has declined. U.S. policymakers have moved on to other pressing concerns, including death panels and the threat posed by government insurance subsidies for illegal immigrants. The prospect for significant, rational reform of financial regulation is shrinking. Congress and the Administration may be about to waste a truly horrendous crisis.

The unprecedented actions of the Federal Reserve, U.S. Treasury, and overseas central banks have brought the developed world’s financial system back from the precipice. The weakest financial institutions have disappeared, merged, been propped up, or been taken over by the government. Stronger risk-taking institutions have scaled back leverage. These developments reduce the immediate risk of another meltdown. It is less clear whether private institutions have been frightened enough to reform their risky old behavior. Many observers, including me, are skeptical that memories of the 2008 catastrophe will exercise a restraining influence on traders and financial managers in, say, 2015. Unless the rules of the financial game are changed by government policymakers, private decision-makers are likely to resume the same bad behavior that gave us last year’s crisis.

I am an economist, not a political insider. I have no idea how Congress and the Administration could make better progress toward reforming the nation’s financial regulatory rules and institutions. I can only look at the meager progress made thus far and agree with Paul Romer, another economist: "A crisis is a terrible thing to waste."