Connectedness and contagion: Protecting the financial system from panics

The Dodd–Frank Act of 2010 was intended to reform financial policies in order to prevent another massive crisis such as the financial meltdown of 2008. Dodd–Frank is largely premised on the diagnosis that connectedness was the major problem in that crisis—that is, that financial institutions were overexposed to one another, resulting in a possible chain reaction of failures. In the book “Connectedness and Contagion,” the author argues that is not connectedness but contagion that is the most significant element of systemic risk facing the financial system. Contagion is an indiscriminate run by short-term creditors of financial institutions that can render otherwise solvent institutions insolvent.

On October 18, the Initiative on Business and Public Policy at Brookings hosted the author of “Connectedness and Contagion,” Harvard Professor and Director of the Committee on Capital Markets Regulation Hal Scott, to discuss his book. He explained how the weapons to protect the financial system have been weakened, followed by an expert panel which discussed what is needed to restore and strengthen the government’s role in fighting contagion to prevent future crises.