Top Economists Craft Sweeping Proposals for Financial Reform
from Renewing America: Debt and Deficits

Top Economists Craft Sweeping Proposals for Financial Reform

December 15, 2009 5:52 pm (EST)

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As Congress debates financial regulation reform, fifteen top economists have developed a set of guiding regulatory principles in a series of papers distributed by the Maurice R. Greenberg Center for Geoeconomic Studies (CGS) at the Council on Foreign Relations. The economists have reached consensus on some of finance’s most bedeviling issues, from the tendency of market participants to take excessive risk to the distinction between investment that is prudent for individual firms and investment that is practical for the financial system as a whole.

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The papers of the Squam Lake Working Group (named after Squam Lake, NH, where they first met) are based on the economists’ shared academic, private sector, and public policy experience.

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"The Squam Lake group highlights reforms on which the nation’s leading finance scholars agree. They are a vital resource for policymakers seeking to reduce the odds of another financial crisis," said CGS director Sebastian Mallaby.

The following are summaries of the seven papers published to date:

-        A Systemic Regulator for Financial Markets, May 2009

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Financial regulations in almost all countries are designed to ensure the soundness of individual institutions, principally commercial banks. This focus on individual firms ignores critical interactions between institutions and can also cause regulators to overlook important changes in the overall financial system. This paper asserts that one regulatory organization in each country should be responsible for overseeing the health and stability of the overall financial system.

-        A New Information Infrastructure for Financial Markets, February 2009

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Information about prices and quantities of assets lies at the heart of well-functioning capital markets. In the current financial crisis, it has become clear that regulatory agencies have not had sufficient information. This paper proposes a new regulatory regime for gathering and disseminating financial market information. This new information framework would bolster the government’s ability to foresee, contain, and, ideally, prevent disruptions to the overall financial services industry.

-        Credit Default Swaps, Clearinghouses, and Exchanges, July 2009

Credit default swaps (CDS) are contracts that provide protection against the risk of default by borrowers. The failure of one important participant in the CDS market can destabilize the financial system by inflicting significant losses on many trading partners simultaneously. A clearinghouse can serve as a buffer between the buyer and seller and eliminate direct exposure to the counterparties’ default. This paper analyzes the market for CDS and makes specific recommendations about appropriate roles for clearinghouses and about how they should be organized.

-        Reforming Capital Requirements for Financial Institutions, April 2009

This paper argues that regulators should consider systemic effects when setting bank capital requirements. Capital requirements should be proportionately higher for larger banks, banks that hold more illiquid assets, and banks that finance more of their operations with short-term debt.

-        An Expedited Resolution Mechanism for Distressed Financial Firms: Regulatory Hybrid Securities, April 2009

This paper recommends support for a new regulatory hybrid security that will expedite the recapitalization of distressed financial companies. The proposed instrument resembles long-term debt in normal times, but would convert to equity when the financial system and the issuing bank are both under financial stress. The regulatory hybrid security the authors envision would be transparent, less costly to taxpayers, and more effective than the ad hoc measures taken in the current crisis.

-        Improving Resolution Options for Systemically Relevant Financial Institutions, October 2009

This paper lays out a series of tests by which reform proposals for financial institutions that are "too big to fail" must be judged. It endorses legislation that requires every such institution to create a "living will" that would help authorities resolve its difficulties.

-        Regulation of Retirement Saving, July 2009

Retirement saving is undergoing a fundamental change as employers shift from defined benefit pension plans to defined contribution plans, such as 401(k) accounts. This paper recommends measures that will improve the investment decisions of employees saving for retirement in defined contribution plans.

The members of the Squam Lake Working Group* are:

Martin N. Baily
Brookings Institution

Andrew B. Bernard
Dartmouth College

John Y. Campbell
Harvard University

John H. Cochrane
University of Chicago

Douglas W. Diamond
University of Chicago

Darrell Duffie
Stanford University

Kenneth R. French
Dartmouth College

Anil K Kashyap
University of Chicago

Frederic S. Mishkin
Columbia University

Raghuram G. Rajan
University of Chicago

Robert J. Shiller
Yale University

Hyun Song Shin
Princeton University

Matthew J. Slaughter
Dartmouth College

Jeremy C. Stein
Harvard University

René M. Stulz
Ohio State University

*David Scharfstein withdrew from the group when he accepted a position at the Treasury department in September 2009.

For the full Squam Lake Working Group paper series, visit:


Founded in 2000, the Maurice R. Greenberg Center for Geoeconomic Studies at the Council on Foreign Relations works to promote a better understanding among policymakers, academic specialists, and the interested public of how economic and political forces interact to influence world affairs. Globalization is fast erasing the boundaries that have traditionally separated economics from foreign policy and national security issues. The growing integration of national economies is increasingly constraining the policy options that government leaders can consider, while government decisions are shaping the pace and course of global economic interactions. It is essential that policymakers and the public have access to rigorous analysis from an independent, nonpartisan source so that they can better comprehend our interconnected world and the foreign policy choices facing the United States and other governments.

The Council on Foreign Relations (CFR) is an independent, nonpartisan membership organization, think tank, and publisher dedicated to being a resource for its members, government officials, business executives, journalists, educators and students, civic and religious leaders, and other interested citizens in order to help them better understand the world and the foreign policy choices facing the United States and other countries.



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