Lawrence Summers, the director of the White House National Economic Council, delivered the keynote at the Stanford Institute for Economic Policy Research’s annual summit Friday.
Summers discussed lessons from the financial crisis as well as potential regulatory changes and long-term economic policies that could strengthen the U.S. financial system in the future.
Despite a significant rebound in the financial markets since lows in early 2009, Summers took a cautionary stand on the state of the U.S. economy, citing high unemployment figures and other indicators of economic weakness.
“We have a long way to go,” Summers said. “The amount that our economy is producing is more than a trillion dollars short of potential.”
In January, with a 9.7 percent unemployment rate, about 14.8 million Americans were unemployed, according to the U.S. Bureau of Labor Statistics. In California, the unemployment rate was 12.5 percent.
However, Summers pointedly rejected the idea that the financial crisis called into question the basic premises of “American capitalism,” or the view that financial crises were an inherent part of economic life.
“The extent and virulence of the liquidity panic was not something that I foresaw then, and until the very moment it arrived it was not something that was generally foreseen,” Summers said.
In this context, Summers defended the unprecedented action the federal government took to stabilize the financial system.
“There are moments when strong public action is necessary to preserve economic stability,” Summers said. “For all its tremendous virtues, we cannot rely on the markets to always be a self-sustaining system.”
According to Summers, the crisis also showed that the financial system in place now was one that “courted excessive risk” rather than containing risk. The system “has proved to be a source of risk that has threatened and wrenched [away] the jobs and livelihoods of hundreds of thousands, if not millions, of people,” he said.
Summers proceeded to outline six areas of regulatory reform that he deemed essential to future financial stability: comprehensive regulation of all systematically important institutions; the creation of a resolution authority that could systematically manage bank failures; regulatory regimes that provide upward pressure on capital and liquidity requirements for financial institutions; compensation for taxpayers for their bailout of the major investment banks; requiring the use of clearinghouses or exchanges for over-the-counter (OTC) derivatives and swaps, financial instruments blamed by many for magnifying the credit crunch; and appropriate restrictions on activity for those who benefit from the safety net provided by the government.
Summers also expressed some support for the “Volcker Rule,” a proposal by former Federal Reserve Chairman Paul Volcker that would inhibit proprietary trading and speculative investments on the part of large investment banks.
“Not every activity that is socially beneficial needs to be carried on within institutions whose liability holders rely on the possibility of government support,” Summers said. “And that’s why Paul Volcker has usefully opened up the question of restrictions on the activity of banks.”
“The ultimate consequence of overly clear policies suggesting that financial institutions are too large to fail, is likely to be financial institutions that are too big to save,” Summers warned.