When it comes to systemic risk, experts at CME Group’s 7th annual Global Financial Leadership Conference remain skeptical about whether policymakers have the right tools, let alone know what to do with them.
Kevin Warsh, a former member of the board of governors at the Federal Reserve, said he is concerned about huge burden being placed on macroprudential oversight, especially considering there is no academic research or history on how to do it. “We are running an experiment we have not run before,” Warsh explained.
MIT professor Andrew Lo said it is not clear that the Federal Reserve’s tools are fit to deal with systemic risk problems because the very nature of systemic risk also continues to evolve. Lo explained that from an academic and policymaking perspective, the financial crisis is the “gift that keeps on giving.”
The creation of the Office of Financial Research was one of the key successes of Dodd-Frank. “We cannot manage what we don’t measure,” Lo said. However, Lo believes it would be a mistake to think Dodd-Frank did a comprehensive job of addressing systemic risk because the law makes not one mention of Fannie Mae and Freddie Mac.
Jamil Nazarali, Senior Managing Director and Head of Execution Services for Citadel, said central clearing mandated via Dodd-Frank was critical in reducing systemic risk. Nazarali also noted that while another crisis is certain to happen, the financial system is better prepared because of three reforms: increased capital requirements, the Volcker Rule and reduced interconnectedness.
Warsh said the “constructive ambiguity” surrounding Dodd-Frank is troublesome and he expressed frustration about how so much of the law has not been implemented more than four years after it was passed. “The world’s banks can do fine with any set of rules, but they need to know them.”
Warsh also believes the regulatory landscape has not in fact shifted all that much, arguing that the regulatory structure post Dodd-Frank looks remarkably similar to the pre-crisis structure. Warsh fears regulators may be “overpromising and under delivering on systemic risk.”
One thing regulators attempting to tackle systemic risk must remember, according to Warsh, is something that has nothing at all to do with policy tools: humility. “Knowing what you don’t know is as important as knowing what you know.”