Remarks of Chairman Timothy Massad before the London School of Economics

I join you at a time of uncertainty. A time when the United States, the United Kingdom and Europe are all entering unchartered political waters.  In the United States, we are 10 days away from the inauguration of a new president whose election defied all political predictions and conventions. What Mr. Trump’s presidency will mean for both domestic policy and the role of the United States in the world is difficult to predict. Here in Britain, the vote to exit the European Union will take the United Kingdom and Europe on a path that is not yet known— to a new relationship that has not yet been defined.  

We find ourselves in a very different position than eight years ago when President Obama was about to take office. In January of 2009, the world was in the depths of the worst financial crisis since the Great Depression. Financial institutions across the globe were on the brink of collapse. In the United States alone, we were losing more than 750,000 jobs a month.  Over time, nearly nine million people lost their jobs, over five million lost their homes, and thirteen trillion dollars in family wealth was destroyed.  Many lives were shattered, and many opportunities were lost.

Worldwide, the damage was similar. In the UK and the EU, unemployment soared to record levels.  And 25 percent of global gross domestic product was lost.

It has been quite a transformation in the last eight years. In the U.S., since 2010 we have added 15.5 million jobs, the unemployment rate has been halved, and home prices have recovered. The Dow Jones Industrial Average was less than 8,500 on January 12, 2009.  Today, it is nearing 20,000.

This climb back from the brink of disaster was the result of a massive government response in the U.S., the UK, the EU, and around the world.  Governments and their central banks took unprecedented actions to stabilize their economies.  And this was followed by actions to address the underlying causes of the crisis that were similarly unprecedented in their scope as well as in their degree of international coordination.   

But the presidential election in the U.S. and the Brexit vote here in the UK have been interpreted as evidence of deep discontent with governmental policies and economic conditions, particularly by working class voters.  To many commentators, these votes called into question assumed wisdom about the benefits of international trade and globalization.  In the United States, there is talk of repealing many of the reforms taken in response to the crisis, as they have been said to hinder economic growth.  And in the UK, the Brexit vote raises questions about the future of London as an international financial center. 

So what may lie ahead when it comes to regulation of our financial markets and institutions? 

I will not make predictions, but rather offer some suggestions about the way forward. And that is, we should not reverse the reforms made since the crisis. I do not believe the discontent that may have driven recent elections would be remedied by dismantling these reforms.  Reducing the risk of financial instability in the future contributes to economic security for all.  But at the same time, we should recognize that addressing the causes of that discontent in full requires a broader response.  

Let’s first go back to the crisis, and how we climbed out of it.  

There were many causes of the crisis — a bubble in house and other asset prices; excessive risk taking by banks; mounting corporate and household debt; and a regulatory system that had major gaps and deficiencies. 

The U.S. government launched an all-out effort to prevent the crisis from becoming a global depression.  Initially, at least, this was a bipartisan effort.  A key part of the response to the crisis in the United States was the Troubled Asset Relief Program, or TARP.  Through TARP, we provided capital to banks — not just the big banks, but hundreds of small and community banks. We implemented a housing program that helped millions of Americans stay in their homes. We took action to restart the frozen credit markets. And we prevented the U.S. auto industry from collapsing. 

The U.S. government took many other actions, including economic stimulus measures.  Other governments took action as well. 

Central banks around the world used their monetary policy muscle to prevent a worldwide great depression.  It was a war fought on many fronts, and it succeeded.

And as the fire was extinguished, we turned to addressing the causes of the crisis, in order to prevent it from happening again. 

This too has been a war fought on many fronts. It has included stronger capital requirements for banks, limits on leverage, reforms of the derivatives market, and the creation of tools to deal with failing financial institutions without using taxpayer funds.

This evening, I will focus on derivatives reform—not only because I have been most involved in that work, but also because it is the area where, in some ways, we have traveled the farthest.  We have gone from a world in which there was essentially no regulation, by any jurisdiction, of certain activities to a remarkable level of international cooperation in the implementation of a sensible, common framework.  

The derivatives markets are comprised of futures, options, and swaps.  Most people do not participate in these markets directly.  And yet they profoundly affect the prices we all pay for food, energy, and most other goods and services. 

If you are a farmer, you want to know what price you will get for your crop in the fall in order to decide how much to plant in the spring.  The derivatives markets allow you to lock in that price, in advance.  You may give up some upside, but you protect yourself on the downside. 

These markets enable utility companies and airlines to hedge the cost of fuel. An auto manufacturer can fix the cost of its aluminum supply. Exporters can manage fluctuations in foreign currencies, and businesses of all types can lock-in their borrowing costs. A pension fund that wants to make sure it can pay out benefits over a very long horizon can use these markets to help lock in its ability to do so.  In the simplest terms, derivatives help businesses throughout the world, up and down the economic value chain, manage price volatility.  In short, derivatives help manage risk.

While most of the derivatives markets worked well during the crisis, one large and unregulated segment intensified the damage. This was the over-the-counter swaps market, and in particular credit default swaps. At the time of the crisis, the swaps market was a tangled spider web of bilateral transactions, particularly among the world’s largest financial institutions, with no transparency and nothing to ensure adequate capital or collateral. Therefore, a default by one institution could easily lead to a cascade of defaults with devastating consequences.

This very scenario brought global financial companies, such as AIG, to the brink of collapse.  Had it collapsed, it would probably have taken the U.S. economy down with it. Therefore, our government committed a total of $182 billion dollars over the course of several months to prevent that from happening—an unfathomable sum. 

And though we recovered all AIG funds at a profit, such a commitment rightly caused public outrage.

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