This Turmoil Shall Pass

U.S. policymakers, and others around the world, have responded aggressively to stabilize the markets, reduce the turmoil's impact on the real economy and address the underlying regulatory gaps and policy weaknesses that these challenges have exposed. The U.S. Federal Reserve and other central banks have taken focused, and sometimes coordinated, actions to protect the financial system from severe disruption by ensuring that markets have access to financing. These steps have helped address the near-term borrowing needs of financial institutions and improved confidence in the markets. Treasury Secretary Henry Paulson and other authorities have called on banks not only to recognize and quickly report their losses, but also to raise additional capital to strengthen their balance sheets and allow for continued lending. In recent months, global financial institutions, many from the United States, have done just that—reporting turmoil-related losses of more than $300 billion and raising over $200 billion in additional capital.

The U.S. government also acted quickly to invigorate the economy through fiscal policy. The $150 billion bipartisan stimulus package will provide temporary tax relief and support the creation of more than half a million additional jobs this year. Policymakers have launched a series of housing-market initiatives to help millions of Americans by increasing the availability of affordable mortgage financing and preventing avoidable foreclosures. There is still more to be done, and the administration has called on Congress to quickly pass Federal Housing Administration modernization that would help as many as 250,000 more homeowners.

As the immediate remedies take effect, we have also begun to focus on the weaknesses in business practices of financial institutions that this experience has revealed, and on fragmented U.S. and European regulatory structures that had difficulties guarding against or responding to modern challenges. U.S. and international policymakers are acting in a targeted but comprehensive way to address the causes of current market instability with steps including strengthening the oversight of risk management and reporting practices of global financial institutions; enhancing disclosure of and the process for setting values for complex products; changing and clarifying the role and use of credit ratings; strengthening the process by which national authorities monitor and respond to risk, and reforming the mortgage-origination process. In each of these broad categories, the specific proposals are concrete, widely accepted and, in a number of cases, already being implemented by national or international authorities as well as by the private sector.

As examples, firms need to improve the way they assess and manage risk, be clearer about the risks to which investors are exposed and give better estimates of the fair value of complex investment products at the core of much of the current market uncertainty. Regulators need to improve their guidelines to firms for how to manage and monitor risk and provide specific guidance regarding their disclosures to investors of complex investment structures and products. Regulators should also improve their cooperation and information-sharing across national borders, including the assessments of financial stability, particularly for the largest, most complex global financial institutions. Credit-rating agencies need to clearly differentiate the ratings schemes for complex products and improve the quality of the information they use for their ratings that is shared with investors.

There is no silver bullet to place financial markets on a sound footing or prevent past excesses from recurring, but each of these specific proposals represents an important step toward addressing the challenges we face. Taken together, they constitute a clear and significant response to the underlying weaknesses that contributed to the turmoil in global financial markets.

Our friends around the world should gain confidence from the fact that U.S. policymakers and their international counterparts are taking aggressive, targeted actions to stabilize the financial markets, to reduce their impact on the economy and the individuals negatively affected by the turmoil and to protect against the same mistakes' being repeated. There are already some early indicators that these actions are beginning to have the desired effect, as markets appear to be gaining confidence and the availability of credit has improved modestly.

Flexibility and resilience in the face of such unexpected financial-market turmoil and economic hardship are among America's greatest strengths. Our objective is to help individuals and markets recover as quickly as possible, while avoiding actions that cause new problems that would hurt our economy in the long run. This storm, too, shall pass, and the United States will emerge, as it always has, as a driver of growth and innovation for the global economy.

McCormick is under secretary for International Affairs in the U. S. Treasury Department.

© 2008