employment status is not what they wish it was. that is a challenge for us and all policymakers going forward. >> you have helped us understand it better. everybody in this room, and my colleagues here at the brookings institute, greatly appreciate someone who can combine outstanding scholarship, careful study of the past for the lessons of the future, a real sense of what extraordinary public service is, and wise public policy. we all want to thank you for an bodying those values and representing us so well today. thank you for yuba city and candor and cautious optimism. please join me and -- thank you for your candor and cautious optimism. please join me in thanking the chairman. >> thank you for the invitation. .

and then, criminal justice professor james lynch looking at crime and the u.s.. after that, offer -- author frank luntz examines public opinion and what people want from their lives. also, your e-mail and phone calls. "washington journal" tomorrow on c-span. sunday, a forum with former president jimmy carter at the carter center in atlanta. they talk about the current health and foreign policy programs. they also take questions from

the audience. >> what are your thoughts about the recent outburst of representative joe wilson during president obama's recent address? the recall a similar event in your political career? >> i am going to be frank with you will. i think it is based on racism. [applause] there is that inherent feeling among many people in this country that an african-american ought not to be president. he ought not to be given the same respect. as if he were right -- he were white. ever since i have been involved in it and 1960's, not only in the south, but also in many places throughout the nation. >> we will show you that entire

hour sunday at 6:00 27:30 p.m.. our discussion on global finance continues the securities and exchange commissioner mary shcapiro. this is about 30 minutes. >> thank you all very much. thank you for the kind introduction and for chairing this very informative and successful conference. it is a pleasure to be back. i have worked with many administrators over the years. they always gave generously of their time and talent to the regulators that were seeking help. i will congratulate all of you on your new home.

there is already a great reputation that the institution holds, not just in the nation goes to capitol, but truly around the world. they helped each day educate -- i want to start by highlighting a sentence that the business school uses. it reads, this business school is committed to developing leaders capable of making complex decisions in a global environment. what stood out for me is that know where it says that they are capable of making good business decisions. just complex ones. i realize there is no way to guarantee good decisions. that is because a business decision is only as good as the information upon which is based. if a business leader does not have or cannot get sufficient information, even the training

and education you get a first- class institution like georgetown university will not guarantee that good business decisions are made. it is likely to be a good decision, only if he has experts that there is probably oil there. it is even better if he can see and appreciate how the exports -- and how much it will cost to find out. the decision to drill may be a good one for the company, but it does not mean it was a well-made decision. think about a ceo who wants to remodel a building on the outskirts of town. it is only a good decision if there is a top-notch appraiser and an architect with a good set of blueprints. without that information, the decision is no better than buying high-priced a lottery

ticket. decisions are based on information. the most successful companies are often the ones that have the best access to information. one more example. take a retail store that knows what their customers buy, how much they need, and when they needed. that store will have the right items in inventory at the right time, and sales will be robust. more information does not necessarily mean better information. too much, and began a not -- and you do not know what is important. it is the right information that matters, the right information that leads to good decisions. investors need information so they can make good decisions. if the information is obscured, vague, too plentiful or misleading, it is false.

the recent economic -- in the early part of the decade, many homes were sold to pay mortgages. many were underwritten using underwriting standards for home buyers -- where home buyers did not need prevent come. the mortgage companies knew that there is a way to push the risk of of themselves on to someone else. they could package these mortgages together and sell them to wall street, which could repackage them as investment vehicles or securities. they really did not know how risky that financial product was. of course, it is possible that some information was out there, perhaps included among a dizzying array of important data or made available in too short a time before an investment decision had to be made. it is also just as likely that

some investors simply decided to rely on experts or pay to assess risks. as we know, many of those ratings were inflated to say the very least. decisions that were based on that wrong information turned out to be anything but right. at the securities and exchange commission, we're focused every day on making sure companies and those to issue securities are disclosing information that will help inform investors. we don't always have the authority to change conduct. we cannot tell rating agency to upgrade or downgrade their ratings. we cannot tell a retail chain to cap the pay of their executives, and we can't tell all company where to drill. -- an oil company where to drill. but transparency leads to better decisions.

the sec's role is well versed in the requirements for annual and quarterly filings by public companies where they report their business and financial results. this information is the lifeblood of the capital markets as it is this information that allows investors to make informed decisions about capital allocation. there are many ways that the sec facilitates the decision of investors through the provision of information. as we have set out to change the sec's approach to protect investors, disclosure is playing a central role. since i have been at the commission, we have done a great deal to streamline and enforcing our focusing processes. we are revamping how we handle the hundreds of thousands of tips we get each year. we are bolstering our training

programs. we're also focusing on the rules we adopt. many of the proposed changes involve one basic goal. getting more of the right information into the hands of investors at the right time. for who is on corporate boards, to who is paying for a credit rating into the data about the successes and failures of those doing the rating. from our risks are being rewarded to the real price the market is willing to pay. in all of these areas, we want investors to be better informed so the decisions are as well. just yesterday, my fellow commissioners and i propose a host of rules regarding credit agencies. one such proposal seems pretty obvious. it says, let us know how good the credit rating agencies really are. credit rating agencies do not

provide enough data about their rating actions to let investors determined their track record. instead, a company touts it when selling securities, investors rely on it without having any understanding about how these ratings have performed in the past. they don't know if they're raiding firm is really good, [unintelligible] he or she has no idea if that aaa should really be triple the. -- ddd. hall often do they change their ratings, and when they upgrade or downgrade them? that little bit of information could go along way in helping an investor decide how much relative weight to give to these ratings. also, we propose a rule that would highlight ratings

shopping. for students, i like it to be able to choose your professor at the beginning of the school year based on who would promise to give you the best grade. because your georgetown students, you are very smart. he take the course with the professor that promised to give you the a. we are sponsors of financial products -- they can actually shop around for rating before buying the one they want. if they tell the world they just got a aaa rating, nobody knows that it was the third grade they received. that is why we hope to shed some light on this practice by requiring companies to disclose not just the final rating, but all preliminary ratings the received. that little bit of information can go a long way in helping an investor decide if the final rating is all it is purported to be.

our new rule of proposals stretched beyond credit ratings. we proposed a series of rules relating to proxy materials that investors receive when they are voting for a board of directors. they can be made up of friends of the ceo, very cool people like rock stars and athletes, but the job of being a corporate director is a serious one as we must all rely on the vigilance, expertise, and the integrity of boards to oversee america opposing corporations. today, companies offer insufficient information about a board candidates actual qualifications for the job. we ask you for better disclosure, qualifications, attributes, or skills. once again, that additional information did not go along way -- who will, through board

service, oversee management. likewise, investors can gain valuable insight if a company rewards risk. compensation drives behavior. the risk-management policy group identified schemes as one of the five primary driving forces of economic turmoil. the financial stability forum composed of governments around the world issued a report agreeing with this assessment and suggesting three principles for sound compensation practices. these principles call for effective compensation with prudent risk-taking and effective supervisory oversight and engagement by stakeholders. the commission has proposed a package of new disclosure rules that are in keeping with these principles. in particular, and powering

stakeholders' with the information necessary for effective engagement. we don't want to ban risk- taking, but we can expose it. it will make shareholders make good decisions. yesterday, we took steps to ban a trading practice -- is the microphones to working? -- is the microphone still working? it is a little in esoteric, but it is important because it is going right to the integrity of the marketplace. i can sell shares of my favorite company. if the exchange routes by order -- there is another buyer waiting perio.

for a fraction of a second, those folks will have a quick peek and head start to decide if they want to execute my trade. this puts the buyer that was publicly indicating that he is ready, willing, and able to match that order at a disadvantage. that is because a select group of participants can cut in line to buy the shares, using the information publicly available by this buyer without ever having to publicly display it. in addition, there will also be a better sense based on information that others won't have. we have now proposed to eliminate it. we can prevent a two-tiered market for those who want access information about the available prices, and those who -- in the area of municipals

purities -- municipal securities, these are securities issued by governments -- they are actually exempt from the detailed disclosure requirements of the federal securities laws. these are the foundation of state and local funding initiatives. securities are hugely popular with retail investors. the commission has managed to create a disclosure regime placing operations, the local government issuers, but on the intermediaries that buy and sell securities for investors. the recent proposals require variable-rate demand obligations and more generally about -- these disclosures are very close to exhausting our statutory

reform in this area. we will work with congress to provide a more robust disclosure and information regime for the future. it is a little bit of information for investors who want to make an informed decision. finally in the same vein, we will open a window into the world of short selling. the sec set out to increase the public availability a short sale related information. as part of the initiative, the regulatory organizations are publishing the aggregate volume of short sales that occurred on a given day for a given security, and they will be publishing on a delayed basis of raw data of individuals or sale transaction as heard in real time. it is a little bit of information that can inform investors as they consider what stocks to buy and sell. in each of the cases involving corporate disclosure, you can see that they are -- corporate

disclosures -- actors may think twice. and we may not be able to force the credit rating agency to make a good ratings. they can be more rigorous and how they rate and avoid conflicts of interest. we might not be able to enforce investors to minimize their reliance on ratings, but by disclosing rating shopping, we hope because than to think about the true value of the rating. we might not be able to get companies to nominate warren buffett's to their boards, but it can encourage them to reconsider nominating someone with a little qualification. if that is what happens, that is not a bad thing. it is not just investors that make good decisions, it is the regulators who need it, too. it is about gathering more information. many of the proposals will help regulators answer key questions

like, how stable are the hedge funds that are not regulated. what types of risks exist as a result of credit defaults swaps and other over-the-counter derivatives. what are the systemic risks that are emerging across the entire financial spectrum? however congress decides to monitor it, beatrice single entity, counsel, or hybrid approach, they will have to take steps to minimize risks before crisis develops and to be ready to act fast. it will have to be able to make good decisions and make good information. in this global financial system, decisions can have a worldwide impact. that is really why we're all about disclosure and transparency. that is why is that the core of what we do. students training to become the future business leaders of america and the rest of the world, i would say this. gathered the information, get

the right information, i understand the information, and no matter how complex the decision, you will be likely to make a good one. please don't forget that investors deserve good information as well. i will be happy to take some questions. >> we are a little behind schedule, so we won't get all the questions in. here are some late arrivals. the first one is an interesting capitalist question. the you feel that hedge funds should publicly disclose more information? couldn't more disclosure hurt investors by deteriorating the fund's strategic decision? >> is a great question, one that we wrestle with a lot. we don't have the authority to require disclosure either to the

regulators or to the public about hedge funds. as legislation advances that would give the sec the authority to register hedge fund advisers, those are exactly the issues we are exploring. we are where the tension for the need for transparency and the need for hedge funds to be able to have an investment strategy that is not front runne by other investors. we're likely to end up with some fairly detailed reporting to regulators at some level of public reporting for hedge funds. it would be hard to draw a distinction between the two, but on time basis, those are issues to be resolved. >> the next question in accounting question. provide your thoughts on how global standard will benefit comparability and disclosures across borders? will improve corporate governance?

>> i am a lawyer, and i can't tell you how often i am answering accounting questions. it has been one of the real revelations of taking this position. my view is, it would be ideal if we could have a single set of high-quality accounting standards that work to globally. the reason for that is that it would allow for compatability over a very large company -- over a very large companies. for companies in similar business sectors. i think it is a very laudable goal. the commission itself published for comment last spring, a road map for ifrs and ultimate adoption. the comment. it closed -- the comment period

closed. bodies are working together on a number of initiatives to try to achieve some convergence of particularly important accounting standards. they have and in no year they are working through. the goal is to achieve a u.s. cap and international standards as possible. i would want to circle back to what we said at the beginning. high quality standards are what is so critical here. investors can make rational decisions, good information to make decisions about capital allocation. the underlying premise for anything we do here has to be that the standards present truthful, neutral, clear, and

honest information about the company. >> next question. as it stands, 80 cftc and the sec will remain separate entities. will other regulatory bodies be effective in keeping up with financial products given how challenging former regulatory authority is divided between the sec into the cftc? >> the cftc was created in 1974. the day after the bill was signed, people started to argue why it wasn't part of the sec right from the beginning. i have chaired the cftc. i am now honored to cheer the sec. i have argued from every direction whether the two

agencies should be merged. my current view -- it has been for a little while, there would be tremendous efficiency for both industry and investors in the merger of the two agencies. clearly not going to happen anytime soon. we have embarked on a program with the cftc to try to work together as effectively as we can for the categories of products that really are very similar under each of our jurisdictions. we have held a couple of days of harmonization hearings. we have a robust work plan as we begin to look at -- where appropriate, try to harmonize regulatory regimes and work together more effectively. if you look at the otc derivatives legislation, you will see that it calls for a significant amount of joint rulemaking between the two

agencies. it is hard enough. it is hard enough to get five commissioners to agree to move forward. now we will have to get tenants moving forward coming from very different philosophical places. we are highly committed to making this process work as effectively as we can. this is really not about the agencies and the end of the day, it is about how to protect the american public and how do we let commerce proceed in a rational, well regulated way. >> we have a question with probably a short answer. is the proposed rule on disclosing rating agencies retroactive? >> i believe it applies to ratings after january 2007. you can read about it in the

federal register. i should add that the performance history will be on a delayed basis. that is an important point. there are basically two bottles of ratings agencies. -- two models of ratings agencies. there is a subscriber paid where the investor pays for the rating. we don't want to disadvantage that subscriber paid model by having their intellectual property out there for all to have on a free basis. nobody will end up paying for it at all. we're trying to encourage competition. >> what role should fannie and freddie going forward -- fannie and freddie plague going forward? >> i have a short answer. it is beyond my pay grade, to

tell you the truth. the administration pushed this if you -- issue of four decision at a later date. it is a very difficult call to make. there are enormous competing interests with respect to the capital markets. i know there is an enormous amount of careful thought going on at the treasury and the fha. i think it is too early to signal where it might land. >> last question. now i have to make a decision. professors aren't good at that. let's and with something noncontroversial. this is not my question. this just came in the mail. the sec is a notoriously hard to change a culture that has stymied previous commissioners.

what are you doing to change the culture? [laughter] >> it is a fair question. the sec has an enormously proud a 75 year history. there is not another agency at the federal government whose commitment over a long period of time to investors, to a fair and free markets, to a level playing fields, matches the sec. i would not have come to the agency if i did not believe it was critically important to the success of our capital markets and the wealth of our citizens. over the last several years, the agency has been caught up in some issues that i think are a little less front and center, particularly post economic crisis. while we care about competitiveness issues, our focus has to be on investors and market integrity.

i have found in my seven months or so at the agency that that message resonates enormously with the staff. changing cultures does not happen overnight. the deep culture is actually a wonderful, strong, pro investor culture. we have to take away some of the shackles that have been put on staff over the years. we have to empower people to do things to take the evidence to the very end of the process. write the rules that are not going to be well liked by industry. we have done and on major rule making this year. i don't ever friend left in the world as a result. we have to be willing to send that message every single day, not just in words, but in deeds. they have been tried to do that with a very aggressive agenda. they're trying to bring in some new skills sets and training programs. there are very new ways of doing

business. we created, for the first time in the agency, a position of risk strategy and innovation. we brought in someone from the university of texas has -- who has written a lot of cutting edge work. the whole idea is to bring a lot of smart people and you can help us throughout the agency think about risk, think about new ways to do things, and bring a fresh perspective. that is one small example. we are planting the seeds to try to focus people back on what our core mission needs to be. maybe you will invite me back in one year and i can give you an update on how we're doing. it has worked every single day. it does not change direction overnight. we're doing all the things that we humanly can to make sure that this agency really is worthy of the confidence of american

investors. thank you. thank you so much. [applause] my pleasure. ho[captioning performed by national captioning institute] [captions copyright national cable satellite corp. 2009] >> we will start the next panel and five minutes. >> remarks now by senior white house economic adviser lawrence summers. he is the keynote speaker of the comments of -- global finance. this is about one hour. >> he will introduce our next guest. [applause]

>> thank you very much, george. i want to thank you all for being here today. i wish to thank the many george town board members for participating in today's conference as well as our finance faculty. chris outstanding efforts have made this event possible. -- whose outstanding efforts have made this event possible. it is my pleasure to be with you here today as we host our first official event in this building. this facility provides a new home for our school of business, a home that will enable our students to meet the challenges of a world where people are increasingly interconnected and nations increasingly interdependent. it is very fitting that we hold this conference on the future of global finance here, and it is very fitting that we hold it

now, as we know that it was exactly one year ago in mid- september that the global financial crisis of 2008 became particularly acute. international stock markets crashed and entered a period of extreme volatility. banks in the u.s. and abroad began to fail. the global community was faced with the greatest economic crisis since the great depression. all of us gathered here today, whether in government, business, media, or academia, are involved in discussions or in teaching ideas about what economic reforms are needed to prevent another global financial crisis. in order to do so, as this conference acknowledges, it is particularly important to focus on the regulation and restructuring of our global financial markets. in all of these discussions and very much in the spirit of service that has enlivened georgetown for over 200 years, we also need to remember one

thing -- we need to remember that free market wealth creation, that economic relations between individuals and nations, the distribution profit -- distribution of profit and what must be conducted with concern for the common good. if we forget this, then all of our work means little. one person who has long worked for the common good is our keynote speaker today, larry summers. he is the current director of the white house's national economic council. until his appointment in january this year, he was the charles w. eliot university professor at harvard. throughout his career, he had shown both an extraordinary capability to address the challenges presented by modern capital markets and an exceptional compassion for the neediest in the global

community. before coming to washington, he had a distinguished academic career teaching economics at harvard and mit. from 1991 to 1993, he served as chief economist at the world bank where he played a key role in designing strategies to help developing countries. later as undersecretary and deputy secretary of the treasury, he was instrumental in creating a u.s. support program for mexico in the wake of its financial crisis and in crafting the international response to the asian financial crisis in 1997. during his tenure as secretary of the treasury in the clinton administration, the united states marked the longest sustained economic growth in our history. internationally, he focused on addressing the challenges presented by modern capital markets. his work with the international monetary fund contributed to a more effective surveillance of financial vulnerabilities, greater transparency, and -- in the global finance the system and the introduction of new lending facilities to deal with accountable account crises. he was also a key figure in

securing significant expansion in aid for the world's poorest and most indebted countries. this led to an increase in healthcare and education in a number of the world's neediest countries. at the end of the clinton administration, dr. summers returned to cambridge, where he served as the president of harvard university. he has a bachelor's degrees in economics from mit, a ph.d. in economics from harvard. his research contributions were recognized when he received the john bates clark medal, given every two years to the outstanding american economist under the age of 40. he was also the very first social scientists to receive the national science foundation's alan t. waterman award for outstanding scientific achievement. he is a member of the national academy of science and has written extensively on economic analysis and policy. it is a special day like today for the georgetown university community when we inaugurate this extraordinary building in

this hall with this very special conference. it is especially a privilege for me to have him with us today to provide his insights. ladies and gentlemen, dr. lawrence summers. [applause] >> jack, thank you very much for those kind words. you described a number of different areas in which i have worked. when i first came to washington, people asked me what was different about working in the treasury department from researching and teaching economics at a university. i used to say that as a

professor of economics, the single worst thing you could do was to sign your name to something you have not written yourself. on the other hand, as a government bureaucrat, it was considered a mark of effectiveness to do so as frequently as possible. [laughter] and then, i went back from washington to serve as harvard's president. people used to ask me, "well, what's different about being harvard's president then working in the government in washington?" i, in those days, gave an answer that as i think about it today was breathtaking in its naivete. i used to say, "washington is so political --" [laughter]

not everybody is rooting for you to succeed in an objective. i might give a slightly different answer today, but in any event, i am very grateful for the opportunity and i'm now having to serve as the director of president obama's national economic council and especially glad to have this opportunity to participate in this celebration of a great business school that is part of a great university at an absolutely critical time. after what we have seen, i think we can probably agree that there may have been no moment in the last half century when the set of subjects that are studied in business school -- finance, effective organizations,

productivity, and efficiency -- they're probably has never been a moment when those subjects were more important to the national and to the global interest. what i would like to do today is talk about one aspect of what is very much a focus of study here, which is the functioning of a healthy finance system. in many ways, we all take what the finance system does for granted, but if you have never thought about it before, you would think that it was something slightly remarkable. in our society, we have millions of households, who want to save for a rainy day or for their retirement or to send their children to college. we have businesses that need financing for their inventories, that have great

ideas for entrepreneurial visions, that want to refurbish a depreciating plan. what the financial system does is performed the profoundly important task of bringing them together, of providing the business that the capital needs while at the same time providing the house will with the opportunity to hold their savings in a secure form where it multiplies with the passage of time. there are few more important questions in any economy and how well this job is done. when it is done better, households earn more on their savings, and more investment can take place because

businesses can borrow at lower cost. think about this -- in a typical economy like the american economy, where the capital output ratio is 3, improving the financial system even a little bit so that projects invested earned an extra 20 basis points is enough to raise the gdp over time by 6%, and there are not many economic issues that loom that large. so the question of the financial system is of profound importance. the question of financial innovation in its management is critical. some time ago, when i was last in government, i compared the modern financial system with all of its innovation to a jet

plane. the invention of the jet plane got people where they were going faster and more comfortably, and that was a clear improvement, but the crashes, when they happened, were that much more damaging and spectacular. and we are seeing something similar with financial innovation. after the last two years, it is increasingly appropriate to ask whether this particular jet plane should be kept in service with the same set of controls or at least whether our regulatory regime is adequate for the future. because we have been reminded of a great deal about financial instability. to be sure, we have made enormous progress.

when the president took office, the most salient question was whether the recession would become a depression. today, the salient questions involve date in the end of the recession and envisioning the recovery -- dating the end of the recession and envisioning the recovery, and so it seems a good time to take stock. here is perhaps the most fundamental reminder. when you study economics, perhaps the most important thing you learn is about the self stabilizing character of markets. we go through lots of examples which students. the basic idea of which is that when there is an excess supply of wheat, prices fall, people grow less. people consume more, and the markets we equilibrates. that is what adam smith had in mind. the metaphor that we often used for this self-equilibrating property of the market, is a

thermostat in which things return to their natural level. that is the right way of thinking about markets. the vast majority of the time. but it was keynes' central insight that two or three times a century the self- equilibrating properties of markets breakdown, and stabilizing mechanisms are overwhelmed by mutually reenforcing vicious cycles. the right metaphor ceases to be a thermostat and becomes an avalanche. consider some of the vicious cycles we have seen in the last few years. the liquidation cycle when financial assets of our value, which forces there sale by those on margin, which closes the prices even lower. a deleveraging cycle where lower prices on institutions, on assets, cause institutions

to have less capital, which leads to less lending, and even more asset devaluation continuing the downward spiral. a credit accelerator cycle in which a weakening economy leads to a weaker financial system, which leads to less lending, which leads to a weaker economy. a keynesian vicious cycle in which lower spending leads to lower employment leads to lower incomes leads to lower spending -- continuing a cycle. and a panicked vicious cycle in which individuals seek financial institutions in trouble, rushed to withdraw their funds, putting those institutions in more trouble, causing others to rushmore to withdraw funds -- rush more to withdraw funds. starting in two dozen 7 but accelerating a year ago this week, these five mutually reinforcing, vicious cycles created a situation more dangerous than anything most of us have ever seen.

they created a situation in which we could not rely on the market's capacity to act. in which there was no alternative to strong public action. president obama's economic recovery and financial stabilization program was premised on exactly this idea of containing vicious cycles. supporting spending, income, and the real economy in order to support the financial system through a direct program of increased spending and reduce taxing, through the recovery act. and supporting the real economy by supporting the financial system through clear commitments to stand behind major institutions and through a major emphasis on transparency

through the stress tests that ultimately forced substantial raising of private capital. the results are becoming clear. the recovery program, the fiscal stimulus, and the financial stress tests have served to quell panic, drive capital raising, and ultimately turn vicious cycles into virtuous circle. today, instead of money going into financial institutions from the government, we are seeing money come back to the government. with the passage of time, these efforts should permit the normal processes of economic growth to greengage, rising incomes and employment, greater credit flows, increased credit spending, stronger american global economy. -- american and global economy. the consensus is that we should expect to see economic growth at a significant rate during the second half of 2009.

yet, despite the normalization of financial conditions, despite the indications of economic growth, we must remain vigilant. concerns remain in many sectors, such as commercial real estate, and the availability -- that the availability of capital and credit remain too tight for too many. as president obama has said, the crisis has been a long time in the making, and we know we cannot turn it around overnight. recovery will likely be measured in years, not weeks or months. but we also know that our economy will be strong for generations to come if we commit ourselves to the work that needs to be done today. we will not make the mistake of prematurely declaring victory for withdrawing public support

for the flow of credit. such mistakes were made in the united states in 1937, and they were made in japan at several junctures during the 1990's. they provide a cautionary tale. and get -- yet, even as we remain vigilant to ensure continuing expansion, it would be irresponsible for us not to learn the lessons of what took place and focus our efforts on assuring that our system becomes much less vulnerable to this kind of instability in the future. whatever plausibility the view that the right posture for policy is to not seek to prevent crisis, but simply to

respond aggressively after crisis takes place. whatever plausibility that view may once have had, it is much less plausible after the events of the past two years. just as the cuban missile crisis spurred a focus on arms control and a reconsideration of the then prevailing system of mutually assured destruction, the events of the past two years have raised grave concerns about the soundness of current public policies towards the financial system. these concerns are framed often as the need for regulators to do a better job, and they do need to do a better job, but to frame these issues only in terms of the quality of regulators' judgment is, i would submit, to frame the issue too narrowly. consider this -- much financial

instability is the result of a simple and natural human phenomenon -- people do today what they wish they had done yesterday. thus, on the upside of every financial bubble are a large number of investors who buy assets not based on fundamentals but instead based on an extrapolation from future past price increases to future returns. financial crises are the result of an overly prevalent and complacent conventional wisdom. complacency -- this fear is what robert merton called a self-denying prophecy. as the expectation that assets are safe and will continue to rise in value results in excess

of investment and excessive lending that sends the sense of the inevitable day -- that sense of the inevitable gains give way to collapse. i stress this point because it is important in thinking about the regulatory context. even the most able and dedicated regulators embedded in an environment that comprises those they regulate in a broadly political community cannot be relied upon to be unveiling stalwarts against income into was impure experience suggests that rather than trying to perfect human judgment, policy can succeed by making the inevitable imperfections less costly. i have already compared the

financial system to a jet plane. let me suggest a different transportation analogy, automobile safety. from the time of henry ford through the late 1950's or early 1960's, we had a paradigm in this country were thinking about automobile safety. it was that drivers needed to be better. we needed to have more driver education. we needed to have better deterrence for unsafe driving -- better deterrents for unsafe driving, and it would just had drivers be better, we would have better automobile safety. we had that paradigm for many years, and every year we had that paradigm, the number of automobile fatalities in the united states increased. how certain moynihan's first important contribution -- patrick moynihan pose a first important contribution was the paper he wrote on automobile

safety in the late 1950's in which he urged an epidemiological approach. it was recognition that improving human performance was a necessary but insufficient strategy. much better results come from assuming that's human corm ridiculous performance -- much better results come from assuming that improvements in human performance alone cannot make it stick. we must come from consequences of focusing on human psychology rather than changing human psychology. the conclusion was that a much more effective approach to automobile safety would be one in which the automobiles and the highways would be billed to

be much safer in the face of the human imperfections and errors that were inevitable. so, too, in addressing financial regulatory reform, i would suggest as a first crucial insight that we focus not so much on making people better but on recognizing that human psychology is what it is and that what we can influence with public policy is the incentives that people face and the consequences of the errors that they will inevitably make. in creating this safer system, a paramount issue must be incentives. a set of issues that economists

refer to as a moral hazard. consider the consequences of enabling institution to borrow in a free market system with a government guarantee, either explicit or implicit. its incentive is to reduce capital since more capital reduces the return on equity. it discourages risk-taking. because with small amounts of capital and a government guarantee, increased risk taking is a heads -- i win -- tales -- the taxpayers lose -- proposition. it attenuates what would otherwise be a strong incentive for lenders to monitor carefully how financial institutions use their money. and it creates a lowest common denominator dynamic in which the imprudent, those who are willing to lend to the lowest spread, to