COMMITTEE ON CAPITAL MARKETS REGULATION THE GLOBAL FINANCIAL CRISIS A Plan for Regulatory Reform May 2009 Copyright © 2009. All rights reserved. COMMITTEE ON CAPITAL MARKETS REGULATION The Committee on Capital Markets Regulation is an independent and nonpartisan 501(c)(3) research organization dedicated to improving the regulation of U.S. capital markets. Twenty-five leaders from the investor community, business, finance, law, accounting, and academia comprise the Committee’s Membership. The Committee Co-Chairs are R. Glenn Hubbard, Dean of Columbia Business School and John L. Thornton, Chairman of the Brookings Institution. The Committee’s President and Director is Hal S. Scott, Nomura Professor and Director of the Program on International Financial Systems at Harvard Law School. The Committee’s research on the regulation of U.S. capital markets provides policymakers with a nonpartisan, empirical foundation for public policy. COMMITTEE ON CAPITAL MARKETS REGULATION MEMBERS William J. Brodsky Chairman & CEO, Chicago Board Options Exchange; Chairman, World Federation of Exchanges Roel C. Campos* Partner in Charge, Cooley Godward Kronish LLP; Former SEC Commissioner Peter C. Clapman President & CEO, Governance for Owners USA Inc. Samuel A. DiPiazza, Jr. Global CEO, PricewaterhouseCoopers Daniel L. Doctoroff President, Bloomberg L.P. Scott C. Evans** Executive Vice President of Asset Management, TIAA-CREF William C. Freda Vice Chairman & U.S. Managing Partner, Deloitte Robert R. Glauber Visiting Professor, Harvard Law School; Former Chairman & CEO, NASD Robert Greifeld** CEO, The NASDAQ OMX Group, Inc. Kenneth C. Griffin President & CEO, Citadel Investment Group LLC R. Glenn Hubbard Dean and Russell L. Carson Professor of Finance and Economics, Columbia Business School Abigail P. Johnson President, Fidelity Investments Personal & Workplace Investing Steve A. Odland Chairman & CEO, Office Depot William G. Parrett Former CEO, Deloitte; Chairman, United States Council for International Business Robert C. Pozen Chairman, MFS Investment Management Edward J. Resch Executive Vice President & CFO, State Street Corporation Wilbur L. Ross, Jr. Chairman & CEO, WL Ross & Co. LLC James F. Rothenberg Chairman & PEO, Capital Research and Management Co. Thomas A. Russo Senior Counsel, Patton Boggs LLP; Adjunct Professor, Columbia University Graduate School of Business Hal S. Scott Nomura Professor and Director of the Program on International Financial Systems, Harvard Law School Leslie N. Silverman Partner, Cleary Gottlieb Steen & Hamilton LLP Paul E. Singer** General Partner, Elliott Management Corporation John L. Thornton Chairman, The Brookings Institution Peter Tufano Sylvan C. Coleman Professor of Financial Management, Harvard Business School Luigi Zingales Robert C. McCormack Professor of Entrepreneurship and Finance, The University of Chicago Booth School of Business * Did not participate in Chapter 6. ** Did not participate in this Report. COMMITTEE ON CAPITAL MARKETS REGULATION TECHNICAL ADVISORY GROUP Steven W. Abrahams Managing Director, Citadel Capital Advisors Peter R. Fisher Co-Head of Fixed-Income, BlackRock, Inc.; Former Under Secretary for Domestic Finance, U.S. Department of Treasury Robert R. Glauber* Visiting Professor, Harvard Law School; Former Chairman & CEO, NASD Boyce I. Greer President, Asset Allocation Division, Fidelity Investments R. Glenn Hubbard* Dean and Russell L. Carson Professor of Finance and Economics, Columbia Business School; Chair, Technical Advisory Group Robert S. Kaplan Professor of Management Practice, Harvard Business School Wilbur L. Ross, Jr.* Chairman & CEO, WL Ross & Co. LLC Hal S. Scott* Nomura Professor and Director of Program on International Financial Systems, Harvard Law School Jeffrey M. Solomon Managing Member, Ramius LLC LEGAL ADVISOR TO THE COMMITTEE Leslie N. Silverman* Cleary Gottlieb Steen & Hamilton LLP * Members of the Committee on Capital Markets Regulation. BOARD OF DIRECTORS Peter C. Clapman Chairman Robert R. Glauber R. Glenn Hubbard Wilbur L. Ross, Jr. Hal S. Scott John L. Thornton MANAGEMENT & ADVISORS Hal S. Scott President and Director Heath P. Tarbert Vice President and Deputy Director Jennifer M. Grygiel Assistant Director Peter W. McClean Senior Advisor Andrew Kuritzkes Senior Advisor Paul S. Giordano Senior Advisor Sara R. Reisman Treasurer Paul E. Lycos Research Consultant Michael D. DiRoma Research Consultant Samantha B. Schwartz Technical Consultant CONTRIBUTORS Adam C. Cooper Kenneth N. Kuttner Andrew Davidson Sebastian Mallaby Tamar Frankel Russell B. Mallett, III Paul S. Giordano Eric D. Roiter Robert R. Glauber David L. Sugerman Seth Grosshandler James Schnurr Howell Jackson Yuli Wang Andrew Kuritzkes David Zaring RESEARCH STAFF Senior Research Associates Steven J. Alden A. Maxwell Jenkins Richard Magrann-Wells Oscar Hackett Helen Lu Yesha Yadav Research Associates Azad Assadipour Jee John Kim Deena Quitman Jonathan Bressler Jeremy C. Kress Sharon Raz Caitlin A. Donovan Tsz Hin Kwok Letitia DeVillar Richardson Nathaniel A. Fischer Alexander Levi Chris Theodoridis Phillipp Fischer Michael Llyod David C. Tolley Bryan Gragg Ephraim Mernick Jessica Vu Lukas Huesler Khanh Dang Ngo Yu Wakae PREFACE This Report examines the regulatory shortcomings that have contributed to the ongoing global financial crisis. When the Committee began its research on improving financial regulation more than a year ago, policymakers scarcely recognized that ineffective regulation could lead to what is presently the worst economic crisis since the Great Depression. Before the crisis, our Members expressed concerns that research and recommendations in this field might simply fall on deaf ears. That is no longer the problem—in the wake of the present crisis policymakers are listening intently. The problem now is very much the opposite—there is a cacophony of voices urging reform. Indeed, it seems as if a new study on the financial crisis emerges with each passing day. Yet we believe the Committee has a uniquely independent and objective voice in this debate. Moreover, this Report goes beyond most insofar as it provides 57 specific recommendations for effective U.S. and global regulatory reform. While others have focused on fixing blame, we focus on solutions. Although this Report represents the Committee’s work, individual Committee Members have expressed varying degrees of comfort with several of our recommendations. In certain instances, we have noted where the Members have been unable to reach a clear majority on a particular issue. Nevertheless, the Report reflects a fair consensus of Committee Members’ viewpoints taken as a whole. These viewpoints are not necessarily those of the institutions of which the Members are a part. Our Executive Summary is just that—a summary. The issues and recommendations set forth there are addressed in further detail in the main body of the Report. We strongly urge you to read the full discussions, as they provide important context and data that illuminate the summary’s necessarily broad treatment of complex issues and the Committee’s nuanced recommendations. We recognize that some of our recommendations may be met by disagreement. Establishing a comprehensive agenda for U.S. and global financial regulatory reform is by no means a science, and continued deliberation on these important matters is essential to achieving meaningful reform. Nevertheless, we believe the collective expertise and experience of the Committee brings an important perspective to the issues addressed and can serve as a leading voice in the discussion of how best to regulate our financial system post-crisis. R. Glenn Hubbard John L. Thornton Hal S. Scott CO-CHAIR CO-CHAIR DIRECTOR OVERVIEW This Report offers a comprehensive and detailed plan for regulatory reform in light of the global financial crisis. Some attribute the present crisis to a dearth of regulation. But that is simplistic at best, entirely inaccurate at worst. The truth is that the financial crisis is the result of—not so much a lack of regulation as—the lack of effective regulation. Indeed, those portions of the financial system hit the hardest by the crisis—such as traditional banks and thrifts—have historically been the most heavily regulated. We think that while more regulation is certainly needed in some areas, our overriding goal must be to make the present regulatory regime far more effective than it has been. That means that reforms should be based on solid principles—chief among them being the reduction of systemic risk. A second theme of this Report is the need for investor protection through greater transparency in the financial system. More information enables the market to more accurately price assets, risk, and other relevant inputs. Much of the present crisis can be attributed to a lack of critical information (and perhaps, in some cases, misinformation). The necessity of building a U.S. financial regulatory structure able to achieve these goals is a third theme of this Report. Simply put, our regulatory structure must be entirely reorganized in order to become more integrated and efficient. A final theme is that a global crisis demands a global solution. The U.S. financial system is best viewed as an integral part of the overall global financial system. No longer can the United States regulate in a vacuum. Coordination with other national regulators and cooperation with regional and international authorities is required. Principles-Based Regulation Focused on Effectiveness We believe as much attention