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The U.S. economy should address post-crisis challenges including Government-Sponsored Enterprise (GSE) reform, the shadow banking market, and the "too big to fail" phenomenon, former treasury secretary Henry Paulson said Monday.
"Every financial crisis has its roots in flawed government policies which create economic excesses or bubbles which are manifested in the financial system," Paulson said while addressing the Economic Club of New York.
He said "to mitigate harm in the public, it is necessary to identify the flawed policies, curb the excesses before the bubble grows too big, address vulnerabilities in the financial systems which have the potential to make the problem bigger and, when a crisis does come, act with force to limit it."
The GSEs, the most well-known of which are Fannie Mae and Freddie Mac, were dominant players in the housing market and are making big money as the U.S. housing market recovers, said Paulson, who also chairs the Paulson Institute. The Federal National Mortgage Association is commonly know as Fannie Mae, while the Federal Home Loan Mortgage Corporation is known as Freddie Mac.
"Today, Fannie Mae and Freddie Mac not only remained a conservatorship, they are more dominant than ever," he said, adding they were "central to our financial system and their failure would have dealt a devastating blow to our economy."
Paulson believes it is now time to talk about GSE reform, stating, "Any organization which replaces the GSE should have a reduced mission."
Paulson suggested the GSE reform be done by "restricting the size of qualifying mortgages, limiting the income of qualifying borrowers, or limiting government insurers to first-time home owners, or some combination of all three."
"A major objective of our reform should be a new system, where private market participants bear significant risk and government insurance is purchased at a price which is sufficiently large to allow a robust private mortgage market," he said.
Paulson also said some of the most serious problems in the U.S. financial markets lie in the "slack lending standards and inadequate regulatory oversight and transparency" in the so-called shadow banking market.
To fix the wholesale lending market, regulators need contingency planning to determine how they would use emergency resolution authorities to deal with a failed dealer and ensure the security collateral is disposed in an orderly manner so as not to initiate or magnify a liquidity crisis, Paulson said.
The market would also benefit from margin requirements that provide a greater financial cushion in a liquidity crisis, and higher capital charges for firms that rely too much on wholesale funding, he added.
Paulson also said the phenomenon of "too big to fail" is "unacceptable and must end" and the best approach is to "reduce the advantage of being large with more stringent capital and liquidity requirements."
Henry Paulson
Former treasury secretaryof the United States
