Preventing a Panic

The first pressing issue—and there is no time to lose—is to get more equity into the bond insurers before the rating agencies downgrade them, or they go bust, and create a devastating financial panic. As former Secretary of the Treasury Lawrence Summers pointed out in the Financial Times, "Their failure or loss of an AAA rating is a potential source of systemic risk."

The prime official responsibility for getting the repairs started swiftly falls on state insurance regulators. The New York state insurance superintendent, Eric Dinallo, has led the way in asking banks and big investors like Warren Buffett to inject fresh equity. But clearly there should be a national policy with the Fed involved.

The second pressing issue is to see what more can be done to rebuild confidence in the financial system. There is one imperative that should drive these reviews. The amount of bank borrowing and leveraging and its inevitable deleveraging must never be allowed again to convert a banking crisis into an economic crisis. The Federal Reserve and the Congress will have to improve, directly or indirectly, scrutiny of the activities of the financial industry that migrated outside normal review. New financial instruments, including default swaps, will have to be regulated and so, too, will the rating agencies that almost literally took the place of the Federal Reserve in controlling lending capacity through securitized obligations.

We have yet to see the problems emerging from the securitization of credit card debt, auto loans, and consumer debt, which will also have to be reviewed and incorporated into a reasonable regulatory system.

It would be revealing to see—before February 5—how the candidates in either party respond to the knotty issues. Our perilous times require expert knowledge and managerial abilities, in addition to uplifting rhetoric.