chance to give us your views right now and again at 2:00 eastern. the number for democrats and republicans

>> georgetown business school held a conference on the implementation of the new financial regulation law. scholars, analysts and regulators all discussed different elements of the new law including how to regulate companies that may pose risks to the entire financial system. and how to effectively enforce the new regulations. in this hour-long portion risk regulation. >> the work is far from done. we have a piece of legislation that's a very complicated piece of legislation. and it has created a lot of uncertainty, a lot of unanswered questions. and we have a terrific panel here that will be able to comment on a number of the issues that with respect to the

systemic risk. so let me start by introducing our panelists here. and immediately to my left here is professor phil swagel who is a professor at the school of business and he teaches a number of very interesting courses here. he was assistant secretary for economic policy at treasury. and in that capacity, he played an important role with t.a.r.p. issues. he has also served of the council of economic advisors at the imf, at the federal reserve and phil has degrees from princeton university and harvard university. next to phil is tim bitsberger. tim is an executive advisor at booze allen. tim has also extensive experience at treasury.

and also at freddie mac where he was senior vice president and treasurer. and tim serves on the board of directors of the cme group. next to tim is steve albrecht. and steve has a law degree from georgetown university in addition to his other degrees. and steve is managing director for regulatory affairs at ge capital and tim also serves in treasury as counselor to the general counsel and acting deputy general counsel. he was very much involved in t.a.r.p. and in issues related to fannie mae and freddie mac. and then we have chris towe. chris -- i'm sorry, chris has been very much responsible for the financial sector work going on at the imf, particularly, and

has recently completed time and will have a lot to share with global coordination that's going on. so let's start -- there are a number of issues here that need discussion. as the secretary wolin how do we have financial institutions and there are a number of issues here and he mentioned the body that is going to decide which nonbanking institutions should come under this umbrella. so i'm going to start off with the broad issue of, are we really simplifying the financial structure, the regulatory structure here or is it becoming more complicated? we've created a whole lot of new agencies.

as far as i know we've gotten rid of one the office of thrift supervision but there are new entities that are created. and for some people they are seeing this as a more complex financial regulatory system and as secretary wolin pointed out a lot more coordination is going to be required. and i'm just wondering what is this going to mean for the marketplace? will these new organizations, these new agencies take care of future problems? and i hate to say this, but there was a survey by the cfe institute where three-quarters of the respondents felt that dodd-frank will not help prevent another financial crisis. i asked a lot of questions and raised a lot of issues here. let me start with tim. >> sure. thank you very much. and just by way of background,

just to add to my resume. i spent about 15 years on wall street as a trader. i traded a lot of derivatives. from there i spent four plus years as assistant secretary treasury and then in 2006 i became the treasurer at freddie mac. i guess you have to be affiliated with georgetown to get your degree but i went to yale and then harvard business school. [laughter] [inaudible] >> yeah, exactly. so i have a front row seat to the crisis. i can definitely saying be the treasurer of freddie mac. i had a front seat of the titanic or the perfect storm, however you want to say that but without a doubt, reform was certainly needed. certainly mortgage underwriting standards became too lax and consumer protections were needed. there were -- there was a lack of communication between a lot of the regulatory agencies.

but to get right to the heart of the matter, i guess -- though i'm coming distant for the need for better coordination i remain a little skeptical that it will be successful and the reason i feel that way is that i think you need a certain type of person or a certain type of qualification in that regulatory role to understand exactly what is going on. and i don't know how many people here have ever traded in interest rate swaps can explain how a cdo is really structured. i've traded cds and that can get in the granularity of the problems that occurred. but i would argue that the regulatory regime and what's required is to get real granular understanding of what's happened. and having read just about all the books on the financial crisis -- the one that stands out to me is michael lewis's book the big short. and all those guys that shorted all the subprime, they came from the outside.

and that is they found out what they thought was a macroissue -- the housing -- there was a housing bubble, there was too much leveraged and they looked to maximize a return on that. and i -- they -- and they didn't approach any type of regulatory federal reserver. but they found what they thought was a mispricing in the marketplace and i think for the new regulatory system to be accessible we need to build a framework in there. the second thing i will say i do think there could be some overlap as a result of dodd-frank. and let's just say, for example, you're scombroek. -- jp morgan. it's not clear what the fdic role is going to be or what the fed's role is going to be. each has regulatory authority or in the case of the fdic, resolution authority over jp morgan but they are each approaching it with a different interest and a different mindset.

so i do worry that there will be some -- there will be conflicts as regulators deal with institutions that they are asked to regulate. >> at first i want to make absolutely sure that everybody understands we welcome anybody from degrees from any place. [laughter] >> but you just have a little more love affection for people who do have a georgetown degree. and phil swagel does have degrees from princeton and harvard. >> they are still executive ed for me. thank you. i agree with a lot of what tim said. i'm probably a little bit more hopeful. there's some irony here. before the dodd-frank was enacted, i testified on it very critically. i do think it will help and in particular ways, you know, with the gaps in the system.

i particularly have in mind aig here where there's no -- you know, no federal agency had direct oversight for aig. ots had for theirs but it was a little bit of the firm but there's no federal agency had ownership or felt responsibility to go out and figure out what's going on. and there's at least two agencies at least certainly treasury, the secretary -- the share of the fsok and the systemic oversight over the whole system and the free safety of the system. and they're not going to find every problem or avoid every crisis but at least there's a responsibility and ownership and the ability to gather the information. i know we're going to get to it later but i worry about once we get the information and once there's a problem what can they do about it? but that's -- that's a second issue. >> i certainly don't envy the governments and the regulators

in the position they find themselves in right now. if you think about sort of what we've been through for the past couple of years and the idea of -- out of dodd-frank saying, you know, never again as secretary wolin we want to make sure there's no more loss of that magnitude or crisis of that magnitude, and so let's pull all the regulators together and say no one knew who was in charge of the systemic risk in the past. now it's you. now it's you guys. it's sort of similar being at homeland security that the best you can hope for is that nothing ever happens. and so it's certainly -- it's a difficult task and it's one of those issues where i think as tim was saying, it takes a lot of understanding of the system just to get your arms around all the moving pieces and all the difficulty in managing a system the size of, you know, our economy and the global economy. let alone being able to then understand, well, where is the next bubble coming from and what do we do about it? so i think it's a very, very difficult task. that they have in front of them.

i'm also, you know, somewhat hopeful because there certainly were some gaps in regulatory coverage in the past that i think were very clear in the crisis and then to the extent now that there is, you know, some overlap as opposed to gaps, neither is perfect but i think you would probably take the overlap that ensure that somebody is assigned to looking at the pieces and certainly some of the derivative side to get a better handle on the side of the derivatives and there's a debate on the right way to do that and the direct attention on derivatives is a good thing as the aig experience taught us. at the end of the day i'm modestly hopeful but it really is a her culeanan task that the regulators have in front of them to try to make better sense of the system but there's also some very good people in the regulatory agencies who i know are taking this very seriously right now.

>> i guess i'm probably unique among the panelists in that i'm canadian so i didn't go to any of the schools and more i didn't serve in treasury. >> but you did go to two fine institutions. >> of course. i mean, to try to come to the initial point as directly as i can, i think -- you know, one of the issues that we struggled very much with during the assessment that we did of the united states over the last year, imf.org, please check it out, is -- you know, i think the crisis, there wasn't a really perfect regulatory framework. we saw a crisis in the united states which has a hugely fragmented regulatory system with multiple regulators, overlapping regulators. we saw a crisis in the uk that had a single fsa-type regulatory

body similarly in germany with the single regulator. the netherlands with the twin peeks model there really wasn't an obvious best practice so that's point 1. point 2, though, i think where we came out on the u.s. was the system is incredibly fragmented and i think there are really good examples in the period leading up to the crisis where that tended to slow decision-making, slow risk identification and really slowed the response to the crisis. and so i think where we came out was -- there really was an opportunity into the crisis and coming out of the crisis of dodd-frank to take a much bolder step and a bolder swing at trying to consolidate. now, unfortunately, that didn't happen. and i think that is unfortunate. that said, the fsoc has an important opportunity but a significant challenges in trying to address the fragmentation. let me name three of them.

one is coordination. there remain a huge number of agencies, we've listed many of them, but, of course, the state regulators at the banks and the banking and insurance side. coordinating all those bodies is going to be very difficult. secondly, there is the issue of the political factor and the extent to which this body and its chairman, the treasury secretary, is going to be very political. and i think what we would ideally like to see in a regulatory agency is supervisory agency is a certain degree of independence. i think that's going to be an important test for the fsoc and i think the third and related challenge is the will to act. again, leading into the crisis we saw risk identification, we saw many of the agencies identifying the subprime as a significant source of risk but really a delayed response to that and i think the real

challenge is going to be to take action and quick action. >> so one of the jobs -- one of the first few jobs of the fsoc is to figure out who was going to get this designation, this very important designation. and supposedly there will be tough, new supervision on whichever institutions are designated as systematically important. and so how -- the secretary mentioned size, leverage which are part of what dodd-frank and he said it was premature for him to comment on who should have this designation. and i'm interested in the panelists' opinion on for who should get this designation? is it size? is it leverage? a combination of size, leverage? what else? recently the stern school at nyu, some of my colleagues there have come up for that in connection. you can go to their website and

they are ranking financial institutions. and their criteria is based on stock market returns and leverage. and they're trying to keep it very, very simple so that it's easy and transparent and easy for the market to follow. but who should get this designation? who should not? it's causing a lot of confusion. and so let me throw that out to you. >> okay. sure, sure. it's a tough one. the first -- you know, my first reaction it shouldn't just be size. some of the largest financial institutions are fidelity, vanguard, some of the other complexes. and i don't think as them risky. they're huge but i don't think of them as risky. on the other hand, the transmission mechanism of the crisis lehman failed and it's not lehman failed and not like it blow up the next second.

it's like the money market fund and we have all said that -- you know, that complex was even safer than the others i just mentioned. so somehow i think it's got to be a mix of size, yes, but really activities and it's got to be both of those together. you know, how you identify -- identify which ones. and i do think there will be an impact. you know, if as a society if we tag, you know, big asset managers as systematically significant, they're going to be tagged with additional capital charges and other things that will put them at a disadvantage and i'm not sure that, you know, in the current environment that they'll have a funding advantage as a result, you know, the sort of too big to fail and, you know, easier to fund. i'm just not sure it will compensate. >> so i think -- yeah, this is a tough one. i think ultimately it's a qualitative assessment and i think it will be very difficult to quantify but things you should look for would be

leverage, interconnectivity. probably a funding needs that roll over on a more frequent basis than not. but, you know, this is -- this is going to come down to a judgment call and i think it's going to be kind of fraught with a lot of kind of second-guessing so this is one that i don't really have a good answer for because i think it's going to be really hard to quantify and discern, you know, you're in this bucket and you're in that bucket. >> do you think the initial judgment will be too broad or too narrow? how you will the incentives be? >> well, i fear it will be too broad. >> too broad. >> chris, what happens in a global sense in all of these are going to have very large global operations. and so how do you wrap around this in a global sense which institutions fit this bucket or don't fit this bucket? >> yeah. again, hugely complex questions. for which there are no easy answers. i think just to -- just to come to the initial premise, though,

another dimension to keep in mind is substitutability. we want to keep in mind either infrastructures or financial conglomerates that are not easy to substitute. so they may -- they may not be large in absolute size and be interconnected but if they go down, the gap couldn't be filled. the other, i think, dimension that one wants to keep in mind, too -- you also want to keep in mind what it is you're going to do with this designation. and there are different again ways to slice that. there's the extent to which you might want to apply some sort of systemic risk charge to them. there's the extent to which you might want to incent them and shape them in behaviors that are systematically risky. there are ways in which -- or options to increase the extent to which you oversee them more stringently and more finely there's the extent to which you might want to apply differential

resolution regime and we may come to that in more detail later. so those are sort of the broader issues. in terms of the global dimensions, i think there are a number. one is on the resolution side, it is incredibly difficult to consider resolving a large domestic financial conglomerate but doing that in the case of conglomerates that span borders is really at least in the present insoluble. so there's a considerable amount of effort that is underway in the basil committee and in the financial stability board to try to develop at least principles for improving the degree to which agencies and regulators can cooperate across borders. in the event of a financial event. also efforts to try to align domestic resolution regimes,

legal frameworks, bankruptcy codes, et cetera to make sure they are at least not unfriendly to cooperation across borders. and then there's the issue of regulatory arbitrage across borders. and the real risk is that you get some -- some national bodies applying much more stringent regulatory regimes and systemic risk charges, for example, that may or may not shift activity across borders that are ways that are not necessarily to be the vantage of the global systemic stability. >> so it's been interesting to see from all of these shifting as to what they do based on what's about to come -- so, for example, you see goldman sachs, they closed their proprimetory unit they are trying to figure out what to do with the investment unit, what's the appropriate size that they should go down to.

the other day there was a charter announced they are going to increase their capital tier one capital from 9% to 11%. basil has set the minimum of 7% but standard charter came out saying they are going to 11%. and the uk regulators are talking about knot just meeting the basil 3 timeline but it needs to happen much faster, much sooner. and you see from all of these are starting to respond. so my question to steve is, what are the consequences of these of who's going to be in a practical sense whoever gets this designation? how is the marketplace getting ready for it? >> well, i think the -- it's another challenge that the regulators face first and then the industry based on what they do. but there's a very delicate balance, i think, in terms of particularly capital is a good

example between derisking and making the systems safer but at the same time maintaining a system that can grow, that encourages, you know, economic development. you know, anytime you raise capital the primary response is, you know, shrink the balance sheet and less lending. and so that is a balance that probably will be able to swing back and forth as the regulators do their work in the coming, you know, decade i would imagine. companies who think right now are looking at this and saying we don't really know enough yet about how this is going to shake out to do too much because on the systemic side, you know, the council is just now seeking comment thinking about how to designate firms let alone setting up the process to do it determining if it will be a small group and a big group and the markets have to take their time and figuring out well, what does that mean in terms of that in a sort of thing to be enhanced, to be a systemic

effort and there's a lot of firms that are making strategic firms of their business models because of businesses they don't want to be in any longer and that sort of thing but in terms of the big picture, what it will mean to be systemic, you know, i think that's -- i think the hope that the regulators will understand particularly at this time when the economy is struggling to regain its footing that you don't want to do too much that would really inhibit growth and set us back even further. so it's a balance. >> too much private sector -- >> i'm probably the only trader that i know that actually thinks theories a lot of good behind the volcker rule. one of the things that i think happened in the 2000's was there was so much liquidity. and the securitization, the capital funding markets were so

misunderstood that that excess liquidity had its spreads and if they had taken out some of their liquidity if the gses, for example, had been less active in subprime, if the proprietary desks had been downsized and you take away that leverage and i think by definition the spreads would have been smaller and some of the things would not have taken place. i think some of these changes can be good. >> some of these things are going to be quite challenging. they're debating about what's going on in the u.s. and chris adds on the global aspects of it which makes it even more complicated. and you're starting to hear where the u.s. and maybe some are pushing for higher capital standards but again, you have france, germany, japan pushing

back and are not so comfortable with higher capital standards. where does all this going to converge, chris? >> well, i think it's going to converge on the basil 3 standards in 2019. so that's -- we have a fairly well defined end point. the real issue now is, i think, twofold. one is will there be a race to the top? will markets force particularly the most internationally active financial institutions to move more quickly. we're seeing signs of that. we're also seeing signs that many countries are also pushing for more stringent capital requirements. and i think, frankly, that's probably to the good. i think the system was overleveraged. it remains overleveraged. and this is probably as good a time as any to start building up capital. if we wait until after the recovery has taken place, then i

think there probably will be no enthusiasm as the lessons learned start to dim in people's memories so i think this is an opportunity that should be taken. and grasped as friendly as possible. >> so is this already starting to happen where there's a pressure to move implementation of basil 3 further down the road and the further you move it, then different parties come up and different ideas and they start diverging instead of converging? >> that's not my sense. my sense is that there's a fairly well defined roadmap for particularly the capital requirements. where i think things are a little bit more fluid is with regard to the basil rules on liquidity. but i think those are starting to gel. i think the degrees of separation if you like among the various parties involved have narrowed. and i think we're going to get fairly clear guidance on where that's going fairly soon. so i'm relatively confident on

that score. i think the one issue that we flagged at the fund where maybe more could have been done, where maybe the compromises might not have been taken is with regard to the definition of capital. there is, i think, a 15% buffer for intangibles which i think we all might have preferred to have seen whites for good. that wasn't done. there will be further opportunities to do that in the future, though. so we can look forward and hope for that. >> so there's -- there's differences on the type of capital. there are also differences on how the resolution should take place? and some countries are pushing for contingent capital and converting debt to equity during periods of -- during periods of crisis and other countries don't like the approach of contingent capital. ...

as a, as a firm starts, their capital starts to weaken but they remain still very viable. there's gone concern contingent capital which it triggered by a regulator when the firm is effectively bankrupt. i think there's, again i'm speaking perhaps more personally here than corporately but my sense is that the gone concern contingent capital has more

promise. the going concern contingent capital idea i think is probably more problematic because i think once that trigger is triggered, it is going to get a cascade effect and you will see a flight from the institution. >> one thing that's interesting to me is convergence of the national attitude, right? it used to be the u.s. was in favor, broadly speaking of more capital, higher capital requirements and europeans, say germany, not so much. i always attributed that to this different attitudes towards the role of the government and availability of public capital. so then in the u.s. we had public capital. basically when the four horsemen of the apocalypse were like an inch away. in germany it was the opposite. 07 there is public capital and con sore shups and things like that. now with the experience of the last couple years i think in other countries it is much more difficult going forward to have that sort of

public capital come into the financial sector. certainly much simpler, much easier than the u.s., right? basically it is unimaginable in the u.s. that we're going to have another t.a.r.p. but, you know, even in other countries the experience of ireland and other countries made it more difficult. and i think that accounts for some of the convergence where other countries are a bit more with us now on higher capital. it doesn't say that if the right amount of more, but, this sort of race to the top that you mentioned with standard chartered i can see it across the countries. >> are countries concerned about competitiveness of the country and regulatory arbitrage but as secretary wolin mentioned, the u.s. was the envy of the world in terms of financial markets, financial sector and if regulations are too high in one country versus the other, should countries be concerned about competitiveness, about

regulatory arbitrage? as some of these discussions are going on do you think they're thinking about these issues? >> yeah, i think this is a bigû issue. i mean countries, you know, it is hard to know what we mean when we say countries but countries are concerned about their growth and well-being of their citizens. they're concerned about the growth and well-being of their corporate sectors. they're concomittanly of cost of capital within their national borders and the extent their financial system is able to provide easy access and fair access to credit. i think they're also concerned about nondiscrimination. i think the interesting issue, especially for the emerging markets now which are becoming much more active internationally, much

more competitive internationally in the financial sphere, these countries are very eager to make sure that they have relatively easy and nondiscriminatory access to investing in the advanced economies. >> moving slightly away from our discussion so far, one of the things that dodd-frank did not address is the gscs and, tim, you have a lot of experience in that area and phil, you've had a lot about gses. what do you think should be the future of gses? >> i'll go second on this one.h+ >> okay. sure, sure. i have, i have my own proposals out there. you know, to me it goes back to this issue i just mentioned a second ago that the role of the government in society in terms of gse reform is a microcosm of the broader social discussion about the role of the government. obviously next tuesday we'll have that discussion in

public. and i suspect going forward there will be a role for the government in housing finance and having a backstop for the gses but it could be a long time before we get to that point. so there is an irony that until then the two firms will be in conservatorship and be fully backed by the united states government. so, i think their future is some hybrid, some government backstop, private firms again but for considerable period there will be, you know, really the government i think financing or providing the liquidity for housing finance which is to me a bit of an uncomfortable situation, so. >> so, when i talk about the gses i would say i spent 15 years on wall street so that kind of defines one border and 4 1/2 years at treasury and that defines the other border. most assume the gses are

somewhere in between -- u huh. the gses are way to the other side of government. that is because, that is funny but sad because the gses were like their own self-contained government bureaucracy but ones that were enormously profitable that. meant over time there was no incentive to change anything they did. in fact they were disincented. the only competitor to esfandiari was freddie mac. the only competitor to freddie mac was fan -- esfandiari. that is unlike any other business where gold competes with goldman and citibank, about. a, deutsch -- b-of-a, deutsche bank, whatever. there was a culture that is changing very quickly but a mind-set at the gses that was just rife with to bring on problems. the idea they could lose money never entered into anyone's mind. so what do the g. ses need going forward?

i think idea they could be privatized is laughable. there is no way they could survive initially as private companies. i don't also don't think they will be fully taken over by hud either. i agree with phil, i think there will be some hybrid model. one you hear getting bandied about makes some sense, the gses are either, they're in a first luck situation. should they be taking losses? they maintain those losses up to a certain level so shareholders are at risk. beyond that they're either explicitly backed by the government or explicitly buying insurance from the government. hard to imagine the gses going away of the as phil and i talked about, gse reform is short for macroeconomic, socioeconomic housing policy. if we think health reform or dodd-frank touches us directly, g, anything that the gse reform will hit us that much harder. >> just a quick, i mean i

think agree with most of what the others have said. the key from where i sit is to try to distinguish between their public policy, or social policy function and the other functions which are to promote healthy, vibrant mortgage market and a market for long-term debt. and i think where the real tensions arose over the last 10 years was the gses were given a much more expensive, costly, risky role in promoting social policies and i think if we can do something in the next year that strips away that responsibility and invests in a explicitly-funded government agency and leaves the gses to do what i believe they were originally intended to do, which is to promote securitization, i think we'll be a lot further ahead than where we are now. >> the only thing i wouldho add to this is, one of the,hg

it is a tangential point but one of the unique things the gse experience gives us is insight to the conservatorship process and the fact that at the time when the crisis was hitting, thankfully congress gave to the treasury department and to their direct regulator the ability to place the gse into conservatorship to save the system. that authority now is here for all large financial institutions. it wasn't there at the time of lehman or the time of aig. it is there now. in some ways with the experience with the gses on the conservatorship side could become a road map to how that might be done in the future if god forbid there is another situation or where actions like that need to be taken. so it's one more facet to this issue. it is not just sort of the housing policy issues need to grapple with but also the effect of what happened when major players are brought into conservatorship and how difficult it is to bring them back out. how do you actually solve coming out on the other side. >> steve, you obviously saw

it very close as you were the lead lawyer on aig. >> one of them. >> yeah. so let me ask, if you were at treasury right now, what all would be going through your mind? if you had to give one piece of advice to treasury right now, what would it be? >> i think, that's tough. there's so many big issuesr right now that are out there that they have to deal with. so i think part of the advice is to, you know, focus and get a few things right. you're not, the legislation require as pretty aggressive time frame so there is nothing you can do about that. but on the systemic risk council, which treasury chairs, you know i think there's a need to put in the time to really think through those issues and try and get them right. in some ways, you know, priority number one being to get solid answers and give some certainty to the marketplace.

because it makes it very difficult for is abouts to operate in a marketplace where there is so much uncertainty and you don't know what the rules are going to be. so i think picking those few things and really working them and sort of growing out from there. i think naturally it is what has to happen. that is certainly one of them. i guess the other, it is just a, just a truism i think of life when you have, everyone talks about phrases like seeing around corners. it is much easier to say when you're talking about the past, well, why couldn't you see around those corners? when you're doing it in the future sometimes you look like "chicken little" or pollyanna and don't really know what is going to be the next bubble or next important issue. going into with a sense of humility you need to it is very difficult to know what is going to happen. in that way it is just as important to have the resolution authority done well and thoughtfully as to try and predict every new crisis coming down the road because you will never be able to predict everything

coming down the road. so if you have a solid foundation whether there is a crisis there is a clear way to deal with the firm that is in crisis and resolve it well. i think that is a critical piece. >> i was going to say i would agree. i would start with easy are solution authority. so in the class i'm teaching now, coteaching with steve, we have students think through a fdi takeover of a bank. an example used $55 million of assets, two branches. tiny bank. and, it took several weeks for the fdic to go from, you know, okay these guys are done, to now they're sold off. so that is weeks. this is something the fdic does all the time now and, you know, what, 80 years, 70 years of experience with. so, $55 million, two branches. just imagine the next aig or lehman or whatever, whatever firm it's going to be. so i think the more they can think about the worst case, and obviously that is something with the t.a.r.p.

that you know, we had done some thinking about it but, you know, had we done more between march and september that would have been, you know, certainly a useful, useful dimension. >> yeah, i, first thing i would do is just manage expectations with the lfr and fsoc. i'm pretty much in the camp of reinhardt and that these things are systemic risk happens and it is not clear if they're preventable or not. but i think one of the things they can do is manage expectations among the fsoc members. build an environment where data is shared. not so much they have the predictive analysis to understand what's going to happen next but when a problem occurs in realtime, they have the, they have the data and they have the relationships they have the wherewithal to better enter things like resolution authority. one of the things when i talk to people about this,

if you had perfect hindsight, i will say the darkest day was either september, october, 2008 when the prime reserve fund broke the buck. that to me is when the world was truly falling apart. if you had perfect insight prior to that, what would you have done if you were the fsoc? would you have stopped the gses growing in the 1990s? would you have stopped bank consolidations in the 2000s. when the securitization market became the largest source of credit than traditional bank lending in 2005? would that have raced your hand? were you concerned about all the liquidity coming in from asia to finance all these bond markets? would you have looked at the growth of derivatives. if you were in the treasury secretary in 2006 would have gone in front in congress you know what we're in a housing bubble, we need to slow things down right now. i think the fsoc to be asked to be a predictive role, politically almost suicide. i would just, i think the first step should be i would encourage data-sharing,

collaborative working agreements to better understand what is actually going on in the markets, so if a problem occurs they're not acting ad hocly as they did in 2008. >> actually, i absolutely agree. in substance that was the darkest moment, right? sort of the days when the prime reserve fund after that broke and money markets shut down and commercial paper shut down. imagine if there was an agency could have said, no, really just that one fund. there are some others in trouble but the corporate parent has been able to downstream some fund and they're okay and they're not breaking the buck. maybe you wouldn't have had panic flight out of money market mutual funds that really sparked the panic. that would be just a homerun if the fsoc or, ofr or someone could do that. >> one example on that would be just the fed and no matter what you might think of the greenspan fed or the bernanke fed prior to lehman reserve fund thing you have to give the bernanke fed an a-plus how they have reacted

since. part of the reason they were able to do what they did is provide a backstop to money markets funds, qe, all the things they have done they could act autonomously. they didn't necessarily have to go to an fsoc meeting, build collaboration amongst the different members to move policy forward. i think that's another good lesson there. >> i guess i would disagree with almost everything that was said. just for the sake of argument. i mean -- >> you and my wife. >> i mean i really do think that an ounce of prevention is worth a pound of cure. i think that, you know, one of the lessons of the crisis is how amazingly well most emerging market economies have skated through it in large part because they went through crises five, 10 years ago and learned some less he is sons. i think there is a lot that

can be learned from that experience. in terms of crisis-proving your economies, making sure that you have sufficiently rigorous and tight regulation, sufficiently rigorous and tight limits on leverage, sufficiently skeptical approaches to supervision and to your and to financial innovation. i think these things can be enormously effective and are really worth pursuing. so what i think i would encourage the treasury or the fsoc is to really focus on those preventative measures in advance to beef up the quality of supervision, consolidated supervision in particular. to enforce and empower the supervisors take action preemptively when they see individual firms taking on excess risk or when the system looks likes it is building risk. think these things can be effective. >> it is sort of a delicate balancing act, how much

regulation is good and how much is not and what can be learned from emerging markets. i remember a senior person in the financial markets in an emerging market, he made the comment to me that, i hope the financial crisis is not seen as in eing markets in such a way that the innovation that is going on, that is stopped, the financial innovation. this is seen as an skution for -- excuse for really pulling back on financial innovation which is to some extent quite limited in emerging markets. it is sort of a delicate act and regulation always seems to be playing catch-up and never manages to get in front of the markets. so you do have emerging markets with a lot more regulation and in some emerging markets it is like, we will make sure the markets don't get ahead of the game. and here it was suddenly the case where financial innovation was getting far ahead of the game.

and it's a delicate balance as to, how do you optimize it. >> can i keep the banter going? >> sure. >> so, to me the, when the world changed was august, september, 2007. and prior to that point i was like in the camp, yeah, subprime is contained, this and that. but in august, september, 2007 that is when countrywide went under. when the asset-backed commercial paper market basically froze up. that is when the libor funding markets froze up. and i remember thinking, okay, this is a lot different than, you know, how my mind and people i know were seeing this, the initial subprime crisis play out. this remember is post the bear stearns hedge funds, not bear stearns going under. this is a sign that one of the things about the bear stearns hedge fund that was interesting was the subprime market initially took a hit but the way these bonds were trading in the marketplace, they were trading at let's say this market value. but because defaults,

defaults were increasing so much their economic value was actually plummeting but because everyone said, oh, my gosh, bear stearns hedge fund imploded, they created like an artificial type market for these, for these bonds. so when we flash forward to september and october of 2007, i was on the phone pretty much every day with treasury, fed, just trying to explain, i think really things are different here. you need to take a closer hard look, really senior people, okay? almost at the top of the food chain. i just don't think they necessarily got what i was saying. and, i get back to my initial comments being made i agree, in a perfect world that's great but where are you going to get the qualified people that are going to be sitting at the top of these regulatory pyramids making these qualified assessments, you know what? this is a real risk. this is just a little bit of a bubble. when oil hit $150 last summer and came right back down, got cut in half and priced to 75, not much really happened.

you know, we survived the california real estate crisis of 1994. we surprised, we survived, you know, 1998 lcm. we survived 2001 nasdaq falling. i think it gets really hard sitting at treasury and fed and determining when is the street complaining and bitching at you things not being sufficient and when is there a real systemic issue out there? i appreciate what you're saying but when you're sitting in those seats making that determination it is a challenging thing to do. >> i think also if i can jump in, it raises the difference between economic policy and supervision. there is, the need for regulators on the ground in the financial institutions to be vigilant in watching institutions from the inside where they sit and then, you know, tim was talking about, it is a different function i think to be, you know, the fed is in charge of monetary policy or the treasury is now the new, the chair of system risk council and looking sort of at the big

picture. those are very different functions and i agree there's a need to be smart at the macro level and a need to be very sharp at the supervision level. >> chris, what do you expect, anything new coming out next month at the g20 meetings?. >> well, you know, frankly i couldn't say. both because i don't know and because if i did i couldn't tell you. no, i think, i think what you have seen out of the, what you've seen out of the finance ministers and governors is essentially just a staging for what's going to come out of the leaders. i suspect what we, what we saw this weekend what we'll be validated and confirmed in the forthcoming summit. >> on that note, let's open it up to questions from the audience and, please let me ask you if when you come forward to introduce yourself. and i would encourage georgetown students, pwc

clients to go ahead and start asking questions. >> thank you. let me take advantage of making that a question here. currently at this moment, particular moment, when a bank lends to a small business and entrepeneur it needs five times as much capital then what it lends to a aaa rated client. which obviously creates a lot of discrimination on that side of the balance sheet. there are more things to systemic risk than banks failing. the banks not performing the function is just a systemic risk. how much do we need clear identification of the purpose of the financial system in order to regulate and move forward? because in the basel regulation there is not one

single word what they are regulating for. >> that's a good, that is a very good point. an implicit, i agree with you. implicit in the basel accord is a, it is, in the u.s. you say we're protecting the dif, the deposit insurance fund. we're protecting the taxpayer. this is very much a precrisis, you want a lot of private capital ahead of of the taxpayer to buffer the taxpayer. obviously what we've seen over the last year, two years, the effect of a financial system not doing its job. sometimes the administration is still wrestling with this, right? they're on their second small business lending initiative. my guess it will be just as effective not as the first one and we'll have another one in a year. yes, i don't have a good, a good solution. i guess only other thing i would sway, a diversity of funding sources is probably the best we could hope for,

you know, in the u.s., we have the banking system like, like say europe but then there's a nonbanks. you know my guess is that venture capital and private equity and other sources of funding and overall regulatory environment and economic environment have hurt them so there are nonfinancial steps that can be taken. basically give surety on the tax code, regulation, health costs these other things that could help funding and help the general economy. but that is outside of basel that is outside of banking. i agree with the premise of the question. it's a tough one trying to protect taxpayers how do you make sure you don't go too far. >> just a quick follow-up. i mean i think the question is an important and profound one. the only comfort i can give you, this may or may not give you much in that respect, but is there has been a lot of work done in the basel community to look at just the questions that

you're asking. looking at the extent to which higher capital dampens average growth. and the extent to which higher capital reduces the risk of a systemic event. and there's some nice papers that the basel committee has put out in the last month or so that really nicely articulates that and nicely attempts at a calibration. the unfortunate fact is, and i think the others have cited reinhardt and rogoff, the unfortunate fact among the g20, the statistics suggest there's a, the risk of a systemic crisis roughly once in every 25 years. the average cost of these crises is in the range of 20 to the 60% of gdp and sometimes higher. so that's really what we're thinking about. the trouble is trying to calibrate the right number in terms of your capital requirements, your leverage requirements, your risk

weights, et cetera to try to ameliorate the risk of a systemic event without dampening the ability of the financial sector to do what it is supposed to do. >> yes? >> hi, good afternoon. i'm a first year mba student here at georgetown. my question is about the, professor, you mentioned the need to sort of balance regulation so that we're not stifling the financial innovation that is occurring in the market. my question is about the overall social value of this innovation and what are the real risking to -- risks to stifling it somewhat? seems to me innovative products like some of the derivatives and credit default swaps led to this crisis which then seized some of the more basic functions of the market, commercial paper, the availability of credit.

what is the social value of these financial innovations? why do we have to be so concerned that they are continued to allow to be developed since they don't seem to have brought, aside from large profits to a few people who used, who were able to gain a lot from them, what social value do they bring and do we really have to be so concerned about? >> no, that is a good question. i will go first. so i'm still very much an optimist on the possibility and the positive possibilities of innovation in the financial sector. and, you know, sure there were problems with innovation. you know, it goes back to what's the cause of the crisis. and i don't think cds or cdos is the innovation is the source of the crisis. there is lots of sources. lack of transparency or increased complexity made things worse but i don't think fundamentally that

caused the crisis. i think ultimately, their bad lending decisions were made and lots of people to blame for that, but ultimately there are economic losses underlying the crisis. my proposal for gse reform that tim alluded to is? really a, really put a big? freddie but eventually let other firms compete in securitization with the idea that there could be more innovation and other ways to fund housing finance. and just to say directly. you know, lots of subprime loans went bad but a lot of them didn't. so that is the trick, if you, you know, save, you know, save these people from subprime loan and not afford the house there are other people who don't get into a home and wait many years to get in. that is the tradeoff to society. to me there is a tradeoff. >> this question kind of a

sentiment link in the public's mind. i have the crisis and hear about the flash crash. you hear about high frequency trading. and, i think that a lot of people out there are starting to wonder, is this financial innovation really good for society society in general. there will be problems with financial innovations. if you look at the whole thing, as, is financial innovation good overall, financial innovation has generally benefited society, but, do you need, to what extent do you need high frequency trading? to what extent do you need to have servers located with exchanges. a lot of questions being asked about how fast do we need to go on this.

>> another question on this i worry about broader issue of inequality. and opportunity. some of the concerns over the negative effects of innovation. i think are better addressed through policies that improve on that and education and training are, you know, would be important avenues there . .

further protection so you could maintain your mission and profitability in your of lending market so i think there's a vibrant vital role for banks and other entities to protect themselves against some type of a credit loss. >> i was just going to say innovation is good, innovation that is geared toward avoiding regulation is bad. innovation that promotes leverage both by household and corporate as beyond their capacity to repay is really bad. [laughter] >> with regard to systemic risk when read draft some of and the new dodd-frank act rules, the role of the exchanges were important with that aspect of exchange trading and exchange clearing trading from the

perspective then you have a mark to market clearing from the systemic risk conscience. there are huge changes coming down the pipe with derivatives in the current level of leverage there and what would be required by the exchange clearing parties in the future so what is the impact on systemic risk of that regulation coming out? secondly, are the new stock exchange facilities and mechanisms to co-op that cried. >> is perfectly fine if anybody wants to address that question, but tomorrow we have a whole panel that will be looking settlements so we will address those issues and even more detail tomorrow. >> i happen to sit on the board of directors of the chicago mercantile exchange which is the largest derivatives futures trading house in the world. these are things we're looking at carefully when i heard your

question earlier to the secretary, a tremendous amount of the rule writing -- this is the uncertainty behind dodd-frank act now and that's a tremendous amount of rulemaking that still hasn't been done. it will impact exactly what you're talking about. i think a lot of people are expecting it to develop. on osher people think that they will have a longer life span but there is no question you could see many more of the exchanges hit but highlight, this is a big uncertainty out there. see ante customers are asking what we think will happen and how this will affect our business, how it will affect our margin of the clearing house etc. so it's a valid point. >> i think it's one of the sleeper issues of dodd-frank, there's so much attention when you look at systemic risk on the institutions. relatively short but important section of the bill with

clarence systems. a lot of authority to the regulators to write rules. a balance in the authority and i think will be a bigger issue that becomes more prominent going forward. certainly you take things like derivatives there'll be more centralized clearing where you are shifting their risk to the clearing house and the critical nature of making sure that the clearing house is well supervised and not creating risk itself. it's a very important question. >> maybe just a began speaking about something and don't know a lot about but i would reinforce the last point shifting activities on to a centralized party or exchanges doesn't necessarily reduce risk of loss those bodies are themselves better supervised, capital requirements are more adequate, so it's absolutely essential if we go this route which is a good

way to go that we couple with these additional measures. the other issue also is the interoperability of these exchanges and the central clearing produce, it's critical because you don't want to lock things up in what it sees cp in ways that allows that to fail. you need to be able to allow some degree of flexibility for the ccp to exchange and the net against each other and this is becoming an import international issue because a lot of these bodies are operating across border. >> any other questions quacks. with that, please join me in thanking our panel. [applause] >> elections are under way for

all u.s. house seats.

we continue our coverage on the implementation of the new financial regulation law. in this portion one of the people who worked on the new regulation, donald coggan, former federal reserve vice chairman has worked for the fed since 1970. this portion is about 45 minutes. [inaudible conversations] >> moving right along as they say we now come to the final

part of today's program which is a keynote speech by a person with a very broad experience in understanding and so this should be a high point of the program. in donald cohn was chairman of the fed reserve system from 2006 to 2010, the advice ben bernanke the of the 2,008 and 99 financial crisis and also served as the appraiser to mr. bernanke is predecessor alan greenspan. he's now a senior fellow at the brookings institution. he is a 40 year veteran of the federal reserve. prior to serving on the board he was a buzzer to the board for monetary policy, secretary of its open market committee

director of the division of monetary affairs and staff director for monetary and financial policy. he also held several posts in the division of research and statistics. it included an associate director chief of capital markets and senior economist. he began his career as a national economist at the of the initial reserve bank of kansas city. he also served as chairman of the committee and of the global financial system and a central bank panel that monitors and examines broad issues for the financial markets systems. he has written extensively on issues related to monetary policy is implementation by the federal reserve. these works were published in volumes issued by various organizations including the federal reserve system, the bank of england, the reserve bank of australia, the bank of japan, the bank of korea, the national

bureau of economic research, and his own institution now the brookings institution. he received his bachelor of arts in economics from the college of wooster in ohio and his ph.d. from the university of michigan. we are proud to present dr. donald cohn. [applause] >> thank you, it's a pleasure to be here. you've been talking about a national reform of they and i guess was next, is that the name of the conference -- i wish i had been here, it's an interesting question i'm going to veer off a little bit here and talk about the economy. so you have been talking about the oil financial background for what's next and i will give a little bit on the macro economy and environment they will be working in there and try to relate the two subjects at least a little, the impact of

financial reform on the economy for a few minutes in my talk. so my overview of the economy is we are in for a slow climb out of a deep hole the with low inflation for some time into the future. the wide slow quacks' although the recession was a deep slow recovery has been an experience baldwin other recessions that occurred in the context of high debt and banking crises. in this case we have households who need to repair their balance sheets, households accumulated very large volume of debts as you know on the basis of rising house values and although debt service burdens have declined substantially with a drop in interest rates, debt levels are still very high and many loans particularly loans backed by mortgages by houses are under water so there's a lot of pain

to work through on the debt side of the household balance sheet. in addition households were counting on high and rising house prices to fund the kids' education, their own retirement, and with a decline in house prices there are going to have to save the old fashion way by not spending. by not consuming all their income. and that building their wealth and paying down their debt in that kind of way. savings rate has risen from a neighborhood of 1 percent are under 2% of years ago to about 6% most recently so every dollar that goes around households have been taking a few more pennies out of that dollar and putting toward saving and, of course, this is absolutely necessary to build a strong sustainable expansion and the economy over time, but as this happens and savings rates have been more money is taken not to and not

spend, of course, that's a big heaven for the u.s. economy in terms of growth. not only households have bounce she repaired to do better financially institutions as well. they came over leverage, will marble two runs because they were financing long-term assets, mortgages in particular with short-term liabilities. as they became worried about their own vulnerability is and the affects of the recession on the borrower's, future credit losses, they needed to rebuild capital, make up for past losses and a tightened terms and conditions of lending a very substantially. once again, this is something that needed to happen, said conditions for lending were way too easy but in that fear and the problems of the recession and became very tight. securities markets are open for corporations as you know. corporate bond markets were -- there are a lot of clothes there. but for our words that are dependent on banks, households, small businesses credit is still

quite high. this is mark steven and the real estate area given for plain vanilla mortgages. some securitization markets are rigged opening but some such as jumbo mortgages are still the impaired. the third problem as we enter the recession with an overhang of houses and probably of consumer durables as well, these houses and durables were purchased with two easy credit including second mortgages, home-equity lines of credit for household durables and this overhang, this excess supply of houses and durable goods knees to be worked off. so this is not a garden variety session that begins when the federal reserve gets word about a recession, and tightened monetary policy very tightly, slams the brakes on spending and spending is cut back then the federal reserve eases policy and

there's a pent-up demand from the spending that didn't get done in the tight policy time. that's not what happened here. federal reserve tightened policy tomba not a lot over 2004 -- 2005 and it wasn't -- we didn't come -- to the recession was caused by an oversupply of houses and other things rather than tight monetary policy of and cutting back on demand that way. the fundamental problem in the bubble of time, there were too many houses, houses that were too large. larger than -- word and the prices too high. it will take awhile to work to these problems. we need to apportion losses between home owners and lenders the mortgage modification, foreclosure, and that process is clearly working imperfectly in many dimensions will take longer than they previously thought.

we need to get people in houses and apartments they can afford over the long term. convert owners to renters were people can't afford to be honors and into worth is a oversaw the houses are most serious problem houses don't depreciate rapidly. the overhang has been accentuated in the recession by weak household formation but even after it recovers and there's more to be quite a few extra houses around and foreclosures, short sales, they shot of inventory to keep the supply coming. as people trade down. so relative to a normal recovery economy is facing the heaven of persistent a weak housing market. in fourth heaven is uncertainty about the future course of the economy. this is a recession, the depth of this, the onset of of financial crisis created a lot of uncertainty and this isn't an experience any of us fortunately have had in our lives. so it's hard to know how to

react, how things will happen. there's a huge amount of uncertainty out there and it's been compound for households by the very weak labor market. this is a sound way to produce more with fewer workers feared it was a substantial increase in productivity in 2009. i've been very cautious about -- businesses have been cautious about hiring rather than adding to payrolls and a weak labor markets feedback on consumer confidence and undoubtedly on consumer spending so we have an adverse loop here between a weak labor markets and consumer spending paid in back on these things. a lot of these ideas that i've talked about it enough to productivity but some of the others are typical of debt and a huge crisis beds and we aren't facing some issues as economy that are not typical of such crises. what is the global character of the recession. the global integration of

financial markets meant that trouble and problem spread rapidly among globally active investors and financial firms' pullback every where at the same time when their access to liquidity and credit worthiness was called into question. emerging market economies have come back from the downdraft of this cost of many of our major trading partners, industrial trading. are still very weak. we cannot rely on the man from these trading partners to close out of this recession. tax and regulatory uncertainty is always with us and it's not the main force blocking spending. i think that's concerned about how the uncertainty and concern about how the recovery is going to go but certainly tax and regulatory uncertainty is weighing on the wrong side. tax -- congress couldn't tell what the taxes would be on january 1st much less what they're going to be over the

next decades as we eventually come to grips with our government deficits and debt problems. on regulation health care changes justified perhaps on various public policy grounds but they are adding to uncertainty about what a new hire will cost over coming years. i think many of these had winds that have been holding us back will obeyed overtime and economic recovery it will strengthen of its kind to be a gradual strengthening from here. households are rebuilding net worth through this saving i was talking about and will slowly get more comfortable with their balance sheet positions here and as dead relative to income false and as with a drop in wealth decline in household housing prices largely behind them. the savings rate is unlikely to rise but anything like the 1% or 6% increase could go up some

more. it not clear whether it will or not but could go up more but the head wind of that very substantial rise in savings, it would be very surprising to have that happen. capital and the financial sector is being rebuilt with greater earnings, problem loans already beginning to add banks and other lenders, probably beginning to compete a little more vigorously for new credits. can see some hints of this and the federal reserve service. the last one was august and another one in november, but any loosening in president is from a very tight level. securitization markets are continuing to open, seeing some of this and the cmb as markets so credits are beginning to ease up, so an honor of this convocation i ask myself what it lacks the financial reform regulatory reform dodd-frank higher capital brave markets and the line until sector and private sector reactions are

likely to have on the recovery, how they are likely to dampen the recovery. i think a key point here is that the political process but in g20 leaders of the financial sector rather than the taxpayers must be equipped to absorber tailor risk and absorb the kind of shock to the system that we have had over the last couple years. now, entail risk, the odds on that kind of shock can be reduced by a number of things. structural things in the financial markets, i guess you talk about derivative markets to them and central counterparties and things like that, that could be very helpful and reducing the complexity and the odds on a structural problem. the tunnel reserve and that the financial sector oversight committee counsel is charged with looking for imbalances,

asset price discontinuities, problems that might be building up and taking action to diffuse those, and also i think will take the pressure off of the financial sector. but even with that sort of trying to reduce the tail risk, the risk was badly misunderstood in this price before the crisis. i think better understanding and more absorption of that tail risk by the financial sector implies higher rates on credits relative to the cost of funds. on a broad variety of credits. having lenders hold more capital, be more liquidity, it's part of the equation that transfer is the risk back from the taxpayers from the private sector. more over the implementation of dodd-frank and basel three will add to uncertainty until implementation is better specify the and sped up. ultimately these extra costs of having the financial sector

rather than the taxpayer their potential risk of another crisis. ultimately borne by the customers of the bank's. lending customers who want to lend shrivelled deposits and barolo, bar with 30-year mortgages are going to find that the spread between borrowing and lending rates are widened out to. so i think there will be in affect on the cost of credit by having the financial sector absorbent these risks. but if the requirements are faced in slowly credit availability should continue to improve given that is much tighter than it needs to be as the economy returns to our prosperity. so there will be a dampening affect but i think is quite limited and there's a very positive long run trade-off for these changes. to the extent of the

requirements and changes and practices maker system safer, more resilient, less subject to the sort of crisis we have just been through, that crisis is having substantial continuing costs, reducing the possibility of incurring those costs again it seems to me is a very positive aspect of regulatory reform and higher capital and liquidity. so i think that in the ebbing, the rating of the heavens from. availability will still occur despite the efforts made to make the financial system safer. overhangs of durables are probably this -- disappearing and another headwind fading a bit of a disappearing and those things to depreciate, durable goods and business capital spending. but we see evidence of pent-up demand in the business sector for equipment that has been strong over recent quarters. productivity is likely to be

growing less rapidly. i don't think it will fall back again but it's not going to be as strong as it was last year. that means as demand strengthens in the economy more will be passed through to the labor markets and therefore i think that will help household confidence and could get into more positive feedback within the -- one that we have now. i said it was a slow climb out of a deep hole. let's talk about the whole for a secondary one of the controversial aspects of the. >> situation is how much of the unemployment, the five percentage point increase in unemployment over the past year, to structural and how much is consequence of the business cycle. i think some is structural. structural unemployment has risen both as a consequence of an extended employment benefits which keep people in the labor market and from accepting jobs that otherwise might except and also john matching issues.

his skills for available jobs. willingness and ability to move to new work. so we're going to have two people building houses, fewer people and financial sectors, to people in consumption sectors, those people need to find jobs in other sectors and the skills to find jobs in the other sectors. so there is some structural unemployment. some of it will go away as the extended unemployment benefits are a case out in coming years, but i think most of what we are seeing is cyclical. most of it is absence of demand rather than structural. i think the job losses are widespread suggesting that it's not just in a couple sectors were people need to find work, it's a very broad and all over the economy. so it's not just about job thatching. as i say at least the majority of the five percentage point

increase in unemployment represents real slacked in the economy and we can see this in the inflation behavior and compensation. inflation core cpi it was in the two or 2.5% range of two years ago and is now one or in little under and most recent data. that suggests there is a very competitive environment with plenty of slack in the economy and people competing for sales. because i see the slack as quite a large and only diminishing very slowly overcoming years i see inflation staying quite low for several years. slack will continue to make the pricing environment both in goods and labor markets highly competitive putting downward pressure on inflation. inflation expectations seemed to be anchored above the current level of inflation and assuming these remain anchored and i will come back to this when i talk

about monetary policy in a second, they will be exerting upward pressure on inflation so you have expectations appear and inflation down there, people acting as they expect inflation to say to% rather than one to pull up the inflation rate. but the slack in the economy and the competition for jobs and to sell products is tending to pull the inflation rate down. ..

>> but there are very, very widespread problems to additional fiscal stimulus. what is skepticism in the political system about the efficacy of the stimulus. we had a slug of stimulus a couple of years ago. it's hard to see the effect. the counterfactual is always a very difficult argument to make in the political arena. so if we hadn't done this, things would have been worse. that's an experience i had at the federal reserve quite a bit in the last few years. if we hadn't taken our actions on liquidity, purchase of securities and whatnot, i think things would have been a lot worse. but it's a hard argument for

people to grasp when you come to the crisis. and it was the worst than it otherwise would be. but there is widespread skepticism about whether it would work, and i think without a long-term plan for dealing with the unsustainable deficit debt situation, short term stay was just makes problems potentially worse. you come into the long come into the next figures with even higher debt. so i think there are, there are a number of reasons to think that fiscal stimulus, however the text empower the economic textbooks that are taught here at georgetown, i'm guessing, whatever they would say about this situation will in the political arena be very difficult to get very, very difficult to get through. and as long as long-term path of fiscal policy is unsustainable, there will be uncertainty about the eventual outcome. and that uncertainty plays on, plays on damping the recovery. and certainty is not good for

people to make forward-looking commitment to spend, capital spending, higher people, things like that. i don't know what to do about that. i think the political system has to come to terms with that. i do think that the system will have to make quickly a decision about what they near-term tax rates will be. and that will relieve some uncertainty. making decision people will work around it. on the regulatory side, as i noted, some regulation is necessary aspect of achieving the social goals, but i think we need to make sure that we are subjecting regulations to rigorous cost-benefit analysis that i think we need to reduce the uncertainty as quickly as possible, put the regulations in place. whether any financial sector or in other sectors. so folks can know what they're dealing with and can work around it. the government needs to recognize, this is part of the

cost-benefit analysis, that businesses must see profitable opportunity to spend or higher people. we have to be careful -- carefully don't dampen that. what about monetary policy? i want to emphasize before i began this little section that i have no inside information you. i have been out for two months, i guess. i was a part of the september deliberations and obviously have not been part of anything since then. and i'm not going to predict what the f1 seat might do. my advice to you is listen to the committee and its chairman. there are much, much more informed about what they might do that i might do. let me make a few points about the potential for future, for possible additional steps by the federal reserve, and hope to help you understand some of the issues, the committee, the federal reserve is grappling with. point number one, the federal reserve has a mandate, has a

legislative mandate for high employment and stable prices. the chairman just the other day to find a stable prices as 2% inflation. he called that the mandate consistent inflation rate. now why did he say to present? that doesn't sound like price stability, and even with errors and biases in the price index, it's probably closer to 1% as absolute price stability. the higher inflation rate should, over time, did you slightly higher now my interest rates, right click so if you're not a interest rates would be about 3% with a 1% inflation rate over a long period, it should be about 4% with a 2% inflation rate over a long period. the higher nominal interest rates in good times means that as a shock hits the economy, the federal reserve has further to

reduce, a downward shock it's the economy, the further reduce rates before it hits zero in order to cushion the economy i guess that shock. so having a 2% inflation definition of price stability gives a little more flexibility and ability for the federal reserve to hit its other, it's of the mandate of maximum employment. so if something is driving unemployment up or driving employment down, it has more room to lower interest rates and cushion that. that's why you call that the mandate consistent inflation rate. as i noted in my presentation, i think both employment and inflation are likely to run short of their goals for sometime. we will be running with a high unemployment rate. it's only gradually declining, and a low inflation rate well below the almost 2% rate that the chairman was talking for a while. i don't expect deflation but i don't expect recession. but i don't expect them to be

near there. the outlook i've outlined for it is not to have those two variables near what the legislation would ask for. as i've also note, declining inflation expectations are an important downside risk. so i said that inflation was being held around 1% by two opposing forces. the slack and the extra people looking for work and businesses looking to sell stuff, and a weak economy, kind of putting downward pressure on inflation. inflation expectations were counterbalancing and fully inflation. inflation expectations start to decline that counterbalancing force start to add and inflation could go down. and declining inflation expectation of the committee put out in its last come in its of its last meeting, and flies that real interest rates, interest rates after inflation, are

rising. this economy, if i'm right, and we're in for a slow climb out of a people, the economy does not need higher real interest rates. discouraging spending. and there is a risk under those circumstances, not my expectation, but a risk under the circumstances you could get into a pretty adverse spiral of rising real interest rates, slower growth, the unemployment rate not declined at all, inflation going down even further. it's not the most likely outcome, but it is a risk and it is clearly one that the f1c is concerned about. as i pointed out in their last an ounce but. monetary policy is not the reason that the recovery is so modest. i pointed to half a dozen headwind to recovery, and mostly involving balance sheet repair and hundreds of houses and things like that. interest rates are incredibly

low. liquidity is plentiful. in every sector of the market. but even though monetary policy isn't a problem, monetary policy potentially, even at the zero lower bound, can help immediately the effects of some of these other things. lowering in immediate long-term interest rates, short-term interest rates already at zero. if the federal reserve were to decide to purchase more in immediate longer-term treasury securities, presumably that would put some downward pressure on intermediate and long-term rates. of course, that reduces the cost of capital, helps to boost asset prices. you are just getting the expected future earnings from corporations, flows of houses at a lower rate and that will raise asset prices. sounds like a constructive thing to do at a time when the economy

is flagging against balance sheet constraints. but there are some negatives that the open market committee is going to have to way. this is about comparing costs and benefits. the benefits are very hard to calibrate. we have very little experience, fortunately, with this kind of policy under these sorts of circumstances. so it's hard to say what additional purchases well, what benefits will bring. it's unlike moving interest rates around in which we have decades of experience doing that, and contract through the economy. we don't have that kind of experience with buying assets. and to some extent these channels are a bit clogged. so you think about long-term interest rates. one channel might be positive would be revived on houses so that borrowers have lower obligations and have more, have

more income, after interest income. but the extent that refis are inhibited by low housing values relative to mortgages, of course, that's going, that's going to dampen the response. and uncertainty dampens the response to lower interest rates. more people are uncertain about the future, the less they are likely to respond to a small decline in the cost of capital. a second problem is the more the fed buys, the more it will have to work at eventually exiting. that is, selling or getting rid of the securities at some point. the federal reserve has worked very hard at developing tools, the instruments to do that. i think this is a very constructive asset. the policy is run by chairman bernanke, but it is absolutely critical that the public have confidence that the central bank can head off inflation when it

needs to do so. i think this is especially important at a time when fiscal policy and the trajectory for the debt and the deficit are not seen as sustainable and under good control. and people do worry about the intersection of fiscal and monetary policy, and the temptation for the fiscal authorities to lean on the monetary authorities to monetize that debt. so i think it's absolutely essential that the federal reserve continue to make the case that it has the tools to exit this policy when it wants to do so. and not only the tools, but the will to do so. and i believe that it does in both cases, everyone at the federal reserve. it's in the drinking fountains i think, in the water, the dna. i'm not sure what the right metaphor is, it is concerned about allowing inflation to rise

to uncontrollable levels. people have either lived through, in my case, or studied the 1970s era that was a very bad time. the central bank is very aware of its part of its mandate for stable prices. and it will take the actions necessary, and i'm completely confident, it will take the actions necessary to meet that piece of its mandate. but it's important that people not think otherwise. and, finally, i think the purchase of any media longer-term treasury securities, driving in interest rates, does distort asset prices to a degree. they are inducing people to take on more credit and interest rate risk than they otherwise would. in a sense, overriding the market judgment of people is the whole point, right, of the exercise of buying the securities, or trying to drive down those interest rates more than they otherwise would be.

but at some point, so it's a deliberate distortion of asset markets in many respects, dried up equity markets, trying to elevate, keep house prices from falling so fast. and that's the way we exit the economy, exit this week growth period more quickly, if that's what they decide to do. but there are risks there. you are inducing people to bring purchases from the future to the present with these low interest rates. at some point as the economy recovers, the distortions will unwind, and we don't want that unwinding to threaten financial stability. so the federal reserve any other regulators are and need to step up supervision to make sure institutions are taking on more risk that they can have a, but they know what they're doing with, and will be ready for the eventual exit from this low

interest rate policy. let me say just a word or two about the international global dimensions of this, which have received heightened attention in recent days. this is a difficult situation, globally. slow growth and industrial economies all around the world, there are some exceptions, but not that many, and i realize not only in the u.s. but in other places as well and monetary policy to help the economies grow. fiscal policy and some other countries, think about the u.k. as being tightened quite substantially. and in places in europe as well. so you got fiscal policy, neutral or typing. they're relying on monetary policy, and that means you've got very low interest rates throughout the industrial world. this is putting upward pressure on exchange rates and asset prices in emerging market economies, which are growing more quickly now.

so to some extent this easy monetary policy is having a facts that are not entirely welcomed in other economies. but i think we must return to higher levels of resource utilization and the united states. this is a very serious situation. it's not in anyone's interest for the u.s. or other international economies to stay week for long. in the u.s. we have a huge reservoir of mom, labor, loss of long term unemployment, longer people are unemployed the less attachment they have to labor force. their job skills deteriorate. there could be permanent a facts of this long-term unemployment on our ability to produce i think we're also saying that the longer this week is for system or there are protectionist pressures which would to the

global economy and the u.s. economy. but when we return to higher levels of spending, we cannot replicate where we were four years ago. where we were four years ago was u.s. consumer spending almost all their income, and accumulating huge amounts of debt. u.s. builders building more houses than anyone would want. and u.s. financial institutions producing some pretty toxic assets in the financial sector. >> we've seen that movie, and it didn't end very well. so we need to come, when we come back to higher levels of employment, we need less consumption, less residential investment, less financial sector activity, and more investment and higher net exports, and a lower current account deficit. the world cannot count on the

u.s. consumer driving global demand. this implies that the rest of the world needs to lift its demand. there's a global demand gap. if the u.s. isn't going to feel it and can't fill it and shouldn't feel it. than the rest of the world is going to have to step in. the parts of the rest of the world, logically bill step in, are the ones that have the surpluses, right, in their current account that are dependent on exports to the u.s. they're not going to be up to do that. they are going to have to have to increase domestic demand. but for their own sake and for the sake of the global economy. now, logically i think most of the policies that will bring about this realignment our demand high policies, the international countries, including the u.s., need to have more sustainable fiscal policies over time, dampening demand from the government sector. in the emerging market economies

need to have more domestic demand so they fill that gap. so mostly it's about affecting demand, but it's also about changing, to make that effect is, we're going to have to change some of the prices from the staff producer and the stuff produced there. and i was glad to see the g20, the g20 pledge for more market determined exchange rates. i think that would be a very constructive move. they also pledged to resist protectionist pressures and strengthen multilateral cooperation. so i think, you know, the devil will be in the details, or maybe a better cliché would be it will be implementing that that's going to be critical. but i think it was, it was helpful, i think, to see the g20 finance ministers, central bank governors, recognizing the changes in the global economy, and at least saying the right

things about addressing those tensions and coming out with more sustainable patterns of growth globally than we've experienced the past few years. that concludes my presentation. i will be happy to take some questions. you guys are so anxious to get to the drinks. [laughter] i wouldn't blame you after listening to me. any questions? go ahead. >> hi. given the point that you made that we are wpt poll deep hole, take a long time to get out, keep pressure on aggregate monies, aggregate credit, because of people deleveraging and credit losses, how long, and given the fact of the banking system is still broken even with this issue and you're not getting the multiplier. in fact, you would expect with quantitative easing, how long can you do this for?

are there any limits -- >> do what for? >> quantitative easing. and are there any of them and asked how big you can allow the balance sheet afford its problematic? >> i think the effects of quantitative easing, not so much, at least so far, have not come so much to get the creation for reserves, which are absolutely correct, they're sitting there, banks don't seem to be anxious to put them to work. bone growth is negative are forever so dependent on category. the loan pricing. so i agree that's not working. but i do think the aspect of quantitative easing that, and we've seen this over the last couple months as chairman bernanke started talking about it again in jackson hole, but lowering interest rates, of elevating equity prices, and of reducing the exchange rate a

little bit. that can have positive effects on the u.s. economy, even if banks are not using, are not trying to use those reserves to expand their balance sheets. it would be better, the whole process would be faster, i think, if banks felt more comfortable and more competent that risk adjusted there were some opportunities out there to make loans, and they started funding small businesses in particular. but that's not a necessary condition for this quantitative easing type of stuff to work. as to the limits, and some theoretical sense, i think the limits -- there aren't many limits, but i think the limits are the negatives does talking about, because i was talking about. so the federal reserve needs to be absolutely certain that people still have confidence

that it can and will exit when it needs to exit in needs to be very, very careful about these distortions and asset prices. even if to some extent they are quite deliberate but it needs supervision and regulation of key financial institution, needs to keep up with those distortions. people need to be careful about what happens when it unwinds. yes. >> i understand the levels of the quantitative easing that we are being talked about in the order of $100 billion a month, multiplied out by a year, 1.2 trillion a year. how is that not monetizing the debt? how our foreign observers not to do that as debasing the current a? >> i don't think without commenting on the amounts that might be done, i think in a sense it is monetizing the debt, because it is buying the dead and creating reserves with it.

but that monetization of the debt is not intended to reduce the discipline on the fiscal authorities. it has no obvious implication, in my mind, or some eventual inflationary out. i believe the federal reserve does have the tools to be monetizing that debt when the time comes. i'm still saying we, we have worked very hard to develop those tools to be able to absorb -- absorb the reserves when it is time to absorb the reserves, to raise interest rates when it's time to raise interest rates. so yes, buying, if they decide to go ahead and do this, they would be buying government securities, and a sense, that is monetizing the debt but i think when people say monetizing the debt, the reason that is a scary term is because it implies a threat of inflation down the road. that the fiscal and monetary

authorities will be tied together so tightly, the monetary authorities won't be able to stop monetizing the debt. and that's not an issue in the united states. the monetary authorities will stop monetizing the debt when it is the appropriate time to do that. i'm completely confident in that. people should not be concerned that purchase of treasury securities will compromise the federal reserve's ability to control inflation. yes. >> we have been talking about the financial regulations here, and the capital requirements for bank if they discriminate a lot between the different type of borrowers. how much do you think that the distortion that the fact that, for instance, small business entrepreneurs they are required for the banks of 8% lending when they landed to them, but when they link to the public sector, it is 0%.

how much does that introduce distortion in the rate as missing them right now? >> so it shouldn't introduce distortion because if it is done correctly, then those capital requirements should be proportional to the risk. so i think it is not a distortion to say to thank him if you're doing something risky you have to hold more cattle together doing something that is not risk you have to hold less capital. i don't think that as a distortion that at the capital requirements are not well calibrated to the risk in the lending, then there will be distortion, i agree. but the effort is to calibrate the capital requirements, and there shouldn't be distortions if it is done right. okay, now it really is time for drinks. all right, thank you very much. [applause]

>> thank you. just remind you, fourth floor is where the cocktails will be in a fisher colloquium, and then for those of you have made dinner reservations, those will be on a tent just off the first floor. thank you all for being here, and i look forward to seeing you this evening. [inaudible conversations] [inaudible conversations]

>> president barack obama reacts to the election results tomorrow when he holds a news conference in the east room.

>> more now from a conference on the implication of the new financial regulation law. in this hour 15 minute portion, the role of enforcement in capital markets. scholars, analyst and regulators all have different element of the new law including how to regulate companies that may pose risks to the entire financial system.

>> thank you very much. so i'm expandable is the panel that is entitled punishment and deterrence. it's moderated by my partner, tom biolsi. >> thank you, mark. good afternoon, everyone. the name of our panel is punishment and deterrence, the role of enforcement of our financial markets. all you have had to do is read a newspaper or watch television to realize that law enforcement agencies at the federal, state, self-regulatory and certainly at the fcc has ramped up significantly in the last two years. what our panel will try to do is to have some key decision-makers share with each of you and all of us their views on some critical questions that, as you run your business is day today, what you must think about because at the end of the day i'm sure the worst nightmare for all of us is business. is to be able to get a question

for me these panels are members of the team as to how the problem happens, and what your organization did to prevent and/or detect it. so we have been blessed. we been blessed with a phenomenal speakers today. i think that one of the things that i would like each of you to do is really think about the role that each of these individuals play, and to think about when you look at their background, in the materials that have been handed out, how they can impact each of your lives and your organizations. so at the far end is rob khuzami. robbie stuart of enforcement, former prosecutor, former general counsel, key decision-makers are cute and wall street journal today. great picture, rob, by the way. [laughter] >> right next to bernie madoff. [laughter] >> next we have david markowitz. david markowitz is a senior executive of in the state attorney general's office, responsible for financial fraud

at the state level. i got to know dave working with him at the newark office of the f. easy. is a very accomplished professional. one that many of us have tremendous respect for. james schear is, the acting head of enforcement of finra, and industry attorney, one who is prosecutor early in his career and has brought tremendous experience, enthusiasm to his current position. dennis mcinerney, assistant attorney general in washington, the justice department -- >> they just gave me a new promotion. >> sheet on the front section, i apologize. chief of the front section to accomplished prosecutor, one who is highly recommended to us for this panel because of his significant involvement in bombing cases the financial services industry.

and then finally bonnie jones, senior prosecutor of the southern district of new york, henley many financial fraud cases that a couple of premium does represent a comment. all of these panels are sharing their own views and they're not giving you use other agencies or other people within the organization. so as such, it is particularly their views and their view of him. and that is required for everyone. so i will say that on behalf of all of the panelists. second, undoubtedly you will have questions, questions about an issue you have seen in the newspaper, i think you're being told about friends in college in the business, maybe friends of yours were under investigation by any of the individuals or their organizations -- [laughter] >> so obviously they can't comment on or respond to questions about current matters. and so as result of that, if and when you have questions, they're happy to answer questions

involving hypothetical issues to the extent it does reflect a current matter before them. and then finally, one of the things we would strongly encourage you to do is, to the extension of questions, if you can wait until the end, and maybe some people he is really urgent and you want ask one of them, i don't know why, but to the extent you do, we would like you to wait to the end because we're quite a bit to cover. all right? so first, what we were tied to do is go down the line and asking about the panelists their perspectiperspective you will have time for all five panels to share their perspectives, but a number of them. and so we'll ask each panelist to lead on discussion and many others will chime in. so the first will be handled by the rob khuzami. rob, everyone is interested in your perspective on the role priority of the sec with regard to enforcement activities currently at a financial services. >> well, thanks, tom. i think that with respect to our

priorities, it's no surprise that the last 16 months or so since i've arrived we've been focused very significantly on cases arising out of the financial crisis. and they have run the gamut as you may know from really the issue reside, in terms of those companies such as countrywide and new center and others who failed to disclose a deteriorating business model, and the additional risks and the inadequate loan reserves or other, other characteristics of their balance sheets that were under stress given what was going on in the mortgage markets. >> we've charged cases arising out of mutual funds, main street, evergreen, morgan keegan who failed to disclose in their files, and sometimes went so far as to let certain data investors out of those funds in advance of public disclosure of any of the

declines, or other bad news. we focus on collateral managers who were rife with conflict of interest in terms of managing cdos, and managed fund and other pooled products. obviously, he arranges a cdos such as goldman sachs, cloning a bank and tbw which we did with the justice department for what was once the largest nondepository financial institution in the country no space for selling fraudulent loans. to colonial bank and engaging in t.a.r.p. front of the things i. so across the whole sort of the spectrum of mortgage products, we've been very active and has been a lot of time doing in the last year. forward-looking, to some degree we are active in every aspect of the financial services. and that's by design. we have present in the broker-dealers, and in investment advisors, financial

statement and accounting fraud, ponzi schemes, all the way sort of across the spectrum. that's by design to make sure that there is a sufficient deterrent impact being felt at the forward-looking i think some of the areas that we focus on are reflected in a special is yours we created earlier this year to really do a deep dive into the investment adviser world, private funds, investment companies and the like, who obviously come out of the economy may move up and down, third party manage are a fact of life and here to stay, and we believe that a close look at their activities, particularly the violation, conflict of interest, and the like, are important to the second group is marketed to switch his focus on large-scale insider trading and market many commission. think of the galion case which we did with bodies office in new york. hedge fund advisers who adopted an effective business model to

obtain inside information really as a matter of routine in order to conduct their trading activity. that in large-scale market many commission with the new technology and data analysis in order for us to better be able to detect patterns in trading, including those cross markets, which is to read this, which would reduce obviously from dodd-frank now that derivatives will no longer, you know, consists of contracts buried deep in the files of derivative dealers. now the stuff can be centrally cleared so we'll have better information, better audit trail, and this transaction and we can see transactions eventually in the derivativderivatives market and the debt market the same weekend in the equity market. so that people are buying protection in advance of bad news in the cds market, they will find themselves the focus of an investigation. structured products remain a priority, not just for obvious reasons for cdos, and other

structured products that we are familiar with, but those that are on the horizon of one form or another. municipal securities, that's going to be a real focus of ours. i think we are concerned that there is, you, $1.8 trillion i believe of outstanding munis. a great deal of pressure on municipalities both in terms of pension obligations and infrastructure needs that may not be properly disclosed. significant dilution issues. a lot of retail, a lot of retail holdings in these instruments. perhaps a misguided you that eventually the state or the other issuers are going to bail them out of these products, if there are problems, and i think also still be the fact that enforcement is really the only force in the field, as you may know, munis are not required to

register with security's of corporate issuers are pics we think enforcement is important in this area that and we have sued the state of new jersey earlier this year for that kind of violation. and lastly, fcpa continues to be a focus of ours. in this greater greater coordination across the globe and i think the u.s. no longer sees himself as kind of a and i think the u.s. no longer sees himself as kind of a and i think the u.s. no longer sees himself as kind of a -- lone voice. catching up to the u.s. began as a matter that dennis is active in. those are in a nutshell kind of our priorities. >> that's a helpful, rather. can just touch upon also the financial fraud we've been reading about in the newspaper, what the sec's enforcement division's role is? >> yet. the president announced a task force earlier this year i believe, and it's an organization that really covers

as many as 70 federal, state, and other agencies, broken down across five working groups, one of which is securities and commodities fraud, but they cover a wide variety of very. and unlike most task force, most effective to the extent which it is there not so much to bring cases in its own name but really to act as a way of coordinating the activities of so many different agencies. if you think is about the foreclosure matters that have been a lot of focus recently, that's the kind of organization they can do a lot of good simply by making sure the efforts of all these there is state federal and other parties are organized, something isn't as who to put a phone call into, or he might face at a meeting and that can really go along way toward helping. so task forces have been effected and the security and commodities world, candidly, we've been partnering closely with everyone you see up here, state authorities, which is the

newark attorney general's office, the justice department, thinner and other tickets kind of a well-worn track in the security and commodities were. not quite so well-worn perhaps any other epic i think the task force particularly helpful in those other areas. >> that's very helpful. dennis come as much of the folks in this room don't want to get a call from folks on rob steen, i think they would even look less forward to a call from someone on your team. justice department, especially on the criminal side the media to share with his thoughts about the priorities,. >> they are very similar to what rob outlined that the sec is focused on. obviously, financial crisis is something that everyone is focused on. and what caused it, either people that should be held accountable or a competition held accountable because not only were negligent or reckless but they didn't willful into misconduct. from loan origination to the

securitization process, to misrepresenting the value of loans or mortgage-backed securities, board cdos, et cetera. t.a.r.p. fraud, all of that is part of what we are focused on. the mortgage fraud area is of particular and if we have been focus on, something just made read about, operations on trains which was a sweet between march and june of this year where a proxy 1500 defendants were caught up in that sweep. the fraud section, just to get a minute about the background of the fraud section compared to the rest of the department of justice, here in d.c. there's a fraud section that focuses on white-collar work. that's what i am part of. that's what i am the chief of. basically the fraud section focuses on securities fraud, commodities fraud, fcpa, any fcpa batter has to go through fraud section, maine justice.

also bank fraud, different procurement fraud, health care fraud, identity theft, is there. all white-collar crime basically goes through the fraud section. or the u.s. attorney's office. and so bonnie, for example, is in the southern district of new york, my old office, and so they are 94 u.s. attorney offices around the country. and either a u.s. attorney's office or the broad -- fraud section or a combination of too often, in fact, the vast majority of the cases of fraud section for example, does we do in partnership with the u.s. attorney's office. so that's big picture. so for example, the fraud section had a strike force in las vegas for mortgage fraud. that was part of the operation stolen dreams sweet. rob already alluded to the lee farkas case where the allegations and that indictment

which were brought in, which in effect as close to a 2 billion-dollar fraud involving tbw and colonial bank, both of which are now in receivership. colonial is one of the top 50 banks in the country, and tbw as robin hood to is one of the maybe the largest private mortgage lending in the country. so we're very focused in a. where very focused on the types of ponzi schemes and investment fraud that rob alluded to. the statistics are really staggering when you consider, just the last two or three months, some of the please and sentences that have seen can be seen in the press. shapiro, the co of capital investments u.s.a., a connection with a 100 -- in connection with an 800, 80 million-dollar investment fraud scheme pled guilty. that was in new jersey.

michael goldberg like guilty to $109 investment fraud scheme in connecticut. corey johnston pled guilty to an 80 million-dollar investment scheme in minnesota. sentences of 23 years, 25 years and 30 years were given to frank for $39 fraud in illinois. trevor cook for 159-dollar ponzi scheme in minnesota, and matthew for a 15 million-dollar scheme in louisiana. idd statistics because i think they really are staggering. i mean, the number of ponzi schemes and other investment frauds that we've been seeing over the last couple of years is like nothing any of us has ever seen. and so that's obviously a very significant part of our focus in the department of justice. on the fcpa side, that has been

increasingly, you know, important for the department over the last five years. there've been over 40 corporate resolutions, and going to talk about this in a few minutes, but one of the things people have questioned is, is the department is focusing on corporate america, or is it just focusing on corporations as opposed to individuals. and the answer is no to both of those questions. we are certainly focused on all companies. and, in fact, if you look at the resolutions over the last five years, more than half of the companies that have been prosecuted for fcpa violations are either foreign companies or u.s. subsidiaries of foreign countries. and if you look at the statistical on individuals, you'll see that there is a significant increase over the last several years, especially over the last two years in terms of the number of individuals we have been prosecuting. and just on that we're going to talk about it a little bit later

on, but just since january of last year, over 80 individuals have been indicted. i'm sorry, over 50 individuals have been indicted since january of last year, and there are 35 that are in the u.s. that are now pending trial. and individuals that we are pursuing are not just mid-level agents or low level employees. they include ceos, cfos, very senior executives. and so i underscore that because that is absolutely one of the priorities of the department. because obviously that's where you have the diggers impact that the final thing i would just make reference to is how we can go about our business. it has that is something that we are very focused on. obviously, people are not interested in having four, five

year investigations in a lot of these things, and we're doing everything we can to speed things along. and illustrate now how we're going about that, which i think it's instructive to us in the department is something that we have now been applied to other areas is how we've gone about addressing health care fraud. back in 2005 and 2006, at least in the fraud section, we indicted single digits in terms of number of people that were indicted for health care fraud. starting in march of 2007, we established a health care fraud strike force, and we have now taken strike forces to seven citi's. miami, houston, l.a., detroit, baton rouge, brooklyn and tampa. and over the course of the last three and a half years we have indicted over 800 individuals as part of those strike force. over 400 have already pled guilty. over 300 have been sentenced. the average sentence is 45 months. that includes a lot of professionals, doctors, nurses,

owners and operators of clinics, et cetera. and the instructive thing, especially in terms of how we go about our business in other areas, from this process is we are no longer taking a long time to issue a grand jury subpoenas, to banks, et cetera, and it could often take three, four years to investigate a health care fraud case. now from the day we start to the day we actually indicted can often just be 90 days. and so as is evidenced in the fact that the strike -- strikeforce to start in march of '07, it tells you that you can actually move very quickly if you are willing to get aggressive, and we are. and that means we're not going to necessarily have cooperating witnesses in all of our cases. it means we may have to rely largely on circumstantial evidence, and it means we will have more trials than we may be had in the past. the fraud section is a good

example of that, and i think it's the case throughout the country in terms of the number of trials we are seeing. in the fraud section alone, and we only have about 65, 70 lawyers currently in the front section, we've had 20 times already this year, and we have another 26 or so trials currently scheduled between now and in of the first quarter of next year. that's because a lot of people are seeing how aggressive we are being and they're trying to test us. that's fair. we certainly don't bring a case, this is something we'll talk a little bit about in a while, in terms of what our standards are. we do not bring cases and less we know beyond a reasonable doubt in our view of the world, that the person is guilty and that we have the ability to prove that. and the track record in terms of how these cases played out i think is proven to, that we have been assessing the cases correctly. but we are actually trying to

apply the same model to the other cases. security fraud cases, ponzi scheme cases, mortgage fraud cases. which is why you see the mortgage fraud suite and what happened there. the farkas case, for example. went very fast in terms of, from basically sometime last year into the time we brought the case. so those are examples of how we are trying to move things along, and we have our standards but we are absolutely committed to bringing to justice very quickly whoever is that maybe has crossed the line. so it's not always easy to figure out, but that's we are committed to doing. >> is very helpful, thank you. dave, those of us to do work in and around the new york area, when does the new attorney general decide to pop is it into one of these situations? what are your priorities?

>> well, that's a question often asked ourselves as well when we spend an awful lot of time thinking through some of those, so of those decisions. i think one of the areas we are in as a delinquent several of the other panelists have already said it is investigating various areas or fallout stemming from the financial crisis. it is an area where we are, and i bet its appropriate place to be, given how much damage the financial crisis is causing and how many questions have come out of the crisis. we may approach things from a slightly different perspective. i think you usually get the same place. but we attempt to see if there's any industry practices or flaws that warrants reform of an issue. and that's something we feel we are very effective at. when we find a come and we think it's a way we can see be very

effective at helping the financial markets. another big area that we have been involved in, not directly related to the financial crisis, has been any pay to play area. new york's pension fund is the third largest pension fund in the nation, and as part of the ongoing investigation obviously there's been a series of announcements in that investigation where a host of corruption, pay to play activity, has been rooted out, partnering with the commission in those cases. i think what you're going to see is not certain what we're doing, we are often constantly reassessing and looking. because one of the interesting things about the current financial markets is things change in a hurry. so we have folks in our office all the time providing us with

information, recommendations, referrals. and we spent a lot of time processing that. i think it's very easy as a regulator to get focus on what you are working on. and we are spending a lot of time saying hey, should we ship some of our resources into this new area to make sure that we are adequately looking into this area. so i think that's a particularly important in our agency. i think it's a clear important problem in any agency where there is a finite resource. those are some of the areas we have been active in, and i would expect we will continue to be active in for some time. >> thank you. james, given far more active? >> our jurisdiction is a little more circumscribed. jurisdiction of my fellow panelists. we are with the industry a celebratory organization for brokers, investment banks, and there's 4700 of those. and we are jurisdiction over those as well as the individuals who work for or otherwise associated with those. there's about 600,000 of those

individuals. when we kind of look at our priority, protecting investors, ensuring market integrity. so in the former we are dealing with investors, one of the things that really kind of focuses our priorities this year is really a fairly unusual environment in which we are now operating. this is a very low cost training environment where it's difficult for folks to get you. that they may be will living on a particularly retirees. and witches would see in a hypothetical over and over again repeat itself over and over again is an individual who is retired, sees a certificate of deposit mature, they want to roll it over and get a similar rate. they can't find that right. so they end up being sent over to see a stockbroker who is going to sell them a product that is purportedly a higher yield, have returned for them that they need to live on. but what happens is those products come with a lot more

risk. the kind of cases that we are seeing an bald really do selling of those products. whether it be intentional this statement about those products and their features or real simple ignorance on the part of the broker and/or his or her firm. kind of interesting example or sort of a typical example, a case we just announced last week where a firm was fined for signs of the cold reverse convertible notes that they're selling these notes to a number of individuals including an 86 year old retiree and a 20 year old door click that and the product is to say the least fairly complicated and its wrists are fairly significant. in these are people who are holding as much as 50 or 60% of the limited assets in those. probably not a good idea here so that's the kind of thing that kind of drives our priorities. on the investor protection side. and how does that kind of follow

from reverse convertible notes? is looking at other structured products like principal protection note, looking at private placements, rate the it doesn't. is look at floating-rate funds and eds, particularly the sort of exotic kind. all sorts of products like that that are unusual. on the institutional side when it comes to market integrity, one of the things about finra, which include examining firms, registering brokers and so forth, is that we're also in many respects a purveyor of market utilities. so we provide that kind of information about the industry. we provide surveillance services. we look at trades on the exchanges. we see probably upwards of 80% of all trading. and was at the pattern to indicate potential abuse. and in most instances refer that to the sec because all that involves unregistered folks. but that information, and that surveillance is very important.

we look at the financial wherewithal of the firms to make sure that they can meet their commitments to their clients. we look at things like anti-money-laundering issues. we look at firms that sort of hold themselves out as the vehicles through which to make illegal distribution to stock, involving be many good. so there's a pretty wide range of priorities and functions at, that finra is responsible for. >> very helpful. so, body, we have left you alone up until now. now you get to reveal your true self. somebody comes to attention, performance, and article you read any newspaper, you get referrals from the sec. we decided what factors you decide whether or not to charge an individual, or investigate an individual? >> thank you, time. i think we get a case in a number of ways. we might get the company may call himself a poor and those they have done something wrong. a regulator like the sec may call us and make a referral.

perhaps they've noticed some suspicious trading patterns or some other conduct that they want to bring to our attention. sometimes people just walk in the door of u.s. attorney's office on a tip. we might get a star or a suspicious activity report that will read about something in the paper. and oftentimes we're actively looking at conduct. in one case, and then our investigation expands dramatically because there's a new lead that would follow up on and so they we're generating additional expansive view of a particular case that takes us down other avenues. . .

but having gone through the threshold level we need to analyze the intent and knowledge and for that sometimes in cases it is not a parent who knew what, the crimes committed in, new there was a crime being committed at an organization. we try to identify the active participants and and work our way through all the members of the conspiracy or the schema from the senior levels of management all the way down to the bookkeepers or low-level staff. we are analyzing each individual's knowledge and intent and the thing to see what they did or didn't do to further the scheme. now part of that process can be complex and it's not always easy to determine who knew what at the time the crime was being committed. oftentimes we are in a position of needing to rely on

cooperating with assists to help us understand the inner workings of a particular scheme or fraud and is worth noting how i think about cooperators and what we do and analyze in terms of deciding who acorn operator might be. we would want to look at that person's role in the schema and determine how long they were a part of it and what was the duration of the individuals involvement in the scheme. we also want to look at the individuals level within the organization as part of management, part of senior management, part of the board, in the financial or accounting department so where is he situated can be important depending on the scheme you are trying to understand. you also want to know someone is of the top of the pyramid because it's the office is practice not to corporate down rather someone who can cooperate above this level in the organization as well as below. also we're looking to see if someone had personal gain or financial reward as part of the

scheme. whatever their involvement was with financial ties with regulatory agencies are dealing with law-enforcement. so once we have that picture we will then want to make sure that we have all the supporting and corroborating evidence. that may be fine records coming e-mail records, business documents and the like. we may look a trading records and other patterns and this will become part of the evidentiary records we will present to a judge or jury down the road. in some cases this will mean we what additional evidence. as you may know and the white caller fight we are using wiretaps to further pursue our case so it may make sense to get authorization to go off on a wiretap to get the proper evidence or conduct surveillance of their proper individuals. perhaps it makes sense to consensual recordings were search for evidence so that we will have complete pitcher to demonstrate the knowledge and intent of the perpetrators of the crime. >> i would just add that really is a sea change from how things

were back when i was in the office in 1989 to 1994. we very rarely went on wiretaps in the securities unit in the seventh district of new york, you didn't do a lot of search warrants were consensual recordings. you did some of it, but nowadays in the white-collar world wiretaps, consensual recordings, search warrants, they are commonplace and its no longer treating white-collar crime and in any different way from and how you treat organized crime or narcotics. >> very helpful, scary but helpful. >> someone like other members of your team and, i think we have a good case. what are the things you think about whether to go after an individual or organization, the facts you think are important and the resources?

what you need for that sort of attention in? >> well, i don't think is particularly mysterious. what the nature of the misconduct, how strong was your case, what are the offenses, kenya prevail at trial. i think that whether or not charges you cannot just charge of our position that whether or not individuals and what are the other remedies that perhaps other law-enforcement agencies have taken or are prepared to take. what consequences to the individual sufferer privately with respect to their position, their role in the entity, private litigation etc. how does it with our priorities. so really all the factors i think that you would guess for

most people you would hope were taken and i considered in making the decision. >> the issues i have heard discussions in many of my career you talk about potential problem is the materiality threshold. is the material to me and my net worth it had inappropriate gain in some sort of conduct or activity that may be inappropriate or are large organization -- is this material and something that in the sec and the government be interested in because the represents a small fraction of my personal not worth or organization size and therefore we believe it's really not material to the government. are those factors? >> it separates the cases were materiality is a legal requirement versus those that is a prudential consideration deciding whether or not you should exercise your discretion to charge a case where that gain or loss might be love. with respect to the former, many

of the securities laws require that in a statement or in the accounting area that there be materiality which is a generally cut off about a 5 percent threshold and so if there is revenue recognition schemes going on for example but it's an amount that falls behold -- below the threshold you might not be you're the obligations. but, of course, that is just a quantitative analysis. they also is a and more qualitative analysis as to whether even absent 5%, it's still a case that can be brought for. as i2% but that takes them and from not any analysts' expectation or eps basis to any expectations, we would certainly take the position that as material not so much because of the high% threshold but because

qualitatively as very significant to the company. with respect to the individual on a discretionary matter there are some that are too small to take into account, but also have to keep in mind and that it still be very significant for the victims of the wrongdoing. so you may look to see whether or not there's private enforcement remedies that have gone on, arbitration resolution to the victim and other law-enforcement taking into account or the areas were from a qualitative perspective of the loss may insignificant but the impact could be significant in an area where we don't have much of a footprint. so if whatever the latest product that might be a constructive and and sold to retail investors, if there's a misrepresentation in it and you think that it's an area that could be very attractive to investors but there is high risk

you might choose to bring a case with a small amount of gain or loss and send that message. >> that's very helpful. >> i would like you to think about this one. in so as a body articulated the, how they analyze whoever was involved. robb has talked about when it gets the agents interest with the sec but when do you decide that, in fact, it's the organization itself and needs to be charged? that's a very serious attack and charging an organization of the ramifications are quite a significant. what are the things you think about? >> let's stock back for a second. we've had corporate criminal liability out in the united states for a hundred years, new york central started in 1909 saying a company could be held criminally liable for the acts of its agents and employees and officers. the next 85 years you didn't see

a lot of companies being prosecuted. and that was basically because it was a by neri menu. you either indicted in or you decline. and to indict a company could have serious collateral consequences and the typical argument by experienced defense lawyers was it would probably kill the company if you're in a financial services area or it could otherwise have serious collateral consequences even if it did until the company. so then in 1994 you have the prudential case which was of first deferred prosecution agreement in a corporate resolutions. in so that introduced the concept of something between -- indict and have a felony conviction and just decline. so you now have many things that you can do short of indictment

and therefore you see a lot more in terms of corporate resolutions and corporate defense counsel now having to really seriously engage with the department of justice then you probably did it prior 21994. what's interesting is that wasn't really used very much between 94 and 2002. on average there were two a year in terms of a corporate resolutions that were either deferred prosecution agreement or not prosecution agreements. then in 2002 you had the arthur andersen case which i actually represented arthur andersen and travel along with rusty hardin in that case. since then from 2003 until 2009, you have averaged 17 deferred prosecution or non prosecution agreements a year. and that's because everybody has recognized that there are severe

collateral consequences at least as i assessed the reason for the change. i think anderson obviously sent a message that this is a significant issue and people have to pay attention to but the department has been paying good attention to this issue, but that means that you have corporates institutions now having to really grapple with the possibility of a charge or something short of a charge and they are a player in the dynamic with a prosecutor, not just individual parent and now, in terms of whether the factors to consider when determining whether or not to pursue a company. basically since 1999 those five issues have been laid out very clearly in what was originally the holding m'aam of the time eric holder was the deputy attorney general and at that time there were eight factors he listed the over the course of the next 10 years. there was another factor that was added the, it went to the

thomson m'aam in 03, mcnulty memo in 06 and then the villa m'aam in 08. all of those are deputy attorney general's issuing guidance to the corporate world as to the factors that are considered when determining whether or not to prosecute a company. bottom line is now is part of the u.s. attorneys' manual. i think that we have landed in a very good place and now, for example, no longer any confusion about whether prosecutors are going to ask for a waiver of the privilege, asked that the company not advance attorneys' fees with individuals of the company, or get too concerned about joint defense agreements. the bottom line is prosecutors want to know the facts and accompany wants to get cooperation -- credit for cooperation, they have to figure out a way to get the facts to the prosecutor. they do not have to waive the privilege, they do not have to do a lot of other things over

the prior 10 years there was some confusion over that. so i think we're in a pretty good place, i could go to the practice listed in the u.s. attorneys' manual now, but basically what you would expect them to be. the nature and seriousness of the offense, how pervasive was it, senior management involved, the history of the company, the first time the company has had an issue or have problems in the past, the timely involuntary exposure as well as cooperation -- and that's a big deal. they are all important the itself disclosure is a very important and helpful staff accompany the as that. south disclosure and cooperation can go a long way to help a company even in the face of a pervasive misconduct or it was very serious and a lot of harm to shareholders and consumers and others, but it does not mean

that if you sell disclose and corporate you automatically will good declaration or even deferred prosecution agreement. but it's a significant factor. if the other factors of the adequacy of existing compliance program meeting prior two this being discovered how was your compliance program, obviously after it was discovered you will be making improvements to that but one of the factors that we consider it and it's a stand-alone factor is how was your compliance program before this came to light. then the sixth factor is the remedial actions and that means how you address the problem once you discover it. the seventh as collateral consequences which obviously is the anderson case as a good example there are serious collateral consequences. they can be false financial services firm. the adequacy of from prosecution of individuals is the eighth of factor which was then an advocacy of civil and regulatory revenues is the ninth factor.

so those of the practice we consider. in so i said to said, nowadays whether or not to pursue companies is part of the standard calculation where 20 years ago it really was in. >> very helpful. david, the attorney general has been active in pursuing things from a civil perspective against companies. tell us a little more. >> i think it is important to know it's one of the back ends of the question that i think any active enforcement program needs to have a robust program of regarding both individual and then entities. we are active in both areas. as think in a particular area we are discussing now, and to do is, i thank you hit on one of the key differences between our of this and most other offices and that we have concurrence in civil and criminal jurisdictions. on the criminal side i really think the analysis is of that

much different from any of the actors that were just outlined. a lot of posts and our office and pryor and federal officials are used to the standards and instinctively think of the issue that way. having civil enforcement power the changes things quite a bit especially when combined with what i said with earlier topic we discussed where we are coming at issues with the reform in mind where we think reform is needed. the job will not get done just by bringing individual actions against individual wrongdoers who may be terminated from a company or what ever happened, that company still exists. so from a law enforcement perspective as well as from a justice to evict them perspective, whether be defrauded investors were consumers or whatever it may be, the institution it may be invaluable in providing recovery

to those investors. equally if not more important is sending a sign in reform measures. that could take place. now, because we can perceive civilly, that creates a few differences. juana is the collateral consequences well they could be significant and we do not underestimate them are going to be far different if one proceeds slowly than if they proceed criminally. criminally you always have to think can you have a repeat of the arthur andersen situation and my guess is ever prosecutor thinks about that with large institutions. so i may not influence the end decision. in the other issue is the standards are different and we look at the standards rigorously , but civil prosecutions has a lower standard than beyond a reasonable doubt standard. under new york's martin act this

standard is even lower than in most civil prosecutions, though i feel that we look at that as a litigation advantage issue now so much as prosecutorial discretion issue. meaning we are looking at its and as it should this person, should this entity be charged. and i think for those reasons those of some of what you might see in our office much more active in the area of cases against entities. >> jim, when you go -- when do you reach out to criminal prosecutors, regulatory prosecutors? when do you make that decision to bring in others? when do you handle the prosecution? >> we work closely with the sec first and foremost for a variety of reasons the least of which there are power regulator. and so we have a vested interest in doing that, but in all

seriousness there are a number of instances where we, cross evidence of wrongdoing and misconduct involving individuals not associated with brokerage firm or investment bank pierson over whom we don't have jurisdiction. depending on the nature of the misconduct, it may be a referral to the sec which we see most often. we make criminal referrals as well particularly when coming across ponzi schemes and out and out that san that's a common thing we see unfortunately in the industry. there are times when we will collaborate with the sec and with the states in matters. sometimes on parallel tracks. we like to work fairly closely with them, but, of course, that is where it comes -- the rub comes from. there are times where we will be accused of working to close with them and the difference of us sitting here, the old joke about which one is different, it is just because we aren't a

government actor and these folks are. as a province of regulator, one of the things we enjoy about that status is quite frankly we pursue our investigations without certain constitutional restrictions so for example if and individual is summoned to the testimony and they choose not to they can be expelled from membership and lose their right or their ability to be a broker. this fifth amendment does not apply in our forum. so worried to lose that ability, in other words, deemed to be a state actor because we were so intertwined with david's folks in an investigation and were really acting hand in glove through us to acquire certain testimony or evidence and so forth that obviously that would raise the issue of whether in a particular case in individual

who was expelled love for failing to assess a lie, whether that was appropriate. there has been litigation about. frank watch on the most serious in that litigation so we need to be careful on that. within these confines of avoiding the kind of what they call into alignment with the sec or in the state regulators, we certainly in to coordinate with them and we do share information and tell our brokers when we call them in for testimony intel firms when we asked for documents and so forth we will share those. and folks like the sec and my folks will come to us with access to that information and we will typically given as long as we're watching to make sure that the decisions we make our independence. they are promise of independent analysis not of state actor and government agency telling us to not do something but rather our

own independent judgment. >> does that create a chilling affect on the inspection an investigation that carry out knowing full well you may turn information over? >> yes, it may. we certainly don't start out investigations typically for that purpose, but it's not uncommon in the course of investigation we find out that davis group is actually looking at that particular issue or robs enforcement folks the alethea something similar and we will do that. that may have a chilling affect but unfortunately for the firm's that doesn't really get them out of their responsibility. they've got to respond to us and the only tool we have quite frankly is what you call membership or the authorization to the license to practice as a broker or maintain business as a brokerage firm. if they don't provide information and cooperate notwithstanding the fears they

have, i will be the consequence and unfortunately that does happen from time to time.s we expelled individuals for that reason. >> rob, a big impetus to this program has been dodd-frank and new authority resources, powers. talk a little about what the sec has been given not just in dodd-frank but other initiatives, not just as an agency but certainly with the enforcement division. >> sure, dodd-frank which someone told me the first acronym i have heard for dodd-frank is drink. [laughter] it was not so bad. 2300 pages of legislation. i think probably the most to marion -- there are a number of investor protection provisions

in the statute. the first and probably the one that's got the most attention is the new whistle-blower authorization where congress has authorized probably the wrong word in -- dictated not in the commission a word and to wander -- the language is important because you can see conceptually defining some of these terms can be challenging -- an award to one or more whistle-blower is who voluntarily provided information to the commission in that leads to a successful enforcement action in a covered of judicial or administrative action. as our challenge is to write rules, implementing this legislation which are due no later then 270 days for the legislation passed so that's the end of april and that is under way. conceptually, i am very excited to have this program up and running because so much of what

has informed the last year of the enforcement division is trying to be as pro active as anticipatory as possible. all of us up here i think share the view that picking up the pieces after the fraud has been committed in -- it is critical and putting people in jail commit these fronts is essential for deterrence. but to some degree it is cold comfort to the people who have lost their life savings, who otherwise were harmed by this misconduct for the money is gone or individuals who have been able to structure defenses and make it much more challenging to prosecute them so so much of what we do is being proactive and identify red flags and a man's and moving more quickly. the whistle blower legislation is one aspect of this and that's why we saw it because it's our view that people coming toward

incentivize by financial reward and will often provide information that might take us much longer time to get it at all if you take ponzi schemes were typically a small number of individuals on the inside are aware of the wrongdoing, the investors are happy because before this thing blows up they are receiving their promised returns even though they have no idea about how those are being achieved and getting paid with other investor money. if you are talking about complicated accounting schemes i can easily be very, if we can get that information earlier we could move more quickly so we are very excited about the prospects with the legislation and. it would also allow us to get individuals who conceal their behavior better because only the insider knows who has covered their tracks and others wanting to about white-collar crime and prosecution is that you're dealing with a class of the plea of pretty smart people who are

often planning defenses at the same time committing their crimes. so if you're trading on the inside information it's a pretty good bet that same time they are trading they've got a file in a desk drawer that has a couple research reports and newspaper article so they can pull it out when the constable comes knocking and say this is why i bought and had nothing to do with my brother in law working on a deal. so you have got to be smart in this business. it's also hopeful that the whistle blower can help us achieve that. at the same time we recognize the challenges. you may get a large number of people who i incentivize by the financial awards. and you've got to be able to make sure you can separate the wheat from the chaff putting on my old general counsel at it was an unusual come march of every year when bonuses were announced the promotions were announced and whistle-blower complaints spite because people weren't

happy with their compensation or didn't get the promised promotion and all of a sudden and they had a whistle blower complaints that they wanted to raise. the challenge is on us and separating the wheat from the chaff and it building infrastructure that allows us to do that. anyway that's responsible and going to take resources, take discipline because of the whistle-blower bar is an active, many represented by counsel and an active in their diligence and persistence. so we've got to have a process that is a sensible. there are particular challenges and the definition of a statute, it's got to have original information and do something somebody thought of honor on a for one of the company already does subpoena for that information. do you still reward them under the circumstances or what ever they herded in some administrative proceeding or what it and already had a case

going investigated an individual presided -- provided information about an ongoing case. what if they just pulls together information from a public file. you don't want to cast the net so why you get too much but you don't want to close off legitimates information as well. so our challenge in crafting these rules. the last point i want to make which may be particular interest to your audience is that we're also respectful of internal corporate process these. ..

in bypass the internal corporate structures that are designed to do with some of this. at the same time, you don't want to rely exclusively on those processes if it turns out they're not taking these complaints seriously. do you strike that balance, how do you protect consumer -- if someone interviews about an internal investigation about wrongdoing here it is and is the in-house counsel folks out the door the person is on the sec making a whistleblower complaint. that's not necessarily an effective way to approach the program. so the whistleblower area -- were very excited and optimistic about it. it's going to be a challenge to structure the walls that balance these competing interests. we have a few others just quickly to take them off.????? some of this is inside baseball, so it may not be of particular

interest. we now have nationwide process we can have a retry or an acquire witnesses to be in court rather than playing endless video depositions and the like which you haven't lived until you've tried a cd okays buy video deposition, but it doesn't make for the most interesting case for the jury. we have clear access to auto workpapers, particularly those that are held by foreign affiliates of u.s. firms. there was some effort and socks to get us that relief. it's easier to get those foreign workpapers now. we can share privileged enervation with our colleagues now. it is not a waiver of a privilege, so i send it documents to ms were barney. persons can be heard later to say that weaves a privilege and therefore all information should

not be disclosed. we also have posed for registration now, which as i mentioned earlier along with central clearing of derivatives ought to give us a lot better transparent even to those worlds and into that treating committee gabriel to going on conduct inspections and examinations of hedge funds where we couldn't before if they weren't registered. just better information in order to conduct trading and other investigations. and lastly, registration of the in this poll advices which is they spoke of the buyers and those who serve as municipal advisors than to be a lot of small shops across the country who trade on their connections to local decision-makers. you know, often unregistered and perhaps not always using the most professional of decisive impact takes in order to secure the business.

so with that kind of greater information and transparency, we are very optimistic that it will all be very helpful to the transparency. >> very well. this is a hypothetical. sure enough, some group if you come steal as the senior prosecutor on the case. you are training nonpublic information and not systemic fraud taken the market. conduct that investigation. but not only to uncover evidence of particular regards to the trader, but there's a very senior official in the company, tom biolsi to say. and tom biolsi is the guy who ultimately internal audit, compliance, general counsel reported up to and while no one could specifically say that we think tom biolsi indications they trade on a particular date

and time at the particular transaction, nonetheless there were concerns being raised up -- nonetheless, there were concerns being raised up, all the way up the food chain. as a senior prosecutor, they provide you with a smoking gun, say on this date are trade entered into the street in conduct which is illegal. so we have concerns. we don't have enough resources. we don't have the ability to look into it is doing. he's using his personal cell phone in a suspicious manner and his colleagues were saying. do you decide to go after senior management? do decide to look into it? >> i certainly think we want to take a look. we want to look at the e-mail trail. we want to follow up with the employees who had spoken to you and alerted you of the conduct that the guard. but i mean, we have a beyond reasonable at doubt standard. it's important i could prove

there was knowledge intense you know about what the traitor was doing and i might want to get your bank records or family records and see if there's some sort of financial gain to you instead of ignoring the conduct. but if you ignore the conduct of knowing what was going on because her firm benefited in some way, you keep making a lot of money for clients come you can be sure we're going to prosecute you, but we have to be a live preview new what was going on. >> rob khuzami. >> are is a little broader. we have sec laws and rules in order to reasonably carry out their supervisory responsibilities. so unlike bonnie who would be required to essentially, you know, find a somewhat inactive participant in the wrong tooting hosted the meeting and conspiracy theory, if they had

red flags, saw a red flags may fail to take the appropriate action. so if you've got a traitor who is blowing through his or her limit on a trading both in bringing your attention and your getting customer complaints in the traitor's assistant comes in and said, i think this guy has a drug problem. if you put those three things together and you fail to take action, i think it's pretty reasonable conclusion that that person would face failure to supervise charges. >> thank you. we don't have much time. any questions from the audience? so with that, i want to thank very much our panelists. sorry -- [laughter] thank you. >> we spent a lot of time talking about the prosecutions. and i'd like to get your views, tools that we can fine for deterrence. one of those in particular with

the office of the funds meant. i'd like to get both pop and rock and dennis' views as to an effective tool in meeting inadequate compliance system and what factors built into that type of structure make it stronger? >> i'm sorry, make what? >> with regard to an office of an abundant, what would you say if your house counsel to structure? >> within your firm? >> yes. >> well, i think what you would want is a couple things. one, you would want to -- and you're talking about someone whose job it is to hear complaints or concerns from your employees and being able to pass them along in a way that's appropriate, i assume? [inaudible] >> yes. look community couple things. you want confidentiality.

if someone wants to complain about their supervisor but they don't have complete assurance or at least enough assurance that can be given an remain confidential come you're not likely to get much of anything. too, i think you've got to have a report in mind that's independent of the front office or the business. perhaps some of which of the various or some other, but perhaps to, you know come you're audit, legal or compliance functions so that even if there isn't really any front office interference in this kind of structure in terms of trying to surprise ascension or squash complaints, the appearance of an independent reporting will be very important from a regulatory point of view to convey the notion that the company takes this seriously, wants to react to the information and doesn't want interference from the business. you need to follow up. you know, it can't just be on

paper. you've got to have people who take those complaints and suggestions and act on them and create a paper trail that shows what you did and why he did it. and to the extent you can, the more you can -- this may be a little bit conflict of confidentiality, but in some circumstances you do it. you want to be allowed to convey back to your workforce that this is an effective tool because concerns or complaints that have been voiced have been listened to and actions have been taken. so i think of the top of my hand does the thing i would to see. [inaudible] >> i haven't seen too many labeled office abutments. there are whistleblower hotlines, pretty common these days. and there are the risk functions of compliance and on the another

set of their own internal mechanism. with that independent directors now who make it more and more direct information. but i haven't seen too many unbuttoning offices. [inaudible] >> -- do you find the office of the incident is an enhancement. and dennis, do you find that as nearly rating factor with regard to the adequacy and repeal actions taken by the entity? >> absolutely. no, it would definitely be one of those in terms of the preexisting client program if you are behind in office up in a batsman and you have the reporting lines along the lines of what rob described, publicized you had confidentiality, you can prove it wasn't a paper program. you periodically audit it to see what it was doing and how it will improve it so that you're constantly reevaluating how it is doing and how to improve it. that's a significant part for

that would certainly help in the discussion. >> speaking of whistleblower hotlines, it seems to me one of the challenges is who should it go to? and should there be an established protocol. dave, you looked at a lot of issues both in the sec's enforcement attorney as well as with the attorney's office. what do you think? >> i think the appropriate office to refer to as whichever office are not at that time. [laughter] but i think the reality is you often see particularly with multiple bounty statue of the various states now have claimed statues, which also have bounties in certain circumstances, which i won't go into now. but in some of those matters, we are seeing multiple result going

on because the referring complaints and, usually represented by counsel wants to maximize their chances of seeing results. so oftentimes that happens without proper information going -- or rather disclosure to all the various offices. so oftentimes it may have been in haphazard way. and i think that -- i think that there are fairly established lines for certain types of issues. for example, for insider trading, there's an established -- just a time-tested established surveillance system, were those claims, those trading issues are going to be picked up by folks at the subway and will be appropriate to justice and that seems to work quite well. and so these other areas, we'll

have to see how it goes. but a lot of it will be at the hands of folks making the results. >> james, when you're thinking about pursuing an investigation involving individuals or organizations, whether sales practices, whether it's involving use of material nonpublic information, to your teams, whether it's on the inspection side or the enforcement side, look at established workers being abused whether it's prior notification of the principles of the wrongdoing? >> outcome i know we do look at that. i'm sorry, we do have a statement is cooperation as well as credit for steps taken internally. we do look at those kinds of activities. i mean, it's very important for us to see a firm go out there, whether it's being tipped off by whistleblower called to the internal firm hotline or to the firm's own mechanisms, whether it's their compliance and audit

procedures or otherwise, to detect attentional violations are actual violations of our rules of the federal securities laws and take action to address those, whether that is through termination of the problematic employee, whether it's through a mediating customers who may have been harmed by misconduct. combinations of those things. those are all factored into it. and we will get credit both in terms of monetary credit has to dollar amount of the sanction as well as other types of credit. so those are important to us. >> bobby. >> in your criminal investigations, do you ever ask for whistleblower hotline records? >> yeah. sometimes the pmm. sometimes you want to see if they complain about the conduct were on and the great source of people going to contact. and in the corporate contract that dennis alluded to, want to

see who's complaining, what they've complained about and if that's working effectively or if they're just ignoring the very complained that are in there and they're not really resulting. it's great to have a system in place if you're not addressing them properly. we have to analyze i think in a different way. you really have a robust system in place. >> any other questions? okay, so, rob, dave, jim, dennis, bonnie. on behalf of everyone, we want to thank you. [applause] thank you. thank you.

>> the "washington post" reports that voters have set a record for early voting in a midterm election. estimates predict over 60 million voters cast early ballots. results of those ballots will start coming shortly after polls close. c-span's election coverage begins at seven eastern. we'll show election results as they come in along with victory and concessions pieces in key races. also, your reaction to tonight's events through phone calls, e-mails and tweets. you can also follow election online at c-span.org. results will be posted as soon as they come in, but you can go there now to see what political analysts are predict gene for tonight. president barack obama reacts to election results tomorrow when he holds a news conference in the east room. the white house says the president will take reporters questions by one easter and c-span will have live coverage.

>> the school always called this a voluntary operating. there's nothing voluntary about about bible reading. >> now, a conference focusing on the u.s. and world economy.

former treasury department general counsel under ronald reagan, peter wallison joins the discussion of global finance regulations. this event was hosted by ihs global insight that uses economic and global forecasting. this is about an hour and 10 minutes. [inaudible conversations] >> okay, we're going to start the session and i understand they're going to be people drifting in. i promise you a very, very, very interesting session on financial reregulation shall we call it. i had a great conference call with the three speakers we have here today on this topic and i can tell you that it was quite -- just that brief conference call was very interesting. i'm for much looking forward to summer detail in extended discussions.

the bios of the speakers are in front of you. i'll just introduce them very briefly and then we'll get going. our first speaker will be doug elliott of the brookings institution. slightly out of order in your program. our second speaker will be peter wallison at the american enterprise institute. in our third speaker will be karen petrou was with the cofounder of the federal financial analytics. each will have prepared comments and then after that we'll do questions and answers. and as we did before, if you could write the questions down, i will than to feel them and can decide who is to answer them. maybe all three, but maybe some will be directed at one or the other. that said, we'll start with doug. and then peter and karen. so doug? >> okay, well, thank you. thank you all for being here.

i'm afraid i had to miss the first part of the conference, but it seemed like it was very interesting from all reports. i guess that makes this a tough act -- makes it a tough act to follow, but i'll do what i can. so, let me start out by making what may or may not be an obvious point, but i think it's too central not to say and which in some way and still find that peter and that disagreeing with the on at least the application of. i think the financial reform is crucially important. my colleagues i'm sure would agree on is we certainly can't afford a massive financial crisis followed by the kind of severe recession that tends to occur in the circumstances. and this was not a unique occurrence. those who have studied financial crises over the years, the most well-known study at this point is by common reinhardt and ken wrote a.

what they have pretty conclusively concluded is a severe financial crisis tends, wherever you are in the world, to be followed by a severe recession. and in fact, what we went through wasn't nearly as bad in percentage terms of what normally happens. in a way, we were lucky. painful as this was, we had about -- you'd know better than i., a 4% decline in economy from peak to trough. the average for the crises that were studied around the world with a 9% decline, with unemployment going up even more than we had. so clearly we don't want that type of thing to happen. but the reforms have to actually make things better, which as i'll describe i think what we're doing guys. and there needs to do it without adding excessive cost. and one point i'd like to make

it even as i believe the reforms being set in place are probably very good, we clearly are going to have a transitional period that we're already in and which does a great deal of uncertainty. uncertainty is that for the economy. it's bad for business. i fully recognize that. but if you believe like me is that we needed very substantial change, you're stuck with the insurgency. were doing things going for it that we haven't done before we have different people doing them and were joined them in different ways. so unfortunately we definitely have to live with the transition costs. now i'm positive i'm general on the substantial reforms as i party indicated. despite the fact i was an investment banker for about 20 years -- so, i'm certainly sympathetic to the industry's feelings about this, which are much more negative than my own. and i would also -- you're going

to find them so positive i'm just going to make one caveat. i'm actually a political independent, not a democrat. so i really do believe the things i'm saying from the analysis i've made, not from some knee-jerk clinical reaction. and also it should be clear, there are things i would done differently and i'm sure there were mistakes. those may not overlap. but i think where we are between the legislation and the regulation gives us to the third place to where we ought to be. and in the real world, doing some in this complex, where we don't know the right answers and there's such a wide spectrum of people be in effect did and you thought all the political problems that exist in this town and in most other capitals, too, i might add. getting two thirds the way there is pretty good.

so my view is that the crisis highlighted quite a number of problems. and the reason you have such comprehensive legislation and make elation is because we found so many problems. and it's not surprising they would be a lot of problems there. we had 25 very good years, from 1982, for about a quarter of a century after that, things mostly just got better and better in terms of finance and risk taking. if you'll recall, the dow was at 800 at its bottom in 1982. almost any other type for any prolonged period financially paid off, as long as you could stick it out. and when things go that well for that long, people are bound to get linux and problems will creep in. so dodd-frank is truly comprehensive. so whether you like the billboards don't like the bill,

it's affecting a very wide range of responsibilities. there's a new consumer regulatory structure with the bill of the consumer protection. i have faith in putting that in, but also scares me a bit. i think we had to have a separate agency to look at this, to make sure it got enough attention. and i could go on at length as to why i think that was necessary. but at the same time, were asking it to be something very difficult, which is to balance protection of the consumer with allowing risk-taking to still happen. my biggest fear -- and in the industry's biggest fear as i go to people in charge of that euro who wind up just stopping a risk, which of course is the gold bureaucrats often have. you tend to stomp a risk without also stomping out economic growth. i hope they get it right. often have faith they will, but

their risks. similarly, were doing a number things on derivatives that will be important. they are going to make it more transparent to enter into these transactions. i believe that the cost for customers will go down over time, taking account of both credit costs and the spread. i think it does a lot of good links. but it's also a pretty massive change. and if we don't get it right in the implementation, it certainly could create a lot of problems. their changes to securitization. this changes to how we regulate the agencies. outside the u.s.a. generally call macroprudential regulation. this is to say we're trying to have the regulators work together to look at the system as a whole to try to stop bubbles were sort of qualified bubbles, credit booms that go a little too far, to stop them before they get too dangerous so we don't suffer when those bubbles then burst. we also are trying to deal with

systemically important financial institutions differently. they are going to have additional burdens that smaller firms don't have. i think that's a good thing for a variety of reasons i'm happy to talk about. but it also means were taking the very most important institutions in making it harder for them to do business. so there's clearly a downside as well. we've had the changes to proprietary training on trend trading, which is one area i can agree with peter on. i hate, loathe, despise and abominate the volker rule. i just think it's bad policy. it's not going to achieve what it says it's going to achieve and it's going to do harm in doing it. thankfully i think the harm is at a low enough level will survive without great pain, but i wish we weren't doing it. now dodd-frank was 2300 pages,

with a type in a lot of space on the pages, but it's a big piece of legislation. nonetheless, it still leaves an awful lot that the regulators are going to have to do. there's hundreds of regulatory decisions that have to be made beyond the system from the studies. there's no institutions to create click the bureau consumer of financial protection, but also the systemic risk council, which had never met before prior to last month. and which is going to have tasks which none of the regulators had on their list to do before. arguably, some of it might have been bad responsibility, but it wasn't all clear and it is just a piece of what they would do. again, all these things come in the studies, the regulations, the setting up the new organizations creates a lot of uncertainty, which in itself is bad, but i just think it's unavoidable unfortunately. now with all this will do is

have considerable effect on institutions, but also more importantly on the real economy, on the users of credit, which is effectively all of us. and there's some things we know directly. votes will be more expensive than what's available. customized riveters will be harder to find because we are trying to really penalize those. market liquidity is likely to decline somewhat. and i guarantee you there will be unanticipated consequences. i'm not smart enough to know what they are, but they'll be there. and just as the illustration, give you one example of something that could turn out that way. we have gone to considerable trouble to make it harder for the rating agencies to make the mistakes they made in the past or for those mistakes to be as harmful. however, the way were doing it is going to make it a significantly less profitable business. but they're less profitable

business, they're going to be able -- they'll have less money to pay to hire good people. you might well find they actually have worse people to do a harder job. in the ratings make it worse, not better. there's absolutely no guarantee that creating changes will be for the better. now, having said all these things and perhaps leaned over backwards emphasizing the negative, i do believe we should collectively be better off, particularly in the long run. in my view, it makes sense for a little growth in the normal years, in exchange for the total disasters that can occur every few decades. what she really love i'm sure is for someone to quantify than to give you the answers. well, people of quantify that, but they come to different answers of course. the institute for international

finance thinks the world will end. and not coincidentally is americanization funded by the banking industry. and they've come to a conclusion conclusion -- i exaggerate the world within. the economy would be 3% closer with the so-called basel iii rule. i don't think they included all the things with dodd-frank, but somewhere in there and they focus on so-called basel iii changes and liquidity three. well, if it's true the economy will shrink by 3%, i think that's too much. i think we've made a mistake. on the other hand, i and others and in particular being a banquet to the national settlement and organization in basel in switzerland are collated a lot of studies, what they concluded with the effect would be an eight the size of

what the aif insane. when you get down to that level are somewhat higher, it seems to me quite clear. i would pay that kind of insurance premium in the short and medium term in exchange for avoiding the really disastrous recession is the one we just had. and i could go on on all these things at great length, but i should let the other speed. >> thank you very much, doug. [applause] >> well, it's wonderful to be here and i appreciate all of you being here and the opportunity to talk with you about the extremely important subject. doug is introduced it very well. he said two things that i thought i could certainly agree with. and i guess all make them sort of the subject of an i'm going to talk about today.

he said we can't afford another financial crisis. and i think we can all agree on that. in the second is reform has to make things better. another point i've been making about this subject for a long time is that the reforms that we have adopted were not addressed to the reasons for the financial crisis. they were far more addressed to a statement of a well known, almost iconic statement at this point, but the but the president's chief of staff when he said never let a good crisis go to waste. in other words, we would have a crisis. let's do what we wanted to do whether or not. and addresses what has caused the crisis. my view is that the crisis was

caused by u.s. government housing policy and not by the things that seem to have underlay the basel iii or postal. there are actually two narratives here. to competing narratives. one is that the crisis was caused by deregulation or lack of deregulation insufficient regulation, greed on wall street, excessive risk-taking and predatory lending. if you think about those items, you can see exactly what the dodd-frank bill intended to do and has now done. it imposed much more stringent regulation on financial institutions and not just banks, but all kinds of financial institutions. what were talking here, they are

large ones, once considered to be systemically different in our economy and we're talking about insurance companies, security firms, hedge funds, finance companies, holding companies are very kind. any kinds of large financial institutions can be subject to very stringent regulation of the kind and even tougher than the kind that's been imposed in the past on banks. and so, a number of things came out of dodd-frank they were to accomplish this, such as the volker rule, which push proprietary trading on omitted banks themselves, but deposit taking entities, but out of any organization that is affiliated with or control the bank. in other words, get the proprietary trading out of the banks because it causes too much risk. i won't go through all of the things that are in dodd-frank right now, but i've also

provided and suggested much tougher regulation for derivatives including particularly credit default swaps and they provided for this consumer financial protection bureau, which was intended at least as it was discussed, there was intended to address a problem of predatory lending, which this narrative believes is the cause -- one of the causes of the financial crisis. now, the result of this i think would be a significant suppression of growth in the united states. and to the extent that it is imitated and it's been imitated around the world, the united states is actually at the forefront of pushing regulation around the world. and to the extent that is happening, it will be much less growth in all of the developed economies. so we have to take very seriously what was thought to be the cause of this financial

crisis because that plays into what kinds of solutions our government develops in the future. now, i have heard something interesting. there was an article in the american banker this morning that one of the congressmen who would be one of the senior officials in the house financial services committee, which is the committee that deals with banking legislation after republicans take over congress has said that he wants to repeal portions of or maybe the entire dodd-frank bill. you can see that there are people who are quite concerned as i am that this bill was not based at the problem that it was intended to solve. now, why did we have a financial crisis? my view is we had because of government policy that required

more mortgages to be made to people who would not ordinarily be seen them in the ordinary course. in the united states we have a huge interest and i think an understandable interest in homeownership. i think there's a lot in homeownership. a lot of good things for families, for neighborhoods. homes would be a good investment. the government's effort to make sure that the homeownership rate increased in the united states resulted in 27 million subprime or other highly risky mortgages in our financial system. 27 million is about half of all mortgages in the financial and. and when the bubble deflated, the result was that these mortgages failed at an enormous rate, an unprecedented rate. and since many of them were

turned into mortgage-backed securities, those mortgage-backed securities lost huge amounts of value very quickly. the -- the investors, seeing these unprecedented rates of mortgage default fled from the market. and the values of these mortgage-backed securities declined precipitously. in addition and probably more important, the huge number of mortgage failures of agencies, foreclosures have resulted in a huge decline in housing prices in the united states. her 2% to 40%, which is far larger than anything in the past and anyone had ever anticipated having in this country. and when that happened, it

caused a loss is throughout our financial system, not only systems that were holding the mortgages themselves, but institutions that were holding mortgage-backed securities that lost their value. and then, under current accounting, which requires marking certain kinds of assets as security assets to market, the institutions that were holding these mortgage-backed securities, that were now suffering enormous losses, had to mark them down. and that is made it appear their capital in. it made them look unstable. it made them like potentially insolvent. so from my death, the cause of the financial crisis was not the lack of regulation or lax

regulation. it was not risk-taking, excessive risk-taking. it was not predatory lending. it was the fact that the major -- a major financial institutions in the country, dealing with mortgages, were required by government policy to make loans that they would not have made otherwise. and let me explain how that happened to work. in 1992, a new act was passed, which imposed on two agencies that you probably have heard of, fannie mae and freddie mac and affordable housing requirement. what wasn't affordable housing requirement? .net that a certain proportion about the mortgages that they thought of originators had to be affordable mortgages. and that meant they had to be made either at or below the immediate income in the area

where they lived. at the same time we had an agency called the federal housing administration, which was in organization controlled by the federal government. and it's purpose was to make sure that people who were of low income and couldn't raise the resources to buy a home, that could raise a down payment, for example, have some access to financing. and this is part of our whole process here in the united states is trying to improve homeownership. and finally, in the early 90's, we tighten the regulation under something called the community reinvestment act, which requires banks to make loans to people who want, at least in a portion of their love, not all of course, but he substantial portion to people who were at or below the 80% immediate income in the areas where they live.

so had sha, fannie and freddie and the banks subject to the community reinvestment act all bidding for mortgages in a relatively small group of people. and that is people who are at or below 100% or 80% of the immediate income in the areas where they live. that was going to happen in a case like that? it's going to get up the prices of those mortgages. status because people want them not because of their access value, but because the government is requiring them to require these mortgages. and that is why after all of this is said and done, we have 27 million sub prime and other risky mortgages in our financial system. 19 million of those were either on the books or were guaranteed

by fha, fannie mae and freddie mac for the banks subject to the community reinvestment act. now for many, many years, no one noticed. everyone is quite happy here. if your descriptions of what was happening are mortgage system come in our financial system but through 2006, you see a lot of boasting about how well we're doing. the homeownership rate in the united states increased from 64%, were begins at her to years in 1994. 54% in 1994 to a 59% in 2003 or 2004. wonderful. we've broken a 30 year record and we've increase homeownership in the united states by 5%. but at what cost? we didn't know what the costs were at the time because as the

bubble, the housing bubble grew, as more and more government money was poured into -- artificially poured into the housing business, it disguised the risks that were being taken because as prices rose, people are taken out mortgages they couldn't afford were able to refinance using the equity they developed in the house because of the rising prices. or if they could never do that, they were able to sell the home or the bank could take it back and sell it for more and not suffer substantial losses. as far as anyone could be, things are going wonderfully. homeownership rate was increasing in the united states and no substantial losses were being suffered. now, we know that underworld is, something seriously bad was happening and it became apparent when the bubble deflated in the

last half of 2007. and i explained what happened after that, while the financial institutions got into serious trouble. and as a result, when we are talking about the need for a dodd-frank act, the question is why do we need this? if we think that deregulation is the problem or we think that lax regulation is the problem, we have to look again. because it doesn't appear to me that deregulation or lax regulation could have stopped this particular development. this development came from the fact that government wanted these mortgages to be made. there wasn't any way that regulation could have stopped them. and even if the regulators had recognized the problem, which

would've been difficult because it can losses were not being suffered by people as long as the bubble was continuing, there was no way for regulation even to have stopped it. but after it happened, we then get a substantial amount of regulation of our economy, which will have a seriously adverse effect on the growth, on innovation, on growth, on risk-taking and the u.s. economy. and if other countries follow our lead and it looks as though they are in fact getting a hand of us in some cases, will have much lower growth in all of the developed world. so this is something that all of you should be concerned about. now what is the policy solution for this? on a policy analyst. doug is a policy analyst. my policy solution is different

from doug's. i'm not happy, as you can tell, about the regulation. what i've done differently? i think it's very hard to abstract from all of this any kind of specific policy. but he will say this, that in general we should keep the government out of intruding political desires, social policies into the financial or economic world. and that's what happened here. the affordable housing requirements for fannie mae and freddie mac were social policy. the community reinvestment not, which requires loads to be made to people who wouldn't otherwise be able to come up with the necessary down payment and so forth, that social policy. so what we have -- what we do as a matter of what we should have done in the united states as a

matter of policy. will we should do in the future is keep the government out of making these decisions or forcing private-sector organizations to make these kinds of choices and decisions. there's a great example that this lesson has not been learned. so if you think well, basel dodk is done. why is this person time it's a mistake like this person is telling it's a mistake because of the lesson is learned were going to do it again. and in fact, there has been introduced into the house financial services committee legislation that barney frank, when mentioned before, was one of the most important people now come is chairman of the committee and could be if the democrats retain control of this as his top priority. this legislation would extend the community reinvestment act to the entire financial system. not just the insured banks, not just the banks that are backed by the government, but to all

financial institutions. whether or not they're regulated by the government and of course almost no other of these institutions is backed by the government, but the community reinvestment act, which would require financing of a committee of poor people who are at or below 80% of the median income in the areas where they live would be extended there. this would have a major impact in a major fervor adverse impact on growth in the united states and bring about the next financial crisis if we fail to learn the lessons of this one. thanks very much. [applause] >> thank you, peter. karen? >> i hate to wait my guide dog up, so i'll just state here.

you've heard just richet discussions of the policy issues in both the dodd-frank act and the global regulatory arena. and i think as you've heard, we've all had differing views on the policy implications of this new regulatory regime are certainly debatable. but the strategic impact is undeniable. and not what i'd like to talk about today. i'd like to take the legislation , the law, the rules and bring them into a market context of like it or not, here's what at least i think this new regulatory framework will do in the united states for one fact your. and i thought given the audience here today will focus on the corporate finance your because i think would be -- i hope interesting to you and also profoundly important from a macroeconomic point of view.

and we are facing a real rewrite of the terms of corporate finance. part of it is from the basel iii fact and not talk about some of the key provisions they are. i'm part of it is from a new global framework often called basel iii, which died in particular talked a little bit about. one important piece of like to emphasize throughout the remarks is we need to think in the united states about the combined effect of dodd-frank and basel iii. the united states has put in law, key provisions, many of which are still only tentatively on the drawing board in the global context of another major financial sectors in the e.u. and japan. we connected them and they're very, very tough. and they're even tougher for sick stomach institutions. whoever they are, will be defining that soon i hope.

in the united states, credit formation is very dependent on the largest financial institutions. they control the vast majority of access in our economy. the bulk of them will be systemic. and so, you need to look as you think this through, not just at the basel iii rules and the dodd-frank requirements on their face, but the combination of them in the fact that in most instances for systemic institution, you take dodd-frank and basel iii and they're tough as you heard doug and peter's site. i think we all agree the rules are very different -- very stringent and then turn the dial. for systemic institution the rules have to be tougher, larger, higher incentives that sooner. now what does that mean in the corporate finance sector? it means i think first time a sharp increases in the cost of credit and also significant changes in the terms of credit. we're going to see a

differentiation between short and long-term credit because there is an important piece of the basel iii framework codified and embodied that doesn't get enough attention in its liquidity rules. i'll describe them very briefly. their formula complicated than they make my head hurt. but they are important and they will have market impact. cost of credit will go up. then the fun everybody got to have with it will drop a lot. some of that is because of the reforms -- the derivatives market by doug in particular talked about. but there's another very important provision in dodd-frank moving and i do not think will move in the international to require new risk pretensions. we'll talk about the secondary market, think of it in the mortgage context for secondary markets, fannie, friday, fha,

all that very important and now on the market. but before the secondary market accounted for 50% of credit formation in the united states as a whole. and these changes in secondary markets will have big strategic impacts. and finally, and thinking about corporate finance i think could the shadow do it? could we impose such a stringent new rules that the banks are forced into a different environment. will the so-called shadow banking system's head back? andersen key provisions here that i think will make it very hard. when you step back really quickly and talk about what i think drives changing cost of credit, the retreat from structured finance and then finally the diminished role of private equity. these provisions again come for both dodd-frank and the basel

iii framework. and i think you'll see that they are really a bias. it's a very tough combination, for all u.s. banking non-banks, including insurance companies that are deemed to be systemic. what does basel iii do? why does it matter for the capital framework? one of the key decisions that was made over the summer will be to change the framework of bank capital, raised in the requirement for 1 dollar essentially to $7 as part of the capital calculation. and that's a lot, particularly when it's a tangible common equity, which is the most robust form of regulatory capital, but also the most expensive to raise. you've seen a lot of the u.s. banks and say despite the statements from the institute of international finance at doug reference and some trade

associations, each of the third quarter earnings calls out. every ceo says i'm not breaking a sweat, i can meet these rules. well, how? if you look at the reason behind not, it's because every bank i know, the ones we work with have significant requirements to change the amount of assets. remember, capital is the ratio. if the amount of capital to the amount of assets. you can meet the ratio to raise. he can raise the numerator or drop the denominator. it's very straightforward. because profitability as measured, of course, as you know returned in equity, the more equity raised, the lower your return. so from worst institutions, they're looking very hard at powder then make that equation work and still keep the market expert patients and their profit object is in some sort of reasonable order?

an element steep drops in risk adjustment assets, which means in terms significant reductions in the amount of corporate credit and consumer credit out there, especially in any sect or deemed a higher risk one. now i mention liquidity rules. i don't want to make you gasp by even trying to describe what's called a liquidity coverage ratio, let alone.net stable fund ratio. these are so hard the global regulators are you rethinking aspects of them. they've never been tried before, but were still putting them out in final form and they are still mandated in the dodd-frank act and they are mandated in the act to be tougher for systemic terms. ..

>> that market will be significantly redefined by virtue, not only of capital rules, but also the liquidity ones. i think the bond market will take one very interesting and mr. shea as this begins to take hold, and i think it will happen

relatively quickly. even though the basel iii capital and liquidity rules have lengthy transition periods, dodd-frank is now. the statute is very clear. the rules have to go into effect quite quickly. why can't corporate finance get around some of these direct impact by going into the secondary markets? that's another piece, up particularly the dodd-frank act. section 941 of the law imposes what i mentioned before. risk retention requirements. if you are a lender or an issuer, you would generally be required to withhold 5% of every $100 of assets you sell into the secondary markets. this fundamentally changes the economic rationale, particularly the capital rationale, and liquidity thinking of secondary markets where you sold the loan, get the money back, though you

didn't avert and hold capital against it and you got new money to do more things with. for any of the frontier, those who work with, you think about in the retail sector, this applies to all institutions, not just to banks, any securitize her, any issuer, any letter whether it is for mortgages, out of loans, credit cards, and to corporations. corporate loans, particularly structured ones like collateralized loan obligations. these are all subject and they are going to change the dynamics of the market a lot. this comes in tandem with the changes done to mention on derivatives, which was identically change the nature of the credit default, credit derivative market with other and in general austria implications in the corporate finance sector. so i think we have to take that into account, and my general view, that the cost of corporate finance and its availability will change, and not for the better it very near term.

could private equity firms still -- feel this would? i don't think so. peter mentioned the key provision in this law, the poker rule, this not only bars organizations from her prior trade trading, but also blocks them from investing in hedge funds and private equity funds. the biggest banks have been significant players in this market. but they have also been huge lenders to it. and other provisions in the law, particularly with regard to credit exposure limits will crimp the back of law. a lot of the keys right now are happy because they think in the banking industry as a private equity arena will leave them open, but their borrowers, they need the money, they need investors, they need the money. they are not putting their own money at. they are putting up somebody's. and much, much less of it will come from u.s. banks. and the private financial

institutions feel these boys? they are going to be tremendous asymmetries in the u.s. will usually framework and global ones. the securitization rules i just mentioned don't apply outside the united states, and the restrictions on proprietary trading and hedge funds, private equity investments do not. you might see some restructuring, particularly in the corporate finance arena with activities house offshore. but nevertheless, i think you'll see a really profound set of implications coming through into the market. now, you've heard so many good policy points about whether this is good or bad, that i don't think i can add much to it. in part because i think it's hard to make judgments about a law that tomorrow will be three months old. it's just a baby. and the basel rules are just beginning to be finalized. and the details will matter a

tremendous amount. how these rules are implemented will drive a lot of strategic thinking at financial organizations. i also think as we try to judge these developments, we need to remember how close we came, the cure may be harsh, but we damn near died when the markets came very, very close. and the need for reform and restructuring i think is demonstrable by the near miss we experienced before all this framework was going to place. but what a framework it is. we have got capital rules on top of liquidity roles a top of the activity rose, i talked of other rules and all sorts of other stuff, securitizations. i haven't even told you in a

2300 pages of dodd-frank. and the hundreds of pages of the basel iii rules are real rewrites of how we do banking. and i think we have seen a pile up on each of these initiatives on its face could be defensible, and many of them i think are. the combination of them to meet is very, very troubling. that the banking industry sent i think is beyond question. that need now to be flogged is i think debatable. and i do think it will be because of the pileup of all of these rules, and i think the big banks won't be the only once in a world of hurt, as a result. we will see, i think, significant changes in the finance sector, and answers implications for the recovery as a result. even if over time these reforms prove themselves as many i think

will, conservation story stable financial market, it's not going to be fun and chill we get there. thank you very much. [applause] >> thanks. already there are lots of questions. i'm going to exercise my prerogative as moderator and asked a couple myself first. first question is do we make any process -- progress on too big to fail. and we further that goal? did we hinder that go? we will start just in this order, peter and then karen. >> there was an effort to address too big to fail, but it's hopeless, given what happened. the record that has been created by first, of rescuing bear stearns, caused huge moral

hazards in the sense that people after that, market participants after that meet any institutional larger than bear stearns would be rescued. a government of course as we know did not rescue him and. and that caused everyone to change, any change in the view of the world. now you didn't know about, you had to know about the condition of your counterparties. and that cause people to stop lending to one another. the hoarding of cash because they weren't sure who was safe and who's not. that's what we know in the financial crisis. so now we have legislation. which purports to address that system, but how it addresses the system, the opposite of the way you would want it to be done. it addresses the system by creating a group of institutions that have yet to be named that are called systemically important. what does that mean?

it means they are, guess what, too big to fail. and then it sets out a system for resolving those institutions to the fdic. i won't get into how that would work. but nevertheless, we are signaling to the market that too big to fail is alive and well. how we could have, how we can come back from that is very difficult to say, but my hope would be that if we didn't have the dodd-frank act, what we would have been able to do is allow some institutions to fail and go into bankruptcy in the normal course. so that the market would understand that every large institution is not going to be taken over by the government. we are nowhere knew that right now. >> i certainly do think too big to fail is alive and well and

dodd-frank. i would just make two points. one is i do think that we provided some additional protections against those institutions in the forms we talked about, karen talked about quite a lot about the additional capital, liquidity requirements. second is, why i really wish we didn't have too big to fail, i think people can really exaggerate the effect of it as compared to the other prompted you do an experiment, and imagine we've got to the crisis with bank of america had been broken up into 20 pieces beforehand and j.p. morgan where i used to work into 15, they all would have done the same thing. they all would've had the same compensation approaches. they all would have done all the other things that blew up. a herd of smaller institutions can cost at least as much trouble. one thing that constantly frustrates me in a dialogue about all this is the small

banks on average did probably worse than the large banks. small banks in washington are considered safe. they lost their money the old fashion way, and much of it was by crazy real estate loans and commercial real estate, commercial real estate has about a two year lag compared. so it was about is how badly they had done until after everyone had made up their mind they hate wall street. >> i've read title ii and i read the fdic noticed to proposed rulemaking that's come out about what is going to do in this new resolution framework. and i've also want to draw your attention to title 11 of the dodd-frank act which doesn't get a lot of attention partly because it into his tight to pick up this law, you would hurt yourself. [laughter] but all of these provisions really redefine what will happen in a crisis.

title 11 is particularly troubling to me because it not only sharply limits the ability of the fdic and the federal and again, it could affect the many ways because some of these programs did contribute to it too big to fail, but we've even barred the federal reserve from engaging in the kind of global swap facilities that were used just most recently in the e.u. sovereign debt crisis. our markers are a lot more on their own than they ever were before, and they are a lot more than any other financial market in the world. the title ii, the fdic approach to system that resolution, is not the mandatory bankruptcy regime that i think peter, you would favor, but it is a significant change from the current expectations, and will lead to a lot more discipline up front the u.s. that is, long-term, unsecured creditors, subordinated debt holders and

shareholders. and that won't apply anywhere else in the world anytime soon. and i think that's a very troubling conundrum. stuck thanks, kendrick i think peter wanted to add something. >> one small point, and that is i think there has been too much focus on the concept of large institutions being too big to fail. it is not the size of the institution that is important, but the function of the institution in the economy. i can accept the proposition that a very large bank might be too big to fail. at least as i see it. businesses put their money in banks. the funds are there for immediate use, but when you talk about other business models like finance companies or insurance companies, or even in investment banks, which we used to have, those institutions are not too big to fail, in my view. because they owe their money in

kind deposit. in kind in some way. that is to say, they are either secured through collateral is asian, or they are owed overtime. they are not withdrawn on demand in most cases. now, some people have made the point that if you are doing overnight funding in the markets, that's the same thing as a deposit. it is withdrawn on demand, but it is not. the difference between a deposit and that overnight repo is clear. and that is a person who is lending money to an institution with an overnight we don't actually has the collateral. if the institution can't pay, the collateral remains with the lender. this provides at least, it might not be 100% coverage, but it provides more than institution would get if the bank stopped meeting its obligations on its

deposits. two completely different things. we made the first mistake in assuming that the mere failure of a non-bank financial institutions like bear stearns would cause some sort of worldwide collapse. and once we did that, we stepped into an entirely new area. and it's going to be very hard to get ourselves out of the quicksand now. >> all right. speaking of too big to fail, peter mentioned fannie and freddie, and i think there is widespread agreement that the congress stuck the issue of fannie and freddie, that been referred to as giant hedge funds with implicit government guarantees. what do we do about them? what do we do about them? we will start with you this time, karen. >> that's a really good question. and i don't take your eyes off another trillion dollar gse this is getting enough attention as it should.

that's the federal home loan bank system. day, like being out of the radar. but they have $1.3 trillion more or less in debt and obligations outstanding with the same in place again and he, and several of the 12 homeland banks are i think in serious financial condition. so we are going to see a significant rewrite that i think not only a family and freddie but also the homeland banks, more often called slavs for a reason. in the next round. the battle lines are really forming over whether they can be privatized, and if so, in what way. and i suspect you'll see a new structure form in which there'll be a lot of up front private capital from lenders, from private mortgage insurance, and from investors, and a catastrophic risk guarantee behind that from the federal government.

the federal reserve is putting a lot of work into how to prices that guarantee, and it's a critical question because if it is ms. price easily it could be within a guarantee. you see the kind of government control of the housing market and some of the distortions. mentioned. but that's the balancing act. i think the outlook right now is for some sort of structure with a guarantee from the federal government. doug? >> it's a great question, obviously. one of the reasons it's a great question is because we know we are not going to do what we should. a large majority of economists, 80, 90% probably, believe the u.s. provides considerably too much support to the housing market. we should do less. we should do or transparently. and we should target it to the people who need the help. instead of targeting it towards the people with more money, which we do by having a tax deduction the way we do and

certain other aspects of how we do it at one level we know the government should step to about the things it's doing. but politically, this is a complete nonstarter. so the question really becomes, what is the compromise that can be found that reduces the government role to the extent that we can politically reduce it while increasing the transparency of the subsidy to the extent that we can politically get away with it? what is that balance? i do think karen is probably right that the industry, which very much wants a government guarantee, we'll get it. probably the best we can do is to try to structure it in the least threatening way possible for the rest of us. >> peter? >> i refuse to believe that anything is a nonstarter. i belong to political party that

wasn't supposed to exist after 2008, and it might well take over congress in this election. so from my perspective, we have very clear lessons, what happens when the government mixes in with the economy. i think the s&l industry which caused a taxpayers $150 billion. the home loan bank system, i could go on and on. it's obvious that once the taxpayers get involved and begin to see the pattern of what happens here, they will recognize that any kind of system in which the government has some say in how it is administered is going to eventually resolved in a catastrophe for them. now, i'm glad to hear that the fed is working on a system for

pricing some sort of catastrophic insurance. that's wonderful, and the fed has great economist and i'm sure they'll come up with a nice number. however, it will be congress that decides how far this catastrophic insurance is applied. and what the actual amount of the insurance will turn out to be. and i can assure you that the only catastrophe in all. will be for the taxpayers. >> all right, thank you. there's some questions directed at each of the individual panelists, but once the panels has answered, if the other two want to say something, feel free. we will start with doug. the question is how confident are you that the banks and banking lobbies, et cetera, won't water down the legislation during the rulemaking process? as it starts to get implemented. >> i would flip it around. i am completely confident they will. the question is what is the extent to which it will.

>> fair enough aspect of course it will. by the way, to some extent they shed. some of what was put into legislation or is coming from the rules is too harsh, or does it make sense. other things i'd like to see stay in there but it probably will get watered down. it's hard, it's hard to get a percentage or to note of even exactly which things. but this is one of the reasons why -- let me step back. i've gone pretty far out on them in making clear i believe that industry can actually absorb these capitol liquidity changes without the kind of disasters that the industry has described, or even i think the extent to which was implied by karen. when i do the numbers as to how i think banks will respond i don't come out that way. but in addition to directly finding it in my numerical analysis, i also have complete

confidence that they will find some loopholes in some ways to operate that will reduce the net effect. >> to a significant effect and still i think the net world will still be tougher. >> peter, question by glass-steagall. removal of glass-steagall or abolition, whatever one says, what role, if any, do you think is played in the debacle we just went through? >> the first thing i have to say is it wasn't a limited. that it wasn't removed. but i mean, it's not sure that everyone understands that. i know you know now what happened with glass-steagall was that they were to types of provisions in glass-steagall. one, said that banks could not engage in underwriting or dealing with security. the other part of glass-steagall said banks can't get away with companies that engage in underwriting or dealing with security.

it was the second that was modified, eliminated. banks are still unable, this is important, because the banks he got into trouble in the financial crisis got into trouble through doing things that banks always did. they made lousy loans. the investment banks that now could be affiliated with banks through bank holding companies, the ones that we know got into trouble, and we can talk about bear stearns and lehman brothers and others, were not affiliated with banks. so you have to say that everything that happens in a financial crisis could have happened even if the glass-steagall remained in effect in its entirety, and that portion have never been repealed. so that's one of the reasons why i have been saying from the beginning be regulation was never an issue here. and, in fact, in addition which

was a improvement act which was adopted in 1991, made things, made regulation of banks tougher. tougher than it ever been before and at the time as i think karen will probably remember. kerry was very active in all of that. but people were saying well, this will prevent any kind of banking crisis in the future. we're not going to have to worry about that. well, that was really jewish or tougher regulation. and, of course, it didn't prevent the next financial crisis. so glass-steagall has had no effect and i think a lot of the talk about it has been an effort to find a cause that didn't really exist. >> thanks. question for you, karen. although others may want to answer it. maybe it's an unfair question. that why haven't the least of

the big financial institutions and more proactive in informing the public of the pitfalls of frank-dodd? if you think that's an unfair question, say so. >> no, i'm often asked the reverse of that which is, why will wall street be good now? and the answer is, no. this is not an industry that attracts philanthropists. [laughter] nor is it an industry that i think attracts senior executives who want to write books about financial reform because peter and doug are doing a great job at it, and, you know, they've got planes to catch and money to make. each of them of course is spinning the legislature. we are for resolution, we are for the end of two big to fail as long as it's prudent.

we believe in a sound capital regime. and certainly, the liquidity rules will require a bit of tightening up. behind that, of course, back to the lobby and to the critical work of crafting something that would be semi-workable. but i think to expect sco's to look you straight in the eye and say, thank god they are saving you from myself.y% >> look, let's be realistic. bankers. so to come out of the ceo of the bank and say, you know, making your $25 million a year, i think there are problems there, there's a really dumb but you can affect public opinion. [laughter] >> good point, good point. okay. slightly more technical question here for all three of you. what magically systemic risk council used to determine

whether and when to act, what measures will use, and could this actually increase moral hazard? >> yes, of course, it increases moral hazard that it will have to. the council when it makes its decision will have no standards whatsoever of making this decision. and i assume the question you're asking is who will be declared to be systemically important institutions. it seems to me that it will be done politically. and that is, if the fed recommends that an institution be regarded as systemically important subject to regulation by the feds council, will say yes, because if they were to say no, and some kind of problem occurs to this institution, the council been will be blamed whereas if something happens to institution, which, of course, it will, when it is under

control of the fed, only the fed will be blamed. so that enforcement is the way it will go. and, of course, moral hazard is increased when any of these institutions have turned over to the mercies of the federal reserve. because the assumption will be as it always is that because they are regulated, they are less risky than institutions that are not regulated. that is a proposition now to me would still have to be demonstrated, but too many people outside in the market and so forth, do believe that if they lend money to an institution that is regulated by the fed as regarded as systemically important, that money is less at risk than if they lend to an institution that is not considered systemically important and is not regulated. moral hazard is an absolute

certainty a result of this process. . . >> you'll be right. >> all right. >> i just wanted to -- from peter's point of view. i agree with doug. i know and talking to some the folks on the council, their initial view is obscene. you know it when you see it. they have pretty much -- the problem is they each had 16 of the 20 institutions the same. it was the four that they all

disagreed on. for those of who are interested in this, you should look at the advance notice of proposed rulemaking that the financial stability oversight council put out recently asking for viewing on how to define systemic. and i do have to differ with peter just because in our practice we have a number of clients who are doing their damnest to make sure they aren't systemic. if it were that cushy, you think they'd want to do it. every institution i know is doing it's damnest to do it. >> thank you. we are out of time. please join me in thanking the panel for a very, very interesting discussion. thank you. [applause] [applause] >> you guys can step down now if you'd like. going to move on to the next discussion. which is by bill gale of brookings on fiscal policy.

>> voters are going to elect all 435 house members, 37 senators, and governors in 37 states. c-span election night coverage begins at 7:30. we'll show election results as they come in, along with victory and concession speeches in key races. also your reaction to tonights event in phone calls, e-mails, and tweets. >> president barack obama reacts to the results tomorrow in a conference in the white house east room. he will take questions at 1:00 eastern. c-span will have live coverage. >> this weekend on booktv "in depth" jonah goldberg, discusses the election results, the conservative movement, and the next wave on the right. sunday at noon eastern on c-span2 booktv.

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[inaudible conversations] [inaudible conversations] >> we started around the issue of fiscal policy a little bit. we talked about it this morning. i did. nigel did. huge questions around us, going forward, timing, expense, details, and our next speaker is somebody who's spent a lot of time on this issue, written a lot. very interesting pieces. we're delighted to have william gale of brookings institution and the tax policy center sort of help us try to sort some of this stuff out. without any further introduction, his bio is in your books. delighted to have bill gale here with us. thank you. >> thanks. all right. well, let's see, thank you very much. let's get this -- right.

no there. to my right. looked to my left. okay. thank you, it's a pleasure to be here. you just heard what i thought was a fabulous discussion of financial regulatory issues. and what i want to do it move from the sublime to the ridiculous, and talk about the federal budget outlook. the -- it's hard to emphasize how messed up the fiscal situation is right now. so what i'll try to do is distinguish various parts of that problem as opposed to just saying it's a big one. if you look at a short term. we have huge deficits right now. if you look in the medium term, the next five or ten years, we have fairly large deficits expected. then if you look at the long term i don't think that, we have even larger deficits expected. it's tempting to say we have one issues, which is big deficits. three sets of issues.

short term, long term, different resolution, they raised different issues. what i want to do is talk through that and talk through what we might actually do in terms of policy response. but i want to first spent a little bit of time in terms of history and terms of how we got here and talk about where we are headed and talk about what we might want to do about it. the history is interesting. this is -- you can treat this graph two ways. one as comic relief, which i'll explain in a second, and the other as a cautionary tale. what this graph shows you is the estimates of federal debt as of 2001. january 2001 when president bush came into office. we had surplus as far as the eye could see. yes, this is federal debt on those graphs. yes, positive numbers go up. and, yes, we expected to run out of federal debt by late in the decade. that is we expected to run

surpluses throughout the decade, the market for federal debt was going to try up by about 2008. and alan greenspan went to congress and said we can't have this. we can't run monetary policy if there's no market for debt, you can't run open market. we have to do the tax cut. that was sort of the turning point in the political debate about the tax cut. anyway, as you know, just to jump to conclusion, we're a can do country. we solved the problem of running out of federal debt. so we don't have to worry about that now. but just to talk you through it, this is the surpluses as far as the eye can see. that's what cbo projected in 2001. i want to emphasize, this is not a criticism of cbo. this is sort of a consensus forecast at the time. with the exception of yours truly. but i'll talk about that in a

second. this is what exactly -- this is what happened with observe budget deficits. and you can see basically three things happened. one the economy, so i'll talk about it in a second. the second, policy response over the course of the decade, and third was the great recession. so if you just start out in 2001 we had a recession that caused revenues to drop as well as the tax cuts that caused revenues to drop. if you look farther in the decade though, by about 2007, we weren't actually doing so badly in terms of the deficits. the deficit was about 2-3% of gdp. interestingly, all of that was because of policy changes. all relative to 2001. all of that was either tax cuts or discretionary spending on the military, campaign in iraq, or the medicare drug benefit, et cetera, but cbos forecast in

2001 of where the economy would be in 2007 was almost exactly right. which is, you know, has to happen once every 20 years or so. but the fact that it happened in 2007 is noteworthy. because right after that, the economy turns down. and so you had the downturn in the economy knocked an enormous amount out of revenues and the policy response on top of that, the stimulus package, t.a.r.p., et cetera, increased the deficit on top of that. so we ended up instead of surpluses as far as the eye can see, you ended up now with deficits as far as the eye can see. and in a relatively short period of time, so there's a cautionary tale here about the ability to forecast these things. also, of course, the deficit is a residual between -- it's a

relatively small residual. so relatively small turn into large in residual deficit. it's worth as a cautionary note to mention that. this is what the bet looks like under the cbo baseline, which i'll tell you about in a second, compare it, of course, to the original surpluses as far as the eye can see. that's sort of how we got here. where are we headed? it's a very good question. and you get like most things in economics, in depends on the assumptions that you make. what i'm showing you here, is the cbo baseline budget. all budget projections in d.c. start with the baseline. and the baseline looked not so bad. the deficit comes down to 3% of gdp.

or 2.5% of gdp by 2014. it stays there the rest of the decade. that's a good outcome. the debt to gdp ratio will be stable as it was as shown in the graph that i just showed you. that's basically where we're trying to go. what's the problem if the baseline is already showing us that? the problem is the baseline is not a projection of likely outcomes. it's by law who -- law what cbo does to construct the baseline is what happens if congress does nothing for the next ten years. there's no changes in spending other than those set up by law. all tax cuts that are supposed to expire, actually expire. the amt, at -- alternative minimum tax, 34 million are on those. and the medicare cuts. there are annual medicare cuts

built into the budget which get over ridden by the congress. but the future budget cuts are still in the budget making the deficit look lower. so the cbo baseline again is basically current law, it's congress literally does nothing for the next ten years. and what i've been doing since 1999 now, this is the source of my comment that i was not forecasting surpluses as far as the eye can see in 2001. what i've been doing since '99, since surpluses first started appearing, i got interested in, you know, is it surplus real? what does it really mean? i started doing business as usual budget, extended policy, current policy, this is obviously judgment. it's not some rigorous methodology. but the idea is to assume that current and future congresseses,

instead of pretending they do nothing, they get extent the, if the amt is going to grow like wild fire, congress reigns it in. so on. a few of these very big moving parts in the budget make alternative quote, unquote realistic assumptions about them. you might argue they are even conservative. and the reason that's important is that it creates -- it has a tremendous impact on the deficit. that is the story under extended policy or current policy or business as usual of where we are headed is much less optimistic than the baseline. under the extent the policy, the deficit only falls to 5% of gdp by 2014. as, of course, is dependent on the economic recovery. even though the economy is doing

great, the deficit starts rising again. there's no issue there. that's just an imbalance between spending in taxes, and basically it's rising entitlements and accumulating net interest payments. by the end of the dedicate, you have a full employment deficit of over 6% of gdp that's rising. that is not a stable situation. we've never had year after year like that in the u.s. economy. if you are wondering where obama coming in, it's the administration policy right in the middle of these two. you can argue about whether they are deficit hawks, relative to extent the policy, or deficit doves relative to the baseline. but in either case, they come in in the middle. what's scary about this is what this scenario looks like. i'm going to show you some numbers for obama policy.

just know the extented policy, business as usual is worth. under obama policy, the debt hits 90% of gdp. this is net debt, by the way. i will answer any question about gross debt with the answer that net debt is what matters. this is the focus on net debt. but it's rising continually over the decade. even though the economy is doing fine. so there's just a fundamental imbalance. and, of course, i'll show you in a second if you go out farther. it gets far worse. i'm sorry. the full employment deficit is 5.2% under obama at the end of the decade. public debt is 90%, spending is 95%, revenue is 20%. perhaps the scariest number, or the one that will wake up the markets or wake up somebody that net interest payments will be 4.1% of gdp by 2020. that's by far the largest in

u.s. history. even after world war ii when our debt was 109% of gdp, our interest payment was 1 or 2% of gdp because interest rates were fairly low. but the credit agencies mark places down when they net interest payment exceed 20% of their revenues. that's a target -- that's an area that we will be in with net interest at 4.1% and net interest at 19.8. i would guess that the announcement would come from the london office of the rating agency, not the new york office. if they follow current practice, we would be downgraded officially at that point. all right. the -- all of the forecasts depending on economic assumptions. i've used cbos economic assumptions throughout. they are basically middle of the road. they might be a little less optimistic than the conservative blue chip, but not by much.

to me the real risk is not that things are going to be so much better than the forecast, but things could be so much worse. we have this financially-induced economic downturn. it was not caused by fed tightening, the way that typical short, shallow recession is in u.s. history. it was caused by the collapse of the financial sector in the 1930s in the way the 1990s was japan was caused. there's a potential for this to turn out to be a very long bumpy downturn, a very weak recovery. historyically, it's taken a long time for economies are releverage after a situation like this. there's been a reduction in the growth rate of potential output as the intermediation of financial sector has come down. to me the big risk is that not we are going to have an 1990s explosion like the internet, but rather we are going to have a

decade like japan did in the 1990s with very weak recovery. if that's the case, of course, all of these numbers are worse. it's impossible, just significantly worse. but besides the economic assumptions, i want to emphasize the political assumptions in here. these are not wildly pessimistic political assumptions. they basically assume that other than doing the things they usually do, congress doesn't do any other nutty thing. they actually enforce paygo rules, that's pay as you go rules, which require that tax cuts be financed by spending cuts or spending increased be financed by tax increases. i assume the reductions in health care payments actually occur. and those assumptions strike me as more optimistic than the economic assumptions.

so i'm not going to say this is a best case outcome, it's certainly not. but there's a lot of downside risk, even with this set of forecast. sorry. okay. so where are we headed in the long term? well, let me just say this ends the good news portion of the talk. [laughter] >> okay? all of those big deficits we were talking about are now scrunched into the little corner of this graph; right? after 2020 is when things really get bad. medicare and medicaid spending start taking off, net interest which was 4% of gdp starts rising continually. you can see the spending curve takes off. whether you use the baseline or the extended policy adjustment. of course, we are not going to get -- let me -- this converts those spending and revenue figures into debt figures that are a share of the economy. we are not going to get to 600%

of gdp in debt. something will happen then, of course. but that's the path we're on is the message from these things. alan owerback who's an economic at the university of california, we have worked to estimate the fiscal gaps. if you look at this graph. supposed we wanted that extended policy line instead of hitting 1,000% of gdp in 2085, supposed we wanted that to hit 60% of gdp in 2085. suppose we want it to be exactly the same ratio then as it was now, what kind of tax or spending adjustment would we need to make that happen? the answer to that is what we calculated called the fiscal gap. i'm sorry, there are too many numbers on this graph, but if you look at just the top line under extended policy, the answer is 6% of gdp just to get you back to the current debt to

gdp in 2085. and it's more than 7% if you want to do it beyond that. after 2085, things look worst to the extent that we can forecast any of that stuff. the proviso about the uncertainty of forecast weighs in here. the 6% of gdp is $900 billion right now. we're talking about an immediate and permanent tax cut or spending cut equal to $900 billion, and then, growing, you know, the economy over the next 75 years. immediateless to -- needless to say, it's completely off of the table. the fiscal commission is trying to come up with 1 or 2%. they are finding that hard. the notion that they could come up with 6%, you know, is off of the table.

okay. so i'm not going to spend a lot of time on why fiscal policy matters. i think people get that. i do want to talk about the impact. how does this happen? what's going to happen if we have deficits? and there's this classic quote from the "sun also rises" where one characters who's name happened to be bill asked the other, how did you go bankrupt? the other one said two ways, gradually, and then suddenly. that's basically how this can happen. okay? and i want to talk about the sudden scenario first. because that's the easier one to talk about. the sudden scenario, there's a crisis, you know, formally, that's a sharp change in investor attitude, capital flees the united states, there's higher interest rates, there's lower value of the dollar because people are getting out of u.s. assets, there's a sharp

outflow of capital from the u.s. there's a lot of discussion of whether this will happen. whether china could trigger this if they said we are not going to buy any more treasury bills, et cetera, et cetera. i don't think this is going to happen. i want to put this up here. but this is not for me the big concern. for the main reason being that china would have to shoot itself in the foot if it did that since they are the biggest holder of u.s. treasuries, and the other thing is if the money left the u.s., it would have to go somewhere else. it's not obvious to me there's any better place to put it than in the u.s. so we should keep this in the back of our minds as a possibility, but a) i don't think it's likely to happen. any time soon, at least. b) even if this doesn't happen, even if we don't have a crisis, it doesn't mean it's not a really big concern.

that's the gradual. that's why this is so important. the gradual approach, if you will, is that deficits suck up national saving, they reduce the amount we can invest, they reduce the productivity and wages of our workers, that reduces future living standards, and that imposes burdens on future generations. not only the increase of debt, but less capital per worker than they'd otherwise have, you know, less investment, less wages, et cetera. that's almost like a stealth bomber time of -- bomber type of thing. you don't see it. if the earthquake knocks over the building, there's the pile of rubble. yeah, the earthquake caused the building. if it's an empty lot and you walk by, people don't think the increase in federal debt caused the capital market not to finance what otherwise would have been a building there. that's the type of affect.

stuff that doesn't happen, but we know must be going on, because there are limits to capital markets in the world and in the closed economy. so the issue here is that these effects happen and they are big. let me just give you one example. i've done research on this that -- on the impact of interest rates, on the impact on interest rates. but a more interesting thing here, which we can talk about if you want, more interesting thing here is the affect on the rate of expansion of economic activities. the imf recently looked at a whole bunch of country over 40 or 50 years and found that if you increase the debt to gdp ratio by 10 percentage points as of some time period, the growth rate after that is lower by .15 percentage points. that doesn't sound like much. then when you think about the u.s. going from a ratio of 40

percentage points of gdp to 90% over the course of the dead dea- decade. if you linearly extracted, you would reduce the growth rate by .5 percentage points. over the following decade, gdp would end up 7.5% lower than it would be. that is an enormous change in gdp, relative to other policies that we can think about. you can't make that up via social security form, you can't make that up tax reform. that's an enormous reduction in gdp. and it's invisible, it's gradual, and in the absence of people running away from the financial market, the only thing that will stop is politics. i'm not optimistic the political

decision will stop that from happening in the absence of a crisis. so the impacts here are serious. even if there's no crisis, the way that i just tried to explain this to my 21-year-old son who is not at all interested in economics, but is very interested in having a credit card is that if you run up a big debt on your credit card bill, the credit card company may raise your interest rates or cancel your card. even if you don't, that doesn't mean you are acting responsibility. you still have the enormous debt that you are building up. you are living beyond your means. you have to pay it off. that's sort of the situation that we are. in the world is not going to cancel our ability to lend. that makes it harder. we have to discipline ourselves. that's not something we are good at. i think there's a real concern here until the medium term and long term. what should we do? i'll be done in about five minutes. i hope we have good time for

questions. >> take your time. we have about 20 minutes. you are in good shape. >> okay. in the short run we have a balanced recovery and fiscal discipline. there's the false discussion about do we tighten the budget or do we expand the budget? the answer is we do both. we do them at different times. we need, i think, another stimulus right now to help the economy return to full employment. at the same time, we need a fiscal discipline plan, kind of a glide path that shows what we are going to do when the economy does recover. and the risk, of course, is if we impose fiscal discipline too soon, we end up repeating the experience of the u.s. in the '30s and japan in the '90s, very briefly the united states in the '30s, the great depression was actually two sharp recessions with a very large expansion in the middle. from '33 to '37, the economy grew very rapidly.

then in '37, tax increases and spending cuts, the economy went back down in a recession that it didn't come out of in the second world war. it did not come out of the bottom. there was a sharp expansion that thank god got cut off, at least in part by policy. japan, the same thing, they had a very deep recession in the early '90s. very long and deep recession in the early '90s. their debt went up. by '95 the economy was strong. '96, time to impose fiscal discipline. they raised taxes, cut spending, the economy went back down in the recession. the asia financial crisis didn't help. in some sense, they've never really gotten out of that. we can discuss that. but, you know, they've had their recovery. but the economy is never quite been the same. of course, nobody knows how long

to impose fiscal expansion and then how soon we need to impose fiscal discipline. at least i don't see the great concern that the markets are going to freak out right now. at more stimulus. although i think if we do have stimulus it should be in the context of a medium term towards some sort of fiscal consolidation. all right, the next ten years, let's talk about this. i showed you the budget, the figures are extended policy we are looking at 6% of gdp, 7% of gdp in deficits. even though the economy is doing fine. that's the real punch line. there's no