to restore market confidence. however, and here's what passes for optimism these days, i take the view that none of th apocalyptic forces will be in place. i don't think the euro will break up. it is a possibility that greece might drop out or be kicked out. but i don't think there will be any widespread defedex there is the eurozone. in fact, as i'll indicate, i think europe will come out of the crisis stronger and over time, will restore its position as a key player in the world economy. why do i say that? three reasons. i've watched the evolution of the whole european integration project for the last 50 years. they've faced a series of crisis. frequently existential crisis to threaten the existence of you're ron and they come out every time stronger and moved on forward

and better. if you look at current crisis and every time it has reached a tipping point, where there was much commentary, it's going to collapse if they don't shape up, every time that's happened they have done enough to avoid the apocalypse. they aif kept going forward and built new institutions. they built a firewall. avoided financial disaster and i think that will continue. for a very simple reason. the overwomening imperative in all european countries to hold the european union together and that now means holding the eurozone together. that has become, for all practical purposes, the definition of you'europe. they know europe is wrapped up in sustaining the euro and they will. one reason is the ghastly history of europe. remember why they created the european union in the first place, to overcome the previous millennium of slaughter in europe, most dramatically, the

first half of the last century. i visited the holocaust museum again. if you've done that recently it gives you plenty of memory of why the europeans have pulled together to avoid letting europe, again, explode into kind of holocaust and disaster that they experienced. so they're going to hold europe together. in addition to that, they have an overwhelming economic interest. germany, the pivotal country, has a nirvana economic situation. germany is the largest surplus trading country and it bases it's whole economy on an export-led economy. when they had their own deutsche welle mark and they would choke off their competitors and fight off the germans. now, the germans have the

world's largest trade surplus and a weak currency which, for them, is the perfect outcome and every german knows it and they'll continue it and virtually at any price would be worth paying for them to keep that situation together. if you went to a new deutschemark it would explode up in value and the whole german economic prok which has been impressive the last few years, would collapse. so the bottom line is both germany and europe as a whole has a huge, huge interest in holding the eurozone together. so my conclusion, and it's, i think, supported by the evolution of the current crisis is that germany will pay whatever is necessary to keep the eurozone together. the european central bank will put in whatever amount of resources are necessary and will play lender of last resort, own though they can't say it. there's one problem with this their you.

neither the germans nor the european central bank nor the europeans broadly can do what i'm confident they will do, why not? it would be the epitome of moral hazard if the germans pronounced that they were going to rescue everybody no matter what the cause. that would take the pressure off. mario moly is speaking on friday and he'll lay it out. he wants to keep the pressure on his country so that the domestic politics will support the reform program that they all know they need so the germans and ecb cannot say they'll provide all the resources even though i'm confident they will. second lip, the usual juggling among the creditors. germany and the other successful northern europeans. the european central bank. the vat bank who are now negotiating and the international monetary fund and they're all tried to fob off shares of the packages to the

others and preserve their own negotiating position stoed, therefore, none of them wants to say he or she will take care of the whole problem, even though, in fact, they will. so the result is a situation that's very unsatisfactory for the market. the market wants to hear assurances and firm words of rescue and those can't be given, even though i'm confident that those rescue also take place and therefore, the market situation is likely to remain unsettled and volatile, even though i'm confident that the outcome will be successful in the sense of successful financial engineering to avoid financial breakdown. but that's not getting to the recession and the underlying economic problem which is still there. i want to draw two or three major conclusions for the united states and answer more questions. as you said, mr., the united states has a huge interest in this situation being resolved successfully.

so we have to do whatever we can to support a successful solution. i agree with simon that the europeans should provide the bulk of the resources to do that and they got the wherewithal but i disagree with him that the international monetary fund shouldn't be available if necessary, we don't know yet, to lend more to help resolve the problem. the imf did pick up one-third of the original packages for greece, portugal and ireland, and i think that was very helpful, not so much in terms of resources but bringing the imf condition into play and helping to promote the necessary adjustmentment in the debtor companies. when i say necessary adjustment, i don't mean just fiscal austerity but structure reforms that are necessary to restore growth. all the debt countries need to restore growth is structural reform of their labor markets,

their uncompetitive private sectors. their own financial systems. all of those structural reforms are needed and the imf is very helpful in promoting that given its experience and the resources that it can bring to bear. so i believe the u.s. should support if it turns out to be necessary, additional imf financial contributions to the european problem on a minority basis, maybe the one-third in the previous cases, maybe less, but certainly it could be significant, and i therefore think the united states should support the current efforts of the imf to created a new fund, 500 to $600 billion which in conjunction with the funds the europeans are raising would take the fire wall to over a trillion. so there would be enough there to avoid any significant financial disruption either from italy or spain. i think the u.s. should support that. but i do not think the united

states should contribute. the funding the imf needs should be borrowed from the big sur plus and creditor companies. china, japan, singapore, hong kong, brazil, russia, mexico, many of those countries already said they will lend and they should be tacked. they have big sur pluses and big reserves. we should support the effort but not put in our own money. the u.s. needs to take this as a wake-up call itself and you suggested that, mr. chairman. if you take those cbo realistic projections and i would say, even add a little more dose of realism, you have u.s. budget deficits exceeding a trillion dollars a year, more than 5% of gdp for the decade to come and then it gets worse because of aging. so if you project the numbers, our debt and deficit numbers within ten years look like

greece' did as it entered into its crisis. the european crisis has shielded us from our own follies. because europe's weakness meant that foreign capital, global capital moved into the dollar and pushed our interest rates lower despite our inability so far to put our own house in order. remember that only three or four years ago, greek interest rates were at the same level as german interest rates. because the omnipotent markets that we like to extoll, got it totally wrong. the markets thought that greek debt was as good as german debt because greece was part of a eurozone led by germany. and all of a sudden they realized that was wrong and greek interest rates tripled the level of germany's. the united states is very happy at the moment to have very low interest rates, in large part because europe and japan are so weak and so the other financial

markets don't attract the capital but that worm could turn very fast, very viciously. and if the european crisis teaches us anything, it's that we have to learn from that example. and not simply delight in the fact we have more time but, either use that time. this committee has played a major leadership role with that and i urge and implore you to take the time that's now available to do that, if not, we, too, two or three years from now, certainly within the next five to ten, could go the way of some of the europeans whose tre vails would we now bewhale. thank you. >>lerrick, thank you for

coming. >> i want to recapitulate what happened. the europe crisis is not a currency. the euro maintained its value. it's at $1.3 which is in historic range. europe has a fiscal crisis compounded by a failure to take corrective action. that's just destroyed its credibility in the capital markets. it is a self-inflicted crisis. the european monetary union set out rules that limited deficits to 3% of gdp and debts to 60% of gdp and the markets said this is a fiscal performance guarantee. they thought that how moj niced the credit throughout the union. you saw the interest rates of greece's debt fall from 8% of germanys to less than a quarter of a percent above germany's. but the rules were never enforced. by 2007, you had ten of the -- seven of the original 12 members over the debt limit by 2010, it was ten of the members.

what had happened was weak governments had used massive borrowing to offer their citizens a standard of living, their productivity could not deliver. and so now what you have when this crisis started in greece in 2009, greece just denounced our deficits two times is what we had told you a few months ago and the market recognize there was a problem. what should have hand two years ago is greece should have defaulted on the debt and the other countries should have just tightened up their budgets. the fundamental problem in europe, really, is european policymakers don't understand the markets and don't like markets and think they can dominate markets and that's why you've seen a mess over the last two to three years. the inability of europe to address its crisis stems from a fundamental disagreement over the responsibilities of members of the eurozone. without a fundamental agreement, all you've seen is a series of political compromises that have only further eroded market

credibility because they failed. germany leads the north and they believe the cause of the crisis is a lack of discipline in the south. profited members should cut their spending, lower their wages, increase their productivity, which is the exact path that germany took in the approximately ten years ago and that's the source of germany's current prosperity. under the german view, each member is responsible form its own fiscal well being and growth. if markets see credible action the crisis will end. southern believe it's caused by germany's success. if germany hand done so well they'd be in good shape. that's an interesting way of accountability but that's their view. they think union solidarity requires massive transfers from the strong members to the weak and they need a euro bond to lower their financing costs and

reduce adjustment paying. what's interesting is the role france played in there. france, instead of steining with the other aaa countries has decided to be the head of the south. they see this as a way of gaining political leadership of europe while leaving the cost of bailouts with germany. as one of the germans told me, the french are very bad at economics but very good at diplomacy. the great danger is that you know have a conflict within europe. germany wants immediate fiscal correction by the individual governments. the rest of europe and the obama administration, want the european central bank so simply print up $2 trillion euros and buy every weak government bond in sight and drive interest rates down to 4% and the real problem can be dealt with later and that's basically mimicking the federal reserve's policy of driving down the interest rates and flooding the economy with cash. germany disagrees. if a long-term solution is not

offered, there's no amount of money that will solve this problem. and i believe that if germany capitulates as my colleague believes they will, you'll wind up with a currency crisis on top of a fiscal crisis. the issue then becomes -- what is the next level of europe? germany has a clear view of what the future of europe is going to be and they've found two tools that will force union fiscal discipline after two years of reasoning, threatening and pleading had no effect on their fellow members. they see market sources fail where diplomacy failed. if you keep painfully high interest rates on the politicians that will compel them to make difficult choices that need to be made. the second step they've done is removed the you thnathan u than

anymority requirements. before they could stop the euro without a veto and therefore, they set up a system where there will be no access to emergency funding unless a member agrees to the fiscal conduct. and what will happen is the fear of being left behind is going to support -- left behind without support is going to force submission to this fiscal reform. and so what you'll see over the next two to three years is germany will draw the eurozone towards a fiscal union with central control over national budgets and strong, automatic sanctions against spending offenders. this is a difficult path. it's the greatest danger is that a crisis will loom in the interim. what you're seeing is a very difficult process and there's going to be missteps. there's going to be obstacles and what you'll see are the markets will become frightened. and the great danger is the politicians will confuse the emd of their world with the end of

"the" world and rush out and bail out every government and bank in site and i'll set back economic stability by a decade. so what should happen is the ecb should act as a support for this difficult path to adjustment, as the europeans go towards fiscal compact and this way they can maintain stability and very fragile markets. what they have to do is not just flood the market, what they should do is announce a rule of intervention that remove the risk of financial panic. but preserve the incentives for governments and for investors and safeguards for inflation-fighting credibility. the great problem in europe is not the problem of deficit or debt. europe has a much more serious long-term problem. you can solve the debt easily. you write it off. you can the deficits easily, i'm saying economically, not

politically, easily, you cut spending. the difficult problem is that southern europe's populations expect a lifestyle their productivity cannot supply. greeks don't have to be germans but they can expect to be -- but then they can't expect to be paid like dper mans. so you have a 25% gap between southern europe and german labor cos costs that are on the closed by deflation. this is a long, painful process that will precipitate a five to seven-year recession in the southern european countries and there you're talking about close to 40% of europe's gdp. the only other alternative is a long-term transfer from europe's north to south. re-unification of germany caused same problem of differing productivity. what the germans decided was they proposed a solidarity tax imposed on west germany to bring east germany up to west der man

standards and it was envisioned as a temporary transition mechanism. it's been in place for 20 years and there's no concept of withdrawing it even at this stage. what you'll see is a transfer from northern europe through taxes and payments and aid, directly and indirectly through higher inflation, in order to bring -- reduce southern europe's debt. one point that you raised in both mr. chairman and you, senator johnson raised -- can this happen in the united states? absolutely. and the fact is, if we don't take corrective action it's going to happen. you raise the concept unsustainable trends, what -- a nobel prize winner had a famous quote about unsustainable trends -- they end! and the fact of the matter is the only reason we haven't had a crisis is far is because the u.s. dollar's role as the

currency in the world butting that not go on. the reason it's not ended is because it's difficult to replace a reserve alternative io and the europeans have their own problems. that saved us. but there's a compact when you're a reserve currency. there's a privilege, which is that the rest of the world gives you television sets and lends you money to buy cars and houses at very low interest rates in return for pieces of paper you print up in the basement of the federal ereserve. in return, we have to keep up the value. we have not kept up our end of the bargain. u.s. dollar interest rates will start rising very quickly. the u.s. dollar will start falling very quickly and we will have a problem very similar to what the weak european countries have right now.

>> thank you. terrific all three. i really appreciate your contributions to the committee. what is your assessment how the basel rounds impact the current european crisis. what is your assessment of what those changes require and how that interacts with what is currently happening? dr. johnson? >> i presume you're talk act the basel records on the capital requirements for banks. >> just so you know, the reason i ask the question, we have had a lot of commentary among colleagues, asking the question, what are the effects of inkresed capital requirements. are they sufficient? are they insufficient. what effect are they having on the current challenges. >> thank you, senator. it's a very good question, and

highly appropriate to ask it. there's something between the agreement of basel and other governments how they agree on what capital should be. if you're holding something that's aaa, you don't have to have a lot of equity. well, what's a aaa asset in the european context? sovereign debt, including greek debt. and as was laid out for you, people were convinced, the markets were convinced greek and german debt were very, very similar in their credit risk. they're not. we're looking at a situation where there's real credit risk across a wide range of european sovereign debt. the entire approach in bah sese deeply flawed. the way it's being implemented

is very problematic. the french and the germans by all accounts are backing away even from what they signed up to in basel. that doesn't necessarily limit what we do. i would argue that we should go further and the federal reserve has indicate there had will be some so-called surcharge, but that's not enough, relative to the losses we potentially face. >> remind us, what are the requirements, what are the capital requirement in the basel round? >> well, it depends on exactly -- it's a complex arrangement. it depends exactly on what financial institutions you're talking about. i would say the did he feel is in the risk-weighted assets. in the risk weights. if the risk weighting is so fundamentally flawed they've missed completely the sovereign debt crisis and the true risks that all these european banks face and that our banks face and they're exposed to the european banks. and to the extent that any bank tells you they've hedged this

risk, they're offsetting a contract, the counterparty risk in that swap is probably with a european bank, at least in part. how big is that? how profound is that risk? we don't know. i talk tthegulors on this issue. i'm a member of the advisory committee that met last week. i don't know the regulators would tell me, even if they knew, but i'm pretty confident they don't know. i'm not saying move everyone to capital requirements. i'm not saying that. you can suspend payments. that would be well received. that would bolster financial stability and growth prospects in the united states. it wouldn't be a negative in this environment if it's applied across the board because of the risks by europe.

>> what ur your assess. of basel and the capital requirements. sufficient? insufficient? do you share the view on this? >> yeah you can i very much share his view. i do think capitaled a quasi is at the heart of financial stability here in europe and everyone else. and we should err on the side of caution going to higher rather than lower capital requirements in order to achieve that outcome. there's a fascinating implications of the last three or four years we should keep in mind. the last crisis was rooted in financial instability in the united states and europe. it turns out there was very little spillover to the emerging markets in developing countries. they got some affect from the

recession and weakening of trade flows. but their financial system stood up much better than hours. why was that? well, they had crises in the past. the asians had crises in the '90s, the latin americans in the '80s. and they did to a large extent get their acts together. they opted to have financial systems that were not as exciting and high-flying as hours, they explicitly determined and opted for more risk adverse systems inkuding much higher capital requirements and that paid off. >> what are their level of capital requirements? >> it differs from country to koun tr i. simon, do you know? the numbers are much higher than our ps they were all put in place as a lesson from those crises and seems to have paid off very heavily. >> 20% is not an unusual level

of capital in these conservative systems that have previously placed here. >> that is a deep problem in these systems. the europeans made a huge mistake on sovereign debt. we made a huge mistake relative to mortgage -- >> we just had a company go down in part because of bets on sompb debt. >> first of all, i echo simon's comments about the basel rule. i would raise two points. first, there's one true law of economics that was first enunciated by the governor from the bank of england in the 19th century. every regulation will be circumvented. so when you start setting out very precise rules, you're setting in motion an entire

system of people who are certainly going to -- are spending their lives thinking how to circumvent them. and remember, regulators are always one crisis behind. they're always thinking about the last crisis. and they are paid farless, work far less hard, and are not as highly skilled as the people attempting to get around the regular plapgs so you must keep in mind you have a problem. the second is, i saw an old photograph of a bank that had been closed back in the 1920s. the window front was very interesting. in 19 -- before the federal reserve, on the front window of every bank, it said capital, $12 million or $12 million or $5 million. now when you look at a bank, it says fdic ensured.

that is a fundamental plob. you have a system where very few people pay attention to the capital of banks. the levels are much higher in developing countries. look at switzerland. it has the greatest interest in preserving its banking system. they propose raising before anyone el, raising capitals to 16%. and probably will go higher in order to establish the absolute credentialn't of their banks in the world. and that's one of the key issues. banking should be a boring business. it should not be a high-flying business where you trade and take risks. it's a boring business. similar to a utility. they're supplying payments, checking, loans to small businesses. this is not an exciting business. it