business, but it's a fundamental business to the economy and the job for the government is to make sure that banks are not in danger. and that's why you make it a boring business. >> thank you. senator johnson? >> this was fascinating testimony. i'm new here, so let me quick ask a question on the asian banks and what they did to solve their problem. when we passed dodd frank, i'm a great believer in not reinventing the wheel. did we take a look at what regulationser what new rules the asian banks put in place? and does it still make sense if we haven't? >> senator, you have to ask your colleagues what they did and didn't look at. my that we were very taken with the exceptional nature of the united states and

there were, of course, various lessons we could have drawn from candidate knave yeah. make banking boring, absolutely. and the scandinavians have come through this crisis from a fiscal point of view and from a growth point of view. their banks got completely out of control, just like emerging problems and they cleaned them up and made them much more conservative and much more careful, including much higher levels of capital. so i fear that we didn't even look enough at international experiences or didn't draw in this dimension the right lessons. >> senator, there's a great irony here. what the asians and other emerging markets adopted after their financial crises, was an idea called an international banking standard which was actually invented by one of our

staff. and the idea was then picked up and heavily promoted with the emerging markets by the u.s. government, by the international monetary fund, and by all right-thinking people who wanted greater global financial stability. but we viewed it adds their kind of adopting our ideas and the implication was our system is fine and should be the model. whether or not our system was fine back then, our system certainly eroded. the regulatory zeal dropped sharply. it was actually the u.s. and the west with its more sophisticated financial systems that developed, promoted those ideas and then as often happens in history, the people who adopted them got well ahead of the curve. >> the question i'm asking,

would we be smart to look at those and adopt those? >> certainly look at it carefully. and simon rightly mentioned, there are some other high income countries, including european countries which have done this quite well. sweden and finland are two cases in point. they had deep financial crises in the early 990s, put their houses in order, dramatically reformed their economy. we used to think sweden, the socialist economy, how could it ever succeed? sweden has been the star, even more than germany in this recent european economic situation, which has come through this current crisis, not totally unscath unscathed, because the neighborhood is rough, but largely unscathed, doing very, very well. they're voted financial minister of the year, et cetera.

having gone through a crisis, taken serious reform in your macro policy pays off heavily when you get hit again. the u.s. which has so far escaped that crisis may be lagging badly and may wind up paying a very heavi havavy pric result. >> they know they live in a dangerous world. they're extremely careful with regard too how they operate. remember, singapore where fiscal prudence is a model we all aspire to. if you want those connections i'm happy to provide that. >> how many pages was their piece of banking legislation? >> that urks i would have to get back to you on, senator, there's

no question, though, that they have a very tough skeptical body of regulators who are actually not captured by the financial sector. it's the one place in the world where the regulators are paid as much as the people who work in the private sector and work harder. i'm not suggesting you'll want to go there for the united states. obviously bank regulators don't have the incentive. >> the thought that kept going through my mind is pass performance doesn't guarantee future results. i hope you're right, but i'm assuming dr. larik and johnson aren't as in agreement in your rosy scenario. >> i think i'm more optimistic because i believe the germans are going to drive europe to a stable fiscal union. it will take a number of years. we're debating before the

conference whether this was the 17th summit and the 19th republican debate in republican presidential candidate debate, or the 19th summit and the 17th republican presidential debate. we have many more summits to go, but they'll get there. i believe. but there is a large risk. one of my colleagues uses an analogy. he says this is a dangerous operation. you could have the most skilled surgeon in the world, but things can go wrong. and so something could go wrong. i think the germans have now found the tools to do that nchs, which are just to keep the interest rates really high on all the politicians that are of the week countries and that will force them to do what german threats and pleading and reasoning did not succeed in doing for two years. and secondly, the new strategy,

which is, if you agree, that's great and you'll get our support. if you don't, go with god. you're on your own. >> and that's the same discipline that will be imposed on the u.s. our creditors will increase our interest rates to force us to do what we need to do? >> yes, that will be what will happen in the end. >> thank you. >> just take a moment, senator. not on your time. i don't want to miss this chance. i want to go to senator merkley. sweden did something to get their toxic assets off their

books. >> i have to leave in five minutes. mr. johnson, you highlighted the unknown nature of the derivative exposures. there's been a lot of discussion about this. every expert i've talked to has said we really have no idea of how the dominos are lined up. it's an incredible thing that in this -- just in this european and american sector we can't quite get our hands around who is underwriting, who is holding and what happens if companies have to perform on those insurance contracts. if that context there's been a lot of discussion in europe about the banning of naked shorts. that is not able to buy a credit default swap unless you own the underlying investment. i believe that one step in that

direction was taken back in october, and if the proposal is ratified, i think it would go into effect in november of this year, something like that. is there a fierce argument back and forth as to whether that's valuable or not? >> my understanding is some financial institutions in europe are still banned from unsovereign debt. to be frank, i think it's swa a misguided approach. a lot of people want to be able to ensure against risk and they want to be able to use the market to that end. if this were a transparent market, if you could trace through underlying exposures, both on a gross and net basis in

real time, i think from a sys m systemsyste systemic stability point of view, we could become more comfortable with it. mega banks take proprietary positions, for example, betting the house. senator conrad made a bet. it doesn't have to be through a naked position necessarily. there are other ways to do it. i think they should move towards transparency in all these markets, rather than banning this or that financial institution. you just shift the risks into other ways that are more murky and we live to regret. >> well, in that context, under dodd/frank, we're setting up a more transparent derivatives market. are there parallel efforts to create both an exchange and a clearinghou

clearinghouse? >> not at the level and for the instruments that would really matter. there's a lot of trading we haven't talked about. they're dragging their feet. and for example, take the euro swap market, interest rate swaps, over $300 trillion in total exposure there. no one can .tell you who exactly owes what to whom, either on a gross basis, which is what really matters or on a net basis, which is the bare minimum you should be able to report. the lack of transparency in this huge market that's become actually the basis for much of the european financial system, that that is deeply, deeply troubling. if that didn't keep the regulators in this country awhack at night, they're not paying attention. >> it does highlight a point that the u.s. to a degree possible needs to involve in a discussion that helps us establish that transparency and trading regime, if you will in

europe and in the united states. >> i just want to add one point. a fundamental problem in the european financial regulatory context is they still do it largely at the national level. they still have not been able to get the european monetary union to encompass european wide financial regulation. and so the problems we have as you're describing are compound the in the european case by their failure to add that dimension across borders. now, there's a similar problem because these exotic financial instruments really do cry out for regulation. that's what basel tries to do. we've got to take the big leap to do a globalized dodd-frank. because without it, the kind of slipping around controls takes

place across borders and you have an escape hatch for whatever regime is in place. >> i have to dash away. i apologize for that. it's been a great discussion. i hope we can really continue to wrestle with these issues of international monetary strategies and institutions. and i wanted to mention that it was a number of years ago that i remember an article in which warren buffett was replacing his investments to be denominated in foreign currencies because of his expectation that the dollar wasn't going to be the global currency. that is also an instrument or a change that would have an impact on the cost of our goods to the world. to the degree the dollar becomes weaker, making them a more affordable to the world. so that's another interesting conversation. i'm sorry i'm going to miss the sweden solution, but i look

forward to hearing about it. thank you. >> thank you, senator merkley. senator thune, would you like to take questioning time now or hold for a moment and we come back to you? >> it's totally up -- i can ask a couple of quick questions. it won't take long if you want. >> okay. then we're going to go to a second round. so if you're prepared, gha. >> thanks for holding a hearing. i think this is an important subject. this is critically important to our country, both in terms of the impact on our economy, but also helping us to recognize the fiscal challenges we face in the long term as well. i would like to get your perspective, if i might, on the panel to something that's been reported. and that is that many of the u.s. banks and money market funds have significantly cut their exposure to euro zone bank

debt in recent months, which i believe is a positive sign given the ongoing crisis in the euro zone. but there's significant exposure that remains. i'm curious to know what your estimate is of the current total u.s. exposure to the european banking system and what level of reduction do you believe is necessary in order to protect financial institutions in this country. >> that is a great question, senator. i think the honest answer is i don't know. i don't know anybody else who knows. you're right, they've cut back their exposure and the european banks have wanted to draw on the credit reserve in order to get dollar funding. so that part i think we should worry about a little bit less. i would focus on the derivative transaction, on the counterparty risks, on u.s. bank exposure, for example, to the interest

rate swap market in euros. it's a huge market. direct exposure and indirect exposure. and i would urge you strongly in public or nor private if you prefer, to bring the relevant regulators before you and discuss this. as a naert of top priority for the budget. because this is a huge fiscal risk that you're facing. so i can't give you a number, and that's not because i don't follow this closely. i follow it very closely. those numbers are not public. if the regulators have them, they should be sharing them with you on some basis. if they don't have them, if they don't know how to calculate that, you should be asking very, very hard questions to them, why not? what would it tack to figure this out? and perhaps you could ask the big banks to come in and testify about this as well. how do they think about exposure, how do they model it? we still give them enormous authority to handle their own risk management. i'm very skeptical they've got a handle on this at all. >> very interesting.

pi suspect that can't be quantified without bringing them in. i would hope they would have some idea about that. anyone else care to comment? >> those numbers aren't public certainly. emt pose sure to european sompb debt is not very great. the exposure or the mutual funds, they have cut back. one thing the europeans have announced is each government will stand behind its large banks no matter what. and secondly, if a national government is not capable, that guarantee will move to the euro zone itself.

the derivative is an important one. one issue about cds, which everyone is disturbed about and the europeans because i don't think they understand how markets work, are trying to band naked cds is that first of all, it's very good that cds should be in centralized depositories so we know where they are. it's very good that people should have to account for them correctly. three important aspects. cds, unlike bonds, which is one of the big problems for euro zone banks, cds are mark to market every day. so that you could have -- for instance, up to cently, you have banks in europe carrying their greek bonds at 100 cents on the dollar, even though in the market they were quoted at 40. however, the cds had to be marked to the 40. so every day, that is reflected in real time.

and third, what's important, the way the cds market works is you have the gross amount then and you have the net amount. and the way the net amounts are calculated is institution by institution. if anl institution has $100 million in cds but has brought back $80 million of cds, the net number is only 20 of expouz sure. there's bilateral netting. if a cds, one of the issues in greece or italy defaults, what happens is the institutions go to each other. that eliminates to a large extent the danger of cascading through the system. there is not, however, what would be very good multilateral netting.

which means you would be able to net out the entire system across many institutions. then the net exposure would be your only concern. but bilateral does faffect the risk financially. >> the europeans have promised to take over some of these national commitment ps .but i think we would agree the greek banks are about to default. in other words, they will not be guaranteed in full that's the information that i've seen. the euro zone is not going to back the greek banks. why do you think they would necessarily back portuguese, irish or italian banks. the second port is on the netting, which i think is hugely important. remember that -- or let me -- i don't want to get too much into the weeds, but if you and i both have contracts and i fail and you don't, you get to accelerate typically, across cds contracts and other derivative contracts, so i have to pay you immediately. but i don't get to axccelerate y

contract on you because you haven't failed. that's why you can bring in the people from fdic, they stress gross expose sure through derivatives. at the moment of systemic weakness, the gloss can actually cascade through. you should have the system, there are ways to agree to net it out properly. that's not in place across europe or across borders. it's not in place fully for the united states. and that is a major weakness in the financial system that will spill over and have fiscal risks for you. >> if i could ask one quickly. i know i'm out of time. but, you know -- >> go ahead, senator. we've been very -- >> we' seen countries like spain and portugal that have enacted fiscal consolidation to balance their debt. and we've seen significant

demand, surprisingly relative to what people may have expected. but maybe the austerity measures were the right approach. their debt to gdp ratios are over 100%. we're at over 100%. and we've had ample warning about where we are and what we need to do. this is a fairly quick question but i would pose it to all of you. what level of debt reduction do you think is necessary over a ten-year period to get our country back on a more sustainable path? >> the conclusions depend a lot on the method of analysis. but the bottom lines are if your national debt to gdp ratio exceeds 60%, you're at risk. if it exceeds 90%, you're almost

certainly going to take a significant hit to your long-term growth. her database which goes back a long way, shows countries gdp to debt ratios get beyond 90%. >> gross debt. gross debt. right. >> gross debt leads to growth rates 1 to 1.5 percentage points per year lower. if your baseline is 2 1/2 to 3 like our, that means you're cutting it in half and getting to a level that's almost what we tended to call a growth recession. certainly not one that keeps the unemployment rate from rising. somewhere in that range, 60 to, say, 100, you clearly don't want to be beyond that. we're already beyond it. all the trajectories take us just off the charts beyond that. and that's why your basic point is so right.

>> i think you aim on 20 to 30. >> gross debt or publicly held? >> held by the private sector. excluding the trust funds. >> soo so that would translate into 80%? >> that's right. there's a problem the way you compare these numbers across countries. the u.s. in some countries such as japan, you should look at the gross number. in the united states, we should look at the net debt, which is what the cvo emphasizes. i think that's a fiscal goal that's entirely achievable. and that's the right time frame and that would not accuse massive problems for the economy. it's consistent with sustaining growth. but i would suggest that slightly lower yields of late have not been -- actually, they've done very little. monetary innovations or solutions to deal with fiscal

mismanagement, it's the ecb providing cheap credit to the banks and the banks then buying the debt with a lot of arm twisting. because the government is running or pushing the banks very hard, the quit pro quo. it's not a solution, it's a -- the cliche is kicking the can down the road. as you know, if you let monetary policy become sub serve yant to fiscal policy and mismanagement, it will end in high inflation and many other problems that were -- that we've experienced in all these countries before. i don't think spain, italy and portugal are on a more stable path. >> the reason yields are down in the peripheral countries is because the ec fw has given unlimited three-year funding at a highly subsidized interest rate. that's why you're seeing the interest rates on the short term come down much more than the long term. they can buy out to three years, have nos by match and do fine. i would raise two ore points to

the question you pazed, senator, which are the level of debt depends on two other factors. first question is what is sustainable. that depends on what the savings rate of the economy is. it makes it very -- japan and italy are very different than the united states. they can support much higher debt levels because the private sector saves a much higher level of their income. that doesn't mean it's good. it just means it's sustainable. you'll have lore growth, it will be very bad. you're diverting resources from the drooift sector to the inefficient public sector, but it's sustainable. the second issue is what percentage of debt is held by foreigners? in this country, a large percentage of the debt is held by foreigners. that means every day an increasing share of every american's life subpoena spent working to pay the chinese. it's effectively working for the chinese. that's what we're doing. as our debt increases, as the

interest expense goes up that money is shifted out of the economy. if that debt was held by other american, you would be transferring money from one group of americans to another group of americans, but it would stay in the u.s. economy. when it's owed by foreigners, you're basically taking all that economic output and just sending it abroad. and that's why -- that makes it unsustainable. and it means that our standard of living is going to fall unless we correct that. >> i just want to add one caveat on the italy, spain point. my colleagues denigrate -- or implied they were denigrating the european central bank's money creation to in part bush down the yield on those bonds. i think that's a good thing. i think that's avoiding the apocalyptic outcome we talked about before. it's also buying time for those countries to put adjustment programs into place.

they have to be economic reform, structural change to get economic growth going again. so the fact that the european central bank is in way acting a lender of last resort i think is a good thing to be applauded and in fact is part of the scenario i spelled out in my opening statement while why i think the apocalypse will not happen because, among other things, the european central bank will play that role. >> thank you, mr. chairman. >> let's go to a second round now. ask the finances to continue. it's been incredibly valuable. i hope other members' staffs are here listening because there's a lot of educating going on here today that's important to us. i would like to go back to what sweden did. if you could remind us of the steps they took that have proved so effective.

>> this is the root not taken by the obama administration. it was considered in january, february, perhaps into march of 2009. the swedes took over the banks. people use the word nationalize. that's a swedish word we don't like to use here. i would say they resolved them. they did an fdic-type takeover and liquidated the banks. they took the toxic assets, the bad loans out of the balance sheets. they created asset management companies, just like we had the resolution trust corporation in the 1980s. the job there is recover some value over three to five years. but sell the assets, get rid of them. they launched three cleaned up banks, new balance sheets, new management. new owners as well. of course, the old owners were wiped out as part of the deal. and they privatized them. the government never wanted to run the credit system.