so the word nationalization was, i think, misunderstood and misused somewhat in our debate. it was an fdic-type resolution process that went pretty well. you end up with banks that are not encumbered by bad loans orally litigation around those loans. that all gets stuffed into the asset management company which does the best to recover value for you. but the main point in terms of what was emphasized earlier is they came out with a much tougher regulatory approach. a much more skeptical view of the bankers. got rid of the interests that captured the hearts and minds of the regulators. swedish banking became boring, super boring.

if you want to go into the risk-taking financial sector, you go to lon dor or new york. you don't go to stockholm. >> if god forbid we have another financial crisis, would we have the financial ability to take over aig the way they did in our crisis? >> well, my understanding of the precise regulation and developing authorities is that you can not bail out individual companies in the way that aig was bailed out. you can not put task payer money at risk in the same way that was done with aig.

including i presume institutions you didn't think were systemically important until a 4:00 on a friday afternoon, you realize they're about to fail and you need to do something by monday. so there are greater powers now to take over and liquidate such institutions, not run them. i think this is an important misunderstandings sometimes. you can liquidate in an orderly manner and you can buffer the rest of the financial system against the consequences of that liquidati liquidation. now, whether those mechanisms are sufficiently credible, i have my doubts on the systemic revolutionary advisory dmit tee. they're moving in the right direction. the ability to credibly threat ton disrupt such a company without using the bankruptcy code, that's a very sensible

goal. if the markets believed the bank of america, citigroup, gold man sacs could fail, then those mega banks would not be able to take on theses by risks. they would not be able to build these massive dangerous exposures across borders. we are not there yet. i think we need to have much more capital system. we should not be bound by the lowest common denominator approach of basel. that is absolutely a blind alley. >> so just to be clear, and i will never forget as long as i live to be called to a meeting in the leaders office, republican, democrat, chairman of the federal reserve, they informed us they were taking over aig the next morning. they told us that they believed they did not, that there would be a global financial collapse in days. that's pretty sobering. but if we had a repeat scenario,

the federal reserve and the secretary of treasury would not have the ability to do what they did with aig. they have a new authority which allows them to liquidate a systemically risky enterprise. second question, if god forbid we had a second crisis, would the federal reserve operating with the treasury have the ability to guarantee money market funds as they did in 2008? to stop a run? >> that's a good. the first part of your description around liquidating -- the options for aig and the liquidation of systemically risky failing enterprises, i believe that was absolutely correct.

on the guaranteed money market, the use of the federal reserve is money powers are now much more constrained. and the view that i get from talking to officials -- i'm not, they can speak for themselves obviously, but this is my impression, is that they would feel much more constrained on the use of those powers relative to fall of 2008, but they do say, both former officials and current officials will say when needed, we will come in and save the day, which i think would include guaranteeing -- >> let me just say to you, the chairman of the federal reserve told me yesterday, the chairman of the federal reserve, that he does not believe they would be able to guarantee money market funds as they did in the 2008 crisis. he does not believe. >> i'm sure that is what he believes. of course, there is the problem or the issue that we have a very powerful and resourceful country with extremely smart people running the executive branch,

which is what you want. if there's a deep enough crisis, there's many innovations they would be able to come up with. and the key to any credible system is a group of banks or small group of banks fail, be liquidated without that affecting the rest of the system and bringing down the economy. if you can credibly threaten that to yours, to everyone, to the markets, then you're in relatively good shape because the markets will understand that. and they'll price risk in a more appropriate manner. if you get into a situation where they think there's going to be a bailout and you're playing chicken with them, well, i would submit to you that the very smart people who will then be running the fed and the treasury and the white house will propose to you, congress, that they find some emergency powers to provide unanticipated forms of bailout in order to prevent a global collapse. . they give you the choice of 20 or 30% decline in gdp or some innovative interpretation of their legal powers, i'm not sure

which way you'll go, but i suspect you don't want the 30% clps in gdc. all of this should be moving much faster towards making failure possible. capitalism without failure is not capitalism. it's a form of socializatiosm. it's a really bad form of socialism to be frank. and that's what we have with the banks and other financial institutions in our economy. >> no matter what regulations say, no matter what law congress has written, no matter what executive order has been fub published, when they call the secretary treasury and the head of the federal reserve and the president and the leaders of congress in a room and say if you don't do this, it's gong to be the end of the world, you will do it, all right? the rule of law -- one thing i've learned, looking at financial crises over the last

15 years. that when push comes to shove and the danger is great enough, every sgovt will forego the rup rule of law and change the law and change the rule, right then and there. it's a sad fact, we all like to think we live by the rule of law. and the only difference between a banana republic and a stable democracy is how big the daner has to be before the government rewrites the rule of law. >> i'm not sure you even need to rewrite the rule of law. there are laws that aren't even spoken off that can be invoked. one law that's invoked for much broader purposes would be relevant in any international

dimension, that law can be invok invoked, in fact, to do almost anything. and so it was the successor of the old trading with the economy act, which was changed in the 1970s. i happened to be involved. but it does give authority to the executive branch to do almost anything under the guise of dealing with an international economic emergency. the situation you hypothesized would certainly be. so whether one has to violate the law or come up with creative interpretations of existing law, i think adam is right. >> i hope adam is right. >> we have an example in this country when you had the chrysler bankruptcy, the government rewrote the bankruptcy code in terms of priority of creditors, putting unsecured creditors ahead of secured creditors. >> let me say, hope is that we take steps necessary to prevent ever getting in that spot again

which is reallyn lge part what this hearing is about. so let me go back to each of you. if you had the power to take a series of steps to protect the united states given the risks that that are known and those that are unknown, what would be the advice that you would give to this committee and what we should do to protect the united states? >> i think it's conceptually simple and actually doable politically. you should prepare for enactment right after next -- the elections later this year, 2013, a budget plan which simultaneously provided some support to economic growth in the short run by continues, for

example, the payroll tax cuts for another year or so. but put into place concrete tangible measures that would reduce the budget deficit to achieve the debt gdp ratio over the next five to seven years. and i don't mean procedures like you did last summer where you commissioned certain deficit reductions that's supposed to be going on now, set up a super committee and put into place sequestration. what that did was put into place procedures, not budget corrections. i think you need to vote two or three major measures that would phase in over a five to ten-year period and concretely reduce the budget deficit to the targeted limit over that time. for example, social security

reform, where you would change the index sags formula, increase the retirement age, maybe one or two other elements to that, which would by definition phase in over a number of years, which is what you want, but would take 1 to 1 1/2 percent of budget deficit over that time which the markets want to hear. that's one. secondly, if you could agree on some revenue increases, which i think is necessary as part of the package, then you come up with the kind of tax change that's necessary to do that and phase it in over ten years. so it has a gradual impact on the economy, can be accommodated by the private sector, not disrupt either growth or their business transactions because it's phased in, but get to an end point which has a significant impact in reducing the budget deficit. if you could find similar measure on the health care side,

obviously be dedesirable to do that. the point being, however, to vote substantive, tangible, concrete measures, put them into law that sets you on a path to phase in the budget correction over the desired time period. that seems to be squares, the short term with the longer term and i think only that will avoid the risk to our country that is continuing to kick our can down the road that it generates. >> agrie making progress on the budget would be huge, particularly in this context. the adjustment you would need to hit, if you're roughly going to a 50% debt to gdp target, it's about a 6% fiscal adjustment. it's pretty large relative to what the u.s. has managed to do before. i think there are many ideas on the table and i don't see any

attraction for any of them at the moment. you might not extend the so called bush era tax cuts. perhaps we should call it the bush/obama tax cuts. that requires agreement in order to extend them. that, i understand you don't want to go there at this point. but if you were to do that, relative to the fiscal adjustment that the united states needs to make, this would take the issue off the table. it's not the whole story. fred is right. there are other things that would need to be considered. the question is, politically, can you kmup kate to the markets that i think we all would agree looking skeptically at the united states in the future. we did it in the 1990s in the united states.

we did it in the past, but somewhat distant past. is the marks are going to question us. that comes very quickly. we do not get a letter saying in 90 days, the markets will turn against you. they turn very, very quickly. we should get ahead of that. other wise we'll be forced into defeated austerity. if you were to allow sequestration to proceed as is currently in the law. economic growth would drop dramatically. we would go from, you know, 2.2, 2.5% growth this year to just over 1% growth next year. so that kind of precipitous

change to me does not make sense. what does make sense is to have, fred, i like what you described, which is something in the stort term. i personally believe we should look at infrastructure. i know economists have resistance to that because of the time necessary. i tell you, if you told the states of this country there was going to be a priority funding available for projects that have national importance in the transportation infrastructure of the united states and you gave them a certain amount of time to obligate those funds, it would happen. but only simultaneously you put into place a policy that made the adjustments to entitlement and, yes, revenue. that to me, i would like the goal of balancing in ten years.

because that would take us a long way in the direction to getting to a debt to gdp that is sustainable. your recommendation to us? >> first of all, senator, that is lulled into a false sense of security by the level of -- how low interest rates are on our debt. >> right now. >> right now. >> it's driven by base cle three factors. one, the mess in europe. there's no other place for international vvs tor investorse their funds. two, the dollar is the reserve currency so foreigners are forced to buy huge amounts of our treasuries. and finally, the federal reserve is buying so many of them themselves. you have very few private investors in the united states buying treasuries. i think going back, what is lacking in this country from a government policy standpoint is

a simple program that answers five questions. those questions are, what are you trying to do, how are you going to do it, why is it going to work, how much is it going to cost, and where are you going to get the money? no, congress hasn't answered that question. the administration has not answered that question. the markets are waiting for an answer to that question. it's been the role of expectations in how people in the economy financial markets work. if there was an answer to that question, the markets would immediately take that expectation of future stability and give us stability today. and until we answer those questions, any stability will be short lived.

>> thank you. senator johnson is recognized for an equivalent amount of time as i just consumed. >> i will be quick because your line of questioning covered an awful lot of what i wanted to talk about. >> we're obviously talking b about structural reform here. we've talking about the book "this time it's different." the question as i was reading that book that popped into my brain. they by and large deflated their currency and devalued their debt. our debt is structural in terms of entitlements. you know, our liabilities that are tied to inflation. i just kind of want to -- from my standpoint, i'm going, we can't really inflate our way out of this debt. that's the question i'm asking. are we in a bigger pickle than past nations. you're shaking your head.

i'll go to you first. >> i was nodding my head actually. we're certainly in a big pickle, there's no question about that.. there is no question about that. and i like to point that you can't inflate your way out of some of the liabilities. you can try to inflate your way out of some of the debt obligations. but our debt maturity is pretty short, about four years. in the uk it's 14 years. the uk has much more incentive to inflate in the classic reinhart way than we do. and ultimately we need to look at the liabilities and the revenues that we're willing to raise to back those. and clearly there is an imbalance. we have a huge advantage potentially relative to other countries, countries in the reinhart and rogoff book. we have a credit line unsurpassed by anything any country has ever had. and we earned that credit line. however, we are in the process of wasting that credit line.

we're not investing in productive assets. we're not upgrading our education system. we're not boosting growth in other ways you might prefer to boost it. we're just spending that, borrowing to finance consumption in excess of our income. and that will absolutely end badly. the pickle we're in could very well end up being a very large one and maybe bigger than what other countries have had. we have an opportunity to fix it, an opportunity that the europeans don't have right now. the europeans are in a different place from us and a much, much tougher place. and we should take that as a cautionary tale and use that to fix our own budget today. so i think we're all on the same page with regard to your general point, senator. >> you touched on my next point i wanted to ask, was about the reserve currency. i know that some countries are talking about maybe a basket of currencies. how long do we have? i realize you can't really answer that. is there really a concerted effort to move away from the u.s. dollar? >> i wrote a book on that a long time ago, try to keep close to it.

it's critical to remember that re a two-edged sword. it buys us more time as colleagues have said, but that also means we tend not to have the pressure that we need to adjust. so even in sort of fundamental terms is it a good thing in the national interest, it's ambiguous. but once the worm does turn, as it inevitably does as we all think, then it can be huge, huge sword of damocles. there are about $25 trillion of foreign held dollars floating around the world economy. that's the sum of the accumulation over the years that let us run the deficits that we're talking about. but we used to call that a doll implies, correctly, that it could come cascading down. and so if the worm turned and the markets began to look askance at what we're doing, then the great reserve currency role of the dollar provides

traditional huge ammunition to intensify the pressure on us as people around the world sell those dollars that they've accumulated over the past decades. now, whether that happens depends on two things. a, is there an alternative to the dollar. in underlying structural terms, the euro certainly is. it's a bigger economy, it has deep financial markets. it meets ought the criteria. if they do get their house in order, two or three years out, they certainly could be. and comes china, which is going to be the biggest economy, thes largest trade and foreign investment flows. once they decide to move off capital controls and make their currencyother alternative. so we're headed toward at least a three-part global monetary system called a currency system, dollar, and euro, and rmb over different time periods. but if we're thinking even five

years, certainly the euro is in the picture. if whi so the nonalternative that adam rightly pointed to now does become very different. so even in an annual flow sense, people are not going to be compelled to put their money in dollars at the extent the reserve currency role is an asset, as it certainly is in a short run, that too will be fading. and then as i say, if the worm turns, it could become a huge liability. i would never rely very much on that one to deal with the sustainability of our situation over any reasonable period of time. >> senator, i think i spent five years in argentina on their debt restructuring. every argentine schoolchild nose because the ones that don't know this have been killed off by darwinian survival. every argentine schoolchild knows there are only three solutions. you write down the debt, you

raise the surplus to pay the debt, or you inflate the debt away. there are no other solutions. we have learned that after 200 years. the question of the reserve currency, you asked the question should there be a basket as an alternative. or could there be. talking a basket. every in the person in the world can create their own reserve basket. if you think you like a basket of reserves that is 20% yen and 10% -- 40% euros and 30% dollars and throw in some brazilian real, you can create that yourself. central banks do that all the time. the idea of creating a, quote, official reserve currency basket, such as the sdr was supposed to be, that's a very inefficient outcome because that's saying we've decided what the optimal basket is. we've set the weights, the percentage of each currency. well, i may like those weights. fred may think i don't like

those weights. i want a different basket. and simon may say i want a third basket. the markets can create their own market there is no purpose to creating a basket currency today. finally, as pretty pointed out, the reserve currency can change very quickly. what has held us up and what has taken the pressure off the u.s. government to actually make the decisions it should have made years ago is because there has been no viability alternative. the euro was a viable alternative. it now isn't for the moment. but as fred said, if they over the next three years, as i believe they do actually put in place a stable system, then it will be. and you'll see massive flows. and the only thing that willsurs will be the speed with which it will take place. >> beg indulgence for one more question. >> absolutely. >> this is about taxes and effect on growth. during my lifetime, the highest marginal tax rate has been 90%,

70%, 50, 28, 31, 35, 39.6, 35. for the last 50 years, prior to 2008, the average amount of revenue generated or extracted from the economy has been 18.1%. and the variation has been really pretty tight around that mean. it goes up too much you end up with a recession. i'm not sure what the cause. but just looking at the data, very tight around that 18.1%. i'm not sure what causes that. i realize tax policy drives it. and when you have high marginal rates you have all kinds of deductions. but i have a suspicion as well that just like with capital gains taxes, when you raise them higher, people expose less of their income to that capital gains tax. so i am highly concerned if we raise taxes, we're going to harm the economic growth. and i really do sincerely believe the number one solution is economic growth. so if you could sort of speak to the effect of marginal tax rates, the ability of the united

states government really to extract much more than that 50-year average over any kind of long period of time, and really speak to increasing tax rates basically to try to drive more revenue. i know that's kind of a big subject. in 30 seconds or less. >> that's a huge and terrific subject, senator. and again, i take this on in the new book that is coming. i think you and i may disagree on how to read the evidence and the ability at the federal level to raise revenue. i take your point, though. there is absolutely right there has been a stability around federal revenues for a long time prior to the crisis. and we should reflect on that. of course, there isn't stability to our future medical costs. and that's the big collision if you look over a 20 or 30-year time profile. if you are really going to cap federal revenue at 18 or 19%, that has major consequences for what you are able to pay in terms of the health care costs of elderly americans. and i think we should have that conversation. i would go on the side of covering more of those health care costs, personally.

we should also control the costs obviously. but those are tough to control. and demographic change and technological changes mean the costs are going to increase. and the cbo, by the way, relative to the european commission is very honest about what the costs are going to be. the europeans not so much. at least that's on the table. but i would go a little bit more towards allowing revenue to increase. and i think there is ways to do that over the medium term, taking the senator's point about dangers of precipitous austerity. but i think we can do that without damaging growth. i think we can actually do that in a way that is pro-growth and quite reasonable. i don't expect that you and i will agree on that in the end, senator. i think that's fine. now is a good year to have that discussion and to get these issues out in the open, and to show people what is the menu. in our book we lay out a menu of options. and we give you a house recommendation from the menu. but you can also pick whatever you want off the menu as long as you get on to what all of today