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 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. 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, before we ever get there, my hope is that we take steps necessary to prevent ever getting in that spot again which is really in large 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