and irresponsible and poses big dangers to ourselves and everyone else. singapore's model is something we should aspire to. >> i can't help but ask a question. how many pages was their piece of banking legislation? >> that 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 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. >> bank regulators doesn't have the incentive the bankers have in terms of circumventing. i was fascinated by your assessment of europe. the thought kept going through my mind is past performance doesn't guarantee future results. i hope you're right. i'm assuming dr. lerrick and dr.

johnson probably aren't in agreement with a rosie scenario. >> i think i'm actually more optimistic than dr. bergsten. i believe it will drive europe to a stable financial union. 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 said 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 believe that the europeans

will manage this process. i think the germans have now found the tools do that, which are just to keep interest rates really high on all the politicians that are of the weak 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. >> that's basically 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. >> 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'm going to turn to the senator immediately so i don't want to

go throu y point. i just want to put on the table i'd like for you to tell us what sweden did because my recollection is they did something with getting the toxic assets oft books of their banks and i can't remember what it was. but at the time we were going through our tarp, i was very intrigued by what sweden did. i don't want this moment to slip. senator? >> thank you, mr. chair. i'm going to ask you all to be very brief because have i to leave in five minutes. mr. johnson, you highlighted the unknown nature of derivative exposures. there's been a lot of discussion about this. every expert i've talked to said we have no idea of how the dominos are lined up. it's an incredible thing that 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. in that context there's been a lot of discussion in europe about the banning of naked shorts, that is not being 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 in year, something like that. can you bring us up to date on that? there's a fierce argument going back and forth as to whetherat'. >> it's a good question, senator. i would like to come back to you on the very precise details and latest information. i can do that quickly. my understanding is that some financial institutions in europe are still band from shorting sovereign debt. >> unsovereign debt, yes. >> and particularly the

europeans have hedge funds in their sights. i think it a somewhat misguided approach. a lot of people in financial markets want to be able tone sure against risk and they want to be able to use the swap 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 realtime, i think from a systemic stability point of view, we could become more comfortable with it. it the lack of the ability of mega banks to quickly take pro pprietary positions, for example, betting the house. mf global failed because of bets made by senior management. it doesn't have to be through a naked s cds contracts necessarily. there are other ways to do it. i think that we should move towards transparency if all these markets rather than bannnancthl -- because you just

shift the risks in other ways that are more murky and that we live to regret. >> in that context, under dodd-frank we're setting up a more transparent derivative mark are there parallel efforts in europe to clear up an exchange and clearinghouse? >> not at the level and for the instruments that would really matter. there's a lot of cross border trading. they are dragging their feet on key parts of this. for example, take the euro swap market, interest rate swaps. it's over $300 trillion inotal exposure there. no one can tell you who owe what is towhom, either on basis or on a net basis, which is the bare minute number you should be able to.

that is deeply troubling. if that isn't keeping regulators in this country awake at night, they're not paying attention. >> it does highlight the point to the u.s. agree to the degree possible has to be involved in a discussion that helps establish that discussion and trading agreement as well in europe as in the united states. >> i wanted to add one point. a fundamental problem in the pe they still do it at the national level. they still have not been able to get the european monetary union to encompass european-wide financial regulation. so the problems that we have, as you're describing, are compounded ie failure to add t dimension across now, there's a similar global problem because the derivative tradings in particular and all these exotic financial

instruments really do cry out for internatiobasel tries to do but it's been very inadequate. so one of these days we've got to take the big leap to do a globalized dodd-frank because without it the kind of slipping around, the controls that adam lerrick mentioned takes place across bored eshs and you have another escape hatch from what every american union takes place. >> i have to dash. i want to say it been a great discussion. i wanted to mention mr. lerrick it was a number of years ago i remember an article in which warren buffett was replacing his effort -- the threat out there could have profound consequences

both enormous shocks but it's also an instrument or a change that would have an impact on the cost of our goods to the world. and to the degree the dollar becomes weaker, making them more affordable to the world. that's another interesting conversation, i'd love to have. 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 -- >> i can ask a couple quick questions. >> then we're going to go to a second round. >> thanks for holding the hearing. i think it's a really important issue. it critically important to our country both in terms of the impact on our economy but also

helping us to recognize fiscal challenges we face in the long term as well. i'd like to get your perspective, if i might, on the panel to certainly that's been reported, and that is many of the u.s. banks and money market funds have significantly cut their exposure to eurozone bank debt but there's significant exmeasure 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 knows. i spent time with officials at the fdic, the new york fed, other bodies recently. i'm not convinced they know.

you're right the mutual funds have cut back their exposure and that's part of the reason the european banks have wand to draw through the federal reserve in order to get dollar funding. so that part i think we should worry about a little less. would i focus on the drif treri exposures, to the u.s. swap market in europe. and i would urge you strongly in public or in private to bring the relevant regulators before you and discuss this, as a matter of time priority for the budget. because this is a huge fiscal risk that you're facing. 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 tors have they should be sharing them with you. you should be asking very, very hard questions to them, what would it take to figure them out and perhaps you could ask the

big banks to come in and testify about this. what is their exposure, what do they think of their exposure, how do they model it? we still give them enormous authority to handle management skeptical they know how to handle this at all. >> i suspect you're right, that that can't be quantified without bringing them in. anyone else care to comment on that? >> those numbers are not public certainly, as dr. johnson said, it's unlikely even our regulators know them for sure. i would say two thing, though. one, the u.s. financial system exposure to european sovereign debt is not very great. the exposure -- or the mutual funds. the exposure is through the banks systems, either that their credit line, their swap lines. one thing that the europeans have announced publicly is that

each national government will stand behind its large banks no matter what and, secondly, if a national government is not capable, that a guarantee will move to the euro zone itself. they've actually made that statement a few months ago.e is raised about derivatives is an important one and comes back to a question that senator merkley raised. one issue about cds which everyone is very dish turnturbet and the europeans because they don't understand are trying to band naked cds is first of all it's very good that cds should be in centralized depositories so we know where they are. it's very good people should have to account for them correctly. three important aspects. cds, unlike bonds, which is one of the big problems for eurozone banks, cds are market to market

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 realtime. secondly, cds90% of cds contracts are collateralized by other securities or cash for the counterparty risk. and, third, what's important in cds, the way the cds market works is you have the gross amount and then you have the net amounts. the net amounts are calculated by institution by institution. if an instuns has sold $100 million of cds but has bought back $80 million of cds, the net number is only 20, their exposure. the way the cds market works is in addition to collateral, there is bilateral netting. so if one of the issuers, meaning greece or italy

defaults, what happens is the institutions go to each other, one by one, and they net it against each other. that eliminates to a large extent the danger of cascading through the system. there is not, however, what would be very good multi-lateral netting, which would mean you'd be able to net out the entire system across many institutions and then the net exposure would be your only concern. >> can i interject two things? first of all, i agree the europeans have promised to take over some of these national commitments to the banks, but i think we would agree that the greek banks are about to default. in order, they will not be guaranteed in full, that's the information that i've seen and that -- the you'-- why do you t they would bank -- the second point is on the netting, which

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 so that i have to pay you immediately but i don't get to accelerate my contract on you because you haven't failed. that is why -- you can bring in the people on fdic who are very good on this, they stress gross exposure through derivatives. you should have the system where there is ways agreed to net it out properly that is not in place within europe, it's not in place across borders and it is not according to the fdic colleagues in place fully for the united states and that is a major weakness of the financial system. >> if i could ask one quickly and i'm out of we --

>> go ahead, senator. we've been very -- >> we've seen countries like spain and portugal, italy that have enacted fiscal con sell dags packages to balance their budgets and enjoyed in some of these sovereign bond auctions some pretty significant demands or pricing relative to what people would have expected but maybe suggesting these austerity steps and measures were the pretty approach and their debt-t debt-to-gdp ratios are over 100%. we're at 100% and we've had ample warnings. 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? >> lots of people have tried to analyze that. we've published a lot of work at our institute, including by

carmen rhinehart, who is one of the great experts on this. the conclusion depends on method analysis but the bottom line is if your fashion 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 that chris whose debt to gdp ratios gets beyond 90% -- >> gross >> gross debt beyond 90% leads to growth rates 1 to 1.5 percentage points per year lower. if your baseline is 2.5 to 3 like ours, that means you're cutting it in hef and getting to what we tend to call a growth recession, certainly not one that keeps the unplomt rate from rising. so somewhere in that range, you can't be too precise, so

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 chart beyond that and that's why your basic point is so right. >> i've written a book that's coming out in april that partly addresses this pip would suggest you aim to 50% debt to gdp -- >> gross debt or publicly sneld. >> held by private sector. >> so that would translate into 80% gross. >> and there is a little problem with the way you compare these numbers across countries. we can go into technical details afterward. the u.s. in some countries such as japan up shouyou should look gross number. in the united states we should look at the net number. that's a goal that's entirely achievable and that's the right time frame and that would not cause massive problems to the economy and is consistent with

sustaining growth. but on the spain, italy and portugal point you made, i would suggest their slightly lower slf late because they did significant fiscal adjustment and did very little. senator johnson coined a great phrase for what's happening. monetary innovations or solutions to do with fiscal mismanagement. it's the ecb providing cheap credit to the banks and the banks then buys up the debt with a lot of arm twisting. the government is running or pushing the banks very hard to the quid pro quo. they're kicking the candidate do down the road. if monetary policy is sub serve yants to fiscal mismanagement it will end in high inflation and many other problems that we've experienced in all these countries before. so i don't think spain, italy and portugal are on a more stable path. >> the reason yields are done in

the peripheral countries is because the ecb is given unlimited three-year funding at a highly subsidized interest rates. that's why you see the interest rates on the short term come down much more than the long term. they can buy out to three years and have no mismatch and do fine. i would raise two other points to the question raised, senator, which are the level of debt depends on two other factors. that is, first question what is sustainable. that depends on what the savings rate of the economy is. it makes a -- japan and italy are very different than the united states. they can support much higher debt levels because their private sector saves a much higher level of their income. that doesn't mean it's d.sustai. you have lower growth and very bad. you divert resources from the private sector to the inefficient public sector but it's sustainable. what percentage of the debt by ?

in this country a large percent foreigners. that means every day an increasing share of every american's life is spent working to pay the chinese. they're effectively working for the chinese. that is 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 americans you would transfer money from one group of americans it to another group of americans, but it would stay in the u.s. economy. when it's owed by foreigners you're taking all that economic output and just handing it -- sending it abroad. that's why that makes it even more unsustainable, makes tun sustainable and makes sure that our standard of living will fall unless we correct that. >> i want to add one comment on the italy and spain point.

they implied they were den grading the european stra bank money creation to yield down the p push on bonds. that's a good thing. that's avoiding the apock liptic outcome we talked about before. it's also buying time for those countries to put adjustment programs into place. they can't be just austerity programs. they have to be economic reforms, structural change it to get reasonable economic growth going again. but they can't do it overnight under the best of worlds. so the fact the european central back is asking as a lender of last resort is a good thing to be applauded and it's part of the scenario i spelled out in the opening statement why i think the apocalypse won't happen because they play that role. >> thank you. >> let's go to a second round continue. we appreciate that. incredibly valuable. i hope, you know, other members,

staff are here listening, because a lot of educating going on here today that's important to us. i'd like back to what sweden did. if you could remind us of the steps they've took that have proved so effective. dr. johnson. >> yes, senator. this is route not taken by the obama administration. it was considered in january/february, perhaps into march of 2009. the swedes took over the bank. people used the word nationalized. i would say they resolved them. they did an fdic take-over and liquidated the banks and made them bankruptcy. they took the toxic assets out of the balance sheets of banks and created asset management companies just like we had the resolution trust corporation after the s and ls in the 1980,

the job recoversome value and sell the assets and get rid of them. they launched three cleaned-up banks, new balance sheets, new management, new owners. of course, the old owners were wiped out as part of the deal. the government never wanted to run the credit system. so the word "nationalization" was misunderstood. it was an fdic resolution process. have banks not incumbered by bad loans or litigation around those loans. that's stuffed into the asset management company, which does its best to recover value for you. but the main point in terms of what fred was emphasizing earlier is they came out of this with a totally different approach to the financial system. much tougher regulator approach. not 1500 pages i would probably write on that senator johnson, but a much more skeptical view

of the bankers. they got rid of the previous powerful interests that controlled those banks that captured the hearts and minds of regulators and shifted the power. swedish banking became super boring, which is his advice here, extremely good advice. if you're a young, aggressive swedish person, you want to take risks you go to london or new york and don't do it in stockholm. >> let me go to another set of questions. if, god forbid, we would have another financial crisis, would our federal reserve have the ability along with the u.s. treasury to take over aig the way they did in our crisis? >> well, my understanding of the precise legal situation and

where the fdic and other regulators are in terms of developing the relevant authorities is that you cannot bail out individual companies in the way that aig was bailed out. you cannot put taxpayer money at risk in the same way that was done for aig. however, there is broad authority to deal with any systemtically important financial institution including i presume institutions you didn't think were important until 4:00 on a friday afternoon. you realize they're about to fail, and you need to do something by monday. there are greater powers now to take over and liquidate such institutions, not tlinl, not run a conservatorship. you can liquidate an institution in an orderly manner and buffer the rest of the financial system against the consequences of that liquidation. now, whether those mechanisms are sufficiently detailed and credible, i have my doubts, and on it this system resolution advisory committee i might stand

out as a skeptic of what the fdic has put on the table so far. they're moving in the right direction. the ability to incredibly threaten to bankrupt such a company without necessarily using the bankruptcy code, because that is part of what can lead to the cataclysmic lehman brothers, that's a sensible goal. if the markets believed that bank of america, citigroup, goldman sachs could fail like mf global failed, then they could borrow so cheaply and at that take on the big risks and build the mass itch, dangerous exposures across borders. we're not there yet but moving in that direction. we need to expedite and have a capital sound. we shouldn't be bound by the lowest deno, ma'am senator approach of basal. that is a blind alley. >> just to be clear if we had -- i will never forget as long as i live being called to a meeting in the leader's office where the leaders of the house and senate,

republican and democrat, chairman of the federal reserve, secretary of the treasury. they informed us they were taking over aig the next morning. they told us they believed if they did not that there would be a global financial collapse in days. that's pretty sobering. 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 it to guarantee money market funds as they did in 2008?