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Too Big to Get Wrong: Getting Financial Regulatory Reform Right

Speaker: Robert E. Diamond, President, Barclays, Plc
Presider: Maria Bartiromo, Anchor,CNBC
December 14, 2009, New York
Council on Foreign Relations

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MARIA BARTIROMO: Hi, everybody. Thank you so much for being here today.

We have a special presentation this morning. We're going to be hearing momentarily from Bob Diamond. As president of Barclays PLC, Bob really has been one of the insiders on the front lines of the incredible year that we have all just witnessed and experienced. And he has also been on front lines in terms of the solutions to the issues that we face, in terms of regulatory reform, as well as business practices in general. So in just a moment I'll introduce Bob.

Just a couple of housekeeping items: Please completely turn off your BlackBerries and your wireless devices to avoid any interferences with the sound system. We will hear from Bob for about 10 minutes; and then we'll do a Q & A; and then, of course, we're opening it up to all of the members this morning.

So we thank you for being here, and please welcome Bob Diamond, president of Barclays PLC. (Applause.)

ROBERT DIAMOND: Thank you, Maria. Thank you, Richard, and all members of the Council. I'm a new member of the Council this year, so this is kind of a double pleasure for me to be here and address this gathering.

I had an opportunity last week to give the Annual Whitehead Lecture at the Chatham House in London -- and don't worry, that was a lecture, this is not, so it won't be -- it won't be quite as long as at the Chatham House. But what's interesting is that that lecture is all about the emphasis on the importance of Anglo-American relations. And I think, to some extent, that goes right to the heart of everything we're talking about, because the two big successful financial centers in the world are the U.K. and the U.S.

And I think -- I thought very carefully about the title of my comments this morning, which are, "Too Big to Get Wrong," and I think if there's anything today that's too big to get wrong, it's regulatory reform. And so I think we need to get more debate and we need to get more discussion.

And in my mind, in its most simplest terms, we have to balance two things, and it's incredibly important to balance two things: On the one hand, we need safe and sound financial systems -- that's what regulatory reform is looking at; and we need safe and sound financial systems that everyone can rely and trust -- rely on and trust. And on the other hand, we need jobs and we need economic growth.

And I think it was very, very interesting that the exit polls in both Virginia and New Jersey in the recent gubernatorial elections were not about health care and were not about banks; it was about deficits, it was spending, it was about taxes, it was about jobs, and it was about economic growth.

And so if we need those two things -- safe and sound financial systems, and economic growth and job creation, the bridge between one and the other is having healthy, strong banks, willing and able to take risk, and willing and able to take cross-border risk in support of free trade and the global economy. And I think that's where the controversy comes in, and I think that's where the debate needs to be.

It's funny to talk about risk and the importance of risk in the wake of the complete collapse of the financial system not much longer than a year ago. But if I give just a couple of examples of the importance that banks play in the transfer of risk between those that want to get rid of their risk and those that need access to risk, it's very, very important; and that's ultimately the role of banks, particularly in the economy in the U.S. and the U.K., and particularly in the cross-border economy.

If you think about a pension fund, for example, a pension is struggling with low to zero interest rates in most of the developed economies around the world, and they need access to yield if people are going to get a payout -- if their assets and liabilities can be in line. And the only way to get that access, without adding to risk by taking equity risk, is to take credit spread.

And, of course, we can't have direct issuance from corporates into pension funds because the concentration of that risk would be too great. And that's where banks come in. Banks can take that risk from the various corporate issuers and secondary traders around the world, and transform that risk in a diversified portfolio of credit spread that fits a pension funds, a pension funds who has assets and liabilities that are, frankly, all around the world.

I think we can give many, many other examples, but the best other example I can give is about the U.S. and U.K. governments today. Both the U.S. and the U.K. governments have sizeable deficits as a direct result of the monetary and fiscal stimulus that's been provided, and the U.S. has almost $2 trillion in debt that needs to be financed this year, in addition to the debt that they knew had to be financed coming into this year.

Barclays today is the number one provider of capital and liquidity both to the U.S. government and to the U.K. government. But, interestingly, there are no solely-domestic providers in the U.S. or in the U.K. All the providers of that liquidity and that capital are global banks and global players -- people who have access to clients, because the clients that are buying the U.S. and U.K. debt are not just from the U.S. and from the U.K., they're from the Middle East, they're from Europe, and they're from Asia.

And so we have to look at all that against a very, very difficult backdrop that all of us know we're operating in, and that's that every bank -- even those banks that did not take any direct funding, and in this case Barclays did not take direct funding, but I put ourselves, as a bank, in this group -- every single bank and every single banker has made mistakes when we look back over the last couple years, and certainly I include myself in that; and every single bank and every single banker has benefitted hugely, whether or not they're taking direct money, from the incredible fiscal and monetary stimulus that's been provided by the governments and the regulators around the world.

And so it's against that backdrop that we also have to recognize that banks are important in the solution. But I would also say that banks "get it." You know, a lot of the regulatory reform -- banks aren't sitting here and waiting until regulatory reform is final out of the Senate, so, around capital, around liquidity, around leverage and around compensation, most of the big banks have already moved smartly in the direction of travel.

So, again, I'm going to use Barclays as an example, but most of our competitors, the numbers would be very, very similar. Our core equity ratio has gone from under 5 percent to 9 percent, a doubling of our core equity. Our leverage has come down from high-30s to low-20s. Our liquidity buffers have gone from about $50 billion in cash every day to over $150 billion in cash every day. And all of the banks in the U.K. and across Europe have openly supported the G-20 FSB/FSA principles and guidelines around compensation. So the banks are moving in the right direction.

And if we're going to work on this together, there's kind of four themes I would throw out that are critically important around getting the regulation right:

And the first is around trading. We've got to end this rhetoric around "casino banking." The facts aren't there. The rhetoric is just too loud. Trading is incredibly important to the success of financial institutions. 98 percent of the losses that we've seen in the banking system to date have started with loans, not trading.

The capital markets, at $146 trillion, are essential for the growth of the global economies. The capital markets, in 2009, represent 150 percent of the assets of every bank everywhere in the world.

And lastly, derivatives are important. Derivatives are important to our clients and our customers. You've seen what Mexico has done recently in structuring hedges on their forward oil production, that allowed them to maintain their credit rating, maintain their budget, and keep their schools open.

We've seen one of our biggest energy companies in the U.S. use the trading and derivatives markets -- working very, very closely with us, the biggest producer, biggest investor in wind farms and alternative energy in the world to be able to hedge out the value of the energy they're going to produce, going forward, so they can monetize today to invest in the wind farms.

So the rhetoric around casino banking has to end -- number one.

Number two is capital. We need an agreed and we need a transparent understanding about what capital is required in banks. And going from under 5 percent in core equity to 9 percent is virtually a doubling in the amount of equity that we're holding, and, as I said, many other banks are doing the same.

But we also have the (Bayh / bi ?) legislation looking at tripling the numerator by saying trading books are going to have double or triple the capital. We have many national regulators looking at denominator saying, 'Well, maybe some things that counted as equity before won't count.' And if we want to quadruple the capital that banks use, that's fine, but what we need to do -- what we must do is be transparent and be agreed, because the amount of capital the banks have will have an impact on the cost of credit, and the cost of credit will have an impact on the global economy.

So it's important that we have an agreed framework and a transparent framework that looks at the cumulative impact of all of the things -- (inaudible) -- the capital base of banks.

The third issue is very, very important to me, and that's the importance of having an international level playing field around capital, around accounting, and around compensation, because without it we create opportunities for regulatory arbitrage. And we've seen the impact of special funding rates on Fannie, on Freddie, on Landesbanks in Germany, creating all kinds of turmoil in the credit markets.

We've certainly seen the opportunity that AIG had to keep a derivatives book in a different regulatory environment. So we need a race to the top here in regulation, not a race to the bottom. And if we can get, broadly, a level playing field between the U.K., Europe and the U.S., it's very, very likely that the other economies and the other regions will follow.

And lastly, it's about "too big to fail." Big and systemic are not synonymous. We've seen very systemic bank failures. And when you look at the number of failures that we've had, they're in the hundreds in the U.S. for the small, narrow banks. There have been many small, narrow banks in the U.K. -- Northern Rock being the poster-child, that have failed because of a single product in a single market, and a reliance on capital-market funding.

Big banks can have a better model. I think the integrated universal banking model is the best for clients -- it's the best for global reach, it's the best for the balance of capital, and very often they can have better management and a better business model.

So the importance of our global financial institutions, who can help clients transfer risk across-border, are critically important for the global economy, even more important for the emerging markets economy. And the debate on "too big to fail" has to step back and deal with the fact that what we need is, we need a regulatory framework that can understand exactly what's going on in those institutions and can manage those institutions. We absolutely need a better regulatory framework. What we don't need is to assume that "bad" is systemic and systemic is bad.

With those introductory comments --. (Applause.)

BARTIROMO: Thanks very much, Bob.

And let me pick up right where you left, on "too big to fail," because I guess this is the issue that so many people are talking about as we look at our current system -- still under review, as having "too big to fail" right now. So what is your solution, in terms of ensuring that we have the big banks out there to ensure capital flows, but at the same time not big enough to take down the entire system?

DIAMOND: No bank should be too big to fail; so the starting point, from point of view, and I think from the regulatory point of view, is the same. But I think jumping into making banks smaller or more narrow is not the right solution.

So I think a regulatory framework in a perfect world -- and we're not in a perfect world -- where we had strong, single national regulators that could integrate around the world -- And we've seen a good start here. We've seen a very good start with the G-20, and the Financial Stability Board, and the guidelines that came out on, in remuneration and compensation -- which avoided some of the extremes of the French, for example; and maybe avoided some of the, what was perceived to be laissez-faire attitude of the U.S. -- and came out with a strong set of principles that were adopted by the G-20.

So I think we have the possibility of a framework that can be supportive of very strong global financial institutions -- who are helping their clients transfer risk, and helping the investments in the emerging economies, in the global economies, and have a regulatory framework. A number of tools in the regulator's kit today around stress tests are really, really important. It can be very, very helpful here.

So I think we absolutely need a better regulatory framework. But I think, assuming that big is bad, or big is systemic, and small is not systemic, is wrong.

BARTIROMO: So is it overseeing specific relationships in counterparty situation(s)? I mean, what would you do, for example, with an AIG? I mean, aren't we seeing so much risk, on so many different places, at different banks around the world, and that's the issue?

DIAMOND: No, and I think this gets into a very tricky issue here.

But I think in AIG's case, the derivatives, or the risk associated with derivatives around CDS and insurance, were in an entity that was outside of the regulatory framework. And that goes right to the heart of "we need a level playing field," but also right to the heart of "we need consistency around a single, or like a single national regulator." So it starts on the national side.

I think we saw the same things at Lehman Brothers when we did the due diligence. Lehman Brothers is a incredibly well-functioning investment bank. The businesses that we acquired from Lehman are far exceeding our expectations. The quality of people is fantastic.

What was the issue? Why did they fail? Well, they failed because the investment bank -- that had the lowest leverage of any investment bank on Wall Street, Lehman Brothers -- had $60 billion of their risk in commercial real estate and in illiquid private equity.

And the two things that I found fascinating -- "fascinating" is an interesting choice of words here -- (laughter) -- I found fascinating is, if we took the $10 billion in illiquid private equity from Lehman Brothers -- now, $10 billion, on a balance sheet at Barclays it's $2 trillion -- if we took that $10 billion onto the balance sheet of Barclays Capital it would have used up more, would have used more regulatory capital than the entire Barclays Capital.

So there's the difference in the regulatory environment of -- (inaudible) -- versus being able to hold things outside of the regulatory environment. And I think anyone would look at the size of Lehman and say $50 billion in commercial real estate was a concentration in an asset class that was inappropriate.

So if I'm going to ask the tough question, Should those things have been addressed? Yes.

BARTIROMO: Are you worried about commercial real estate, by the way, for next year?

DIAMOND: You always ask me that question. (Laughter.)

BARTIROMO: I do. And I know you're very exposed --

DIAMOND: (Laughs.)

BARTIROMO: -- and I'm wondering how real a threat this is, because it keeps coming up.

DIAMOND: It's really tough to deal with commercial real estate as one market, because I think the difference between, you know, having exposure in Japan and having it in the U.S. is different. But I also think of the U.S. being in a strip mall in Arizona, versus being in a Manhattan --. So it's very, very different.

And I don't want to go across the piece with a comment, but what I would say is this: The price levels today are down so substantially that we're seeing real serious money come into the market. That doesn't always signal a bottom, but it does signal that we're going to start to see deals. And I know we're working on two or three very large deals of new money coming into the commercial real estate market. I think it's very, very specific to the quality of the location and the quality of the deal.

And I think -- well, one of the things that has been mentioned, in terms of a worry, is in commercial banks where there's a lot of exposure in commercial real estate. If it's in an accrual book, the mark-to-market levels -- ours is all in a mark-to-market book, so if the market stabilizes, we're marked at that level. Where I think one of the worries in the U.S. is a lot of the commercial banks have things in a loan book, where even if it stabilizes now, there's going to be a lot of write-downs over the next six, 12, 18 months, even with no change in the market.

So I think there's the accounting issue with commercial banks in the U.S., but I do think we're seeing money come into the market. And whether this is the bottom, or we just start to see a lot of two-way activity here, and some of the quality things move up and the weak things move down, I think it's a much different environment today.

BARTIROMO: You're saying that the reform is "too big to get wrong." I'm going to get back to the other three important items -- capital, international level playing field, and derivatives in a moment, but do you think that we could see another period the way we saw last year when the financial system truly did feel like it was teetering?

DIAMOND: No. And I think one of the things that's important to understand is that the -- I guess a couple of things. And one of the reasons that I think it's important to understand that banks do "get it" is the dramatic change in the profile of banks' capital structures today versus then.

And I'll just run through the numbers again, but, you know, at Barclays analysts and regulators would tend to look at Tier 1, not core equity. Now it's all about core equity, so the analysis is move to a higher quality of equity. The amount of equity that we had, which was just under 5 percent, is now 9 percent. So it's virtually doubled. Leverage is down. Liquidity buffers are up.

And so I think, unsurprisingly, in a reaction to what has happened, the quality of equity, the quantity of equity, and the quality of the financials of banks is much better. And, clearly, the -- you know, the relationship with the regulators, both national and internationally, is at a much different level.

BARTIROMO: And so do you feel confident that there is enough capital in the system today? Because some people still argue that small or midcap businesses don't have the access that the capital -- and I know it's incredibly important to have an agreed upon, transparent level of capital, which we're still waiting on, I think.

DIAMOND: There is a lot of noise about "people can't get credit." And I think, you know, some of that is a natural -- I suppose, a natural move to higher levels of capital, and liquidity, and lower -- or, sorry, higher levels of liquidity in capital, lower levels of leverage in the banks.

But I think what's also happened is the cost of credit has changed dramatically. And it goes back to what I've talked about, in terms of, you know, doubling of a core equity and preparing for some of the other things that are going to happen in the numerator and the denominator, being very clear and being focused on the impact of all these changes on the cost of credit.

So, has cost of credit increased? Absolutely. Is that what we would expect, coming from an environment where there was too much money, and too much leverage and too little risk? Absolutely.

BARTIROMO: So, as far as capital today -- I recognize what you've done, in terms of core equity at Barclays, but, overall, do you feel confident that there isn't, in fact, enough capital in the system?

DIAMOND: I don't want to pick on individual banks or individual sectors, but, yes, I think that the dramatic change in capital in the financial markets is strong. I think the discussions that are happening in Europe, around the G-20 and around -- (inaudible) -- in terms of new capital directives, are becoming increasingly focused on just this: What's the impact of the cumulative things that have gone on? And what is the impact of other things that we're thinking about?

So I think there's a much better debate, in terms of looking at these, particularly through -- (inaudible) and the G-20.

BARTIROMO: And it seems that it's been increasingly obvious over the years that we need an international, sort of, playing field that, you know, everyone agrees to, whether it's compensation, or capital, or some of the other important things that you mentioned. Why aren't we seeing that? And why do you think we haven't seen one international standard, given that the world is small and the markets are so global?

DIAMOND: Well, Marie, I think, to me, it was very interesting -- and if you look back at the crisis that we've been through in the last couple years, and particularly, you know, the lurching a year ago October when the markets and the economy really fell off a cliff, one of the unintended consequences -- and it was disappointing to me, was how domestic each country became.

So with a common currency, and all the integration across Europe, France was focused on France; Germany was focused on Germany; the U.K. was focused on the U.K.; and, frankly, I'd say here in the States there was a lot more "No jobs overseas;" "Let's worry about the U.S. issues."

And I think -- you know, one of the things I mentioned at the Chatham House lecture is it's a worry to me, but there is no economy in the world, there's no city in the world that has benefitted more from trade over the centuries than London. And for London and the U.K. to be looking as inward as they are today is worrisome.

I think it's a natural reaction to the crisis, and I think it helps (us) understand why it's so difficult for the U.S., the U.K., Germany, Switzerland to say, you know, our banks should be regulated globally. I think the first thing to do is to pull that regulation home.

But I think we don't get integration and coordination, we'll be missing something that's very, very important, because I think as I said earlier, I think the integrated global banks are so important to fostering cross-border flows, cross-border risk transfer, economic growth around the world. And I think, for the first time, we're seeing some real positives there -- in the G-20, in the Financial Stability Board.

BARTIROMO: As a British bank, have you benefitted from the policing of compensation here in the United States?

DIAMOND: Hmmm. (Laughter.) I think in the U.S. the policing of compensation has been primarily around the TARP banks. And I think, in the U.K. and Europe, it's been around banks.

And so we were quick to support the G-20 principles, which were the G-20 FSB/FSA principles, which were around pay-for-performance, not failure, which we believe in; it was around increasing levels of deferral -- I would say that we are more of, kind of a 25 percent of comp was deferred, and the principals are 40 (percent) to 60 percent of comp are deferred; more equity as opposed to cash; stronger ability of a bank, that if people behave poorly, or you have to restate accounts to take the money back, all things that we believe in.

And I think, as a British bank, we've always had a governance by our board over compensation decisions, so a lot of the governance issues are things we support. But to be fair, as a U.K. bank, we've always had that governance. So I think a lot more transparency and a lot more governance around this process is correct. And I think last week, obviously, there was an additional one-off tax, that's going to be impacted on all the financial institutions, that was separate from what we had agreed to with the G-20.

BARTIROMO: First, the governance around derivatives. Some bankers are upset to be seeing the derivatives trading on -- the idea to do it on an exchange and taking away an enormous amount of profitability. On the other hand, can you talk more a bit about making the case to ensure derivatives have a home and are used? You made a lot of positive stances around derivatives, and yet people worry that this is the core reason, in many cases, that we saw the system really shake.

DIAMOND: You know, derivatives are a fantastic example, but -- I'm going to ramble on this one a little bit, you know, derivatives did not bring the system down.

You know, I think when Lehman went into bankruptcy on that Sunday night, I think what shocked people is that derivatives were settled by morning. And, you know, all the dealers ripped up their derivatives; went into the markets and replaced them; and I think every single one of us took a loss.

But you know what was great? By 9:00 the next morning we knew what the loss was, and it was over, and there was no residual risk. It was the cash positions that created the very, very difficult position.

Derivative legislation today is the perfect example of balancing "safe and sound" with jobs and economic growth. You want "safe and sound?" Put everything on an exchange; put everything in a clearing system, and we'll be completely safe and sound. And I'll tell you, the exchanges and the clearing houses will be really, really happy, because they'll have a lot of business.

Who won't be happy? Who won't be happy is the government of Mexico. Who won't be happy is our large -- the 35 corporates that we have invited to come and talk to Congress, because the end-users of sophisticated, structured risk management solutions would not be well-served by that. We don't have a corporate client anywhere in the world that doesn't manufacture in multiple locations, sell in multiple locations, have shareholders in multiple locations, raise debt and equity in multiple locations, and import raw materials in multiple locations.

So every single corporate we deal with has huge issues around managing the risk associated with duration, interest rates, credit, equity, but, most importantly, commodities. In a (word ?) we've seen the oil price go from $40 to $180; crash down to $40; settle somewhere around $70. Can you imagine managing a oil-producing economy, or managing an airline in that environment? We need risk management and, therefore, we need derivatives.

So what got through the House -- with, I think, a lot of fantastic work from some of our end-user clients, is that the majority of derivatives should be on an exchange and go through a clearing house, but we should have an opportunity for our end-user clients supporting all the things the regulators want, in terms of complete transparency and complete recordkeeping.

And so I felt pretty good about the legislation coming out of the House, because it did recognize that balance. And I think it's a very, very good example of it, if we go too far down the "safe and sound" we run the risk of hurting the ultimate clients -- our corporates, and our governments and our pension funds -- in stifling economic growth.

BARTIROMO: So what happens now? What is the timing, in terms of the next steps for this financial reform as it moves through the Senate, in your view?

DIAMOND: You want me to tell you the timing of legislation in the U.S. -- (laughter.)

BARTIROMO: Yeah, exactly. You think we'll have legislation by mid-2010, or is that too -- (inaudible) --

DIAMOND: I think that's highly optimistic. But what I would say is this started with a Treasury proposal. I think, much to my -- I'm really pleased the House improved on it. I'm also very pleased that the House said, "we think this can improve further," as they handed it to the Senate, so there's not as much pride of authorship as I think we've seen around other legislation. And I think that there's more that can be done in the Senate. And I think that's an optimistic view.

BARTIROMO: What are your thoughts on the consumer agency part of this? A lot of people have worried that this is going to create more bureaucracy and unneeded bad consequences; and yet, you know, when you talk about fees and some of the other things, as it relates to the consumer, others believe that this is really necessary. What are your thoughts on the consumer agency in this reform?

DIAMOND: Well, I think if we can get -- and our activity at Barclays in the U.S. is primarily around the institutional markets, so we're not as close to the legislation here as maybe we are in the U.K., and Spain and Italy, where we have a much bigger consumer bank.

But I think this is very important to the public. And I think for consumers to feel that there is a regulatory body that is -- you know, just as we talked about, ensuring that there's a safeness, and a soundness and a fairness to consumer banking is important.

It all comes down to the quality of the legislation. So is the direction of a consumer protection agency right? Yes. Is the quality of the legislation where it needs to be? That's -- I don't have a strong view on that.

BARTIROMO: How do things feel to you right now?

DIAMOND: I think we're in the balance. I think -- that's a very good question.

I think I feel terrific that it wasn't much longer than a year ago where, if we're being honest with ourselves, it looked really, really, difficult in terms of the complete collapse of the financial system, complete collapse in confidence, a complete collapse of the global economy.

And the recovery is real. It's real in the financial system and -- you asked me do I think that can happen again, and I don't. It's absolutely real in the economy, and I think the recovery in the economy is real.

The question in my mind is, is it sustainable? And I think where I worry a lot is that the two countries that I care about a lot -- the U.K. and U.S. -- have the high deficits, high taxes. And if we don't address the issues around deficits and taxes, then my fear is that we're going to continue to lose both political and economic influence to the East.

And I think that's the trend that we've been on, and I don't think that's this year's issue or next year's issue or the year after's issue. But I think that's the big issue that we're facing, as Americans.

And I think that goes right to the heart of my concerns on getting regulatory reform right is that we can help either end of that. If we get regulatory reform right and we get healthy, strong banks and a financial system that's safe and sound and banks that are willing to take risk and foster economic growth and job creation, then we can begin to attack the deficit and taxes, over time.

If we go the other way, we're going to exacerbate the issues around deficits and taxes. And I think the U.S. will continue to lose political and economic influence to the East.

So I think there's an awful lot to play for.

BARTIROMO: We're going to open it up to the members in just a moment, but you mentioned the East, and I think this is the topic of conversation throughout the world right now, the rising of the East, the economic influence and power continuing to shift.

What are the implications, and what do you think America should be doing to hold onto its superpower and -- I don't want to say dominant status, but clearly, we are seeing increasing influence, and it starts with China.

DIAMOND: Yeah, I think China's one -- and we've seen many -- success stories over the years, of Japan and Korea and now China, in terms of economic growth in the East.

I think what surprises a lot of people is not that China is the third-largest exporter in the world. I think what surprises a lot of people is China's the fourth-largest importer in the world and that the value of exports and imports are fairly well balanced.

So I hate to be boring in my answer, but if we focus in the U.S. on deficits, on spending, on taxes, on getting a safe and sound financial system and getting banks healthy and competitive, I think that's the best thing that we can do.

BARTIROMO: Questions from our members?

QUESTIONER: Thanks. I'm Lucy Komisar. I'm a journalist.

Getting back to the question of derivatives, the legislation exempts from trading on exchanges not only the derivatives bought by the companies' end users, but the hedge funds.

Is this not a huge loophole? Because then anybody who might be required to trade on the exchanges can move these trades through the hedge funds, many of which are very non-transparent anyway; many of them are based offshore. Isn't this a way to get around the regulation? Should the hedge funds be included, required to trade on exchanges in derivatives?

DIAMOND: I'm going to ask that more broadly than the question was asked, because I actually am not that close to it. I was not aware that that exemption was in place.

I've been asked a slightly different question, Lucy, by -- let me try and answer it a different way and see if it answers your question, which is do I believe that hedge funds should be regulated.

And I think the answer I've had is that I think that, to the extent that transactions are regulated, whether they're done by banks or insurance companies or hedge funds, I think they should be regulated.

And the danger we have is allowing certain sectors of the financial industry to operate without regulation on transactions that are the same as other institutions that are regulated.

So I think, to the extent that we put the trading of derivatives onto exchanges and exempt end users and corporates, that's -- that is what I believe. But I'm not close enough to the detail of what was actually legislated that --

QUESTIONER: (Off mike) -- included in the exemption --

DIAMOND: Well, I think that -- my principle would be that the regulation should be around transactions, as opposed to specific institutions.

BARTIROMO: Yes, sir?

QUESTIONER: Thank you very much. Mahesh Kotecha, Structured Credit International.

My question is simple. A lot of the issues that we have had a resolution on have been regarding the banking system, the regulation of banks or regulated institutions.

Much of the difficulty came from the non-banking banks, the non-bank banking system. And that system is still a little bit slow recovering.

Could you comment on the outlook for that?

DIAMOND: Non-bank is very, very broad. And I think there is -- as we led up through 2005, 2006 and 2007, money was so easy. The leverage was so easy to get, and risk -- people just weren't worried about risk, because it had been the environment as I just described.

I think a lot of people entered the lending market that were not natural lenders, and probably won't come back, because I don't expect to see the liquidity that way.

So not knowing more about a specific sector that you're talking about, I think of the many things that we look back on and say we should have seen signs of that in 2006 and 2007. I think one of them was the number of non-banks that were entering the lending market.

And one of the things that regulators are dealing with when they're looking at lending in the domestic economies is the amount of lending that was done by non-banks is down tremendously.

And each domestic economy is looking for the domestic banks to pick up as they look at the statistics, and it's putting a lot of pressure on the domestic banks.

It goes a little bit further -- and this goes to the danger, in my mind, of not getting right between domestic regulation and international regulation.

If you look at a bank like Barclay's, our lead regulator is the FSA, which is appropriate and correct. But only about a third of our business is retail and commercial banking in the U.K. About two-thirds is cross-border.

HSBC is not much different; Standard Charter is not much different. J.P. Morgan in the States, I would guess, is -- probably between a third and a half is domestic. So we also have to be balanced about the importance of banks that do cross-border business, as opposed to only domestic business.

But I think, in answer -- final answer to your question, I don't think a lot of the non-bank lending is going to come back into the markets.

QUESTIONER: But will the non-banks -- the insurance companies, the -- will they be under the same kind of standard that the banks will be, as it relates to lending?

DIAMOND: It's not clear to me, in the U.S., that they will. And I think one of the issues that we're facing here, and it's still to play for, is who is the systemic risk regulator. And it's getting a lot of debate on Capitol Hill.

And the U.S. has many different regulators in the financial services industry, and I think the way I would say it is if -- this is an easy way out, without trying to be political. If we're starting today, we wouldn't have this many different, independent regulators in the financial services industry.

I think, in my opinion, we'd have regulators across the financial services industry and across similar types of transactions.

QUESTIONER: So do you -- would you like to see the Fed as the systemic regulator or not?

DIAMOND: I think, if you talk to participants in the market like me, we unabashedly see the Fed as a strong regulator and the one that has the skill set to take that role, if one were going to be picked.

BARTIROMO: Jamie?

QUESTIONER: Hi. I'm Jamie Misseck (ph), of Kissinger Associates.

I was wondering if you could speak to any concerns you may have about sovereign debt in the future, and especially in the developed world and the ramifications if a country of significance, perhaps in Italy, really starts to get into trouble.

DIAMOND: Well, that's a great question. I almost don't know where to start. (Chuckles.)

I think, as you look outside of the OECD, the thing that struck me when I started doing research for a lot of the things I've been saying about regulation -- and I started thinking about the importance of global banks, and naturally I said, but I'd better prove some of this to myself and make sure it's not just because we're a global bank.

And one of the things we looked at is the impact, over the last 10, 20, 30 years, of cross-border flows, foreign direct investment, capital markets, however you want to say it, the private sector versus development aid, and it's stunning.

The impact of just foreign direct investment -- forget all the cross-border flows -- is 10 times that of development aid in the emerging economies.

So we have to start from the position -- and I am -- feel even more strongly that as we're thinking outside of the OECD, without the capital markets, without stronger global banks, we're going to have a real decline in the quality of life and the quality of the economy outside of the OECD.

It's not going to get picked up by government development aid. It's 300 billion (dollars) to 30 billion (dollars) last year. The numbers are absolutely stark.

The second thing I would say to your question, in the OECD, wow. What happened in Greece I think was market-significant.

And I think the impact of that and the warning on that across Europe -- deficits, taxing, spending, all the issues that we're talking about and the importance of the U.S. and the importance of the U.K. -- I think it's terrific that now those are going to be recognized in terms of the spreads in debt and the ability to fund and finance that.

Is it going to focus people more on their fiscal picture? Absolutely.

And then we had another big one. We had the issue in Dubai, where I think the advertisement for that -- if there was one big headline, it's be careful. We're not -- the government, the corporate and the individual are actually separate.

And I think any of us doing business in the Middle East have always struggled, both from a positive and a negative point of view, is how do you differentiate between what's personal wealth, what's country wealth, and what's corporate wealth. And on the other side, what's personal debt, what's corporate debt, and what's --

And I think we got, loud and clear, that in Dubai there is a difference between what's sovereign and what's corporate. We got a bit of confusion -- is that now, is the bonds basically got supported by Abu Dhabi overnight -- which I think is great for the capital markets.

I really hope, though the capital markets don't forget the lesson that they were taught. And I think it's good for the markets. I think it's much healthier for the markets if lending and borrowing are differentiated, based on credit ratings and the ability of a country to fund itself and to have the right credit rating and to manage the deficit and manage taxes.

So I actually think that all these moves we're seeing -- in the short run could be very painful for certain sovereigns -- in the long run are extremely good for the capital markets and reinforce all the things I was saying about the incredible importance of let's not get too-big-to-fail out of kilter, here.

Big, global banks are really, really important for the world, if they're well managed.

QUESTIONER: Well --

DIAMOND: They have to be well managed, absolutely. And we saw some cases where they weren't, and that's when the regulator should come in and absolutely take action.

QUESTIONER: Well, you would think that -- we are seeing more of a focus on what you're saying -- deficit, taxation -- because of what has gone on, whether it's Dubai, Greece, not to mention what we've gone through.

So can you make some recommendations in terms of how these things should look at -- how, for example, should the administration be taking the deficit reduction as more of a priority? Is it pulling back spending? Is that what you're talking about?

DIAMOND: Well -- (chuckles) -- there's many, many, many, many ways to do that.

But I think first and foremost is that there is some consensus that this is important, that this is a priority. And some debate and discussion that if it's not, then these are the consequences.

And what I worry about is that we're looking inward, we're looking at domestic programs, and we're not looking at the potential for America's position, both from a influence point of view, a political point of view, but also an economic point of view in the world, and the potential impact --

It's getting more press now on the dollar and the value of the dollar. But it goes right to the heart of the -- what do people mean when they say the full faith and credit of the United States government?

That's always been kind of taken for granted. And I think it is taken for granted now. And I don't mean to say that this is next year's problem or the year after problem, but we're sowing seeds here.

QUESTIONER: And as far as taxation, you're talking about incentivizing companies to create jobs through taxation policy?

DIAMOND: I think in taxation it's -- my views are similar in the U.S. and in the U.K., which is I think I recognize the difficult economic balance right now. And I'm not pushing back on higher taxes for wealthy people.

As long as there's a recognition that we have to do this during a time that's very difficult, but that it's not our ongoing policy and that we're actually thinking forward to if we can reduce the deficit, if we can get the economy back in balance, what would be the right policy in terms of taxes.

It's just not factually a good example of countries who have had, as a policy, to be the high tax rate for corporates and individuals that have been economically successfully.

BARTIROMO: Henny?

QUESTIONER: Thank you. Henny Sender, The Financial Times.

DIAMOND: Hi, Henny.

QUESTIONER: One of my favorite data points of recent weeks is the fact that the day before they announced the restructuring, Nakheel were trading well above par.

There are some people who worry that zero-interest rates have worked too well in reflating asset prices, whether you look at what's going on in the high-yield market here or the way different -- the bonds of different sovereigns are trading, or you look at Nakheel.

I wonder if you could comment on whether the asset reflation has gone too far, as people search for yield, which is of course what got us into trouble in the first place.

Thank you.

DIAMOND: Yeah, it's -- (inaudible); talk about a balance that's important. And I think it's what you're hearing from every country is, at what point do we start unwinding the fiscal and monetary stimulus?

And my view and, I think, the view of the economists and analyses that I rely on most closely, is that governments are going to err on the side of leaving things in place too long, not reversing the policies too early.

And I think that's probably right, that I think if I was faced with those two issues --

It's just not that long ago -- it's 12 months ago when I think the U.S. economy and the global economic absolutely fell off a cliff. And I don't think we had ever seen anything that sharp, that sudden, or that global.

And I think it's remarkable how, as early as March, we were seeing signs of recovery in China, and by May in Germany and France, with positive industrial production.

So I think we need a balance here, but I think, to your point, I think the risk is greater that they will leave policies in place a little bit too long, rather than pull them away a little bit too early.

And that does create the issue that you're talking about, Henny, and I think we have to be very, very conscious of it. I don't see that issue right now, but risk-free rates at zero are absolutely going to create the need for people to take risk, as I was talking about with pension funds earlier.

Pension funds cannot exist with zero risk-free interest rates. It's not going to be a balance; they're not going to be able to pay the pensioners.

So there are different ways to get that risk, and I think part of the reason we saw the collapse in credit spreads last year were money funds and pension funds moving into credit risk.

So it is a balance. I don't have a great answer.

My answer is I think we will err on the side of inflation, not deflation.

BARTIROMO: Jeffrey?

QUESTIONER: Jeffrey Rosen, Lazard.

Thinking about the regulatory system of the future, two questions that are connected. The first is what do you see the role, or what should be the role of mark-to-market accounting? Because there is a debate from time to time that it should be applied rigorously and all times be a Lloyd Blankfein approach, and there's another debate that it should be applied more flexibly.

And similarly -- and the two questions connect -- what's the right role of capital ratios? Should they be constant through all cycles, or should they be flexible through cycles, with more capital during good cycles and less capital during bad cycles being required?

DIAMOND: Great questions.

I think the -- and it goes right to the heart of level playing field and unintended consequences.

If you take the mark-to-market versus loan accounting debate broadly, then Europe -- this is an extreme -- Europe would go to all-loan accounting; no more mark-to-market. And the U.S., particularly those like Lloyd, that come from an investment banking background without a consumer loan book, would say mark-to-market is the only way to go.

And I think what's critically important is we get a balance around the world. And right now, almost more than capital, the accounting rules between the U.K., Europe, and the U.S., there's a lot of -- there's just not a lot of consensus, and this is one of the key areas.

And I worry very, very much that as we've seen with so many institutions that are able to arbitrage the various systems, that we're running into some very serious unintended consequences. So I'd love to see some balance.

My own view is that there is a balance there. As we're dealing with real consumer banking, then the provision of mortgages, which are left there more to maturity than, kind of, the traditional loan accounting, seems to be to be the most appropriate.

I don't think we want an environment where very bank everywhere in the world, as soon as they lend you a dollar, is marking it to market.

On the other hand, I think that as trading books go, then it's got to be, clearly, mark-to-market. And I think we can find a way to balance those two. So I don't think it's all one or all the other.

But I think it's incredibly important that even if we're a little bit off, we're consistent around the world and we have a common set of accounting standards.

If Barclay's reports its balance sheet on U.S. (gap ?), it's a trillion dollars lower than if we report our balance sheet on international accounting standards. These aren't small numbers.

(Laughter.)

So how the hell is an analyst supposed to figure out which is the better bank, when there's a trillion dollars, just based on -- one nets down derivatives and the other grosses up derivatives? It's just -- it's crazy.

In terms of cyclicality -- I think you're onto a great issue -- is one of the unintended consequences of Basel II is pro-cyclicality. So the worse an asset got, the more capital against it.

And if you're a regulator and you know a bank has a bad asset, you know what's going to happen. If you keep putting more capital into a bad asset, there's less capital going out to do new business.

So I believe that Basel's thinking this through. I think the U.K.'s thinking it through. I think the U.S. is thinking it through.

And there needs to be a way to, as the Spanish have done -- and I think it's one of the reasons the Spanish banks, in an economy with almost 20 percent unemployment, have looked fairly strong, is their regulation requires additional reserves during good times, to serve in bad times. And that's 100 percent unallowed, in our accounting.

So at Barclay's or at J.P. Morgan, if the times are good, we're not allowed to hold extra reserves. We have to report it through P and L.

So I think that a balance of cyclicality, Jeffrey, is a very important part of regulation, going forward, we would hope, where banks are allowed to keep provisions --transparently, but keep provisions during the good times so when the difficult times go, we're not holding more and more capital against the same assets.

BARTIROMO: That makes sense. That was a great question. Thanks, Jeffrey.

Yes, sir?

QUESTIONER: Kim Davis from Charles Bank Capital.

Could you talk about the rating agencies? You didn't get to that. And also, to what extent should a consumer in the U.K. be able to rely on an S&P rating of a U.S. bond?

DIAMOND: Ah, there's no way I'm going to get this question answered without making enemies. (Laughter.) So -- I think it I'll just go for it.

The simplest way I would answer the question on rating agencies is if anyone, anyone throughout Barclays makes a decision around risk using a rating agency, they're fired. (Laughter.)

There may be a lot of reasons for rating agencies and they may be helpful in very many ways as a part of an overall policy. But I think one of the real problems was people were using them to make risk decisions.

And whether prior to the BGI-BlackRock deal -- where now Larry Fink can make this decision; I won't make it -- in BGI we would never make investment decisions, or in BarCap we would never make risk decisions using regulatory agencies. And whenever it did happen, it ended in tears.

Secondly, I would say the model still doesn't work for me. I don't get the conflict of interest. And so should we do away with rating agencies or do we have more work to do in terms of finding the right balance and the right lack of conflicts?

I'm very surprised that we're this far into the crisis and this issue hasn't raised its head. I think it's only because there are so many other bigger crises. (Chuckles.)

But it absolutely needs an answer, and I think that the message I would give to people is just use rating agencies around risk decisions and investment decisions as a piece of information. Don't use it for the decision-making.

BARTIROMO: It's interesting that it's not part of the bill on the table, rating agency oversight.

DIAMOND: Yeah.

QUESTIONER: (Off mike.)

BARTIROMO: It is.

QUESTIONER: (Off mike) -- is not addressed. (Inaudible.)

DIAMOND: Yeah. That's -- it's a business model issue. It doesn't lend itself to legislation. (It's a ?) business model.

QUESTIONER: Well, there are business methods to remove the conflict by charging on every new issue and every secondary market trade. And that exists in the Municipal Securities Rulemaking Board precedent, which has nearly three decades of existence.

It's a statutory board that charges the industry, and then the industry fund pays for the services. The same could be done for ratings.

BARTIROMO: (Inaudible.)

Tom.

QUESTIONER: About a public policy issue, since we're at the Council.

I'm sorry. Tom Glocer of Thompson-Reuters. Thank you, Mr. President. (Scattered laughter.)

Last year it was reported by Reuters, among others, that it was the U.K. regulators who put the kibosh on Lehman Sunday, on you guys buying pre-bankruptcy, rather than post-.

Now, I recognize, and all the lawyers in the room will recognize why, from your shareholder point of view, it might have -- it was better to buy out of bankruptcy.

But from a public policy point of view, do you think the world would've been in a better place -- we would have seen a bit less meltdown, the hedge fund collateral issue in London could have been avoided -- had they let you buy Sunday, rather than the following week?

DIAMOND: I have to back up, because it wasn't the U.K. regulators that turned it down, in fact. And I'm on the record, so this is nothing new, but it puts me with a different scenario of events than come in the too-big-to-fail book. And I will say that I certainly, as did John, our side of the story.

When we proposed the deal Saturday morning, the deal had two components before we were willing to recommend to the FSA. Well, the first component was dealing with the 60 billion (dollars) in commercial real estate in illiquid private equity.

And our proposal was to leave that as Lehman. We would put what we were willing to pay, and you'd put the preferred stock in -- it sewed up as a self-liquidating trust. And I knew from the beginning that Secretary Paulson was clear of no government monies.

So my suggestion was that we try and -- all of us in the industry try and fund this self-liquidating trust. And to his credit, Secretary Paulson got it done.

The second issue was, as a U.K. bank, we didn't have the authority to give a clearing guarantee or a funding guarantee Monday morning, and to propose to the FSA that we were going to do this deal at x amount, which we had agreed with Secretary Paulson and President Geithner the amount we were willing to pay. And that wasn't an issue.

But we needed a guarantee for funding and clearing, because we couldn't do it without a shareholder vote. And we had agreed with the FSA that we wouldn't recommend a deal if we didn't have it, and that could neither come from the FSA, by charter, nor would we expect it to be a U.K. obligation. We expected to have to find a third party or have it provided by the Fed.

And while there were calls back and forth, we always felt from the beginning that in order for a U.K.-based bank to do a deal here, it was going to require a clearing and funding guarantee here. And I think that's where the debate was.

I've shied away from hindsight, Tom. And I've been asked by a lot of people, you know, you were pretty clever to wait till Monday. I had no idea. (Laughter.) I wish I was that clever.

I'm very happy to say I have no experience with bankruptcy, either personal or corporate. (Laughter.) I had no idea --

I honestly didn't think, to be perfectly frank, when we walked away around noon that day, I still thought there'd be a managed exit. I didn't think it would go into Chapter 11, and it was only when it -- that evening when we began working on an opportunity for that.

So was it best for the system? If everything else stayed fine and Lehman had a buyer, would it have been better? Of course. But you just don't know; if Lehman had been saved, would one of the other things have fallen?

And I think that's the question that I find very difficult. I look at what Secretary Paulson and President Geithner were dealing with and the number of balls those two weeks that were in the air, and I think it would be so presumptuous for any of us to second-guess.

I know they gave it everything they had. I think they were 24x7. I saw them in action. They were bold, they were tough, and the financial system's been saved.

And I think to go back with 20-20 and pretend we could figure out how the other dominoes would fall is just too tough.

BARTIROMO: How much of a part of the conversation was AIG during the Lehman conversation? Since AIG happened just a couple of days later, was that a big topic of conversation in the rooms?

DIAMOND: It was never a conversation formally. It was in all the side conversations going on. But it was never a formal -- AIG never came up in any of our discussions with the Treasury and the Fed.

But the fear that there might be something with that out there was in a lot of the side conversations.

BARTIROMO: Bob, would you like to add anything else?

DIAMOND: Maria, I can't believe you came and moderated this for me. I'm honored. Thank you very much. (Laughter.)

BARTIROMO: Thank you very much.

Thank you, Bob Diamond. Thanks, everybody.

DIAMOND: Thank you. (Applause.)

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