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Media Conference Call: The G20 Summit

Speakers: Steven Dunaway, Adjunct Senior Fellow for International Economics, Council on Foreign Relations, and Matthew J. Slaughter, Adjunct Senior Fellow for Business and Globalization, Council on Foreign Relations
Presider: Sebastian Mallaby, Director of the Maurice R. Greenberg Center for Geoeconomic Studies and Paul A. Volcker Senior Fellow for International Economics; Deputy Director of Studies, Council on Foreign Relations
March 24, 2009
Council on Foreign Relations

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SEBASTIAN MALLABY:  Thanks very much.  This is Sebastian Mallaby.  I direct the Center for Geoeconomic Studies at the Council on Foreign Relations.  And thanks for joining this call on the G-20 next week.

With me on the line, we've got CFRs adjunct senior fellows, Steven Dunaway, who joined us recently after spending 25 years as a senior economist at the IMF, most recently as the top person on China, although before that he was also in charge of missions to do Article IV consultations on the U.S. economy.  And Steve Dunaway is also the author of our newest council special report, which is about the connection between the balance of payments imbalances in the world, and the financial crisis, and what might be done to reduce those imbalances, which is one issue I think for the G-20 which has been something that should be on the agenda, didn't seem to be so much on the radar screen but has become I think newly topical with the comments today -- or the article published today by Central Bank governor Zhou in China.  So we'll get to that in a minute.

I've also got with me Matthew Slaughter, who's a professor at Dartmouth at Tuck Business School, as well as being an adjunct senior fellow with us.  And Matt is one of the prime movers in a group called the Squam Lake Group, which is a group of financial academic economists that have come together to brainstorm about reform of the regulations of finance.  And so that is another issue which is sort of on the G-20 agenda and which Matt Slaughter can address.  You can read the first Squam Lake paper on the systemic risk regulator, which I think is what Tim Geithner was asking for when he went to the House just today, and which Barney Frank is keen to give him, sort of the economic logic behind the systemic risk regulator is described very well in the first Squam Lake paper, which you can find on our website, cfr.org/cgs for Center for Geoeconomic studies.  And that's also where you can find Steve Dunaway's council special report on global imbalances.

So to get to the G-20, it seems like the immediate issues are stimulus, fiscal stimulus; secondly, sort of the immediate efforts to fix the banking system so it can carry on lending; and thirdly, the debate over IMF enlargement.  We're happy to go into those issues, if you'd like, in the Q&A, which we'll get to without too much Fidel Castro-style filibustering.  But in the beginning of this, I want to focus on the two sort of areas of expertise of the speakers I have with me, starting with Steve Dunaway.

Steve, you know, you've written this report on how global imbalances lay behind the financial crisis, and now you have the Chinese themselves who have traditionally thought to be the ones who didn't want to bring this issue up, and in a bleak way, kind of making reference to the unhappiness with a system in which the dollar is at the core of the payment system internationally.  And you highlight that in your report as well as the contributing factors behind the imbalances.  Could you just elaborate on that and tell us what you think of the Chinese idea?

STEVEN DUNAWAY:  Certainly, Sebastian.  You know, in looking at the imbalances, you know, there's a lot of analysis that has been done.  And I guess one thing I tried to highlight was a question of how did the imbalances grow and persist as long as they did.  And there are three features in the international financial system, which contributed to that, and the first one being the role of the reserve currency, and particularly the dollar as the key reserve currency in the system, and how that then favors the United States in terms of making it a bit easier and a bit cheaper to finance its current account deficits.

A second feature is an asymmetry in adjustment that countries that face upward pressure on their exchange rates don't face the same kind of pressure to adjust their balance of payments positions.  And this is something the Chinese have certainly taken advantage of in terms of the way they have managed their exchange rate, and it explains the very large buildup in reserves.

Now, the third feature relates more to floating exchange rates and how at times they can provide a kind of sheltering effect that will delay structural reforms.  But, you know, in this question with the Chinese new proposal, to some extent, the Chinese authorities have made these comments before, and expressed this concern about the dollar's role as a reserve currency.  At the same time, they have strongly resisted the idea that their actions with respect to managing the Renminbi have been a major contributor to global imbalances.  So from that point of view, it's kind of ironic that they see one side of the question but not the other.

MALLABY:  You mean, they see this side that says because the dollar is the reserve currency, it enables the U.S. to run a persistent balance-of-payments deficit, so that's what they're acknowledging.  What they're not acknowledging is their own role in contributing to the imbalances.

DUNAWAY:  Exactly.  And some of this concern I guess is over the role of the dollar, some of it is kind of a reflection of the comments roughly about a week ago by Premier Wen about their concern about the value of their U.S. dollar assets, particularly with the large, large potential issue of new U.S. government debt.  But then, you know, there's a simple solution to the problem in terms of they can stop buying U.S. government assets.  You know, someone else will step in and take up the slack.  But if they stop buying U.S. dollar assets they then are faced with a situation where they will not be able to tightly manage the exchange rate between the Renminbi and the dollar, and that clearly has been their goal particularly since mid-August, when that exchange rate has been effectively repaid.  There's been very little movement in it.

So on one hand, they want-- in effect guarantee on the value of their U.S. dollar holdings, but on the other hand, they don't want to do potentially--- in particular increasing the flexibility in the exchange rate, which would eliminate part of the problem in terms of they wouldn't be accumulating as much -- much in terms of foreign exchange reserves.  But it's also an important step for them as well in terms of helping to reorient the Chinese economy away from its current very heavy dependence on investment in exports to drive growth.

MALLABY:  So I guess one question about this comment today, this article that they've published on the Central Bank website, is whether to view it as an encouraging sign that the issue of sort of imbalances and the -- you know, that the Chinese are at last recognizing that the status quo is unsustainable, and therefore they're coming up with somewhat out-of-the-box proposals, like a new reserve currency managed by the IMF.  So whether or not such a reserve currency could possibly function, the fact that the Chinese even raise the issue is perhaps indicative of -- that they see that the problem that the status quo can't work indefinitely.

DUNAWAY:  Well, that would be very encouraging if that's the case, that they see this as a first step in terms of trying to improve some of these potential faults in the international financial system to help in this process of addressing the global imbalances.  Now, we'll have to wait and see.  I guess a key part of it will be what comes out in terms of the statement that comes out of the summit.  In the November summit it was quite surprising that there was no mention of the global imbalances, a very oblique suggestion about global imbalances playing -- this playing a role in the situation.  And by all accounts, the reason was resistance by the Chinese, that they did not want an explicit reference to global imbalances in the statement, again, because they were maintaining this position, and they continued, at least up to now, maintaining the position that this is a problem that was created by the advanced countries and not a problem created by the emerging markets, in particular, by policies in China.

MALLABY:  They may have been resisting acknowledgment of a problem that in his recent speech at the Council on Foreign Relations, Ben Bernanke said, you know, was kind of at the core of the whole crisis, which is why I think your report provides the analysis and explains why the argument matters at a time when most governments in deference to China are not willing to make that argument.

I want to switch a bit now to talk to Matt Slaughter a bit about the financial regulation questions, which, again, are very much to befall with the discussion of the systemic risk regulator.  Matt, your first paper sort of speaks to that a bit.  Can you just outline the argument as to why there is a market failure, why government needs to think about the financial system beyond the sort of traditional regulating institution one at a time that we've had -- (inaudible).

MATTHEW J. SLAUGHTER:  Sure.  I'd be happy to, Sebastian.  I think one of the insights of our Squam Lake Working Group on this first issue of kind of the systemic regulator is the basic issue of information.  I think in the United States, one of the challenges right now is a lot of the regulatory agencies are, in law and in practice set up to monitor individual financial institutions.  So there's different -- as lots of us know, different institutions that focus on different parts of the financial system: commercial banks, bank holding companies -- (inaudible) -- and so forth.

But one of the challenges is there's a limited focus on trying to put together the individual pieces of information about individual financial institutions to try to look at the financial system as a whole.  And this isn't rocket science, but it's on a basic level one of the challenges that our country and many others face, is we don't have that system-wide focus where the goal is to try to protect the integrity of the financial system and its links to the broader economy, not necessarily protecting individual banks or other institutions but with an eye to the whole financial system.

So in this working -- in this first working paper, we've argued that government regulators need new authority and a new kind of information infrastructure to collect and analyze information from all relevant financial institutions.  There are a couple of key features of that that I'll highlight.  One is we think all large financial institutions should have to report information -- two kinds of basic types of information; one is their AFA (ph) position.  A second is their counterparty risk and knowing kind of who different financial institutions are linked to.  That needs to be done on a regular basis, so we came to the idea of doing it quarterly.

Second, regulators need to have a standardized way to kind of -- to measure valuations and risk exposures, so there's got to be more continuity across different regulators about how different assets are going to be valued.  There needs to be -- third, there needs to be regulatory authority so that these different agencies can -- (inaudible) -- exchange information and speak to each other about these things.

And then another piece I'll highlight is we think that for different reasons, given that there is a limited regulatory capacity, we think it's important that after some time lag, and depending on the kind of information gathered, perhaps with some aggregation, the information that's collected by regulators should be released to the private sector.  I think that's going to have the advantage of allowing private market participants to supplement the insights that regulatory agencies might provide.  But just giving a hair of complexity of our capital markets today, we see high value in complimenting government analysis with that of private actors.

MALLABY:  Matt, it seems to me that, you know, with respect to the G-20, a big question is which kinds of financial regulation reform do require the G-20 to coordinate an international response, and which kinds, on the other hand, can frankly be done by one country by itself, and you don't particularly need the cumbersome efforts to do international diplomacy.  So it would strike me, for example, that everybody wants to move over the counter -- swaps and so forth -- onto exchanges because then there's less counterparty risk, less of a sort of chain reaction if Lehman Brothers goes down, if there's an exchange in the clearing house standing between the next Lehman Brothers that fails and all of the other banks that were doing business with it.

So this idea of an exchange-traded options or swaps, particularly, moving them out of the over-the-counter realm is I think widely supported.  But it seems that one could envisage a derivatives exchange in Paris or London or Tokyo or Chicago setting up the clearing house that one needs with minimal reference to anybody in any other country, and international players could come and trade those instruments on that exchange.  So it would have international ramifications for global finance without needing to be globally coordinated when you create the exchange.  So I just say that as an example of something which maybe the G-20 doesn't need to get into because it can be done without international coordination.

What would you say if I turned the question around?  I mean, which of the financial regulation issues that do need to be reformed and really cannot be sensibly addressed without international cooperation?

SLAUGHTER:  Boy, that's a great question, Sebastian.  I think one of them is the theory of information revelation, and whether -- (inaudible) -- regulation or through the market processes and market changing -- the mix between tailored financial products and more standardized ones that can be migrated to clearing houses and exchanges.  I think it would need to be worked out.  We imagine -- say, let's start with the information mechanism that we've proposed.  You could imagine starting it within individual countries.  I think that's how it would have to start given the legal and regulatory guidance that would need to be provided within each country.

That said, one of the challenges then I think is going to be, given how many of these assets are traded across borders, given the globalization of finance that Steve's new CSR speaks to, almost inherently we can imagine in the information collection there's going to be communication across borders about these things.

The other thing I would say is I think there's a sense now -- a little bit of a presumption I'd call it of that it's clear that a lot of financial assets that get traded should be migrated to clearing houses and exchanges.  Two things of caution there: one is some financial assets are very differentiated, and it's hard to see just kind of the technology of how you would standardize them enough to move them to exchanges.

And another, it's important to I think continue to recognize even in the current financial crisis that, like, in all other industries, there's a lot of value in finance and product innovation and heterogeneity of products, and that in and of itself makes it -- it's something that pushes against moving things onto standardize contracts and -- (inaudible) -- exchanges.  Clearing houses might be sort of an intermediate step between those two things.  But if there is -- if the market sort of delivers more standardized products -- and I think your point you made in this question is well-taken, which is the market itself can lead to some of that information revelation to complement what regulators might do.

MALLABY:  I mean, just to press this point about the systemic risk regulator, since it is something which I think came up in the Turner report in the U.K. last week where -- which is the sort of -- their equivalent -- I mean, they have their kind of big blueprint of how financial reform should proceed.  It includes the systemic risk regulator; equally it is front and center of the agenda here in the U.S.

In fact, if the point of a systemic risk regulator is to figure out where the system is vulnerable -- and the system is generally vulnerable because a lot of leveraged traders have piled into one particular bet, and if they try to revert that bet and run for the exit all at once, they wouldn't all be able to get out before the thing crashed.  That's sort of the standard description of the kind of systemic vulnerability that you would discover through this process.

But if half of the traders in a particular bet like, let's say, you know, your long Brazilian equities, if half of the players are actually not American -- they're based in Asia or they're a sovereign wealth fund, or it's a Thai trading company that happens to have a treasury department with a lot of ambition, you know, if you're trying to identify crowded trades, but half of the crowd is invisible because it's not in the U.S., do you achieve anything at all?  Are Barney Frank and Tim Geithner going in the wrong direction?

SLAUGHTER:  Oh, your example is a good one.  I think it speaks to the limit of a systemic regulator and the role in aggregating and -- (inaudible) -- information.  One of the challenges, to just build on your example, is if then all parties -- (inaudible) -- scattered around the globe decide that they want to sell a particular asset, it's difficult to know what correlations might arise in the portfolios of key investors where they might then be compelled to sell other assets, whether that's going to be some financial corporation's debt, is it going to be a particular stock.

And so I think people should approach the idea of a systemic regulator with an appropriate bit of caution.  It's not as if -- I think it's definitely the sense of our group it's not the case that a systemic regulator is -- even if they have better information will somehow be magically enabled to identify potential crowded trade, as you described, then have any authority to compel parties either within that jurisdiction or in other jurisdictions to change their portfolio holdings.

So I think on our mind kind of what motivated our argument for a better information collection mechanism was the recent experience in the crisis, especially in the United States, where -- (inaudible) -- example of AIG, there were a lot of different agencies that had regulatory oversight of particular parts of AIG, but it wasn't until -- in -- (inaudible) -- it wasn't until the company itself approached certain regulators, the Federal Reserve system and others, explaining the magnitude of the collateral calls that they were facing, that the broad regulatory system realized it was a problem that needed to be addressed.

MALLABY:  Right.  Certainly in our firm, in researching a book on hedge funds, I've just been rereading all of the material on long-term capital management, and it's stunning the parallel with AIG, and that AIG was writing credit default swaps, sort of insuring against bond default for masses and masses of other players out there in the system so that there was one insurance rater for, you know, hundreds of counterparties.  And if anyone had realized that, they should have said, gee, one insurer surely can't pay out if everybody claims at the same time.

In the same way, with the long-term capital management, which went down in 1998, it had written insurance against equity market and volatility for dozens of other players in the system that were trying to insure themselves against a sudden market fall because of the Asian financial crisis.  And, again, if somebody had asked the question about the system, perhaps somebody -- the regulators could have intervened in time before it all blew up.

I want to give people on the line a chance to ask questions so we can direct the comments in whatever direction people find useful.  So let's cut of our discussion there.  And operator, perhaps you can invite people on the line to ask questions.

OPERATOR:  Okay, most certainly.  At this time we will open the floor for questions.  If you would like to ask a question, please press the star key followed by the one key on your touchtone phone now.  Questions will be taken in the order they are received.

And our first question comes from Les Whittington at Toronto Star newspaper.

QUESTIONER:  Hello, yes.  A very interesting discussion and thanks for having us.  I wanted to ask perhaps Mr. Slaughter or whoever would be best to discuss it, what the expectations are for progress at the G-20 on the whole question of reforming financial systems and providing better or more coordinated regulation of financial markets.  And how long would it take the U.S., in particular, assuming it does move forward with these things and is able to close the circle a bit on some of these, how long do you think it will take?

MALLABY:  The question -- in light of the fact that the negotiations on -- capital adequacy standards under the Basel Committee, took something like seven or so years to do, I think it's a good question.  But I'm sorry, Matt, go ahead.

SLAUGHTER:  No, Sebastian, you read my mind; I was going to start with that quick comment -- (laughter) -- basically to say, you know, deep capital markets are going to take a long time.  So, again, hopefully expectations are properly set, which is I would hope the G-20 meeting next week will be regarded as an important next step in these conversations.  To take the U.S. example, and in many other countries, there's going to be -- need to be in some cases new legislation, so it's going to have to work for the legislative process in each country.  There's going to have to be regulatory guidance provided, new regs written.  So if I think -- just to stick as one example of the information revelation mechanism, one big open question is sort of which agency or agencies will be tasked with this new oversight from a systemic perspective rather than from an individual institution perspective.  So it's going to take a while I think, is the appropriate answer.

MALLABY:  And just actually, to make the connection between the two parts of our discussion here, it's in a way precisely because fixing financial regulation is unbelievably complicated -- probably does involve some difficult cross-border diplomacy, and may in the end be only semi effective, that I think Chairman Bernanke, you know, comes back to the view that, sure, we should regulate better, but when you've got massive flows of cheap capital coming from surplus countries like China into the U.S. economy and essentially making capital cheap, the capital will express itself in some form of bubble because your financial regulation, even if we rethink it now, is going to be hard-put to clamp down in all of the possible things that can go wrong in a financial system.

So there is -- when you hear Matt being -- you know, saying, let's set expectations in a sensible fashion, it does connect to why we also think that you've got to look at the sources of these massive capital flows, namely the global imbalances that Steve was talking about earlier.

Sorry, okay.  Next question.

OPERATOR:  Okay, our next question comes from Simon Kennedy at Bloomberg.

QUESTIONER:  Following on from that question also, something that Sebastian said earlier, how important is it that the G-20 next week comes up with I guess the buzz word being a coordinated approach to regulation?  What are the risks of them not doing so and how likely that they actually will kind of come around a group of principles, and maybe not a global regulator, for example, but something that they can all work together going forward on?

MALLABY:  Matt, do you want to have a crack or that, or Steve, feel free to weigh in if you would like to.

DUNAWAY:  Okay, let Matt go.

SLAUGHTER:  Sure.  A great question.  I guess -- not to parse it too finely but I guess it depends on what you mean by coordinated.  So take the U.K. and the U.S., for example.  Starting from coming into the crisis with a very different framework for how the regulatory structure was established, with the FSA in the U.K., there was sort of a much more centralized, principles-based regulatory mechanism.  And in the U.S. we come into it with a very fragmented kind of rules-based regulatory mechanism.

And I will point out, many people, at least in the United States, in the months and few years before the crisis, had been looking across the ocean saying, wow, we in the U.S. really need to move to the U.K. model; it seems more efficient.  Concerns had been voiced about the declining competitiveness of American capital markets and that our fragmented regulatory structure was part of the reason for that.

And I'm presenting on the point Sebastian made, connecting it with global imbalances.  I think one of the messages to keep in mind is that the deep forces that play of global imbalances and the savings investment imbalances, those things are going to take a long time to hopefully be addressed as -- again, Steve's nice CSR points out with the mix of consumption versus investment in China and conversely with the U.S., that's going to take a long time to work.

So when I think of coordinated on your question, Simon, I think of it is as an exchange of best practices.  What are you guys thinking?  What do you think is going to work?  And then Sebastian's point about some of this is going to have to be international.  Where do we internationally need to be talking to each other about information we're collecting about capital adequacy, about different particular issues.

MALLABY:  I think it is worth also kind of remembering that it's not as though at the moment the level of international coordination is zero, that we can flick a switch and move to a new coordinated world and then suddenly we'll be better off.  I mean the truth is that you already have the International Monetary Fund doing some work in the area of reporting on the fairness of countries' international systems; I mean that could probably be upgraded and made more consistent -- perhaps Steve knows more details than I do on that -- but my sense is that the coverage has been not of all countries.

Then there's the Financial Stability Forum, which has tried to think about systemic risks across the global system.  You've got the Basel Committee, which has a long-standing interest in capital adequacy requirements for deposit-taking banks.

You know, there's been talk in the G-20 context in the last few months of a new, quote, "college of supervisors," the idea being that, you know, Deutsche Bank shouldn't be regulated just by a German supervisor, you know, because Deutsche Bank does a quarter of its business in London.  So to understand that Deutsche Bank is about to go up in smoke you need to understand what it's doing in London as well as in Germany.  Well, that's true and obvious and that's why in fact the German regulators for a long time have already been calling up their friends in London and, you know, having conference calls and referring to one another its findings.

So I think politicians, frankly, have, you know, in a way to divert attention from their own failures to respond to the crisis domestically, have pointed to a lack of international coordination as the culprit to sort of distract attention from what more they possibly could do at home.  It's a familiar game that national leaders play with multilateral systems.  But we shouldn't be fooled into thinking that there's some kind of magic silver bullet in international coordination.

DUNAWAY:  Let me add just one thing along those lines and reinforce what Matt was saying as well, is that there's parallel tracks that things can move on.  You don't need to just focus on international cooperation.  As Matt pointed out, there's a lot of potential -- well, there's huge flaws in the current system in the U.S. and -- in the regulation of insurance is one key area which Matt had brought out.  So there's a lot that U.S. on its own can do to improve its regulatory and supervisory system without waiting for some type of international agreement.

MALLABY:  Should we go to another question?

OPERATOR:  Okay, as a reminder, if you would like to ask a question, please press *1 on your telephone keypad.

Our next question comes from Veronica Smith at AFP.

QUESTIONER:  Hello.  Thank you very much.

I'd like to ask what the prospects are of a voiced support and a factual support of the IMF in terms of its surveillance methods and in terms of some of the resources it would need for this crisis.

MALLABY:  That sounds like that's meant for you, Steven.

DUNAWAY:  Yeah.

MALLABY:  Maybe you could also comment on your prescriptions about how the management of the IMF could be strengthened.

DUNAWAY:  Yeah, I think you've hit on an important point, and one of the things I tried to emphasize on in the CSR is that I think one of the primary purposes of the IMF is more on the surveillance side, to ensure the smooth functioning of the international financial system.  And it's -- one part of the Fund's job, which it's had problems in handling in recent years -- and I guess I see as the key source for the problems is in terms of more, kind of political influences that have an impact on IMF assessments of countries' policies.  And I guess the key source of those influences comes from the role that the IMF's executive board plays in the surveillance process.  Now the way the system is set up the IMF's view on a country's policies is the view that is expressed by the IMF board when it completes a review of a country report as part of their annual Article IV consultation.

And the problem is is that what comes out of those reviews by the executive board, instead of reflecting just, you know, the technical judgments of the IMF's expert staff, is also -- also reflects some of the political influences that various countries may reflect on their positioning with respect to how much they want to criticize their fellow countries.

But that's a very important part of surveillance in the Fund, is being able to marshal this peer pressure to bring about change.  Because on the surveillance side, the Fund has no means of trying to compel countries to change policies; all they can do is to try to persuade them or, using whatever means possible, to build, you know, peer pressure or public pressure to get countries to make policy changes which are in their own best interest but also in the best interest of other countries in the world.

Fund management also plays a role in this as well.  I think a very important change there that would help -- and again, it's more in terms of, on the surveillance side, pushing the technical aspects of the assessments of country's policies.  And there I think what's important is to change the process for selection of the IMF's top management -- the managing director and the deputy managing directors.

Now they're chosen primarily, you know, for political considerations, geographic considerations, instead of just strictly on the basis of merit.  And I think if you change the system and put them mainly on a merit basis and an evaluation of how -- whether a particular candidate for one of those top jobs, how they would be able to carry out the responsibilities, you know, I think the system would work much better.

Now, I'm not the first one to mention this and to make these particular suggestions on reform.  In fact the IMF's own Internal Evaluation Office has made a similar suggestion.

But I guess one thing in bringing out in the CSR as well is one thing I'm concerned about in the G-20 process, there's a lot of discussion of, you know, providing additional resources to the IMF, you know, to help out in the event of a crisis, but to me what's most important is that the IMF is there and, through its surveillance capacity, able to try to head crises off before they develop.

MALLABY:  Okay, great.

Another question?

OPERATOR:  As a reminder, if you'd like to ask a question, please press *1.

Our next question is from Dong Liu (sp) from China Press.

QUESTIONER:  Thank you.  My question actually is a follow-up question about policy coordination.  And I know many Chinese people are concerned about the safety of their dollar assets, and particularly there are concerns about a recent Federal Reserve decision to buy the treasury directly from the Treasury Department.  So my question is, how does the United States assure Chinese to be confident to continue to buy the treasury -- U.S. Treasury bonds?  And also will the United States avoid taking the unilateral selfish policy in the process of stimulating the economy?

MALLABY:  Can you just repeat the last bit of your question -- can the United States avoid the --

QUESTIONER:  Avoid taking the selfish policy in the process of stimulating the economy.

MALLABY:  All right.  Yes, okay.

Steve, you want to have a crack at that?

DUNAWAY:  Sure.  Well, on the first part, you know, the Fed's recent announcement that they're going to step in and if necessary purchase treasuries is -- I would've thought was good news for the Chinese authorities.  Effectively the Fed is establishing a floor under the crisis of U.S. treasuries.

The other part of it is that, you know, I think there's a lot of potential misunderstanding in terms of the significance of China's purchases of U.S. treasuries -- that, yes, it's been the largest purchaser; it is the largest holder of treasury securities.  Now, if China decides that treasury securities are too risky and that they want to buy something else, that doesn't necessarily mean there's going to be dramatic drop in the value of U.S. treasuries, particularly right now because there is large world demand for risk-free assets and very strong demand for U.S. treasuries.  And then now with the Fed, which as part of its policy of quantitative easing is effectively targeting longer term interest rates through purchasing treasuries -- that basically would -- should ensure, you know, a significant stability in the treasury market.

Now, the other part is if the Chinese authorities are really concerned about the value of their reserves, they have to ask themselves the question, do they really need to continue to build reserves at the levels that they have up to now?  And that would entail a change in the exchange rate policy as -- to compliment other policy changes, which they're already embarked on.

So, you know, the choice of building reserve assets is up to the Chinese.  Now, whether they in the end given the exchange rate policy objectives -- they have very little choice except to buy U.S. dollar assets if that is the exchange rate policy they want to fund.

Now, with respect to U.S. policy actions -- well, you cannot expect a country to follow policy actions that are not in their own best interests.  A key role for the fund is to ensure that those policy actions do not have significant negative effects on other countries.  And so I would imagine -- and the policies that the U.S. has proposed are consistent with their own self interest, and they're also consistent with this idea over time of being able to deal with some of the underlying policies that contributed to global imbalances.

The Obama administration, you know, with its stimulus package, the way it's been structured is consistent with what I talk about in the report in terms of its emphasis on the spending side and one-off actions so it doesn't create an ongoing stream of expenditures in growth and debt.  Also in terms of the blueprint that they offered for the -- dealing with the U.S. fiscal deficit over time, which is a key way to boost U.S. national savings -- that's all consistent with the policy actions that they need to do -- what -- and would be beneficial for the rest of the world at the same time.

QUESTIONER:  May I have a follow-up question?

MALLABY:  Sure.

QUESTIONER:  Yeah.  Yesterday the Chinese official expect their -- (inaudible) -- to participate in special fund by the IMF to assist developing countries.  Do you think it's a good idea for the Chinese to avoid the risk to continue buying the U.S. treasury?

DUNAWAY:  Well --

MALLABY:  You avoid the risk of buying U.S. treasuries by putting your money --

QUESTIONER:  Yeah, they put the money into an IMF special fund.

MALLABY:  -- instead.  Yeah, I see, okay.

DUNAWAY:  Well, that -- you know, that may be one reason to do it.  I would hope that the -- and the better reason to do it would be that China would see that that would be an appropriate role for it to play in the world financial system, to provide these additional resources to help in the context of a crisis situation so that -- you know, a big reason for the establishment of the IMF in the first place was to try -- and for its lending programs -- is to try to mitigate the effects of a problem in one country from hitting other countries.

QUESTIONER:  Thank you.

MALLABY:  Good.  Any other questions?

OPERATOR:  As a reminder, if you'd like to ask a question, please press *1.

Our next question comes from Diana Gregg at BNA.

QUESTIONER:  Yes, hi.  I just wondered -- you both -- or all three of you, I guess -- seem to think that, you know, reform of financial regulation takes a long time, and you're sort of downplaying expectations for the April Summit.  But I'm wondering, can you at least make some predictions of what you think will come out of that event or is it just simply going to reassert some of the items that they mentioned back in November?

MALLABY:  What I think is that back in November, you know, there was sort of an agreement in principle to look at this area, and that's been reiterated most notably by the Europeans leading up to the April 2nd Summit because the European view is, you know, don't talk to us about stimulus nonstop; we don't want to throw money into stimulus until you show us that the financial system is functioning better.

But, you know, one just cannot escape the truth that fixing complex issues like how you look at systemic risk or how you design capital adequacy standards is very complicated and it's going to take a long time to do, and if you try to do it internationally it will take even longer than if you tried to do it nationally.   And so I think it's a pretty uncontroversial prediction to say that whilst there will be mention of financial regulation at this summit, to expect action is not realistic.  But perhaps others want to -- maybe I misunderstood your question, or maybe Matt wants to join in.

SLAUGHTER:  No, Sebastian.  I'd echo what you said.  I guess I just -- in terms of, if there's an expectation of practical policy changes -- we've figured out that law 'X' should be written or amended to do this, or regulator 'Y' should now be doing this -- I just think very few if any countries are at that point yet.  These are just really complicated issues.

That said, I think signaling to markets and to fellow governments the dedication and acknowledgement of the importance of this issue is paramount.  So I would hope there would be some strong language and statement on that.  I don't mean to downplay the symbolic and real value of reaffirming that.

MALLABY:  I happen to --

SLAUGHTER:  But to be--

MALLABY:  I was just going to say, I happen to have on my screen here a quick list of four points that I extracted from reading about the U.K. plan on financial system reform -- the things that the U.K. thinks are important.

The first thing is a systemic risk regulation, which is a highly complicated thing to design, and there are questions about how much you achieve until you make it international.

The second thing is that one should fix bankers' incentives so that they do not have an incentive to risk shareholders' money by -- and therefore they want to create clawbacks so that they are compensated for performance over a longer time horizon.  And that's something which is -- seems sensible but is not really a G-20 issue in the sense that one could do it on a national level.

There's a question of standardization of accounting for risk assets, which Matt referred to before, but I think the -- (inaudible) -- exercise over many, many years is trying to do this kind of exercise just for one type of financial institution, namely banks, without even getting to hedge funds, insurance companies, investment banks, and so on.  You know, it just shows you that it's an incredibly difficult thing to do, partly because financial assets simply aren't standards -- that when one says "standardized accounting" for these things, it's these things themselves that are not standard.  It's tough to do it, and particularly on a short time horizon.

The fourth thing is, you know, that there should be capital charges on less liquid assets held by financial institutions, so if you take the risk of investing in something illiquid, you should have to hold more capital to back up that risk.  But the fact is that defining which assets are liquid and which are illiquid is difficult because the liquidity of an asset changes in different trading conditions in markets.

So I just think, you know, when you go down these lists of financial reform ideas -- and they all bear serious consideration, but none of them are simple and the moment hasn't come, I don't think yet, where the debate has ripened to the point where one could expect action.

Is there another question?

OPERATOR:  Our next question comes from Veronica Smith at AFP.

QUESTIONER:  Hello.  Thank you again.  I would like to know what is -- your thinking on the prospects of actually finding a value for the heart of the problem -- the toxic assets.  The U.S. has made some moves in that direction, but it seems to me that we're quite far away from getting any kind of value on these assets.  Do you see the G-20 summit actually tackling this issue with some sort of firmness?

MALLABY:  I have a view on that, but maybe others want to -- Matt, Steve, do you want to take a shot at that?

DUNAWAY:  Well, I'll let Matt go first and then I'll be happy to make a comment.

SLAUGHTER:  I guess if I think about in the U.S. one of the major classes of assets that seems to be so problematic in many ways are assets derived from the value of underlying individual mortgages in the U.S.  So that -- part of the challenge is the underlying economic -- or what's happening in the U.S. housing market; what's happening in the broader U.S. economy -- and if the real economy continues to deteriorate and there's greater pressure on the income statements and balance sheets of American households, the payment trajectories on the mortgages of these homes is more and more difficult to understand in the future.

So that's one where, again -- and to -- Sebastian's comment a moment ago -- you know, the elected leaders of the G-20 countries have many powers, but one is not unbundling these really complicated assets and putting down and figuring out how to value them.  That's a process that's very important that the market in some sense is going to have to figure out, perhaps with some partnership with the government -- and Secretary Geithner's plan strives to do, that was proposed yesterday.

You know, for all these assets, I mean, kind of giving the dollar a notional face value, you can think about some market value that's somewhere between zero and a hundred cents on the dollar.  And part of the challenge I think is whether the market participants want to know what that price is -- both from an individual company's financial liability perspective and also from a regulatory perspective.

DUNAWAY:  Yeah, I think that's the key, is your -- in essence you have to recreate a market for these assets.  And Secretary Geithner's plan yesterday is one way to do that.  But you know, the devil is always in the details, so in the end it's all going to depend upon not only being able to bring investors in but also the holders of these assets, in terms of what -- prices at which they're willing to sell.

And to some extent you end up with a first mover problem, in terms of who wants to be the first investor in, but also on the sales side, you know, which of the financial institutions wants to be the first one to test the waters and to sell these assets.  So once you get over that initial hurdle, things could improve quite rapidly.  You know, we saw a very similar situation back during the savings and loan crisis where -- with the Resolution Trust Corporation, when they first set up the auctions of the assets that they already had on their books.  In the initial rounds of auctions you saw very low prices for the assets, and it set off some hew and cry amongst some of the existing savings and loans that were sound financially -- concerns about how cheap that the assets were selling.  But what happened in subsequent rounds of the auctions is at least you established a floor value, and from there investors could determine -- you know, they had some idea of what their downside risk was.  And so from there they could determine whether they wanted to participate or not.  And then that result was that at subsequent auctions the prices started to rise dramatically, and the activity in the auctions increased.

Now, you've got a somewhat similar situation here, except it's kind of turned around a little bit with these private-public partnerships being the purchaser.  So I think the key thing really, in terms of kicking this off, is the willingness of the banks to sell the assets and what prices -- again, that first mover problem in terms of who comes in to be the first of the financial institutions to sell these assets.

MALLABY:  I think we're almost out of time.  I would just build slightly on what Steve said at the end of that comment, which is to say that, you know, in the resolution of the S&L loans, it was the government selling the loans at auction to purely private buyers, and therefore the prices that you got in those auctions were really what the market was willing to pay for those loans.

If you look at the Treasury description on its website yesterday of how you would buy -- how you would finance the purchase now of a toxic loan, it gives an example where the loan cost 84 cents because it was 100 (cents) and has been marked down 16 percent, so it is 84 cents.  And it envisages that private investors will put in only 6 cents, and the other 78 cents of the price would either be money from the Treasury or money -- loans guaranteed by the FDIC.  So the market portion of the purchase is extremely small -- less than 10 percent of the price being paid.  And therefore I think it's highly dubious that, you know, the prices that get set in this process really have anything to do with the market price because it's a market that is made possible only by massive government subsidy.

So one can see why the Treasury is where it is, because politically it couldn't go to Congress and get the money to buy up all the toxic assets -- there's just too many of them -- and therefore repeating the Resolution Trust Corporation, where that was the model, is impossible.  But because it's now forced into Plan B by the political impossibility of Plan A, I think Plan B may end up having a tough time really resolving the problem.

Let's -- we're out of time.  Thank you to everybody that called in.  Thank you very much to Steve Dunaway and Matt Slaughter.  And once again, I do commend both of their recent reports , the Council's Special Report on Global Imbalances and the Financial Crisis, and the Squam Lake Papers series, both of which can be found on the website of the Center for Geoeconomic Studies, which is www.cfr.org/cgs, for Center for Geoeconomic Studies.

Thank you very much.

 

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