Please note these are extracts of his speech and not a verbatim transcript.
Thank you for that nice introduction. I’m honored to be here with the governor and deputy mayor and so many old and good friends.
I got to know Peter during my days at the Treasury. He definitely has a way with words. I remember one day he came to see me and said, “Mr. Secretary, there’s no one who is a greater supporter of the US than I am. I am such a deep admirer of the United States. You have this “can do” approach in America, but you know, I’m getting worried. I think the motto may no longer be “can do”, but "can sue.”
Peter became a champion of a long overdue rapport with the American system of liability reform or tort reform.
I’ll always recall a pleasant day in London several years back with Gordon Brown, who wanted to show me the leading financial institutions of London. He picked Lloyd’s to highlight London’s prominence in the global financial market. We had a pleasant day there. We gave some speeches, we had the press and we had the leadership of the organization. A remarkable thing happened that day, Gordon Brown smiled. If the British public could see more of that side of him, his poll numbers might get out of the single digits.
I did greatly value the counsel of Lord Levene and the role of this great company in making the American economy stronger and healthier and we all admire you for your role in the post 9-11 experience- which played such a huge and important role.
But I am delighted to be here for one particular reason. I’m going to let you in on a secret. There is a long tradition at the Treasury, that Treasury Secretaries upon leaving office step aside and aren’t seen or heard from again to leave room for the successor, so not to get in the way or create problems. A tradition, I’m told, that is also observed sometimes at the Federal Reserve. So tonight, in a way, this is a coming out party for me. I’m delighted to have such a wonderful group to come out of the cocoon to end the hibernation and to rejoin the active world of commerce, finance and economics.
In preparing for these comments, I went back and looked at what’s gone on in the US economy. When I left two years ago things were pretty good. We had the longest period successive job creation and GDP was terrific, inflation wasn’t observable, productivity was high, and wages were rising. You can imagine my astonishment when I checked the data and saw that there’s now a recession, a housing crisis and a credit crisis. In the US, talks of the US problems creating contagion in the global economy.
All I can say is that things were a lot different two years ago. It was a great privilege to serve as the Secretary of Treasury. When you get a call from a future president of the US and he says, “I’d like you to be my HUD Secretary” or “I’d like you to take on the energy department,” tell him ‘No, I think I’d prefer the Treasury Department.” You’ll have more fun at the treasury, and you’ll accomplish more.
Washington is a tough place. It’s hard to get much done in Washington. There’s a bitterness and hostility and a partisanship that you have to live with to really understand it. It’s the only city I know where half the people get up during the day trying to figure out how they can sabotage the other half.
It’s a different Washington, than the one I knew during the Ford administration, when I was also privileged to serve in the Department of Transportation. At that time, Democrats and Republicans actually spoke to each other, actually knew each others families, and were actually civil to one another. Unfortunately today the civilities in Washington no longer exist.
When I returned to Washington, I got a rude awakening. Four days into the job, I appeared before the House Committee that reviews the President’s budget. As the Treasury Secretary, it was my job to take up the budget and defend it. So here I am on my inaugural visit to Congress, defending the budget of the President of the United States.
I laid out the case and the first member of Congress, a senior member from the Democratic side looks at me and said, “Mr. Secretary, the economy is a disaster. You have taken us from large surpluses to a deficit. There have been three million jobs lost since this Administration came in. Wages and real incomes are falling. This is the worst economic record since the depression. Mr. Secretary, you’re a disaster, you ought to be impeached.” And I’m thinking, I’ve been on the job four days. Give me a little time here, Congressman.
Let me share another story. When the President was interviewing me, he made it clear that he was looking for a focus on communication. He said that, “I really want to spend time communicating with Congress. We’re going to have some major legislation and the tax bill to get in line and beyond the Congress we need better communication with the American people.” They need to understand what we're trying to accomplish.
A month or two later we’re sitting in the Oval Office and he’s about to announce me to the American public as his nominee to be the Treasury Secretary. He said, “John, I’ve had the best reports on you from the staff. They’re really looking forward to having you on the team. They say you’re a good speaker, a good communicator, they tell me you even do it extemporaneously. You do it without notes.” I said, “Yeah, I was a college professor for a time and I learned you’re more effective at holding people’s attention if you don’t seem to be leading, but engaging.” Then he looked at me sternly and said, “John, in this job use notes.” What he had in mind was is the fact that a Treasury Secretary or any other secretary at a major post can make news you don't want to make. A secretary who says the wrong things on subjects of great interest that could have far-reaching political and economic consequences.
No subject would this be truer than the extraordinarily sensitive subject of the dollar. The financial press loves to raise questions about the dollar. It’s their favorite subject. Every Treasury Secretary learns how to fend them off with some little “the dollar is strong” mantra or “you know our policy on the dollar,” or “our policy on the dollar hasn’t changed.”We may favor strong dollars in the open competitive market, with the intervention kept to a minimum. But if you get that wrong—sometimes the incumbent does get it wrong—creates huge permeations in the market. Two-and-a-half trillion dollars in trades per day with another derivative swap of two-and-a-half trillion, you have five trillion dollars. The FX traders make fortunes on those bits of money. I’m convinced there’s a conspiracy between them and the financial press to create perforations. You’ve got to be really careful. There’s story I’ll share with you that illustrates this point.
A very able and cautious Treasury Secretary was speaking to a small group of people, very similar to this one. After his comments, the audience asked, “Will you answer a few questions?” and he said, “Certainly, I’d be pleased to take some questions.” The first question had to do with the currency of the dollar. “Is your strong dollar policy still effective?” The Treasury Secretary looked at the Chairman and asked, “Are there any members of the media present?” He assured him there were no members of the media present. He looked at the Chairman and said, “Are my comments going to be confidential? Are these comments off-the-record?” He was assured the comments were off-the-record. He then looked at the questioner and said, “No comment.”
Recently, Chairman Bolger observed that the dollar is in crisis. I have great regard for Chairman Bolger. He’s one of my favorite people. He deserves enormous credit for having tamed inflationary expectations and putting the American economy on a fathered course after the later part of the eighties and up until recently. But, I don’t agree with that observation. In fact, I think the adverse of that is the truth.
We’d have a real crisis if the dollar wasn’t performing the way it is. Let me explain. The American economy today is resting on the dollar. It’s resting on exports. With the weakness we see in every sector with credit debt tightening, housing in a slump, auto sales down sharply, retail sales down sharply across board, financial assets selling at huge discounts there’s one thing that is keeping the American economy going, its exports.
Exports are largely offsetting the other things- particularly housing. One percent GDP growth lift is coming out of exports, and with the tightening of exports, we’re also getting other benefits out of this adjustment that’s occurring. Consumption is coming down, therefore will rise, and this long period of excess credit and liquidity and under pricing of risk is being brought to an end.
Peter asked me to talk about the big picture. So, how does this all tie together? How does this all tie together with this larger set of adjustments known as global imbalances or the current deficit/surplus? It does all tie together, it seems to me.
How did we get into this situation? Where did it come from? Well, American consumption habits, our propensity to consume foreign goods, has lead to a larger account deficit. Our larger account deficit has created a surplus in other parts of the world, mainly the Middle East, but also China. In the earlier part of this century, a sizable pool of surplus savings developed. That sizable pool called ‘a savings glut’ by Chairman Bernanke when he was Chairman of the Board back in 2001 or 2002 had an understandable and direct result. It dropped interest rates at the long end of the curve. Now you’re sitting in the Federal Reserve, or the Bank of England, or in Chrysler at the ECB and you see the long end of the curve come down. An inverted yield-curve is likely to produce very unwanted results in US economy, particularly coming off of the tech bubble coming out of the US equity market, the recession of Oct ’01, 9-11, the awful corporate scandals, and the fact that Europe was virtually stagnant at that time and Japan was in a stagnant, no growth, mode as well.
The word deflation was everywhere, and Central Bank governors are charged with the responsibility to keep inflation expectation in tow, but also to avoid deflation. They look at these numbers, and what do they do? They lowered the low end, and you can criticize them for lowering the low end, but that’s looking in the rear view mirror. If you’re seeing where they were with the equation in 2002 and 2003, you’d make the same decision they did, even though there were really far reaching implications of that decision to lower the low end.
As it rose in value, and continued to rise, interest rates stayed down, and one of those assets was housing. Housing changed its character in the American economy. It went from an illiquid asset too a liquid asset because as housing prices continued to rise people were able to do these equity extracting loans. Those equity extracting loans, in turn, fueled the huge consumption binge. There was a period where America was consuming at the rate of 130 percent of the increase of the disposable income. How long can you do that? Not long before you have to borrow.
The other corrective effect of the actions of the Central Bank governor to avoid inflation was to create the search for yield. Remember that? A lot of clever people developed models to show how to get yield. You know the story.
The CEO’s swore in the CIVs… and I wonder how much the CEO’s and executive vice presidents of those institutions who ended up making large amounts of money by marketing these things which were basically the products of mathematicians models, but never understood them?
But they did meet the demand of the market place for years. They found something too good to be true. Much higher yields than could be expected given the risk profiles anticipated and given the ratings from the rating agents who said this stuff looks pretty safe. If you can invest in something that gets high returns but is as safe as corporate A Bond or treasury, what do you do? You buy it.
This stuff spreads all through the world and it contributes to the building up of extraordinary amounts of debt. The housing market lead to a lot of debt. The liquidity of inside financial institutions lead to a lot of CIV's and lending. Short-term borrowing with long-term lending always ends in an eventual collapse in the long-term financial market.
So what’s happening today seems pretty clear. Lots of mistakes were made. Too much debt got issued. Housing prices went up too high, but the banks used the “loan value will be up next year, so we’ll give you the loan anyway, and you build up the debt and you build up the debt and you build up the debt” model. And we build up consumption, and we live beyond our means and now we’re paying the price. It’s a painful price, but it’s an adjustment that had to occur.
When I was in the Treasury there were lots of complaints about US economic policy. One complaint about the US economy was that we ran large deficits through the government and we didn’t save through our housing. We have a negative savings rate in the US, but you can’t go on forever with a negative savings rate.
What I think is really happening here is a long-term overdue correction, which will require consumption to come down and housing prices to come down to clear the market. Since a lot of questionable debt was put out on all sorts of investments, the correction process is working there too. And now it’s hit virtually every class, hasn’t it? Not subprime anymore. It’s way beyond subprime problems. It’s hit every class. Some of you are living it today.
It’s going to take time to correct it, but the market will correct for it. It’s now correcting for it and the dollar is a part of the adjustment process, which is painful in the short-term, but healthy in the long-term.
I think we should worry most about a political and regulatory overreaction. Financial markets occasionally blow up. All of you who have been in financial markets and have seen it before. Mistakes get made. In the late nineties, people thought emerging debt markets were pretty sound and pretty safe, and a good place to make money and they blew up. Then there is the recent history that the dotcoms were pretty safe, and a good place to put money, and they blew up. Now we find out that housing isn’t as safe and we find out that these exotic financial instruments weren’t as safe either. And the market responds.
Today very few subprime loans are being made and very few CIVs (collective investment vehicles) are being created. Counterparties are looking at what they’re getting and checking it out. Today CEO’s of financial institutions are checking on the credit quality of the borrowers. They’re asking the questions they forgot to ask which are the fundamental questions of financial institutions: How does this obligation get repaid? What are my risks of not getting repaid on this institution?
The market itself is correcting, and those mistakes won’t get made for the next five to ten years because of the collective memory of people in financial institutions. However the memories will dim and those mistakes will be repeated. The UK and the US are comparative lives in services, and no service more so than financial services. The worrisome thing here is that the Sarbanes-Oxley-type overreaction to the mess that we’re all going through. That would really shortchange the UK and the US in the long-term.
Now, that doesn’t mean some correction isn’t called for. It seems to me there will be a natural market and regulatory correction too. Way too many regulators in the US are without oversight and none of them are really responsible for systemic risk.
The regulators looked at capital ratios and didn’t look at liquidity. You need to look at liquidity as well. The experience of the UK should tell us. We need to do some streamlining. We can’t make the public purse available to some financial institutions and not expect those institutions to be regulated.
We are going to see some extension of regulation to broker dealers and investment bankers. The worrisome thing, though, is a significant overreaction. When I was in the U.K. I never got into the stock exchange. I kept looking for that secret statue of Sarbanes and Oxley, because I was convinced it was somewhere in the London Stock Exchange.
There will be, especially with the new Congress and President, a far-reaching look at financial institutions, how this came about and how to avoid it. My counsel will avoid financial messes. They’re part of the optimism that is built into human nature. While we will be looking at ways to reign in a suspending risk sum, we have to do that in a way that doesn’t eliminate the capacity for the innovations that the Governor and Deputy Mayor talked about. It’s critical to the goal of New York and critical to the role of London.
I’m an optimist and I bought my optimism from someone with close ties to this country and close ties to his native London. That’s Winston Churchill. I’ll close with a thought from Mr. Churchill that I hope you will find cheers you up after all this gloomy news. That thought is this: Churchill observed of America that ‘it always finds the right answer, after it has exhausted every other possibility.’
