FROM THE OFFICE OF PUBLIC AFFAIRS

I would to thank Peter Kann for that introduction, and Dow Jones and The Wall Street Journal for hosting this conference, and for inviting me to speak with you today.

I would like to focus my remarks today on a topic of immense importance not only to the nations of the Americas, but also the rest of the world: the urgent need to adapt and reform the international financial system for the 21st century. The backdrop for my discussion is the global financial crisis, which erupted in Thailand over a year ago, spread throughout Asia, and to Russia, and now threatens to spread to Latin America. This crisis has presented unprecedented and enormously complex challenges to the international financial system created fifty years ago; clearly the time has come to build a stronger system better suited for the challenges of the ever-changing modern global economy. And it is a challenge that will be a focus of this weekend's meetings of the Group of Seven industrialized nations, next week's meeting of the group of G-7 and emerging market economies, and next week's Annual Meetings of the World Bank and International Monetary Fund. Today I would like to discuss the approach of the United States to these issues and areas where we believe we must take action.

Any discussion of changes to the global financial system should be, from my perspective, grounded in a fundamental belief that a market-based global economic system, based on the relatively free flow of goods, services and capital between nations around the world, will best promote global economic well being in the decades ahead. This system has been embraced by an increasing number of nations over recent years, and has produced enormous gains in human welfare. The enormous increases in trade and cross border capital flows have very much contributed to our own economic well-being, and contributed even more to emerging markets, as great flows of investment capital have helped lift millions of people out of poverty. Despite the recent crisis, most emerging markets across the globe -- in Latin America, Asia and Eastern Europe -- are far better off today than before they embraced the global market-based system. For example, even with the recent crisis, real per capita incomes in Korea and Thailand are about 60% higher than ten years ago.

However, I also believe that the global economy cannot live with the kinds of vast and systemic disruptions that have occurred over the last year. We must address this challenge in both the short and long-term.

In the short-term, the international community has worked aggressively to face the immediate tasks of limiting the damage from what is generally viewed as one of the most serious financial challenges of the last 50 years and helping the affected emerging markets return to stability and growth.

I believe the International Monetary Fund -- around which much of this effort has been centered -- has, on the whole, made sensible policy judgements in the face of complex and in many ways unprecedented challenges. And the IMF has adjusted those judgements as circumstances have warranted. The industrialized nations have worked in many ways to support this strategy, in conjunction with the IMF and the World Bank, and bilaterally. The President has now advocated in his recent speech moving forward in several other areas. Included in these is a recognition that the balance of risk has shifted, as the G-7 Finance Ministers and Central Bank Governors stated on the day the President spoke. He also emphasized there is no doubt that we have much work to do in response to the current crisis. This crisis, as I have said, developed over many years, and in my view the world is going to have to work through these problems for some time to come.

For the long term, this crisis illustrates how, while free markets bring enormous benefits, there are also accompanying problems that markets themselves cannot solve. Dealing with the problems that markets alone cannot solve is essential to help maintain and expand the free market system. This was the logic behind the reforms and financial regulatory structure the United States instituted for domestic markets in the 1930s: the Securities and Exchange Commission; laws against manipulation; disclosure requirements; and a whole range of other measures, so that our nation could receive the benefits of open capital markets with the accompanying problems greatly moderated. At the same time, the United States began the introduction of deposit insurance, which helped to strengthen confidence in our banking system.

Similarly, the international community is now working toward reforming the global financial architecture to reduce the frequency and severity of financial instability in the future and, when instability occurs, to deal with it more effectively. The international community launched a renewed effort at the 1994 G-7 leaders meeting in Naples. At that time, President Clinton, recognizing that we needed a global financial architecture commensurate with greatly changed conditions, called for a review of the existing system. Out of that came a series of reforms adopted at the 1995 G-7 leaders meetings which have been referred to as the Halifax initiatives. Six months ago, we expanded on that effort to involve the Finance Ministers and Central Bank Governors from the G-7 and key emerging markets to look toward broader and deeper measures. At that time, the United States laid out a number of proposals in three broad areas for the group to consider. Now, in a meeting on October 5th, reports reflecting the work of 22 countries will be presented suggesting concrete steps and proposals for future work to improve transparency, strengthen country financial systems, and improve management of international financial crises with private sector involvement.

Now we need to implement the recommendations, move forward on those complex issues that have not been fully resolved, and, extend the reach of reform to other areas, as President Clinton said in his speech last month. We must create a modern framework for the global markets of the 21st century, though doing so will not be easy or quick, in order to improve and retain the market-based system that will best promote future global economic well being.

To begin to accomplish these purposes, we need to understand that the responsibility for these crises does not lie in the emerging markets alone. A combination of factors underlie the crisis of the last year: the dramatic changes in the global financial markets in recent decades; the basic dynamics of markets; and the ill-discipline of creditors and investors in the industrial nations, as well as the macroeconomic imbalances and the flawed financial systems in a number of emerging market economies.

First, the emerging market economies. Although circumstances differ in each of the nations that have been enveloped in crisis, many shared a problem of underdeveloped and in some cases badly flawed and poorly regulated financial systems and other structural problems. One key problem was that banks and corporations in those countries borrowed too much in foreign currency on a short term basis. In addition, banks in many cases extended credit on an unsound basis, often as a result of government-directed lending or, non-arms length relationships between creditors and borrowers. Moreover, many of these countries had very serious macroeconomic imbalances and exchange rate problems. Thus these countries were more vulnerable to excess injections of outside capital.

Second, the backdrop of dramatic changes in global financial markets in the last three decades. I began working in these markets in 1966 and I experienced firsthand those changes. Over the last 30 years, global capital flows have increased exponentially. The amount of money that crosses a trader's desk is enormously greater today then when I left Wall Street six years ago to say nothing of ten or twenty years ago, or fifty years ago when the Bretton Woods institutions were created. The speed of flows as a result of changes in technology has vastly increased. So has the diversity of capital providers. Thirty years ago, providers were almost all banks; today there are all sorts of providers, from mutual funds to endowments. There are also a great variety of investment instruments, from plain vanilla bonds and stocks to immensely complex derivatives. Moreover, a very large numbers of developing countries have more recently received large flows of capital, while 20 or 30 years ago significant capital was going to far fewer emerging market countries. Any one of these changes would have been highly consequential. All together, they have been revolutionary.

But the third major contributing factor was something that has not changed over time -- the basic dynamics of markets, and in particular their tendency to go to extremes. This has been a subject of enormous attention back through the centuries during other famous global crises -- such as the Tulip Crisis in Holland in the 17th century, or the South Sea Bubble crisis of the 18th century, and the Depression of the 1930s. The dynamics of markets, as a very wise man said to me early in my years on Wall Street, are rooted in the human psyche.

Taken together, this combination of flawed economies, changes in the international markets and the unchanging human psyche underlying markets helped produce the crisis of the last year. The crisis did not begin in Thailand, as is often said; Thailand was simply the first country in which these factors combusted.

I have seen this many times in the course of my career. As creditors and investors in industrialized countries sought returns during a prosperous market era where spreads progressively narrowed and risk premium shrunk, they reached for yields and paid less and less attention to risk -- a common phenomenon during good times. As evidence, just look at the low level of risk premiums across almost all assets going back a year or two. This included extending more and more credit to, and investing more and more in, emerging markets in amounts not justified by the underlying fundamentals.

When you look at all of this, one thing is clear: had the circumstances in the countries been sounder, or capital flows been less excessive, there would have been problems, but not of the size and scale that resulted in the current crisis.

From the first eruption in Thailand we said there was some chance that this crisis could spread across the region and beyond, to envelop an ever increasing number of countries, which has, of course, happened. We are now seeing this in Latin America, where while much remains to be done, major nations have made great progress in the last ten years in dealing with macroeconomic and structural issues. Just as capital once flowed into emerging market countries without, in too many instances, due regard for proper analysis and weighting of risks, it is now too often flowing out in a non-discriminatory, overly negative reaction to the fundamentals. And that is leading to a contagion effect in Latin America that is, in my judgement, incommensurate with the accomplishments of economic policy regimes in many Latin American nations.

A good example is Brazil, which has made important strides since President Cardoso launched the real plan in 1994, helping to end inflation, privatizing key sectors of the economy, and achieving many other structural reforms. While all countries have challenges they need to meet, President Cardoso's commitment last week to accelerate reforms in this time of financial market turbulence is a next critical step. As I said at the time, the United States believes that the economic well-being of Brazil is critically important not only to our economy, but to the entire hemisphere. And we are in close consultation with Brazil and the international community about what we can do to be helpful.

Let me now turn to the long-term -- and the major foundation pieces for the architecture of the global financial system of the future. Before we consider these long term changes, we must remember two critical points: first, that this subject be approached with great seriousness of purpose, and second, that everyone with a stake in the process must do their part.

First, let me say a word about the need for seriousness. In recent months, there has been no shortage of proposals that on the surface seem attractive. But what is needed with each proposal is a rigorous analysis and evaluation of all so that serious judgments can be made and the resulting blueprints and plans can stand the test of time. Moreover, as important as accomplishing what needs to be done is avoiding what should not be done.

Second, going forward, everyone with a stake in the process -- from governments in both emerging markets and industrialized nations, to creditors and investors, and to the international financial institutions -- must do their part. Each of these players will have different responsibilities.

For their part, as the international financial institutions help countries change, they must also change themselves. I have no doubt that they will be very different institutions in five years time: more transparent; more open; and more accountable. The IMF and the World Bank must also examine their programs and policies and change them where needed. For example they must work harder on providing adequate social support and on reinforcing good governance and reinforcing political commitment to reform. And, I might add, we in the United States must fulfill our responsibility -- and provide the funding that the President has requested for the IMF. The international community must have the resources that it needs to deal with this crisis that has spread to so many emerging economies and threatens the economic well being of the American people.

The industrialized nations, both individually and as a group, also have significant responsibilities. Because policy shortcomings in the major industrial economies affect all nations in the global economy, we must act to maintain stability and growth in our own economies as a source of strength for the rest of the world. In the 1980's and early 1990's, it was the enormous fiscal deficit of the United States that posed the greatest danger to global economic growth.

Going forward today, Japan must urgently implement strong effective measures to lead to strong, sustained demand led growth, critical not only for its own benefit, but also for recovery from the global crisis. In the future, industrial nations must work together so that each country fulfills its responsibilities to promote sound policies and sustain growth. The interdependence of our economics, and of all members of our global economy, makes this imperative.

I also believe that it is in the enlightened self-interest of the industrial nations to greatly increase international support to help build the foundations of private sector-based economies in developing countries. Developing nations with better education, worker protections, health care, stronger legal systems and good governance regimes will be better markets for all of us -- and they will be better able to withstand the vicissitudes of global financial markets. As we move forward, let us not forget about the countries most in need of assistance through programs such as HIPC. These steps will not be easy politically, but the leaders of the industrial nations, in both the public and private sectors, must lead their own people to support strong international economic policy.

Finally, the emerging market economies must also do their part. The greatest challenge for these countries is to pursue sound macroeconomic policies and implement the reforms necessary to regain stability and growth. The present crisis has demonstrated yet again that reform can only work, and confidence thereby be created, in countries that take the political steps to build support for and then implement reform. Building support for reform is undeniably difficult, but, as the events of the past year in Indonesia and Russia have so amply demonstrated, the politics of reform are as important as the policies of reform. In nations where political will and economic reform have gone hand in hand, such as Korea and Thailand, we are now seeing some progress toward recovery.

I have thus far discussed a number of central components of a future architecture -- reforms of the IMF and the other international financial institutions, G-7 efforts to promote sound policies and growth, and increased support to help build the foundations of private sector-based economies in developing countries. Another critical issue is exchange rate regimes. There is a much controversy about the relative merit of floating versus fixed regimes, but there should be no controversy -- looking at the experience of recent years -- that whatever regime a nation chooses, it must be committed to all the policies that are needed to maintain it. Another area whose importance for the long-term architecture has been reinforced by this crisis is effective social safety nets and humanitarian aid. As President Clinton said in his recent speech, "If we want these countries to do tough things, we have to protect the most defenseless people in the society and we have to protect people who get hurt when they didn't do anything wrong." We -- the international community -- must move forward on all these areas.

Let me now outline four additional concrete, mutually reinforcing areas for action. They are: (1) increased openness in the international financial system; (2) strengthened national financial systems, particularly in emerging market economies; (3) promotion in industrial nations of more soundly based capital flows; and (4) developing new ways to respond to crises, including greater participation by the private sector.

First, a new openness in international finance. There are two parts to this challenge: making information more available, and making sure it is used well. The Working Group report on transparency and accountability released next week will call for the IMF to examine and broadly publicize countries' adherence to international standards of transparency -- both of data and, more broadly, of fiscal and monetary policy. As I have already mentioned, the IMF itself also needs to be more transparent. The report will further call for international agreements on higher accounting and disclosure standards for private financial institutions -- including sound practices for loan evaluation, loan-loss provisioning and credit risk disclosure. And it will recommend private and official sector efforts to look at appropriate disclosure of international exposures of all types of financial institutions, including hedge funds. As I announced last week, the President's Working Group on Financial Markets will prepare a careful analysis of these firms and their practices in the United States.

Second, strengthened national financial systems, focusing on better operation, management and regulation of recipients of capital in emerging markets. The Working Group's interim report on this subject will outline new standards and principles for corporate governance, bank restructuring, deposit insurance, and foreign exchange and interest rate risk management. Now we are moving forward on ways to support countries' efforts to implement these standards and to provide incentives for those efforts to be significant. For example, the international community is supporting a stepped-up financial sector capability at the international financial institutions, anchored at the IMF. This effort will include greater training for supervisors of financial institutions. We in the United States are also pressing for new ways for the private sector to help implement sound market practices, including surveillance -- such as through an accreditation system for national bank supervisors.

Third, promoting more soundly-based capital flows. The need is for measures that will effectively encourage providers of portfolio capital and banks to analyze and weigh risks and rewards in a more disciplined fashion in both good times and bad. Market discipline -- which is central to a market-based economy encouraging sound policy and allocating capital efficiently -- only works if market participants act with discipline. Toward this end, we in the industrialized countries must provide better regulation and supervision -- including more effective focus on risk management systems in financial institutions -- and strong prudential standards that pay attention to the riskiness of different types of investment, through a broad range of financial institutions, not merely banks. In addition, improved transparency in the financial sectors of emerging markets can provide investors with information they need to weigh risks, and thereby facilitate market discipline.

In taking such steps, however, we must avoid actions that may offer short-term relief but create permanent damage in developed and emerging market countries. While instituting broad controls on capital outflows, for example, is tempting, they will almost surely not be effective over time, will deter capital from flowing into a country, and will often tend to be used as a substitute for real reform. More effective regulation and supervision will be an important part of preventing future crises and realizing the potential of the global economy. But appropriate regulation of capital markets is one thing, wholesale distortions of them is quite another.

Some say that a special problem is posed by short term speculative capital that in very large amounts can de-stabilize exchange rates and may even be intentionally used to do so. My own view is that these very short-term speculative capital flows have played a relatively small part of what happened in the current crisis, although on an individual day in individual currencies effects may have been significant. If everything else is working right, the ability of this capital to promote sustained de-stabilization is probably quite limited. However, this issue warrants additional consideration.

Fourth and finally, responses to crises must include appropriate private sector involvement and new financing mechanisms to combat contagion. During the current crisis, the international community has provided assistance conditioned on reform to deal with the problems that gave rise to the crisis and to create the confidence necessary to attract capital again. And as we recognized in Korea, in a world where private capital flows dwarf official ones, the private sector must play its part.

Looking ahead, private sector burden sharing is critical, not only because there will not be sufficient official money for all circumstances, but also because it is absolutely essential in inducing market discipline and, lessening the so-called moral hazard issue. In the past -- when the volume of capital flows was much smaller and when banks accounted for the vast majority of those flows -- the international community found ways, as, for example, during the 1980s debt crisis, for the private sector to restructure and where necessary reduce debt burdens, in parallel with official sector support efforts. Our challenge is to develop new procedures for effective management of financial difficulties that are suitable to the very different markets we have today, including the significance of securitized credit provision. Unilateral actions have been seen to be highly damaging.

The Working Group report on this addresses this exceedingly complicated set of issues. It calls for concrete reforms to increase the private sector's role in prevention and resolution of crises, including much-improved insolvency and debtor-creditor regimes and the inclusion of new creditor coordination clauses in bond contracts among debtors and creditors. As part of the architecture of the future, we will actively support new forms of private sector involvement, ranging from the development of innovative financing mechanisms to allow more flexibility in payments and guard against unexpected shocks, to more direct private sector involvement at times of crisis with the provision of private liquidity alongside official funds.

Today, we face a key challenge in limiting contagion and promoting an appropriate recovery of private capital flows. For the future architecture, where contagion is the predominant problem rather than policy issues in the affected country, the emphasis could be on finding new ways to make liquidity available in ways which do not lead to undue moral hazard effects. These actions will not provide the full change needed on crisis response, but they are important steps in the development of more permanent change. I believe that these changes will contribute significantly to the financial architecture of the future with respect to crisis response.

Our belief in markets stems partly from the capacity of markets to discipline governments to pursue the right policies for solid growth. Our goal should be a strong market-based financial architecture which induces sound decision-making by investors, encourages capital to be used productively, and rewards governments that pursue sound policies. I believe that, with all of the steps I have discussed today -- with reforms of the IMF and other international financial institutions, with industrialized countries all working together to pursue sound policies, with intensified support for the countries in crisis and for the poorest nations, and with the concrete reforms to increase transparency, strengthen financial systems, promote soundly-based capital flows and improve the response to crises -- with all these steps, we will make enormous headway toward building that kind of system.

Let me conclude by stating that together we must move energetically to meet the immediate challenges of the crisis and to build a modern architecture for a market-based system -- one that is far less susceptible to systemic instability and more fully able to help us realize the potential of the global economy for the next century.

We need to be bold in our thinking, but equally we need to be serious in our thinking. Thank you very much.