FROM THE OFFICE OF PUBLIC AFFAIRS

Chairman Leach, Ranking Member LaFalce and Members of the Committee, thank you for providing this opportunity for me to present the Administration's approach to reforming the global financial architecture. This is one of the most important issues that we face in the international arena, as the events of the past two years have demonstrated. It is also one in which Americans -- workers, businesses and farmers -- have an enormous stake. Just as the origins of the crisis were complex, so are the challenges we face in trying to reform the system.

Overall, the aim of President Clinton's approach is to build an international financial system that best promotes global growth, that contributes to a broad-based sharing in the benefits of that growth, and that is less prone to crisis and better equipped to deal with crises when they occur. We want to help all countries equip themselves to be able to participate effectively in the global financial system. This means working with developing countries to identify policies that can best realize the benefits of global integration while limiting the potential risks, and creating stronger incentives for them to put these policies in place. It also means acting to induce creditors and lenders in industrial countries to assess risk more appropriately, so as to help avoid excesses in capital flows and leverage. Finally, it means equipping the international community to deal more effectively with those crises that occur.

The international community, with the leadership of the United States, has made important progress so far. There is now a broad-based consensus on the appropriate framework for reform, although within that framework there are a number of important issues still to be resolved. While we have made meaningful progress, much work lies ahead. The international community's efforts involve a collection of actions that I believe, over time, will constitute a powerful program of reform.

Today I would like to focus on some of the most important elements of our work, in six broad categories:

• involvement of the private sector in crisis prevention and management, including reform of national bankruptcy regimes;
• strengthening and reforming the international financial institutions;
• improving transparency and disclosure, including use of standards and best practices;
• strengthening macroeconomic policies and financial systems in emerging markets, including sustainable exchange-rate regimes;
• strengthening financial regulation in industrial countries; and
• promoting policies that minimize the human cost of crises.

Involvement of the Private Sector in Crisis Prevention and Management, Including Bankruptcy Reform

The role of the private sector in resolving crises is one of the most complex issues we face today, involving powerful competing considerations. We must not undermine the obligation of countries to pay their debts in full and on time. To do so could cause a reduction in critical flows of private-sector trade credits and investment, and increase the potential for contagion. At the same time, market discipline only works if creditors and investors bear the consequences of the risks they take. The high yields on many emerging market debts indicate private creditors' expectations that some of these debts will not be paid in full or on time.

We must strike the right balance between these considerations on a practical case-by-case basis. When a government's capacity to pay its debts in full and on time may depend on the provision of official resources, the international community will need always to consider carefully whether there is a role for the private sector. In some cases it may be appropriate to seek maintenance of exposure levels or a restructuring or refinancing of debt held by private creditors. This approach was quite effective in the case of Korea's external bank debt, for example, by providing the breathing room Korea needed to stabilize its finances and implement the structural reforms necessary to put its economy back on track. In other -- truly exceptional -- cases, negotiations may break down and it may not be possible to avoid a temporary non-negotiated interruption in some debt payments owed to private creditors.

Additionally, there is no reason why one category of unsecured private creditors should be regarded as inherently privileged relative to others in a similar position. When both are material, claims of bondholders should not be viewed as necessarily senior to claims of banks.

In addition, there is a growing consensus in support of a number of ex ante measures that can help both to reduce the impact of financial shocks and to promote more orderly crisis resolution. Contingent lines of credit arranged with the private sector -- as established by Argentina, for example -- may be able to make a contribution in this regard. We also encourage the broader use of provisions in bond contracts that can facilitate creditor coordination. Through the IFIs and more generally, we also strongly support steps to strengthen national bankruptcy regimes that can help prevent private debt problems from escalating into broader sovereign crises.

Strengthening and Reforming the IFIs

The international financial institutions, especially the IMF, will continue to play a central role in preserving the stability of the global financial system, and in responding effectively to financial crises when they occur. To accomplish this reliably, their capacities need strengthening and their policies need reform. We have made significant progress in both areas, and are committed to a continuing process of reevaluation and reform.

The increase in IMF quotas and the New Arrangements to Borrow, made possible by legislation passed by Congress last October, provided the international community with much-needed financial resources at a critically important time. We very much appreciated the leadership and support of this Committee in that effort, Mr. Chairman. Since then, the IMF has established a Contingent Credit Line, which enhances its capacity to utilize its resources in a manner that will help to prevent financial crises. This new capability not only will help protect countries with good policies against a sudden loss of market confidence, but it is also designed as an incentive for countries to make sound policy choices to reduce their vulnerability to crisis. These policies include the adoption of sound debt management practices, efforts to develop strong bankruptcy and supervisory regimes, and the maintenance of sound macroeconomic policies and sustainable exchange-rate regimes.

The IMF has also implemented important new reforms to improve the openness of its own policies and operations. There is now a formal presumption that borrowing countries will release to the public the Letters of Intent that set forth their program commitments. The Executive Board has also instituted a pilot program for the release of Article IV staff reports and adopted a systematic approach to releasing information about major policy changes. While greater efforts are still needed to make the IMF an even more open institution, these steps, which occurred as a result of strong advocacy by the United States, represent significant progress.

The terms and conditions of IMF programs also increasingly reflect the experience of recent crises and the reform efforts -- led by the United States -- to address a broader spectrum of policy concerns in programs. Under the IMF's Supplemental Reserve Facility, substantial interest rate premiums have been a feature of all recent major IMF lending programs. And program content increasingly reflects our policy objectives: increased trade liberalization, the elimination of subsidies and directed lending, reductions in military and other unproductive spending, the promotion of core labor rights and protection of the environment. While more needs to be done, the improvement so far is real and encouraging and we are continuing our efforts.

The Multilateral Development Banks (MDBs) have also demonstrated an increased capacity for crisis response. The World Bank and the Inter-American Development Bank have introduced a new lending instrument to finance structural reform in countries with exceptional financing needs, enabling these institutions to provide emergency assistance more quickly and in greater amounts when a crisis occurs. Work is also underway in the World Bank and other MDBs to catalyze greater long-term capital flows to emerging markets through use of guarantee mechanisms.

Transparency and Disclosure, Including Use of Standards and Best Practices

Continuing progress in improving the quality and quantity of data about countries and markets is essential for markets to function efficiently and with discipline. In fact, one of the necessary and legitimate roles for governments is to create conditions for the disclosure of information that, left to themselves, markets would not provide. Steps to improve disclosure and transparency can also serve as powerful inducements for countries to adopt sound policies that serve the interests of both the markets and the countries themselves. For example, the IMF has continued to enhance its Special Data Dissemination Standard by establishing a new comprehensive format for disclosure of full information on country reserves, and work is underway on further improvements.

Important progress has been made in the international community in establishing sets of standards and best practices that can help guide countries' policies and serve as a benchmark for country performance. We support pulling together these standards into a comprehensive matrix that includes the fundamentals of sound economic management and financial sector stability. We also support efforts to monitor and assess country progress in adopting these standards, and for the results to be made publicly available. The IMF and the World Bank have already begun to increase their capacity for such monitoring and assessment, and we encourage their continued efforts and collaboration.

Strengthening Policies and Financial Systems in Emerging Markets

One of the striking elements of the recent crisis was the extent to which countries reached for short-term capital and thereby greatly increased their vulnerability to financial shocks. In order to reduce this risk, we support the development of international guidelines for sound debt management to discourage disproportionate reliance on short-term capital flows in favor of more stable long-term debt profiles and the development of domestic debt markets.

Similarly, the short-term foreign currency exposures of the banking system can be a dangerous source of instability in countries with underdeveloped financial systems and regulatory regimes. In such cases, countries should adopt limits on such exposures. Overall, the benefits to a developing nation of short-term borrowing -- lower cost of credit and not having to make the difficult changes necessary to borrow at longer terms -- are often more than offset by the benefits of a longer-term debt profile that better insulates the country against the risks of market instability.

Finally, a country's choice of an exchange-rate regime is of central importance, although we must always recognize that the key to currency stability is the soundness of underlying macroeconomic and financial policies. At the core of each recent crisis has been a rigid exchange rate regime that ultimately proved unsustainable. We believe that the international community should not provide exceptional, large-scale official finance to countries intervening heavily to defend an exchange-rate peg, except when the peg is judged sustainable and certain exceptional conditions have been met, such as a potential systemic threat.

Strengthening Prudential Regulation in Industrial Countries

The recent crises revealed important shortcomings in the way investors and creditors in industrial countries evaluated and priced the risk of their emerging-market assets. There are a number of appropriate measures we can take to strengthen prudential oversight of financial market participants, especially in this central area of risk management.

One important step is the updating of the Basle Capital Accord by making it more sensitive to the risks of short-term lending and of lending to emerging markets. In addition, financial market participants need to strengthen their practices of managing credit and market risk -- and supervisors need to increase their oversight in this area -- in order to dampen investors' and lenders' tendency to underestimate risks in good times and exaggerate them in bad times.

This Committee has already examined the recommendations in last month's report by the President's Working Group on Financial Markets, so I will not discuss them in detail here. The report's recommended improvements in disclosure and risk-management practices for highly-leveraged institutions would, if implemented, help to constrain excessive leverage in the system and thus contribute to a reduction in systemic risk.

Finally, the G-7 has already taken a significant step by establishing the Financial Stability Forum. The Forum will provide a high-level mechanism to improve international cooperation in the design and practice of financial and regulatory policies. Already, it has been agreed to establish three working groups that also will include representatives from non-G-7 countries.

Promoting Policies to Minimize the Human Cost of Financial Crises

Generally, an international financial system that faces a lesser threat of crisis, and that is better equipped to handle crises that occur, is one that will contribute substantially to sharing more broadly the benefits of growth and open markets. More specifically, additional steps should be taken to prevent the burden of crises from falling disproportionately on society's most vulnerable members and to help countries establish in advance policies that make their economies more resilient if crisis strikes.

There are several conclusions we can draw from the recent crises as they apply to principles and practices of good social policy. They include the importance of:

• maintaining a fiscal framework designed to protect core social expenditures at pre-crisis levels, or at least to prevent disproportionate reductions;
• designing means-tested programs for the poor and disadvantaged and developing effective and targeted programs for the most vulnerable;
• strengthening anti-corruption measures, especially through fiscal transparency and accountability; and
• adhering to core labor standards.

With our strong support and encouragement, the World Bank has undertaken an effort to distill a set of social sector principles with a view to identifying practices and policies to incorporate into country programs. The MDBs should commit a substantial portion of their lending resources to the social sector, including assistance to help establish functioning social safety nets. In fact, since the onset of the crisis, the World Bank and the Asian Development Bank have agreed to at least double their assistance to the most vulnerable in Asia. In designing its assistance programs, the IMF also should take into account whether funding is adequate for social safety nets and other targeted social programs, even during periods of needed fiscal consolidation.

Conclusion

Mr. Chairman, our approach to reforming the global financial architecture is based on the fundamental belief that market-based systems create the best prospects for job creation, economic growth and rising living standards both in the U.S. and around the world. We also believe that governments play a necessary role in creating the conditions for markets to produce the best results, and that we have a responsibility to act accordingly. We believe that the result of the approach I have outlined will be a more robust global economy that is less susceptible to instability and crisis, and we will continue our efforts to build an international consensus toward that end.

Thank you very much, Mr. Chairman, and I will be pleased to respond to the Committee's questions.