FROM THE OFFICE OF PUBLIC AFFAIRS

Today I would like to discuss the international financial system in the wake of the financial crisis in Asia; what we can learn from these events about the opportunities and risks of a global financial market; and how we can strengthen the architecture of the international financial system to realize the potential of a 21st century global economy.

These issues of architecture will be at the top of the agenda this week when the world financial community gathers here in Washington for the spring meetings of the Group of Seven industrialized nations and the policy making bodies of the International Monetary Fund and the World Bank. In addition, Chairman Greenspan and I will host a special meeting of a group of ministers and governors from advanced, emerging and transition economies to discuss architecture. In a moment I will discuss the US approach to changes in the international financial architecture, which we will bring to these meetings, just as the other nations of the world will bring their ideas and suggestions. But first, I think it is important to place these discussions in broader historical context.

Over the last ten to fifteen years, we have seen the rapid evolution of a new era of the global economy and global financial markets, an era that presents enormous opportunities for workers, farmers and businesses around the globe. And the changes have been dramatic. Greatly increased flows of trade, capital, information and technology have helped promote global output. Most large businesses, both here in the United States and elsewhere have become global. Developing countries have become important participants in the global economy; for example, they now absorb more than 40 percent of our country's exports. Financial liberalization and technological innovation have produced an ever broader range of new services and products.

A decade ago, official capital flows to developing countries were much greater than private capital flows. Today, annual private flows of capital to developing countries around the world are more than seven times larger than official flows. In 1996, more than $250 billion in private capital flowed to emerging markets -- compared to roughly $20 billion ten years ago. All of this explains why fluctuations in the Thai baht, or the fortunes of the Korean stock market can now affect workers, farmers and businesses in the United States and all over the world and appear daily on the front page of our newspapers. A decade ago practically no one outside the affected countries would have noticed.

Global economic and financial integration with respect to trade and capital flows have brought tremendous benefits here in the United States through increased exports, more high-paying jobs, higher standards of living and lower inflation. The huge increase in private capital flows to developing countries have, among other things, helped finance a great increase in imports from industrialized countries, including our own. Developing countries form Latin America to Asia have also benefited greatly, as increased capital flows financed greater investment and contributed substantially to the high rates of growth in many such countries, promoting higher standards of living and lifting millions out of poverty. The recent economic turmoil in Asia should not, for example, detract from what Asia has achieved over the last 25 years. Even under the more pessimistic forecasts, living standards in Korea, Thailand and Indonesia would still be three times higher at the end of this year than they were 20 years ago, and the poverty rates much lower. Even with the current crisis, per capita income would be higher than in 1995.

As we have seen in recent years, however, this new era brings not only great opportunities and benefits, but also new challenges and risks. How effectively the international community meets these challenges and manages the risks, will have an enormous impact in the years ahead on our economic well-being, and the economic well-being of all countries.

One great challenge is to greatly broaden participation in the benefits of the global economy. Despite vast global economic growth over the past decade, over half the people of the world still live in poverty and that is a problem not only for the countries with high poverty rates but for all of us. The developing countries are our markets for the future, and their economic well-being promotes our economic well-being. Here at home, global financial integration benefits the great majority of Americans, but one of the concerns often expressed -- and it is a concern that I share -- is that, throughout the industrialized countries, including the United States, those who are well-equipped to compete in the global economy are doing better and better, and those who are not so well-equipped risk falling further and further behind.

But the answer to these challenges is not to turn inward, or to dismantle the global economy that has benefited so many. The answer is for all nations, including the United States, to make it easier for those who are dislocated to reenter the economy successfully; to focus on education and training to equip citizens with the tools to prosper in the global economy; to build social safety nets to protect the people who would otherwise be left behind; to work for broad implementation of core labor standards throughout the globe; and to promote democracy and human rights. The benefits of the global economy will only be realized if we and all other nations build broad-based support at home for forward-looking international economic policies. That support will only occur if these benefits are broadly shared.

A half century ago, when the world was emerging from a very different period of history, Franklin D. Roosevelt urged Americans to support him in working with other nations to create international institutions that would spell the difference "between a world caught again in the maelstrom of panic and economic warfare...and a world in which the members strive for a better life through mutual trust, cooperation and assistance." The result was the Bretton Woods institutions -- the International Monetary Fund and the World Bank -- followed later by a range of other collaborative arrangements, such as the World Trade Organization, central bank networks, and the regional development banks. This international architecture has worked to support growth and financial stability and open markets around the globe, greatly benefiting generations of Americans.

Throughout their history, the international financial institutions have had to adapt to a changing global economic landscape, and they have, by and large, done so successfully. But over recent years, the pace of change in the global economy has accelerated. The Asian crisis has demonstrated how badly flawed financial sectors in a few developing countries, and inadequate risk assessment by international creditors and investors, can have significant impact in countries around the globe. Once, unsound macro-economic, financial and other policies in emerging economies would have had little impact on other nations. Now, unsound policies in these countries can harm economies throughout the global economy -- such as our large budget deficits did in the 1980s -- and the problems of each country are the problems of all of us.

That is why, even before the turmoil in Asia, the United States and the international community have been working to strengthen the international financial architecture. Our goals are clear: to promote broadly shared growth in both the developed and developing world, to be better able to prevent future crises, and to deal with them when they occur, and by making the architecture as modern as the markets. The United States began this effort four years ago at a G-7 leaders' meeting in Naples and, working with other nations, the first concrete steps were launched at the G-7 summit the following year in Halifax. Going forward will not require the kind of far-reaching institutional change that we saw in 1945, but the international architecture does need to adapt substantially for the very different circumstances that have developed over the past decade, and to fully prepare for the challenges of tomorrow. This adaptation involves great intellectual complexities and great international political complexities and will occur not at one time, but in pieces over an extended period of time.

There are a whole range of issues that are profoundly important to the strength of individual economies and the global economy -- sound macroeconomic policies, education, health care, and the environment number among them. There is also a detailed agenda for reform of the IMF concerning, among other things, its lending programs. But today I would like to focus on three challenges that have been brought home by the financial crisis in Asia and that are most directly related to financial stability and building a stronger global financial market. These are: providing better information through improved disclosure and transparency; building strong national financial sectors; and creating mechanisms so that the private sector more fully bears the consequences of its credit and investment decisions, including in times of crisis.

The first critical area is better information. When investors are well-informed, use that information wisely, and expect to bear their consequences of their actions, they will make better decisions. That is good for them and can be a powerful force in promoting good policies among nations. National policy makers also need better information, to guide their actions, and anticipate potential problems.

However, there are obstacles to getting good information about economic and financial matters. One is the temptation -- in the private sector and in government -- to avoid disclosing problems. But sooner or later, as we have seen in Asia, the problems will make themselves known -- and in the meantime they only become more severe. In the Asian economies that suffered crises, very effective strategies for achieving many years of rapid growth had masked the growth of problems. In many cases, lack of data meant that no one had a true understanding of this build up or of these economies' vulnerabilities.

Another obstacle is the difficulty of collecting relevant information on a timely basis. In the modern, very complex global financial markets investors and policy makers need more types of information then ever before. For example, public and private institutions have to better identify and disclose the effects of derivatives and other off-balance sheet items on financial risks and vulnerabilities.

Just as important as having good information is using that information well. Risk and credit evaluation have often not kept pace with the development of new products and markets. Indeed, in the Asian crisis we were struck by how few of the international creditors and investors in these economies had the appropriate expertise and knowledge on weighting of risk.

While to some measure this may simply reflect the seemingly inevitable tendency for investors and creditors to at times get overly optimistic or pessimistic -- and at those times to forego adequate analysis -- the incentives to be rigorous should be maximized, which at the least involves questions of moral hazard and regulatory regimes. When creditors and investors come closer to functioning with full analytic rigor, markets will more effectively perform their critical disciplining function in favor of good policy, disclosure, strong financial sectors and the like.

Even before the Asian crisis we had been involved in an intensive effort to improve the quality and quantity of international economic and financial information, including greater IMF transparency. Many countries are now publishing more and better data as a result of these efforts and the IMF is more open about its analysis. But events in Asia have shown we need to strengthen these initiatives. We propose four steps to do so.

First, there needs to be a substantial expansion in the types of economic and financial data made available. In particular, it is essential to get good information on the external liabilities of both the public and private sectors. The IMF's Special Data Dissemination Standards should require countries to provide a complete picture of usable central bank reserves, including any forward liabilities, foreign currency liabilities of the commercial banks, as well as indicators on the health of the financial sector. The Bank for International Settlements should expand its reporting on cross border bank flows to get better, broader, and more timely data on external lending to a country. Governments and international financial institutions also need to make this data more easily accessible to investors, particularly through the internet.

Second, we need to explore how to obtain and publicize a broader range of qualitative descriptive information on financial sector matters that affect the risk of investing in emerging markets, including detail on banking supervision, bankruptcy procedures, perhaps judicial systems, credit cultures and skills in the banking sector. We must now resolve the many difficult issues with regard to these qualitative matters, for example, how best to describe them and who should perform this function.

To support these efforts on disclosure, private sector groups should provide their own ideas about the data and information they would find most helpful, and ways to encourage wider use of available information and appropriate focus on risk.

Third, the IMF needs to make its analyses and lending conditions more transparent. This will involve more frequent and regular publication of a number of IMF documents, analyses, and letters of intent. However, while greater transparency to help investors reach an informed judgment about potential problems is essential, giving the IMF the responsibility to publicly predict formal warnings of crisis is not. While it is possible to identify problems that may develop into difficulties and occasionally into crisis, it is not possible in our view to reliably predict combustion into crisis.

Fourth, we need to increase incentives for countries to improve transparency. The discipline of the market is always the best and most powerful incentive, and can work here to induce better disclosure. Analysts and rating agencies also need to pay close attention to the availability and quality of data and information when determining credit worthiness and asset allocations. In addition, the IMF and other international financial institutions should publicize their concerns about important gaps in countries' disclosure and consider conditioning access to loans on countries' willingness to improve their transparency.

The second critical area we are focused on is strengthening national financial systems. A common element amongst the countries involved in the crisis in Asia -- and, for that matter, in virtually all countries experiencing financial crises -- is a badly flawed domestic financial sector.

Developing a strong financial system that is a match for the challenges of a global financial market is a long and difficult process. The institutions and laws we have in the United States to supervise our domestic financial system were developed over a period of a hundred years and must constantly be updated. We ourselves had an enormous financial sector problem with our Savings and Loan crisis in the 1980s. That crisis stemmed in part from a failure to supervise those institutions adequately as they moved into new services, and to a delay in taking decisive corrective action. Building strong financial sectors will unquestionably be key to financial stability and growth in emerging economies.

Given the effects that weak financial systems can have internationally, the time has come for a more systematic approach to strengthening national financial systems that would involve a more intensive assessment of the vulnerabilities in national financial systems and steps to promote reforms. To do this, we need action in the following areas.

First, we need to develop a more complete range of global standards to guide individual governments' efforts. As a result of the Halifax initiatives, the Basle Committee has now developed the "Core Principles for Effective Banking Supervision." IOSCO, the organization that brings together securities regulators from around the globe, is already well on the way to developing an analogous set of principles for the supervision of securities firms. But we believe core principles should be developed and adopted in additional areas that affect the underlying strength of a financial system, including bankruptcy regimes, accounting and disclosure, loan classification, and overall corporate governance. Other practices which need to be adopted include promoting credit risk management, helping address the problems of connected and directed lending, maturity and currency mismatches, and encouraging a strong credit culture and the requisite skills in a nation's banking system. Different countries have and will continue to have different ways of doing these things, but we must agree to certain high quality internationally acceptable standards.

Second, we need to fill a gap in today's international architecture to provide for international surveillance of countries' financial regulatory and supervisory systems, just as the IMF now carries out surveillance of macroeconomic policies. There are a number of different ways that this could be done -- perhaps through a joint initiative with the IMF and the World Bank, with the use of existing expertise of regulators. But it is critically important to find an appropriate way to fill this gap.

Enhanced surveillance will help induce national authorities to bring their practices up to internationally-acceptable levels, as I set forth in the standards I just discussed, and reduce financial risk. These assessments can lay the groundwork for policy discussions and appropriate assistance, where needed, from the IMF and the multilateral development banks for programs to strengthen financial systems. In addition, analysis of this kind should feed into the range of key documents we believe the IMF should be releasing more systematically. This would then bring into play the most powerful incentive, the markets.

Third, we should consider examining other incentives that could be brought to bear for strengthening financial systems. For example, authorities in major financial centers could consider conditioning access to their markets by banks from other countries on a strong home country supervisory regime, as demonstrated by adherence to the Basle Core Principles, plus whatever relevant additional standards are developed.

Let me also make two additional points relating to financial sectors and capital markets. Experience shows that when countries allow foreign financial service providers into their markets -- with all the competition, capital and expertise they bring with them -- the strength of financial systems is greatly enhanced. The recent WTO agreement in financial services is a major step forward here.

In addition, while attempts to limit inflows of capital, such as Chile's short-term capital controls, have been advocated by some, it is key--independent of the merits or drawbacks of such measures -- that this sort of approach not distract policy makers from implementing the underlying sound policies that are the real foundation for stability and growth. Having said that, it may be worth exploring narrower, prudential limits on banks to prevent an excessive buildup of short-term foreign currency liabilities.

The third and final critical area that I want to discuss today is building effective mechanisms for creditors and investors to more fully bear the consequences of their actions. We cannot prevent crises from happening entirely. When crises do occur, as most recently in Asia, the provision of temporary financial support by the IMF, conditioned on countries pursuing sound policies, is essential in providing countries the breathing room they need to stabilize their currencies, restore market confidence and resume growth. It limits the risk that the crisis will worsen or spread. But, and the balance here will always be difficult, the private sector must fully bear the consequences of its decisions in the context of restoring financial stability.

There are two reasons to focus on the private sector bearing the consequences of its actions. In a world in which trillions of dollars flow through international markets every day there is simply not going to be enough official financing for the crises that could take place. There is also a risk with international assistance of what economists call "moral hazard:" that providing official financial assistance shields creditors and investors from the consequences of bad decisions and sows the seeds of futures crises. Some protection of creditors may be an inevitable by-product of the overarching objective of restoring financial stability, but this protection should be kept to the minimum possible.

When investors bear more responsibility for their actions, they have a better incentive to analyze and weigh risks appropriately. This, in turn, will promote good policy in all countries, including our own, and help prevent instability and crisis. Markets are a powerful force and our goal must be to make markets work better, while still providing the essential international support to help countries in crisis and guard against contagion risks.

There are a number of ways that the private sector can be involved when the IMF is providing emergency support at a time of country crisis, as the recent cases in Asia have shown. In Korea, international banks stretched out and renegotiated a substantial proportion of outstanding loans while the IMF has provided emergency financing to Korea, drawing upon its new, short term, high interest lending facility, conditioned on strong policies. In Indonesia, foreign banks are now negotiating with a committee representing private sector corporate debtors, while the Indonesia program with the IMF is aimed at putting in place a more stable macroeconomic environment.

While the whole question of private sector involvement is extremely complicated -- and there are many areas that may not have yet been fully explored -- let me just mention a few thoughts as to possible mechanisms.

In general, the promotion of new, more flexible forms of debt agreements and indentures would provide a framework for direct negotiations between creditors and investors. In addition, the IMF should explore lending into arrears -- in other words, the IMF continuing to provide financing to countries even when those countries may be behind on the debt payments to some private creditors -- to create a situation in which debtors and creditors work things out themselves. A broader, international bankruptcy regime of some sort may have great appeal, but, at least with current knowledge, the political obstacles may be insurmountable. However, strong bankruptcy laws and institutions covering debtor-creditor relations can mean business failures have a better chance of being resolved quickly and with less impact on the broader economy. Governments could then reduce the scope of formal guarantees to create a more healthy environment with the presumption that corporate debt will not be protected, and that where appropriate banks will be allowed to fail. Various insurance plans for creditors have also been suggested, but none so far proposed seem likely to be effective and some may create additional moral hazard problems.

Before I conclude, I want to comment on a critical immediate issue. The IMF has been central to the effort to restore financial stability in Asia and the IMF will be central to restoring financial stability in response to crises in the years ahead -- matters that are critically important to the economic well-being of the American people. All of this underscores the importance of Congress approving full funding for the IMF, as requested by the President. As a result of the recent situation in Asia, the IMF's normal financial resources are approaching historically low levels. The IMF might not have the capacity to respond effectively if the Asian crisis were to deepen, spread to other developing countries throughout the globe, or if a new crisis were to develop in the near term. Every day that this continues is another day of vulnerability for American workers, farmers, and businesses. Congress should act and act now. And our capacity to influence the IMF to deal with these new challenges turns upon our capacity to support the IMF with the funding it needs.

As I said earlier, there are many steps we need to take to build a strong global economy that benefits everyone. But the objectives I have described today -- better information; stronger national financial systems; and mechanisms so that the private sector more fully bears the consequences of its investment decisions -- are critical elements in strengthening the architecture of the international financial system, especially with regards to preventing and dealing with financial instability and crisis.

Progress will take time and immense amounts of energy on the part of the international community, and in our country, close cooperation between Congress and the Administration. But our success in meeting the challenge of strengthening the international financial architecture will be critical to global prosperity -- and our own country's economic well-being -- for years and decades to come. Thank you very much.