FROM THE OFFICE OF PUBLIC AFFAIRS

It is a pleasure to be here this afternoon. Let me begin by expressing my deep gratitude to Yale Law School for this honor.

Alumni weekends and class reunions are usually an opportunity for looking back and reminiscing. But, I would like to take a different tack, and offer some reflections on a very contemporary situation, very much in the headlines these days: the global financial crisis of the past year. Most of what has been written about this crisis concerns economic policy issues and judgments. However, of equal importance, but less discussed, are the political and legal issues involved. One of the reinforced lessons of the past year and half in that all these -- economic, legal and political issues -- must be addressed effectively as the international community works to meet the two great challenges posed by what is often being described as the greatest financial crisis of the past 50 years; these two challenges being, firstly, dealing with the immediate crisis to restore financial stability and growth, and secondly, revising the framework or architecture of the global financial system to make it as modern as the markets.

At the heart of both of these challenges is the gap -- and the question of how to bridge the gap -- between the sovereignty of nations on the one hand, and the demands of the transnation global economy on the other hand. This gap, and the economic interdependence of all nations in today's global economy, was expanded rather tellingly the other day by a Latin American finance minister, who told me how difficult it is to explain to his people why their currency is under pressure and their interest rates are higher because the Russian Duma failed to raise taxes, but that is precisely what happened when global market confidence was badly shaken by Russia's failed economic policy actions.

This tension between sovereignty and the global economy is all the more important as a result of enormous changes, greatly increasing the economic interdependence of nations; that have occurred in the international economy over recent decades, changes that I experienced firsthand -- as I'm sure many of you did -- during my 26 years on Wall Street. Since I first started working at a trading desk over thirty years ago, global capital flows have increased exponentially, as has the speed of flows as a result of changes in technology. And capital providers have become more diverse, with the traditional bank role being joined by enormous flows into securities of all types, including highly complicated derivatives. Moreover, a very large number of developing countries have recently received large flows of capital, while 20 or 30 years ago significant capital was going to far fewer emerging market countries. The combination of all of these changes has been truly revolutionary, benefitting tens of millions of people around the globe, but also creating new risk.

Against that backdrop, the world is now experiencing its most serious financial crisis in many respects of the last fifty years. While it is often said that the crisis began in Thailand, that is not so. Thailand was simply the first country in which crisis erupted, the result of a combustible mix of problems that developed over many years: the excesses in investment and credit extension from developed nations into developing nations, without adequate weighting of risk and, in the developing nations, badly flawed financial systems, various other structural problems and macroeconomic policy imbalances. And, 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 risks.

This crisis presents unprecedented and enormously complex challenges to the nations involved and the international community. I have no doubt that over the next ten or fifteen years, there will be a vast number of articles, books and graduate theses analyzing this crisis, providing at least some insights that don't exist today. Having said that, I believe that we have a good understanding of the crisis, what needs to be done, and the components of an effective architecture for the future global financial system. However, there are no magic wands or easy answers; a crisis that is a product of problems that developed over many years will take time to work out; and working out requires that each nation -- industrial and developing and each international financial institution -- do its part. With this in mind, let me make some observations about the political and legal dimensions of crisis response and architectural reform which are too often under appreciated.

First, the politics. There are two aspects to the political dimension to this crisis: generating broad public and political support for effective economic policies, and providing strong leadership for sound economic policy.

Generating broad support for effective economic policies requires getting the stakeholders to buy into these policies, to feel that this is in their interest; this is true in both industrial and developing countries. The experience of Korea demonstrates how generating political support and effectuating economic reform must go hand in hand. The new government of President Kim Dae-Jung, a remarkable leader who had been in prison for his beliefs and then eventually became President, pulled together companies and labor unions to build support for reform. Now, short term interest rates have fallen from 25% to 7%; the currency has substantially strengthened. A similar process occurred in Thailand, though in both cases great challenges remain ahead. In Russia and Indonesia, on the other hand, as you all know well, the political systems never took ownership of reform, the economic policy decision in the proposed reform programs consequently became irrelevant, and the economics are in dire straits.

Just as generating support for effective policies is critical in developing countries, so is it a critical in industrialized countries. In Japan, for example, the absence of strong public support for bank reform and fiscal stimulus has led to seven years of extremely slow growth and three quarters now of recession, which in turn has affected not only the people of Japan but has been a central problem for the rest of Asia and the entire global economy. And in the United States we have just completed a year long struggle to approve funding for the IMF, a funding which we could have well used some time ago, and we still must pay off our arrears to the United Nations, and support trade liberalization at a time when protectionist pressure may be building.

Let me also add that a key part of building support for reform in developing countries is to help those most affected by the crisis, as for example, through assistance from the international community.

Leadership is also critical in making the politics of reform equal the policies of reform -- political leaders who understand the nature of economic problems and have the political courage and ability to make and sustain decisions that are often very difficult politically. A good example is how President Clinton reacted when we met with him in the Oval Office on a Monday night in 1995 to discuss the Mexico relief package in response to the peso crisis. I told the President that a poll published that day showed that the great majority of the American public was opposed to support for Mexico, but I than said that without that support, there was a real chance that the economy of Mexico could collapse, and crisis spread elsewhere in Latin America and beyond. Without hesitation he told us to go ahead with the package, and today Mexico is back on the path toward stability and growth, though with many challenges still to face.

One of the great political challenges in the decades ahead, in developing and industrial countries, is for democracies to be able to make the unpopular economic decisions requisite for success in a transnational, interdependent global economy. Another, similar challenge, is for sovereign nations to make the political decisions on economic cooperation necessary for the global economy of the 21st century. It is critical to global economic well being and social and political stability that these challenges be met.

Let me turn now to another major factor not often discussed with respect to the challenges of dealing with the current crisis and building an architecture for the future -- legal systems, institutions, and processes.

A strong legal system is essential for a strong economy. Indeed, a key factor in the crisis in many countries was a failure of the legal system -- pervasive corruption, a lack of clear laws and an ineffective judicial process. Building a sound legal and judicial framework includes establishing the rule of law, transparency, court systems and mechanisms by which disputes can be resolved quickly and fairly and combating corruption. An example that may seem somewhat acentric but is central to dealing with crisis is having effective bankruptcy laws and processes. Recovery in Korea and Thailand has been hampered by the inability to work out the widespread debt problems of the banking and corporate sectors.

In many respects, these political and legal challenges are ones that governments have faced for a long time. What is different is how much it all matters in an interdependent global economy, where events in each country affect other countries vastly more than ten or fifteen years ago. It used to be, for example, that few in this country knew about the exchange rate of the Thai Baht, or declines in the Hong Kong stock exchange; now these events make front page news in papers across the globe and affect us all. Because of this interdependence there is an enormously heightened importance, first, of each country taking the right actions internally, and second, creating international mechanisms that encourage countries to make the right decisions, and that deal effectively with the over-arching issues of the global economy. At the core of these challenges is reconciling the sovereignty of nations with the transnational nature of the global economy.

Looking at all of this, some have argued that in today's world of huge global markets, government has, in essence, become largely irrelevant. I think that's exactly wrong. Government decisions will greatly affect how these markets will treat a country's economy. Moreover, decisions a country makes are all the more important because they can so substantially affect other economies.

The central organizing principle for our market based system is its tendency to reward companies and countries for good behavior, punish companies and countries for bad behavior, and allocate capital efficiently. But for markets to exercise this discipline, they must act with discipline. I've already referred to the excesses in lending and investing, stemming from an ever greater tendency to underweight risk as good times continued, that contributed so much to this crisis. Moreover, markets by their nature simply will not or cannot deal with some problems. If we are going to maintain and expand a market-based economic system, we are going to have to deal with these shortcomings of that system. Similar consensus motivated the reforms in the financial regulatory structure the United States has instituted for its domestic markets in the twentieth century, such as the creation of the Federal Reserve in 1913, and the 33 and 34 Acts during the Depression.

Similarly, this concern underpins the international community's ongoing but now greatly intensified focus on reforming global financial architecture for the 21st century. This involves enormously complex issues such as creating overarching surveillance of national financial system regulators, overcoming the effectiveness of countries that choose to provide safe havens from regulation, a potential problem, for example, with respect to the possible regulation of hedge funds, and making lenders and creditors part of the solution when crisis hits so that they bear the consequences of the risks they take. This last is especially important, since there is no international bankruptcy law and the debtors are often sovereign nations.

It is critical to remember, in designing new architecture, that broadly, the new global economy and global financial markets have produced enormous gains in human welfare, in countries around the world, including our own. And in my view, a market broad economic system and relatively free global trade in goods and services and flow of capital are the systems most likely to promote global economic well being going forward. But the world cannot live with the kinds of disruptions we have experienced over the last year. So, to retain this system we must make it less prone to instability, and more effective in dealing with the instability that does occur. And, we must make it a system that provides a real opportunity for all if the system is to have sustained political support.

So, considered fully, the critically important and intense efforts to deal with today's financial crisis and to design the architecture of tomorrow lie at the intersection of laws, politics, and policy-- the intersection where Yale Law School has lived intellectually for many decades, as manifested in the integration of law, policy and politics in the international arena so strongly advocated by Myres McDougal. It seems to me that this Law School is exceedingly well positioned to contribute to the understanding and intellectual work product requisite to addressing these great and important challenges arising from the global financial crisis. This might not be as interesting as arguing the question whether evil is an absolute or subjective matters but it is of enormous importance to the world we all live on in the years ahead, and a fitting subject for the School that long housed Myres McDougal.

In closing, it is nice to be back in New Haven and to remember the intellectual fervor of my years here and the enduring friendships that Judy and I formed in those years. So again, for all the Yale Law School has meant for my family and to me, and for this honor, thank you.