FROM THE OFFICE OF PUBLIC AFFAIRS

It would be an honor for anyone to speak to this distinguished gathering.  It is especially an honor for me as a Treasury official, because you play the central role in the theme I’d like to examine today. 

My theme is the remarkable resilience of the U.S. financial markets – and how you in the private sector, and we in the public sector, need to work to keep it that way.

I begin with a scenario with which many of you may be familiar.  Imagine that the stock market has fallen, say a third, since its peak two years before.  The economy is in the doldrums.  And to top it off, an enemy has attacked the United States, slaying thousands of U.S. citizens.  The stock market tanks even further.

 The year?  No, not 2001.  It was 1941.  And the story of the financial markets then, as now, was one of bouncing back to meet the challenge.  Has it been the financial regulators, the government, that explains this resilience?  I’d say no.  While the government may help (putting aside the military, which had a little to do with defeating the Axis in the 1940s and Al-Qaeda and other terrorist threats today), the real leadership has come from the private sector.

Take the corporate scandals of the past year or so.  Of course, Sarbanes-Oxley and the reforms the Securities and Exchange Commission has implemented have helped.  But the main reason calm has more or less returned to the equity markets is that investors have forced a new discipline on corporate issuers, forcing them to right their internal governance after an age of excess.

 The same goes for the clarity of firms’ financial reporting.  As a number of leading financial firms have discovered, investors now charge a premium for financial disclosures as murky as a muddy pool.

 And the private sector – that’s you – also has a much richer appreciation now, as do we all, of infrastructure resiliency.  Before September 11, most of the financial industry, certainly its high-flying leaders, saw back-up systems and sites – the emergency plumbing of Wall Street – as the province of back-office worry-warts.   Important, maybe, but bothersome.  But what those back-office guys knew is that the deal isn’t done until it’s fully cleared and settled; and a Wall Street with cracked pipes smells as rosy and functions as well as a stopped-up bathroom plumbing.  It turns out that all those Y2K preparations proved more useful than we had thought.  And going forward we won’t make the same mistakes.

 Admittedly, the effort to improve the resiliency of our financial markets involves costs, but these are insurance premia.  The costs of being unprepared would be much higher to both you and the economy than the costs of improving financial market resiliency.
 
I’d like to discuss three ongoing projects or issues concerning financial markets of interest to all of us.  Your interest in these issues is due to your roles as financial market participants.  The Treasury’s interest in the efficiency and resiliency of our financial markets stems from our responsibilities for financial market policy.   We are also vitally interested in the secondary as well as primary government securities markets.  As this audience appreciates, the Treasury relies heavily on the primary market to meet our financing needs and issues new securities every week of the year.  The primary market in turn relies on its backbone, the secondary market, to attract consistent and deep interest.

First is the Federal Reserve’s initiative to explore how to improve the arrangements for payment and settlement of and related services for government security transactions.   The Federal Reserve is concerned about what happens if one of the two major clearing banks for government securities is unable to provide services to the dealer community.  This concern, which we at the Treasury share, has received greater attention because of the aftermath of September 11.  However, we are not just concerned about what happens as a result of a physical attack or natural disaster, since there are other reasons that a clearing bank might be unable to function.  Some scenarios for an involuntary exit of a clearing bank from the business may be unlikely, but are not impossible.

The first major step in the project was the Federal Reserve’s and the SEC’s white paper in May – “Structural Change in the Settlement of Government Securities: Issues and Options.”  Treasury staff were involved in the discussions with interested parties prior to the release of the white paper and assisted in its preparation. 

In response to the comments on the white paper, the Federal Reserve last month established a private-sector working group on government securities clearance and settlement.  That group is charged with preparing for the Federal Reserve a report discussing possible mechanisms by which if one functional clearing bank for whatever reason has to cease serving customers, the other could step in. 

The working group includes representatives of the two clearing banks, the dealer and broker community, the mutual fund industry, and other interested parties.  Staff from the Treasury, as well as from the Federal Reserve and the SEC, are attending meetings of the working group as observers and technical advisers.

Many of the issues before the working group are far from easy, such as those posed by triparty repos, and the group’s task is important.  The Treasury will accordingly keep a close eye on developments in this area.   Let me be clear, however.  We do not at this time prefer a particular solution for mitigating these risks.   We believe that the best solutions will come from a cooperative effort with the private sector, as with the Federal Reserve’s working group.  I challenge you, and ask you, to make the most of this project.  Only if you provide the technical expertise and analysis of those who work in the markets every day, and only if you propose practical options that the various industry segments can accept, will this working group lead the industry and us to a robust solution.

A second issue is the concerns that have been raised about General Collateral Financing (GCF) repos cleared through the Government Securities Clearing Corporation.  The concerns center on the settlement practices for this product and on the net debt cap limits on payments made through the Federal Reserve System.  We at the Treasury are monitoring this discussion with care.  This product, which has shown enormous growth in the last several years, provides important benefits to participants in the government securities market.  We hope that the parties involved can devise creative solutions to the concerns raised.  We have not taken a position, but will continue to talk to interested parties and intend to be as helpful as we can in assisting the effort to come up with solutions.

The last project of note is the draft white paper on “Sound Practices to Strengthen Resilience of the U.S. Financial System,” which the Federal Reserve, the Office of the Comptroller of the Currency, and the SEC issued in August.  We understand that there is some controversy about aspects of this paper.  How to improve resiliency of our financial system in the event of catastrophic events and how best to achieve and implement these mechanisms are and should be topics of legitimate debate.  We believe, however, that it is vitally important that we improve the resiliency of the financial system because of its indispensable role in our economy.                 

 Let me return to my overall theme: that the primary responsibility and capability for improving the resiliency of our financial markets lies, as a dictate of reality, with the private sector.  We are ready to do our part.  But without your initiative, creativity, expertise, and leadership, we cannot make our financial markets as robust as they must be for the challenges ahead.