United States Diplomatic Mission

Ambassador Philip D. Murphy at Hertie School of Governance

Transatlantic Responses to the Financial Crisis
and the Roadmap for International Financial Reform
Hertie School of Governance
Berlin, April 28, 2010
Ambassador Philip D. Murphy

Vielen Dank, Professor Dr. Anheier,
sehr geehrter Bundespräsident a. D. Professor Dr. Herzog, Frau Herzog,
Professor Dr. Biedenkopf,
Professor Dr. Endres,
Mitglieder der Hertie Stiftung und des Hertie Kuratoriums,
Studenten und Dozenten der Hertie School of Governance,
Staatssekretär Dr. Wolff,
Mitglieder des Bundestages,
sehr verehrte Diskussionsteilnehmer,
meine Damen und Herren,

Professor Enderlein, im vergangenen Dezember haben Sie mich zu dieser Veranstaltung eingeladen. Damals war Paul Volcker in Berlin. Wir aßen mit Ihnen zu Abend, führten eine lebhafte Diskussion über Präsident Obamas Vorschläge zur US-Finanzreform und den Umfang der transatlantischen und internationalen Zusammenarbeit – speziell im Kontext der Finanzkrise. Heute, vier Monate später, arbeiten Demokraten und Republikaner die Details eines Reformpakets aus. Dieses Paket wird dann dem Senat zur Diskussion und zur Verabschiedung vorgelegt. Das Thema ist diese Woche in Washington von zentraler Bedeutung. Professor Enderlein, Ihr Timing ist wirklich gut. Sie haben den Zeitpunkt dieser Veranstaltung offenbar sehr, sehr sorgfältig gewählt. Danke, dass sie mir die Gelegenheit geben, einige Worte zur Diskussion beizutragen.

[Professor Enderlein, last December you invited me to participate in this program. Paul Volcker was in Berlin and you joined us for dinner and a lively discussion of both President Obama’s domestic financial reform proposals and the broader scope of transatlantic and international cooperation – especially in the context of the financial crisis. Today, four months later, Democrats and Republicans are hammering out the more specific parameters of a reform package before it comes to the full floor of the Senate for debate and passage into law. The topic is front and center in Washington this week. Professor Enderlein, you have very good timing. You obviously planned the timing of this event very, very carefully. Thank you for giving me the opportunity to add a few words to this discussion.]

President Obama has also had a lot to say on the issue of financial reform. Last week he spoke in New York on the topic and today in an hour or two he will he holding a town hall on the subject in Quincy, Illinois. From the White House to Wall Street to Main Street, he is urging lawmakers to redouble efforts to pass legislation to overhaul America’s financial regulation system. The discussions around the Senate legislation this week appear to be very polarized at the moment -- but negotiators have still expressed hopes for a bipartisan deal. I am of the fervent opinion that the American people will accept nothing less, and insist on financial market reform. Financial market reform will therefore happen although the exact change is still to be determined.

The necessity for this reform was made crystal clear by the financial crisis that first surfaced in the U.S. real estate market over two years ago. The crisis spread to Wall Street – and beyond – in no time. Several of America’s largest and oldest financial institutions collapsed, or nearly collapsed. In many countries, including Germany, there was initially a sense that the U.S. banking crisis would not spread. As we all know, as it turned out, many foreign banks and in particular German banks – the world champion exporters of capital – were hard hit.

We have learned – hopefully – a number of important lessons from this crisis. One lesson:  there are moments when strong government action is necessary to preserve economic stability. The stimulus programs that were implemented in the wake of the crisis by the United States, Germany and many other countries were undeniably effective. The crisis is receding and the economy is improving. In the United States, we have seen three quarters of positive growth. We are repairing our financial system at much lower cost than anyone anticipated. In fact, it is expected that hundreds of billions of dollars in available but unused TARP – that stands for Troubled Assets Relief Program -- resources will be returned to the American people. That is a rare achievement in Washington.

The true measure of this crisis, however, must be measured by the millions of lost jobs, the trillions in lost savings and the thousands of failed businesses. These indicators underlie the lessons of this crisis that are essential for longer-term economic policy and financial regulation. Economists and historians will be conducting an autopsy of the crisis for years to come. There should, however, be no debate about one thing: a central cause of the crisis was a financial regulatory system that was decades out of date and riddled with loopholes. The shortcomings of our regulatory system therefore had a very real and harmful impact on Americans, many of whom had nothing to do with Wall Street.

That applies to every country touched by the crisis. Overall financial market transparency, the "too-big-to-fail" problem,  the gaps caused by a "shadow" banking system, assessing who should bear the downside risk for failure, finding incentives that balance risk with responsibility – all these issues have been discussed at international meetings in Washington, London and Pittsburgh. President Obama, Chancellor Merkel and other G-20 leaders agreed – and are determined – to coordinate their response to the financial crisis by launching an ambitious regulatory reform agenda. There may not be agreement on all points but there is consensus on the need for reform. Strong financial systems are the foundation of sustainable economy for the future. The G-20 set out timetables for coordinating and then implementing new standards nationally. Here on this side of the Atlantic, the German government took early steps to overhaul its financial market regulatory system, reflecting its unique national financial system. Core changes concerning banking supervision were put in place by the Act on the Strengthening of Financial Market and Insurance Supervision in July 2009. Chancellor Merkel's cabinet approved draft legislation on executive compensation. Her Cabinet also took on the "too-big-to-fail" problem by approving a new insolvency law for banks. President Obama first unveiled his proposals for financial market regulatory reform last June. Certainly in the United States, reform is long overdue.

Free markets and a strong financial sector are part of what has made both America and Germany what they are today. Both for good and for bad, what happens in banks, executive board rooms and stock exchanges has real consequences across national economies, and around the world. A set of updated, commonsense rules to ensure accountability is an essential element of economic growth in the 21st century. And that such rules would be in everybody’s best interests – including those who sit in the banks, board rooms and stock exchanges.

Reform can bring a transparency to financial markets that I believe will ultimately be beneficial for all participants. For example, a central phenomenon of the crisis was the usage of derivatives and other financial instruments in ways that became so opaque and so complex that neither the people implementing them nor those charged with overseeing them understood the full implication of their actions. That is not to say that there is not a legitimate role for these financial instruments. Derivatives are crucial parts of the financial and economic system not only in this country but elsewhere around the world. Businesses large and small depend on the smooth functioning of the derivatives markets. When properly used and backed by sufficient collateral, they are a valuable financial tool. By managing exposure to fluctuating prices or currencies and fluctuating markets, derivatives can in fact help allay risk and spur investment – when they work properly. The problem is these markets have operated in the shadows of the economy, invisible to regulators and invisible to the public. Derivatives were bought and sold with little oversight, or as Warren Buffett said, until they became “financial weapons of mass destruction.”  The Senate bill, currently up for debate, would bring standardized derivatives into central clearing houses and trading facilities. Regulators will be able to monitor risks more effectively and prevent fraud, manipulation and abuse.

Another important element of financial reform proposals are strong consumer financial protections. Again, this is in everybody’s best interests. Reform is not about stifling competition or innovation. In fact, as President Obama pointed out to a Wall Street audience last week, it is just the opposite. Instead of competing to offer confusing products, companies will compete by offering better products. That will mean more choices for consumers, more opportunities for businesses, and more stability in our financial system.

The reforms that the President hopes Congress will approve gives shareholders new powers in the financial system. They will get a voice with respect to the salaries and bonuses awarded to executives. Without a doubt, in some cases, salaries and bonuses have created incentives to take risks that led to a relentless focus on a company’s next quarter, to the detriment of its next year or its next decade. That is wrong. I can think of many times both now as a diplomat and earlier as a banker, when it would have been very wrong to define the future based on a trend of the moment. Companies like nations or also individuals for that matter, should stick to a handful of core objectives and initiatives and not be swayed by the trend or fashion of the day and pay their people that way. There are always immediate, short-term actions that can be taken in response to current acute conditions, but those actions must not dictate or dominate the vital, long-term agenda. It is wrong and often irresponsible to extrapolate from either of those extremes. The wiser and the more careful course is to focus on long-term initiatives that can preemptively define a better future. In approaching our foreign policy priorities, my boss Secretary of State Hillary Rodham Clinton says that we have to deal with “the urgent, the important, and the long-term all at once.”  I would plead in all cases never to forget and always to consider the long-term element. I think this is also a good template for organizations.

In the context of financial reform, new financial regulations will place some limits on the kinds of risks that banking institutions can take – both short and long term. Professor Enderlein, I would like to say that we heard about the “Volcker Rule” first at the dinner last December with Paul Volcker here in Berlin. In truth, it was not announced until January but certainly the size of banks and the kinds of risks that banking institutions can take have been part of the debate all along – and Paul has often led the debate on this proposal. As we advance to the next phase of recovery from the economic crisis of the past two years, these are key factors in building confidence. And markets depend on confidence. They need clear rules and sound practices and they work best when basic safeguards are in place – safeguards that prevent abuse and check excesses. There has always been a tension between the necessity for rules and the desire to allow markets to function without interference. Managing this tension is what has allowed diverse and vibrant economies like Germany and the United States to keep up with a changing world. It is this tension that allows markets to adapt, to renew themselves and to thrive.

Even the smartest regulators however, armed with the best tools, will not be able to preempt every crisis, foresee all problems or anticipate unintended consequences. The best strategy for stability is to create a financial system with clear rules that set unambiguous limits on leverage and risk – clear rules, not onerous rules that suppress enterprise and innovation.

It is important that banks not see regulatory reform as just a source of uncertainty. The United States is recognized around the world as the place where new technologies and dominant firms can be started in someone's garage. It is banks that finance the startups where dreams are launched and new jobs are created. Even in times when problem loans reach record levels, banks need to continue to make credit available. That is the function of the financial system – to  allocate capital, to diversify and distribute risk. It has in many respects performed that function very well. But it has often also itself been a source of risk. Over the last three decades, look at the Latin American debt crisis, the 1987 stock market crash, the S&L debacle, the Mexican financial crisis, the Asian financial crisis, Russia/LTCM, the dot-com bubble, Enron, and now the financial crisis. As Larry Summers recently pointed out, John Kennedy took arms control far more seriously after the Cuban Missile Crisis. After the events of the last two years, we need to rethink very seriously, domestically and globally, our system of financial regulation. The President is determined to apply the lessons learned from the financial crisis to build a financial regulatory system for the 21st century. The so-called silver lining of all this pain should be that we have, at the end of the day, a much stronger framework and a more sustainable global economy.

The crisis was international and required an international response. As I mentioned earlier, G-20 leaders are determined to coordinate reform efforts and implement the new standards nationally. National strategies are an essential part of the equation. Countries have diverse banking and legal frameworks. They are sovereign states with national legislatures that must approve new regulations. One of the challenges is that in the globalized environment of the 21st century, companies, large and small, are almost certain to span national borders in one respect or another. Uneven implementation of reforms creates uncertainty for firms as they try to navigate myriad national regulatory frameworks. This can cause unforeseeable distortions in the global financial system. It is therefore critical that even as we move forward in our national contexts, we strengthen coordination within the G-20, the IMF, the Basel Committee and the Financial Stability Board. We have unique systems, but the U.S. and Europe – and Germany in particular – have much to gain by reading from the same script when it comes to revamping our regulatory framework. I am convinced that the need for a global financial system with consistent rules enforced evenly across countries – a level playing field – is essential, especially as we see the increasing presence and influence of new emerging economies like China and India in the international financial landscape. But our commitment to building a more resilient financial system is only one part of the story.

We are also committed to promoting sustainable patterns of global growth. Last April, the International Monetary Fund was projecting global growth in 2010 of just 1.9 percent. It is now projecting growth of 4.2 percent. Trade has risen more than 25 percent, and finance is flowing again to emerging markets. But much remains to be done. The pace of expansion still remains uneven across countries and regions. The financial crisis caused enormous suffering, affecting the most vulnerable in countries around the world. Unemployment is still unacceptably high.

I spoke earlier about long-term goals. One such long-term goal is to ensure the global economic growth of the next few decades is more balanced than that the last. In the United States, we are moving to stimulate private investment and job creation while boosting competitiveness and taking greater care to live within our means. Countries with large external surpluses, are looking for future sources of growth that are less dependent on fluctuations in global demand. In Germany’s case, I want to make clear, this does not/not mean that your country should export less or be less competitive, and it certainly does not mean that we lump Germany into the same category as China when we speak about imbalances. Rather, Germany may need to look for new ways to stimulate domestic investment and consumption. How you do that is something that you would know better than I, but I think you would agree that this is a good time for all of us to think about new, more sustainable business models.

Finally, I would be remiss in concluding my remarks without mentioning the financial situation in Greece and the implications for the EMU. It is another example of the collision of national and transnational agendas. Two years ago, we saw how dysfunctions in real estate markets exploded to affect international markets. Today we see how the budgetary imbalances and indebtedness of one sovereign country can affect the affairs of other nations.  The issues are complex, regional, and increasingly of global concern. Cycles for countries take a long time to ebb and will take a long while to flow. There are no easy fixes. I witnessed the Asian financial crisis in the late 1990s firsthand as a banker. The good news in this painful chapter is that if a package of strong reforms and substantial concrete financial support can be put quickly in place and progress can be measured, markets will express belief giving space to do the heavy lifting. That process will serve both the economy in question and regional interests.

Kurz gesagt, es bleibt noch viel zu tun. Aber ich glaube, dass das Glas halb voll ist. Und ich gehe davon aus, dass die hier anwesenden Experten genauso optimistisch sind, wenn es um die Erneuerung des Weltwirtschaftssystems geht. Vielleicht gibt es einen überraschenden Neuanfang wie beim Phönix aus der Asche. Vielen Dank für Ihre Aufmerksamkeit.

[In short, much remains to be done. But I believe in the glass half full philosophy. And I take it that the panel of experts this evening is just as optimistic about the chances for a renewal of the global economic system, and a miraculous comeback like Phoenix rising from the ashes. Thank you for your attention.]