Its my pleasure to remind you that you are welcome to buy a copy and how will be available to autograph them after words. Here we are in the stylish new Conference Center to discuss a very old problem, namely how best to survive financial panic of which there have been many throughout the century, how to survive the fear and mistrust when financial actors try to withdrawal from risk to protect themselves, a rational strategy for each but as we all no, not when they do it at the same time. It is highly interesting historically but much more pressing than we can consider as how scotts book does in detail. What should we do in the next panic that will arrive sooner or later. Two centuries ago they accurately observed, on extraordinary occasions, a panic may seize the country one becomes desirous of possessing him self of precious metals. Again such panic concludes that banks have no security on any system that is to say that private banks on their own. In 1873 they drew the conclusion we all know whats true then and is still true now to which, if all the creditors demand their money at once, they cant have it. Moreover they go on, when apprehension passes a certain bound, no private banker is safe. They also say every banker knows that if he has to prove he is worthy of credit, however good his argument may be, in fact his credit is gone. Thats what happens in a panic. Everybodys credit is gone because nobody can prove he is worthy of credit and were not even sure about their own solvency. What do you do then . Then you have to finance the bust. The central bank and the government treasury provide new debt and new equity, expanding their own Balance Sheets so everybody elses Balance Sheet can shrink, expanding their own so everyone elses can go down. That is what you have to do if you want to avoid driving asset prices into a wild downside overshoot. His book discusses how this survival process has been made much harder by the post crisis legislation in the u. S. And the dodd frank act. He interestingly points out how this is different from other countries. For example he said the United States is unique in bailouts in the future. There will be bailouts in the future but they could be harder to do. We could greatly reject the changes that have been made if theyre not corrected before the next crisis and those changes will make things, the next time, a lot worse. How scott will present his book for about 25 minutes and then we will have comments from our outstanding panel. Our author, hal scott is a professor and director of a program on International Systems at the Harvard Law School where he has taught since 1975. He is also director of the markets regulation, a member of the britton Woods Committee and the past president of the international. [inaudible] his books include the Global Financial crisis and tonight he is presenting connectedness and contagion. He will discuss how to be better prepared for the next crisis. Welcome to the pope podium. [applause] thank you for the introduction and thank you for hosting this event. The thesis of my book is that the heart of the 2008 crisis, and most other crazies was Systemic Risk in the form of contagion. This crisis was successfully stems with weapons. Post crisis all of these weapons were eliminated primarily by dodd frank as undesirable bailouts. Dodd frank purports to solve the contagion problem with what i call to wings and a prayer. The wings are heightened capital and new liquidity requirements. You dont ever abolish the Fire Department even if you have. [inaudible] thats what the attitude has been. Have an anti bailout consensus that is very low so we are dangerously exposed to future crisis. Let me talk about the elements of sis democrat. The point of the Financial System is to prevent Systemic Risk of which there are three varieties that i call the three cs. Correlation, connectedness and contagion. Connectedness comes into flavors it can set off a Chain Reaction of failure. One failure can uncover the finding of more failures. If repose were to fail, that would create a problem. Contagion is where the actual ale your or of failure of the Financial Institution causes shortterm credit or investors to and withhold funding for Financial Institutions either out of a lack of information or a rational for some combination. The first part of the book looks at whether the problem in 2008 was contagion or connectedness. Contagion, in my view, was the primary driver of the 2008 financial crisis, basically asset, was not the primary driver, excuse me, of the financial crisis. Major banks saw some deposit runs but. [inaudible] they put contagion in overdrive is shortterm creditors headed for the exit internet thats feared for the institutions to which they extended credit might be the same fate. The failure triggered a major run on u. S. Money market funds starting with the reserve primary fund on september 16, 2008 going mainly to investor. [inaudible] the runs spread quickly across the industry, including institutions with no significant [inaudible] it also spread to commercial paper markets and money market shifted for government securities. Many banks discontinued lending completely. Thats what happened. Many people believed asset connectedness was a major problem during the crisis. The book examines the claim in detail. It was less than a penny on the dollar and no Financial Institution connected failed as a result of the failure of lehman. Moreover, no Financial Institution exposed if aig would have failed. This does not take account of the cds that they had on aig which further protected them from loss. Nonetheless, the scenario coming out of the crisis was that it was connectedness problem. Dodd frank reforms largely focused on this. Its largely built around connectedness. We will look at the terms of designation. A lot of connectedness. As a Central Clearing for all the derivatives, they argue we have to meet julys losses and we will have a Chain ReactionChain Reaction of failure. It certainly bilateral exposure in dodd frank. While one can argue that these reforms are desirable as prevented measures, generally apart from the experience in 2008 connectedness was not a problem in 2008. Dodd frank also gives Something Else which was to legislate with wrist act ii contagion. As i said at the outset, 33 measures were deployed during the crisis to stop this on banks , limited ability of guarantees. [inaudible] the fed was created in 1913 to to stop financial panics. The latest of which was 1907. Interestingly, that panic in 1907 started in the nonbank sector at the Knickerbocker Trust company. During the 2008 crisis the fed discharges a last resort responsibility to a variety of names, lower penalty rate, discount window and wider access for primary dealers for the window and a term auction facility for major changes. A number of new facilities were created for nonbanks. I cant go into all of them here but they included the commercial Paper Funding Facility to purchase unsecured and a bcp paper from issuers and the money market investor funding facility to purchase assets for Money Market Funds to provide them with liquidity. The supply of this liquidity to the Financial Sector doubled to 2 trillion by 2009. In 2007, before these actions, 91 of the Balance Sheet was of the Balance Sheet was invested in u. S. Treasuries, by 2009 it was only 25 due to lending expansion. Supply and liquidity to the nonbank system was fairly important. More portly, the availability of these facilities help stop the run. The fed and taxpayer actually benefited. They make money on the assets and supports general revenue. In 2008. [inaudible] as i said a key part of the lending was to nonbanks but the contagion run was centered after the 2084 failure. I estimate there was about 7 trillion. The percent of this in nonbanks, Money Market Funds and broker deals. The ability to lend to nonbanks in a crisis is essential. I would expect this to increase as lending and Capital Market activities are driven out of the overregulated Banking System. The Legal Authority for this funding to nonbanks was the quite broad Section Three of the Federal Reserve act. It provided that in unusual circumstances the board could authorized loans to any individual or business. This authority is quite separate from the discount window authority under sections 10b and 132 of the Federal Reserve document to lend to depository institutions. This was crucial in stopping the contagious run, after the fact it was and continues to be widely attacked. Legitimate concerns are there but the beneficiary were largely victims that cant panics. Solid institutions would be set by these runs. This anti bailout concern triggered radical calls for changes for nonbanks but it did not transfer over to the feds count window. The result was that the dodd frank act laced constraints on the feds are teen three lending authorities. What are they. The fed can only lend to nonbanks with the approval of the secretary of treasury under procedures adopted in consultation with treasury. Interestingly this requirement for approval was first put forward by the treasury itself then added by the secretary. Perhaps this was just another chapter in the fed chapter 24 or maybe they thought it was a way to protect the fed from greater restrictions which were being considered in the congress. One can argue with the importance. It is really taking independent authority away from the fab. The law secretaries and treasury and the new anti bailout environment be willing cheerleaders . Treasury approval was now carrying a significant risk. If we think it is important for the fed to have independence to lend to banks, why not the nonbanks and everincreasing in factor. Second the amendment that they provide can no longer make one off loans to single beneficiaries that it did in 2008 to aig. It must now do so under abroad program. Institutions must be eligible for any fed program. This means eligible at the time the fed provides the first loan it may make it harder because youll have to wait till five institutions have the problem. If it means ever eligible for a loan then it is not much of a restriction but under that interpretation first loan could trigger calls of problems or illegality. A lentil value was assigned. This rained in the Feds Authority to buy unsecured commercial paper which it did for major. [inaudible] during the crisis. Fourth the fed can only loan to solvent institutions, a requirement not applied to banks, just nonbanks. The solvency requirement is a cardinal principle in the 19th century formulation of the window of laughable resort one reason for not requiring the central bank is the judging solvency is extremely difficult. An underlying argument for solvency requirement is that it should be a fiscal issue and that the congress would play a major role through preparation as it did indeed. I sort of agree with this point. If you have that point of view then lender of last resort needs to be coupled with Standing Authority so there is the possibility that the treasury can act when the fed cant. A fifth provision of dodd frank provides for disclosure. All loans to nonbanks must be reported within seven days to the chairman of the house and Senate Financial committee must be disclosed to the public within a year. On the banking side, one change on the window, all discount window loans must be publicly reported within two years. The concern of those Disclosure Requirements are much more stringent than those facing any other major bank. Within two years they discourage buyers concerned with stigma from seeking needed support. Thats the worst than the problem. You want them to get the support indeed in the crisis, they avoid the discount window out of the fear that their borrowing could be leaked or covered by illness. They can no longer pass on discount window loans to their affiliates without being subject to normal section 23 a limits on inter affiliate lending which would be precluding the pass off. This means substantial borrowing would have to occur under the new restrictions of 133. Indeed the multiplicity that are now imposed on section 133 but did not apply to discount window borrowing which is reserved for depository institutions, the new york fed president suggests last may that the congress amend its discount window authority to. [inaudible] this is dead on arrival because it would, in effect, represent a repeal a repeal of the dodd frank restrictions. They said they could live with these restrictions on november 15 last year they passed an act largely along party lines. The bill has not been enacted into law. Federal reserve can only lend two nonbanks if all regulators of the potential borrower which would include the sec or the cf pb would have to certify that the borrower was not insolvent. Chair yell and said the time that these provisions would end Federal Reserve lending to nonbanks. This has now been incorporated into the house financial reform. These attacks on the feds role of lender of last resort are not recent. My book were counts how opposition to court federal bank whether lending to commercial or Bank Borrowers goes back to the early controversies over the first and Second National bank. Andrew jackson vetoed the renewal of the Second National bank in 1832. It is this debate over federal Bank Institutions that took us so long to create the fed in 1913. The debate still goes on. All right, so the second part of the fight against contagion were guarantees. They used the authority to remove authority for transaction accounts. Increased insurance limits. Wow dodd frank increase the limits to two 250,000, they 50000, they couldnt raise limits in the future without joint resolution from congress. [inaudible] this power was also taken away by dodd frank. They did make money on these programs. In addition, in 2008, the treasury used this authority to guarantee the Money Market Funds this had a major effect on the funds. This was taken away by dodd frank, no by the earlier tarp legislation. Runs on Money Market Funds remain a problem in my view which has not been cured by the secs required floating Net Asset Value on prime institutional funds. They expect values to go lower. Sec rules give the authority to charge for redemptions in average conditions. The final tool we will use to combat contagion is tart. As of june 2016, there had been 200 alien of capital injection in the bank. The treasury made, not lost 16point to billion. The taxpayer did not pay portraits tarp expires by its own terms. Much unlike the eu which has Standing Authority for capital injections, the u. S. Needs such injections in the future, authority would have to be obtained and might have to be contained in limits for the crisis itself as it was in 2000. Now, on contagion fighting powers had been curtailed, the centers of dodd frank point to what i call to wings and a prayer. The wings being capital and liquidity and the prayer being the resolution procedures. The premise is that contagion is much less likely if you nine not worry about it before. We have greatly increased Capital Requirements, nope doubt about it. I put aside the difficult issue about methodology and Capital Requirements. [inaudible] lets not fool ourselves. There are major methodological problems in Capital Requirements when theyre not done by the market. Capital requirements can reduce Systemic Risk by decreasing the probability of bank failure from any form and they generally reduce. [inaudible] no realistic level of capital can prevent a run on banks. Fire sales and capital is quickly eroded. Even higher capital proposals like suggestions of 20 or 30 of leverage ratio, and Capital Requirements only apply to banks, not to the ever increasingly important nonbanks. The second way was liquidity. After the 2008 crisis, we adopted certain liquidity requirements, most notably the coverage ratio which has a 30 day horizon and requires banks to hold high quality liquid assets to cover funding runoffs. These requirements in effect scourge lending. Again, they do not a plate apply to nonbanks. As for Capital Requirements, there are significant issues around runoff exemptions and liquid assets. In my view, the new adoption of private liquidity requirements represent a retreat by the fed from providing public liquidity as a lender of last resort. The fed can now say it will only be a backup source of liquidity. The frontline is the banks liquidity itself. Ironically the private requirements may actually reduce collective private liquidity because it requires each bank to hold their own liquidity rather than making it available to others in a crisis. Whether it really comes to prevent that lending is open to question. Two minutes, i think ill make it. So the prayer is