Reduce the likelihood of another crisis and its severity if it occurs may prove beneficial, although i argue with some of the details but the book argues persuasively that none of these reforms individually or collectively are sufficient to stop one once it starts, there is another point i need to make on a personal note. Many years, the richmond fed has warned of the dangers of fed policies or actions involving credit allocation. My colleague and a good friend refers to credit policy is distinct from Monetary Policy. I share this concern and have to confess i have generally thought about it in a macro Monetary Policy rather than the context of the letter of last resort. Scotts book challenges me by demonstrating the financial crisis is an oldfashioned run forcing me to ask if it would be feasible dealing with a future crisis to involve some credit policy risk. That has me asking fundamental questions. I feel compelled to offer i found the reasoning in a few sections on the 10 side. One section in chapter 21 discusses the possibility the feds current reverse repo program might be used to or result in some way a crowding out of a significant portion of the economys private liability and goes on to consider how such a Development Might conflict with the feds basic Monetary Policy objective. I was on an amtrak train south of washington behind a Freight Train when i read that session so maybe that had something to do with it. One or two others could be simplified a little bit. I have probably said enough to signal i can do it. I can do it. In closing let me salute the issue that the strength of the book for me highlights. Discretionary Emergency Powers will confront rising. How do we reconcile legitimacy requirements of a democratic society. This is a critical question with highly populist elements, the doddfrank requirement of treasury secretary approval and discussion and importantly the requirement, company requirement the secretary consult with the elected president in making such decisions is a recognition of this issue although we have seen it is problematic. Resolving this fundamental tension in our political economy if possible at all, this particular book, some question about the issue. I believe the contribution, the former Deputy Governor of the bank of england regarding the legitimacy of Central Bank Independence not only the emergency lending arena but Monetary Policy arena. Inking, some of his work from what i have seen, that is a good place to start thinking about these issues. This is a really interesting book. One is called connectedness. The term fragility is used to describe what he is talking about with connectedness or network, a huge amount of research by finance professors on finance and scott comes along and tells us a lot of this research is useless or not relevant to explaining the financial crisis for reasons i will talk about in a minute. The second see that is not in the title of the book, the title which is connectedness, the second is what scott calls correlation. I like to think of correlation as capital associated with deleveraging. So a big shock is declining real estate prices, the economy, it turns out the real estate assets affected a lot of them are there in the Banking System, Mortgage Loans of various types and turns out loantovalue ratios were very high and when standards are relaxed the result was one housing prices fell, many banks simultaneously are in a correlated manner from their capital and their are a lot of macroeconomic and finance research that says Financial Institutions are going to deleverage and the reason they have to deleverage is they are holding these mortgages with leverage as capital leverages 201 or whatever ratio is. Then there is the third see in the title, contagion, that is what i call panic, and what a lot of other people would call panic. Scotts book gives us a different view on the financial crisis and its relationship to the doddfrank act before i read the book. Before i read the book, the way it changed, the way i used to summarize the doddfrank act is a big hole in the Financial System as a result of declining real estate prices and the problem that needs to be fixed was banks needed more capital. The sooner they got it, the more capital they got the more rapidly the Financial System recovered. My summary of the doddfrank act, the doddfrank act did encourage policies to make banks have more capital, really what it did is put regulations on the Financial System so the authors of the doddfrank act had thing to tradeoff between mandating more capital and mandating more regulation and they chose to mandate more regulation but scotts book changed my view on that and as he points out if you have a capital problem or even if you dont have a capital problem you can have a panic which people are going to tell you if you do have a capital problem it keeps getting worse. Before the Financial Institutions collapse or declare bankruptcy from lack of capital people are going to try to pull their money out and when that happens you are going to have a panic and the panic is not only going to hit the bank that was truly undercapitalized and on the verge of insolvency but all the other things in the system regardless whether they are well it will be indiscriminate and create a crisis and require Immediate Response and the Immediate Response that is necessary to fight this contagion or this panic is lender of last resort or other credit support facilities have to be provided by the fed so how scotts work comes in, its as if you look at the doddfrank act which you are going to find is not just imposing regulations on regulations for regulation sake but the misguided theory behind it is that the saids lender of last resort Facility Needs to be curtailed and needs to be harder for the fed to provide liquidity support to Financial Institutions need to be recapitalized but you have a panic going on and you need some strong immediate action. He spells out the scenario in great detail and it changed how i think about the financial crisis and it does make me worry whether the fed has the tools it will need to fight the next financial crisis especially the next financial crisis originates outside the Banking System the fed itself is most capable of making lender of last resort loans. That is the big picture. There are some interesting chapters in the book that described in more detail what i just said so let me mention a few of them. In talking about connectedness he paints a beautiful picture of Lehman Brothers, Lehman Brothers itself is an incredibly fragile institution, huge important connections between the Holding Company and subsidiaries and the result of that is if problems start within Lehman Brothers there is a connectedness problem, these problems spread throughout Lehman Brothers so Lehman Brothers itself, a very detailed picture, Lehman Brothers itself collapses in a very connected way but the sense in which he is saying the connectedness was not important for the financial crisis is when you look to see how the financial crisis spreads from Lehman Brothers to the rest of the economy it didnt spread through connections. Didnt spread lehman was defaulting to Goldman Sachs which defaulted to the next and the next and the economy. That way. Instead Lehman Brothers just kind of collapsed rather neatly through its own internal fragility but it didnt spread to the rest of the system through these connections which it spread through panic, the reserve funds, those lehman assets declined in value, investors in the Money Market Fund will happen. The investors who invested in the other Money Market Funds panicked, pool their money out of those funds even if they didnt invest in lehman assets at all. Takes an interesting picture of how fragile Lehman Brothers in itself and how that fragility was not what made things passive the rest of the Financial System. If you look at the collapse of bear stearns which happened months before, bear stearns collapsed in a way that was similar to lehman, you didnt have the panic at that time. The panic waited until later. Interesting thoughts about connectedness, let me talk about correlational what i call capital. The crisis of 2008 was largely a problem of capital and the book has interesting chapters on contingent capital as a way to deal with this and also quarterly resolution. One minute left. Early resolution and other ways to bail out and tired and how that happened but i end with one note about contingent capital. One area where i disagree with the book. Contingent capital does not have to be longterm liability of the bank, it can be shortterm. Contingent capital is it has to be replaced, the banks got one year maturity contingent capital but the bank cant replace it with contingent capital. That contingent capital is not being replaced. It has to get converted into equity. The second thing that i finally disagree with, he says one trigger mechanism for contingent capital, gets into trouble, one conversion, bank stocks decline and gets converted. Scotts book says if that happens that can amplify panic and that is not quite right because one interesting thing about contingent capital is panic makes contingent Capital Investors not rollover the capital so that it converts. All of a sudden theres a massive inflow of new equity the Banking System has gotten from the conversion of contingent capital and that is going to stop panic, not make them worse. We should think about that and certainly think about, worry about the ability of the fed to exercise the powers that it needs to act as lender of last resort next time a financial crisis occurs. [applause] be change in his new book connectedness and contagion protectiung the Financial System from panics hal scott reminders historically the first and most important function of the central bank, the provision of lender of last resort liquidity to stem the financial crisis. Lender of last resort was the reason most Central Banks were originally created. Doddfrank comes along and sort of cut off the Federal Reserves ability to effectively do lender of last resort, lending for much of the economy. I will focus my remarks on lender of last resort. In his book hal scott does a good job distancing between connectedness and contagion. All Financial Institutions are connected, no surprise there but contagion is a property whereby the wellbeing of one firm can impact the wellbeing of many separate firms that are not necessarily connected to the firm in question. For example the reserve primary fund breaks the buck and other institution money funds without exposure to either the reserve primary fund or Lehman Brothers need liquidity assistance to meet redemptions. The classic example of contagion, a run on one bank creates a general panic and depositors run healthy unconnected banks. The Federal Reserves wideranging powers in the recent financial crisis has been unfavorably portrayed as a taxpayer bailout of the financial sector. As a consequence the doddfrank act place new limits on Federal Reserve powers. It is a complex issue. Emergency provision of liquidity will probably always have the appearance of a special privilege for a few select firms and in a real sense it is. It protects Financial Firms from suffering firesale losses. The justification for llr is Financial Firms undertake fire sales which affect other firms and firms may be rational for shortterm creditors they are not always justified through economic fundamentals. It is based on the idea everybody can be made better off if the government can prevent panic but the feds llr policies were discretionary, so without these fundamentals, should be allowed to fail the is the rub is in the midst of a run you cant tell the difference between a firm that deserves liquidity support and one that isnt. The judgment call can always be open to criticism. Why save bear stearns and let lehman fail and save aig the next week . Discretionary policy create a lot of problems. The need for llr is somewhat ironic given regulatory rhetoric. Financial regulators are quick to highlight the disciplining effect of market forces. Almost never described as such but a bank run is the most fundamental of all market system forces. Many scholarly papers are written to explain how the battle business model, investing longterm loans is a market innovation, not a mistake. Investors require banks to fund themselves using shortterm liabilities precisely because of this fragility impose discipline on the banks investment decisions. It was unlikely to be a successful banker, at least not for very long. Regulators espouse the enthusiasm but simultaneously argue they need lots of tools to prevent bank runs and fire sales. House got hal scott suggested is stacked against new discretionary fed lender of last resort powers. The political Sticking Point maybe not lender of last resort so much as free and discretionary of the prior fed l rr arrangement, the Federal Reserve should work together, it relies on a market where institutions pay the taxpayers to purchase liquidity insurance, i want to go farther in the next few minutes i have. They will sell liquidity options. Liquidity options are options that can be presented to the Federal Reserve and exercised as long as they have appropriate collateral and receive a loan from the fed. The fed should sell two kind of liquidity options. One that allows the Term Exchange of collateral, i bring bank loans to the fed and get treasury bills in return and one that allows acceptable specified collateral to be exchanged for reserve or balances for a fixed term. There is security lending liquidity option in a repo kind of lending option. The instrument should be sold at regular fed auctions and they should be traded in secondary markets. The option should have specified Exchange Terms that are less generous than those in the private security and lending markets. The price of liquidity options reflect shadow price of emergency liquidity. With Bank Liquidity coverage ratio and funding ratios, and Financial Institutions, they were amended to allow liquidity options to satisfy this requirement. And the risk sharing, the Self Insurance approach for liquidity insurance. If you did Something Like this with market terms, emergency liquidity access would no longer be a special privilege but the exercise of liquidity insurance on previously agreedupon terms paid for the right to exercise the liquidity option. They should be open to all Financial Institutions, not just depositories. If the liquidity crisis were subsequently to develop, the terms of the liquidity insurance contracts could be adjusted to allow the fed to provide all the emergency liquidity the economy needed. They could lower the rate over the market rate, change collateral terms and still sell them to meet the liquidity demands of the economy. This removed the need for the Federal Reserve to determine whether an institution is solvent, liquidity support, they have the option and the collateral to honor the contract, taxpayer losses could be prevented by the appropriate haircut and granting the Federal Reserve priority on borrowing institutions that subsequently enter bankruptcy and post losses on the fed. A marketbased solution to some of these problems stem the issues, and how it talks about a proposal, i would like to see in a little more detail. Many problems we discuss in the book, the book discusses an important issue, a lot of food for thought about the right way forward. The most distressing problem created by doddfrank. And al mentioned Musical Chairs. We challenged after the crisis to come up with a metaphor for panic and Musical Chairs is a natural one. Imagine a game of Musical Chairs that has 500. For a Financial System, one of the problems for a lot of factors, 500 people playing Musical Chairs, 700 chairs, the music that is playing is charming. Everybody easily find the chair. Suddenly the music shifts to obnoxious popular music, 400 chairs are removed, 500 players, 300 chairs and that is a great picture what happens. Comments coming. A reference to paul tucker and the legitimacy of central bank independents which is under discussion. Peter wollaston and i discussed coauthoring a piece on contagion. P