Program might be used to or result in some way a crowding out of a significant portion of the economy shortterm private credit liability. And then it goes on to consider this is where i got into trouble. Such a Development Might conflict with the fifth Monetary Policy octave i got confused i will tell you i was on an amtrak south of washington behind a Freight Train when i read that section. That had something to do with it. But ting that section and one or two others could have been simplified a little bit and then clarified. I probably said enough by now to signal my high regard for this book, i can do it. I can do it. [laughter] but in closing let me salute that the very strength of the book for me actually highlights if the fed and the fdsc needs strong and essentially discretionary Emergency Powers to prevent or confront o runs how do we reck are sile such powers with legitimacy requirements of a democratic society. This is a Critical Condition in today political environment with this populous element. That dot frank requirement of secretary approval and weve discussed launched to nonbanks and the requirement, company requirement that the secretary consulted with the elected president in making such decisions is presumably a recognition of this issue although we have seen i would argue a problematic one. Resolving this fundamental tension in our political economy if thats possible at all is beyond the scope of this particular book although theres no question that hal is aware of the issue. Yods believe some of the contribution of paul tucker former Deputy Governor of the bank of england regarding the legitimate city of central bank independents not only in the emergency legending arena but in the arena looking at them as a regime taking them together some of the his work and i havent finished it yet but what had ive seen i think thats a good place to start thinking more about these issues. Thank you very much. Thank you. [applause] this is a really interesting book. Hes got three scott has three cs one of them is called connectedness, finance professors and microeconomists often use term to describe what hes talking about with connectedness or o networks but put a huge amount of by young professor on Network Theory and application and networks to finance. And how scott comes along and tells us in a lot of his research is pretty useless or o not really relevant to plaining what happened the financial crisis for some good reason ill talk about in a minute. Youve got the second c thats not in the title of the book, but the title of the book is connectedness in contagion. The second c is scott called the correlation. I like to think of correlation as Capitol Associated with a big shock in this case it was the decline in real estate prices. Hits the economy, and it turns out that the real estate assets that are affected a lot of them are in the Banking System. Their Mortgage Loans of various times and learn to ratio are high and legending has been relaxed so result when housing prices fell many banks simultaneously or in a car related manner suffered hits to their capital and theres Financial Research that swhais that happens, these Financial Institutions are going to deleverage. And that the reason they have to deleverage is they were holding these mortgages with leverage. You know, theyre capital leverage ten or 20 to 1 whatever ratio ising that regulators allow them to hold it. Expwn theres the third c, thats in the title contagion, and contagion is what i call panic and i think what david calls panic and what a lot of people would call panic. Now, how scott books gives us a different view on the financial crisis and its relationship with the dot frank act than the view that ive had before i read the book. So lead me tell you the view i had before the book and changed my view. The way i used to summarize the dot frank act is to to think of a decline of the real estate prices and problem that need to bics ifed was banks needed more capital and the sooner they got it, and more capitol they got, the more rapidly the Financial System would resolve. And my summary of the dot frank act was that while the dot frank act did encourage policies to make banks have more capital, mainly what it did is impose a lot of regulation on the Financial System so that the authors of the dot frank act had faced a tradeoff between simply man dating more capital and man ditting more regulation. And they chose to mandate more redges than more capital. But how scotts book has changed my view on that and as he points out, is if you have a capital problem or even if you dont have a capital problem you can have a panic but charles good heart and ricardo and other people will tell you if you have a capital problem that 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 map happens you are going to have a panic and not only going to hit the bank that maybe it was truly under capitalized on verge of insolvency but hit banks regardless whether theyre well capitalized or not but it is going to create a crisis. An the crisis requires Immediate Response. And the Immediate Response that is necessary to fight this contagion or this panic is last resort facility or other credits work facility and they pretty much have to be provided by the fed. And so how scotts book comes in and sayses you at the dot frank act what youre going to find is not just imposing regulation on regulations for regulations sake. But theres a misguided theory behind it. And misguided theory behind it is that feds render eve last resort facility need to be curtailed harder for the feds to provide liquidity support to Financial Institutions that may well need to be recontaminate liesed but in the meantime you have a panic going on, and you need to address that panic with some very strong immediate action. So he spells out this scenario in great detail an changed the way i think about the financial crisis and makes me worry our fed has tools that it will need to fight the next financial crisis especially if might well happen is next financial crisis originates outside of the Banking System that the fed is itself is most capable of making of resort loans to. So thats the big picture. Theres some very interesting chapters in the book that describe the more details about what i just said. So let me mention a few of them. First of all in talking about connectedness. He paints a beautiful picture of Lehman Brothers. And Lehman Brothers itself is an incredibly fragile institution. Theyre a huge important connection between the company and the subsidiary and cross guarantee and so forth, and the result of that is that if problems start within Lehman Brothers theres a connectedness problem. These problems are going to spread throughout Lehman Brothers. And so Lehman Brothers itself as he paints a detailed picture Lehman Brothers itsz collapse in a very connected way. But the sense hes saying connectedness not so important for financial crisis is when you look to see how the financial crisis spread from Lehman Brothers to the rest of the economy, it didnt spread through connections it denied spread lehman was defaulting to another Goldman Sachs and then default to the next one and next one default to the next one and economy blew up that way. Instead lehman brother kind of collapsed wrath arer need t neatly through its own internal but didnt spread to the rest of the system through the connections but through the rest of the system through panic to reserve fund and access and decline in value and that market fund lost the money so what happened . The investors who invested in other market fund panic, and pull their money out of the funds even though funds didnt invest in lehman asset is at all so paints an interesting picture of how fragile it was within itself, and also how that that was not what made things spread to the Financial System indeed if you look at the collapse that happened months before, it collapsed in a way that was similar to lehman and you didnt have the panic at that time. The panic waited until it could occur later. So interesting thoughts about connectedness let me talk about cor or what i like to call capitol. Crisis 2008 was capital and book has interesting chapters oz a way theyre a way to deal with this. It also has chapters on a resolution and a resolution and other ways to bailout and tarp and how that happen haded. But ill end my comments with just one note, one area where i slightly disagree with. Contingent capital is not a longterm of the bank but could be key term, that it has to be replaced that it the bank, bank lets say one year maturity matures, but the bank cant replace it with new capitol then right then and there that capital is not replaced but converted into equity. So it doesnt have to be longterm and second thing about it that i slightly disagree with he says that one trigger mechanism for capital which is securities that will convert into i equity when bank gets ino trouble is one version proposal to look at dex of bank stocks that decline than the capital gets converted. House scotty book says that happen hads that can amplify panic, and i think thats not quite right because one interesting thing about con it makes it not roll over capital so that it converts. All of a sudden theres in massive inflow of new equity that Banking System gotten from conversion of the capital and i think thats going to stop panic not make them divorce. So mechanisms and capitalizing or something, we should think about and we should certainly think about, worry about the ability of the fed to exercise the powers that it needs after the winner of last resort next time a financial crisis occurs. Thank you. [applause] in his new book connectedness and contagion al scott reminds using that hicksly the first and most important function of a central bank is the provision of lender of last resorts liquidity to stand for crisis. Llr for short was reason that most Central Banks were originally created. And yet dot frank comes along and it sort of cuts off the Federal Reserves ability affectively do wonder of last resort landing for the economy. Im going to focus on legender of last resort in a book he does a job of distinguishing between connectedness and contagion all large financials institutions but contagion is a property by well being of one firm can impact well being of many separate firms that are not necessarily connected to firm in question. For example welcome the reserve primary fund breaks the buck and soon other institution only money funds without exposure to either the reserve primary fund or Lehman Brothers need liquidity assistance from their parents to meet redeemses. Classic example of contagion run on one bank creates general panic and deposit run healthy unconnected banks. The Federal Reserves wide range use of llr power in recent financial crisis has been unfavorably portrayed as a taxpayer bailout of the financial sector. Everybody can be made better off if the government can prevent panic redemption, but the feds llr policies were discretionary. If rub, of course, is in the midst of a run, you cant tell the difference between and the judgment call can always be open to criticism. This discretionary policy created a lot of problems. And if you think about it, the need for llr is somewhat ironic given regulatory rhetoric. Financial regulators are quick to highlight the disciplining effects of market forces. While almost never described as such, a bank run is perhaps the most fundamental of all market discipline forces. Many scholarly papers are written to explain how banks fragile business model, borrowing short and investing longterm in opaque loans, is a market innovation, not a mistake. Its before government safety nets. Investors required banks to fund themselves using shortterm liabilities and demandable deposits precisely because this fragility imposed restrictions on the banks investment decisions. Unlikely to be successful, at least not for very long. And so while regulators espoused the enthusiasm for market disciplining, they simultaneously argue they need lots of tools and discretions to prevent bank runs and and fire sales. Hal scott rightly suggests that postcrisis politics are stacked against new discretionary fed lender of last resort powers. However, i think the political Sticking Point may be not lender of last resort so much as free, the free and discretionary nature of the prior fed llr arrangements. The congress and the Federal Reserve, in my opinion, should Work Together to develop a new approach for lender of last resort that relies on a market where institutions pay the taxpayers to purchase liquidity Insurance Coverage before its needed. Indeed, hal discusses such a proposal in his book, but i want go a little bit farther in the next few minutes i have. The Federal Reserve should be required to sellly liquidity options. Now, liquidity options are once a firm owns, can be exercised as long as they have appropriate collateral, and they would receive a loan from are the fed. I believe the fed should sell two al qaeda of liquidity two kinds of liquidity options. One that allows the exchange of collateral and one that allows acceptable specified collateral to be exchanged for reserve or balances for a fixed term. So theres a securities lend liquidity option and a repo kind of lending option. The instrument i believe should be sold at regular fed auctions, and they should be traded in secondary markets thereafter. The options should have specified exchange terms, haircuts and implicit rate, that are less generous than those prevailing in the lending and repo markets. The price of these liquidity options would reflect the shadow price of emergency liquidity. If Bank Liquidity coverage ratios and net Stable Funding ratios these new rules we put on systemically important Financial Institutions, if they were amended to satisfy this requirement, we could create a Natural Market for these options. Banks would buy them. This arraigningment would drastically improve arrangement would drastically improve the current selfinsurance approach for liquidity insurance which hal mentioned. If we did Something Like this with market terms, emergency liquidity access would no longer be a special privilege, but merely the exercise ofly of liquidity [inaudible] terms that firms pay for for the right to exercise liquidity option. The pressure of these options and their use should be open to all Financial Institutions, not just depositories. So nonbanks as well should have access. If a liquidity crisis were to develop, the terms of the insurance contracts could be adjust ared to allow the fed to provide all the emergency liquidity the economy needed. So they could lower the rate over the market rate, change the collateral terms, they could adapt the options and still sell them and meet the liquidity demands of the economy. This approach would remove the need for the Federal Reserve to determine whether or not an institution is solvent, to seek liquidity support. If they have the option and the collateral, the fed would honor contract. And taxpayer losses could be prevented by appropriate be haircuts and setting the Federal Reserve priority on any borrowing institutions that sub subsequently entered bankruptcy and posted losses on the fed. I think a marketbased solution would stem a lot of the llr issues, and hal brings up this and talks about a proposal in his book. And i would like to see, i would like to see folks take that up in a little more detail, because i think it solves many of the problems that we discuss in the book. I think the book discusses a very, very important issue, and it gives you, gives us a lot of food for thought about the right, the right way forward. Llr in particular, i find to be the most distressing problems created by doddfrank. Thank you very much. [applause] thank you, paul. And thank you to all the commenters were going to give hal some time to respond in any way he likes to those comments. While hes thinking, al mentioned Musical Chairs. And when challenged after the crisis to come up with a metaphor for a panic, Musical Chairs is a natural one. And i invoked this one. Imagine a game of musical chills that has 500 for a Financial System, youve got a lot of them. Youve got 500 people playing Musical Chairs, but theres 700 chairs. And the music thats playing is a charming mozart serenade. And when it stops, everybody easily finds a chair. We call that high liquidity. Suddenly, the music shifts to raucous, obnoxious music and 400 chairs are removed. And i think thats a great picture of what happens in the panic. Hal, comments on the comments. Yes. So, al, you ended with the reference to [inaudible] and the legitimacy to central bank dependence. To me, i remember an aei person, peter wallison, and i discussed coauthoring a piece on contagion along the lines i developed, and pet