Rubin on global financial infrastructure

[Robert Weissman <rob@essential.org>]

Interesting quote: 

Some countries may deem more comprehensive measures -- such as
Chilean-style taxes on short-term capital inflows -- to be appropriate.
Like all controls, they can be difficult to administer and can decline in
effectiveness over time. This suggests that if they are adopted, they
should be seen as transitional measures.  What is most important is that
they not be a substitute for fundamental reform to strengthen and
liberalize financial systems.

When crisis strikes, countries may be tempted to introduce controls on
capital outflows in an ad hoc response. But the bulk of experience
suggests that controls on capital outflows become ineffective over time.
Most important, they can do long-term damage to a country's capacity to
attract foreign investment, and are often used to avoid or delay
fundamental reforms.

Robert Weissman
Essential Information			|   Internet:	rob@essential.org


EMBARGOED UNTIL 11 a.m. EDT
Text as Prepared for Delivery
April 21, 1999
RR-3093

 TREASURY SECRETARY ROBERT E. RUBIN REMARKS ON REFORM OF THE INTERNATIONAL
   FINANCIAL ARCHITECTURE TO THE SCHOOL OF ADVANCE INTERNATIONAL STUDIES 

I am here today to discuss the United States' agenda for the future global
financial architecture: the actions we have taken
already and are in the process of taking, and our proposals for further
change. 

In the past two years, the international community has mobilized enormous
official resources in response to the financial
crisis that has adversely affected a large number of nations and peoples
around the world. This crisis has heightened the
broad-based awareness -- in both developed and developing countries -- of
the risks and opportunities of a global economy.
While our own economy has remained strong, American workers, businessmen
and farmers have been affected by the
crisis. Certain sectors have been hit severely, and the crisis has created
additional risks to the economy overall. That is why
Americans have a critical stake in an effective response to this crisis,
as well as in building a stronger, more stable
international financial system for the future. And that is why the United
States, and so many nations, have been intensely
focused on international financial reform, and must continue to be
intensely focused on reform for a long time to come. 

Our approach to this work has been informed by the fundamental belief that
a market- based system provides the best
prospect for creating jobs, spurring economic activity, and raising living
standards in the U.S. and around the world. But
we have an equally strong belief that government action is needed for
markets to produce the best results. There are certain
purposes, for example, universal education, that markets by their nature
cannot meet. And markets, by themselves, do not
necessarily create the conditions needed for them to function well, for
example, the provision of full and adequate
information. 

President Clinton's approach to international financial reform is built on
these two beliefs. Our overall goal is to build an
international financial system that best promotes global growth, that best
contributes to broadly sharing that growth, that is
less prone to crisis, and that is better able to manage crises when they
occur. We want to equip all countries to be able to
participate effectively in the global financial system. Achieving those
objectives means both working with developing
countries to identify the policies they need to realize most effectively
the benefits of global finance and integration while
limiting its potential risks, and creating stronger incentives for
developing countries to put those policies in place. It also
means acting to induce creditors and investors in industrial countries to
weigh risk more appropriately, so as to help avoid
the excesses in capital flows and leverage that contributed significantly
to the crisis. And it means equipping the international
community to more effectively deal with those crises that occur. 

Let me spend just one minute on the causes of the recent crisis, because
the experience of the past two years has provided
important insights on how we can best go forward. The crisis that first
erupted in Thailand did not have a single, simple
cause. Weak policies and institutions in many developing countries, and an
inadequate focus on risk on the part of banks
and investors in industrial countries, combined together to produce
vulnerabilities in these economies. It was this
combination that led ultimately to the abrupt collapse in confidence that
spread through Asia and other emerging economies
from the summer of 1997 onwards. And after confidence was lost, the
collapse risked become self-fulfilling, as investors
who had previously extended excessive credit to developing countries
over-reacted in the opposite direction, and began to
pull out of developing countries indiscriminately. 

Just as the causes of the crisis were complex, so too are the issues we
face in reforming the architecture of the global
financial markets. There are no simple answers or magic wands. There are
often powerful competing considerations that
need to be reconciled. And there are some problems to which there is not
currently a completely satisfactory solution. The
consequence is that reform is not going to involve a single dramatic
announcement but a collection of actions over time.
Some of these have already been taken or are in the process of happening.
Others will take shape going forward. 

We have helped to build a broad-based international consensus on the
appropriate framework for reform. This consensus
has made possible concrete progress in a number of critical areas: 

       There is a dramatic improvement underway in the quality of the
information available to markets about the risks in
       emerging market economies.

       A set of more powerful tools is now or soon will be in place to
equip the international community to respond more
       effectively to crises, including the IMF's Supplemental Reserve
Facility -- which has been used in all of the IMF's
       recent major programs -- and the proposed Contingent Credit Line.
The Contingent Credit Line is designed to
       reduce the risk of contagion to countries with strong polices and
institutions. It will be structured so as to help
       induce a range of policies to reduce a country's vulnerability to
crisis, including the adoption of sound debt
       management practices, efforts to develop strong bankruptcy and
supervisory regimes and the maintenance of sound
       macroeconomic policies and sustainable exchange rate regimes.

       Substantial progress has been made toward developing a much broader
set of standards and best practices, based on
       the model of the Basle Core Principles, in areas that are essential
to making financial systems work in today's global
       economy, be it an effective legal system, elements of sound
monetary and fiscal policies, or internationally agreed
       principles of good corporate governance.

To continue to build a market-based system that is less susceptible to
crisis, a critical challenge is to develop better
inducements for developing economies to adopt sound policies and for
industrial country creditors and investors to weigh
risks more appropriately in decision making. These range from better
transparency and disclosure for both developing
countries and industrial country financial institutions to better employ
the pressure for market discipline; to the conditions we
place on official finance -- including the new Contingent Credit Line in
the IMF; to changes in capital standards and an
improved focus on risk management in industrial countries. 

In all of these areas, our work must be done with full respect for and
recognition of the differences among nations. Different
countries may implement the same principles in different ways. Yet we all
must recognize that the costs of weak policies and
poor credit decisions, whether in developing or developed economies, are
not just borne by the countries themselves and
their creditors. In an interdependent world, as we have learned, these
mistakes can well spill over and affect their neighbors
and the rest of the world. This growing interdependence has given all
nations a greater stake in avoiding each others'
problems and being successful, and creates a responsibility for all
nations to pursue sound polices. 

Our framework for reform involves changes in a great many areas. What I
would like to do today is focus on concrete
further steps we support in five particularly difficult areas of the
agenda: 

       the role of the private sector in resolving crises;

       exchange rate regimes;

       how developing countries deal with capital flows;

       excesses in capital flows and leverage on the part of creditors and
investors in industrial countries; and

       greater support for those most in need in crisis countries.

The role of the private sector in resolving crises 

The role of the private sector in resolving crises is one of the most
complex issues that we currently confront, involving
powerful competing considerations. The steps we take must not undermine
the obligation of countries to meet their debts in
full and on time. Otherwise, the private investment and financial flows
that are critical to trade and growth will diminish, and
the risk of contagion will increase. Yet market discipline will work only
if creditors bear the consequences of the risks that
they take. The high yields on many emerging market debts indicate private
creditors' expectations that some of these debts
will not be paid in full or on time. 

Striking the right balance between these considerations will always be
difficult and must proceed on a case-by-case basis.
There can be no one-size-fits-all approach. What we need to work toward is
a system in which countries can address debt
problems in a market-based, cooperative and orderly way, which may or may
not be accompanied by official finance, and
that does not threaten the health of the system as a whole. 

The practical approaches the international community has taken in recent
cases are establishing a growing set of examples
about the right balance, and about how the relevant parties should
interact with each other. The international community
should continue to make these judgments in the context of this overall
framework, and work towards refining these
approaches over time. 

When a government's capacity to pay its debts on time and in full may
depend on the provision of official resources, we
believe that the international community will need always to consider
carefully whether there is a role for the private sector in
sharing the burden of adjustment. But, as I have just discussed, the
question of what this role should be in a given case is
extraordinarily complicated. In some cases it may be appropriate to seek
maintenance of exposure levels or to seek a
restructuring or refinancing of a country's private debt obligations. In
other -- truly exceptional -- cases, negotiations may
break down and it may not be possible to avoid a temporary interruption in
some debt payments. When a country is
nonetheless implementing a strong program of policy reform, the door to
official finance should be kept open even if
cooperative efforts to clear outstanding arrears with private creditors
have yet to be concluded. More broadly, there is no
reason why one category of unsecured private creditors should be regarded
as inherently privileged relative to others in a
similar position. When both are material, claims of bondholders should not
be viewed as necessarily senior to claims of
banks. 

Going forward, we believe the international community should continue to
encourage the broader use of provisions in bond
contracts of clauses that can facilitate creditor coordination. These
clauses are desirable for both borrowers and lenders. We
also support steps to strengthen national insolvency codes and to
strengthen the operation of insolvency regimes, since these
can help prevent private debt problems from accumulating and ultimately
spilling over to the sovereign. 

Exchange rate regimes 

Second, choice of exchange rate regimes for emerging market economies. No
exchange rate, fixed or floating, can remain
stable unless it is backed by sound policies. Flexible rates generally
allow more monetary policy independence and greater
flexibility in response to shocks. But countries with a history of extreme
volatility understandably may show a preference
for greater exchange rate stability. Countries that choose fixed rates
must recognize the costs and tradeoffs. They must be
willing, as necessary, to subordinate other policy goals to that of fixing
the rate. Recent history suggests that
institutionalizing that subordination may be essential or close to
essential for sustaining a credible commitment to fixed rates;
and in some cases, where the conditions are right, currency boards appear
to have been effective toward that end. But these
institutional mechanisms will work only when backed by a real political
commitment to reform and sound policy. 

The right exchange rate regime is a choice for the individual country. Yet
at the center of each recent crisis has been a rigid
exchange rate regime that proved ultimately unsustainable. The costs of
failed regimes can be significant, not only for the
countries involved but also for other countries and for the system as a
whole. We believe that, under the circumstances, the
international community's judgments about how to respond to the recent
crisis were right. Yet it is also important to shape
expectations about the official response going forward, as this will have
an important impact on policy choices and we want
to strengthen incentives for the adoption and maintenance of sustainable
exchange rate regimes. As a matter of policy, we
believe that the international community should not provide exceptional
large scale official finance to countries intervening
heavily to defend an exchange rate peg, except where the peg is judged
sustainable and certain exceptional conditions have
been met, such as when the necessary disciplines have been
institutionalized or when an immediate shift away from a fixed
exchange rate is judged to pose systemic risks. 

Some countries have recently considered making another country's currency
their own: in particular, adopting the dollar.
This is a highly consequential step for any country, one that has to be
considered very carefully and, in our view, should not
be done without consultation with United States authorities. On one hand,
dollarization offers the attractive promise of
enhancing stability. On the other hand, the country also must be prepared
to accept the potentially significant consequences
of doing without the capacity independently to adjust the exchange rate or
the direction of domestic interest rates. The
implications for the United States are also consequential. We do not have
an a priori view as to our reaction to the concept of
dollarization. We would also observe that there are a variety of possible
ways for a country to dollarize. But it would not, in
our judgment, be appropriate for United States authorities to extend the
net of bank supervision, to provide access to the
Federal Reserve discount window, or to adjust bank supervisory
responsibilities or the procedures or orientation of U.S.
monetary policy in light of another country's decision to dollarize its
monetary system. 

Dealing with capital flows 

Third, dealing with capital flows, including the issues of debt management
and capital controls. One of the striking elements
of the recent crisis was the extent to which countries actually reached
for short-term capital, and thereby greatly increased
their vulnerability to crises down the road. The lesson of these
experiences is that the greater protection provided by long-
term borrowing is worth paying for. 

Countries' own interest in avoiding the costs of crises provides a strong
incentive to protect themselves better against market
volatility in the future. But the costs of inappropriately reaching for
short-term capital are borne not just by the countries and
creditors concerned -- the international community has a large stake in
these decisions. That is why we support the
development of international guidelines for sound debt management to
discourage countries from taking too many risks. 

These guidelines would aim to encourage both a greater reliance on
long-term rather than short-term borrowing and the
development of domestic debt markets that allow governments and
corporations to borrow at longer maturities in their own
currencies. It may be cheaper to borrow at short maturities, and it is
often easier than making the sometimes difficult policy
changes needed to be able to borrow long-term, and to attract more
investment flows. But the benefits of short-term
borrowing, even if substantial, are often more than offset by the benefits
of a debt profile better insulated from periods of
market volatility. 

Going forward, the recent crisis has shown equally clearly that it not
enough for governments to do a better job of managing
their own debt. They also should resist tax regimes, restraints on
long-term investment, and special facilities that distort
private flows toward short- term borrowing. Where financial systems and
supervisory regimes are underdeveloped, steps
are probably needed to limit banks' foreign currency exposures, especially
their short-term foreign borrowing. The limits of
governmental guarantees for the external obligations of domestic borrowers
-- especially banks -- should be made clear, and
the nature and scope of the domestic financial safety nets clearly
defined. 

Some countries may deem more comprehensive measures -- such as
Chilean-style taxes on short-term capital inflows -- to
be appropriate. Like all controls, they can be difficult to administer and
can decline in effectiveness over time. This suggests
that if they are adopted, they should be seen as transitional measures.
What is most important is that they not be a substitute
for fundamental reform to strengthen and liberalize financial systems. 

When crisis strikes, countries may be tempted to introduce controls on
capital outflows in an ad hoc response. But the bulk
of experience suggests that controls on capital outflows become
ineffective over time. Most important, they can do long-term
damage to a country's capacity to attract foreign investment, and are
often used to avoid or delay fundamental reforms. 

Excesses in capital flows and excesses in leverage 

Fourth, we must take steps in industrial countries to address excesses in
capital flows and excesses in leverage. Excesses in
capital flows and excesses in leverage are separate but related problems.
Excessive leverage can at times fuel excessive
capital flows. In addition, both excessive capital flows and excessive
leverage can be indicative of broader failures in
transparency and risk management. While creditors and debtors now may be
unduly withdrawing capital from developing
countries, there is still a need to address the weaknesses in risk
assessment that contributed to the recent crisis. 

Our market-based economy relies on market participants to provide
discipline. But market discipline can break down, and
market history indicates that even painful lessons recede from memory with
time. That is why we support mechanisms to
induce a much stronger focus on risk management during good times, because
reducing the excesses of the booms will
reduce the likelihood and severity of busts. 

In this context we believe it critical to create the right incentives for
prudent bank credit judgments and lending decisions.
This is why we consider it very important that the Basle Committee work
quickly to complete its updating of the Basle
Capital Accord, by expanding the number of credit-risk categories and
revising the current all-or-nothing system for
classifying loans to sovereign borrowers. We also strongly support actions
that are being taken by the international
community and within the United States to focus supervisors much more
strongly on banks' assessment of market risk and
their systems for evaluating that risk. With respect to both of these
concerns, the President's Working Group on Financial
Markets, which includes the chairpersons of the principal federal
regulatory bodies in the United States and the Secretary of
the Treasury, will soon be releasing proposals to require more disclosure
of the exposure of financial institutions to other
financial institutions. This will increase market scrutiny over the
interbank market -- including the market for interbank
lending to developing countries -- as well as increase scrutiny of
exposure to highly leveraged market participants. 

As we strengthen risk management in the major financial centers, we also
need to do more to make sure that these efforts are
not undercut by lax practices in offshore financial centers. A variety of
incentives could be used to press offshore centers to
improve their standards, including a higher risk weighting on bank lending
to counterparties operating out of an offshore
jurisdiction that does not adhere to the regulatory standards of major
market centers or provide adequate supervision. 

Beyond these measures, we need to take additional steps to address
excessive leverage. As events in global financial markets
in the summer and fall of 1998 demonstrated, the amount of leverage in the
financial system, combined with aggressive risk
taking, can greatly magnify the negative effects of any shock.
Additionally, the near-collapse of Long Term Capital
Management highlighted the possibility that excessive leverage in one
financial institution could increase the likelihood of a
general breakdown in the functioning of financial markets. 

In this context, hedge funds have generated a great deal of attention. But
excessive leverage is not limited to hedge funds.
Other financial institutions, including some banks and securities firms,
are larger, and generally more highly leveraged, than
hedge funds. That is why there is a strong case for improving public
reporting and disclosure by financial institutions and
their creditors and for tightening risk management practices more
generally. The President's Working Group on Financial
Markets will soon be releasing detailed, concrete proposals in these
areas. 

Concerns have been expressed about the impact of such highly-leveraged and
other large institutional investors on market
dynamics generally, and on vulnerable economies in particular. While we
believe that such activity can affect markets in
some circumstances and for limited periods, we do not believe that it was
a basic cause of the financial market crises of the
past two years. 

Greater support for those most in need in crisis countries 

Building a system that is less prone to crisis and better able to address
crises when they occur is one of the best things that
we can do to see that the benefits of growth are shared more broadly in
the world. The recent crisis threatened or reversed
the middle income ascendency of many and worsened the hardships of the
poor. The international community should take
additional steps to help prevent crises from having undue effects on the
most vulnerable, and to help countries put into place,
before crisis strikes, the kind of policies that can make them more
resilient if it does occur. 

To help protect the vulnerable during times of crisis, the MDBs should
rearrange their lending priorities and make available
fast-disbursing emergency lending to help support safety nets, basic
health care and education. Special programs to help
create jobs for the most vulnerable may also have a role. The IMF should
take into consideration the impact of its prescribed
fiscal stance on social spending, and make sure that budgets for core
social programs like health and education are
maintained, or at least not disproportionately cut, even during periods of
needed fiscal consolidation. 

More broadly, an open international financial system works best if all
countries equip their people to prosper in a modern
economy. Such policies are the responsibility of individual governments.
But the international community can help, by
identifying and helping to finance the implementation of the policies
needed to provide this foundation for broad-based
growth, from the provision of basic education and public health, to
support for core labor standards that promote worker
participation in the benefits of growth. 

Conclusion 

Market-based economic systems, and global capital flows, offer great
promise for the global economy, but we can and must
greatly reduce the disruptions that can occur, with all the hardship that
they produce. The issues involved in this reform are
complex and pose difficult questions balancing strong competing factors.
As I have said, there are no magic wands. But
over time, the steps we have taken and those we propose constitute a very
powerful program of reform -- one that will have
an increasingly powerful effect on the way the global financial system
functions. The result should be a more robust global
economy -- one less susceptible to crises, one better equipped to deal
with crises and one with greater growth, more broadly
shared. And the continued strong engagement by the United States, working
with the rest of the international community,
will be essential if this outcome is to be achieved. Thank you very much.