Beyond the Crisis: Reflections on the Challenges - FEDERAL RESERVE BANK of NEW YORK
Speech
Beyond the Crisis: Reflections on the Challenges
December 2, 2009
Posted December 3, 2009
Terrence J.
Checki
, Executive Vice President
Remarks at the Foreign Policy Association Corporate Dinner, New York City
I want to thank Noel and Gonzalo and the Foreign Policy Association (FPA)
for this award, for this great honor—and for bringing together so many
old friends.
I also want to thank Bill, Jerry and Paul for their exceedingly generous comments.
More importantly, I would like to thank them, and all of you with whom I have
worked over the years, for your patience as you educated me, and for your generosity
in sharing your insights and your understanding. I am very grateful.
It is no secret that I believe the best public policy is made quietly, behind
the scenes. So it is not often that I allow myself to be on this side
of a microphone. Actually, I am still wondering how I
did
let
this happen.
As you know, much of my career at the New York Fed has been spent working
with countries in the Emerging World. And for much of that time, the
focus was on dealing with episodes of financial stress originating there. There
have also been events closer to home—9/11, Long-Term Capital Management
(LTCM), the 1987 stock market crash—in which the Federal Reserve played
a role in helping our markets and economy work their way through.
Those experiences taught those of us that went through them a great deal about
how crises develop and unfold, and about ways they are best managed.
But even for those of us who have seen their fair share of stressful episodes,
the events of the past year and a half were without precedent in terms of complexity,
speed, magnitude, and frightening implications.
This was not merely distress at
an
institution, or troubles in
a
market,
it was a run on the system. Liquidity, trading, and confidence collapsed
virtually overnight. In an industry that runs on confidence—the
root of the word credit comes from the Latin “to trust”—suddenly
no institution in the world trusted or wanted to deal with another unless a
central bank stood between them.
How did we get ourselves into such a mess? Much of recent commentary
has focused on assigning blame, and surely there is plenty to go around. But
a narrative focused mainly on finding culprits risks obscuring the deeper structural
issues that were integral to the crisis, and that will need to be dealt with
if we are to successfully move to a more resilient system.
The vulnerabilities at the heart of the problem—excessive complexity,
leverage, and opacity—did not emerge overnight. They evolved over
a period of years, against a backdrop of benign macroeconomic and financial
conditions that fostered an under-appreciation of risk and a reach for yield
by investors.
The past two decades were a period of enormous financial innovation, reflecting
changes in technology, accounting, regulation, instrumentation and market practice.
Our system evolved from one
funded
by intermediaries, to one largely
financed
by
markets. The traditional ties between borrower and creditor were weakened
as credit risk became just another commodity to be traded and distributed.
These developments contributed to economic vibrancy and efficiency. But
they also helped obscure growing leverage and declining underwriting standards,
and encouraged the fanciful belief that the US economy and financial system
were infinitely resilient and could support our living beyond our means indefinitely.
The tipping point at which confidence is lost and replaced by uncertainty,
mistrust and fear is never visible until after it occurs. And so it was
this time.
Unprecedented policy interventions were needed to put a floor under
confidence and pull us back from the brink.
And while we have come a long way since the
dark days of last year, the history of this episode is still being written,
and the recent celebration in markets seems oddly premature. The decline in
global manufacturing and trade over the last year (which was as or more severe
than the first year of the Great Depression), will cast a long shadow, notwithstanding
recent improvement.
A range of vulnerabilities still remain, not only for the
economy, but also with regard to the unfinished business of cleaning up the
banking system and the prudent exit from unprecedented policy interventions—processes
that present complex challenges, that involve potentially important indirect
as well as direct effects, and that will need to be carried out without a guide
book. We have been using experimental drugs on a rare disease—and while
the patient’s vitals are improving, the cure could have important and
long-term side-effects that need to be closely monitored.
The upshot is that a quick return to business as usual is highly unlikely.
And also undesirable. Restoring growth and stability will require movement
toward a new economic equilibrium, a more sustainable one; one based more on
competing in the global economy, and less on spending and borrowing. Needless
to say, establishing such a shift will not be without its challenges.
The broad parameters of what needs to be done seem reasonably well understood:
We need to deliver on meaningful reform of our financial system, taking
into account the lessons from the recent past. This will entail better capital
and liquidity buffers, more comprehensive and systemic oversight, more robust
market structures, and better tools for defusing and unwinding systemic threats.
Our public finances need to be put back on track. We would be kidding
ourselves if we believed that today’s large structural fiscal deficits
are consistent with a continuing strong global leadership role.
And we need to strengthen our competitiveness in the global marketplace
and rebuild our once vibrant tradable goods sector and our infrastructure.
Meeting these challenges will not be easy, and the process will necessarily
take time. We need to navigate the transition from near-term support
for our convalescing economy and markets into longer-term thrift and higher
margins for safety in the financial sector. We face difficult choices
regarding spending priorities and the means to pay for them, as well as thorny
questions regarding appropriate design and oversight of our financial system.
We also face challenges in terms of our global leadership. Economics and
finance have increasingly become the principle theater of engagement globally.
We have enjoyed many advantages in this realm over the years: the large size
of our economy and its historical dynamism, the vitality and sophistication
of our financial markets, and our track record for economic management.
But the world has been changing in important ways, many of them related to
continued growth in the emerging world. There is no question that the current
crisis has given additional impetus to a dynamic that was already well in train:
a shift in the economic center of gravity from the so-called advanced economies
toward the emerging world.
The emerging world already accounts for about half
of global output, and that share will almost certainly rise significantly in
the years ahead, as the combination of demographics, investment and continued
policy improvements propels many economies forward. We already have one new
entrant to the short list of largest economies, and others are likely to join
the club.
This has been a remarkable era; we are no longer alone as the central
axis for the global economy. New linkages are developing across and between
regions and countries, new economic and financial arrangements are being discussed,
and the groundwork for new currency arrangements are being explored.
The choice
that faces us is to attempt to shape these various developments—the
evolution of the global financial and trade architecture and global patterns
of saving and investment—or risk being shaped by them now and in the
future. For my money, better to be one of the shapers than just a “shapee.”
As we strive to exert leadership in the economic and financial realm, we need
to keep in mind that, while we have many cards to play, our hand is not as
strong as it once was, and therefore we will have to play it differently if
we are to be effective.
The crisis has affected the United States’ standing in the world, confidence
in our economic management, and has called into question our ability to lead.
We can help answer those questions by putting our house in order and delivering
on the reform agenda confronting us—but this will take time. Meanwhile,
our relative status is changing, as other countries expand their economic and
financial footprints, and their influence.
The recent move to the G20 as the key forum for addressing global governance
issues was necessary and overdue. But making that process work will be
far more challenging than achieving consensus in the old club of rich nations.
While we have much common ground with the emerging world, there are numerous
differences as well, with regard to income levels, views on the role of the
state and markets, institutional development, political histories, and alignment
on security issues. Matters are further complicated by the heterogeneity
within the emerging world itself.
All of this implies a greater premium on consensus
building and diplomacy on our part, recognizing that our leverage will not
be what it once was. We also need to be attentive to the messages we receive
(such as rumblings about the dollar and our policies and priorities) even when
we disagree with them, and sensitive to signs of change in the economic environment
and their potential implications (such as new trade linkages, the growth of
state-linked investment vehicles, and shifts in attitudes toward capital mobility).
In sum, whether the continued evolution of the global economic and financial
landscape will be an opportunity or a threat depends in part on the rest of
the world, but mostly it depends on us. It depends on whether we will
be ready to compete in the realm of business and finance and of ideas, and
on whether we can adapt our leadership style to changing circumstances and
imperatives. There is no question we have our work cut out for us, but
if history has shown us anything, it is that we are at our best when we are
challenged.
Let me conclude on personal note. It would be difficult to miss
the criticisms that have been swirling about the Fed recently. One lesson that
has been driven home to me over the years (and I think now about the examples
set forth by Chairman Volcker and Secretary Brady and others in this room and
elsewhere) is that it takes wisdom to know what to do in the face of crisis—and
it takes courage to actually do it.
Now I am not suggesting that the decisions
taken during those frenzied days last year, when markets were melting down
and institutions were lined up like so many dominoes ready to topple, were
wise or even necessarily right.
But what I can tell you is that those decisions were made for the right reasons.
They were based on the facts as we understood them at the time—not
as we wanted them to be, but as we found them—and in the time frames
that circumstances required. And they were based on what we believed
was needed to turn the tide and protect the citizens of this country—indeed
the globe—from the unthinkable: an economic and financial breakdown
of catastrophic proportion. The broad societal costs that may have been averted
will remain unknowable, but those who would ignore them do little service to
the public debate.
The men and women of the Federal Reserve—Bill Dudley and some of my
colleagues are here tonight—are acutely aware that they hold a unique
public trust; it is a rare privilege and a unifying, motivating force for them,
and they execute on it every day with great skill, integrity and dedication.
As they deal with the challenges ahead, I know they would welcome your encouragement
and support.
Thank you.
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