 Mae'r ddweud wedi'u cyhoedd yma yn ffwrdd y rhan o'r ffwrdd yn ymwneud o'r ysgolodau. Mae'r ddweud o'r ysgolodau hynny yn y ddweud o'r ffwrdd yn y ffwrdd ymwneud yn y ffwrdd ymwneud. Ond rwy'n credu i'r panallys cyngorol, ond mae'n clywed o'r cyfwladig ei ffwrdd yn fwyaf. Mae'n ddweud i ddweud i'r ddweud. First of all, when we talk, we will treat markets as a broad term to include the major institutions that are engaged in them, particularly though not exclusively, but particularly banks, so it's institutions and markets and their complex interplay. And the second and more important point is given where we were five years ago, I think most of the people in the room, perhaps even all of them will remember where we were five years ago, which was more or less just after Armageddon, the proposition that we are ever so micro marginally safer than that doesn't really tell us anything very useful because it means we're sort of a millimetre from Armageddon or whatever it will be. So the debate theme once must take as being do we think it's safer in the sense that we have eight, and that's for you to decide and for the debaters to persuade you, a reasonably safe. You have to decide what reasonable safety is and what the trade offs are system, not just whether it's a fractionally better than it was at the moment of the biggest crisis for 80 years and arguably the biggest financial crisis ever. So I think that will help you to frame the debate. Just to animate it, I've been told that this is apparently on Facebook. This was put up to an internet poll and 24 people, and this is not a very large sample, I have to say, pretty disappointing. 24 people voted that the answer to this question is yes. They are safer and 111 people voted no. So at least on the basis of this completely unrepresentative sample, the proponents of the motion have a tough job in front of them. I should also apologise because I've also got nothing to do with this, that the panel is overwhelmingly loaded with British people. If you include the moderator, I don't know how that happened, and the other two are at least living and working in the US. Maybe that's appropriate given where the real mayhem started. I think London in New York can claim a fair degree of centrality in the crisis, so maybe that's not inappropriate. So the way we're going to proceed, by the way just to remind you of the usual things, no cell phones, all that stuff, the way we're going to proceed, we're going to proceed as if it were a debate. Each participant will have five minutes to make their case. We will start with the proponents because the motion is a market safer now, and the proponents, the first proposer will propose that markets are safer. Obviously the opposition will argue they are not in the sense that I have tried to define it as precisely as I've tried to define it. The first speaker will be Douglas Flint, who is the group chairman of HSBC Holdings of HSBC. And his seconder will also be the third speaker, will be Anthony Jenkins, who's group chief executive of Barclays. They are on the right-hand side there. And the second speaker, so the first opposer, will be Paul Singer, who's founder and chief executive officer of Elliott Management, and his seconder will be Anartad Marti, who's a professor of finance and economics at Stanford Graduate School of Business and has written a very powerful and controversial book on this subject. So I expect a pretty lively debate. After they have presented their arguments, we will engage for a few minutes, 10, 15 minutes sort of, allow them to play off against each other. I hope that they will be vigorous but polite after all this is Davos. Then it will go to you. I would like to keep the spirit of a debate. So what I'm going to, I'm actually going to allow comments, but the comments will have to be really brief. So 20, 30 seconds, otherwise you can ask questions. And I would like to take them in people who are in favour of the motion, who think it is safer, reasonably safe and people are against it, alternatively. So we have a degree of interplay also with the audience, then we'll have a summation at the end. We only have an hour, so let's get going. Sorry, an hour and a quarter, so let's get going. I hope I've set the rules reasonably clearly and I hope we all enjoy ourselves. So let me ask Douglas to start off by saying why markets are in the sense of defined safe. Martin, thanks very much. It's a great pleasure to be here so far at least. I want to start off with a simple statement. I believe markets are safer and quite markedly so. Indeed it would be extraordinary and it would be a shocking indictment of the industry. It's regulated as public policy makers if after six years following a dramatic crisis the efforts hadn't been made successfully to make the system safer than it was in 2007, 2008. So it would be a shocking reflection if that were not the case. I want to put my remarks into three headings around the topic. One, the ability to withstand shocks, it's a great deal higher, the improvement in market infrastructure and oversight that's taken place and behavioural changes and incentives in the broadest sense, how they've changed over the last half dozen years or so that I think has contributed to a more sound financial system. I'm not going into a great deal of numbers in this but I mean in relation to the first thing the ability to withstand shocks depends whose research you read that the amount of capital in the system is three, four, five, six times more than it was pre-crisis so the capital that has been raised and the quality of capital that is in the system is significantly enhanced to what it was before which was clearly inadequate. Secondly, the liquidity of the system which was I think something that had been inadequately governance in the past by the regulatory community and indeed within some individual institutions significantly more liquidity within the system enhanced by much more focus on a simple leverage ratio which has been calibrated really only in the last few weeks or so but an attention to leverage of the system so that there isn't the reliance on risk weights to the degree that there was. But even within that topic a significant amount of recalibration has taken place of risk weights that were demonstrated to be poorly calculated and falsely measured during the crisis and finally in terms of the ability to withstand shocks every major regulator in the world now requires major institutions going down to quite a small level to produce and validate stress testing, stress tests which they have to demonstrate to their regulators would enable them to withstand shocks and these are not trivial exercises the one we do in the United States amounts to some 12,000 pages of input and similar size in the UK but of course the ability to withstand shocks in some ways is good but it's not complete in the sense that just because you can withstand a shock a shock because you've taken a lot more of shareholder's money to start with and therefore pre-funded the cost of the next crisis isn't a particularly good story to give to people that hey we've taken your money up front so we can lose it without coming back to you for more is not a good example so the second two aspects I think are more important and more fundamental. In terms of market infrastructure and oversight the creation of centre counter parties to give much more transparency on risk where it is and to enable offsets to be made much more easily than would have been the case in the over the counter markets also to give regulators and public policy makers a vision of where the risk is and to put a huge penalty on over the counter i bilateral trades that caused a great deal of the problem in the past. We're certainly not going to go into the detail but whether you go for Valkers, Vickers, Lickenin, the parliamentary commission in the United Kingdom all of them looking at the structure of the industry aimed in many ways coming at it from different angles to remove totally or to a large extent the ability of regulated institutions to engage in propriety trading with the UK going even further and mandating a separation of certain activities into the so-called ring-fence building. I think it's going to be a good thing to do with the EU coming up with similar proposals with a different shape shortly. Another important aspect is a much more intensive discussion between regulators supervising the institutions on recovery and resolution planning, again tens of thousands of pages, whether it needs to be that long would be a good question but tens of thousands of pages in all the major jurisdictions effectively planning for our own demise and how that could be affected. Virtually no other industry perhaps apart from nuclear power where the industry has to demonstrate that in the event of something untoward leading to the collapse of the industry how would it be dealt with. Supervisor resources significantly enhanced in terms of number and increasingly in quality. The team that looks after HSBC is probably six times the size it was in 2007. I'll let regulators talk about whether it was too many now or too few then but it's six or seven times the size that it was then. Finally, macro prudential, all the financial policy and stability committees. That was me telling me I'd run out of time a little bit but I want to make some comments and behaviour. I'll take a little bit more. First of all, remuneration will not a good answer but the industry is longer to farrow, malice, clawback, much more in stock. Importantly, the OCC has just published a paper on heightened standards for risk taking with a significant amount of board accountability. In the UK, the new senior persons resumed puts a reverse burden of proof of management for regulatory failure, puts criminal penalties on management for failure and puts significantly more burden on the board. We've got consumer protection bodies now much, much stronger and more prevalent in the UK, the US and many other parts of the world and huge oversight from the media, politicians, public policy makers. And the penalties of getting it wrong are out of all sight as to where they were before the crisis. And then the final point I want to make, which I think is the most important and isn't talked about, this is the final point, Martin. I don't think there is any doubt that the system is safer because the amount of time the board spans on regulatory matters, on oversight, on recovery and resolution, on the whole dealing with the issues, the legacy issues probably takes minimum of 50% of board time, more likely two thirds of board time and in some parts of the year 75% to 80% of board time. So when the board is spending two thirds to three quarters of its time dealing still five years after the crisis with the aftermath of the crisis and management is spending a majority of its time contributing to that debate, there is nobody in that room I can assure you that wants to take the risk of ever being in that space again. Thank you. Thank you very much. So my, the second speaker and first opposer of the motion of why banks are not safer is Paul Singer. Thanks, Martin. It can't be that safer comes from relatively modest improvements in certain metrics plus private and policymaker half steps at the end of which five years later still leaves in my view the system prone to the next financial crisis. I don't believe the financial system is and the markets are safer. I don't believe they are safe. There have been a variety of policy steps since 2008 of course, including the thousands of pages that Douglas mentioned of regulation and regulatory attempts. Some of the policy steps have been in the right direction. Some have been in the wrong direction, but the leverage in the system, especially in derivatives positions has not been meaningfully reduced and the opacity in the system, particularly in derivatives and other complicated securities has not been changed at all. Let me start or give you some numbers. 1981, 2008 and recently. 1981, the average typical top tier financial institution bank had tangible assets to tangible common equity of around 15 times. Just before the crisis in 2008, that average was somewhere, and of course there were many that were much worse than this, but somewhere around 30. That's back to mid teens, mid to upper teens. 1981, I chose that year because it was basically before the derivatives age, so derivatives positions were close to non existent on financial institution balance sheets. But in 2008, just before the crisis, each of these institutions had dozens of trillions of dollars of notional amounts of derivatives, and the number is only modestly lower now, and in some of the institutions, the number is actually higher now. And in the aggregate, notional globally are up 36% from the third quarter of 2008 to the third quarter of 2013. Of course notional amount is not the proper risk measure to assess the risks of derivatives positions, but it's not possible because of the opacity to understand what proportion of those positions is the functional equivalent of risk positions, the same kinds of positions that are on the balance sheet. So if you take arbitrarily 5% of the notional amounts of the derivatives on the typical large institutions financial statements and edit to tangible assets, what happens is that the leverage ratio goes from roughly 15 times to roughly 40 times. But nobody knows if the right number is 40 times or 60 times or some number in between. And that's way way too much. So in that sense, nothing really has changed since 2008. But there are five factors that are impactful in my view of my conclusion that the financial system is still unsafe. Number one, and I'm not ranking these, quantitative easing of central bank policies around the globe. They've bought $15 trillion, give or take a couple of trillion, of stocks and bonds, mostly bonds. And the prices of stocks and bonds have been distorted by that purchase. There's no telling whether the unwind of that will be moderately disruptive, not disruptive at all, a cascade or an instant and intense and abrupt change in the price. Of stocks and bonds. That's quantitative easing. Sovereign, sovereign risks. What stopped the 2008 crisis was the major sovereigns calling a halt. They basically guaranteed the global system. We all know that since then the credit quality of the major sovereigns is, let's call it in question. It's being questioned. It's not just the downgrades, but the fiscal, monetary, regulatory and other policies, their inability to generate growth. So the sovereigns may or may not be the last line of defense in the next stemming or preventing or calling a halt to the next financial crisis. Number three, prosecutorial zeal and prosecutorial tone. The drift is against finance, financial institutions. And if a major institution is as an institution is prosecuted criminally, there's no telling how it can fold back into a market and market action. The lessons of 2008, the most important point I think I want to make. The lesson of 2008 was, which was actually episodic. It wasn't all in one. It was several things over several months. The lesson was, when in doubt about an institution, stop trading, move your assets, sell your claims. So maybe later in the session we'll get a chance to flesh out some of these things. Thank you very much. And thank you also for keeping to time impressively. We're doing very well. So the second speaker for the for the motion is Anthony Jenkins. Thank you. I don't propose to repeat the points that Douglas made because I agree with them. But I want to pose this question. What is the purpose of the financial system? The purpose of the financial system, of course, has to be the greater good of society and citizens, specifically the interests of shareholders, but also of customers and clients of the people employed in these businesses and the direct and indirect contributions that financial institutions make to society. We, of course, want a safe and sound financial system, but we also want one that has capacity and capability to support society and deliver on the objectives that I described. The fundamental question of why did the financial system approach, as Martin said, Armageddon, really comes down to the question of risk. The financial system is engaged in the business of risk. When you, as an individual, give your money to a financial institution, you assume they will give it back to you. When you, as a financial institution, lend money to an individual or a company, you assume it will come back to you. So, the business of the financial system is about the management of risk. Where the system failed and where institutions failed within it, it was because they misunderstood and mispriced risk. That happened with retail-focused institutions, institutional-focused institutions, relatively large ones, relatively smaller ones. It is this notion that institutions must understand and price risk much better if we are to have a safer system. Much has been done at the institutional level, as Douglas was describing, and with regulators, to ensure that risk is viewed through multiple different prisms. As you know, in Europe, the system has been based primarily around risk weightings in the United States, more around absolute levels of leverage. You need both. Both perspectives are important on risk. The forensic analysis of the balance sheets of large financial institutions is intense, as Douglas was describing, and, again, seeks to look at the risks on the balance sheet through multiple different lenses. I think it is very difficult to argue that the financial system is not safer than it was in 2008. But the question is how much safer is it? The amounts of capital that banks are carrying, the levels of leverage, the levels of liquidity are all more favourable. The level of supervision is more favourable. The emphasis that institutions like ours are placing on culture and conduct so that we do the right business in the right way reduces the probability that the events of 2008 will be repeated. But it does not, in my view, eliminate them, not by a long way. We still have a significant amount of work to conclude the implementation of all of the regulatory changes. This will not happen until close to the end of this decade. At that point, we will and should be able to answer the question that we have reached a point where the level of safety and soundness in the system versus the capacity of the system is in equilibrium. For that to happen, the agreements that have been reached, the requirements of the regulators have to be implemented, of course. We need to have a period of bedding down for those measures to be confident that they are going to be effective. But I would say that the other point that we must not lose sight of is that we are talking about a financial system. Focusing exclusively on banks does not solve this problem because risk moves around the system. It moves into shadow banking, moves into the insurance industry. And if we do not take a systemic approach to this, then we could fight yesterday's war, solve the problem in the banking system only to have it migrate to another part of the financial system. So, I would argue that the system is safer than it was in 2008. It needs to be safer yet. And societies around the world need to decide through a democratic process, a process which is already underway, how we balance safety and soundness with capacity within the system. Thank you very much. Masterpiece of time compression. So that leaves Anart. And I think you posed the question very well at the end. The question that the system is safer, but is it safe enough? So Anart, is the system safe enough? Definitely not. I want people to think first on 2006. What did the system look like in January 2007? Record year for the banks 2006 was not a worry in the world. Risk was spread, innovations all over. We didn't have a worry in the world. It didn't take very long for us to feel extremely unsafe. And that was five, some years ago, very, very unsafe, scared even. So the question is, is it likelihood that we would face something like this? Not next week or next month, but in the next five years, ten years. Is it lower? Not significantly. Not enough for where we are right now. So in my view, definitely the system is not safe. The risk is hiding. The risk is all over. And there's too much collateral damage when this risk doesn't work. And we have the right to ask how safe should the system be? And for what purpose is it the way it is? Some people want you to believe that financial crisis have an element or a large element of natural disasters. Stuff happens and suddenly liquidity dries up and then runs happen and central banks and governments rush to the scene. If it was a natural disaster, we want the ambulances there. We want them to do what they can. But this narrative is very bad as an analogy. This is not a natural disaster in hardly any way at all. Financial crisis are man-made disasters. And the people responsible are many. And some of them are not here today. It starts with lawmakers. It starts with lawmakers who make laws. Some of the laws that were made turn out to be counterproductive. And then authorities are given to regulators to monitor this system and ensure that it's not harmful to other people, like other regulated industries. These regulators, as it turned out, designed very flawed and bad regulation and proceeded not to enforce them very effectively. So, and throughout this, of course, the industry lobbied with the lawmakers and with the regulators. Politicians also lobbied with the regulators sometimes. And the bottom line of that was a system that was incredibly fragile and that could not withstand a small shock in housing markets in the U.S. And some defaults there where, again, we can talk about that particular lending. So we had a major crisis that caused harm to millions and millions and millions of innocent people. And so what are we told about this situation? The system got so fragile and we're told that it's no longer as fragile as it is. It's true that there are committees and some names were rattled here. It's true that some laws changed somewhere. There were reform efforts. But I think when you look closely, you're going to discover that these reforms are essentially tweaks. And that some of the major fundamental risks have actually not been properly addressed. Paul mentioned the derivatives risks. That's a huge problem. There's an enormous amount of risk just two days ago in the Wall Street Journal was a story about that. The risks are maybe seen a little bit more than before, but they're still far from being seen. Lost absorption. They always say more than before, but how much? Nobody, no corporation lives like the banks on such thin margins and no corporation needs to, not even banks. Where we are is nowhere at all where we need to be, nowhere even close. And so let me give you my analogy that is not the natural disaster analogy. Imagine there was a speed limit of 90 miles an hour for wreckless, for loaded trucks in residential area, 90 miles an hour, very unsafe speed. And it wasn't even enforced and the measurements of those risks were difficult and all of that. And then you have reforms. You have some explosions. You have reforms. The reforms reduce the speed limits to 85 miles an hour. But the driver might not be controlling that truck. There must be fog that's preventing the risks that are lurking from being seen. Are we safe? Are we safe enough and why? That's the question. That's about what we're talking about. Tweaks in some measures that you can point to that are supposed to make you think that you should just turn to other things. It's very scary situation. It's very bad. So it's reckless driving that you should be thinking about. It's shoddy construction that can't withstand small earthquakes. It's pollution. It's actions that are harming many other people and need effective regulations but are not effectively regulated right now. So that's the situation. Instead of what we have, instead of controlling this harm and this conduct, we have policies that encourage and reward it perversely and that's the system response to that. So I don't know why are we here where there's a lot of blindness to risk and to the way risks are taken and to the nature of the problems in the system and among policymakers. Maybe some people don't understand the nature of what's going on. Maybe they should seem complicated. One thing is sure there's a lot of politics in banking, a lot of politics. And in this background a lot of claims are made that are not actually valid and yet they live and they affect policy. So I can spend many hours as some of you know unpacking, trying to unpack those arguments and sort of see exactly the sense in which some things might be right but twisted or not. Let's remember one thing. 2008 saw the fall of 2008, the end of 2008 and that whole year, so the largest decline in output since the Great Depression. Credit froze and it was not the result of effective regulation of this system. So there are the classic lines that scare policymakers and it's a complicated thing to unpack but I will just end with not my words because I don't usually use that kind of language but I am quoting. And I'm going to quote a little passage that describes an interaction between Paul Volcker, ex-Fed Chair from the 80s and the then Senator Ted Kaufman from four years ago, January 2010, Volcker as described by the staffer of Kaufman in a book. Volcker says, you know, just about whatever anyone proposes, no matter what it is, the banks will come out and claim that it will restrict credit and harm the economy. He took a long pause while Ted and I leaned in closer to hear what he'd say next. I'm quoting. It's all bullshit, he said. I can elaborate on why in what sense he was right. Thank you very much. Well, we've certainly had a vigorous discussion and not too much agreement. So let's unpack it a little bit in the next discussion. Douglas started off by basically telling us that the system had become safer in absolutely central directions, its ability to withstand shocks through rising capitalisation, to reduce leverage, strengthening of market infrastructure and the robustness of market infrastructure and really quite important changes in incentives within the institutions. And he mentioned, among others, the incentives for boards to spend 50% to 70% of their time thinking about regulation rather than the business. Paul argued against this, that there's a tremendous, it's still a tremendously highly levered business and with an immense amount of concealed and opaque leverage. And in addition to that, and he gave some figures on this, and in addition to that, it is vulnerable to some really quite big and quite obvious risks. And he stressed three, the unwinding of QE, the fact that he was too delicate to put this, that all the relevant governments are now bust and can't do this again, save them again. And there are these mad prosecutors out there who might impose really quite significant risks. Anthony Jenkins responded by reminding us that the purpose of the financial system is to serve the economy. This is inherently a business of managing risk, a very complicated one. It was clearly not understood properly before the crisis, but we've moved very dramatically towards understanding it better. We're on a journey, but we are clearly towards a system which is both better able to understand and manage and contain risks in a reasonable way. And then finally, Annart responded by saying we've got the wrong model of this. It's not a set of national disasters that come out of it. The system itself generates the risks, they're man-made. It was incredibly, unbelievably fragile before and we know that it's become possibly a little less fragile here. Her metaphor was moved for the speed limit from 90 to 85 miles an hour. But that's still far too fast, it's still far too dangerous. And of course, when there are explosions, there are tremendous damage. And then she called in aid, more or less everybody's favourite central banker, Paul Volker, who denied that as a result of more regulatory efforts, particularly raising equity and so forth, the banking system will be seriously impaired in its ability to serve the economy. So I think this really does set out the range of issues. I'd like to start, if I may, just to bring the questions to you all with a question to you, Douglas. Focusing on questions raised by both, but Anthony might want to respond too, both Paul and Annart raised, which is yes, leverage has been reduced, the system has become less fragile somewhat. But there's a tremendous amount of concealed leverage in the system. It still is a far more leveraged industry than any other. I mean, it's operating with incredibly small equity basis compared with any other risk-taking business and we know the risks are very big. And there are some obvious and very big risks out there. So why should we think it's now safe enough? OK. I think that's a thrust of this. I think one of the responses I'd make to what Annart said is that it's absolutely true that the banking industry has a very different leverage dynamic than our clients. But by definition, it's because our clients have much less leverage than we do than we can have the leverage we have. So people say, how can you have so little capital against the balance sheet? It's because if you take our bank, for example, the average loan to value of a mortgage in the UK is about 50%. So the equity in the mortgage book is with our clients. In Hong Kong, it's more like 75, 80%. So the fact that our clients have a lot of equity against the risk that they're taking means that the banks, when they do an incremental amount of lending, don't need to have so much capital against that. You've got to look at it in the aggregate. I mean, if one takes, as a given, and I'm sure there'll be some challenge, that banks have been taken away completely from proprietary position taking, the risk that it resides on our balance sheet is the risk that we wholesale on behalf of our clients. Economies grow because our customers take risk and we facilitate the allocation of credit and the management of that risk. And the residual risk from undertaking that activity sits on our balance sheets and we manage that. If we don't take risk, then either that risk continues to reside simply on the corporate balance sheets and on personal balance sheets or in parts of the unregulated system, it surely must be better, and this is the final point, it surely must be better to put the risk into a system that is subject to a significant amount of regulation and supervision. And where, you know, I take the point on opaque and lack of transparency, but surely we can fix that. I mean, Financial Stability Board did a study last year along with the industry and indeed the buy side on enhanced disclosure. We need to keep enhancing disclosure so that the points that Paul made that it's too opaque and we don't let sand it recede into history. There's no reason we can't be fully transparent. We should never have as an excuse we don't understand the risk in your balance sheet. I can tell you, we understand the risk in the balance sheet, our regulators understand the risk in the balance sheet and if we need to do more to let the analysts and the public understand the risk in the balance sheet, then tell us how to do it. Would one of you two like to respond, Paul's, to that? And then, of course, this is the core issue, so it's about the management of risk and the extent of risk and where it lies and whether this has been fundamentally changed. So Paul, what's your response to what Douglas has said? The framework of what Douglas has been talking about is a banking framework, customers, customer balance sheets, lending. And I think he's right about the customer and the classical banking aspects of the major global financial institutions. We need big ones, we need ones that are trusted, we need banking institutions that are not just sound, they're unquestionably sound. But what's happened in the last 30 or so years is that globally the major banks in the world have added the biggest trading books, however you want to describe these books. Proprietary trading is just one way to describe the books. There's hedging and hedging creates in some ways and in some situations a risk limitation. In other ways it creates two delinked positions, by the way, at the worst possible time. And so the biggest banks in the world, together with the biggest trading books, some have uncharitably called them the biggest hedge funds in the world, which, because no hedge fund provided systemic risk in 2008, and all of their leverage ratios, no matter how you slice it, are more than 10 times that of the firm that I've run, which is a hedge fund and which trades derivatives, trades everything that the big financial institutions trade. And so the thing that I most disagree with is the concept that these institutions unquestionably understand their risks. If we play in slow motion very briefly, Martin, what happened in 2008, at least two major things happened at once. Many of the world's major financial institutions didn't have a clue about the characteristics and risks of some of the inventions of their structuring desks or other parts of their firms. And so a basic lack of misunderstanding enabled firms to have tens and dozens of billions of dollars of AAA horrendous securities that were about to go to 20 cents on the dollar very, very quickly. A number two thing that happened in 2008, which number two has definitely not been solved, and that is the, let's call it size and surprise, size and surprise. Size means at a certain point in position taking, whether we're not positions or hedges or outright positions, the failure of the position to trade the way the street or the management or the risk committee thinks it should trade, actually creates a surprise which turns into much greater losses than expected. And because of the size of all the positions in the system, in particularly the derivatives books, you have a cascading transmission of incredibly strangely trading instruments. And so that part has not been resolved and solved. I recommend. Paul, you'll have to. Sorry. That's all right. Have I stopped something? Remind me to talk about the BIS. Okay. But I think it's fair now to give Antony. No, no. You raised some absolutely fundamental issues on, and Douglas talked about the banks as lending institutions. So now the question is what about the banks as hedge funds, as Paul put it, not complementary surprisingly from him. Well, he's a hedge fund. Yeah, exactly. That's the point. Look, to solve the problem, you've got to define the problem, right? And Paul makes good points about derivatives. But let's be realistic here. If you look at the banks that failed through the crisis, I'll just take the UK as an example. Northern Rock, a building society, HBOS, commercial lending, and to a very large extent, RBS also, the problems were not confined to the space of derivatives. And if we were really to understand this problem, we tend to always describe it in technocratic terms. And that's an important way to think about it. But it's much more important to think about this in human terms. I was discussing this with a central banker recently. I said, I studied economics at university. I wish I'd studied psychology because this crisis that we had, and that described very well, we all felt we were on the edge of the abyss, is not a new phenomenon in human history. The problem is, when you had the South Sea bubble, it really didn't matter because it was contained geographically. The interconnectivity of the global economy means that the risk is much greater and much more systemic than it ever was before. So if we really want to solve this problem, we have to get into the animal spirits of the people who are running these businesses, regulating these businesses, creating the legislation around it. We all were given the alchemy of, we can take all this bad risk over here and magically transform it into triple anus risk. That doesn't happen. That doesn't happen in real life. And however clever people are with algorithms and models, you can't spin straw into gold. And one of the problems about all of these discussions is, I don't think we're going to have another problem like this in the next five years, maybe the next ten years. But we will have another problem like this when all the people like us who carry the scars of this have retired or died because that's human nature. What we need to do is find a way to box in the animal spirits through profound change, sort of change we've been talking about. I'm very interested in this conversation about derivatives because I don't think the opponents are saying that derivatives are bad. Derivatives provide a socially useful purpose. If you're a food manufacturer, you want to hedge your input prices. If you're an airline, you want to hedge your fuel costs. If you're a pension fund, you have to protect against longevity risk. I don't think you're saying that, but I do agree that in some ways boxing that risk in in a way that means that the animal spirits can't take root again is a very, very important thing. And I'm sort of curious about what your position on derivatives is because are you saying there shouldn't be any at all in the world or are you saying they should be handled in a different way? I just want to clarify this because you said something very important. You stress, which seems to be correct, that we have a completely global interconnected system. And when things go seriously wrong, it becomes a major global crisis. And that wasn't true. It's always been true to some degree. Kendall Berger's work makes that clear, but it's probably more true now than ever before at a certain speed. The logical implication of that would seem to be, and it seems to be consistent in what you say, that the system really has to be in some obvious sense in its bits components, much safer than it ever was before because the damage it can do is so much safer, bigger than before. Would you accept the logic of that? I do, but I think the definition of safety has to be a technocratic solution to this is necessary but not sufficient. There is also a, how do we confine and direct the inherent cleverness of a lot of people that work in the industry for good? And that's why this question of what sort of derivatives, if any, should we have? What sort of derivatives are positive for society? I know many of our clients around the world need derivatives to do their business. And that business that they do affects the lives of citizens. If you have a pension, you are a consumer of derivatives. If you plan an aeroplane, you are a consumer of derivatives. So the question is, for the opponents, I think, how would you constrain, confine the derivatives market? Or would you just say the risk is too high we should eliminate? And Art, what's your response to what has been said by the proposers on these follow-ups? Well, obviously, the focus is on what society needs banks to do, but I completely disagree that we need this leverage to be as it is. And I definitely do not have time here, but that's why I spend a year and a half writing a whole book on trying to explain why the existence of banks in the space where they are, which they have absolutely no reason at all to be at, which is a single-digit amount of equity which nobody, without any regulation, goes to, and nobody needs to, including the banks, is a completely unhealthy existence that not only risks the banks but risks the rest of us, and does not do anything good in exchange, nothing. So all the trade-offs that you're told about are just wrong. Lending, if anything, is entirely distorted by extreme leverage of this sort, which is a permanent distress situation. A heavy-borrower does not invest in some useful things that are not enough upside in them and loves more risk, more borrowing gets addicted in some fashion. And there's a system we have that perversely encourages that through sort of a safety net. No business in this economy has the easy money that banks have to play with. Depositors walk in the bank and give the banks money, no strings attached. They expect the regulators to behave in their place as normal creditors would. Other businesses would be stopped from borrowing as much way before they got to these levels, and keeping banks there has no benefit to society, zero. The levels should be completely different. So I completely disagree on the leverage, and I happen to understand a lot about the economics of fund, I believe. I want to ask each of you one very simple question, and then I'll go to the floor, and I'll start with Douglas the question, seems to me directly relevant, is it safe enough, is do you believe that the implicit subsidies in the major countries to the banking industry are now close to zero? Or are the government's societies a whole still, in some obvious sense, still the backstop for the banking system? Governments decided a long time ago, particularly with the creation of the Federal Reserve, to provide a backstop for insured deposits. The benefit of that goes to society for insured deposits. Beyond that completely, that's formal and clear, beyond that, because clearly what happened in the crisis went well beyond that. Beyond that too, I don't accept the calibration of the subsidies that some people have calculated, because if there is a benefit, it's reflected in the rate at which banks can borrow, which sets the reference rate against which they price credit to their clients. So if banks are getting a subsidy and their reference rate, they're passing that on to society in terms of cheaper finance, so society is getting the benefit, not the banks. Paul? I think it's clear that the global financial system and the major institutions, which I agree with Anthony, goes well beyond banks to a number of other kinds of institutions that are really financial institutions. I think the governmental guarantee and therefore subsidy is intact and in the absence of that, but I don't even know what the absence would look like since there's such a commitment to not have the next financial crisis allowed to happen by banks. I think the point about interest rates is accurate, but I don't think it's as powerful a point as that because of the inability of investors to understand the financial condition of the major financial institutions, they are not able to stand on their own in the next financial crisis. Anthony, would you like to add anything to what Douglas said on that specific, but I think it's a very central point, about whether they're safe enough? I think I agree with Douglas. Clearly we've talked a lot about regulation changes that have happened and are to come, and I think we are substantially through that process. It will take till the end of the decade to conclude those, but I basically agree with Douglas. Well, sometimes we're told that there are no subsidies and sometimes we're told that there are subsidies but they're passing them on. Whichever it is, it's a crazy system. Imagine that you subsidized, the trucking companies got subsidized insurance to drive fast, got bonuses when they arrived fast, but then of course when they exploded we had the collateral damage that was not included there. Imagine that we allowed companies to pollute a river and produce cheap dyes and that's the chosen method to produce the dyes, but they have a perfectly equally costly clean alternative, but we happen to subsidize the one that pollutes. That's what's going on here. We're subsidizing the polluting way to fund investments and that's the way all subsidies to banks are given and all supports to banks are given more and more and more debt that distorts everything. Lots of risk is taken. Risk is important. I come from Silicon Valley. Lots of risk is taken. Much more risk than in lending. Lending is not as risky an activity as some innovation is. It's never in the private market without regulation funded in the way that banks fund it and that's because the banks start with insured funding and cheap funding for which they provide service. From that point on, they don't want to put their money at the risk. That's the beginning of the economics of it. I'm going to turn to the audience, but may I tell you I've made a change. We're going to have a vote. I think you've all got a little machine. I was thinking of asking a vote at the beginning and the end, but I thought that was a bit sadistic. Perhaps I was being too kind for fairly obvious reasons. We're going to have a vote at the end, but now I want to take questions or points. I'd like to start, if I may, in the first five, ten minutes with a series of possibly very, very brief points in the debate. It's a debate that you can make questions one and I'd like to start with somebody who's on the proposer's side. Somebody wants to say, they are safe enough. Question or comment? I'm going to say yes or no at this point, but I do want Mr Singer to address Mr Jenkins' question. As a policymaker, can you illuminate the good guy derivatives and the bad guy derivatives and how as policy makers we could actually tackle the notion of strictly limiting derivatives on off-balance sheets, rather than on them, and in a way that would not harm the use of derivatives for those legitimate business purposes? I'll come to the question. Can you just hold on, Paul? Anybody wants to make a point or question more on the opposing side, but it doesn't matter. That doesn't really matter desperately, sort of mixed up debate discussion. I think I take the view that they are safer, but that the sense of injustice that arose as a result of the crisis has not been satisfied, and that injustice is being played out by the desire of people to continue to punish and extract confessions from the bankers, and that will go on for a very long time. There's nothing they can do to rectify that sense of injustice. The better way of dealing with that injustice would not have been had the bonuses in the first place, which would have been possible if you had proper accounting. If the accounting standards properly measured when banks are making profits, rather than this fictional accounting system which allows apparent profits to generate, and will allow them to generate again now out of which huge, apparently deserved rewards can be paid to the bankers, and the public won't let them get away with that. Nothing they can do will let them get away with it, will they? But I think it is safer. Good question. I'll take two more, and then we'll get a lady here on the right. What can I give you? One argument on each part of the debate. One is why it's safer. I think it has been mentioned, but the powerfulness of the new recovery and resolution mechanism has been underestimated, I think. The fact that you bail in everybody except your mum, and in Cyprus, almost your mum, in sugar deposits were paid in. So that is a very powerful deterrent, I think, which argues for a safer system. However, on the other side of the argument, the fact that concentration risk has increased in the system as a whole, as part of the crisis resolution. Biger banks got bigger, and the smaller were not bailed out failed. So that concentration risk is higher, and how we take that into account. Final point. Somebody else? Jeremy, do you want to answer the question? That doesn't seem to like the fractional reserve banking per se, so I'd like to ask her what she proposes as a solution, or an alternative to this, given that banking is at the centre of credit creation, and that drives great. Okay, I'm going to start on what are good derivatives and what are bad derivatives. Paul, are you going to be brave enough to give the senator a list? Yes, and thank you, Senator, for enabling me to answer Anthony's question, which I was anxious to do. Let me make a couple of points about my view about derivatives. I love trading them. It's something that we and other people like ourselves try to find opportunities to trade to make money. Number two. I think on balance, my view is on balance there's been a net negative to society in this particular type of invention. Many inventions have lots of positives for society. I think there's been a net negative. I think the hedging benefits have been exaggerated over the years, and they are outweighed by the complexity, the growing complexity, and by the leverage. You use the word good and bad. I don't think of it that way, although some of those subprime securities were just plain old bad. What I think about derivatives is that if every institution that owns or trades them is properly margined and is marked to market, including end users, including every institution, including sovereigns, multilateral institutions, then the system would be safe. If people were margined the way customers of investment banks were margined, then it's not a capital issue. Capital is a kind of a banking concept, but it's margin. Margin is a customer concept. Because of margins, margin account customers don't typically cause the world to collapse. I just want to make one more point about this. Anthony, I believe, made an interesting point about the firms that actually went bust. A good point, but I want to point out that Chairman Bernanke stated, and I don't quote much from Chairman Bernanke in a positive way. But this is a special exception in honor of Martin. And Jamie Dimon seconded that in the absence of the government guarantee, 12 out of 13 of the largest banks in the world would have gone out of business. Now, I'm not going to argue and say no, it would have been six or seven, and I'll bet that Anthony and Douglas won't argue that point either. But the extreme of leverage and fragility was found in 2008. And I think the point that Anat made about the leverage and when you reduce it from 95 to 85 and it's still unsafe, you haven't done anything for yourself in a positive manner. I think it's only fair to ask whether one of you would really want to defend the social utility of derivatives because this has been pretty sweeping. I agree with Jeremy. I think you've got to peel back the onion to the individual types and who's using them and for what purpose. I mean, I think the creation of central counterparties and putting the vast majority of derivatives into a system where they'll be transparent, where the risks are and where they will be margined and margined prudently. And that's still to be finalized, but I'm sure it's going to be prudent. I think has made the system that's probably the single most important thing to making the system safer and indeed reducing the volume and complexity of OTC derivatives. But there is a huge demand from customers, from every aspect of managing their risks for instruments that take that risk away from them, push them into a risk management framework that can handle them. If we don't do that as an industry, someone else has got to do it or those risks line naked on power companies, pension funds, airlines, agricultural producers and so on. It's surely got to be better for society to put the risks into a framework where they can be managed professionally and transparently, properly capitalized margin. To do so otherwise, I think pushes the risk back to people who are unable to handle it. I'm going to move on because just because we had, do you want, do you desperate to say something on this? Not on this. Well, we'll come back. The next question, which I thought was really important, and I want to address to either Douglas or Anthony, is bonuses all very well. But if it turns out the profits that were made were illusory, they created a particularly, you know, as I pointed out, the banking industry looked great in 2006 and bonuses were paid and people walked off with lots of money and the society in very many ways ended up holding the bag. That did clearly create huge rage. There's no question. Can you actually swear that on the basis of what has happened in these various areas, which you talked about, Douglas, that this is really sort of over? There's a lot of skepticism about this and I'm not the only skeptic. Look, I think the point was very well made about the anger of society at the role the banks paid played in the crisis and that fairly also said that it was not solely the role of the banks. I think there has been more restraint in banking than in other than there have been previously in both the quantum, but more importantly in the structure. Douglas referred to some of this in his remarks. Very heavy levels of deferral, the ability to claw back formalis, high amounts of compensation paid in stock for senior people aligning their interests with those of the shareholders. I think we have come a very long way in aligning the interests of the employees of an organisation with those of the shareholder with those of society. The interests of society in this debate are represented by the regulators and the regulators have an intense interest in what we do on compensation. From the point of view of is this acceptable, is this justifiable, but also from the point of view of its impact on our balance sheet and our capital position. So I think we have made a great deal of progress. I will say though that I understand the sentiment that says why are people paid so much money in banking. The responsibility that people like Douglas and I have to our shareholders is if we are in those businesses we have to be competitive to attract the best talent. And that means that on occasion we will have to pay money for people that we need to go on the team. However, I think the mitigation of the risk from immigration has been quite successful actually. Well or not, this is a really big issue. So has the incentive structure of the banking industry in your view been de-risked in these respects which have been raised? Can we tell the people that it will never happen again? Definitely not. Cloudbacks if you go and read our rare, the legal issues around cloudbacks are not so simple and so I think the incentives remain distorted in the system. I did want to make sure to talk to the bail-in issues and to fractional reserve especially around the bail-ins. All the substitutes for equity that are not equity, actual common equity are inferior to equity. In the crisis nobody except in Lehman Brothers who was promised anything even if they were supposed to absorb losses did absorb losses. This is a fact in this situation and I sit on the FDS system resolution by the committee and it comes up all the time. Two things about it, not reliable and collateral damage. If you had to trigger it, it's a complicated process, it's a disruptive process. Before it, it's disruptive, disruptive because everybody rushes about. It's disruptive for any number of reasons during and before. Beyond that, because I understand about the economics of funding, I can tell you that any overhangs even from tarp distorts lending. Any debt that is hanging over the decision maker's head is not helping lending, is distorting lending in favor of risk against some loans that are not attractive. Lending is mostly, a credit country is mostly an overhang problem and there's no reason to have so much overhangs all the time. That's the existence of banks is with too much overhangs that they just get themselves into. Could you just very very briefly explain for everybody here may not have taken the basic finance course with you what a debt overhang means? Let me talk about the homeowner who doesn't invest in the house. There's substantial evidence that underwater homeowners or just distressed homeowners are not maintaining houses, are not investing in houses. There is collateral damage, there's damage to the creditors and damage to the overall efficiency because they're not making investments that should be made and there's damage to the neighborhoods. So there's collateral damage from that. That is in the homeowner context. When investments are not made, particularly when loans are not made, the economy suffers. So there's a collateral damage from high distress all the time. When a borer takes on additional debt, second mortgage, the previous creditor suffers. It goes down to everybody. Default is more likely, foreclosure is more likely, neighborhoods are harmed. That's in the context of housing. So debt overhangs prevent, create a situation that's entirely due to conflict of interest between borers and creditors, which pit make the borer avoid certain investments that, because they can't get the creditor to participate in the investment, would essentially give a gift to the creditor at their expense. There isn't enough left for them to benefit and bias them in favor of investments that might actually harm the overall pie, but benefit them at the expense of the creditors. In other words, you can get bad decisions on both kinds. Decisions, investments that should be made that are not made, investments that are made that shouldn't be made, both types. That's the essence of the inefficiencies of high indebtedness, and that's part of why creditors write a lot of covenants into debt, but bank debt does not have that characteristic or substantial amount of it is not of the form that comes with contracts that protect creditors. Creditors think they're going to leave just to say one sentence on that. There is this notion that banks create money, but let me just say the following about this, and we have a chapter in the book about this, so I really can't, obviously, under time circumstances go through this. Every private money in the economy, every private money, in other words, everything except central bank money is somebody's debt. No matter what else you say, this is a fact. It's somebody's debt. It's as money-like, as safe, and as liquid, as the issuer of that money, as the liquidity of those markets. All of those can go away, and people's perception and the moneyness can change. On fractional reserve, the models that are used in banking often assume that a central banker or somebody presses a button somewhere and the loan comes out the other side. Well, in between the button that's pressed and all the transmissions and the loan that's made is a banker, and it's still a corporation as a person making the decision, and they will do what they'll do. I thought it would be very important to give Douglas and Anthony a response because it's an incredibly important point to get to the heart of these on recovery and resolution. That's the ambulances, by the way. That's the ambulances by the roadside. Corners. Yes, Annan, stop. This idea that we can bail in debt in a crisis rather than rescue the institutions and rather than have much more equity is a central idea, a really core idea of our reform process. Douglas mentioned it, I think, I'm sure, right at the beginning. It's unquestionably, and that is not the only person who's sceptical about the possibility of this, partly because of the failure of subordinated debt in the last crisis. How would you sort of convince people here that that absolutely crucial element, this sort of quasi-equity in the system, which is notionally supposed to make it reasonable, would actually work in a major crisis? Would either of you like to respond to that? I think very important question. I think it would respond because, in fact, legislation is put in place to ensure that it will respond. So an FDIC on the Bank of England and the two major jurisdictions have concluded that if the circumstances of 2007 and 2008 were to happen again, they are much better prepared in terms of infrastructure to deal with it. The point from the institution side I would make is that I think the learnings that we have learned, and I think the industry would say the same, from going through the process of recovery and resolution planning in terms of where the interdependencies within a large group are, where the interdependencies with market infrastructure are, how you would deal with operational continuities in the event that a peace or a large peace or even the whole institution were to get into difficulty, I think have been tremendously powerfully positive for building resilience within our own operating procedures. The final point I'll make because it's obsession of mine is, I think that bail-in is often proposed as a holy grail solution and I think when policy makers say never again must the taxpayer be called upon, I think that's a wonderfully seductive sentence for the public until you finish the sentence which says never again will the taxpayer be called upon because we will have hardwired the losses into your pensions and savings through bail-in because effectively bail-in is your pensions and savings. I mean, there is no money other than society's money, so those who have put debt funding into the bank are going to be bailed in, it's not their money, it's long-term savings and pensions money, so at the end of the day what we've got to do is find a way to ensure that the possibility of another systemic crisis is as low as possible because the losses will fall in society through different routes, but the losses will fall in society. There is no pool of money, whether it's capital or bail-in debt that doesn't go back to the man in the street. The final question that was left out standing and then I will stop it which I think is also very, very important is concentration. I think it's unambiguous, there's no doubt that the number of major institutions globally has reduced if we among in the developed world I'm going to leave aside the obvious fact that the banks from other countries are likely to enter the system and that's going to create very interesting situations, Chinese, Indian, so forth. But if we look at it, if you look at the list of globally significant international financial institutions, it's an extraordinarily small number, a little over 20 if I remember correctly, of immensely big institutions with monstrous balance sheets by the standards of any other business, and two of them you represent obviously two of them, and there are several others. Is that shift to concentration, and it's a change, one towards stability or away from it seems pretty central to me, Anthony? I don't think there's an easy answer to that question. In some senses it comes back to this notion of do the institutions understand risk? Have they allocated capital appropriately to that risk? Do they price the risk appropriately? The chances of doing that in a larger institution are probably greater than in a smaller one, and so I think concentration is actually not the big issue here, I think the big issue is do banks and other actors in the system understand their risks, manage their risks, price their risks, and is there an effective governance of that on behalf of society through the regulatory mechanisms? That's what we have to build towards. We can, and of course it is a continuum, I would say, and that is at the far end of the continuum that says basically all banking is bad, or most all banking is bad, but banking done in a certain way, done in the way we do it today, is a risk to society. At the other end of the spectrum there's 2008. I think what we need to do is decide where we want to be on that spectrum. We can manage our institutions in many different ways, but we need to decide because we need to be able to continue to change and improve them and make them safer. That's very briefly because otherwise we can't keep people from the next exciting, even more, no, there's no such a more exciting thing. Two very simple points, we said at the beginning of the designation of systemically important institutions, this would have the unintended consequence of concentrating risk and it has done, I mean, I think the marketplace says if people are designated as systemically important, that means there are systemically important and even no matter how much policy makers say that doesn't give them any privileges, I don't think people accept that that wouldn't be the case. The second point is in concentration. I think it's far less relevant to looking at institutions. I don't think it's the question of the shape or the nature of the containers in which the risk is. I think it's other systemic risks, no matter how many containers you spread them over that are systemic to the system. A simple observation, I believe too big to fail is around two things. Housing finance and sovereign debt, you look at every crisis, these are the two assets that are most mispriced and these are the two assets that public policy and regulatory policy gives the most privilege to. So the two asset classes that banks are most incentive to invest in are the two systemic asset classes. And that's crazy. Yes, and now to a poll on concentration but not just one of you. Do you want to say anything on concentration risk or we could leave that? Can I say something on SIFI's systemically important? I think that's a very mischievous designation and any company in today's world of almost infinite leverage possibilities can become systemically important or un-become systemically important almost overnight. And so I think that every institution that is governed by capital rules, leverage rules, margin rules should be margined the same. And I think that's a lot better than having regulators make these arbitrary and inflexible ultimately designations that actually don't correlate much with who's risky and who's not risky. Firms that are not systemically important but are similarly situated with many other firms that are the same way can provide systemic risk. I'm going to go if I don't want to... I need to make one statement. Okay, one statement. Last one. Well, I think Anthony mischaracterized entirely what I was saying. I am not hating banks. My concern is with the regulators that are not helping the banks be healthier institutions that the economy needs. That's my problem. My problem is I want strong banks. Maybe it's somewhat fewer but healthy. I think we can have good banking but I think it's bad banking that's harming the economy. Bad meaning weak, that's what I mean. Zombie banks that are living, that's what I mean. I decided that we should have to continue the discussion because the issues were so important rather than they have a whole series of summary statements because you're all very smart people and you know exactly what was said. It seems to me the central issues are clear. Has the system been delivered enough in all its complexity including derivatives? Are markets now robust enough in the way they interact with one another or have incentives being changed enough and the regulatory structure that surrounds it enough therefore ultimately is the system safe enough and you as I said have to decide whether or not you've been persuaded that that is the case. I think we've had a very good discussion. You take out your little machines. I hope this works. I'm not a master of this technology. What does one press if one thinks one and two? Is the international financial system safer now in the relevant sense than it was five years ago? You press one if it's yes and two if it's no. Go. And the answer is? Recount. Relative to this benchmark. I'd like to thank the participants for what I think was a very, very good discussion. Would you thank them and thank the audience.