Media Conference Call: Lessons of the Financial Crisis

SEBASTIAN MALLABY: I'm Sebastian Mallaby. I direct the Center for Geoeconomic Studies at the Council on Foreign Relations. Thank you to everybody for joining this call. One of the best things we've done this year, amongst a range of reports on the Financial Crisis, is Benn Steil's special report, "Lessons of the Financial Crisis."

So the point of this call is to ask Benn to explain the message. If you'd like to get a hold of the report and you don't have one, you can find it on the cfr.org website; even better, cfr.org/cgs for Center for Geoeconomic Studies. It's called "Lessons of the Financial Crisis."

So let me hand it over to Benn. He'll do a sort of 10-minute overview of the report.

BENN STEIL: Thanks, Sebastian.

The first thing I'd like to emphasize is, although the current crisis has had many features that we hadn't seen in previous crises -- for example, the credit default swap market didn't exist 10 years ago -- this crisis is fundamentally a classic bust of a classic credit boom, the sort of bust of a credit boom that we've seen many, many times in the past.

In particular, there are enormous historical parallels with the 1920s. Most people, when they talk about the 1920s, focus on the stock market crash in 1929. But it's important to recognize that there was a massive credit boom across the U.S. economy.

There was a real estate bubble as well. And the epicenter of that real estate bubble was actually in Florida. So there are enormous parallels between this crisis and previous ones.

There are a number of very important policies that stoked the buildup of debt, across the economy, over the course of the past decade. I'm going to focus on a few of them. One that I'd mention at the outset, because I don't think it's gotten nearly enough attention, is taxation policy. And I will talk a bit about why I think that's been very important.

I'm concerned that the current focus, reform focus, in Washington at the moment is on what I would call institutional fixes; that is, beefing up and reallocating regulatory responsibilities among regulatory agencies. And I don't think that that's nearly enough, however important it might be, to make sure that we don't get into a crisis like this again.

And the reason that I say that is that there are many aspects of the crisis as it was developing that were actually quite consistent with some general thrust of government policy; for example, expanding credit to low-income households, or in the case of U.S. investment banks, increasing their leverage - there was a great concern in Washington with increasingly the competitiveness of U.S. financial institutions, particularly vis-a-vis the European counterparts.

With regard to expanding credit to low-income households, I refer to two quite interesting side-by-side articles in The Wall Street Journal yesterday, one of which is titled, "U.S. Median House Price Declines 14 Percent." And of course, if you only read that article, and you didn't know anything about what was going on during the housing boom, you would naturally come to the conclusion that mortgage lending needs to be better regulated. But right next to that article is another one entitled, "Housing Boom Aided Minorities." And the subtitle is, "Home Ownership Reached Record Levels, Narrowing the Gap With Whites." And of course, that's all we knew at the time that the bubble was developing. Nobody wanted to deal with the question of what would happen should it burst.

But certainly, expanding home ownership among low-income households and minorities was a priority in government policy. So if we had relied on government institutions or credit-ratings agencies in order to forestall the growth of risky lending, we probably would have met with a severe backlash in Washington that would have neutered such interventions.

So I'm going to focus right now on just a few of the major policy areas where I think we need significant reforms going forward. First and foremost in this crisis, monetary policy played a very significant role. Interest rates were extremely low by historical standards, from 2002 to 2005. In particular, the federal funds rate was between 1 and 2 percent. And more importantly, real inflation-adjusted interest rates during most of this period were negative, which is a situation we had not seen since the 1970s. And that was perhaps the most important policy mistake that was made during that period that fueled the boom.

I mentioned taxation policy at the outset. Taxation policy encouraged both households and companies to build up their debt stock enormously. At the household level, we had mortgage-interest tax deductibility and also, very importantly, home-equity-loan-interest deductibility. Both of these encouraged people to borrow more than they otherwise would have to buy houses; to buy bigger houses than they otherwise would have; and then to borrow against those houses, reducing the equity in their home, because of home-equity-loan-interest deductibility, therefore increasing their risk of default.

And it's important to understand that, as a matter of social policy, mortgage-interest deductibility was not a wise policy, as low-income households generally didn't pay income tax and therefore didn't even benefit from it.

At the corporate level, it's important to understand that companies face an enormous penalty for financing themselves with equity capital. The effective tax rate for companies using equity finance for an investment is about 36 percent. The equivalent effective tax rate for debt financing is actually negative 6 percent, and that's because of, in particular, interest deductibility and accelerated depreciation for debt-financed investments.

If you've ever wondered why banks seem to abhor the thought of having to raise additional equity capital and abhor the idea of holding loans on their balance sheets, it's precisely because the taxation system makes equity-financed investments so expensive. Banks prefer to use debt.

We're very concerned now, in terms of public policy, with underpinning the securitization market. Well, securitization was grossly overinflated over the course of the past decade because of taxation, because banks did not want to hold loans on their balance sheet. Because of the fact that it would have to be supported by relatively expensive equity capital, they naturally sought to securitize debt, in particular mortgages, to package them together and to distribute them.

One very detrimental side effect of this was that the whole important process of borrower screening and monitoring was effectively obliterated. In the olden days, when a borrower wanted to get a mortgage, he went to the bank, and the bank screened the borrower. Once it made the loan, it had enormous incentive to monitor the borrower and make sure that he repaid.

But with the way securitization works, the bank often knows nothing about the borrower at all. A credit-rating agency looks at the loan after the fact, slaps a credit rating on it. It has an incentive to provide a very positive rating for that security, because the credit-ratings agency is being paid by the issuer. And then, of course, the bank sells off the mortgage, so it no longer has any interest in collecting on it.

One of the things that I recommend in the report is that issuers of mortgage-backed securities or asset-backed securities should be required to maintain a material economic interest in those securities that they originate in order to make sure that we re-inject borrower screening and monitoring into the process. This would also have the positive effect of encouraging alternatives to securitization that have a lot of the benefits without having the systemic costs, in particular the use of covered bonds, particularly in the mortgage market, where banks do keep loans on their book but issue debt that are backed by those loans as collateral. Covered bonds are used very widely in the European markets.

One final point I would emphasize at the outset of our discussion is the international dimension of the crisis, and particularly the fact that countries that were most affected by the crisis actually had no exposure to U.S. toxic assets. I'm thinking in particular of developing countries and smaller European countries on the periphery of the eurozone. As we've seen in past crises, when there's an international flight to safety, investors rush to dollars, in particular, or euros to a lesser extent, and that has had a devastating impact on smaller and developing countries.

Up to now, the policy debate in this regard has been focused entirely on beefing up the resources for the IMF. No doubt that's necessary in the midst of this current crisis, but it does nothing to make sure that these crises do not reemerge. Every five or six years or so, we're faced with a new currency crisis someplace in the word with new calls for the IMF to have more resources and more power to intervene.

I think the most important reform that Europe could undertake is making it much easier for countries on the periphery of the eurozone to enter the eurozone, and that would make sure in the future that they are not faced with the devastating capital flight that they have suffered in the course of the current crisis. Iceland, in particular, is only the most dramatic case of a country on the periphery of the eurozone that was very badly hit by the crisis.

Sebastian?

MALLABY: Thanks, Benn.

Let me just make a couple of points about why your analysis strikes me as so salient. One is that there's this debate going on, obviously, now with the expectation of a major package in Congress, led by Barney Frank, with a sort of, you know, overall regulatory response to what went wrong in the financial system.

I think everyone would agree, though, that, you know, first, do no harm. And if harm has been caused by an excess of leverage in the economy, with debt to GDP going from about 150 percent in 1980 to 350 percent at its peak just before the bubble burst, if we want to get that number down, it's crazy that government is actively encouraging leverage in all these ways that you describe. It's like saying we want to wean ourselves off oil, but when you look at the federal tax code in its detail, you discover that there are actually oil production subsidies. This is a perversity on that scale.

And I think it's wildly underdiscussed. People are running around offering all kinds of other sorts of regulatory fix, but not getting to the obvious point that, if you don't like leverage, the government shouldn't be encouraging people to have more of it.

The other thing I would say -- do you want to respond to that?

STEIL: I agree with that point entirely. I would say broadly that there were two different ways that we could have addressed this crisis from the outset.

One is to have tried to clean up the banks' balance sheets immediately. Create, for example, a "good bank, bad bank" structure right away, get bad assets off the balance sheets of the banks; wipe out the old equity owners; replace them with new equity owners, basically a Sweden approach writ large, and then there would have been no problem in the banking sector to restart the lending process -- probably under very different terms. We probably wouldn't have seen, for example, nearly as much securitization or high-risk subprime loans.

Instead, we were very reluctant to go down that route, and we've seen the government try to replace the leverage that we've lost in the private sector with their own leverage. Government agencies of all sorts, Treasury, FDIC, the U.S. Federal Reserve have been throwing guarantees at debt right and left.

The TALF program, for example, is trying to keep up securitization levels to an extent that we probably should not consider desirable going forward. So the approach we've taken, I think, is actually pushing us in the direction of keeping too much debt in the economy.

MALLABY: Right, and that gets to the second point that I was going to make, which is that your analysis in this report, which you present mainly because you're offering, sort of, solutions to financial regulation, actually also relates directly to the question of green shoots and whether we are about to get into, you know, a better macroeconomic picture, whether the economy takes off again, because one of the big wild cards in any scenario that predicts a recovery is, you know, where does consumption come from?

And consumption as you've described has been underpinned by debt. I saw one number, actually, from McKenzie Global Institute suggesting that if household savings in the United States had been constant between 1980 and 2007, households would have spent $1 trillion less in 2007.

STEIL: Yes.

MALLABY: So that's, you know, very -- in a $14 trillion economy, $1 trillion less of aggregate demand is a pretty serious number.

So how do you think the government should be, you know, balancing the desire to get leverage out of the system, because it turns out to have been dangerous, with the problem that if you take the medicine to which we're addicted away too quickly, the green shoots will die?

STEIL: Well, we like to focus on this broad concept of an output gap, the notion that the economy is now producing more than can be supported by private demand. So the government has to step in to fill the breach. Well, it's important to understand that a lot of the consumption and the spending that we had back in 2006 and 2007 was based on imaginary wealth, was based on debt.

For example, we're constantly seeing articles about how auto sales are down 50 percent from last year. Well, we're not going to go back to an environment of auto sales at those old levels any time soon, because much of that was being supported by debt and imaginary wealth. We're trying desperately to prop up state and city spending levels that were premised on the continuation of tax revenues that again were being supported by imaginary wealth, by inflated debt levels. And we're going to have to ratchet down our expectations about the sort of state and local spending levels that can be supported in the future.

I think we are likely to see some return to modest growth perhaps early next year, given the overwhelming power of the monetary and fiscal medicine that the government is injecting right now. My big concern is that we're just building up for the next phase of this crisis. Once lending starts picking up again, once the de-leveraging process has played out, and the velocity of money starts picking up in the financial sector, the Fed is going to be forced to wind down a $3 trillion balance sheet exceptionally quickly, to dump up to a trillion dollars of private assets on the market very quickly, in order to soak up the dollars it's pumped into the economy. I fear that they won't do this nearly quickly enough, and nearly aggressively enough. And if that's the case, what we're going to see is a big decline in the Treasury market -- in other words, Treasury yields rising significantly, a big fall in the dollar, and six months to a year behind that, a significant rise in inflation. So we may be building up big problems for the future.

MALLABY: I just want to, I mean, make sure that I have understood it and everybody on the phone has understood it. This debate, therefore -- if we're asked the question, so Benn Steil's report, you know, explains how the government in a myriad different ways encourages this leverage that we now see as poisonous; why would the government do this? Well, the answer is that it doesn't want to face the consequences of deleveraging; namely, a lower growth rate and a more prolonged recession. So is that right? It's feeding more leverage back into the system deliberately, with some of the structuring of the PPIP plan for buying toxic assets, with the structuring of the TALF. It's deliberately trying to releverage, you know, the way that home equity -- home mortgage refinancing's proceeding across the board, because rates have been driven down deliberately by the authorities.

Given the choice between addressing the financial regulatory arguments in your report and simply feeding more stimulus into the economy, perhaps understandably, the administration has picked the second.

STEIL: Yes. The key word is "understandably." Obviously, there were many features of the boom period that were very desirable. Growth in the economy is exceptionally desirable. There were some aspects of the bubble that actually had distributional effects that were considered very positive in Washington. You know, I point to one, the growth of home ownership among low-income and minority households. And obviously, the use of institutions like Fannie Mae and Freddie Mac to support the growth of such loans was completely consistent with government policy at the time.

And I think part of what we're trying to do now is to ensure that we don't lose the benefits of that period. But that requires us keeping the country as a whole at exceptionally elevated, and probably irresponsible, levels of debt.

MALLABY: I'm going to ask people on the line to -- if they've got questions as well. But let me just get to one other point before I do that; which is that, you know, your report has -- addresses a lot of other of the, you know, debates in financial regulation, what to do about credit-rating agencies, what to do about capital adequacy regulation and so on. But the one that's in the news right today, with Tim Geithner's statement yesterday, is this question of moving credit default swaps onto exchanges. And in your report you talk particularly about the ways that that could be done badly.

STEIL: Yes. And in fact, Tim Geithner's gone further than that now, and I think he's pushing in the right direction, which is to expand the focus beyond credit default swaps which obviously played a significant role in this crisis, particularly with regard to the collapse of AIG, and move the focus into the area of OTC derivatives generally.

When there's no central clearing mechanism for these products, you have a number of problems. First of all, there's no transparency. Nobody knows the level of risk that institutions are bearing, or the distribution of risk. At the time that AIG first went to Treasury and the Fed in September asking for assistance, they were told "No" in a very public way. But when they opened the books and revealed their credit default swaps positions, then Treasury were exceptionally surprised and reversed course extremely quickly.

Now, if we only focus on getting credit default swaps on a clearinghouse, where we have more transparency, where we have netting of trades, novation of trades and absorption of default risk, by a well-capitalized entity, if we only concentrate on credit default swaps, then we can rest assured that the next crisis that involved the OTC markets will involve another instrument that becomes exceptionally popular.

So I think they're right to expand their focus in the OTC derivatives area. But I suspect they'll face a number of challenges. For example, Treasury wants to see, quote-unquote, "standardized" products moved on clearinghouse. It's not always easy to determine what exactly a standardized product is.

These contracts are developed privately within financial institutions. Different financial institutions come up with different variations of these contracts. And determining what's exactly customized and what's standardized, I suspect, won't be quite that easy.

Secondly you've got an intellectual property rights issue here. The reason that banks devote resources to developing contracts, like this, is that they can make money by trading them bilaterally with their customers.

If they have to put these contracts that they invent on a central clearinghouse, they're effectively supporting financially and intellectually the development of markets that they don't benefit from, to the extent that they've provided the intellectual capital for them.

So I think Geithner is going in the right direction. But I suspect that there will be complications in implementing this particular regime.

MALLABY: Right. And as I remember, you've also got some concerns about how this should be coordinated, across the Atlantic.

STEIL: I do.

The OTC derivatives market, for all its failing in the counterparty risk area, has been an enormous success in terms of stimulating risk-management products, many of which eventually do become large and standardized and move on exchange. And it's important to understand that this market is genuinely global. It's not an offshore market. It's not a U.S. market. It's not a European market.

It's governed by law, private law, that's encompassed in a 32-page document that can be downloaded online from ISDA, the International Swaps and Derivatives Association, which specifies the terms of the contract and how matters would be dealt with in the event, for example, of a default on a credit default swap. And it specifies that any dispute will be governed by either a U.K. common-law court or a New York State common-law court, depending on the will of the parties.

Now with both the EU and the U.S. rushing to produce their own clearing solutions, a market that was once legitimately global may now be bifurcated between two regions, therefore fragmenting the market and producing an element of regulatory arbitrage into the market that, I think, would be undesirable. So I would like to see some coordination between the U.S. and the EU to keep the market legitimately global, but with important minimum standards being harmonized -- for example, on margining.

MALLABY: By the way, I think the issues that Benn has just been talking about are a wonderful illustration of the way that, in the good times, when global economies are working well, we think that markets regulate themselves -- and, in fact, the 32-page contract that Benn mentioned can simply be downloaded from a website, and that's how you structure the legal agreement around an over-the-counter derivatives trade.

The replacement of that sort of self-governance by market participants and the creation instead of a government-initiated exchange and clearinghouse, I think, is sort of a subset of a wider phenomenon where, in the bad times, people worry that markets don't run themselves, and maybe they go to the -- a bit too far in the opposite direction of getting government into lots of aspects of economic life. Perhaps it's necessary; perhaps it's an overshoot. One can debate that. But in any case, there is this cyclical effect in people's attitudes towards governance, of which OTC derivatives are a good example.

Let's open it up, and if anybody would like to ask a question, please weigh in. Benn's report is pretty wide ranging, as you can hear. He's comfortable both on the microeconomics of financial regulation and on the macroeconomy or the future of the dollar and so forth. So almost any question is fair game.

OPERATOR: Thank you. At this time, we will open the floor for questions. If you'd like to ask a question, please press the "star" key followed by the "1" key on your touch-tone phones now. Questions will be taken in the order they are received. Once again, that's the "star" key followed by the "1" key on your touch-tone phones now.

And our first question comes from Chris Cermak.

QUESTIONER: Hi, yes, this is Chris Cermak with the German press agency DPA. And I was wondering, in light of what you've discussed today, what do you think of whether banks should be paying back the loans that they've already received? You know, Goldman Sachs and JP Morgan and others are already considering paying back some of the TARP money. What kind of effect will that have on the lending that you talk about? Will it increase, will it -- or will it decrease the lending that's out there?

STEIL: Well, I think it varies from institution to institution. I think the very fact that these institutions like Goldman Sachs are talking seriously about wanting to pay back the money is a positive development, because we don't want to have long-term government capital playing a significant role in the operation of our financial markets.

But I think Treasury does bear some responsibility to make sure that institutions that do pay back this government capital do have sufficient private capital to ensure that they don't get into further difficulties if, for example, the real-estate market continues to deteriorate and unemployment continues to rise and economic activity in general continues to decline. So Treasury's right to be very cautious about it.

One area where there hasn't been much attention paid where I do have particular concerns is Goldman Sachs and Morgan Stanley deciding to become bank holding companies. Why, exactly, did they decide to do that?

Well, at the height of the crisis I think they came to the conclusion that in a crisis, the only stable, reliable funding base for an institution such as theirs was taxpayer-insured bank deposits. And that's very worrying, because I don't think going forward we want risk-taking institutions to be resting on government-insured deposits in order to fund those activities.

So I think as we emerge from the crisis, we're going to have to start asking some serious questions about what financial institutions should and should not be able to do with government-insured deposit money. I think this whole idea, for example, of narrow banks which can only engage in very limited risk taking activities using government-insured deposits will have to reemerge, because I don't think we want a situation where institutions are taking enormous proprietary trading risks using government-insured deposits, because in that case, market discipline is entirely obliterated. If I know that irrespective of how Goldman Sachs or Morgan Stanley or another major financial institution decides to invest my money in the markets, I will ultimately be paid back by the U.S. taxpayer, then I'm not going to care about it. I'm not going to be prudent in deciding which institutions I should make my deposits with.

MALLABY: Okay. Is there another question?

OPERATOR: I'm showing our next question coming from Yamin Onaro (ph).

I just wanted to follow up. I'm with Bloomberg News. I just wanted to follow up on what you just said.

This profit -- risk-taking issue has been something that the G-30 report pointed out a couple months go. But where do you draw the line with risk taking; i.e., you know, the ones that were bank holding companies, such as CitiGroup, Bank of America, J.P. Morgan, they also have took a lot of risk, although, you know, they are part -- bank holding companies that are FDIC-backed, at least their deposits are FDIC-backed.

STEIL: Exactly.

QUESTIONER: So I mean -- and it's not necessarily -- I mean, Goldman is a big hedge fund, yes, but Citi wasn't a big hedge fund, yet it was taking big risk with the securitization machine that was going on. So how do you -- and that's part of the banking that's going to be allowed, or where do you draw the line?

STEIL: Oh, correct, I agree with you entirely. Goldman Sachs and Morgan Stanley, in becoming bank holding companies, have become obviously much more like Citigroup, and particularly now, when we've expanded FDIC deposit insurance guarantees to $250,000 per account. And there's certainly reason to speculate that if any of these major financial institutions were to go bankrupt, that the de facto deposit insurance will actually be much broader than that.

We need to revisit the whole question of what financial institutions should and should not be able to do using government-insured deposits. This is not a question that I think should be limited to these new bank holding companies like Goldman Sachs and Morgan Stanley, but this is a question that we have to ask about the financial sector.

QUESTIONER: I understand.

MALLABY: Then we should reimpose Glass-Steagall.

STEIL: I don't think it's specifically a question of Glass-Steagall. It's a question of having, at the very least, certain firewalls within institutions that says, well, with certain types of funding -- for example, government-insured deposits -- only certain types of investments will be considered acceptable. They'll -- that's the idea of a narrow bank.

So if we're going to have government-insured deposits, I think we need to circumscribe exactly the way that deposit money can be used to fund risk-taking activities.

MALLABY: Okay. Is there another question?

OPERATOR: Thank you. Once again, if you'd like to ask a question, please press the star key followed by the 1 key on your touch-tone phones now. Questions will be taken in the order they are received.

Once again, the star key followed by the 1 key.

MALLABY: Yeah. While we're waiting to see if there's another question, Benn, there's something I've been worrying -- wondering about as well, which is, in this whole debate about credit rating agencies, is there a way to regulate them and make them more effective, or what should be done there?

STEIL: Well, I don't believe so, and I make that clear in the report.

There are two charges that could potentially be levied against credit-ratings agencies in this crisis. One is that they're incompetent, and the second is that they're compromised by their business model. In other words, they're being paid by the issuers, and therefore they have an incentive to provide quick and positive ratings for the products that are presented to them.

With regard to their competence, there's no way you can inculcate more competence through regulation. That's something that can only be stimulated, at best, through competition. And the current regulatory regime, as you know, Sebastian, acts to restrict competition, because you can't get into the ratings agency business unless you're approved by the SEC, and the SEC has approved very few institutions over the past three decades. So that's one problem.

With regard to the notion that we can regulate away their conflicts of interest, I have no confidence in that. For example, there are ideas floating about to bar or restrict the ability of credit ratings agencies to earn their income from issuers. Well, issuers are the only ones who have clear incentives to pay for these credit ratings.

For example, investors, broadly speaking, do not have incentives to pay for credit ratings, because of the free-rider problem. Once a credit rating is issued, anyone can benefit from knowing about that credit rating. So issuers are the ones who have the incentive to pay for it. If we stop issuers from paying credit ratings agencies to provide credit ratings, then credit ratings agencies will have very little incentive to dedicate capital to this particular business. They might as well go do something else.

So there's no way really to square this circle. In my view, we need to move entirely in the other direction. Right now, they are the gatekeepers to the financial markets because of government regulation -- in particular, rules that restrict state and federal government institutions, even the U.S. Federal Reserve, to investing in assets that are rated by credit ratings agencies, as, for example, triple-A. We need to extract the credit-ratings agencies from the regulatory process entirely.

And you might ask, well, what could we possibly do to replace them? For example, they are part of the capital-adequacy regime. Well, there are other metrics, I would argue much sounder metrics, that we could use to determine the riskiness of an asset besides a credit rating, which is granted by a credit-ratings agency. For example, we could look at that asset's yield spread vis-a-vis Treasurys, which is something people do in the market all the time.

So I have great confidence that, if the credit-ratings agencies are extracted from the regulatory process and are no longer put in charge of determining what assets are risky and what are not, that the private sector will be -- will be able to determine this much more effectively because they will have clearer incentives to do so.

MALLABY: Okay. If there are any other questions?

OPERATOR: I'm showing a question coming from Chris Cermak.

QUESTIONER: Hi. I thought I'd take some opportunity for a quick follow-up. I was just wondering, as banks start to repay the TARP money, what kind of long-term lesson do you think the banks have learned about how much they should tighten the credit standards that they have? Do you think there's been a -- in other words, do you think there's been a change in the mindset of the financial industry? Or is it really up to the government to keep a watchful eye on the risks that are being taken?

STEIL: That's a great question. I think in the short term, perhaps there has been some change in the mindset, because right now most financial institutions are focused on survival. But as the markets begin to perk up, as the housing and real-estate market begins to revive, there's no doubt that an appetite for risk-taking is going to reemerge.

And that's where I become very concerned about the added risks that we might see in the market based on government participation -- in particular, as I pointed to before, the fact that institutions like Goldman Sachs and Morgan Stanley want to use government-backed funding to support their activities in the form of government-insured deposits. That is, they don't want government capital, because that comes hand in hand with government regulation and government interference with their internal corporate governance. But they're very happy to operate with capital that's insured by the government.

So that's why I focus, in the report, on changing policies to change the incentives that these institutions take -- for example, through changes in the taxation system to eliminate the huge advantages to debt financing over equity financing, to impose restrictions on leverage ratios going forward, and making other changes in the financial landscape that make it less likely that when one major financial institution gets into difficulty, that they drag down others. For example, this whole idea of having central clearinghouses in the OTC markets for standardized derivative contracts is one way to ensure that we don't repeat the problems that we had with AIG.

MALLABY: And you have a nice phrase for that in the report, right? Instead of making the financial system fail-safe, because that's impossible, you want to make it safe to fail.

STEIL: That's right. Up to now the general philosophy that's underpinned regulation, both in the United States and the European Union, is that if you focus on making individual financial institutions safe, you thereby make the system as a whole safe.

As we've seen in this particular crisis, prudent actions taken by prudent financial institutions -- for example, ceasing lending or dumping assets, selling assets on the market very quickly, en masse -- can have devastating effects on other prudent institutions in a way in which the entire system is undermined. So we need to concentrate on developing these safe-fail approaches, as I call them, to market regulation.

MALLABY: Okay. Terrific.

Any more questions at that?

OPERATOR: I'm not showing any more questions at this time.

MALLABY: Okay. Well, thank you to everybody for joining the call. Thank you to Benn Steil for explaining the world. The report, "Lessons of the Financial Crisis," is a very clear and lucid read. It's, as I say, on the website. If you go to -- if you put "Benn Steil" into Google, S-T-E-I-L, you will find it, or you can simply go to cfr.org/cgs, for Center for Geoeconomic Studies, and you will find it by scrolling down and looking for COUNCIL SPECIAL REPORTS. It's the first one there.

So thanks again to everybody. Thank you to Benn. The call is now ended. Bye-bye.

STEIL: Thank you, Sebastian.

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