<html><body>American Enterprise Institute October 08, 2008 [Edited transcript from audio tapes] <TABLE cellSpacing=1 cellPadding=1 width="100%" border=0> <TBODY> <TR> <TD> <DIV class=BodyText>8:45 a.m.</DIV></TD> <TD> <DIV class=BodyText> Registration</DIV></TD> <TD> <DIV class=BodyText> </DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD></TR> <TR> <TD> <DIV class=BodyText>9:00 </DIV></TD> <TD> <DIV class=BodyText>Panelists: </DIV></TD> <TD> <DIV class=BodyText><A class=eResources href="http://www.aei.org/scholars/scholarID.72/scholar.asp">Desmond Lachman</A>, AEI </DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText><A class=eResources href="http://www.aei.org/scholars/scholarID.98/scholar.asp">Adam Lerrick</A>, AEI and Carnegie Mellon University</DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText>Allan Mendelowitz, Federal Housing Finance Board </DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText>Carmen M. Reinhart, University of Maryland</DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText>Moderator:</DIV></TD> <TD> <DIV class=BodyText><A class=eResources href="http://www.aei.org/scholars/scholarID.88/scholar.asp">Alex J. Pollock</A>, AEI</DIV></TD></TR> <TR> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD> <TD> <DIV class=BodyText> </DIV></TD></TR> <TR> <TD> <DIV class=BodyText>11:00</DIV></TD> <TD> <DIV class=BodyText>Adjournment</DIV></TD></TR></TBODY></TABLE> Proceedings: American Enterprise Institute The Theory and Practice of Bailouts Wednesday, October 08, 2008 [Note: There are several audio glitches in the recording.] Alex J. Pollock:  All right, good morning, and welcome to our conference on the Theory and the Practice of Bailouts.  Bailouts are the order of the day and of each day, it seems, as we go by.  And this conference has turned out to be even more timely than I thought, with the sequence of deflation of the bubble bust, which turned into a severe bust and now a financial panic. As we look over the last several months, we ve had a lot of practice in bailouts, although it isn t clear that we have a theory which is guiding all this practice.  But the sequence of events has been very true to the classic descriptions of financial enthusiasms followed by what they used to call credit revulsion and panic.  It makes me think of my old friend Hyman Minsky, who is, I m sure, looking down with intellectual satisfaction from financial Valhalla in his theory of the buildup of financial fragility as an endogenous natural development in financial systems.  I have the Pollock summary of the Minsky theory, which is, leverage is the snake in the free market Garden of Eden, leverage is the temptation that leads us into getting into trouble. Now, a bubble bust bailout and we re, of course, in the bailout phase, I want to just take a minute to talk about one reason why bailouts happen.  They happen because governments all around the world, including in the United States, have decided they want to provide a risk-free asset to the public and a financial instrument that people can hold without risk of loss, of course, these being deposits.  But these deposits fund a business which is quite risky and highly leveraged, namely, banking.  And if you think about it a minute, it s manifestly impossible to have risk-free funding of something which is itself quite risky.  That s a contradiction in terms, and therefore, occasionally, when the financial system, the banking system gets in trouble, the government, in order to carry out this notion of protecting the public s financial instruments, finds itself in the role of provider of bailouts, that is to say of moving public funds into financial firms. Now, we all know Walter Bagehot s classic rule of how to quell a panic, which is that the Central Bank should lend freely at a penalty rate.  And in most panics, which are characterized as liquidity problems, this works well.  It worked in all of the panics when Alan Greenspan was chairman of the Fed.  The lend freely from the Fed was enough to quell the panic.  However, occasionally, the busts are so severe that the problem becomes not liquidity but capital.  And it appears that the financial system and the banks in particular have run through their capital or at least may have run through their capital.  Nobody knows who is broke and who is solvent.  Uncertainty is extremely high.  Much of the financial system is feared to be insolvent and when that happens, it s not enough to have a liquidity bailout.  You need a capital bailout and the taxpayers become involuntary equity investors, as the British just announced this morning for their banks, as was done in Japan and Scandinavia in the 1990 s, as was done in this country through the Reconstruction Finance Corporation in the 1930 s.  And it seems to me that we are now there in the U.S. as well and that we need a 21st century taxpayer equity investor. Now, it seems to me the most straightforward way to have the taxpayer be an equity investor is to make exquisite equity investment in financial firms by the government on behalf of the taxpayer, but the taxpayers ought to seriously be thought about as investors.  This ought to be run to make a profit in the intermediate term.  And if it does succeed in making a profit, it s my view that the taxpayers ought to get dividends on their involuntary investments.  It could be in the form of tax credits or even cash payments, but they ought to, the taxpayers themselves, in my view, ought to have an upside, personally, as well as collectively in general, [audio glitch 00:06:37 - 00:06:54] outstanding panel we have in the order that they will speak.  And we re still missing one of our speakers and hope that she appears, but we will move on nonetheless. Our first speaker is going to be Adam Lerrick.  Adam is a visiting scholar at AEI and he is the Friends of Allan H. Meltzer Professor of Economics at Carnegie Mellon University.  He studies international capital markets, hedge funds, international financial crisis, sovereign debt restructuring, one form of bailout and economic development.  He originated and led the negotiation team of the Argentine Bond Restructuring Agency, after the Argentine Bond Defaults.  He served as adviser on international economic policy to the Joint Economic Committee of the U.S. Congress and was head of product development for international capital markets at Salomon Brothers and Credit Suisse First Boston, among other deep financial experience. Our second speaker is going to be Allan Mendelowitz, who is a director of the Federal Housing Finance Board, where he has been since 2000, and he served as the chairman of that board from 2000 to 2001.  He was previously executive director of the U.S. Trade Deficit Review Commission, vice president of the Economic Strategy Institute and an executive vice president of the Export-Import Bank.  And from 1981 to 1995, he was a managing director at the General Accounting Office, especially to the point of today s office.  He was the senior GAO staff representative to the government side of the negotiation in the Chrysler bailout of a generation ago and he is going to share some of the lessons of that experience today. If she gets here, Carmen Reinhart will be our third speaker.  She is a professor of economics at the School of Public Policy and in the Department of Economics at the University of Maryland; a research associate at the National Bureau of Economic Research.  She served on the editorial boards of the American Economic Review and the Journal of International Economics, and has also previously worked on Wall Street.  Especially to the point today, Carmen is currently working with Ken Rogoff on a book on the history of financial crises entitled This Time is Different: Eight Centuries of Financial Folly discussing the patterns of financial booms and busts and bailouts over not only decades but centuries. And, finally, Desmond Lachman will wrap up our panel.  Desmond is a resident fellow at AEI and a close colleague and friend of mine.  He and I have been reinforcing each other s bearishness on the housing bubble and its aftermath for two years now.  Although this morning, Desmond told me he should not be characterized as having been bearish, simply as having been right.  He was previously a managing director and chief emerging market economic strategist at Salomon Smith Barney, deputy director in the International Monetary Fund s Policy and Review Department, and Desmond writes on topics including economic policy, monetary reform, import issues, exchange rates, emerging market economies and, notably, the effects of the, now, collapsed housing bubble. And what we re going to do is have 13 to 15 minute presentations from each of the panelists.  After that, we ll give the panelists a chance to react to each other, if they like, and after that, we will open the floor to questions from you and we will adjourn promptly at 11 o clock or whenever your questions run out, whichever comes first.  Adam Lerrick:  [Audio glitch] Fifteen months ago, I was talking to one of the senior officials at the Federal Reserve and I happened to mention that I had two new puppies and he asked me what were their names.  I said, Their names are Crisis and Chaos.   And he laughed and he said, As I had thought, things were that bad.   And in fact, now, I see my puppies names in the newspaper [audio glitch] refusing cash, you know there is real trouble in the markets.  And their reasoning and their answer was, Well, we ll take your money as long as you commit to lock it in for at least six months.   And I said, Well, isn t that not what a money market fund is about?  The idea of a money market fund is you get your money everyday or whenever you want.   And they said, No, no, we re now only taking new funds if they re committed for six-month minimums. I think one thing that Alex talked about which he didn t mention this morning, which is referred to, at least here at AEI, as the Pollock rule, which is that every government, of every party, in every country, when confronted with a financial crisis, will bail everyone out every time.  And I think that sort of summarizes it.  And the fundamental -- but there is one fundamental law of crisis, which is that policy makers are always one crisis behind, and that s the best we can hope that they can keep up with.  And Alex is right.  Bailouts are political.  They re not an economic phenomenon. And one of the troubles is that the policy makers and the people running the financial institutions confuse the end of their world with the end of the world, and they re very different.  I think that people have to realize that crises are a fact of a capitalist economy.  As Allan Meltzer, our colleague here at AEI and my close colleague at Carnegie Mellon, says, Capitalism without losses is like religion without sin.  It doesn t work.   And that s the case here. But when looking at a crisis, which is what each policymaker has to do, you have to remember that if you re only looking at this crisis, a bailout is always the best solution because a bailout makes the problem go away.  Everybody is happy.  The losses disappear magically onto the balance sheet of taxpayers and the markets return to functioning normally and no one is hurt.  And I guess the best example I have of that was that when I was -- after the Mexican bailout.  Mexico was bailed out by the U.S. Treasury in 1994, 95.  And approximately a year and a half, two years later, Mexico repaid its loan to the U.S. Treasury.  And I was having a meeting with Larry Summers on a different subject the day after Mexico had repaid.  And Larry was very proud of that intervention because the bailout had made the problem more or less go away and he said, And look, we even got paid back with interest, the U.S. Treasury.  And I said, Larry, I don t know whether Mexico was the right decision or the wrong decision.  All I m telling you is next time; it will be ten times as big and ten times as fast.   And Larry looked at me the way he looks at everyone who disagrees with him and sort of says, All right, so tell me why you think such a stupid thing.   And I said, Because markets learn from your behavior and they will adjust their future behavior based on what they ve learned from your reaction to past crises.  And so next time, they won t think, Will the treasury or the IMF intervene?   They ll say, We expect them to intervene and, therefore, we can go and make very risky bets without fear of very significant losses.   And that really turns the financial markets into a casino.  And think of a casino where the house rule is very simple.  When you win, you win and when you lose, you don t pay. Now, a lot of people will go to that casino.  I might even go to that casino.  But the problem is under that rule, everyone will be happy except the casino will very, very soon go bankrupt.  And that s what happens when you have this type of intervention.  I think there are, sort of, two cardinal rules of successful bailouts.  The first one is overwhelming force, and that s the key rule of any intervention.  Whether it s a bailout, whether it s in a foreign exchange market, if a government is going to intervene, it has to do it with overwhelming force because if it doesn t, it will not restore confidence and will not prevent destabilizing speculative behavior. And the perfect bailout, of course, is one where you announce such overwhelming force that you never even have to intervene, that you actually never spend the money.  You just convince the market that if things go in the direction you don t like, there ll be so much money there that it will correct the problem immediately.  And if the market is convinced of that, then the market will correct the problem for you because they ll just assume the problem is going away without you actually expending any money. The second big problem -- rule that should be followed in bailouts, it is very seldom is, but we ve seen some examples recently where they are trying to follow it, is to try to preserve incentives and discipline.  Because what you don t want to do is let everyone off scot-free.  If people have made bad decisions, they have to have losses.  If they ve taken inordinate risks, they should have to bear the consequences of those risks. And the way you have to do that is that when the government intervenes, it becomes the preferred creditor, that everyone else takes a back seat to the government and the taxpayer.  That means that the common shareholders have to be wiped out, the preferred shareholders have to be wiped out, the subordinated debt holders have to be wiped out, and the senior debt holders have to be wiped out.  Because what the government is trying to do is stabilize the system.  It s not trying to stabilize any individual institution. And the last thing they have to do, of course, is remove management.  If these are the people that got you in trouble, they have to go.  And we actually have an example where Congress actually got it right compared to the administration, which is fiducial, in the United States, which is the rule, the regulation that Congress passed for intervention in insolvent banks.  There, it s automatic.  It s on automatic pilot.  That s what you saw in Washington Mutual when Washington Mutual was taken over.  When a bank cannot meet a solvency test, meaning that it cannot borrow enough funds in the market, with collateral, to actually meet its funding needs, it is taken over instantaneously.  The shareholders are wiped out.  The preferred shareholders are wiped - everyone is wiped out.  The management is thrown out and it just happens automatically.  And the reason for that was that Congress did not want to let the regulatory agencies have the ability to delay a seizure of an insolvent institution and hence, cause the taxpayer to take a huge amount of funding risk. But remember, again, the job of the bailout is to preserve the system, not the institution.  And in the current crisis, one of the things they re trying to do, very hard, is worry about what we call counterparty settlement risk, which has become a huge issue with derivative contracts that now run not maturities of five days or settlements of five days or one month, some of them run for seven, ten years and that people are taking counterparty risks, and that s where the government has to intervene to stop any cascading effect through the financial system. Talking a little bit about the current crisis, this is not a liquidity crisis.  This is an information crisis.  Lenders have plenty of funds but they re hoarding their cash because they cannot distinguish the weak from the sound borrowers and so they lend to no one.  Think of it as you have money to lend and there are 100 institutions out there, banks that you could deposit your money with.  And you know that five of them are in terrible shape but you don t know which five they are.  Your natural reaction is to lend to no one.  And that is one of the problems we have.  And that is the reason that the massive liquidity injections that we ve seen from the Federal Reserve and from the European Central Bank have not restored market functionality.  They can push the money into the system but if the banks won t lend it and would just sit on the cash, it does not cause the commercial bank system to start functioning and to start making loans to individuals and housing and to businesses.  But what it has done is transform central banks into medium-term lenders against illiquid and risky collateral.  Because what s happened is the banks that have plenty of cash, they just sit on their cash and don t lend it out.  The banks that need cash, they have no alternative except to go to the Federal Reserve or the Central Bank and borrow against collateral.  And they ve run out of traditional collateral, of U.S. government bonds, and so they have now expanded the range of eligible collateral to include mortgage securities and other asset-backed securities. And so until there has been enough disclosure for the markets to identify the weak institutions, they will not return to normal function.  They will just sit there.  And that is why you are now seeing calls in the last week or so for the central banks to act as a clearing house guarantor in the interbank market.  That, in essence, what would happen is, since Bank A won t lend to Bank B, what they want is Bank A to lend to the Federal Reserve who will then re-lend it to Bank B.  And the Federal Reserve will stand in the middle of all those trades and guarantee and eliminate the counterparty risks for all the lenders.  And that s one way of solving it but, remember, who is going to foot the bill if Bank B doesn t repay the loan?  It s not going to be Bank A.  It s going to be the Federal Reserve. Right now, this crisis will end when asset prices find their new equilibrium levels, which are much at lower levels.  In particular, housing assets in the United States which are the source of the original crisis, if you look at the sales, the auction sales of foreclosed houses in the U.S., there are actually buyers out there if the prices fall to 40, 50, 60 percent from their peak values.  Many types of buyers, individuals looking to buy a house, small investors that want to buy one or two houses to rent, and you even have massive funds that have dedicated one to two billion to buying individual houses throughout the United States and holding them as a portfolio.  But the problem is that s not an answer either the banks want to hear and not one that homeowners want to hear as the solution to this crisis.  And so you have Congress which is delaying the adjustment process.  And the problem is the longer you delay this adjustment process, the longer we are going to have stagnation and the longer it will be before the system goes back to functioning normally. And we have a very recent example, Japan in the 1990 s.  There, they had a real estate bubble.  It collapsed.  The government allowed banks to keep those assets at their book value, the original cost, and not write them down for many years, and what happened is the banks just sat on them.  They wouldn t sell them to anyone because if they actually sold them at the market value, they d have huge losses.  So they could maintain this fiction that they are actually worth a hundred cents on the dollar by just rolling over the loans on their balance sheet. And in the U.S., we had a similar example, which was the developing country figure Latin American debt crisis in the 1980 s.  There, the commercial banks kept maintaining these loans at 100 cents on the dollar on their books, even though no one was paying.  What they did is they just kept re-lending new loans to Brazil, to Argentina, and to Mexico so they could then pay off the old loans and pay the interest on them.  And it only ended the day that -- Male voice:  Citibank. Adam Lerrick:  Citibank. Male voice:  Two point two billion. Adam Lerrick:  Right, that John Reed -- Male voice:  1987. Adam Lerrick:  That s right, when John Reed woke up one morning and said, Enough is enough.  We re just going to write them all off down to zero.  And we think they re worth more than zero but if we write them down to zero, no one can say we ve been overly optimistic.  And if something comes back, great, if not, that s too bad.  We re going on with our lives.    And that was a very courageous move and he was rewarded because the day he announced it, Citibank stock jumped 20 percent.  And that forced every other major bank in this country to do the same and that was the end of the freezing of the U.S. banking system back in the 1980 s. One thing to think about when you re thinking about this crisis, and there s a lot of discussion, which is the Treasury program to buy the assets, of the $700 billion to buy assets of weak or distressed assets from financial institutions, it appears, throughout the world.  There s an inherent conflict in that program because it has twin goals.  The first goal is to minimize the cost of the taxpayer.  That would mean we should buy them at low prices.  The problem is, if you buy them at low prices, one, many of the banks will refuse to sell.  Secondly, if they do sell, they re going to have huge losses to recognize and, hence, write-downs in their capital and they won t be able to lend because banks can only lend a multiple of their capital.  And so you have a conflict that if you want to minimize the risk for the taxpayer, and pay low prices.  But if you want the banking system to go back to functioning, you have to pay high prices, but then you put a risk on the taxpayer.  And that is the conflict that s going to be very difficult for them to resolve in this problem. One of the issues is future regulation, and we re going to have future regulation, right?  How bad it s going to be, we ll have to see.  It usually is quite bad because the initial reaction to any crisis is to have massive regulation and to do it quickly and then you make mistakes.  I will remind you, there s a very famous governor of the Bank of England from the   19th century who said, There s only one true law of economics.  Every regulation will be circumvented.   And that s reassuring for members of Congress, I m sure, but the fact is that s basically true.  As Danny DeVito said on the movie Other People s Money, when threatened with regulation, he said, It doesn t matter.  You can change the rules but you can t change the game.   And that s one of the things we have to think about.  So the issue is how do you stop, try to minimize the risk of crisis and their severity?  And the first thing is you have to have an integrated approach to regulation; whatever the product is, whether you call it a swap, whether you call it an insurance contract, whether you call it an exchange trade or derivative.  If it has the same economic substance, it should have the same regulation.  There should be no way to get around, let s say, reporting to the CFTC by calling it a swap as opposed to trading it on an exchange, if you re trading oil contracts. The second thing is you have to have an integrated approach across national boundaries.  It serves no purpose for the United States to have wonderful regulation if the FSA in England doesn t or if the BaFin in Germany doesn t or if Singapore doesn t because the markets will just move.  Remember, when everyone talked about hedge fund regulation, I always used to laugh when Connecticut, the State of Connecticut, where there are many hedge funds, used to say they If the federal government won t regulate hedge funds, we re going to regulate hedge funds.   And I laughed and I said, You know, every major hedge fund can move its entire operations outside the United States within 12 hours.   They have all the plans in place.  They have all the clearing in place.  They have the office space in place.  So the idea that you could somehow regulate them in Greenwich, Connecticut and stop them from moving to White Plains, New York, which is three miles away, was also quite interesting, as an approach. I think the major thing one could do to reduce the possibility of these problems in the future is increased disclosure, because disclosure is the most important element, information, allowing markets to identify risk and segregate weak borrowers and maintain lending to strong solvent institutions.  Now, disclosure would allow markets and policy makers to see risks before they become massive losses.  And I don t really care whether that means that the financial statements of Citigroup are as thick as the New York telephone book.  If they actually were there and people could see every single asset that s on the balance sheet with its characteristics and be able to look on a database and see what that pool was, if it s an asset-backed pool, that will go a long way to minimizing these risks because lenders and counterparties would take preventive measures to prevent -- to protect themselves in case this [audio glitch] was actually materialize.  Because, remember, markets hate surprises.  Surprises will cause panics.  If an event is foreseen, the actual fact will have no impact on the market. The best example we have, which is something Desmond and I have talked about many times, is the default of Argentina.  Argentina defaulted on $100 billion of debt, the largest sovereign default in history, and the day it happened, nothing happened.  Not even the prices of Argentina s own bonds changed.  It was so well foreseen.  And that s what you want to try to get to. Alex J. Pollock:  One minute. Adam Lerrick:   I have about four lines.   The second key point is that you have to think that if taxpayer funds could be at risk, the government must control the activity.  A simple rule.  And you have to force banks -- if you look at the AIG bailout, that s what I m -- that s even five bailouts behind.  If you look at the AIG bailout, AIG is a huge financial institution, clearly, of a systemic importance to the global system.  All its problems can -- it has four businesses, three of them very sound and one of them at high risk.  They are in the business of insurance, insurance policies for people and for companies.  They are in the business of asset management.  They have SunAmerica Mutual Funds.  They have the largest aircraft leasing company.  And they have an in-house hedge fund called AIG Financial Products.  Three of them are totally sound.  AIG Financial Products is the source of all these problems.  And the reason this was a problem for the entire company was that AIG Financial Products was built not on its own balance sheet or its own capital or its own risk management tools.  It was built on a super senior guarantee of the AIG parent.  And that s why no one in the market paid any attention.  They didn t care whether AIG Financial Products knew what it was doing.  They didn t care whether they were profitable.  They didn t care whether they had capital.  They didn t care if it was run by a group of chimpanzees.  They had the credit of AIG behind it.  And that s how AIG Financial Products was able to accumulate $400 billion of derivative exposure to the market and that s why AIG Financial Products was more than half of the total debt of AIG when it went bankrupt. So I think you have to think of a system where if financial institutions where the government will intervene, in case there s trouble, they have to segregate their speculative activity in standalone vehicles.  It just makes common sense.  And then I ll yield the floor back to our moderator. Alex J. Pollock:  Thank you very much, Adam.  Your two points, I ll just pick up on.  One is on the house prices.  A general rule of price corrections is, prices have to get to the point where there is a speculative interest which will enter the market, like people who will buy houses just to hold them for a few years and therefore, absorb the inventory.  The other, when you were talking about expectations, is another of Pollock s laws, which is that financial crises are always a surprise.  And the reason is because if they d been expected, they would already have happened.  So when they really do happen, at least some people are surprised.  Let s go on to Allan. Allan Mendelowitz:  Actually, I ve been sitting here trying to figure out what would be included in eight centuries of financial crisis in Carmen and Ken s forthcoming book -- Alex J. Pollock:  Let s go back to the [indiscernible] Allan Mendelowitz:  Well, your historical record is better than mine because I remember reading about the tulip bubble in Holland and the South Sea Island bubble, but I couldn t quite remember what went back 800 years.  But then, I remember reading Thucydides and his account of the Peloponnesian Wars in which there is a whole discussion about the financial challenge that the Peloponnesian Wars presented.  And there is a discussion in Thucydides on the part of the Athenian leadership that if they really ran short of money, all wouldn t be lost because they had a gold statue of Athena on the Acropolis and they could melt the statue of Athena down to fund the war.  So then maybe, they should be working on a book that goes back 2,500 years.  Anyway, let s see, how do I -- there we go.  What do I do now?  Anybody know?  Slideshows, there we go, okay.  Great, okay, way to go.  Alex J. Pollock:  Hope it s not an automatic pilot. Allan Mendelowitz:  I got a little suspicious when Adam switched seats with me and said he was technologically challenged.  And didn t want to admit I had the same problem. Adam Lerrick:  Because I believe in full disclosure. Allan Mendelowitz:  What I d like to do is spend a few minutes today talking about is the notion that if the government is going to get involved in a bailout, it turns out that bailouts actually can be done right.  And I want the draw on some of the lessons that were learned from the Chrysler Loan Guarantee of 1980.  And, okay, that didn t do it.  I hit the arrow key, nothing happened.  Is there an arrow key here?  Oh, fantastic, thank you.  Okay, we re doing well.  Hopefully, that s the last technological intervention necessary.  And I would -- Alex J. Pollock:  We will call it a bailout. Allan Mendelowitz:  Bailouts can be done right but they require a credible policy framework and this is really the challenge presented in this crisis and by this administration.  We ve had eight years of government economic policy based on the flimsiest of analytical frameworks known in the economics profession as Neanderthal Economics .  The depth of the analytical framework doesn t go any deeper than, Market good, government bad .  I m sure you ve all heard it.  And when you have an administration that basically takes the position that markets are perfect and government doesn t have to do anything and if the market is perfect and the government does something, it s always going to be bad.  There s a very strong ideological and dogmatic opposition to do nothing when the crises arise.  And we ve reached a circumstance now where events have gotten ahead of ideology, and panic over the feared consequences of a meltdown in the financial markets has triumphed over dogma. And the most, and this is going to be my good line of the day so I m looking for a laugh, the most free market of the administrations had a complete about-face over a weekend, and that administration, which came off as eight years ago as social conservatives is leaving office as conservative socialists -- thank you, it doesn t get any better than that -- coming forward with a proposed massive government intervention of the private sector on a scale that we haven t seen in my lifetime.  When the administration s proposal was put forward, I think it was criticized by everybody on the right and in the left.  And I think that the reason why they came forward with a proposal that, in my view, was really a nonstarter, from a number of perspectives, was that they lack they policy framework in which to structure the intervention.  And if you don t have a policy framework in which to structure an intervention, you re just sort of like flailing around trying to reinvent the wheel in a crisis situation.  And hence, the administration put forward a proposal making the Secretary of the Treasury the dictator of the economy and giving him the authority to spend $700 billion of taxpayer money without any accountability, any oversight, without any risk of legal review or conditionality. And I want to emphasize that word, conditionality, because Desmond used to work at the IMF and conditionality is the most important word in the lexicon of the IMF, and that is, if the IMF is going to put money into a troubled country, it comes with conditions.  And the conditions are what have to be done to fix the situation and repair the circumstance.  And none of that was included in the administration proposal.  And hence, the proposal was met with total incredulity. Nevertheless, I do believe it s possible to structure an effective and responsible government intervention in response to a crisis.  And a well-structured government intervention requires a policy framework and a successful government intervention must have well understood principles that are critical for success.  And I think the 1980 Chrysler Loan Guarantee is the premier example of the successful government intervention. The first reason why it succeeded was that it was structured well from the start.  The second, why it succeeded was it was clearly and carefully structured to succeed.  And third, the Chrysler Loan Guarantee had all the elements that one would expect from a government intervention: accountability, conditionality, oversight, and responsibility that everyone should expect from the exercise of government authority in a democracy. And I have to tell you, on a personal level, when I got tapped to sort of spend a year working seven days a week and 18-hour days working on this, I was a little uncomfortable because I was not enthusiastic about the idea of the government intervening to save a company, which probably should have gone bankrupt, in my prior view of what was going on.  And it took me a while to learn enough to realize that there were alternatives that were acceptable. And secondly, those of us who did the deal and worked on it everyday, we were haunted by the specter that everything we did had the potential for creating a precedent.  And one of the things that we constantly were aware of and tried to avoid was, in effect, through our precedents, creating a road map that other businesses that were failing would find us a desirable alternative to bankruptcy.  And so we were very much concerned about doing it right and not creating a precedent that, in fact, would lead to other unwarranted government interventions in the economy. Now, the Chrysler Loan Guarantee program embodied seven principles that I think are sensible, essential for a government intervention.  The first was an intervention should be designed to implement and achieve a clear public policy objective and the program should be designed to actually achieve that public policy objective.  I think, as Adam mentioned, there is a notion that there is a public policy objective to the intervention of the current crisis.  We re trying to save the whole system. In the case of Chrysler, there was a public policy objective and it actually took some doing to sort of uncover a defensible public policy objective.  And actually, I have an 82 article that I wrote with Brian Freeman, who was my counterpart from the Treasury department doing the deal, called Chrysler Loan Guarantee Program in Search of a Policy.  It was in the spring issue of the Journal of Policy Analysis and Management.  So if you re interested in the public policy justification, in a somewhat longer context, you can look up that 82 article in the Journal of Policy Analysis and Management. But in the case of Chrysler, I think the objective was clearly tied to the circumstances that existed in the energy and the automobile market in the United States.  For those of you who don t remember the 1970 s, we are getting sort of knocked from pillar to post by swings in energy prices.  In 1978, and this was only five years after the first energy crisis of 1973, in 1978, the number one problem in the auto industry was the industry couldn t produce enough V8 engines.  That was the key shortage.  In 1979, the Shah fell, the price of oil quadrupled, and suddenly, everybody wanted to buy four-cylinder fuel-efficient cars and there wasn t capacity.  Chrysler, in 1980, basically ran out of cash in the last six months of the four-year product development cycle for the introduction and launch of a new four-cylinder fuel-efficient car that was exactly what the market was looking for.  There was a tremendous shortage in the market and, in effect, what the loan guarantee did was to preserve the product development launch and production capacity for upwards of a million units of the type of car that was in very short supply. Secondly, one of the aspects which is little noted is that the decision making authority was vested not in a single individual, but it was vested in a strong independent board which had three voting members and all decisions made with respect to the Chrysler Loan Guarantee had to be the result of a vote of these three members.  And the three members were the Secretary of the Treasury, the Chairman of the Board of Governors of the Fed, Mr. Volcker, and the Comptroller General of the United States, Elmer Staats.  And I have to tell you, the fact that there was a board, as opposed to a single decision maker, was critical to the final design and success of the program. And I ll give you one little story and that is the issue of warrants.  Everyone talks about one of the key, nice aspects of the Chrysler program was that in return for the loan guarantees, the federal government took warrants.  And when the loans were paid off, we sold the warrants for over a $300 million-profit and everybody points to the success of that.  Well, without a board, there would have been no warrants in the deal.  We, at the staff level, had clearly determined that warrants would be an essential part of the program for a number of reasons.  As we re sort of, this thing sort of was developing, evolving, Iacocca went to the Deputy Secretary of the Treasury and said, Look, we don t want any warrants.   And the Deputy Secretary of the Treasury said, Fine.   And at which point, Brian, who was my counterpart from the Treasury, came to me and said, Hey, Iacocca got through to the guys upstairs and they agreed to leave the warrants out.   And I said, I ll fix it.   I went back to my principal, who was Elmer Staats, Comptroller General of the United States, and I went to him and I said, Look, Elmer, I need a decision from you really quickly.  There is one aspect to this deal, which, if it s not included, you can t vote for it.   And he said, What s that?   I said, Warrants.   And he looked at me very quizzically and he said, Warrants?  What are we going to do?  Take over the company?   And I said, No.   I said, If this thing works, the taxpayers are going to be compensated for the risk they ve taken on.   And I said, Furthermore, the one part that we can t force to make significant contributions are the shareholders so we re going to water them down.   He said, Fine. We used to meet everyday at 6 o clock.  The Deputy Secretary of the Treasury, General Counsel of the Treasury, who was also the General Counsel of the Chrysler Loan Guarantee Board.  My counterpart from Treasury, my counterpart from the Fed, and me, we d sit there and literally, checking off the per chart for the day and we re going down the list and the deputy goes and he said, Warrants out.   And I put my hand up and I said, Excuse me.   And he said, Yes?   And I said, My principal won t vote for the deal if there aren t warrants in it.   Warrants are in, move down to the next issue. Use government funds solely to achieve the clear public policy objective.  One of the things that we constantly focused on was if we re going to put taxpayer funds at risk, they were not going to be used merely to enrich constituent interest of Chrysler.  Chrysler was not going to be a pipe through which public funds flow to constituent interest.  And therefore, we had to make sure that the constituent interested groups such as workers, creditors, et cetera did not receive direct benefits.  And one of the ways we did this was to make sure that all interested parties who stood to gain from the success of Chrysler, tied to the Federal Loan Guarantee, contributed to the turnaround.  And so anyone who had an interest in the success and viability of Chrysler contributed.  That meant workers, creditors, suppliers, dealers and investors.  And to double sort of belts and suspenders, all material expenditures or funds by Chrysler as well as all contracts that the company entered into required approval of the Chrysler Corporation Loan Guarantee Board, which was the government board. Fourth, use government resources sparingly.  I have to tell you, when Paulson went to the Congress and said, Give me 800, $700 billion , my reaction was, Geez, that s real money.   Give a little thought to it.  Just because it s taxpayer money doesn t mean you can get it in gobs and throw it around.  In the case of the Chrysler program, for every dollar of federally guaranteed funds, before a dollar could go into Chrysler, there had to be $2.00 of funds that went into the company from other sources, namely, the constituent interest groups.  So those $2.00 for every dollar and the matching funds that went in came from things like workers who gave up wages and benefits, creditors who gave up debt, the banks that owed Chrysler money gave up their debt to the parent for $0.85 cents on the dollar.  States and localities where Chrysler had plants loaned additional of money.  Iacocca worked for a dollar a day, and I got to tell you, what really annoyed him, more than anything else, was we forced the company to sell of all assets that weren t core to the automobile business.  That meant things like the Chrysler tank works to generate working capital, Chrysler Marine, and Iacocca s personal Gulfstream jet.  And he was furious.  I got to tell you, he didn t mind working for free because he was going to get the upside on his stock issuance.  But he really was annoyed he had to give -- in fact, when the loan guarantees were paid off, the first thing he did was not buy another Gulfstream.   He bought the company.  He bought Gulfstream Aerospace and made it a Chrysler subsidiary.  I mean, he wanted to stick his thumb in our eyes the best he could and that was the best evidence I had that we were doing things right. Fifth, there should be a reasonable assurance of repayment of federally guaranteed monies.  Chrysler could not receive the loan guarantees in federal government unless there was a determination by the Chrysler Corporation Loan Guarantee Board, the three voting members who I mentioned earlier, that there was a reasonable assurance of repayment.  And this was based upon several things.  One was the company had to present credible operating and financing plans, demonstrating how the company would succeed, if they receive the federal guaranteed funds.  And I got to tell you, this was not clear to Chrysler.  The bill passed the end of December.  It got signed the first week in January and we were there within a couple of days starting to work on the program.  I walked into the Chrysler boardroom and I was met by their finance people.  And the first thing they said to me was, Okay, give me our money.   And I said, Wait.  Wait a minute.  There are some conditions you have to meet first.   And they said, Yes, we got the bill.  Give us our money.   And so we said, Well, you got to come up with operating and financing plans, operating plans, business plans that show that you re going to make it and financing plans that show you have the resources to implement the business plan.   Well, they sent a set of plans that made no sense whatsoever and we sent them back and said, Hey, this makes no sense.   So they came up with another one and we looked at it and said, This makes no sense.   It took about three months before Chrysler had scaled back its business plan in a way that made sense from a business perspective and had the adequate funding to implement it.  And one other thing is we took a priority security interest in every single asset of the company.  I mean, everything, raw material, works in progress, built-up inventory, plans, trademarks, patents.  Every bank that had a compensating balance with an offset right had to see those offset rights to the federal government.  When we were done, in return for the federal money, no one stood between the federal government and every single asset of the company.  If Chrysler went under, the taxpayers were not going to be left in the lurch.  Sixth, limit the program s time frame and scope.  I said we were concerned.  We didn t want to create a permanent entitlement for the business sector.  And so the Chrysler program was narrowly drawn with respect to Chrysler.  The estimate was that they could make it with $1.5 billion, maximum, in federally guaranteed funds.  They wound up in the end taking $1.2 and the outstanding debt was limited to a maximum of ten years and no permanent government agency or enduring corporate entitlement was created. Alex J. Pollock:  One minute. Allan Mendelowitz:  Perfect.  Seven, and the government should share in the upside of success, and I told you the story of the warrants and I told you, in the context of why having a board is important, which is why I believe all regulatory authorities, with respect to the government, need boards. The presence of a board and the record of the board deliberations ensures that decisions are made based upon good data, good analysis and credible arguments rather than someone being panicked or providing a flimsy excuse.  And the upside of success for the taxpayers, with respect to Chrysler, was the fact that we took warrants in the company, which when the loan guarantees were paid off four years early in -- I m sorry, six years early, they were outstanding only about four years.  The government got prepared to sell these warrants. Chrysler made another run at the loan guarantee board.  Iacocca came in and said, You don t really want to exercise those warrants.  You don t want to sell them.  You re going to weaken the company.  We want you to just give them back for free.   And I went back up to the Comptroller General.  We had a new Comptroller General, and I said to him, Listen, I just want to give you the history of why we have these warrants and why Iacocca s request is outrageous.   And it turns out I didn t have any difficulty convincing anybody of why we weren t going to give away the warrants.  We put them out to auction and sold them for over $300 million. So when it comes to a government intervention, the success of the Chrysler Loan Guarantee program demonstrates that we, in fact, used to know how to do it right.  And if we learned from the past, there s no reason why we can t do it right in the future.  Thank you. Alex J. Pollock:  Thanks, Allan.  Desmond. Desmond Lachman:  I guess, while I m just waiting for my slides to go up, I can t help thinking that, Alex, with the title The Theory and Practice of Bailouts that this is somewhat of a dig at economists.  There s the old joke about economists that says that an economist is somebody who sees something working in practice and then asks himself whether that works in theory as well.  Alex, thank you very much for inviting me. Male voice:  If all else fails, I can push -- [indiscernible] Desmond Lachman:  Okay, thank you. Male voice:  Just give me five seconds. Desmond Lachman:  Thank you very much for inviting me to this seminar and once again, I ve got to compliment you on the timing of the seminar.  It seems that each time we have a seminar, you time it so perfectly that we had the commercial paper market totally freezing up, total paralysis on Wall Street.  This morning at 7:00, we had coordinated interest rate cuts, which is another sign that the crisis is deepening.  And to add to the excitement, the Bank of England announced something like an $87 billion-bailout package of its banks, which is being described by the Financial Times as a partial nationalization.  My solution to the current crisis, perhaps, is that you stop having these seminars so we don t have all of these events occurring. I want to take a somewhat different approach and I want to just look at the bailout that is being attempted.  But to put it into some kind of context, and I would start by saying that I share Paul Volcker s view of what is going on, is that he says that he s been around a long time.  He s seen very many crises but he s seen nothing quite as complicated as this crisis and he warns that if the policy mistakes -- we could be going back to the 30s.  I m not encouraged by the policy makers right now.  I m not encouraged by the fact that it was as early as yesterday that somebody like Ben Bernanke is fretting about inflation and telling us that maybe he ll cut interest rates at the end of the month to find that he s got to cut interest rates about eight hours later.  It doesn t give me a sense that they know what is up or that they ve really got a game plan. So the first point I d make is that I don t see this as being an ordinary crisis.  What I also think is that a bailout is inevitable, but it s important that the bailout is seen as part of a broader strategy.  I don t get the sense that they ve got a strategy in terms of how to bail out the financial system much less what to do about the non-bank financial system which is even larger.  But they re not putting it into the context of what is occurring to the economy overall.  That bailout, as necessary as it is, can only be one component of a way to treat what has to be our biggest crisis in the last 80 years. I would agree with Adam that there are liquidity and informational aspects to the problem, but what seems to me at the heart of the problem is a solvency problem.  Not to put a fine point under it, much of the banking system is broke and it s going to take taxpayer money to get the banking system lending again.  If we don t get the banking system lending, we re in big trouble. And in this regard, I think that time is of the essence.  The longer that it takes us to do the inevitable bailout, the deeper the recession is going to be.  The deeper the recession is going to be, the more the problems there are going to be in the banking sector, the larger the bailout is going to have to be. So in short, I m suggesting that we need a real, coordinated approach and it s very unfortunate that this crisis is a occurring at a time, at a political cycle where it s very difficult to get the coordinated action together, even if they understood what it was that needs to be done. Let me just start with just reviewing a little bit about how this bailout system is being operated.  And I ve got to say that I used the title there, Bailing Out on the Run.   I should say that I spent a career at the IMF working on emerging markets and I never expected to see what I m seeing in the United States.  That policy is in a totally reactive mode, that we just get one action after another; we just get great inconsistencies in the way in which a policy is dealt with. So just to take an example, we decide - first, it takes us an afternoon, a Sunday afternoon in March, something like March the 15th, to realize that Bear Stearns has a $9 trillion dollar derivative book and that maybe, if we let Bear Stearns fold, that s going to cause problems right through the financial system, so we decided to bail them out. Six month later, Lehman Brothers, which has got a similar derivatives books, similar counterparty problems, we decide, let s engage in this experiment of drawing a line in the sand, only to find out two days later that we ve got to bail out, now, an insurance company, not a financial system.  I can say the same with the way in which they dealt with Fannie and Freddie in July, only to have to reverse themselves in September, and I think that, as Allan mentioned, I think that the Paulson Plan was an outrage, asking $700 billion in a three-page paper while giving absolutely no idea.  And even at this late stage in the game, I m not quite sure what it is that the Paulson Plan is actually going about. So it bothers me that there s actually doesn t seem to be a real strategy on the bailout side.  I think that I would just say that if you re approaching policy, the first thing to do is to start with making a diagnosis of what is actually wrong.  Why is it that we re heading into a major recession that s likely to be a prolonged recession?  And if we don t make the right diagnosis as to the causes, then I don t think that the prescription can be the case. As I ve said, that I think that the bailout is only part of the solution.  We ve got to recognize that its solvency and we ve got to accompany it with a whole bunch of other measures.  Just in terms of the, what I call the anatomy of the crisis, what the diagnosis is, I think that there are many things that are going wrong.  But the two major aspects that are driving this economy down -- and unless you address those simultaneously, you don t have a chance of stopping that because what we ve got is we ve got what the Federal Reserve now calls adverse feedback loops operating in spades, so that what I d say is that the two issues that I would be really highlighting is we ve got asset price deflation, of a major sort, on the one side.  The other side is we ve got a deleveraging process that is occurring in the banking sector and I m afraid that deleveraging process is now occurring in the non-bank sector.  I m not sure what you do about it.  We ve left this pretty late.  Hedge funds have had major withdrawals in the last month.  They had the biggest withdrawal -- I should say they ve had the biggest losses in the last month.  They lost something like four and a half percent, the biggest loss since 1998, and they apparently had something like $100 billion in redemptions, which means that they re now in the process of selling assets on a falling market, which means that they re just going to get additional redemptions going on, and I m not sure how you break that. Just let me talk a little bit more about the asset price deflation.  The first part is on the housing market where we ve already seen house prices fall by something like 16 percent the past year, and the red line is what the forward market is indicating,  going forward.  Now, I m not optimistic in terms of the housing market sorting itself out because I think that what you ve got is you ve got a perverse dynamic working there when prices fall.  What occurs is supply, rather than decreasing, actually increases, because what you have is, as house prices fall, you get more households with negative equity.  More households with negative equity means that they walk away from the mortgage, which means that you have increased foreclosures, which means you have an increased supply, so there s got to be something from the outside, in my view, that breaks that.  That has to be part of the solution. What is troubling on the asset price deflation side is that as prices -- what we ve now got is not simply home prices falling at roundabout 20 percent, but we ve got equity prices now, since the beginning of the year, we ve had equity prices falling by 30 percent.  We ve had bond prices, I m talking about corporate bonds, they re falling by some amount of 20 percent.  So this chart, which is a little bit dated, this chart would go down like another five, ten percent, but you see that we haven t had anything like this the past 25, 30 years.  And my estimate is that if house -- if asset prices, in general, falling like 20 percent, which I don t think is an unreasonable assumption, what we are in effect doing is we re wiping out 80 percentage points of GDP.  And if you just assume that you use the Fed model that you -- $0.04 on the dollar is the impact on the consumer.  That alone is a shock to the economy of about two and a half, three points of GDP, which is not small change. Just in terms of the deleveraging story, I think that this chart, which is the TED Spread, it s basically three-month Treasuries against three-month commercial paper.  What that is, is a very good indication of the stress within the banking sector.  And despite all of the liquidity that is being poured into the banking sector, we ve got the situation now worse than it was at the height of the crisis in August 2007, which I would think suggests that just throwing more liquidity at it is not the solution.  The problems are a whole lot deeper.  What this, of course, is doing is it s coursing corporate borrowing rates to increase.  So even though the Fed might be cutting interest rates, it s not doing much good because the final borrower is having to pay more for the loan. What this is also leading to, and once again, this chart is a little dated, what it s leading to is banks actually contracting credit now at the fastest pace that they ve done it in the post-war period, the red line is what occurred the last three months, but that goes through to something like July.  What s been occurring in the market since September; that line is going to be going way down.  The economy is totally starved of capital that creditors are just not throwing through the economy in the bank side.  The non-banks are even worse.  The whole securitization market has frozen up, so there is no alternative but to intervene in a big way in the banks if we re going to be getting the banks going forward. My view on what is needed right now is something very much along the lines of what we might have had in 1933, the Roosevelt New Deal sort of idea, something very bold in its scope, and I think that they ve got to be, in my view, they ve got to be four components if there is to be any chance that this recession doesn t morph into something that could be really very nasty. And the four aspects are that you ve got to really address the capital inadequacy problem of the banks; that you ve got to stabilize the housing market, maybe through a home loan corporation; you ve got to cut interest rates very much more aggressively; and Fannie, you ve got to come up with another stimulus package.  Now, if you do that all together, I think you stand a chance.  If you don t, I think there is big trouble. Let me just mention briefly the notion of the Paulson Plan.  I think that there s no chance that it works if all that it s doing, as Adam indicates, if all that they re doing is they re buying assets off the bank s balance sheets at more or less the price at which they ve got them marked, you re not providing the banks with additional capital.  What you re doing is you re allowing the banks to deleverage perhaps to the $700 billion, but the issue is do the banks not need to deleverage even more given their capital inadequacy? This chart, which is once again an old chart, just shows what s been going on globally with the banks.  That the banks have already recognized something like, globally, $500 billion of losses but the capital they ve raised is only $350 billion.  And it s not very encouraging that the IMF now is increasing the estimate of the losses that the banks have suffered globally from poor lending practices.  They used to be at something like $1 trillion.  They are now talking about $1.4 trillion, and I m afraid that as the recession deepens, as the housing prices continue to decline, those numbers are going to escalate.  So what we ve got is we ve got a problem where the banks are very short of capital and they might have to be reducing their balance sheets by $2 trillion.  The Paulson Plan, by giving them $700 billion doesn t do it.  What has to occur is capital has to be injected into the banks that certainly -- I totally agree with Adam that for moral hazard reasons, wipe out the shareholders, get rid of the management, do what you have to do, but you can t afford to have banks that aren t adequately capitalized. I think that I ve been too upbeat in this presentation so I think I ll just talk about stuff that we can t really deal with, and I ve just put up two slides.  One, this slide, I think, tells it all, is it shows what the development has been in the financial system over the last ten years.  And what one sees from that slide is that banks aren t really very important in the financial system.  Much as we re going in for the bailout of the banks, what s occurring is that they re dwarfed by what I call other financial intermediaries, hedge funds, private equity firms, and the like.  And as I mentioned, they ve got this problem now with a run on the hedge funds.  I m not sure how one deals with it.  And the last chart that I ve put up is the one that keeps Warren Buffett awake at night is the credit derivatives markets.  Once again, this chart isn t totally updated.  From nothing in 2000, this has got now a face value -- that chart shows at $45 trillion the face value of the derivatives.  They are now at something like $62 trillion.  If we get problems in the hedge funds, I m not sure where I m going to be moving. Alex J. Pollock:  Thank you, Desmond, I think.  Having had three different and really stimulating presentations; let me see if any of the panelists want to react to what somebody else has said or simply amplify on their own comments.  Anybody?  Okay, go ahead Allan. Allan Mendelowitz:  I have to say this.  It was worth my time just being able to sit here and listen to Desmond and Adam.  When you look at the principles that are teased out of the Chrysler Program, one of the things is you should design a program where what you re doing achieves what you re looking to achieve.  And the biggest problem I had with the Treasury Department s proposal and perhaps with the statute that got passed, is that it s focused around something that I don t quite understand how it s going to do what it s supposed to do.  The central problem the financial sector today, I mean, there are clear solvency issues.  The solvency issues have created an inadequate capitalization of the financial sector.  The inadequate capitalization of financial sectors led to a lack of confidence, and so everybody is shutting down.  Nobody wants to trade because you don t know what the financial conditions of your counterparties are. And so it seems to me what you want to do is you want to recapitalize the financial institutions.  And the best way to recapitalize the financial institutions is to inject capital into them directly.  You basically have the government stand up, buy preferred stock, and I think the economists, where, irrespective of what perspective they bring from where they stand in the profession, I think it s probably the most widely held view that the way to recapitalize is to put capital in directly.  You buy preferred stock and then you let time reveal what the embedded losses are in these troubled assets.  If it turns out the embedded losses are less, then the common shareholders, actually, are left with something.  If it turns out over time the embedded losses turn out to wipe out the common shareholders and you ve wiped them out, you still have an adequately capitalized institution and the government then sells it off. And I think that I still can t figure out what possible reason the solution that the Treasury Department proposed was this buying up troubled assets because it creates a real problem.  If you buy them at market, you don t interject -- you don t inject any capital into the banking system.  And if you buy them above market, then you, in effect, are providing a very inefficient, indirect way of providing capital. So I think that while the $700 billion figure looks like a lot of money, I think it s structured, in the current proposal, in a way that is a very inefficient use of taxpayer funds, not very responsible use of taxpayer funds, and unfortunately, won t lead directly to the thing we re trying to achieve, which is unfreezing of the markets. Alex J. Pollock:  May I just make a comment on what can happen at the end if you do go the preferred stock route, which I agree would make sense and suggested in my own remarks?  And that is, the government doesn t necessarily have to sell the preferred stock to anybody.  It could just be refinanced out by -- when things right, as they ultimately will, you simply refloat the capital in the private market and all of these investments should be redeemable at par.  You just redeem them out and that s the, if it gets there, the desirable end of the game.  Adam, did you have a comment you wanted to make? Adam Lerrick:  Yes, [audio glitch] on what Allan said.  And far be it from me to try to defend the $700 billion package because I think it violates the cardinal rule of intervention.  It s not overwhelming force.  It s clearly not -- the $700 billion is not enough money to achieve what they want to achieve.  I think that s, again, a political compromise.  I think if Mr. Paulson would come to Congress and say, I want $3 trillion, that would have been a problem, especially with only a three-page outline without an oversight board. But that s the type of number you would have to be thinking about today to solve this problem and restore confidence.  I think the rationale behind the Treasury program, and I think I am more sympathetic to the rationale than many people.  The rationale is we re not trying to render some commercial bank solvent or shore up some -- it s not as though -- like in England today, they announced their six commercial banks, we re going to make sure those six commercial banks are solvent.  That s not what the Treasury is trying to do.  Maybe that s what the Treasury should have done, but that s not what they re trying to do.  What they re trying to do is unfreeze the market.  And the way you unfreeze the market is not by putting capital into certain institutions so they can lend again.  What they re trying to do is establish liquid markets in all of these assets.  And one of the problems that they re dealing with, and some of my colleagues are shocked when I say this, is that right now, mark to market doesn t work.  Because mark to market only works when there s a market, all right?  It does not solve the problem to mark to a price where no one trades at, where there are no buyers, there are no sellers.  And that s what partly is going on in the system today.  That many of these assets that are terribly complicated, that are not even understood by the banks that created them, let alone the investors who hold them, are sitting there and they are using -- they don t even have a price, an indicated price for that asset.  They are trying to derive a price from another index that s traded, which tries to mimic assets similar to the one they have in their portfolio when it really doesn t.  And that s why these marks are not valid marks and that s why you start to see Mr. Bernanke talk about what he calls, not mark to market, but mark to hold to maturity values. So that if you have -- the market price of the asset might be $0.30 on the dollar, but if you can actually look at the asset, establish what are reasonable assumptions as to what default rates or losses will be on that asset, and what is a reasonable interest rate to apply to that asset, that might generate a much higher value.  And that s why he is talking about the program with the Treasury buying at mark to hold to maturity values, not mark to market values.  That is a very dangerous game to play because you can make the value of anything you want by just changing the assumptions on losses and the assumptions on what s the appropriate interest rate.  But that is what they re trying to do.  They re trying to set prices for assets that don t have prices now.  And if they can even set those prices for ten percent of the stock of those assets, that will then return the markets to function for the other 90 percent.  And that s why they re not trying to address the problem of solvency of Washington Mutual or of Royal Bank of Scotland.  They re trying to make the mark and go back to a liquid functioning market.  And that s why they re buying assets, not investing in institutions. Alex J. Pollock:  Desmond. Desmond Lachman:  Thank you.  My problem with the Paulson Plan wasn t in terms of size, that I think that $700 billion is a lot of money, and if it were properly spent, it could do a lot of good, that, basically, that plan is totally non-targeted.  That what you re doing is you re buying assets.  That is going to be benefiting banks that are solvent together with banks that are insolvent.  Whereas, the real problem is the banks that are insolvent that are in the process of having to deleverage because they are insolvent, and what I mean by deleveraging is that you ve got a whole swath of banks that have to sell assets or contract credit, but they can t all successfully do it at the same time because in the process, what they are doing is they are just driving down the price of the assets even further, which increases the size of the loss, which means that they ve got to deleverage some more.  So basically, what you re wanting to do is you re wanting to target the money that you re spending to recapitalize the banks that are short of capital.  You re not wanting to engage in buying assets. Just as an aside, the way in which Paulson is presenting the plan, and I think that that is correct, is it s not going to cost anywhere near $700 billion because for it to cost $700 billion means that he s got to buy assets at a price and sell them at zero, which isn t the case.  He is claiming that he is going to be buying this at roundabout the price at which these assets are worth or below.  He pretends that we might even see a profit from it. Alex J. Pollock:  Now, I know that some of you have questions, but I m going to give each of the panelists a maximum of one more minute, if you have another minute s worth of comments.  Allan, you. Allan Mendelowitz:  Yes, I ve got to say that I think this notion of focus on the private label mortgage-backed security market is a mistake.  The private label mortgage-backed security market is a totally flawed financial instrument.  The crisis that we have today -- I ve heard the ideologue say it was created by Fannie and Freddie.  The reality is it wasn t created by Fannie and Freddie.  They did not create this crisis.  This crisis was created by the purely private sector originate to distribute model of private label mortgage-backed securities.  And the reason why they created this problem is that the product was fundamentally flawed because of a misalignment of interest.  The private label mortgage-backed security market, they originated through a broker, distributed through a private label mortgage-backed security market, led to a total collapse of credit underwriting.  And it turned out that the systemic risk associated with the private sector mortgage origination model held much greater systemic risk than any systemic risk associated with Fannie and Freddie.  That s what the reality is.  That s what the most incredible situation is today.  And so we have a situation where [cross-talking] Alex J. Pollock:  Okay, you minute is up. Allan Mendelowitz:  No, just let me finish the thought.  At the end of the day, we don t know what the embedded losses are in these instruments simply because the credit underwriting was so bad.  Secondly, we don t know what the embedded losses are because we ve had a transformation in credit, in the past couple of years.  Credit has moved from an analysis of ability to pay to the reality of willingness to pay.  We have people with the ability to pay who are walking away from their mortgages and their houses because the values of the houses that plummeted enough that they re so far upside down on their houses; they see no financial benefits in staying current on their mortgages. And I think that when you have a situation where none of the underwriting even took into account the fact that there was a relationship between housing price changes and credit risk, you have a product that there s no point in trying to make liquid.  You re better off trying to recapitalize the system and letting the -- over time, figure out, in fact, what the embedded losses are.  If the holders of these assets made good financial decisions and they re not as bad as we think they are now, they ll benefit.  If they made bad financial decisions, they ll get wiped out but we ll preserve the system. Alex J. Pollock:  I m glad we got back to the bailout at the end of the comments.  My view is that we should not let anybody off so free, Allan, as you just let the government.  There s no doubt that Fannie and Freddie were major enablers of the expansion of the housing bubble.  They were big buyers of subprime securities, which you don t like, end of all day loans.  And interestingly, Fannie and Freddie got ultimately pushed over the edge by credit risk, which nobody predicted, including non-friends of Fannie and Freddie, like me, didn t predict that it would be credit risk in the end.  I just want to make one other comment, and then we re going to introduce our recently arrived panelist.  Desmond s comment, I think, is extremely important that it s possible for any one balance sheet to shrink.  But it is not possible for all balance sheets, in the aggregate, to shrink together without a price collapse.  So in can be rational for each economic actor to say, I m going to de-lever, cut back on my credit, build up my cash.   But if all actors try to do that at the same time, it can t happen.  So some other balance sheet has to be expanding while the aggregate private balance sheet shrinks.  Well, whose balance sheet is that?  It s the government s balance sheet.  So it s sort of a natural yin and yang over cycles of booms and busts.  And in the bust, what happens is the private balance sheets correcting their former over-exuberance shrink and the offset is the government s balance sheet expands, and the challenge is to make sure that expansion isn t permanent and that it cycle s back at the end of the bust. Now, the gentleman who has just joined us is not Carmen Reinhart.  Carmen, unfortunately, I just found out, got quite ill this morning and was unable to come.  But Vince Reinhart is here, and thank you, Vince, for coming in and standing in.  We ve been talking about bailouts.  We were about to go to questions but before we do, Vince, why don t you just take five minutes to say anything you want to say on the topic of bailouts, the Paulson Plan, or even to the extent you want to quickly summarize Carmen s seven sanctuaries of financial busts and bailouts?  Thank you very much for joining us. Vincent Reinhart:  Yes.  This is a crisis not only in financial markets.  It s in Carmen s gastrointestinal tract.  The good news is I have talked to her and she is doing much better.  I take my responsibility seriously so the views I express are not necessarily mine.  What they are is informed by work, my wife Carmen, who is at the University of Maryland, formerly a colleague of Des at the International Monetary Fund, and even before that, working with the sense of irony at Bear Stearns, is working with Ken Rogoff of Harvard.  And they have a book with Princeton University Press called This Time It s Different:  Eight Hundred Years of Financial Folly.  And for those who don t know that old saying, This time it s different, comes from a Wall Street expression which is, More money has been lost from five words that at the point of a gun.   Those words are, this time it s different. What I d like to do, informed by that study of 800 years of different exchange rate, banking and financial market crises, and sovereign defaults, talk about three rules of the theory and practice of bailouts, the topic of this title conference, and second, four financial crises facts, so four fun facts about financial crisis. So three rules on the theory of bailouts: number one, don t do them.  Number two, if you break rule one, at least be consistent.  Rule number three, if you break rule two, be prepared to spend a lot.  And I think that s really where we are.  Why?  Let s talk about those in turn. Economists have a strong predilection to be against bailouts simply because of what it does to incentives.  The prospect that the government will step in and nationalize losses when it didn t share in the gains creates important incentive problems.  Included in those incentive problems or what it does to managers who accept the possibility that their bad behavior will be corrected by subsequent government action. Now, my favorite example of this happens, and I ve said it before in panels like this, happens to be what Lehman Brothers did the week after Bear Stearns was bailed out by the federal government.  Lehman Brothers put together bits and pieces of mortgage securities that they had left on the cutting room floor, rolled them up into one new issue of about $3 billion that had one economic purpose.  The only economic purpose it had is it was structured so it would be eligible as collateral for borrowing from the Federal Reserve. So what would you want to do?  What s the good idea behind a bailout?  You buy time to fix the problem.  What exactly did Lehman do?  They bought time to hide the problem even deeper in its balance sheet and be more efficient in extracting resources from the government. Now, if you don t think investment bankers have a sense of irony, you should note the name of that security issue.  They were called Freedom Notes.  And for all those who know the Janis Joplin song written by Kris Kristofferson, Freedom is Just Another Word for Nothing Left to Lose.   Okay, so that s why you don t want to do them. If, however, you decide it is appropriate that there is an economic loss that because of some coordination failure, because of just the scope and scale of the loss, or other imperfections in markets, it is appropriate to send government resources to a particular sector, there s rule number two, be consistent.  I would argue that the government s actions over the prior nine months actually made the problem worse, made the problem worse because we drew uncertain lines of the scale and scope of the intervention. First, in terms of not knowing who would be helped, we knew, however, what the government playbook is.  When the government steps in, they dilute shareholders and they protect debt holders.  That creates a self financing funding -- self funding strategy, and that is sell the stock short and buy debt.  Why?  Because when the government steps in, they ll dilute the shareholders and they will protect the debt holders.  So all of this concern about short sales is basically a sideshow.  Having created a very large incentive to do so, the government then complained that people were doing so. The second problem associated with those uncertain lines is that encouragement is speculation that bad incentives from management also discourages capital from coming in to the financial sector.  Step back a minute.  Where are we?  We are with a financial system in which the firms at the center of our trading system don t have enough capital.  We were seeing a private sector in place in which capital was coming in.  A lot of capital raised, almost around $400 billion.  But that process stopped, and that process stopped in part because of the uncertain scale and scope of government interactions. But that brings me to the third rule.  If you ve broken the first two rules, if you ve been inconsistent, if you ve actually done bailouts and been inconsistent in how you do those bailouts, you ll create a problem the government will have to solve, and the government will have to solve it by substituting for that private capital, government resources.  That s the bad news about the legislation that just passed.  The good news is it provides a platform to be more consistent in the application of those funds.  That is, having been part of the problem, the government could be the solution. Now, four fun facts about financial crisis come out of this book, forthcoming from Princeton University Press, which are related to those three rules about bailouts.  First, financial crises are not atypical over time or across countries.  I always remember Mike Mussa, when he was Chief Economist of the International Monetary Fund, had opened a conference on the IMF and Crisis Management.  And Mike, being Mike, the IMF and Crisis Management, we ve certainly managed to have a lot of crises.  And that s basically it.  Over across the U.S. history and across countries, financial crises are repeated and they follow the same basic playbook, the playbook being that individual financial firms never provide enough protection from a withdrawal from liquidity.  That is, they leave themselves open or vulnerable to funding runs. What was portfolio insurance in 1987?  It was the belief that you could dynamically hedge your problems because the market would always be liquid.  What did LTCM do?  LTCM wrote a huge amount of flood insurance protecting against a spike in liquidity leaving its balance sheet open when there was a spike in liquidity.  What are main features of the alphabet soup that we ve learned over the last year?  Either auction rate instruments, the illusion that you can borrow long term at a short term rate, SIV s that you can borrow short and fund long?  Again and again, we re learning that under provisioning four, the withdrawal from liquidity leads to problems.  They re not atypical.  They re also not isolated.  That is, financial crises occur across countries.  And as the globalization of financial trading has increased, as how financial interconnectedness has increased, so, too, has the probability that events are shared. Third, they tend not to be short.  Financial crises take a while to get recognized, to get resolved, and to bring the economy back.  And that s something I ll talk at the end. And the fourth thing to remember, if you look at the long sweep of time, financial crises are not cheap.  They re not cheap in terms of the output loss associated with that or the amount of debt that governments accumulate either for the direct resources they put into the industry or the consequence of the economic dislocations that lead to other spending. Now, what I did want to highlight is the issue of why aren t they short?  And that relates to another irregularity in the data, and that is, financial crises that are recognized quicker and responded to quicker are cheaper.  The longer you take, the more expensive it gets.  Why?  Well, recognize that a government response has three parts, first, you have to recognize the problem, then you have to legislate the problem, then you have to implement that legislative response, then the markets have to heal. That leads to three useful comparisons.  Japan had a lost decade.  Why?  Because they were in denial so long that there was a problem.  They also had given their political set-up considerable governmental problems in terms of finding a leader willing to recognize the problem.  And then lastly, that those solutions were then turned over to officials who were reluctant to implement the policies.  The Nordic countries are the other end of that example.  A ministerial government that actually works can recognize a problem quicker and put legislation in place quicker and they worked with officials to implement that.  Where are we?  Part of the reason it s taken a while is it took a while to recognize that, essentially, a one and a half trillion dollar loss in mortgages would be magnified by markets, but we ve also had the governmental response.  And the governmental response is probably something not to speak too much about. Alex J. Pollock:  Thank you, Vince, very much and thanks for joining us.  As some of you have heard this story before, Vince s point on liquidity, and how across the centuries, there s always a liquidity issue.  I was, several months ago, at a conference, The Developing Financial Bust, this was last fall.  And a senior economist from one of the major multinational institutions said, What we have learned from this crisis is the importance of liquidity risk.   And I said, Yes, that s what we learn from every crisis.   Now, it s time for your questions.  I ll remind you how this works.  We have a microphone over here.  First, wait for the microphone.  Second, give us your name and affiliation, and then your question.  The bearded gentleman sort of halfway back here. Bert Ely:  My name is Bert Ely.  I m a banking consultant here in town.  I have a question that really, I guess, is aimed primarily to Desmond and Adam.  This goes back to your chart, the Case-Shiller chart, showing housing prices.  And it showed housing prices bottoming out well above where they were as recently as 2000, which suggests that there may be actions to try and put a floor under housing prices above where they really ought to be, particularly in terms of relationship to income and affordability.  And so the question I would ask is, doesn t this create actual delay in resolving problems because prices haven t yet hit a clearing level?  Which comes to Adam s point or a question for Adam about the bailout plan, if the government buys up all these mortgage assets, both securities as well as whole loans, isn t that creating a market overhang that is going to also maintain the depression in the housing markets?  And isn t the experience in Texas in the 80s, with the huge housing overhang there, illustrative that prices have just got to crash, markets had to clear.  As someone said, housing has to become a point where it becomes a speculative investment.  And isn t the Treasury holding tank in a notion of trying to prevent foreclosures actually just going to prolong the problem and make it worse and make it more expensive? Alex J. Pollock:  I will take this as one question with two parts, first part for Desmond on the house prices, and second, for Adam. Desmond Lachman:  Thanks for that question.  Just in terms of the charts, that red line that I was showing is what the future prices are implying.  That doesn t necessarily mean that the future prices are correct, that that is just taken from the forward market that Case-Shiller has got a forward market for houses and that just happens to be what people are putting in.  My expectation is that if they ve got it wrong, that the recession proves to be deeper than we thought or that the financial crisis is deeper, the markets will change, we could get the price falling further. I think you re absolutely right in that you certainly don t want to stabilize prices at a level that is way above what is the fundamental equilibrium level.  I think, my fear, the reason that I think that you need intervention of some sort in the housing market on a big scale is very much in the same way as house prices overshot their fundamental values to the tune of like 80 percent on the way up.  There s no reason why they don t overshoot on the way down.  And what I m suggesting is that we ve got a very bad dynamic in that house market that has to be broken.  And by the time we get around to do this, I would expect that we re going to be very close to the fundamental level. Alex J. Pollock:  Adam? Adam Lerrick:  Well, you re absolutely right.  The more we delay the necessary adjustment, the worse it s going to be.  Vincent mentioned the lost decade in Japan.  It was because the government just refused and allowed the banks not to recognize the losses and postpone the necessary [indiscernible].  I don t know where the equilibrium level is.  If I could predict that, I wouldn t be here, I d be very rich.  The issue is, and you re absolutely right, if the government program -- and one of the most dangerous features of the government program was the provision that was added in by the Congress which is that if the Treasury gets control of any whole loans or any pools that they can get control of the whole, they will automatically modify them so the people will be able to pay their mortgages.  And that s fine, as long as the prices are not too far away from the value of the mortgage.  If you get to a situation where prices are falling 50 percent or 30 percent where there s negative equity with the other problems, then you re right, you can create - you will delay the necessary adjustment process.  I think that that is one of the great dangers going forward, that for political reasons, the adjustment process will be delayed. One thing that Alex came to me, it must be four, six months ago, and he said, Guess what percentage of regional and small commercial banks portfolios are in real estate?   I said, I don t know, 65 percent.   And he said, You re right, 68 percent or something like that.   And that is the next trouble in the future.  Everyone focuses on Washington Mutual, on Citigroup, on Wachovia.  We have yet to see how this is going to play out when you get to the smaller banks, going forward, and that s what the FDIC is so worried about right now. Alex J. Pollock:  Vince, you have a short comment? Vincent R. Reinhart:  Yes, I m channeling Carmen, who s known as the scourge of moderators, but I would add to your list of overhangs to the Japanese real estate market.  Those properties were sitting on the balance sheets of commercial banks funded at zero to zero interest rate.  And so for a decade, property prices declined because everybody knew there was this huge overhang. Alex J. Pollock:  Next question?  Back here, Bob. Bob Feinberg [phonetic]:  All right.  Alex, I m Bob Feinberg and I wrote the Descending Views on the Chrysler Bailout.  I m not asking for equal time, but - Alex J. Pollock:  And you can t have it. Bob Feinberg:  Why I ask for something in here, [audio glitch] by which the people are asking for these bailouts couldn t have them also and at the time I was moved to poetry, the first thing, it was, Brother, can you spare a dime to help keep Chrysler in the bank that Mr. Iacocca [audio glitch] to keep his company from going broken?   This was a hit on the Treasury by big time lobbyists that were employed [audio glitch] and we can see two years later that look where Chrysler is today and we can also see that the world market for autos can only support a limited number of producers. So my point is that this bailout should not be celebrated as a success because it has led to and contributed to what we have now, and that s the -- obviously, one could say that the question is, how can you defend this, but we got the defense first and it s a just brief rebuttal. Alex J. Pollock:  Okay Allan, I think that s a question for you. Allan Mendelowitz:  Was it a question or a statement?  Now look, I don t want to go through the subsequent 30 years of history but - and I think that the current state of Chrysler is proof positive that you can t run a business without good management.  And my own view is it s Lee Iacocca s ego that created the situation we have at Chrysler, not the government loan guarantee.  He basically made very bad decisions about successors.  He had a difficult time giving up the company.  Before Mercedes took it over, it was the low cost manufacturer with the fastest turnaround on product launch, had the best design studio in the industry, and was doing quite well.  It was run into the ground by bad management, but that would be a subject of another whole session. Alex J. Pollock:  Thank you.  I have a question over here and then we ll come to you, right here. David Brussel [phonetic]:  David Brussel, Treasury Department.  I heard two theories up here.  Adam had an information problem is what we re facing right now, and over here, and Desmond, like it s been said, a solvency problem.  And I guess I d like to hear a little bit of a debate perhaps between the panelists as to what our problem really is. And in that regard, I guess I have a question also as to what is meant by a solvency problem?  Does that mean that banks and other institutions are insolvent at today s market prices or are they insolvent regardless, even under recovered markets or what exactly do you mean in that case?  And as one last footnote, as I m a little bit puzzled about how a bank deleverages by just converting its liabilities or selling its assets, converting them into cash at the depressed market price.  It doesn t change the amount of equity in the firm. Alex J. Pollock:  Okay, who d like to take that or any part of it?  Desmond? Desmond Lachman:  I think somehow they ve had enough of me [audio glitch] I m not sure that it s productive to try to distinguish, do we have a liquidity problem, do we have a transparency problem, do we have a solvency problem?  My answer is we ve got all of the problems so that we certainly do have a transparency problem or an information problem.  That we ve got highly complicated instruments that are very difficult to evaluate on your own balance sheet, how much more so on somebody else s balance sheet, and that that might have been at some stage where you ve got banks not wanting to lend to one another because they ve got no clue of what is the status of the balance sheet of the bank to which they re lending.  So you ve certainly got a transparency problem.  I think that you ve got a solvency problem in the sense that marking the assets at the prices, you ve got a shortage of capital in the banks, that you ve got a capital inadequacy problem. As soon as you ve got a problem of capital inadequacy, it means that with that amount of capital, you can t support a certain amount of lending so you can t support the assets that you ve got on your balance sheet.  So what you ve got to do is you ve got to bring your assets down so that it s in conformity with the capital.  So if, for instance, you re short of $200 billion of capital and the leverage ratio is ten, you re talking about you ve got to reduce your balance sheet by $2 trillion, selling the assets, and as I mentioned before, when you try to do that, all you do is you depress the asset prices further so that you ve got a bigger capital inadequacy problem and you re just chasing your tail, and that s the reason why I think you need intervention. Alex J. Pollock:  I ll just add also, if anybody else is thinking of [audio glitch] that they not only do your assets have to come down, more importantly, your debt has to come down.  And the market will take your debt down for you by refusing to roll it over.  But other comments? Adam Lerrick:  Well, for sure, I don t think we have a liquidity crisis by any stretch of the imagination.  There s plenty of liquidity.  It s just not flowing.  And maybe someone would say, Well, but that s the definition of liquidity crisis.   I don t consider that.  A liquidity crisis is when there literally is not cash in the system to flow.  Whether we have an information crisis or solvency crisis, we don t know until we have the information.  All right, that is very simple okay, because maybe I m wrong.  Maybe if you say there were 100 major financial institutions in the world you re worried about and I m saying well, there are five that are bad and we just have to figure out who they are.  Well, maybe I m wrong.  Maybe there are 95 that are bad, but we won t know that answer until we get the information.  So once you decide - once you disclose the information, then you ll know whether you have a solvency crisis or not.  Right now, everyone is just guessing and that s what s turning a potential solvency crisis into a liquidity crisis because people just won t lend the cash they have.  And that s why I say it s an information crisis as a first step and if it turns out that of the 100 major financial institutions in the world, 95 are insolvent, then we have a solvency problem. On your second point of how do you deleverage a balance sheet just by selling an asset for cash, it s very simple.  If you turn an asset that has a capital charge, let s say under the BIS rules or the controller of the currencies rules, into pure cash, there s no capital charge against pure cash and that s how you could - so if someone has $100 million of mortgages on their balance sheet or mortgage-backed securities and they sell them for -- and they re carrying them at $30 million, let s say they ve already written it down.  They still have to allocate six or eight percent depending on the country and depending on the reserve of their capital to that or $24 million.  If they actually - it was $300 million.  If on the other hand, they sell it for $300 million cash, they freed up $24 million of capital and that s why the deleveraging could work. Alex J. Pollock:  Vince, another comment? Vincent R. Reinhart:  Yes, so the three prices to keep in mind for the residential assets.  First, it s the price currently in the distressed market conditions given the absence of liquidity and information problems.  Second, there s the price those assets would command if risk taking was more normal and markets were functioning better.  The idea of TARP is to get those prices back toward those, but there s a third price to keep in mind and that is the prices of residential assets that would make all firms solvent.  You can t actually raise prices that high.  There is an economic loss associated with elevated mortgage defaults.  The question is how many firms are between where prices would be in normal times versus where prices would be if firms are fully solvent.  The important thing that TARP does is allow the solvent firms to make their balance sheets liquid so they can take over the insolvent ones.  This is in part legislation that will help facilitate the consolidation of the industry. Desmond Lachman:  Just quickly, just on the solvency issue, I disagree that we don t know that there s a solvency problem.   What we don t know is how big the solvency problem is.  This could be a tremendous solvency problem.  Banks have already recognized $500 billion of loan.  Try to put it in terms of rather capital problem; banks have already recognized $500 billion in losses.  They ve only raised $350 billion in capital.  My arithmetic is that they re short of $150 billion in capital and that is going to escalate as they mark the loss up because we know that they re holding a boatload of stuff in tier three which means that they re marking it to model rather than to remotely what the price is. Alex J. Pollock:  Right, we got to get down to other questions here.  Yes? Ron Trombone [phonetic]:  Ron Trombone, University of Maryland University College.  I ve looked at the [indiscernible] reports from any of the companies that have been in trouble this year and they ve all had very clean audit opinions and they ve had clean Sarbanes-Oxley reports also.  This actually applies to Fannie, which voluntarily does this, even though it doesn t report.  Freddie doesn t.  Do we have a fix for some of these things so that perhaps we have an early warning system in the future to tie us up? Alex J. Pollock:  Allan, I m going give this one to you because you and I have [audio glitch] many times. Allan Mendelowitz:  That is an absolutely wonderful question.  Peter Wallison and Bob Litan had this wonderful joint monograph on the problems with the accounting profession jointly published by AEI and Brookings and I would refer it to anyone.  It s a good read and it s right on the mark.  I mean, my view is the central problem with the accounting rules is that it s Lewis Carroll, Through the Looking Glass, Alice in Wonderland.  The changes in the accounting profession over the past ten years, in my view, have driven a wedge between the two, economic condition of a business and the gap numbers.  And the worst manifestation of that is that you have business leaders, managers, executives making suboptimal business decisions in order to get good gap numbers. And so my view is that the accounting profession should give up on the notion that you can come up with one number, profits that will tell you anything.  And what you should be looking for is a much more robust and full disclosure that gives you a whole vector of numbers, which together, will help you understand the condition of the business and that means you want to get one set of historical numbers, historical record.  You want to get one set of numbers that you can market just to know the liquidation value and you want to get all sorts of numbers that are critical to the real success of a business that don t get published now.  Things like accident rates amongst employees, things like warranty costs associated with products and so on. Alex J. Pollock:  Okay, Adam. Adam Lerrick:  I have a very simple solution, okay?  Make them publish everything, all right?  Everyone used to rely on rating agencies, Oh, it s Triple A, I don t need to read the perspectives, right?  Arthur Anderson has signed off on the books.  I don t need to read the balance sheet, we need to get away from that delegation of authority and decision making.  And when you look at the financial savings, you could look up every single asset with all its characters and every single liability and newest characteristics and it s not that hard.  Every security has a [indiscernible] number.  You could actually see if they want to disclose it and then you could decide yourself.  Each investor would decide himself, Do I think they re solvent or not solvent?  Do I think they re a good business or not in a good business?  I don t need to look at the - I can create my own numbers.   And given the amount of capital and private sector hands, whether it s private equity, firms or whether it s hedge funds or whether it s distressed hedge funds, there ll be plenty of people that we ll be happy to do that for them. Alex J. Pollock:  Okay, I m going take two more questions.  Michael and then you and then we re running out of time. Michael Leo [phonetic]:  Hi, I m Michael Leo, a financial services consultant.  I m picking up on a comment that Adam made and something that Vincent also referred to and that is that if you re going to do a bailout, if you want to maintain market discipline and incentives, you need to take out debt holders as well as the shareholders.  I can see where that works in an individual institutional framework, as it did in Chrysler where you did have across-the-board sacrifices.  When you re dealing with an entire banking system and an entire financial system where you have a lot of the ambiguities and lack of transparency that you see, do you really think you might cause greater problems?  And I take Fannie Mae and Freddie Mac, for example, could you really have made the situation a lot worse by penalizing the debt holders as well as the shareholders? Alex J. Pollock:  Just note, while people are thinking of the answer to that, in Washington Mutual, the senior bond holders are going to suffer very heavy losses and we ll have to think about the ramifications of that.  Vince?  Not the covered bonds but the senior bond holders.  Adam or Vince or anybody? Adam Lerrick:  Well, first of all, when I say senior debt holders, I m not talking about depositors and I m not talking about people that - let s call it senior unsecured debt holders in a bank that would typically be at the holding company level not at the bank itself.  But in the case of Fannie Mae and Freddie Mac, there were very unusual circumstances, which is that their senior debt was held by central banks based on this belief of an implicit, and now explicit, guarantee by the federal government.  I think that was a mistake to have encouraged that belief for so many years, but they did so they had to resolve that way. But if you look at - take the example of AIG and compare it to Lehman Brothers.  If you look at where AIG senior bonds are trading, I haven t checked them this week, they re probably falling more, but ten days ago, they were trading it around 40.  Lehman Brothers senior debt was trading at around 15.  Clearly, both were going to have substantial hits.  I think -- remember the cardinal rule, and I hope Vince will agree with me on this, your aim is to reserve this function of this system.  You don t care about the individual institution and you certainly don t want to bail out people that have lent money, specifically, to that institution, such as Lehman Brothers. I mean, I think a good example, the reason, in my opinion, that the Treasury had to intervene for the money market industry, money market fund, was because they did bail out Bear Stearns.  And if they hadn t bailed out Bear Stearns, money market funds would not have continued or even increased their purchase of Lehman Brothers Commercial Paper.  But they thought -- and this is where Vince s part about consistent action -- if you take the action you should never have taken, you should at least be consistent in taking it, and there you have the problem.  Well, oh, they bailed out Bear Stearns Commercial Paper holders.  There s no risk if Lehman Brothers -- I mean, Lehman Brothers was a clearly foreseen event.  Everyone knew for months that Lehman Brothers was a risky business.  So if a money market fund that s trying to have only buy A1, P1, or top rate commercial continues buying it, they re doing what we used to call in the sovereign debt business, they re doing the moral hazard trade.  They re not betting on Lehman Brothers, they re betting on a bailout. Alex J. Pollock:  A very good point.  I m going to come to our last question here. Chapman Reeves [phonetic]:  Chapman Reeves, [indiscernible] Corporation.  Whether the call comes as a surprise not, I think that receiving the plea for help, those receiving the plea for help always faced the same core choice.  What recommendations would you suggest for responding to the financial crisis that our country currently faces regarding reforms and is there an international financial system in - is our international financial system in a fair robust health?  Is it because the international architecture of the international financial system has major gaps?  Is it the hardware, is it the software, is it the policies, or is it the practices?  Is there a need for an upgrade? Alex J. Pollock:  That s a good broad question to end on.  Who d like to take that up? Allan Mendelowitz:  We need an upgrade. Alex J. Pollock:  Desmond? Desmond Lachman:  I think we certainly are going to need reforms that there are very many lessons that we can learn both in the United States and abroad that it s going to be a long time.  We re going be studying this for a long while, figuring out how we got into the mess, what were the mistakes we made.  There are plenty of things that went wrong, but I think that right now, the priority is how do we try to break this downward spiral?  I think that that is really going to be the first order of business and I don t think that we re there yet. Alex J. Pollock:  And that is the bailout.  With that, ladies and gentlemen, thank you very much for joining us and let s show our appreciation to the outstanding panel.  Thank you. [End of transcript]</body></html>