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- [00:01]
Sir Howard Davies
Good afternoon, ladies and gentlemen. Welcome to the Sheikh Zain Theatre and a particularly warm welcome to Vikram Pandit of Citigroup. I have a particular reason to welcome Vikram here. We worked together for a while at Morgan Stanley a few years ago before he left to set up his own hedge fund operation which eventually went back into Citigroup. And it also gave me as a long standing Citibank retail customer, which I am, an opportunity which you rarely get, to complain personally to the boss about the fact that they just closed my branch on the Strand. And you may accurately measure whether the director of the LSE has any influence by walking along the Strand next week and seeing if it's been reopened. Because it's only been closed for about three weeks. So I thought it was a good time to intervene. However, that probably is not going to be the main topic of what Bikram has to say today because he has boldly decided to launch into a discussion on the future of banking in a global economy. There is hardly a topic that is more topical or indeed more a subject of lively debate and dispute at present, both here of course and in the US with lively arguments about whether we need a new Glass Steagall, whether we should have narrow banks, what the future role of the state in banking is going to be. And so it's terrifically timely that he should come and talk to us about about that. Vikram, of course, went in to be the boss of Citi at the end of December 2007. So for most things, not guilty. Though of course as time goes on that becomes a more difficult line to adopt. As I discovered at the lse, the longer I'm here the more I get blamed for every damn thing. But. We're very pleased to see him. I know there are a number of people here who have got job offers at Citi and the measure of course, of the success of today will be how many of them send letters saying they've had second thoughts but with no more ado. Vikram.
- [02:42]
Vikram Pandit
Welcome, Howard. That's terrific. I remember you exactly the way you are today from my days at Morgan Stanley. Howard's promised me, by the way, that if I keep the branch open he'll single handedly make sure it's profitable. Anyway, it's great to be here. I suppose I should say I'm glad to be here. Thank you for inviting me. It's great to speak here with all of you. Citi and LSE have had a very longstanding relationship. Many of our greatest leaders and biggest contributors at Citi have come from lse. And today I look forward to your questions from this outstanding set of students. I want to talk to you a little bit about the financial architecture that's going to serve your generation in the future. When I was in the City about nine months ago, I spoke at the British Bankers Association. And back then, which was early on, I suggested we really needed a serious rethink of global financial architecture. And particularly driven by the fact I thought it was inadequate. What we had today was inadequate for the modern times. And certainly looking back at what happened with Lehman, looking back at the events that followed major recapitalizations of some of the largest banks in the world, and for that matter, the recession that's concurrent with all those events, it's pretty clear that we have a lot of work to do. Most importantly, when a financial crisis spills out and impacts the lives of people around the world, it's clear that we need to rethink the events. Not only the events that caused where we are, but we need to rethink the global financial architecture that got us here in the first place. And in reality, we never really had a global architecture. Instead, we've been riding on a high speed train, but on rails that were laid more than 60 years ago for a simpler, slower paced world. Government regulatory mechanisms and private sector managers had capacity limitations that could not handle the rapidly accelerating pace and volume of new financial products. And eventually our high speed train exceeded the system's capacity to control it. For me personally to lead Citi in these exceptional times has been a humbling and sobering experience. Many of the colleagues that we've had in global financial centers around the world have lost their jobs and historical institutions have shut their doors. And for that matter, the very bedrock of the principles of capitalism has been shaken. And the world is watching quite literally what we in the banking community are doing on a daily basis. And as I mentioned, the members of U.S. congress, Congress only a couple of weeks ago. I get the new reality and I make sure that Citi gets it as well. Since I became CEO at Citi in December 2007, we've been taking steps to achieve a rapid return to profitability and to be part of the solution to the problems we're facing in the financial community. We're not only restructuring our company and reworking our internal systems of risk management, but we're also collaborating with governments in ways we never anticipated because we are a major systemic financial institution. And I'll say more about Citi a little bit later, but I want to be very clear that we at Citi recognize that we must be a leader in helping to shape the new global financial architecture. We are keenly aware that hundreds of millions of people are expecting us to to deliver many exceptional people, scholars, government officials, private sector experts are contributing to the multilateral discussion about the new global financial framework. Thankfully, a renewed political will articulated through the G20 heads of state has moved decisively beyond what we thought were going to be tactical and technical discussions to one that's considerably more strategic, more transparent and more inclusive. I believe the net result will be a global system that is far better understood, much better regulated and much better appreciated. That said, we clearly are in early stages of an exercise and this exercise can still fall short of an effective solution. Which leads me to a crucial point, especially for all of us today. The work we're doing now, the reshaping of global financial markets in the next few years will have an extraordinary impact on the potential for raising living standards, improving quality of life and confronting urgent global issues over the next 50 years. We cannot underestimate the scale of the impact. In my view, this is a paradigm shift and this is the shift that will determine how well the global resetting is managed. It will be one of the defining historical events of my generation, and for that matter, your generation as well. I believe, along with many others who are directly involved. Three issues are critical to the creation of 21st century global regulatory system. First, we need a regulatory structure that will allow markets to clear efficiently. Second, we need a financial architecture that can truly optimize global GDP growth. And third, we clearly need a lot of global coordination. Let me start with the regulatory structure and we all understand the regulatory debate is complex. But to me it is clear that it should not be about rebalancing between governments and the free markets. The debate needs to be about how we design regulation and market architecture that allows free free markets to flourish while still being systemically responsible. It's a question of how tightly you hold a canary in your hand. Let me be clear. We do need regulations to make markets work better. The place to start is by regulating transparency. Transparent markets generally work, and in this particular case, partial regulation is not the second best answer. Of course, the pushback to this view is always that there is self interest in free markets and the markets need self interest to work and that is unavoidable. Not only that, we need it. Self interest is a driver of creativity and innovation and wealth creation. But self interest does need checks and balances. Markets can do that extremely well as being arbiters and by clearing trades. But that can only happen if there is transparency. Many fundamental parts of our financial markets remain opaque. For some reason, they have been shielded in different ways from the information revolution. In addition, individuals generally have no incentive to seek transparency. Market participants need access to trading information volumes, open interest financial information that is easily understood at the international level. We need to ensure that institutions created to manage the process have the tools and the mandate to maintain the transparency needed for more efficient market behavior. Let me turn to the issue of level playing field A System for Uniform and Consistent Measurement clearly, one of the biggest challenges for developing a unified international regulatory regime is measurement. Good accounting policies and consistent capital requirements are critical to measurement. Amongst other things, good accounting policy, globally considered and globally applied, is essential for stable markets that encourage investment, innovation and growth. Right now I believe we don't have that. We don't even have consistent capital requirements globally, which creates an unlevel playing field and leads to behavior that increases systemic risk. In addition, our accounting systems can work better. There is a significant divergence between economics and accounting. Accounting rules do not necessarily capture economic value. Nowhere is this clearer than in the measurement of capital supporting businesses. As economists and and well trained and savvy mathematicians, all of you here at LSE know that any capital in any organization can be measured by using contingent claims analysis. Contingent claims analysis looks at current and future cash flow net realizable values both on the asset side but also on the liability side and brings this back to the present, the present being the value of the enterprise. This approach recognizes that the value of an asset is not entirely independent of the liability funding it. Confusion arises when we treat assets and liabilities separately or just think about the value of assets and completely ignore liabilities. The two formats for financial institutions where current policies work best are for a trading firm that carries liquid tradable assets and a firm that's therefore funded also by wholesale liquid and tradable liabilities. It's clear in these kind of firms you can use mark to market accounting and it should apply. Current accounting also works in pure banks where it makes sense to have total accrual accounting because long term assets are funded with stable long term deposits and therefore what matters is realized and expected losses, not liquidity. This is also an example where accounting works in an asset liability matched application. Where accounting stops working is when we have deposits that fund tradable assets, particularly when only one side of the balance sheet is mark to market, or when we have wholesale funds that fund accrual assets. In both of these cases, accounting and economics diverge significantly over the last year and a half billions of dollars of capital in the banking system have been impacted by various accounting rules, including this asset liability mismatch. The debate is not whether to mark the market or not. It's about applying a consistent contingent claims analysis to true truly understand the capitalization of banks. Lastly, let me turn to the need for overarching systemic regulators. Regardless of what we do, not every market will be transparent. Not every financial product or risk can be quantified in a way that allows markets to clear. This is when regulators need to step in and aggregate information to make sure that actions and self interest still manage to drive a consistent result for the economy. We've also seen that in times of stress, just about any meaningful financial institution is systemically important. We must therefore cast a very wide net around many financial institutions and activities. I really want to hear your point of view on these three transparency, creating a level playing field and the need for systemic regulators. I know that Sir Howard has written extensively on regulatory architectures, especially on what is needed in the EU in terms of systemic surveillance. I also want to hear your thoughts about what you consider the right architecture to be for driving optimal GDP growth. Let me turn to that for a minute. Historically, bank lending created, or rather bank lending funded credit creation. You all know at student of economics that over the past 20 years or so, finance companies and securitization markets surpassed banks in providing most of the credit growth, particularly in the US and particularly to fund small medium enterprises, entrepreneurs, innovative industries and this finance company and securitization phenomena was often beyond the reach of banking regulators. As we think about designing the new architecture, we need to ask how much global GDP growth do we desire or should we have? How much credit creation does that level of GDP growth require? Is the funding available for that desired level of credit? Is there funding available for that desired level of credit creation? And I think what you will find is when you do the analysis, it is clear that there are not enough bank deposits in the world to support the credit requirements. To drive optimal GDP growth around the.
- [16:19]
Audience Member 1
World.
- [16:21]
Vikram Pandit
And to create therefore this opportunity for growth, we need alternative credit creation vehicles such as securitization markets to remain vital and flourishing. Global regulators are taking aggressive steps to unfreeze these types of markets. In the US the treasury and the Federal Reserve recently announced a program to unfreeze the securitization markets. The program called talf, is Term Asset Backed securities Loan Facility. This is a program that will provide approximately a trillion dollars to increase credit availability to consumers in the U.S. but many of these programs that are designed to jump start securitizations and alternative ways of credit creation may turn out to be temporary solutions. And we need to think about permanent long term solutions. And it's very likely that such solutions are going to require a helping hand. One of the most important legacies we're leaving behind for all of you as risk managers and all of you as finance experts in the future is a wonderful stress test that you're going to apply to everything from here on. As a matter of fact, if you apply this stress test to a lot of the business models and risk taking activities such as securitization or finance companies and or many other financial services organization, the numbers would suggest that the cost of running these or the equity requirements against funding these structures may turn out to be prohibitively expensive. And so, as we think about jump starting credit creation, it's very important for us to understand the short term steps are important, but we're going to have to address something more fundamental to create an architecture that will deliver the level of credit creation for us to drive GDP growth. The most interesting thing is this is not the first time this has happened. And I hate to go back and talk about the American Depression, but let me do that anyway. The US Government during the American Depression established federal deposit insurance. And this was in recognition of the fact that you needed deposits to create credit and people weren't willing to provide deposits in the banks, but it wasn't clear that deposits would be safe. And so the concept of deposit insurance was created. And this was an important thing in an era where deposits funded credit creation. In today's market, deposits don't account for much of the credit creation. As a matter of fact, wholesale funding drives credit creation through vehicles like securitizations. And one of the key questions that we're going to have to address as we think about global architecture is whether we need the equivalent of deposit insurance to attract wholesale funding to drive credit creation. In the past, to drive securitization and credit creation, we relied on rating agencies to arbitrate the cycle and arbitrate the market. Looking forward, it's unlikely that rating agencies are going to be able to serve the same function. And therefore we're going to have to think about different mechanisms to drive these types of credit creation mechanisms. Let me go back to the insurance structure and let me leave that with you. As a suggestion. Any insurance based program is likely to provide more checks and balances to deal with complex markets, much more so than any rating agencies can. And we may need a long term insurance structure around money markets or around mortgages, as they have in Canada where these are government sponsored insurance structures. The goal of course is to design a system that will allow markets to clear and that will allow GDP to grow at an optimal rate. We can all agree that there aren't enough deposits in the world to fund optimal GDP growth and a safety net for wholesale funding markets developed in a global coordinated way may be an answer. To do this though, we need global coordination. Let me talk about global coordination. Of course we need to recognize that globalization continues to be a powerful force of nature. Free trade and international capital flow still offer the same promise of expanding global wealth and improving social welfare as they always have. And I firmly believe this. It couldn't be clearer to me that the financial crisis was not caused solely by complexity or globalization. The crisis also happened because we did not build the rails to cope with the new high speed trains. The principles of global coordination are straightforward. They are uniformity of approaches to market structure, strong linkages between central banks throughout the world, well capitalized clearinghouses throughout the world, consistent rules for capital accounting, foreign exchange, et cetera that promote global capital flows without hindrance. I mentioned earlier that we at Citi intend to be leaders in creating the new regulatory framework. Despite the disappointments and turmoils we have faced for more than a year, I believe we're going to play an important role in restoring the global balance. Global financial architecture and global economic growth. Our core mission at Citi is to enable capital to flow around the world and to stimulate economic growth. In these times, cross border capital flows from savings rich economies to savings short economies are going to be essential to restart global economic growth. There is no question about that. No financial institution in the world is as well positioned to provide these services as Citi. We operate in 109 nations with more than eight out of every 10 employees working in their home countries. We are a unique franchise with an operating model that allows us to be both very local and very global. Many others talk about this, but we actually do it. One of the most immediate challenges in the global economy is to keep global markets open and accessible for trade and investment. In this period, for the 30 OECD countries alone, total exports in 2007amounted to US$11 trillion and imports reached US$11.5 trillion. Before I conclude I've talked to you today about the three critical issues I believe we all need to face for the next generation's financial architecture. One is regulation. The second is financial architecture to drive credit creation and the last Point being global coordination. I said at the beginning that we're still in very early stages of creating a global regulatory system, an effort that could still fall short of an effective solution. But I must say I'm optimistic. We have a better understanding now of the causes of the extreme dislocation and disruption. And understanding the causes will enable us to move quickly towards a rebuilt system. Each of us remembers history in the context of our generation and our education. Many aspects of what we're going through today. The first Global recession in 60 years are not that unusual. What we learn time after time is that the answers to crises of these magnitude often have a common thread. The answers are discovered and implemented through the collective genius of dedicated intellectual capital. So for all the outstanding students that are here today, I want to extend an invitation. In the global financial industry, and certainly at Citi, we're searching for the best and brightest of your generation. We're eager for you to participate in this historic process of reform and revitalize the global financial markets. How well or how poorly the global financial markets are reshaped is in both of our generation's hands. Sir Howard, I appreciate this opportunity to come here and speak with all your outstanding students. I thank you very much. Should we hear what's on their minds and take some questions?
- [25:00]
Sir Howard Davies
Come down.
- [25:00]
Vikram Pandit
Thank you. That's great.
- [25:11]
Sir Howard Davies
Well, I will throw it open to the audience in just one second, but let me take the chair's privilege to ask you one question of my own.
- [25:19]
Vikram Pandit
Because you said, yes, the bank will be open on strain.
- [25:26]
Sir Howard Davies
Because you said in the first part of your speech, when you were talking about the accounting issues and the problems of having different types of accounting applying to different sides of the balance sheet. And you said that one model that didn't work was when you had deposits, particularly retail deposits, funding tradable assets on the other side. But is that if you take that argument to its logical conclusion, is that not, in fact, an argument for a new class? Steagall, and for saying that the universal banks that have been built up should. Should in fact, be broken up, because there's just no way that you can create an accounting or sensible environment in which you can have those assets and liabilities held together.
- [26:11]
Vikram Pandit
Let's go back and think about banks for a minute and I'll talk about how I think about running a bank and what the key issues are. We can talk a little bit about Glass Steagall, and I think it wasn't necessarily the repeal of Glass Steagall, but it was the sort of the inadequacy of the regulatory structure following the repeal. That probably got us into a lot of issues we got into here. Let's think about a bank. What does a bank do? As you rightly pointed out, we take deposits, we get some wholesale funding on top of that, and take all that money and put it to work by investing in assets. You certainly want to make sure when you put all that money to work in assets, you. You do it in a diversified way. We found out historically that banks that take deposits and wholesale funding and put it all to work in, say, Houston, in the U.S. particularly Houston real estate, well, that model didn't work because there's so much concentration. And when Houston real estate turns, you've got a problem. Through this cycle, we've all realized that as a bank, when you take your deposits and your wholesale funding and put it all to work against US Real estate, broadly speaking, that hasn't worked either. And so the fundamental principle of running a bank is not only do you need to raise deposits in wholesale funding, but you must put it to work in a diversified way across all sorts of asset classes. If you take that to your logical extreme, it shouldn't only be loans, it shouldn't only be real estate loans, consumer loans, or bank loans. You should have the proper asset class diversification and geographical diversification that you would need for any endowment, any foundation, any other system. So it makes sense from our perspective to have the ability to take deposits and wholesale funding and put that to work in asset classes across equities, fixed income currencies, commodities loans, credit across all of these around the world. Because. Because by doing that correctly will create a more stable banking structure. If you were to do that, you'd have to trade equities, you'd have to trade credit, you'd have to trade those things, which is therefore the repeal of Glass Steagall Act. It makes sense for banks to do that. It isn't necessarily the principle of it. It's a question of how do you implement it, how do you execute against it. And I think what happened over the last five years, thanks to certain central bank policies, because interest rates were coming down, it became clear to a lot of people that you could actually buy any asset, any asset class, just hang on to it and you made money because all assets went up in price and it generated, in our language, what is known as a carry trade. A lot of companies got carried away with the carry trade and the net result of that is some of the stuff you're seeing. So I wanted to take a few minutes to explain to you sort of the architecture of what a bank is. It really isn't so much about Glass Steagall or not. As a matter of fact, Glass Steagall didn't exist outside of the US Anywhere in the world. So why does that make sense in the US it's not about that. It's really about how do you run a bank. And I do think that's one of the reasons why a new regulatory architect is really important to make sure that we have the right kind of asset liability management for the least amount of risk going forward.
- [29:40]
Sir Howard Davies
Thank you for that. And the second point you made was about the level playing field. I'm always slightly nervous about this analogy because if there were level playing fields, why did teams change ends at half time? But this is a philosophical question.
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Audience Member 1
But.
- [29:57]
Sir Howard Davies
The question that I really pose on that, which I think you're particularly interesting position to answer because you went on a kind of Knight's move from Morgan Stanley to Citibank via a hedge fund, which is kind of hopping out of the regulatory structure and then hopping.
- [30:15]
Vikram Pandit
I've done it all.
- [30:16]
Sir Howard Davies
You've done it all. So you've hopped out and you've hopped back. In the middle of this crisis, of course, the regulatory structure has changed because the investment banks such as us still exist and now bank holding companies. And it's quite clear that becoming a bank holding company is going to involve reduction in leverage. I mean, that's inherent in this. And indeed leverage of institutions like yours is being cut back. So what does that imply for the institutions outside that regulated frontier? Do we really have a level playing field? Or in fact, the problems that we've experienced recently in regulated institutions, are they now going to reappear on the other side in the hedge fund sector or in private equity, unless we extend the regulatory reach to cover them? So have we got a stable frontier of regulation now?
- [31:05]
Vikram Pandit
That is the question. The question we need to ask is how wide a net do we need to cast? What kind of institutions do we need to pick up? And there are two sets of issues here. The first set of issues relates to the fact that entire sectors of the securitization market and entire large finance companies like GE Capital, et cetera, were unregulated. But they served some of the same functions that banks do. They made loans, except they didn't make loans by funding them with deposits. They made loans by acquiring wholesale funding to make those loans. When there are systemic issues, they are just as important systemically as any other regulated institution. As a matter of fact, Having a large unregulated financial sector without a level playing field for rules like capital accounting, what it does is drives that sector to drive pricing in the market at such a level that it affects the regulated sector. So there is an externality that is imposed by the unregulated sector sector on the regulated sector, which makes this question really important. Now I think that's why I said when you look at, when you're in times of stress, it isn't about large institutions being systemically important. Even the smaller ones are. I believe there was some belief, maybe Lehman wasn't systemically important, but look what happened. So as you think about this, you have to think about size, scope, casting the wide net, not only in the context of what is large, what is small, what is meaningful systemically and good times, but what is that answer in bad times. I suspect that picks up a lot of institutions, a lot of different kinds of companies. And you must do that because if one of the roles of the regulators is to clear markets by getting at information that markets cannot get at by their own, on their own, you need to have that information coming content in there. I think that's sort of the part on that. The biggest question in the marketplace though is we don't know what this unregulated system is going to look like. Because the unregulated financial system did not work on taking deposits. They worked on wholesale funding. It is safe to say again that there are three sources of really credit creation. As I said, banks, finance companies and securitization markets. The second two have been curtailed dramatically. And the reason is it's not clear exactly what the wholesale funding mechanism is going to be for the next generation that's going to support these. So in some ways where we are today and the nature of the wholesale funding markets might in themselves limit that unregulated activity. Anyway, thanks.
- [33:49]
Sir Howard Davies
Let me open it up some. My rights as a customer have I think been used up. A guy with a pink tie. Five or six ray up. Yeah.
- [33:59]
Vikram Pandit
No, no. The well dressed gentleman with the pink tie. Pink tie.
- [34:03]
Dimitri
Thank you. My name is dimitri. I'm a second year economic student at LC. Thank you very much for your talk, Mr. Panit. You've mentioned that you see that the short term steps targeting the credit creation will be necessary before we reach this new financial system, financial parity. But clearly there are great dangers lying in these short term steps. And one of them being the politicians not only in the States, but also in this country and other countries trying to appease their voters. By bringing them back their ability to over borrow credit cards and get the houses on 100% mortgages, et cetera. Would you say that clearly that would be disastrous for the world economy and for the United States especially? Would you say that you as a person face a strong political criticism pretty much on a daily basis in Washington? Would you say that politicians in the States are willing to engage in this quest and not make the mistakes, not bring the past back and reach the new solution for the American economy and the world economy? Thank you.
- [35:05]
Vikram Pandit
There's no question we live in a political economy and we can just need to read the newspapers every day to understand that. I do genuinely believe that when you look at America, every branch of the government, every politician is actually really asking the questions about what is right for America. The problem comes about, if there is ever a problem, because not everybody has the same idea about what is right for America. And therein lies the debate. But the debate is pretty much around tactics rather than goals of what we need to do. And sometimes it may look like we may be taking too long or there may be points of view expressed to sometimes just vent the anger and frustration that people are feeling in the economy. But ultimately we get to the right answer. And I guess the best phrase to me that I've used, unfortunately too often with too many governments around the world being in 109 countries, is that the Americans, Winston Churchill said this. Americans wind up doing the right thing, but only after exhausting every other alternative.
- [36:22]
Sir Howard Davies
Who's next? Yeah.
- [36:26]
Audience Member 1
I know you've talked about the lack of regulatory oversight. I just wanted to just read something to you which I came across in the FT today, which I thought particularly amusing. It was in the FT of yesterday, the head of the UK Financial Investments is a chap called John Kingman. He looks after the bank stakes which the UK government now has. And in defense of the frugality of the UK FIS business activities, his chairman yesterday said, I just want you to note that Kingman was paid less than John Thain's chauffeur. Now, the point I'm trying to make down here is do you think it's fair and reasonable that a regulator should be so poorly paid? And I speak in defense here of Howard as opposed to the management of the sort of banks he does regulate. He or she does regulate because from time to time you may have an imbalance in quality here. I don't speak about Howard between the regulator and the bank in question. And the second thing, which on the whole regulatory framework is, you know, you Touched on it yourself. You looked at GE Capital a few years ago. You look what happened to their spreads then because of the mismatch between CP paper, which they were funding on, and their asset package. You look at the likes of an aig, which is a hedge fund in disguise and arguably regulated by an insurance regulator who knows next to nothing about credit derivatives and the like. You look at Porsche today, which is a hedge fund and in disguise too. So by and large, doesn't the regulators have a terribly difficult job? Because as you've touched on, well, he's probably not very well paid, he's probably not very well funded. There are corporates which get around that. And worst of all, I mean, look at your own bank in question. You have management teams who've been paid an awful lot of money who haven't really done their job terribly well.
- [38:08]
Vikram Pandit
I suspect a lot of the latter people are gone from, from where we are. But let's step back. I do think that we need to rethink compensation. I really do think we need to do that on all fronts. Clearly on Wall street and the financial institutions, we've made mistakes. It hasn't been perfect, it's been not long term enough. It didn't have things like clawbacks for the right behavior, et cetera. And so I couldn't agree with you more. We have to rethink compensation in a much more broader way. I'd also add to you that not everybody works in public service solely for the purpose of money as well as we know and as we know in the US as well, as a matter of fact, some of the best people decide that's really what they want to do. But I completely appreciate what you're saying and completely understand that if we're going to go to this framework which says let's let markets clear, give them as much transparency as possible to clear, but also let's have an overarching regulator because not everything is transparent and they need to act as the clearing body that you need to have the talent. We all need to think about that.
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Sir Howard Davies
Next. Yeah, man about sixth row moustache. Well.
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Audience Member 2
Hi, Vikram. I used to work for SmithBank in New York till last year. Thanks for coming to London. The first question is the cost of compliance for a bank in the US when there are multiple overlapping regulators like occ, ots, then Federalists, supervisory arm. Have you communicated this and how painful it is for a bank with multiple regulators, unlike FSA in the us uk, that's one. And second, why did we sell Smith Bunny?
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Vikram Pandit
Okay.
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Sir Howard Davies
All right.
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Vikram Pandit
You know, that's an awkward question given that one of the directors of Morgan Stanley is right here and we did not sell Smith Barney. We thought both these companies could enjoy synergies by having a more efficient organization with greater scale. If we did it put them together rather than separately.
- [40:27]
Sir Howard Davies
That's what we thought too.
- [40:29]
Vikram Pandit
Yeah. Thank you. What can I tell you? I love all my regulators. Okay. The point is not has not gone unnoticed and frankly I don't need to talk about it or say anything about it. It is clear that when you look at the US the multiple regulators each looking at slice with their own sort of goals and their own dispatch can in turn cause friction in getting to the right answers. Which is part of the previous question we talked about. In the political economy it's not not only by politicians but when you have multiple regulatory agencies getting them all aligned same place. That's not an easy job either because everybody has their own objectives per se. I am hoping quite seriously and I would be quite optimistic about this as a matter of fact, when we get to the other side of this, we'll resolve a lot of these issues.
- [41:32]
Sir Howard Davies
Yeah.
- [41:37]
Anna
My name is Anna, I'm a Fed user in the lse. One of the things that this crisis explores is that not only do we have institutions which are too big to fail, we actually have institutions that are too big to be saved. Especially in the uk, in Switzerland or in countries where, say Ireland, where the assets of the banking sector clearly exceeded GDP many times. What do you think is the long term solution to this problem in terms of how do we make sure that we have banks that are capable of serving the global economy but are not too big to be saved by the national government officer?
- [42:14]
Vikram Pandit
I think that's probably, I would say that's one of the most fundamental issues that has to be thought through because you can understand the reaction to that question can go a variety of different ways. Some ways it can go can actually hinder the process of globalization and free trade, et cetera. The there are other ways it can go which can actually make these banks even better. I'm a firm believer by the way, that nothing's going to stop globalization. You may have some friction here or there and that globalization only works on global Rails and we provide them at Citi and that we need banks that through their own internal clearing, payments and other systems can transfer money around the world and make sure that they serve companies in the country they're in. That's a necessity to serve global commerce. I think it's a big issue but that issue, I suppose, has a similar answer to the Glass Steagall issue. In many ways, it isn't about the architecture. It's about what the goals were and how somebody ran that. And so you take some banks that may have, if you have $4 of assets and you only had $1 of deposits to serve the $4 of assets, then you had $3 of wholesale funding. That's not truly a bank in its classical form. That doesn't go to the statement of whether or not they should be global. It goes to the statement of is that a way to run a bank? Is that what you want to do? What we do around the world, you go to Mexico, you go to India, you go to Poland, you go to Korea. We run a bank on the ground that's asset liability matched and capitalized in a way that the local regulators look at it and say, it's a local bank, it's well capitalized, it's working as if it's their bank. And then we connect the world on top of that. So there are some basic principles to how you run a bank which is in many countries now, we happen to have done it, I shouldn't say 200 years, but. But at least for about 110, 125 years exactly, doing it that way correctly. So I do believe a lot of that is about execution. A lot of that is about the architecture by which you run a bank. And for that to make sure banks have the right architecture, the preferred solution to me is better regulatory oversight that guides the banks to the right asset liability management framework.
- [44:43]
Sir Howard Davies
Was one behind. Yeah. Second row.
- [44:51]
Corinna Robinson
Corinna Robinson from the Herald Tribune. What I wanted to get a feel for, because you've talked in very broad terms, if you could have the regulatory regime that you think Citi would make the biggest profits in, but without being a systemic risk to the global system, what would you come up with? Would you come up with leverage ratios?
- [45:11]
Vikram Pandit
How.
- [45:12]
Corinna Robinson
Because you must have a vision of what this should be like. And if you could tell us a bit about it.
- [45:19]
Vikram Pandit
Well, I've talked about this briefly in the past. I know Sir Howard's talked about the architecture as well. You know, the principles are sort of the principles we talked about with which is that it's really not about absolute capital requirements. I think capital requirements are important, but it's about consistent capital requirements. If I give you one company that has a capital requirement, another one that doesn't, but because the other one doesn't, it can run a much higher leverage ratio. Therefore, drive down prices and what you get paid for risk, the regulated entity starts picking that up in its portfolio and that risk from one side externalizes from to the other. So perhaps the single most important thing is this overarching regulatory oversight concept where you pick up a lot of entities that would have been historically unregulated. You need to pick them up and you need to have a consistent accounting and capital regime around the world that is really, really critical. Those are sort of the base things. Now, there are a hundred other things that go beyond that to create a stable architecture per se. But let me be very clear that not all of SETI's problems were because of regulatory architecture. Some of our people did have something to do with it.
- [46:42]
Sir Howard Davies
Yeah. So going in white near the back there, third row down. Thomas Piou Postgraduate Student Economics Two very short questions. What is your unbiased estimate of the day on which city will be nationalized? Second, what is your unbiased estimate on which date would be optimal for me to buy city shares?
- [47:10]
Vikram Pandit
Well, if the first occurs, the second would be precluded, right? So it's a path dependent question, as only an economist can ask. So what can I say that hasn't already been said by the Treasury Secretary, by Ben Bernanke at the Fed, by Sheila Bair of the fdic, for that matter, by Larry Summers, by the President. The goal is not nationalization. The goal starts by recognizing that the world has some serious economic issues. And in those in that environment, you need stable banking, you need a stable banking system and you need credit creation. And what has become obvious to everybody is that when you have assets of the kind any bank does, and you go through the economic environment of the sort you're going through today, that that causes a lot of stress and that having a stable, viable banking system requires support, not only support in the form of capital, which has been provided in the US and here, but really it's liquidity support, it's funding support. If I need to issue commercial paper, I can go to the Fed, so can every other bank in the US If I need liquidity against my assets, I can take it in as collateral and get liquidity against it. If I need to raise long term funding, I have an FDI guarantee. I could probably take this chair in and I'd get some money for it as well. So fundamentally, whether you call it nationalized, socialized support, just about every large financial institution in the US for that matter, many financial institutions in the world are operating because the largest of either central banks or governments that's where we are. And the real question in the minds of everybody is how do you get from here to there? Because here to there is going to take some time. What's the best way of doing that? And for that they have articulated some very simple principles. You cannot be a capitalist economy and have nationalized banks. It just doesn't make sense. So free market, private capital, banks that work correctly, franchise value of banks, all those things are important. And role of the government is to lend a helping hand to get from here to there. In turn, all of us have to do exactly what we always do. Be systemically responsible, make sure we understand the role of the support that's given to us, et cetera. I think that's sort of where we are. And I really don't know what nationalization means because to have funding support from FDIC could count as nationalization or to have no shares outstanding, the government owns a bank, that we count as nationalization. These are shades of gray, let us admit and make sure we all understand the new reality, which is to say the banking system is supported by both the central bank and the government in.
- [50:11]
Sir Howard Davies
The U.S. who is one?
- [50:18]
Vikram Pandit
Well, you know, the shares have been cheap for a very long period of time anyway.
- [50:26]
Sir Howard Davies
Are you authorized to give financial advice in this jurisdiction?
- [50:33]
Anna
Yeah.
- [50:38]
Vikram Pandit
I highly suggest you talk your financial advisor. Thank you.
- [50:46]
Sir Howard Davies
What?
- [50:46]
Audience Member 1
It was a guy in the middle.
- [50:47]
Sir Howard Davies
Yeah. With. With a sort of. I don't know what to describe that. I can't really see what it is.
- [50:53]
Vikram Pandit
Sort of whatever it is. Looks great.
- [50:55]
Sir Howard Davies
Looks, yeah. Greeny Brown. That's it. Yeah, you? That's it.
- [51:01]
Edward Huang
Hello, my name is Edward Huang, second year student here. Do you not think that this idea of the new sort of global infrastructure would create for an unrealistic or somewhat unreasonable expectations gap between regulators and banks? I mean, I don't think you can really go to any government or even big four accounting firm and ask them to run an efficient sort of risk optimization model.
- [51:23]
Dimitri
Right?
- [51:24]
Edward Huang
I mean, would you suggest something like a quasi public firm like the Fed? But we all know how well that worked. Greenspan could even stay with the Taylor rule.
- [51:32]
Vikram Pandit
Come on. Let's start by admitting that there are no perfect solutions and that this is always a journey, it's not a destination we also need. We also know that free markets capitalism isn't necessarily the best system, but it's better than any other alternatives that we have. We start with those constraints and within those constraints we have to design systems which starts with markets. Markets are very good arbiters by the way. They can be. Again, if they have lot of information to do the analysis, they usually come to a pretty good answer. You have to design markets that work, but when there are markets that don't have a chance of clearing, you need regulators to step in. That doesn't mean optimization models necessarily, but that means understanding things like levers that regulators have, capital, leverage, accounting. I mean, there are lots of levers that regulators have to make sure that you get to sustainability systemically responsible way. Now, ideally we'd have, as you economists would know, complete markets. You know what complete markets are here.
- [52:47]
Audience Member 2
Sort of.
- [52:49]
Vikram Pandit
All right, anyway, go look it up. If you don't know. Ideally you'd have complete markets, you don't have complete markets. And when you don't have complete markets, you need some overarching architecture to step in and do it with all its issues, all its foibles, all its fallacies, is still the best alternative we have.
- [53:05]
Sir Howard Davies
We'll take one more, I guess. Yeah.
- [53:13]
Akhil Chenwal
Akhil Chenwal second year undergraduate in Economics One of the means of bringing back trust and confidence as a system is bringing back trust and confidence in what companies and business leaders say. We had Lehman and Bear saying with we're fine, and we figured out they weren't. We had GE saying we're not going to cut our dividend and then they did. We had Citi saying we're well capitalized by Tier One, and then saying, oh, sorry, it's TCE instead. So how do we bring about trust in what you say and the words?
- [53:45]
Vikram Pandit
In the long run, the issue of trust and confidence is about the entire economy and it's about the entire financial system. That's really the place to start. And the fact of the matter is that we talk, you know, we can talk a lot about the economic policies that are in place, which are pretty good, by the way. They're very comprehensive. I think they're going to work. But fundamentally the task ahead of all of us is to restore trust and confidence. And what you find is that at the end of the day, the markets today are so tentative and so sort of, so unsure of themselves that they're not the ones that are providing the confidence necessarily to the marketplace. But having said that, market activity can drive confidence down in institutions. And so what you look at, when you look at sort of the effects that have been occurring out there is not so much the economics of the issue. The economics are you have enough capital. The economics of tier 1 capital is more than enough, and it should work. As a matter of fact, when you talk to long Holders of common stock, they'll tell you that. On the other hand, the fact is that if the market goes the other way and says, really, you know, that's not good enough, we need something else, and drives your stock price down, which in turn creates an issue of confidence in your company, then you act to defend it. So I guess what I'm saying there is that it is almost impossible for any institution to stand up on its own and create that confidence. The confidence is about confidence in the financial system, and that's not going to come from the markets. Ultimately, what all the markets recognize is that there is a giant actor out there called the government and the central bank that is going to be critical to this economic recovery and critical to the stability and the fate of the financial system. Ultimate confidence is going to come from what they say. Not much has been said, although they have started. Bernanke said that, Sheila Bair said that they started building confidence in financial systems in the US But I suppose one of the steps that's going to be important to see if they draw a line on the sand is the stress test. They've been talking about looking at all the banks, applying a stress test, looking at how much capital do you need? Do you have enough? Do you need more? Are you going to have enough to go through a stressful situation over the next two years and still be well capitalized on the other side? This probably is really the first attempt by the regulators and the government to say we're going to apply the same yardstick to every bank. And on the other side of that, we'll top off banks if they need to be topped off or not. But at that point, everybody is on a level playing field in terms of capital based on what the stress test shows for the next two years, that to me is going to be a fundamental time to see whether that starts restoring confidence in the financial system as a whole. Most of the time what you find is that when one bank is attacked, it isn't only about the bank, is about every other bank. The dominoes are very important. So the issue of confidence has to be handled together. I'm looking forward to the stress test and looking forward to the output of that. I think that becomes really probably could be a turning point for establishing confidence in the financial system.
- [57:11]
Sir Howard Davies
Thank you. We're going to have to stop there because I just caught the eye of Danny Kwar, the head of our economics department, who's going to deliver a lecture on completion markets here starting in five minutes. But in the meantime, we know that you must be really quite busy. And it's therefore particularly pleasing that you should spend a bit of time coming and talking to our students about the problems of the bank. And also, of course, about the future of the regulatory system. We really appreciate it. Before I stop and you thank the however, can I just ask one thing? That we need to make our escape down this. If you could just wait for us to get out before you jump up. But thank you very much for coming.
- [57:55]
Vikram Pandit
Well, see, Howard, you don't understand. I would do almost anything to get away from New York.