FRED KEMPE: I am just going to briefly welcome you to this event, part of a new speakers series that we have launched. But I am going to do the moderating here, and I want to turn over the podium to our new chairman, Senator Chuck Hagel.
CHUCK HAGEL: Fred, thank you. Good morning. Thank you also for coming this morning. I am very proud of this institution, as I know all of you who have been associated with it over many years are proud of this institution. I am proud of it because it is today and has been focused on the important and relevant challenges facing our world. And it is, I think, as important today as it has ever been. And like all things in life, things just don’t happen. It takes an immense amount of leadership and effort, resources, and prioritizing what it is that we wish to accomplish. Under Fred’s leadership over the last few years, Brent Scowcroft, General Jim Jones, Ambassador Catto and others, this institution has not only survived, but it has been enhanced and strengthened in playing an even more significant role in affairs that affect the world today than it ever has. So I am very proud to be a part of this.
As Fred noted – and we all understand this – all six-and-a-half billion people on the face of the Earth today are part of a global community. And that global community is underpinned, supported, directed, framed, and shaped by a global economy. We cannot disconnect any aspect of business, of our economy from the future of mankind. It drives everything. What Brent and Fred and Jim Jones initiated a couple of years ago was a particular focus on this as not just an adjunct, but an essential part of the overall mission of the Atlantic Council. And for those reasons and many more, we are particularly proud of this program.
I would say as I conclude and ask Brent Scowcroft to come up and present his remarks as he introduces our speaker this morning, that there are so many possibilities that we now have in the world. Yes, they are connected to and part of the great universe of challenges. But we are living at this amazing historic time when we are truly redefining the shape of the world. We essentially are building a new world order. And to have an opportunity, all of us, to be part of that at this time is remarkable. And we must not squander that. So we are so proud, not only to have so many of the people here who have been part of this organization over the past few years, but the new forces and new companies and new leaders and new individuals that are also now part of the Atlantic Council.
Thank you very much. And with that, I have the distinct privilege, of course, of introducing a dear, dear friend, much admired by not just everyone in this room and in this country, but in the world. If you were there – and many of you, if not most of you were the two nights ago, when we held a pretty significant and I think pretty successful evening due to Fred and others’ work on this and his tremendous staff – what we heard the other night was history. It was a remarkable retelling of some of the most historic events over the last 50 years from the men who participated and led those events. This is an individual who was right in the middle of that and has been for many years, continues to be in the middle of the action, General Brent Scowcroft.
BRENT SCOWCROFT: I am just here to introduce the speaker. (Laughter.) And it is a great pleasure to introduce Dr. Josef Ackermann, chairman of Deutsche Bank. He is a valued member of our International Advisory Board. We met all day yesterday, had a very stimulating discussion.
The first surprise about Dr. Ackermann, for most of us, is that he is not German. He was born in St. Gallen, Switzerland. He graduated from and got a Ph.D. from the University of St. Gallen. He, after that, joined Schweizerische – did I do all right? – (laughter) – Kreditanstalt Bank, which is called SKA, in 1977, and rose to president in 1993. In 1996, he joined Deutsche Bank, where he became chairman in 2006. He is on a wide variety of boards, supervisor and charitable entities, including as co-chairman of the World Economic Forum Board and on the advisory board of the Metropolitan Opera, which gives you a good sense of the spread of his activities.
He keeps his hand in academia, as well, with an appointment at the London School of Economics and at Goethe University in Frankfurt. He has been very vocal in recent times on the subject he is going to discuss today, the financial crisis, including the role of private executives, the role of government and so on.
Let me end with what I think is, perhaps, the most dramatic aspect at the present time. And that is he has just been reappointed as chairman of Deutsche Bank at a time when banks and bank executives are falling like flies around the world. Dr. Ackermann, it is a great pleasure to have you with us.
JOSEF ACKERMANN: Well, good morning, ladies and gentlemen. Thank you very much for these most charming introductory remarks. Actually, it is a coincidence and it is quite interesting to be able to address such a prestigious group here in Washington, whereas on the streets of Europe, a lot of people, the unions, but also politicians have so many nice things to say about banks. (Laughter.)
By the way, I just have to add one thing. Yes, I am on this – I think it is called artistic advisory board of the Met, but to be honest, I have never been asked for any artistic advice. (Laughter.) But the older you get, the more kind of mandates like this you get.
Well, I would like to talk today not so much – I mean, in my introductory remarks. I am happy to answer any questions you will have later on, on more details of the banking and financial crisis. But I would really like to say a few words about what I think, in the political discussion, we will have tremendous debates in the years to come, and I may, of course, focus more on what I know better, Europe. But I think there are also some signals that we will have similar discussions in the United States.
It is clear that the financial crisis confronts us with challenges – and we have heard that in every speech around the world – of unprecedented scale. For the first time since World War II, global economy will be in recession, with developments we were unprepared for, as we had little or almost no experience and no precedents to draw upon. I am the chairman of the International Bankers Association, and for years we talked about crisis prevention, crisis management in emerging economies. We never talked about crisis prevention and crisis management in the industrialized world. We wouldn’t have dared to say a word about the United States in that context, just to say how unprepared we were, also intellectually, to cope with these kinds of issues.
Hence, in dealing with the crisis, governments, parliaments and business had to improvise in unchartered territory. I think it is fair to say this is true throughout the world. What we face is a severe financial crisis first then economic crisis. As in the ’30s, this crisis represents a watershed event for the role of the state. It has triggered the change in what the public expects from the state and what they are willing to allow banks and companies in general to do.
Change will also be reflected in new institutional arrangements. That is no surprise that we are not having meetings of the G-7, but now of the G-20. I think the financial crisis is at its heart a crisis of trust. Banks distrust each other. Client and investors distrust banks. In addition, there is a complete loss of trust in institutions that are supposed to foster trust, namely – banking, among others. All the assumptions we have worked by, namely, there will be a decoupling from the real economy, from the financial world or a decoupling from emerging economies, from the industrialized world have all been proven entirely wrong.
I think what we have really underestimated in the whole context – and I could talk about the luncheon meeting we had with the Secretary of the Treasury and head of the New York Fed at the time with four or five bankers. We talked in June 2007 about the second half of the year. And we mentioned all this – the fundamental imbalances, the real estate, this equilibrium, the subprime, the hedge funds, the private equity, the Chinese currencies, etc. We felt, however, that at the time and in a phase when we have excess liquidity with a very expansionary monetary policy that we will continue to muddle through. We had the assumption that risks are spread globally, but everybody is only taking risks he can absorb.
All of these basic assumptions were wrong when people suddenly realized, when two hedge funds collapsed in the United States. Another one had to be rescued over the weekend. Some public-sector banks in Germany and in Europe got into deep difficulties. And people realized two things. There is much more leverage in the system than we ever expected. And risks are spread globally. Some people have taken risks they could not digest. Suddenly, you have seen obviously, there are much more defects in the system. Something happened, which we never anticipated, namely, in a time of excess liquidity from a central bank’s point of view, we had a complete investor strike and a complete drying up of money markets. Since then, there is no demand for certain products. And if you have no demand, even for the highest-quality products, if you have to sell them, you have a complete collapse of the price levels. This is basic economics.
In the last two years, we have seen that, and this has not changed. So the industry has not and will not be able to restore trust on its own. We are confronted with a systemic banking crisis. Hence, a trusted third party was needed (that is – and I hate to say that as a market economist – that is the state.) So we need the injection of tremendous liquidity from central banks and we need it – the government – to help restore confidence in the system.
As a consequence, of course, the state has now assumed a far greater role. It is an owner or partial owner of financial institutions. The state is a guarantor of debt and certain obligations, it is a provider of liquidity by the central banking system, and it is even a guarantor for loans granted by the financial system. So effectively, this has thrown governments back into a role they have largely relinquished since the 1980s.
Now, this ought not to become entrenched, I would say, as a market economist. History teaches us private business and enterprise create wealth and normally not the state. It was for good reason that our societies embarked on a course of deregulation and liberalization in the ’80s in an effort to boost growth rates. It holds true, in particular, for financial services, as numerous studies have shown that financial systems with high state ownership are less steep, less innovative and result in lower economic growth.
By the way, two things, which I would like to add in the financial crisis and which is normally not even argued about is compensation as one of the causes. And the other one is how attractive the home market is. The interesting thing is – and I just say this in order to make you think twice or three times about certain statements you hear all the time – the banks, which lost most money, had no real compensation system, namely the public-sector banks in Germany. The other one is that many of those banks which lost the most had an unprofitable home market – no real business model, and had to extend their activities to make money outside, either by investing into toxic – in hindsight – toxic assets in the United States or by lending money into projects they didn’t quite understand outside the home market.
Moreover, the greater role now, seen in the context of emergency measures, risks overburdening the state in the long run. Fiscal deficits have risen to unimaginable levels of more than 10 percent of GDP in this country, probably, and in U.K. These large fiscal expenditures burden future generations at a time when we should be reducing budget deficits rather than increasing them in light of demographic developments. Thus, greater government involvement, although it is needed – and there is no alternative to it, and I would like to stress that – should be targeted and temporary only.
We don’t need a large role for the state as a principle. We need better rules and stronger institutions. The state can best fulfill its role not by playing a larger role in the economy directly, but by setting the rules – and the right rules – that govern the behavior of private actors. Incidentally, the importance of setting the right incentives has once again been underlined by the current crisis. Given that the inefficiencies in existing rules, for instance, on capital requirements and off-balance sheet vehicles have contributed vastly to this crisis.
The good thing is that there is a large consensus on the measures needed between the public sector and the private sector. So, the Financial Stability Forum, the G-20 action plan, the Turner Report in the United Kingdom, are all very much in sync with what the Institute of International Finance said for the private sector or the Corrigan Report in New York.
Apart from changes in the substance of the rules, we also need a greater harmonization of the rules and coordinate enforcement. In no small part, the current crisis was caused by discrepancies between nation-based supervision and national rules on the one hand and global markets and global players on the other. Hence, we need to align our rules and our institutions with the reality of a global economy. That was the normative aspect of my speech.
Now, for what is likely to happen. What I have covered so far may not turn out to be the actual outcome of the dynamics that are currently being shaped by political and economic developments. Political – and who knows that better than many of you – approaches come in cycles. For three decades prior to the crisis, we saw the intellectual ascendancy of the Reagan-Thatcher revolution, which itself, of course, followed four decades of post-war Keynesian consensus. These cycles have a penchant to overshoot. And the pendulum will probably swing back now towards a large role for the state than is sensible in the interest of long-term growth.
The state is now again seen as a beneficial actor in its own right, one that should play an active role in the economy. All the opinion polls in Germany show that there is not many in favor of injecting capital into the banking system, but many feel that the government should clearly play a major role in monitoring and steering businesses going forward. How far this changed mood will translate into policy changes will ultimately depend on the course of the crisis. The more taxpayer money is needed, and the deeper the recession becomes, the more extensive the rollback of liberal markets will be.
These political dynamics will redefine the tradeoffs that govern the role of the state. Based on theory put forward by Hobbes and Locke of the social contract between the state and its citizens, the state’s role is defined by the amount of responsibility citizens want to transfer to it. As such, the role of the state in the economy, as well, is not a given, but it is based on popular opinion and the will of the majority. This is one of the underlying reasons for why the role of the state fluctuates over time. The pre-crisis paradigm was ‘the market knows best and less government is better.’ I think this is epitomized in President Reagan’s quote and I quote, “the most dangerous words are I am from the government and I am here to help.” (Laughter.)
The post-crisis mood was captured best, in my view, by Nicolas Sarkozy of France, who said the all powerful market that is always right is finished. I was criticized some months ago when I said disequilibrium in the real-estate market takes much longer [to manifest and self-correct], financial markets don’t have the patience to wait so long. That is why concerted actions are necessary, because I do not believe in the self-healing forces of markets in such a short period of time. I think I still would confirm that this is my view and I think it was right.
It is likely that consensus in society will be shaped by several different traits some examples of which we may be seeing. There will be a new consensus on the balance between growth and equality. A more egalitarian income distribution is valued higher than the dynamics which a greater differentiation of wages can bring. Even the United States, which – I mean, for us, it is surprising – this becomes more and more an issue. This reassessment involves, among other things, a greater taxation, of course, of the rich. Rules for executive compensation will also be stricter. Three-quarters of people in the United States and the EU think managers are overpaid and unethical. There will be a new tradeoff between the creativity of the financial industry and its benefits for the economy as a whole and stability. The balance has clearly shifted towards advocating stability, even the willingness to forgo the benefits of a more dynamic financial sector.
People are now talking about narrow banking, about very focused, small banks. They are talking about reestablishing some sort of a Glass-Steagall Act. Consensus is that a bank which is too big to fail is too big by definition. It is not illogical. However, I would argue that diversified banks have done much better than focused banks, narrow banks, which are too exposed to one market, to one product, or to one client segment.
There will be a new balance between integration and stability. Benefits from cross-border integration of markets in general and financial markets, in particular, should in the eyes of many take second stage to what is perceived as full national control triggered by the clear recognition that we do not have the tools and processes to deal with the failure of cross-border firms. And you see, for instance, the liquidity arrangements in the U.K., there is a clear focus on national control and I understand that.
If you are a taxpayer who has to put up a lot of money to rescue banks, you want to be sure that the liquidity of these banks is around the corner. You want to see it every day and you want to touch it. Of course, banks who run their businesses globally along product lines, along divisional lines have a different approach. They don’t care whether the liquidity is available in Chile or in the U.K. But we are running the risk of a disintegration of the global economy in this kind of discussion.
So what could be the future shape of capitalism against this background? We will probably see the following characteristics: lower growth rates, greater emphasis on equality and stability of economic structures and financial systems and less openness, which will take a toll in the form of lower growth rates. We will see less openness, we are unlikely to see the open market, global capitalism of the first few years of the 21st century.
Make no mistake; globalization is not a natural force. It is manmade and can be destroyed by our own hands. There have been worrying developments; support for openness is waning. In the latest Pew Global Attitudes Study, only 53 percent of people in the United States supported the notion that growing trade ties between countries are good or somewhat good – down from 78 percent in 2002. Support in Germany, in France, in the U.K. has also fallen over time, but from a higher initial level. So in Germany in ’08, it is still at 87 percent.
Already there is worrying evidence of greater protectionism. In the context of rescue packages, banks have been ordered or at least encouraged to redirect lending to domestic markets. One of the problems in the credit-supply, credit-crunch discussion in Europe is that certain foreign banks are exiting foreign activities because they have to redirect their activities to domestic markets.
Several countries have raised tariffs and non-tariff barriers to trade. And in spite of solemn declarations, very little progress on WTO agreements is problematic. I think we will see less homogeneous – the spectrum of economic and social models will broaden. Although Fukuyama’s “End of History” concept was always, in my view, a little bit exaggerated, it is true that there has been a broad consensus on the benefits of the liberal-market economy model. But the West and its model of capitalism have lost credibility in this crisis.
Prima facie other models seem to have performed relatively well. For instance, state capitalism in China. To be sure, the case is still undecided and was not entirely convincing to start with. But one thing is certain; discussions of alternatives to capitalism will intensify – and to globalization – not least because of the growing weight of emerging markets in the global economy and newly founded assertiveness as creditor nations.
The extent of the swing of the political pendulum will differ in the United States and Europe. In the U.S., undoubtedly, there will be more restrictive rules in the financial industry, but beyond that, so far, little evidence, in my view, for a fundamental critique of market-economy principles. In the FT/Harris Poll, despite broad agreement on the judgment of managers, there is disagreement on performance base pay. Only one-third of Americans and Britains support the notion that bonuses will form a lower part of managers’ pay in the future, but two-thirds of continental Europeans. But note, a recent Rasmussen Poll found that only 53 percent of adult Americans believe that capitalism is better than socialism. In Europe, the support for market and social market economy is much, much lower now than it was ever before.
Furthermore, in Europe, capitalism was always less in fashion and only grudgingly accepted even after the Reagan-Thatcher revolution. Now critics of the model have been provided with new fodder. It is fairly likely that this will result in a permanently higher role for the state.
Let me conclude. The current financial crisis will prove to be a watershed event – not just because of the severity of the recession, but also as a period that reshapes our political system. Having said this and to end on a somewhat optimistic note, the swing may in the end prove not to be quite as radical as some would expect. It is interesting to note that the extreme political left, and extreme right, for that matter – at least in Germany – has not benefited so far from the market turnaround. Probably, this also points to a lack of credible alternatives given the poor track record of huge state interventions in the past. Also, the huge public deficits will put the limit on what the state can achieve regardless of which political direction the government favors.
This also increases the probability that overall change may be less radical than some rhetoric today would now suggest. And this, ladies and gentlemen, would not be a bad thing. Thank you.
MR. KEMPE: Dr. Ackermann, thank you so much for what was a remarkably deep, intellectually rich and insightful speech, essentially on the future of capitalism. A permanently higher role for the state, you talked about, as Senator Hagel said earlier, a watershed event, inflection point in history. I have been reading and hearing a lot on this subject, and I am not sure any of us have ever heard it put together that well in such a short period of time.
Before I turn to the audience, let me just ask one or two questions, myself. You also have to deal with the economy as it is now – and there are some confusing signs. U.S. GDP down 6 percent in the first quarter. Germany is seeing a 20-percent drop in exports. For a country like Germany, that is pretty frightening. And the U.S. also – where is the growth going to come from – export-led growth, but in what markets? OECD predicts a 15-percent drop in Germany’s trade balance 2009.
On the other hand, banks are turning profits, stock markets responding, some of our shares are underwater a little bit less. So are we seeing a false dawn or are we seeing the beginning of a – perhaps even a turnaround?
MR. ACKERMANN: Well, let me start with the financial sector. Of course, not all the banks are showing profit. The question, of course, is what kind of risks are still hidden in the balance sheets of banks? And that is an unknown. Some of the estimates are mind-boggling. I think it depends very much on where the real economy is heading. The fact is that the financial markets have in certain areas started to recover a little bit, also the equity markets, and some of the credit markets. Of course, it is also true that the banking structure has changed dramatically. I mean, let’s say the wholesale investment banking arena, we normally talked about eight to 10 global players. This number is now down to probably five. Some have lost out and are no longer operating in this market. And some others have clearly been so affected that they had to reduce their risk appetite.
So the stronger players are benefiting from gaining market share from better markets. I think we have some sort of an oligopolistic structure, which in itself has some challenges because the large exposure rule – if I looked at it from an overall perspective it is becoming more and more an issue. You have banks very big now on a global level. And they are really too big to fail. And in that sense, of course, the whole discussion of the interconnectedness of whether banks can exit markets without jeopardizing the system as a whole will become even more challenging.
And I think we have to work on that. And I am not in favor of the narrow bank or Glass-Steagall-light but I think we have to find systems within the banking system like you have it in the chocolate industry and others, where one company goes under, you still are not jeopardizing the system as a whole. As a matter of fact, probably the weaker players are even benefiting from it. But in the banking system, as the collapse of the Lehman has demonstrated, in such a volatile situation, the collapse of such a bank has dramatic impact on many other banks; loss of confidence, but also, of course, complete dislocations of financial markets.
And I think we have to work on that in order to find counterparties, which take part of the risk and mitigate the risk between banks. So the financial sector still is very, very volatile. And I would not read too much into few stronger banks benefiting now from this shakeup. But the system as a whole is still extremely, extremely difficult. And I don’t want to be too technical, but you have two books in a trading balance sheet – in a bank’s balance sheet, trading book. The trading books for the larger banks had all their toxic assets, had to be marked to market. I think that is more or less digested. But you have, of course, similar products in the banking book valued completely differently. And in addition, you have now, as a consequence of the real economy, that has not even started. You will see risk provisions going up in consumer lending, in commercial real estate, maybe in leverage loans and many others.
So in that sense, I think the worst is not over. And in addition, you have major regions which are struggling right now. And if risks increase in that area, I think that will be a next wave hitting the banks. I always said that the crises were not the tsunami – people always said this was a financial tsunami. That is absolute nonsense. A tsunami is – the way I understand it and we have seen in Asia is one big wave or maybe a second big wave. Those who were a little bit more remote, those who were up on a hill, those who were riding on the waves, they were secure. That would have been easier. If the subprime crisis would have been the tsunami, it would have been more or less okay. This was $1.3 billion of exposure. I think we would have coped with that in the global context.
The fact is that we have a series of earthquakes and even worse: ever-changing epicenters. So once it was the subprime, then it was the leverage loan, then it was commercial real estate and another one. And who knows where the next epicenter will be? And that is why the whole thing is so fragile. You have to be so aware of that and so sensitive to some of these challenges.
Now, the real economy – where should the growth come from? I mean, I said it in my introductory remarks. I don’t think it will come on the same level as we were used to. The deleveraging of the system – and I think the key to understand the financial crisis is to understand that we had a banking system and we had a huge shadow banking system. And the shadow banking system were hedge funds, very positive. At that time, $2.6 trillion in assets under management; now down to probably about $1 trillion. You had some private equity with huge leverage. You had off-balance sheet vehicles, the famous SIVs and SPVs. And you had regional banks in Europe and other parts of the world buying hundreds of billions of these assets. All this shadow banking has more or less collapsed.
So where should demand for these products come from at a time when everyone is still deleveraging? We are reducing balance sheets. We are further selling assets, putting more pressure on the price level. And that is true for households. This is true for banks. This is true for corporations. And this is only offset to some extent by governments and by central banks, which are inflating balance sheets. So in that sense – and this is not sustainable either because first of all, it is very expensive; secondly, you have the crowding-out affect on capital markets.
So I think the deleveraging is by no means over. And we have put a tremendous pressure on economic growth. And that means that yes, we will grow. We will recover again from this tremendous collapse we had. But it will not be the same as it was. And to assume that China and India, or the BRIC countries, countries can offset Europe and the United States is, of course, not very realistic either. I mean, they will help, but not in a sufficient way. So we will be confronted with lower growth rates, which leads to unemployment issues. I mean, in Germany, we are talking about 3 million to 4 million unemployed this year and 5 million next year. This is a tremendous increase in a very short period of time. And of course, what does that mean in terms of social stability, in terms of government support in fiscal deficits. It is a big question.
And I think this is one thing. The other one is that this will lead to some sort of protectionism, which would be failure on interests. I think the refocusing on national interests is not helping the global economy. And I wouldn’t go that far, but you may see a disintegration of, to some extent, of the global economy, which would also cost us a lot longer term. So I think there are a lot of risks regarding what might happen. But I mean, many of these trends we have to fight with all we can and to have a different approach and hopefully, that we are not falling back into some sort of protectionism, into some sort of social instability, those who are willing to work harder, they should also be compensated for that. I am not talking about excesses in this area, but I am talking about the principle.
MR. KEMPE: Quick question and then we will go to the audience on this protectionist point. What are you seeing factually that concerns you most regarding that? It was a big issue before the G-20. Of course, everyone said, the national leaders, everyone said we are definitely not going to go in that direction. On the other hand, banks like your own are under pressure to lend more domestically, not so much – I don’t know how much on your bank, but certainly other banks are feeling those sorts of pressures. What are you seeing in terms of this protectionist threat that concerns you the most factually?
MR. ACKERMANN: Well, I mean, in the broad sense, we have a round in the WTO that we don’t make any progress. I mean, that is on a macro, global level – that banks now being owned or partially owned by governments are asked to do more for their home country is a consequence. I am not saying this is wrong. As a taxpayer, I am asking the same. But I am just saying this is not in the interest of the global economy.
By the way, one of the reasons we are fighting very much not to accept money from government is because we want to say we want to grow globally. We want to be upgrading wherever we think there is potential and not just because taxpayers or politicians want to see us to do more in some parts of the world. I mean, the big – The credit crunch is always a very dangerous discussion because first of all, credit demand is also going down because there are fewer investments, fewer expansion plans and many other things. And of course, we were criticized for lending too much and taking too much risk. Now we are criticized for not lending enough and not taking risks.
So, I mean, what is bad long term – as an economist, of course, I have to say never throw good money after bad money. But that is, of course, seen different from someone who needs more help.
MR. KEMPE: That is the truth. Thank you, Dr. All right, let me turn to the audience, General Scowcroft, perhaps. I see you have the first question. And if you could – you don’t need to identify yourself.
LT. GEN. SCOWCROFT: I’m Brent Scowcroft.
MR. KEMPE: (Laughter.) But if the rest of you could identify yourselves.
LT. GEN. SCOWCROFT: Dr. Ackermann, pursuing the last remarks you made, let me take you back to your normative part. You pointed out so clearly we have a globalized economy. We certainly don’t have a globalized political structure to deal with the globalized economy. The primary instruments we have, the Bretton Woods system, was built in 1944 for a very different kind of thing. What do you think needs to be done there?
MR. ACKERMANN: Well, I think we – I mean, we should start with the, probably, practical issues right now. We should harmonize accounting rules. We should harmonize regulation – banks, financial markets regulations. We should improve the cooperation between central banks. We should improve the cooperation between the regulatory borders. And that would already be a very important step in the right direction before we – I think on the Bretton Woods, the overall financial market architecture or the currency system, I am of the opinion that this actually serves us well.
There are two discussions. And maybe I should have said that. Of course, in Europe – same in the United States, but in Europe, their people want to change the system. And that is a different political agenda. And of course, I would say we should not change the system. The system has served us well. But the system has deficits. And we have to eliminate the deficits and correct some of the excesses. And I think that is the fundamental discussion between the two different schools. And now to start talking about changing the system in many areas would actually, in my view, not be in the interest of stabilizing the current situation. I mean, for those who are familiar with German literature, the – Goethe’s “Faust” has really regained tremendous importance – (laughter) – because what he says is – if you will remember that he lost the liberty of his soul when he said to the passing moment, stay, you are so fair.
And actually, then he said, then I am going to die. And this is a little bit what has driven us. I mean, we wanted to be better like in the Olympics, you want this higher – altius, citius, fortis. You want to be higher, stronger, and faster. And the whole system is based on that. Now, of course, some people say we have gone too far. And you hear how I am criticized in Germany not for making not enough money, but in making too much money.
It is kind of amazing actually that people are saying we shouldn’t be as profitable because by being even more profitable, we achieve two things. We take risks, which no one can understand. But more importantly, we are putting others under tremendous pressure. And they are making mistakes. So if everybody would run a little bit slower, we would all be better off. It is quite an amazing change in this, you know, if you ask the passing moment to stay and not to move, you are actually better off and you should not die. You should be happy and sleep better.
And I think that is really the fundamental debate between – and it is a very philosophical debate between those who want to change the system to a better, but more harmonious, probably slower system with slower moves and those who think no, we all benefited from the fact that we have had this growth, that we created a lot of wealth for people in emerging economies, everyone in the world benefited from it. But that is, if I may, in political terms a bit more socialistic, versus the liberal approach. And I think that is the fundamental discussion that you will have – also, by the way, to some extent, with the election campaigns now in Europe.
MR. KEMPE: To quote Goethe, it is – [in German], which is the two souls are actually competing for dominance.
MR. ACKERMANN: Absolutely, absolutely.
MR. KEMPE: Paula.
Q: Thank you. Paula Stern, member of the Atlantic Council Board. Thank you for a wonderful statement to frame the philosophical questions that are facing all of us. My question to you is a bit related to Brent’s question and it deals with governance. But while Brent was asking about the governance reforms that may be necessary on a global basis, I am interested in knowing what your advice would be for those board members who will be representing government when they take a stake in some of these corporations, both in the real economy, as well as in the financial sector? Who are they supposed to answer to? What should be their guiding philosophy? What are their fiduciary duties?
MR. ACKERMANN: Well, it is probably a discussion we have many times in the U.S., and only, it’s a little bit of a new problem.
Q: That’s right.
MR. ACKERMANN: But my immediate reaction would be –
Q: That’s why I asked you.
MR. ACKERMANN: My immediate reaction would be: do everything that the government can to exit this bank as quickly as possible. So: help to make the banks stronger and give it back to the private sector, because I think it is in the interest of taxpayers, it is in the interest of the economy as a whole.
I mean, under the assumption that private sector is normally more efficient in doing a better job to create wealth over time. I think, therefore, only one challenge, namely, that governments can exit now. I recently had a meeting with the U.K. government, and I think Gordon Brown and Darling said immediately, we would like to do that tomorrow. So someone else, then, must be more critical, and I don’t want to quote who it was, and said bankers are greedy for money, politicians are greedy for power. So whether this is true – (laughter) – I don’t know. But there may be in certain areas some reluctance to exit. But I think we should push for exit.
And in that sense, I would, you know, do whatever is needed to make this bank strong. So improving risk management, improving compensation teams, having the right incentive structures in place, having transparency on all the risks, having a business model, which is sound and not a business model, which cannot produce revenues, and that is why we have to invest into activities, which we don’t understand just to look a bit better. I mean, I am not even criticizing some of these banks, if I say so, because – if you have no real business model where you can make money.
What some people did to build up good-rated assets with a little bit higher yield – you would have asked yourself why is the yield higher with the same ratings? There must be a little bit more risk in it. Anyhow, assuming that a triple A, double A rated product is a good product, and assuming that AA, AAA should always be somewhere, in terms of price, around 100, and then to say, and the finance market is always open because there is all this excess liquidity, these are not stupid assumptions.
And actually, it is like perpetuum mobile. You have got the merchants and you start with one million and then you ended up with 20, 50, 100 billion. And it was good. You had no capital to allocate to them. And you had almost no costs. Your cost-income ratio improved dramatically. And your return equity improved dramatically. And I think that is wrong for two reasons. I think we should challenge each other more. And it is very simple when I try to explain this. If you have excess supply, irrespective of the quality of the product, the price will collapse.
I mean, if you have the best wine seller of Bordeaux wines, and everybody wants to sell this Bordeaux wine in the world, and you have to mark to market – you are a wine seller – your marks and your valuation will go down to 10 or 20 percent of what you originally paid. And if you had borrowed money in order to build up this wine cellar, you will even be forced to join the sellers and you will put more pressure on the market. So this is a dynamic, which people have to ask. Don’t rely on the assumption that the good quality product is always worth 100.
I mean, we understand that in the equity market. But obviously, we didn’t quite understand it in the credit market. And by the way, if I may give you another advice, never believe a loan in the results of models and stress testing and economic capitalist calculations. Always ask yourself what is the notion at stake. And what I want to say is if you invest 100 units – whatever it is, dollars – someone may tell you the value at risk of this is only two. It is always based on some years of input. Someone may say we have to allocate economic capital of three or four.
So you say, that is actually not much. Hundred, you may lose two or three in a worst-case scenario. The stress testing may say you may lose five. And what we learn on this is that in such a worst-case scenario, the volatility and the swings are much bigger. And you can lose 80 or 90 percent. And then probably, 100 when you lose 80 or 90 may destroy your franchise. That is why I am saying ask more about what are the notional amounts at risk. Maybe you are avoiding all the risk and then you have soon no risk to avoid if you go too far. But at least, it gives you a better hint and a better understanding of what kind of risks your bank is taking.
MR. KEMPE: Thank you. Ambassador Burt?
Q: Rick Burt. I would be interested in your views on the implications of this crisis for Europe and the EU, in particular. And I mean that in two different senses. One, say, in the area of monetary and fiscal policy. To what extent has it really deepened the strains among states, say, on the one hand, like Germany that have always pursued a much more conservative anti-inflationary policy, and say, countries in Eastern Europe and others on the periphery of Europe who would much prefer to see expansionism policies? Does this put the euro in doubt in any real degree?
And then in a regional sense, Eastern and Western Europe. It is interesting that Eastern Europe has probably been hit harder than practically any region in the world. And how does that affect – how is that going to affect how Europe goes forward and at least tries to deepen its existing institutions?
MR. ACKERMANN: Well, you, as former ambassador, you are as familiar as I am with the European thinking. But I think your questions are very well taken. I was in New York a few weeks ago and meeting with investors and hedge funds. And they were betting on two things: the collapse of the euro and the falling apart of the euro system. I hope, as a European – not as a Swiss, as a European – (laughter) – I have to be honest here – that both bets will not happen. I think we have to do everything to defend the euro and the European Union. That will be a disaster for Europe if it fell back to the old era of the tensions between these different countries. And I think everybody is aware of that.
Q: But you do agree that it is a risk that is inherent in where we are right now?
MR. ACKERMANN: Yeah, that is what I am going to say. But there are some risks – I mean, first of all, just look at the credit spreads for certain countries now. And the question is, you know, how it be that some countries have to pay much higher rates on spreads for their financing than others? It is starting the interest of Europe. And of course, there are two proposals. One proposal is we should issue some sort of a euro bond. And of course, Germany and other strong countries are not very happy about that. I mean, why should we pay higher because Greece and Italy and others are part of that? So in that sense – and at the end, we will probably all move up. And I think this kind of competitive environment between states is not bad.
And the other thing is that we think about something like a European monetary fund, where we have stakes in it. And like the IMF is borrowing money, but then give it to certain countries – how that works is difficult to say. But the dislocations in the European system are challenging, no doubt about that. And we are completely different real economies and completely different strengths in the financial system.
Now, the good thing is actually that in the financial system so far, some of the weaker countries have done pretty well – the Greek banks, the Italian banks, the Spanish banks, Portuguese banks have actually done better than some of the German banks or the U.K. banks – outside the euro-zone – but that is something, which is a real challenging issue. I think everybody is willing to support each other whatever it costs because it will be really very, very dangerous for Europe.
Now, Eastern Europe is, of course, the other thing. I mean, it is always – if you have a buildup of a new region, especially in such good times that you are also making, probably, decisions which in hindsight are probably creating some sort of problems. And this has to be corrected. This will be expensive. It is different from country to country. Some countries are doing better. So to talk about Eastern Europe as a whole is actually not fair. You really have to talk about different countries in Eastern Europe.
But even here, I think it is in the interest, although it is politically more difficult, to support Eastern Europe because to fall back into the situation that we have, almost a Cold War situation, that will be, again, very, very negative. So whatever it costs, I think we have to keep Europe together and we have to work that Europe is not suffering too much. And we should not destroy the progress made in creating market mechanisms and in the belief of globality. Some of the people, the leaders who have been very outspoken about the benefits of open market, of open economies, of opening up the political arena may be under pressure if unemployment goes up and up and up.
So people will say, well, you told us this is good for us to be an integral part of the global economy. But now we are actually seeing that being more – focusing on national interests and being a little bit more closed-shop, we might have done better for a while. So in that sense, I think we have to demonstrate that open economies are better, that open dialogue, open political systems are better, and to convince new members who aren’t as experienced with this kind of thinking on not falling back into an old thinking and some of the populist movements will gain importance.
MR. KEMPE: Jack James in the back.
Q: Jack James from the German Studies Institute. Would you perhaps share with us your evaluation of the central bank? That is to say, Mr. Trichet, who was just in New York on Sunday made the same comment that you did. We were unprepared. We didn’t know what was going to hit us. And that makes everybody nervous when that level of unexpectation is going to hit us. There is an old expression about the fact that economic predictions make astrology look good. And the question is, how would you evaluate how Mr. Trichet has handled the situation? And is there some other function or an expansion of some capacity in terms of renewing institutions that you would want the European Central Bank to have?
MR. ACKERMANN: First of all, the European Central Bank did a fantastic job in dealing with the crisis. I mean, they were, in my view – if I had to rank them, I would say they were number one. How they reacted, how they responded. They were very fast. One thing, which some people didn’t understand – their primary mandate is price stability, different from the Fed in the U.S. or other central banks. When the inflationary pressure was over 3 percent, although there were signs of a slowing down of the economy, they still adopted an even more strict monetary policy and raised interest rates.
Some people said, you know, that was a mistake. No, that was not a mistake. It was a logic at that time of their mandate. They had to do that. They had to bring inflationary expectations down, and they did so. And then, of course, they started to adopt a more expansionary monetary policy.
Now, in terms of being prepared, let me say – and I am not critical of – he is a good friend and he is actually very close to Deutsche Bank, Chairman Greenspan. But the – what is really – was the philosophy of, especially central bankers, but primarily of the Fed was it is not possible to detect bubbles in advance. You have to wait until they burst and then you deal with the consequences. I know how difficult it is to detect bubbles. I mean, you know, it is an old saying in banking, if you avoid all the risks, you have soon no risk to avoid, which means that yes, each time you think there is a risk and a bubble and you get out of it, you will probably lose a lot of opportunities.
I lectured at Columbia a few weeks ago. And George Soros said, Mr. Ackermann, I said that in ’87. I said, yes, George. But if I had done what you said in ’87, I would no longer be in office because we would not be in business. So it is always – you know, there are always people – and I am not criticizing George Soros, but I am just saying you can always say in the long run because we will get bubbles but, you know, there will be some bubble in China or in India or in Switzerland, wherever in the world. And what should we do? So in that sense, it is difficult. But I must say over the last two to three years before the crisis started, there were so many excesses that actually, if someone had had a little bit of authority to speak up, we would have done better.
And there are two things. We had meetings with central bankers and the BAS always in the first week of January in Basle, Switzerland. And we always said where are the risks? And we always said what I said before, well, you know, the risks are globally spread assuming that everybody takes only the risks that he can absorb and digest is actually not a systemic problem. If you invest half a percentage point – if you net worth into toxic assets, in hindsight, yes, you may lose half a percentage point, but that is not going to destroy your wealth. And suddenly, we have seen that this assumption was not true. Some people have gone much beyond that.
So we were somewhat complacent in assuming that whatever the external shocks were, we always muddle through for decades and decades. And maybe we should be a little bit more strict in saying, but now we really want to know what the aggregate numbers are and where the risks are allocated.
Secondly, the leveraging in the system, the building up of this kind of pyramids and bubbles was not unknown. Everybody has seen that. We talked about it. That risk that was underpriced for emerging economies, as well as for leveraged loans, was no surprise. We discussed that for years. We tried to find all the answers and the justification. Why is this? The savings in China and productivity gains, a completely new world order and, you know, all the textbooks are wrong. Maybe in hindsight, the textbooks of classical economy were not that wrong.
Thirdly, if I go with the – more as, to demonstrate how it worked in the leverage-loan business. Merchant spreads were very low. And because we were in such a competitive environment, everybody wanted to be part of that leverage loan business because it was very profitable with all the additional transactions that we were willing to lend money for almost nothing. But then it got worse. In this competitive race, someone said I don’t like these covenants. They are too strict. So we offered “covenant-lite.”
The third phase, we said, well, we don’t actually want to pay interest now. I said, don’t worry. You will pay the interest at the end of this transaction. And at the end, someone said well, I don’t even have equity to invest. Don’t worry, we give you the equity. And so we offered equity bridges. I mean, probably without the collapse in 2007/2008, we would have probably gone on with the next nonsense. If someone had monitored that, I don’t think that banks – we operate – and that is what I am saying is difficult, but I think it is true. If you are on the – again, I only work with European examples. On the soccer field, you have rules you have to accept. But to change the rules yourself is very difficult.
I mean, I could say, you know, we are the team. We play against you, but we set different rules. We never shoot with full force because that is not fair. Or we don’t touch you – you know, we always stay away from you because that is a nice game. That is fine. But we will never be world champion. We will never win. And so in that sense, to say, well, you know, you play with different rules. I mean, I am not talking about not ethical or not complying with any regulations, but I am talking about just accepting the rules of the market.
If you don’t do as the market requires to do, you are not very long in business. So in that sense, I think it is very difficult for market disciplines to hold back. And that is why regulators, standard setters, governments have a very important role. And the same is true. You need someone who can speak up with authority and say now we have to change the rules. Things are going out of hand.
And the private sector now under the leadership of Jacques de Larosière, the former head of the IMF and the former governor of the bank of Canada. We have established a group – a monitoring group, which exactly that kind of mandate. And of course, people talk about the IMF giving that role about others, but I think we have to try. Just to say it is difficult and it didn’t work in the past – maybe it is a better system than what we had just to give us a little bit more hints and more warnings in advance and market participants would immediately change their behavior if they knew that is probably going into a situation where we may lose a lot of money. So in that sense, I think yes, we were unprepared.
MR. KEMPE: Thank you, Dr. Ackermann. We only really have three, four more minutes. So let me take a question from John Macomber in the corner. And then I have a weakness for the “Wall Street Journal,” an abiding weakness. So Bob, if you go afterwards, but let’s make the questions very brief, please.
Q: I will be brief. My name is John Macomber and I would like to follow on directly from your last comments about rules – knowing full well that if you want to follow a different set of rules, you are out of business pretty quickly. The competition will just murder you on that. But going back to your earlier comments about the globalization of this issue, from a pragmatic point of view, how in this country can we do a better job of integrating our rulemaking with the European sector? I am focusing particularly on the European sector because that is the other half of the gorilla. And this is a question that everyone wants to duck in this country. We have not had any clarity on it. And it seems to me that following directly off of what you just said that that is the single biggest pragmatic question that we have to answer right now.
MR. KEMPE: And let me take the last question to Bob Davis.
Q: Bob Davis from the “Wall Street Journal.” You were talking about different regulatory issues that you will have to face. One of the most important, I think is all over the world – regulators are going to make decisions about institutions that are systemically important. I don’t think there is any way that Deutsche Bank won’t be considered that. Wouldn’t that give huge advantages to a company designated – or considered in such a fashion in terms of being able to raise capital? And wouldn’t it also encourage the same sort of risky behavior or even riskier behavior given that the companies will know they are not going to – that the state will protect them? And also, are there any disadvantages to such a designation?
MR. ACKERMANN: Well, first, I couldn’t agree more. And I think they need more harmonization. I am going to give you one example very simple. The U.S. GAAP and IFRS, the difference, our balance sheet in IFRS is €2.2 trillion. Under U.S. GAPP, it is $980 billion. I mean, that explains it all. Talking about leverage and so this huge difference. So completely different treatment of derivatives portfolios, I think that that – and you could go on forever.
So in that sense, yes, we need to have an open dialogue. And, you know, what we really should shoot for is, as in a marriage or in a merger, don’t say, you know, A is better than B; say let’s create C, which takes the best elements from A and B. And I think that should be the thinking. And then everybody can bring it what is best in relative terms and forget what is weak in relative terms. And maybe we create a few things, which are better. But they are really on the regulatory front. In my view, we have four things – more capital, more liquidity – I mean, more liquidity cushion, leverage as a benchmark, lower leverage and probably the skin in the game, so people have to adopt same due diligence whether they sell products or whether they retain them.
Not too much, but at least to give this kind of discipline to the market. That is much more important, in my view, than narrow banking and plastic light, which, in my view, would not make the system strong in going forward.
MR. KEMPE: And I apologize to people I didn’t get to. We do have to close after you answer Bob Davis’ question. And I particularly apologize to the board members I didn’t get to.
MR. ACKERMANN: Well, as a matter of fact, almost every bank is now considered systemically relevant, so I don’t think that is a big difference. But yes, of course, the question is if you have guarantees or if you have implied guarantees or if you have state support, are you capable of funding cheaper? Yes, to some extent, that is right. But the interesting thing is that Deutsche Bank, for instance, has much cheaper funding if you take the CDS spreads five years than some of the state-aided banks. So obviously, markets are differentiating between different banks. And of course, the implied guarantee is also very important if you are a systemically relevant bank.
But there are a lot of distortions in the historic perspective. You have got capital – you have got different restrictions and different jurisdictions, more pragmatic in a few countries, less pragmatic in others. And you are also protecting and rescuing weaker banks and by doing this, actually challenging – I am not saying weakening, but challenging the stronger banks in a market, where actually the weak players should exit the market.
But that is all theory. You can talk about that for many, many days and weeks. The fact is there are no alternatives to what we are doing and the governments are doing because what we have seen in the Lehman case. This is probably, in a historic perspective, not a wrong decision for moral hazard reasons. People have to know that weaker banks can exit and can fail and you can lose money with banks collapsing. On the other hand, in such a volatile, fragile situation, it was the wrong decision because it led to the loss of confidence into other banks. And of course, it put more pressure on the pricing as a consequence of the unbinding of positions.
So in that sense, it was the wrong moment, but the right message.
MR. KEMPE: Dr. Ackermann, by way of thanks, let me just say a couple of things. First of all, thank you for having been and being such an active member of our International Advisory Board. We created this group to bring the leading bankers, business thinkers of Europe primarily to the U.S. to infect the policy community with their thoughts. And we had an excellent board meeting yesterday, where I think that is exactly what happened. It was a terrific exchange. And thank you for that.
You have established the tone we wanted for the speaker series today. We wanted it at this high level. We wanted it with this sort of depth. We wanted it with this sort of vision at this time, at this historic inflection point. And congratulations to you and to Deutsche Bank, also. It was very kind of you to time this around – I know it was unintended, but it is always nice for a former newsman to have a little bit of a peg for a wonderful event. So congratulations to you, to Deutsche Bank. And thank you so much for what I think the audience would agree was just a fascinating, fascinating time.
Transcript by Federal News Service, Washington, D.C.