[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]





                          THE EUROZONE CRISIS:
                    DESTABILIZING THE GLOBAL ECONOMY

=======================================================================


                                HEARING

                               BEFORE THE

                   SUBCOMMITTEE ON EUROPE AND EURASIA

                                 OF THE

                      COMMITTEE ON FOREIGN AFFAIRS
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 27, 2011

                               __________

                           Serial No. 112-94

                               __________

        Printed for the use of the Committee on Foreign Affairs







 Available via the World Wide Web: http://www.foreignaffairs.house.gov/



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                      COMMITTEE ON FOREIGN AFFAIRS

                 ILEANA ROS-LEHTINEN, Florida, Chairman
CHRISTOPHER H. SMITH, New Jersey     HOWARD L. BERMAN, California
DAN BURTON, Indiana                  GARY L. ACKERMAN, New York
ELTON GALLEGLY, California           ENI F.H. FALEOMAVAEGA, American 
DANA ROHRABACHER, California             Samoa
DONALD A. MANZULLO, Illinois         DONALD M. PAYNE, New Jersey
EDWARD R. ROYCE, California          BRAD SHERMAN, California
STEVE CHABOT, Ohio                   ELIOT L. ENGEL, New York
RON PAUL, Texas                      GREGORY W. MEEKS, New York
MIKE PENCE, Indiana                  RUSS CARNAHAN, Missouri
JOE WILSON, South Carolina           ALBIO SIRES, New Jersey
CONNIE MACK, Florida                 GERALD E. CONNOLLY, Virginia
JEFF FORTENBERRY, Nebraska           THEODORE E. DEUTCH, Florida
MICHAEL T. McCAUL, Texas             DENNIS CARDOZA, California
TED POE, Texas                       BEN CHANDLER, Kentucky
GUS M. BILIRAKIS, Florida            BRIAN HIGGINS, New York
JEAN SCHMIDT, Ohio                   ALLYSON SCHWARTZ, Pennsylvania
BILL JOHNSON, Ohio                   CHRISTOPHER S. MURPHY, Connecticut
DAVID RIVERA, Florida                FREDERICA WILSON, Florida
MIKE KELLY, Pennsylvania             KAREN BASS, California
TIM GRIFFIN, Arkansas                WILLIAM KEATING, Massachusetts
TOM MARINO, Pennsylvania             DAVID CICILLINE, Rhode Island
JEFF DUNCAN, South Carolina
ANN MARIE BUERKLE, New York
RENEE ELLMERS, North Carolina
ROBERT TURNER, New York
                   Yleem D.S. Poblete, Staff Director
             Richard J. Kessler, Democratic Staff Director
                                 ------                                

                   Subcommittee on Europe and Eurasia

                     DAN BURTON, Indiana, Chairman
ELTON GALLEGLY, California           GREGORY W. MEEKS, New York
GUS M. BILIRAKIS, Florida            ELIOT L. ENGEL, New York
TIM GRIFFIN, Arkansas                ALBIO SIRES, New Jersey
TOM MARINO, Pennsylvania             THEODORE E. DEUTCH, Florida
JEAN SCHMIDT, Ohio
TED POE, Texas













                            C O N T E N T S

                              ----------                              
                                                                   Page

                               WITNESSES

Mr. Jacob Funk Kirkegaard, research fellow, The Peterson 
  Institute for International Economics..........................     7
Desmond Lachman, Ph.D., resident fellow, American Enterprise 
  Institute......................................................    28
Mr. Bruce Stokes, senior Transatlantic fellow, German Marshall 
  Fund of the United States......................................    43

          LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING

The Honorable Dan Burton, a Representative in Congress from the 
  State of Indiana, and chairman, Subcommittee on Europe and 
  Eurasia: Prepared statement....................................     3
Mr. Jacob Funk Kirkegaard: Prepared statement....................    10
Desmond Lachman, Ph.D.: Prepared statement.......................    31
Mr. Bruce Stokes: Prepared statement.............................    45

                                APPENDIX

Hearing notice...................................................    60
Hearing minutes..................................................    61
Congressional Reserch Service Memorandum: The Eurzone Debt Crisis    62

 
         THE EUROZONE CRISIS: DESTABILIZING THE GLOBAL ECONOMY

                              ----------                              


                       THURSDAY, OCTOBER 27, 2011

                  House of Representatives,
                Subcommittee on Europe and Eurasia,
                              Committee on Foreign Affairs,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 2 o'clock 
p.m., in room 2172, Rayburn House Office Building, Hon. Dan 
Burton (chairman of the subcommittee) presiding.
    Mr. Burton. The committee will come to order. This hearing 
is on the eurozone crisis and the potential destabilizing of 
the global economy. And the subcommittee will come to order.
    Since the fall of 2009, starting with the revelation of 
Greek fiscal problems, we watched a series of unfortunate 
events take place that have fostered bailouts of Greece, 
Ireland and Portugal and possible intervention in Spain and 
Italy. Europe and the entire global economy are in a dire 
predicament that has far-reaching consequences. Trillions upon 
trillions of dollars are at stake as we look to stem a possible 
worldwide economic depression.
    Members of the European Union created the Eurozone in 1992 
with a vision to create a single monetary policy for all of 
Europe. The euro would become the common currency adopted among 
nations who all adhered to a strict monetary policy that 
provided greater stability. However, the Eurozone also brought 
additional bureaucracy where individual nations still acted in 
their own best interest, oftentimes hiding or misstating 
realities of their economy, which only exacerbated the 
situation. In addition, the European Union failed to adopt 
mechanisms that could move swiftly to deal with quickly 
changing market conditions and important oversight institutions 
to provide transparency and accountability among the Eurozone 
partners.
    The current economic situation in Europe has uncovered many 
of these shortfalls and has exposed them as the main causes of 
the ongoing crisis. Accordingly, the Europeans have left the 
world wondering if the steps they are taking to right the 
crisis are effective and enough.
    Due to the crisis, we have witnessed a creation of three 
European lending mechanisms, the largest, the trillion dollar 
European Financial Stability Facility, along with the 
assistance from the European Central Bank and the International 
Monetary Fund, has so far lent Portugal, Greece and Ireland 
over $1 trillion. This is only the beginning as some analysts 
estimate that Europeans will need another $2 trillion to 
recapitalize European banks and the coffers of crisis 
countries.
    Meanwhile, European leaders continue to meet repeatedly and 
results depend on a clear consensus on how to resolve a problem 
that has been fluctuating for nearly 2 years.
    The United States is not immune from these troubles, and 
this is not just a European problem that Europeans must solve.
    The U.S. economy intertwines with the European economy, and 
the nations of Europe combine to be the largest trading partner 
of the United States and the partnership is approximately five 
times greater than our partnership with China. Due to the 
crisis, U.S. exporters face tougher market conditions, as the 
euro devalues and European partners cannot afford to import as 
many manufactured or agricultural goods.
    The United States stock markets, which are going up like a 
rocket today, are in a constant flux as traders react to the 
changing stabilities of the investment climates. U.S. banks, 
despite ample warnings of the ongoing market volatility, still 
hold European bonds and securities, a value estimated to be as 
high as $2 trillion, and we will talk about that in a few 
minutes.
    As chairman, I visited with leaders and discussed with 
experts the complexities of the crisis. Many public leaders I 
have met with have not provided clarity and have not been 
forthcoming regarding the true extent of the crisis. Political 
leaders over the months, including U.S. officials, have 
routinely relayed to us that the crisis is close to 
stabilizing, that recovery is working, that governments are 
taking reform measures and that growth is just around the 
corner.
    In contrast, the EFSF has grown from 440 billion euros to 
780 billion euros to now over 1 trillion euros. Additionally, I 
asked Treasury officials to testify in September, to which they 
asked for postponement until after the IMF and the World Bank 
meetings and the meetings they had yesterday. This past 
Tuesday, they again asked us to delay this hearing to November 
until after the G-20 meetings. Their excuse, contrary to what 
we hear from public statements, is that the markets are too 
volatile and that any statement can further harm the situation.
    These are not signs that recovery is working or that growth 
is just around the corner. The U.S. Government should not ask 
or expect the American people to play kick the can while 
political leaders sort out the global economy behind closed 
doors. The people and the markets have a right to know. If we 
are not open and transparent, we are only preserving an 
artificial sense of stability. And this is not sustainable, and 
the longer we wait, the worse it will be when reality comes 
crashing down.
    The current situation does not call for us to point fingers 
and lay blame. I recognize that the crisis is not easy to 
solve. The complexities of the crisis are diverse and unique, 
with each country having its own cocktail that has led to its 
current predicament. However, we must be honest about the 
situation and no longer gloss over dilemmas that may drag the 
entire globe into a deep recession, and we are very concerned 
about the financial involvement that the United States may face 
down the road.
    And with that, I will yield to my goodlooking friend here, 
my ranking member Mr. Meeks.
    [The prepared statement of Mr. Burton follows:]
    
    
    
                              ----------                              

    Mr. Meeks. Thank you, Chairman.
    And I want to thank Chairman Burton for scheduling this 
hearing on the Eurozone crisis and its effects on the global 
economy. The Transatlantic trade relationship is the largest in 
the world, and it is in our interest to make sure that this 
works to the benefit of the estimated 15 million jobs that have 
been generated from this relationship on both sides of the 
Atlantic.
    I agree with the chairman that it is important for us to 
get an accurate perception of U.S. exposure to the Eurozone 
crisis. But I think it is just as important to look forward and 
examine how we can transition from this situation, where the 
Eurozone is under immense pressure, to a situation where growth 
is generated and jobs are created from our mutual trade and 
investments.
    The financial crisis has exposed serious structural 
shortcomings in the mechanisms governing the euro project and 
tested European unity. I find it relevant to note that while it 
has not been beautiful to look at, European leaders do appear 
to have the resources, the capacity and the political will to 
deal with the challenges they face.
    Just yesterday European leaders reached an agreement with 
the banks to take a 50-percent loss on the value of their Greek 
debt and expanding their capital reserves. There is also an 
agreement to expand the European Financial Stability Facility 
to approximately $1.4 trillion. And I hope that these measures 
will allow Europe to move forward.
    I think it is important for us to acknowledge that there 
are different reasons for the Eurozone problems. I suspect that 
we are committing an analytical error by discussing one 
Eurozone crisis as opposed to a Greek fiscal crisis, an Irish 
banking crisis and a Portuguese competitiveness crisis. Are 
they even really related? Are we throwing ourselves off track 
by cobbling these issues together and looking in vain for 
single causes, symptoms and solutions? I hope that our panel 
can give us a detailed perspective on that.
    Some of the commentary that I have read recently seems more 
like Schadenfreude, the German expression, which I did not 
pronounce correctly, but taking delight in others' bad fortune, 
than actual analysis. We can probably agree that the euro came 
into existence prematurely and without the requisite 
institutional oversight.
    But it seems to me that we may have lost sight of the 
advantages of the euro entirely during the last couple of 
years. I would point to price transparency and stability; 
elimination of exchange-rate fluctuations; fees and transition 
costs; increased cross-border trade; market expansion; and 
lower interest rates. And I ask our panelists to evaluate 
whether these benefits no longer outweigh the disadvantages 
that are more obvious today than they were in the past.
    Estonia just joined earlier this year, and as far as I am 
aware, others are still lining up to qualify. What should we 
make of this fact? Is there a scenario under which the euro 
emerges from the current situation in a stronger, leaner and 
meaner form? I believe that it is important to know the details 
about how problems arose in the Eurozone in order for us to 
avoid them in the future.
    But ultimately, I think the biggest question is how do we 
find opportunities to ensure growth and job creation together 
with the Europeans, for it is important for both sides of the 
Atlantic to create jobs and to lift ourselves out of this 
economic situation that we are in?
    And I thank you, Mr. Chairman. I yield back.
    And I apologize because, Mr. Chairman, I know this hearing 
is important, but there is an airplane waiting for me, and 
there is a meeting waiting for me in New York.
    Mr. Burton. And your wife is waiting for you.
    Mr. Meeks. And my wife is waiting for me. I got 670,000 who 
vote for me, and they need me there.
    Mr. Burton. That is more information than I need, but I am 
glad you are here. We will give you all the questions and 
answers, and the other members.
    Mr. Meeks. Great. Thank you, sir. And thank you for being 
here.
    Mr. Burton. I want you to know that, since you are only 
looking at me----
    Mr. Meeks. I am just nervous leaving you here by yourself, 
though. You know, generally, I have to hold your hand and kick 
you under the table.
    Mr. Burton. Get out of here.
    Let me just say to you that this is a very important 
hearing, even though you just have me to look at.
    Many of my colleagues had to get back to their districts; 
that is why they left. But I can assure you that all of the 
information you are going to give us today will be utilized and 
that everybody on the committee will have it, as well as 
others, because this is a very, very important issue right now. 
I know the stock market and everybody is Kumbaya today, 
everything is great, but I hope you will give us the real 
picture so the American people know where we stand.
    Jacob Kirkegaard, you have been with the Peterson Institute 
for International Economics since 2002. Your diverse current 
research focuses on long-term fiscal challenges, European 
regional economic integration, structural economic reform 
issues, among other issues, and it is good to see you again.
    I appreciate you being here.
    Desmond Lachman joined American Enterprise Institute after 
serving as managing director and chief emerging market and 
economic strategist at Salomon Smith Barney. He previously 
served as deputy director on the International Monetary Fund's 
Policy, Development and Review Department and was active in 
staff formation of IMF policies. At AEI, Mr. Lachman is focused 
on the global macro-economy, global currency issues and the 
multilateral lending agencies.
    I really appreciate you being here as well.
    And Bruce Stokes joined the German Marshall Fund as a 
senior Transatlantic fellow for economics in September 2010. He 
is a former international economics columnist for the National 
Journal, a Washington-based public policy magazine, where he is 
now a contributing editor. He is also a former senior fellow at 
the Council on Foreign Relations.
    So since I am going to be using your testimony in a lot of 
ways, I need to swear you in, so that we have it, because I am 
going to have the Treasury testify, and if there are any 
differences, we want to make sure that we have got it on the 
record.
    So could you stand and raise your right hand, please?
    [Witnesses sworn.]
    Mr. Burton. Thank you very much. Okay.
    Mr. Kirkegaard, would you like to start off?
    Mr. Kirkegaard. Most certainly.
    Mr. Burton. If we could try to keep the remarks to 5 or 6 
minutes, we would really appreciate it, so we can get into the 
dialogue and questions.

 STATEMENT OF MR. JACOB FUNK KIRKEGAARD, RESEARCH FELLOW, THE 
         PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS

    Mr. Kirkegaard. Chairman Burton, Ranking Member Meeks----
    Mr. Burton. I don't think your microphone is on.
    Mr. Kirkegaard. Chairman Burton, other members of the 
committee, it is a pleasure for me to appear before you to 
testify on the origin, current status of and responses to the 
euro area crisis.
    In my oral remarks today, I intend to summarize my 
available written testimony as well as briefly touch on the 
events of last night in Brussels. It is clear that the euro 
area has gradually, since May 2010, taken the central place in 
an increasing volatile global economy. The correct diagnosis 
for the euro area crisis is, however, not one but at least four 
deep overlapping and mutually reinforcing crises: A crisis of 
institutional design, a fiscal crisis, a crisis of 
competitiveness; and a banking crisis. None of the four crises 
can be solved in isolation. The current euro area situation is 
therefore characterized by an extreme degree of complexity.
    Essentially no single comprehensive answer to the crisis is 
currently available to European policymakers, and as a result, 
the drawn-out inconclusive crisis containment efforts witnessed 
in Europe since early 2010, in which I will include yesterday's 
deal in Brussels, will continue. Economic catastrophes may be 
avoided, but certainly all volatility will remain with us for 
the foreseeable future.
    The euro area suffers, first and foremost, from a 
fundamental institutional credibility problem. It needs a new 
rule book. Binding rules for individual member states' fiscal 
performance must be crafted enabling the euro area as a whole 
to compel even large countries, such as Italy, to comply with 
them. The currency union must moreover be equipped with a 
sizable independent fiscal capacity capable in a crisis of both 
providing emergency financial assistance to member states in 
need and act broadly and forcefully to restore market 
confidence. European leaders have so far merely begun these 
tasks, and ultimately any credible solution will require a 
revision of the European treaty, a process which in itself will 
take several more years.
    Secondly, the euro area suffers from a fiscal crisis 
centered in Greece, a country which will need to restructure 
its government debt. However, as concerns over fiscal 
sustainability in the euro area stretches also to Italy, a 
country which is too big to bail out, the principal challenge 
in the euro area is how to avoid the issue of contagion and how 
to ring-fence an inevitable Greek debt restructuring so as to 
avoid a generalized undermining of the risk-free status of euro 
area government debt. To achieve this goal, substantial further 
financial support will in the years ahead have to be made 
available to Greece, Ireland and Portugal, and it is clear that 
such resources should overwhelmingly come from the euro area 
itself with a component provided by the IMF. However, 
ultimately euro area fiscal stability will only be achieved 
through the longer-term domestic consolidation and reform 
effort, notably in Italy.
    Thirdly, large parts of the euro area's southern periphery 
suffers from an acute crisis of competitiveness, which these 
countries, without the ability to devalue national currencies, 
have no short-term way to overcome. Instead, the euro area 
periphery is compelled to gradually restore their 
competitiveness through deep supply-side structural reforms of 
labor and product markets. Previous experiences from other 
countries suggest that this type of reform will only have a 
positive economic effect in the long run, while indeed 
adversely affecting growth in the short term.
    Lastly, the euro area suffers from an oversized and 
undercapitalized banking system which owns a large amount of 
national government debt from the euro area. There is, 
consequently, across the euro area a large degree of 
interdependence between the financial solidity of large 
domestic banking systems and the national government--and 
national government solvency. Euro area leaders have recently 
raised capital requirements for euro area banks last night 
again to 9 percent core tier equity, but recalling the 
precarious fiscal situation of several governments themselves, 
they will be unable to bring the longer-term recapitalization 
process of the euro area banking system to an expeditious 
conclusion. Instability will consequently continue to haunt the 
euro area banking system in the times ahead.
    Now, turning now to the Transatlantic relationship and the 
effects on the U.S. from this farfetched crisis, there is no 
doubt that Europe, as the largest destination of U.S. exports 
and foreign direct investments, as well as extensive cross 
ownership of loss financial institution, the United States will 
suffer a significant negative adverse shock from a further 
unexpected rapid deterioration in the euro area crisis.
    It is consequently in the vital national interest of the 
United States that Europe fixes its problem. However, the 
possible direct action by policymakers in the United States had 
been limited by the fact that this is, despite increasing 
global spill-over potential, still at heart a domestic economic 
crisis inside another sovereign jurisdiction. The ability of 
U.S. Government--of the U.S. Government to bilaterally affect 
the outcome of the euro area crisis is consequently and indeed 
appropriately limited.
    At the same time, in my opinion, the U.S. Government 
representatives have since the beginning of the euro crisis 
exercised important indirect pressure through multilateral 
channels and especially the IMF to expedite the European crisis 
resolution process and push it in generally beneficial 
directions.
    However, it is not for the United States to bilaterally 
provide any financial support to the euro area. This is a task 
predominantly for Europe itself as well as the appropriate 
multilateral organization, notably the IMF. Indeed, the euro 
area crisis has underlined how it is in America's evident 
national interest to help maintain the prominence of the IMF as 
the key global financial crisis manager. As a declining 
relative share of the global economy, it is evidently in the 
United States' direct interest to sustain the global dominant 
role of the IMF, thereby shielding it from potential threats 
from new institutional initiatives originating outside the 
traditional G-7 countries.
    Upholding the dominant position of the IMF, in whose 
establishment, design leadership, and current modus operandi 
the United States has historically played a far larger role 
than its current and especially future global economic weight 
will dictate, is a critically important issue. It is 
consequently in the direct interest of the United States to 
continue to fully support the IMF and participate fully in all 
internationally agreed capital commitments to the IMF and 
provide the organizations with the biggest possible toolkit 
with which to combat future global economic crisis in general, 
including currently in the euro area.
    However, the euro area crisis is first and foremost a 
European crisis and should and will ultimately be solved 
predominantly through European efforts and resources.
    I thank you for this opportunity to address the committee 
today and look forward to answering any questions you might 
have.
    [The prepared statement of Kirkegaard follows:]
    
    
    
                              ----------                              

    Mr. Burton. Thank you very much.
    Mr. Lachman.

STATEMENT OF DESMOND LACHMAN, PH.D., RESIDENT FELLOW, AMERICAN 
                      ENTERPRISE INSTITUTE

    Mr. Lachman. Thank you, Mr. Chairman, for giving me the 
honor to testify before this subcommittee.
    In my remarks, what I would like to do is to emphasize the 
seriousness of this Eurozone crisis and to provide reasons why 
I think we are going to see an intensification of the crisis in 
the months ahead, despite the summit last night.
    What I would also like to do is I would also like to 
emphasize the importance of this crisis for the United States 
economy, both through our export side and through our bank 
exposure.
    I agree that the crisis is a complex crisis, but I would 
say that the main origin of the crisis is that for many years, 
the countries did not play by the rules of a currency union. 
Whereas the Maastricht criteria required that these countries 
run budget deficits of 3 percent of GDP, countries, Greece, 
Portugal, Ireland and Spain, routinely ran deficits either well 
in excess of 10 percent of GDP or very close to 10 percent of 
GDP. As a result, they built up huge debt positions well over 
100 percent of GDP; they lost competitiveness; and they had 
very large balance of payment deficits.
    The essence of the peripheral countries' problem right now 
is, how do you correct those kind of imbalances when you don't 
have a currency to devalue? IMF EU-imposed fiscal austerity in 
these circumstances is driving these economies into very deep 
recessions. That in turn is making them lose their tax base, 
make them lose the political willingness to stay the course, 
and it is an exercise in futility to impose further fiscal 
austerity on them of the type that we are getting right now.
    I think that what is also important to understand in the 
crisis is that while we are talking about relatively small 
countries at the European periphery, these countries are 
enormously indebted to the banks in the core countries. If we 
look at Portugal, Ireland, Greece and Spain, we are talking 
about $2 trillion worth of sovereign debt, and a lot of that is 
held by the banks.
    What we have seen in recent months is not an easing of this 
crisis but an intensification of the crisis. Greece's economy 
is on the cusp of a major default. Its economy is in free fall. 
They are not meeting the IMF targets. There is really real 
political tension on the streets. The Papandreou government 
doesn't look like it has got a long life ahead of it.
    This has spread to Ireland and Portugal, but what is really 
of concern is the difficulty of Spain and Italy to borrow in 
capital markets without the support of the ECB. If Spain and 
Italy were to fail, that would be the end of the European 
experiment.
    The European banking system is already showing real signs 
of strain that are reminiscent of our banking crisis in 2008-
2009. Banks are not lending. Banks are parking money with the 
ECB. They don't trust one another's balance sheet. We are 
already at the start of what could be a credit crunch in 
Europe.
    The final point about the intensification of the crisis is 
we are seeing that the key economies of Germany and France are 
losing steam. They look like they are already on the close edge 
of a recession. And if we do get a banking credit crunch, that 
is almost certain to push them into recession. And without 
growth in Europe, there is no way that the countries on the 
periphery are going to resolve their problem.
    A positive sign in Europe is that at last, after many 
months of denial, the Europeans are recognizing that they have 
got a major problem. What they tried to do last night is move 
the crisis in the right direction. They tried to get resolution 
on the Greek situation. They tried to begin recapitalizing the 
banks. And they tried to put up a firewall against Spain and 
Italy.
    I am afraid that I have got doubts about the efficacy of 
this program, and I think that this might be another episode of 
too little too late that has characterized the Europeanefforts 
to date. It is not clear that a haircut of Greece of 50 percent 
puts Greece on a sustainable path when the Europeans themselves 
recognize that Greece's debt after all of this is still going 
to be at 120 percent of GDP.
    It is also not clear that the Europeans can come up with 
$1.4 trillion of unconditional money to provide a credible 
firewall to Spain and Italy. That money is going to be subject 
to Italy and Spain agreeing to conditions either imposed by, 
effectively, the Germans through their Bundestag or through the 
IMF.
    Funny, I would say, that on the issue of the bank 
recapitalization, the way in which it is being gone about is 
this is likely to provoke a deepening in the credit crunch in 
Europe because the banks, far from raising capital at depressed 
equity prices, what they are going to do is they are going to 
engage in restricting their lending and selling off assets, 
which is going to be not good for the European economy.
    My final point is that we in the United States should not 
take any comfort out of what is going on in Europe from purely 
self-interest reasons. You have mentioned that the United 
States has got very strong trade relations with Europe. We have 
got very strong investments in Europe. I would say that that is 
certainly true. But what is of deep concern is the 
interconnection between the United States financial system and 
that in Europe.
    I would just point out that money market funds in the 
United States were reported by Fitch rating agency to have as 
much as 45 percent of their $2.7 trillion of assets lent out to 
European banks. That is an amount that is way in excess of $1 
trillion. The U.S. banks themselves have got loan exposure to 
France and Germany of $1 trillion. And we don't know the extent 
of credit default swaps and other derivatives that our banks 
have written both on the periphery and on the European banking 
system, so we really do have to hope that the European 
situation resolves itself.
    The U.S. is helping the Europeans, both through the Federal 
Reserve, providing liquidity through their swap operations and 
through the IMF.
    I would just close by saying that I am not sure that there 
is a whole lot more that the United States can do or that the 
United States should do. The problems in Europe, in my view, 
are ones not of liquidity but are ones of solvency that require 
debt write downs and don't require more money to be thrown at 
it. I don't see why United States taxpayers should be putting 
up more money risk on that side.
    And I would just note that in 2008-2009, when the United 
States had a banking and credit market crisis, the Europeans 
did not come and provide us with financing. I think I would see 
it exactly the same way; this is a European problem that the 
Europeans need to address. And we have got to hope that they 
address it correctly because if they don't, we are in the same 
boat as they are.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Lachman follows:]
    
    
    
                              ----------                              

    Mr. Burton. Thank you very much.
    Mr. Stokes.

  STATEMENT OF MR. BRUCE STOKES, SENIOR TRANSATLANTIC FELLOW, 
           GERMAN MARSHALL FUND OF THE UNITED STATES

    Mr. Stokes. Chairman Burton and Ranking Member Meeks and 
distinguished members of the committee, it is a distinct honor 
and a privilege to appear before you today. My remarks today, 
of course, represent my own opinions and not the views of the 
German Marshall Fund of the United States.
    I would like to focus my remarks, if I could, not on how we 
got into this mess and not even on what the U.S. could do 
directly to help Europe with its problems, but how we can both 
work together to both help grow the Transatlantic economy out 
of the dilemma we now face in a way that is of mutual self-
interest to both Europe and the United States.
    I think it is particularly timely that you have called this 
session today, Mr. Chairman, after the European summit about 
the euro crisis. It is far too early, I think we all agree, to 
have a definitive decision about what has been decided last 
night and whether Europe can stem its bleeding and start to 
heal its own wounds.
    But experience has taught us that at every juncture of this 
unfolding saga, the European actions have been a day late and a 
euro short, so I think we have every reason to be skeptical. 
And we can only hope for the best.
    As you mentioned, Mr. Chairman, America has a huge stake in 
Europe finally resolving its crisis. I don't need to belabor 
you with the numbers. But clearly, we have intertwined 
economies. And as Ben Franklin once said, we may all hang 
together, or we are going to hang separately here. So we have 
to work together on this crisis, because a European lost decade 
would do profound damage to the U.S. economy.
    To date, much of the discussion in Washington about the 
euro crisis has been about how to defend ourselves against 
contagion from Europe's sovereign debt problems, but to turn 
the old American football maxim on its head, in this case, I 
suggest you use it: The best defense would be a good offense.
    The great recession has demonstrated once again that the 
economic fates of Europe and America are inextricably linked, 
stubbornly high unemployment on both sides of the Atlantic and 
flagging consumer and investor confidence has shaken the 
Transatlantic marketplace more than any other event since the 
Great Depression. The need for closer economic cooperation to 
overcome these problems, I submit to you, has never been 
greater.
    Americans and Europeans are both telling their elected 
leaders that they need jobs, and they need growth. Our mutual 
debt overhang and the near exhaustion of monetary policy means 
both Washington and Brussels must look elsewhere to address 
their citizens' needs. The most promising and immediate way to 
do this is by launching a Transatlantic jobs and growth 
initiative, anchored in an effort to remove all taxes on and 
barriers to Transatlantic trade and investment. Never has such 
an initiative been more timely, nor more necessary.
    The benefits of such an effort would be significant. A 
study last year by the European Center for International 
Political Economy in Brussels estimated that the elimination of 
all EU tariffs on U.S. goods would boost American exports to 
Europe by $53 billion. In 2009, a European Commission study 
found that eliminating nontariff Transatlantic trade barriers 
would add more than $50 billion to the U.S. economy.
    These estimates are a reminder that Transatlantic barriers 
to trade and investment may be small compared to the barriers 
we face in other parts of the world, such as China, but their 
removal will pay significant dividends. To put these 
prospective benefits in context, the payoff from eliminating 
Transatlantic trade barriers exceeds the likely economic 
benefit to the United States from completion of the Doha round. 
It also exceeds the potential economic benefit to the United 
States of TPP, the Trans-Pacific Partnership, which we are now 
negotiating.
    How can we possibly leave these benefits sitting on the 
table while we pursue less substantial, more elusive payoffs 
elsewhere? Interest in a Transatlantic jobs and growth 
initiative is growing. The U.S. Chamber of Commerce has called 
for the elimination of all barriers to goods traded between 
Europe and the United States as a first step toward a full 
fledged Transatlantic free trade agreement. The U.S. Coalition 
of Services Industries has suggested pursuit of a Transatlantic 
free trade area in services. The Transatlantic Business 
Dialogue has long advocated the establishment of a barrier free 
Transatlantic market. The Transatlantic Policy Network, made up 
of Members of Congress, the European Parliament and 
Transatlantic business leaders, has recently called for a 
growth and jobs initiative that would lead to the creation of a 
Transatlantic market by 2020.
    And late in September your counterparts in the European 
Parliament called for a comprehensive Transatlantic growth and 
jobs initiative. I might add, the German Marshall Fund is also 
helping to facilitate a task force led by the Swedish trade 
minister and your former colleague, Representative Jim Kolbe of 
Arizona. Early next year, it will add its own recommendations 
to these calls for creating jobs and growth through greater 
Transatlantic trade and investment.
    So how might we proceed? At the U.S.-EU Submit November 
28th, President Obama and his European counterparts should 
instruct their teams to come up with a Transatlantic jobs and 
growth initiative. This initiative should be ready to be signed 
in mid-May 2012 at the G-8 submit in Chicago. The initiative 
should have multiple pillars. These could include but would not 
necessarily be limited to elimination of all tariffs, free 
trade in services and an investment agreement. Most important, 
these efforts should run in parallel but not be dependent upon 
each other. We can eliminate tariffs rapidly so we should do 
so. If it takes longer to hammer out an agreement on services, 
that should not hold us back from harvesting the benefits of 
eliminating taxes on goods.
    Mr. Chairman, the current economic crisis presents a unique 
opportunity for political leadership. Americans and Europeans, 
both as consumers and investors, want jobs. They want growth. 
And I submit to you, above all, they want a reason to hope. 
What they lack is a sense of direction and purpose. A 
Transatlantic jobs and growth initiative is a way to turn the 
euro crisis into an economic opportunity for all Americans.
    Thank you and I look forward to your questions and 
comments.
    [The prepared statement of Mr. Stokes follows:]
    
    
    
                              ----------                              

    Mr. Burton. Do you have a proposal? I would like to have 
that to be able to disseminate that to my colleagues.
    Mr. Stokes. I would be happy to do that.
    Mr. Burton. Because that might be food for thought.
    When we draft some legislation, that might be helpful.
    Mr. Stokes. Terrific.
    Mr. Burton. Obviously, it is not going to happen right 
away; it is going to take some time.
    The first thing I wanted to ask you about is, and it is 
very interesting, after listening to you, how the stock markets 
jumped up 300 points or so today because of the announcement 
yesterday. Talk about building hopes on dreams. I mean I think 
it is great, but from what you all said, it is pretty obvious 
that there is a long way for us to go or for the world to go.
    According to the information that we got from the CRS, 
Congressional Research Service, we have about $2.08 trillion in 
direct exposure and potential exposure to Europe from the 
countries of Portugal, Ireland, Italy, Greece, Spain, Germany 
and France. And I was interviewed on television a while ago, 
and they said, well, why are you including Germany and France, 
because they don't have any problem? But Germany and France, 
according to CRS, have a great deal of exposure to these other 
countries, Portugal, Ireland, Italy, Greece and Spain. And as a 
result, if they go belly up, then it is going to have an impact 
on them as well.
    So I guess the first question I would like to ask is, what 
do we do? I just got back from Greece, and you just said, Mr. 
Stokes, that we ought to have this Transatlantic initiative and 
that there ought to be the ability to create jobs so that there 
will be more purchasing. I don't know how that is going to 
work.
    I had people I was with over there from the government that 
were having their salaries cut by 40 percent, their retirement 
cut by 40 percent, and that is just the first tranche. I mean, 
according to what happened yesterday, there are going to be 
additional cuts in economies in Greece and these other 
countries, and I don't know how they are going to be able to 
expand their economy when these cuts take place. I mean, how 
can a person or a country that has a 40-percent cut in the 
incomes of people or in their retirement, how can they afford 
to buy products or even produce products and expend them and 
sell them around the rest of the world? The solution is kind of 
a Gordian Knot.
    And what we wanted to find out from you today is, first of 
all, what is our exposure? And second, what can we do, without 
exposing ourselves further, to stimulate a solution to the 
problem? And I will ask any of you to answer that question. It 
is a tough one. Go ahead.
    Mr. Lachman. First, let me take your question on exposure. 
That is the right way of looking at it, is if the United States 
has loaned money to French and German banks that are themselves 
exposed to Greece, Portugal and Ireland, we are exposed to 
Greece, Portugal and Ireland. So our exposure to the German and 
French banking system is of relevance, even though we don't--
even though we haven't made loans to Greece and Portugal and 
Ireland. By lending to the banks in France and Germany, we have 
got that exposure.
    So the crisis in the periphery can lead to a major European 
banking crisis. Officials at the European Central Bank worry 
about if Greece defaults, then we are going to get a whole wave 
of defaults and the European banking system is going to have 
its Lehman moments, and that would really impact us. I think on 
your second question, that goes to the heart of the matter in 
terms of Greece.
    We have got to realize that over the past 2 years, Greece's 
GDP has already fallen by 12 percent. Their unemployment is 
already at 16 percent. The main driver in that process has been 
a savage approach to the budget, massive cuts all around, 
raising revenues to the tune of something like 5 full 
percentage points of GDP in a single year at a time that the 
country is already in recession, that is driving it further 
into recession. What Greece has now got to look forward to 
under the IMF EU program is more fiscal austerity in even worse 
circumstances. So it shouldn't be any great surprise if the 
Greek economy collapses any further in 2012.
    The way out of the solution from Greece's point of view is 
problematic from the rest of Europe's point of view, is that 
Greece has to write down its debt in a major way. A start was 
made last night toward that. But that is not nearly sufficient 
if Greece is, after all of these cuts in this restructuring, 
Greece's debt is still going to be 120 percent of GDP. That is 
far too high for--after a restructuring. But Greece is probably 
going to have to leave the euro at some stage, that it has a 
very much depreciated exchange rate; that would boost both its 
export sector and its tourist sector, would allow Greece to 
become a more viable economy. I am not saying that that is an 
easy path for Greece to follow, but what I am saying is that 
for Greece not to follow that path is a sure recipe for a deep 
depression, not for 1 year, not for 2 years, but probably for 
the whole decade.
    Mr. Burton. Go ahead.
    Mr. Stokes. Just a couple of points, Mr. Chairman.
    One, I think to echo Desmond's point that he made in his 
testimony, it is not clear that we understand our total 
exposure. If you talk to the Fed or you talk to the IMF, they 
aren't sure who holds a lot of this insurance that banks have 
taken out on their debt.
    Now, it may well be they know and they just aren't about to 
share it because it would move markets. But it does seem to me 
that certainly in closed session, that is something that 
Congress should press them on, because at least people like 
yourself and the committee need to know what our real exposure 
is, and if they don't know, to find out what needs to be done 
to find out so that we don't have an AIG experience.
    Mr. Burton. Pardon me for interrupting, but we just met 
with some of the officials from the Treasury Department, and we 
were not able to at that particular moment get any additional 
information other than what we already had. And they kind of 
downplayed the situation, saying that over the next several 
months, when Europe and the EU work out these kinks and come up 
with a final plan, that the solution or the situation could get 
a whole lot better.
    They didn't allay a lot of my fears, and that is why I 
wanted to have you gentlemen here today, so we could get the 
independent view from outside our Government.
    Mr. Stokes. Two other points. One to your point about, why 
would we assume that there could be demand in places like 
Greece in the immediate future. And I think that is absolutely 
right; there is not going to be. I was trying to lay out a 
strategy, it seems to me, if we are trying to somehow at some 
point in the future help restore growth in Europe. But I think 
in the immediate term, we have to assume that Europe is in for 
a prolonged period of stagnation, if not recession.
    And that leads me to my third point, which seems to me a 
valid point for this committee to be focusing on, is what are 
the foreign policy implications to the United States of a 
Europe that is stagnating or actually having a lost decade in 
terms of our ability to work with Europe on a range of issues 
from Russia to other parts of its periphery, to the global 
public goods issues of defense and foreign aid and things of 
that nature? How do the Chinese take advantage of this? I think 
all of those are legitimate concerns that we all need to be 
more worried about.
    Mr. Burton. Well, what I would really appreciate, and you 
gentlemen are the experts, and you have the expertise and the 
background to come up with potential solutions, and those of us 
in the Congress are neophytes when you start talking about 
world economics, we just obviously don't know the answers. And 
when you talk to the people in the government, as you said, it 
is kind of a veiled answer with a lot of hyperbole without any 
real juice. So what I would really appreciate, and I really 
mean this, I would like to have you and your think tanks to 
come up with, as well as the Heritage Foundation, to come up 
with some potential solutions, even if it is not of an 
immediate nature, something that might take 5, 10 years. 
Because from what I see in my small amount of wisdom, this 
thing is not going to go away any time soon, and it is going to 
have an impact on us.
    Now, the other question I wanted to ask is, the President 
has been calling Sarkozy and the German leader every day or two 
talking to them about this. And Sarkozy said that he is 
planning to go to China to talk to them about these bonds and 
the potential purchasing of these bonds. You are shaking your 
head there, so I would like to hear your response after I ask 
the question. And they are also talking about Japan purchasing 
some of these bonds.
    What puzzles me is if financial institutions and 
individuals are taking a 50-percent haircut on Greece and the 
problem is not served, you still have 120 percent of GDP, what 
is the incentive for anybody to buy the bonds, knowing the 
fiscal problems that exist, not only in Greece but these other 
countries? And if these countries do buy the bonds, what is the 
incentive? Is it going to be a high rate of interest, which is 
going to be a very difficult thing to deal with? And is the 
United States in some way going to be involved in purchasing 
some more of this problem? And that is really concerning me, 
because as I looked at these figures from CRS, and I know I am 
covering a lot of ground, so please bear with me, because this 
is not an easy issue, and you see that we have got a total by, 
in CRs' opinion, of exposure of over $2 trillion, how in the 
world could we involve ourselves by buying more of that debt? 
And can the Fed and the Treasury Department circumvent Congress 
as it has in the past with the first two tranches to buy these 
bonds? Is there a way that they can do that and circumvent 
Congress? I know I am covering a lot of ground here.
    Mr. Kirkegaard. Well, starting with your first question 
regarding the Chinese and potential Asian involvement in these 
type of bonds, I will say that I think these type of headlines 
should basically be discarded in my opinion.
    Mr. Burton. Well, then where is the money going to come 
from, because they are talking about taking this up to $1 
trillion?
    Mr. Kirkegaard. Well, I would say that every talk coming 
out of Europe in the last day or so, since last night, about 
turning the EFSF into a bazooka, whether you do it with 
leverage or you do it with Chinese or other bricks or oil 
investments or whatever you choose to do, is a side show. It is 
not essentially in my opinion going to be credible. Because the 
money, in my opinion, is not going to be there. Because China 
has a long history of essentially meeting with various European 
leaders and promising maybe a lot--there are a lot of headlines 
in the press--but they basically never commit. The only major 
assets that China buys, euro-denominated assets that China 
buys, are essentially safe German Government bonds as well as a 
relatively small amount of these EFSF bonds. The idea that 
China is going to pour hundreds of billions of dollars into 
this new investment vehicle I regard, frankly, as a fantasy.
    Mr. Burton. How about Japan?
    Mr. Kirkegaard. Again, I think the Japanese might be 
willing to do it. But again, it is not to the tune that is 
required. If the idea here that we want to turn this into a 
bazooka, something that can intimidate and have the respect of 
markets, that is where the number of the 1.4 trillion euros 
comes from. It is not--the money isn't going to be there. And I 
think the biggest illusion, and this is essentially where I 
come back to the side show that I talked about, is that the 
Europeans are trying to basically create the illusion that the 
European Central Bank is going to hand over to this new 
leveraged EFSF, this new bazooka, if you like, these new 
entities, such that the European Central Bank no longer has to 
be directly involved. But the reality is very different. The 
reality is that the European Central Bank is going to remain 
very directly involved as the ultimate financial backstop for 
the euro area as a whole, and essentially, all these both of 
these two new options, the leveraged bond insurance scheme that 
they have talked about, as well as this new special investment 
vehicle that is open for interested private and public 
investors, as I said, I don't think we should expect very much 
of that. But it doesn't actually matter very much because the 
ECB is going to remain involved. The one thing that we were 
sure about last night was that there will be no handover.
    Mr. Burton. How can the European Central Bank come up with 
the funds that are necessary? I mean, I am----
    Mr. Kirkegaard. Well, the European Central Bank is a 
central bank. They can create money. That is the ultimate----
    Mr. Burton. How do they create money? They don't have the 
ability to print money like we do in our Treasury, do they?
    Mr. Kirkegaard. Yes, they do. They call it a security 
markets program in which they can basically----
    Mr. Burton. So they can inflate the money supply?
    Mr. Kirkegaard. If they wanted to.
    Mr. Burton. Okay. I am sorry, go ahead.
    Mr. Lachman. Well, I would agree with Mr. Kirkegaard that 
the Europeans don't have a bazooka in place, and that is cause 
for great concern about Italy and Spain over the longer run, 
whether Italy and Spain aren't going to be tested by the 
markets in the way in which they were in July, which would 
really be a big headache for Europe. But the issue on the ECB 
is while theoretically the ECB could behave like the Federal 
Reserve and print money and go out and buy bonds and engage in 
quantive easing, the major shareholder of the ECB, namely 
Germany, thinks that that is the road toward deflation, 
debasing the currency, all sorts of problems, that we have 
already had two governors of the ECB of German origin, Axel 
Weber and Juergen Stark, leave the ECB precisely for those kind 
of reasons. The president of the Bundesbank doesn't think it is 
a good idea. The President of Germany thinks that the ECB is on 
the wrong track. So the notion that the ECB is going to go up 
there and print the money, I just don't see that the German are 
going to allow it. And that was part of the deal yesterday with 
Mrs. Merkel that the Bundestag indicated that they were dead 
set against converting the EFSF into a bank that would then be 
able to borrow from the ECB. So there are serious political 
constraints on the ECB from the German----
    Mr. Burton. I will go back to you, but they have had huge 
inflation problems in past history in Germany.
    Mr. Lachman. Absolutely.
    Mr. Burton. And assuming that the European Central Bank 
does inflate the currency supply, it would seem to me that the 
big kahunas over there, i.e. Germany, would say, ``Hey, no.''
    Go ahead.
    Mr. Kirkegaard. Maybe I should just clarify. When I say 
that the ECB is going to be the final backstop, I am not saying 
that--I am certainly not suggesting that I believe the European 
Central Bank is going to go out and do what we understand as 
quantitative easing here in the United States.
    What I suggest is that the ECB will do what is necessary to 
calm a financial panic, which means that they will effectively 
put a floor under the--or they will cap what, for instance, 
Italian yields can go up to. Currently Italian yields are 
somewhere between 5.5 and 6. When they reached 6.2 or 6.3 in 
early August, the ECB intervened, bringing them back down 
again.
    Mr. Burton. How long can they do that?
    Mr. Kirkegaard. Well, they can essentially continue to do 
that for as long as they want. They would prefer not to do 
that. But what I am suggesting is that they can do that to the 
extent they won't be able to drive it back down to say a spread 
of, or a yield of say 300 or 400 basis points, so that the 
economic pressure will remain very heavily on the Italy and 
especially the Italian Government, but from the perspective of 
the ECB, this is actually leverage. This is something that the 
ECB arguably, in my opinion, believes is necessary to force the 
Italian Government under Silvio Berlusconi to do the kind of 
structural reforms that the ECB has been calling for the 
Italian Government to do for many, many years. They basically 
are effectively painting Mr. Berlusconi into a corner.
    And the other thing is that when they do these emergency 
interventions, and I think we should try to keep things in 
perspective, because they have done this already, they have 
expanded their balance sheet with about 1--or just 1.6 or maybe 
about 2 percent of euro area GDP. The Federal Reserve and the 
Bank of England have expanded their respective balance sheets, 
you know, 13 or 14 percent of GDP. So the relative magnitudes 
of ECB interventions are quite small, much, much smaller, and 
they are also sterilized. So the expansion area effect on the 
monetary supply isn't there, or essentially not there at least. 
So I don't think that there is any immediate inflationary risk 
involved with this. And the really key issue here is the ECB is 
the only institution that has that capacity, and they use this 
power strategically to put pressure on elected politicians in 
Europe to do the kinds of reforms that they believe are 
necessary for the European----
    Mr. Burton. I don't know, that just sounds like a stretch 
to me that they are going to be able to control all that. But 
then you guys are the experts, and I am not.
    Now, let me ask the big question, how do we protect 
America, and is there anything we can do to protect America? 
Because we have this potential 2 trillion, and it is probably a 
lot more than that--because of what you said awhile ago, I 
think it was you, Desmond, where you said that 45 percent of 
our money market funds are invested in Europe. My gosh, that is 
trillions and trillions of dollars. So if they go south, how do 
we protect ourselves? I mean, the financial institutions, what 
is the answer?
    Mr. Lachman. Well, I think that the answer is at least to 
try to be transparent about it to recognize what the problem 
is, to come up with solutions that would be of a prudential 
side. I think the same thing would be true of economic planning 
in general. If we really do have the risk that Europe is going 
to be into recession and that it is going to impact our 
economy, it doesn't make sense for us to be basing our budget 
projections, for instance, on very rosy scenarios that the 
Congressional Budget Office is coming up with. This really 
would underline how much more serious our long-run budget 
problems are. It would also inform how we would deal with 
foreign stimulus in the short run.
    All of these kind of issues I think really have to be 
looked at rather carefully that one really has to take into 
account that Europe accounts for a third of the global economy, 
that if Europe runs into trouble it is almost certain to impact 
us in a very hard way, and we should be basing our policy on 
that basis. I don't think that we can do much to stop this 
event in Europe occurring, that that is way beyond what we can 
do or what we should do, but we should at least base our 
policies on the likelihood that we are going to be hit by 
European shock in 2012.
    Mr. Burton. You think it is going to be in 2012.
    Mr. Lachman. I should just mention that I spent a career at 
the International Monetary Fund looking at fixed exchange rate 
systems. And I think I know when an exchange rate system is 
approaching its end game; that this is really occurring in 
Europe.
    If you look at what has occurred over the last 18 months, 
this is accelerating that what we are getting both in the 
periphery, we are getting what we call austerity fatigue that 
the people--there is so much more budget adjustment that they 
can do. Yet in the core countries, the richer countries of the 
north--and I am not just thinking about Germany. I am thinking 
about the Netherlands. I am thinking about Finland. I am 
thinking about Austria. I am thinking about Slovakia. They are 
suffering from bailout fatigue. Their taxpayers feel that they 
have been lied to by the politicians, that in May 2010, this 
was only going to be a one-shot deal. Then we get Ireland in 
December. Then we Portugal in April. Then we get another 
round--this is endless.
    The taxpayers, 70 percent of the German population is 
against bailouts. You know, that this is what is occurring, 
that as this crisis continues, what you are going to get is you 
are going to get more austerity fatigue in the periphery; you 
are going to get more bailout fatigue in the core. And that 
doesn't, in my view, make for a happy outcome.
    Mr. Stokes. If I might just amplify what Desmond said in 
terms of our own condition. It seems to me that at the end of 
the day, we will do what we need to do for the U.S. economy, 
based largely on our domestic needs. But as we move forward, I 
think the prospect of stagnation in Europe has to inform more 
of our discussion than it has in the past.
    And this is going to run counter to some of the things that 
we seem to now hold dear to our heart about trying to cut the 
budget. It may in fact mitigate against cuts in our budget 
initially, just because we may need the stimulus.
    It does, it seems to me, impact on what we do about 
promoting exports. I think we are going to have to do more to 
try to promote exports because if Europe is stagnant, the 
dollar may rebound, and that would hurt our exports.
    Mr. Burton. You think the euro is going to devalue?
    Mr. Stokes. I say that, but there is no explanation as to 
why the euro is as strong as it is now. But that may well be 
because money is flowing back into Europe from European banks 
overseas to try to fortify their positions. That won't last 
forever.
    And I think we also, to answer your question, how do we 
unwind this? We have to do it very carefully because if we pull 
our money out of Europe in a very defensive and dramatic way, 
we could really send things spiralling downward.
    Mr. Burton. I am going to ask you a pretty tough question 
here. You may not have the answer.
    I am on the Government Reform and Oversight Committee as 
well, and we had Secretary Paulson before the committee and 
Geithner. And I believe they misled us. But nevertheless, I 
think I could even prove it. But I don't think I will go into 
the details.
    But the thing is, there was a financial institution, and it 
eludes me which one it was, and Paulson allegedly talked to the 
chairman of the board and told them they had to do certain 
things to purchase another entity and if they didn't do it, 
that the CEO was going to lose his job. And I think the CEO 
ultimately did lose his job. It was later on.
    I just wonder, do you think it is possible that the 
administration through the various agencies of government, 
Treasury and so forth, could literally force financial 
institutions to buy these euro bonds to try to help void up the 
situation over there?
    Mr. Lachman. If they did, I think that that would be 
terribly misguided.
    Mr. Burton. I am sure of that.
    Mr. Lachman. Why expose them to further losses? We have got 
a sufficient exposure to Europe without our buying additional 
bonds.
    Mr. Burton. So you would not see that under any 
circumstances?
    Mr. Lachman. I would think that if they coerced--it is 
another thing if markets are operating and they decide----
    Mr. Burton. No, I am not talking about markets.
    Mr. Lachman. I think that a coercive purchase would be 
rather foolish because part of the problem is that we are 
dealing with solvency problems and that what has been going on 
for a long time is we are kicking the can forward just by 
financing. So to engage in this kind of operation, one is just 
continuing the process of kicking the can further down the 
road, only to have a bigger crisis down the end.
    Mr. Burton. Let me ask you one more time, each one of your 
think tanks, if you could--the chairman of the Ways and Means 
Committee is a friend of mine and Appropriations. I would be 
happy if you could give us some suggestions on things we can do 
to try to protect the American economy and our currency, either 
legislatively or through talking to the various agencies of 
government. If you could get that to me, I will make sure it 
gets to the proper people.
    Our committee oversees Europe and Eurasia from a number of 
standpoints, but fiscally, we are not the ones to make these 
suggestions or changes. But I will get it to them.
    Now, let me ask you one last question, why is the stock 
market up 300-plus points today, because everything you have 
told me makes it sound to me like we are still building this 
castle on a house of cards? And I just don't understand it, 
because there is no real solution. They haven't even come up 
with a plan.
    Mr. Stokes. As a friend of mine on Wall Street once said to 
me, Bruce, you have to understand these trades are made by 
over-caffeinated 24-year-olds, who basically trade on the 
headlines. They don't even read the details. And not only do 
they trade on the headlines, but they trade on how they think 
the other 24-year-olds are going to trade on the headlines. In 
other words, it is about how other people will react, not even 
whether they think the headline is right.
    So I think we won't know whether this is sustainable for 
another week or so, when people begin to actually delve into 
the details.
    Mr. Kirkegaard. I would just add to that, it certainly 
shows the European leaders were very good at playing down 
expectations in the market for the actual deliverable, so that 
when they came up with what they came up with last night, which 
I was, I will say, I was personally marginally surprised on the 
upside; clearly, the market was surprised substantially on the 
upside. So it is clever expectation management to a certain 
extent in my opinion as well.
    But I agree with what Bruce said; we won't ultimately know 
whether last night's deal was really worth anything until we 
see the fine detail or until we know what, for instance, Silvio 
Berlusconi and others are actually going to do what they said 
they were going to do.
    Mr. Burton. Well, I just met with the Treasury Department 
people before this. They didn't want to testify in an open 
session. But Berlusconi sent a 7-page letter, I guess, 
explaining how and why and what he would do to comply with the 
EU and their demands. And it remains to be seen.
    The other thing that they said, from the Treasury, was 
that--I asked well, who is going to buy these bonds? And they 
both mentioned both China and Japan. And you seem to have a 
different opinion about that. And if that is not the case, I 
still wonder where in the world they are going to get the 
money. And you keep going back to the European bank--Central 
Bank. Anyhow, go ahead.
    Mr. Lachman. I think that you could get outside money by 
the way in which they are doing it, because what they are doing 
is they are taking $250 billion euros, and they are using that 
to provide insurance that they will take the first loss. So 
what they are doing is they are offering to take the first 20 
percent of any loss on bonds purchased.
    So, for instance, if you buy an Italian bond, you know that 
if the Italian bond goes from 100 to 80, you don't lose; you 
pick up the 5-percent interest rate. So that is a reasonable 
deal in the case of Italy, where it is unlikely that Italy is 
going to devalue by more than 20 percent. So you could get 
people to buy on that basis.
    What you are doing, though, is you are putting the German 
and the French taxpayer at huge risk, that this is like a 
structured product where the German and the French have got the 
equity tranche of a CEO, which isn't a good idea for them to 
have. But if you are the Chinese, you can feel comfortable 
having the mezzanine or the AAA rated part of that structure.
    Mr. Stokes. And I think, to amplify Desmond's point, I 
mean, what Desmond was saying, in essence, the money is going 
to come from the Germans. And whether the Germans like that or 
not, and there is no political support for that, the Germans 
can afford to do this. They have to make a calculation about 
whether it is in their self-interest to do it or not. And their 
leadership has certainly not convinced their public that it is 
in their self-interest. And I think that we have to continue to 
pressure them to say look, there is money in Europe to deal 
with a lot of this problem and you haven't mobilized all of 
your own resources. And I think we need to continue to press 
them on that.
    Mr. Burton. I want to thank you very, very much and your 
testimony has been very, very enlightening. And I will make 
sure--and I would like to have your opening statements and all 
of the details of it, and I am going to make sure that our 
colleagues on the financial institutions committees get a copy 
of that and make sure they read it.
    With that, thank you very much. We will stand adjourned.
    [Whereupon, at 3:15 p.m., the subcommittee was adjourned.]
                                     

                                     

                            A P P E N D I X

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     Material Submitted for the Hearing Record




                                 
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