MBN: The Monte Bubbles Network

July 27

Secretary Paulson Statement on Foreign Investment and National Security Act

Washington, DC--Treasury Secretary Henry M. Paulson, Jr. issued the following statement on the enactment of the Foreign Investment and National Security Act and the need for congressional approval of four pending free trade agreements:

--Treasury Secretary Henry M. Paulson, Jr. issued the following statement on the enactment of the Foreign Investment and National Security Act and the need for congressional approval of four pending free trade agreements:

I commend Congress, especially the Senate Banking and the House Financial Services Committee, for their successful efforts to reach bipartisan agreement. These efforts resulted in a law that will accomplish our mutual goals of ensuring that the Committee on Foreign Investment in the U.S., CFIUS, can continue to address national security imperatives while also reaffirming that America welcomes foreign investment.

The CFIUS process applies only when a transaction may be related to national security, and that is a very small percentage of foreign investment. The vast majority are mergers, acquisitions and investments, and don't receive a CFIUS review. Last year, and historically, only 10 percent of foreign direct investments were reviewed by CFIUS, and the vast majority of those received a review which was resolved without controversy. Importantly, the new law maintains CFIUS' narrow focus on transactions that raise national security concerns.

President Bush, through his open economies statement on May 10, 2007, and the Congress, through their actions on this bill, have reaffirmed that the U.S. continues to welcome foreign investment.

Foreign investment in America creates jobs and revitalizes communities. Foreign owned companies directly provide jobs to over 5 million U.S. workers, or almost 5 percent of our domestic workforce, and they support almost the same number of jobs indirectly.

Today, the United States sends a clear signal to the rest of the world that we continue to have an open economy. We are committed to encouraging other countries to deepen their commitment to open investment policies.

An open economy includes vigorous promotion of open investment, free markets and trade. And so, open investment is an important, but not the entire, statement of our principles. It is equally important to enact laws that encourage trade. Four Free Trade Agreements - three in Latin America and a fourth with South Korea – are awaiting Congressional action.

Approval of the Peru, Colombia and Panama FTAs are critical. We need to support democratic countries in our neighborhood. These countries are working to develop greater opportunities for their citizens. Economic opportunity that arises out of free trade will help build a thriving middle class in these countries, reducing poverty and creating new markets for U.S. goods.

The Korean FTA will create new opportunities for U.S. exporters and investors with our seventh largest trading partner.

We have worked with Congressional leaders to address their concerns about labor and environment provisions. In May, the FTAs were revised to include these agreed-upon changes, and that was to clear the way for Congressional approval.

Instead, congressional action is being delayed because some are now insisting that Peru, Colombia and Panama change their domestic laws before Congress will consider these agreements. That requirement is unprecedented and unfair and raises doubts about the ability of the United States to deliver on our international commitments.

We need Congress to ratify these FTAs, and I hope we will see Congress act on all of them in September.

The U.S. has long been a world leader in working to expand trade and break down barriers to trade, and to promote investments that benefit our citizens and the citizens of other nations. These policies are vital to ensuring a strong domestic and global economy.

 

Paulson Closing Statement at the
U.S. Business Tax Competitiveness Conference

Washington, DC--I hope that this morning's discussions have been as informative for you as they have been for me.

I hope that this morning's discussions have been as informative for you as they have been for me.

The distinguished experts and leaders who joined us did not disappoint; we have heard a variety of perspectives and candid discussion. And there is a strong consensus that our business tax system is far from optimal, and is undermining the competitiveness of American workers.

The business tax system has a very tangible impact on workers' daily lives and living standards. The goal of a business tax regime should be to minimize economic distortions and allow capital to flow to its most efficient use. Capital is the necessary fuel that provides workers the greatest opportunity for productive jobs, higher incomes, and living standards. Higher living standards, efficient use of capital and maintaining competitiveness are our mutual goals. They are the answer to the question "What are we trying to achieve?"

This morning we examined the options for answering the logical next question, which is "How do we best achieve it?" We heard from professors and policy-makers who have studied how to address the issues of complexity, targeted preferences, depreciation regimes, and incentives for entrepreneurship for many years. CEOs educated us on the impact the tax system has on investment, innovation, and expansion decisions. We heard some ideas for improving the system without sacrificing revenue, which could bring greater prosperity through new jobs and increased opportunities for workers.

It is clear from our discussion that America needs to remain alert and responsive to changing global economic conditions. Other nations have seen the results of the bold tax reforms enacted by the U.S. in the 1980s and they have moved to follow our example. And with much of the world having reduced their corporate rates, we now have the second highest statutory corporate tax rate among OECD nations.

The American economy today is healthy and we have record-low unemployment. But we must look to our future competitiveness with the goal of making sure that our policies recognize and respond to changes in the global marketplace.

We can't turn back the clock on globalization, nor should we want to. A globally integrated economy leads to greater innovation by American companies and gives American consumers a wider variety of choices and lower prices on a wide range of products from food to clothes to cars. Our business tax system must be one that will help our companies and workers successfully compete in a dynamic global economy.

We heard many good ideas and relevant insights here today. Much of our discussion confirmed what we at Treasury have already identified as elements of our business tax system that are obstacles to U.S. competitiveness. We also heard insights and ideas that have prompted additional thinking. We will spend some time digesting today's discussion and will then develop specific follow-up steps in the coming months to build support for the need to improve our business tax system, and ideas for doing just that.

It is important to act comprehensively and prudently, rather than respond on an ad hoc basis to current headlines. Promoting an efficient business tax system is a high priority for me, and I look forward to working with you on this complicated and significant endeavor.

Thank you again for joining us this morning.

Paulson Opening Statement at the U.S. Business Tax Competitiveness Conference

Washington, DC-- Good morning; thank you for coming today. And, thank you to the distinguished group of business, policy, and academic leaders who have joined us. With me here on stage for our first session are:

Good morning; thank you for coming today. And, thank you to the distinguished group of business, policy, and academic leaders who have joined us. With me here on stage for our first session are:

Michael Boskin, professor of economics at Stanford University and former chairman of the President's Council of Economic Advisors;

Safra Catz, President and CFO of Oracle Corporation;

Martin Feldstein, professor of economics at Harvard University and former chairman of the President's Council of Economic Advisors;

Alan Greenspan, former Chairman of the U.S. Federal Reserve Bank;

Jim Owens, Chairman and CEO of Capterpillar, Inc.; and,

Fred Smith, Chairman, President and CEO of FedEx Corporation.

Welcome, and I look forward to our panel.

My goal is to promote the policies and conditions for economic growth that will maintain and enhance our competitiveness, and lead to greater American prosperity. Enhanced competitiveness means new and better-paying jobs and higher living standards for American workers.

We all know two facts: first, that taxes are a drag on economic growth, and second, that taxes are necessary to raise revenues to fund federal government priorities. The question we must ask ourselves, then is this: for a given level of revenue, what business tax regime best maximizes job creation and economic growth and in doing so promotes higher standards of living for Americans?

Our current business tax system is clearly not optimal. It includes ad-hoc policies and preferences that result in a narrow tax base and create distortions that divert capital from its most efficient use. These include: complex, targeted provisions; depreciation schedules without clear rationale; taxation of capital income that discourages saving and investment; and, double taxation of corporate profits that can lead to misallocation of capital.

We have made great strides in the last few years. The 2001 reduction of individual income tax rates has helped flow-through businesses flourish and create jobs. In 2003 we reduced -- although we did not eliminate -- double taxation of dividends. Now, though, it is time for a comprehensive look at our system for taxing business.

Systemic distortions impact not only corporate owners, the shareholders, but also the employees. When capital is available to purchase new machine tools, to modernize an assembly line, or purchase laptop computers for a traveling sales force, employees are more productive. Greater productivity means a company can expand, increase wages, and provide new opportunities for employee advancement.

When an inefficient business taxation system discourages marginal investments, our workers pay the price.

We will discuss the economic distortions caused by the current system during our first roundtable session.

The business tax system must also take into account the reality of an integrated global economy, marked by borderless capital. Although many American workers don't feel that they are the essential drivers of the world's most powerful economy, they are.

Global economic expansion is not a zero-sum proposition -- it is no more true that a job created in Dublin means one less job in Denver, than that a job created in Miami means one less job in Minneapolis.

Foreign investments made by U.S. corporations bring real benefits to the domestic economy. A U.S. production facility overseas creates new export platforms, producing goods for sale in the world market that wouldn't be possible otherwise. U.S. companies support this international expansion by creating entry-level, mid-range, and high-paying jobs here -- productive jobs that raise living standards.

If American companies miss opportunities to build and sell overseas, it's a sure bet in this global economy that some other company will step in when we do not. Then the productivity and wage gains will go abroad, not to Americans. In today's competitive marketplace, if American companies can't expand globally, they risk stagnating at home.

Our business tax system should therefore not discourage inward and outward investment flows that are critical to U.S. businesses' ability to maintain their leadership positions around the world. Our second roundtable will look at the international tax system, and how we can best maximize our position in the global economy.

Now, when our economy is in a position of strength, is an opportune time to discuss the business tax system and its impact on workers, investment, and the United States' ability to compete in the world marketplace.

I look forward to hearing the panel's views and will ask them to start our conversation with this question: What is the impact of the business tax system on the competitiveness of U.S. businesses and how important are taxes relative to other factors which determine our economic competitiveness?

 

Statement of David H. McCormick
Nominee for Under Secretary of the Treasury
for International Affairs to the
U.S. Senate Committee on Finance

Chairman Baucus, Ranking Member Grassley, and members of the Committee on Finance, thank you for the opportunity to appear before you today. I am honored that President Bush has nominated me to serve as Under Secretary of the Treasury for International Affairs and, if confirmed, to have the opportunity to work with Secretary Paulson, the Treasury staff and others in the administration. I'd also like to take a moment to thank my wife Amy and our four children - who are here today - for their unwavering support for my public service.

If confirmed, I also look forward to working closely with this committee, the United States Senate, and your colleagues in the House of Representatives to advance U.S. economic interests at home and abroad.

My experiences as a senior member of the President's economic team, as a public company CEO, and as a former military officer have prepared me well for the position to which I have been nominated.

In my first role in government as Under Secretary of Commerce for Export Administration, I led a 250-person organization responsible for balancing the promotion of U.S. technology exports with the imperative of protecting our national security by controlling the transfer of militarily-sensitive technologies. In this position, I coordinated with other government agencies consulted actively with members of Congress and their staffs, worked closely with the business community, and engaged senior foreign officials in reaching agreement on multilateral approaches for satisfying both of these objectives.

This experience has been crucial to my success as the President's principal White House advisor for international economic policy with responsibilities closely aligned with those of the Under Secretary of Treasury for International Affairs. In my current role, I have led the US-Japan sub-cabinet economic dialogue, directed White House involvement in policies affecting foreign investment in the United States, and coordinated U.S. policy regarding multilateral debt relief, the President's U.S. AIDS Initiative, and the Millennium Challenge Account. I have also served as the President's personal representative for major economic summits such as those of the US-EU, APEC, and the G8.

My experiences in the private sector too are relevant to the responsibilities of the Under Secretary of Treasury. As a consultant serving Global 2000 companies, I worked with senior executives to develop and execute strategies for improving the growth and performance of their businesses. As an entrepreneur and public company CEO, I helped build and lead a profitable 1,000+ person technology organization with 25 offices worldwide. During this time, I collaborated with business leaders around the globe, and I witnessed firsthand their challenges in maintaining competitiveness in times of accelerating change.

Prior to my business career, I was a veteran of the first Gulf War and I served for five years as an active Army officer. From this experience, I learned the importance of setting a clear direction for an organization, communicating clearly and often, and leading by example. I followed this service with formal training in economics and foreign policy, receiving a Ph.D. from Princeton in 1996. Since that time, I have written regularly on economic, national security, and business-related issues.

I'm confident that based on these experiences I have the capacity to take on the responsibilities of Under Secretary and execute them successfully. If confirmed, I will immediately focus on pressing issues such as addressing growing global imbalances, accelerating China's stable integration into the global economy, and ensuring that development assistance from the multilateral development banks is deployed effectively around the world. I will also focus on advancing the President's vision for opening foreign markets for U.S. goods and services and accelerating the transition of many developing countries to true market-based economies. I will emphasize the critical importance of economic growth, good governance, and the rule of law in ensuring that all parts of the global economy can become vibrant and prosperous, while at the same time maintaining vigilance to try to prevent future financial crises.

Mr. Chairman, Senator Grassley, I am grateful for this opportunity to appear before you today. I would be pleased to answer any questions you and other members of the Committee may have.

 

Treasury Releases Business Taxation and
Global Competitiveness Background
Paper

Washington, D.C.--The Treasury Department released today a background paper concerning some of the many issues to be discussed Thursday, July 26 at the Treasury Conference on Business Taxation and Global Competitiveness.

The Treasury Department released today a background paper concerning some of the many issues to be discussed Thursday, July 26 at the Treasury Conference on Business Taxation and Global Competitiveness.

The paper details:

the extent to which special provisions narrow the business tax base;

the importance of the non-corporate sector generally subject to the individual tax rather than the corporate tax;

the various ways the tax system distorts economic decisions; and

how the level of U.S. tax compares with our major trading partners (G7, OECD, and emerging market countries).

The paper also discusses the U.S. system for taxing international income and examines how that affects business decisions. A PDF copy of the paper is attached.

REPORTS

Tax Conference Background Paper

 

Twin Treasury Actions Take Aim at Hizballah’s Support Network

The U.S. Department of the Treasury today targeted Hizballah's support network by designating the Iran-based Martyrs Foundation, including its U.S. branch, and the finance firm Al-Qard al-Hassan (AQAH) under Executive Order 13224. Two individuals were also designated today for the role they play in Hizballah's support network.

"We will continue to target those who form the financial backbone of Hizballah, Hamas, PIJ and other terrorist groups that are attempting to destabilize Lebanon and target innocent civilians," said Stuart Levey, Under Secretary for Terrorism and Financial Intelligence. "We will not allow organizations that support terrorism to raise money in the United States or to evade our measures and continue to operate simply by changing their names."

The Martyrs Foundation

The Martyrs Foundation is an Iranian parastatal organization that channels financial support from Iran to several terrorist organizations in the Levant, including Hizballah, Hamas, and the Palestinian Islamic Jihad (PIJ). To this end, the Martyrs Foundation established branches in Lebanon staffed by leaders and members of these same terrorist groups. Martyrs Foundation branches in Lebanon has also provided financial support to the families of killed or imprisoned Hizballah and PIJ members, including suicide bombers in the Palestinian territories.

In addition to fundraising responsibilities, senior Martyrs Foundation officials were directly involved in Hizballah operations against Israel during the July-August 2006 conflict. In addition, a Lebanon-based leader of the Martyrs Foundation has directed and financed terrorist cells in the Gaza Strip that worked with Hizballah and PIJ.

Today's designation includes the Goodwill Charitable Organization (GCO), a fundraising office established by the Martyrs Foundation in Dearborn, Michigan. GCO is a Hizballah front organization that reports directly to the leadership of the Martyrs Foundation in Lebanon. Hizballah recruited GCO leaders and has maintained close contact with GCO representatives in the United States.

GCO has provided financial support to Hizballah directly and through the Martyrs Foundation in Lebanon. Hizballah's leaders in Lebanon have instructed Hizballah members in the United States to send their contributions to GCO and to contact the GCO for the purpose of contributing to the Martyrs Foundation. Since its founding, GCO has sent a significant amount of money to the Martyrs Foundation in Lebanon.

Al-Qard al-Hassan

Hizballah has used AQAH as a cover to manage its financial activity. AQAH is run by Husayn al-Shami, a senior Hizballah leader who has served as a member of Hizballah's Shura Council and as head of several Hizballah-controlled organizations.

Following the September 7, 2006 designation of al-Shami, along with Bayt al-Mal and Yousser Company for Finance and Investment, AQAH assumed a more prominent role in Hizballah's financial infrastructure. As of February 2007, bank accounts of Bayt al-Mal and Yousser Company were changed and re-registered in the name of senior employees of AQAH.

Further, after the majority of Bayt al-Mal's offices were destroyed during the summer 2006 conflict, Hizballah transferred a portion of its financial activity to AQAH, giving Hizballah access to the international banking system.

Individuals

Treasury's action today also targets Qasem Aliq, a Hizballah official who was previously the director for the Martyrs Foundation branch in Lebanon. In addition to overseeing Martyrs Foundation's operation, Aliq worked closely with senior Hizballah officials. Aliq currently serves as the director of Jihad al-Bina, a Lebanon-based construction company formed and operated by Hizballah and previously designated by the Treasury.

Also designated today was Ahmad al-Shami, who has worked for the Martyrs Foundation in Lebanon and has been in frequent contact with GCO. Money raised by GCO was sent to al-Shami in Lebanon to be distributed to the Martyrs Foundation. Hizballah leadership placed Ahmad al-Shami in his position at the Martyrs Foundation in Lebanon.

Today's action is being taken pursuant to Executive Order 13224, which is aimed at financially isolating terrorists and their support networks. Designations under E.O. 13224 freeze any assets the designees may have under U.S. jurisdiction and prohibit transactions by U.S. persons with the designees.

 

Steel Statement on Basel II Resolution

Treasury Under Secretary for Domestic Finance Robert K. Steel released the following statement today regarding the Basel II Accord agreement among the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Office of Thrift Supervision:

"The federal financial regulators must be commended today for their work on Basel II. Resolution on this matter is an essential component of any effort to modernize our regulatory structure and to strengthen American capital markets' competitiveness.

"This is a challenging issue, requiring a complex balance of safety, soundness and global competitiveness concerns. The regulators demonstrated a willingness to work together with the best interests of the United States in mind and I look forward to seeing the results of their cooperation."

 

United States and Other Paris Club Creditors Provide Further Debt Relief to Afghanistan

Washington, D.C.--The United States and fellow Paris Club members Russia and Germany agreed Wednesday to provide additional debt relief to Afghanistan under the terms of the enhanced Heavily Indebted Poor Countries (HIPC) initiative. This agreement allows Afghanistan to benefit from debt reduction under the HIPC initiative of 92 percent, which is worth approximately $1 billion.

The United States and fellow Paris Club members Russia and Germany agreed Wednesday to provide additional debt relief to Afghanistan under the terms of the enhanced Heavily Indebted Poor Countries (HIPC) initiative. This agreement allows Afghanistan to benefit from debt reduction under the HIPC initiative of 92 percent, which is worth approximately $1 billion.

Under the HIPC framework, the three bilateral creditors will cancel 90 percent of the non-concessional debt payments Afghanistan would owe during its current IMF program, deepening the relief the three countries agreed to provide in the Paris Club in July 2006. The United States will go beyond the HIPC framework and forgive 100 percent of all debt payments falling due.

The debt relief follows a decision by the executive boards of the World Bank and IMF – with strong U.S. support – to declare earlier this month that Afghanistan had formally qualified for the HIPC initiative. To achieve this, the Afghan government had to adhere to the terms of its IMF program as well as meet certain other requirements. All remaining debt will be forgiven by the United States, Russia and Germany once Afghanistan reaches the completion point of its HIPC program. Total debt relief for Afghanistan will equal more than $11 billion, which represents more than 99 percent of its total debt.

It is a major achievement of the Afghan government to qualify for HIPC debt relief. This debt relief is a crucial step towards normalizing Afghanistan's relations with the international financial community and in helping Afghanistan move towards economic sustainability.

The United States urges Afghanistan's other bilateral creditors to join the Paris Club members by providing 100 percent debt reduction.

 

 

July 6

 

Treasury Awards $3.6 Million to Organizations ServingEconomically Distressed Native American Communities

Crazy Horse, South Dakota – The director of the U.S. Treasury Department's Community Development Financial Institutions (CDFI) Fund, Kimberly A. Reed, visited South Dakota's Crazy Horse Memorial today to announce awards totaling $3,632,292 to 19 organizations serving Native American or Alaskan Native communities in 12 states. The awards were made through the CDFI Fund's Native American CDFI Assistance (NACA) Program.

The director of the U.S. Treasury Department's Community Development Financial Institutions (CDFI) Fund, Kimberly A. Reed, visited South Dakota's Crazy Horse Memorial today to announce awards totaling $3,632,292 to 19 organizations serving Native American or Alaskan Native communities in 12 states. The awards were made through the CDFI Fund's Native American CDFI Assistance (NACA) Program.

"Today, we are recognizing 19 Native organizations that are on the front lines to provide important financial education, create critically needed jobs and help Native families and communities build personal wealth," said CDFI Fund Director Reed. "We are very pleased to know that the over $3.6 million being awarded today will provide these community-based lenders the resources to do more of this important work in Native American and Alaskan Native communities."

Treasury held the national award announcement at the Crazy Horse Memorial to highlight the four South Dakota-based award recipients: First Nations Oweesta Corporation (Rapid City), The Lakota Fund (Kyle), Mazaska Owecaso Otipi Financial, Inc. (Pine Ridge), and the Teton Coalition, Inc. (Rapid City) – all of which are leaders serving the community development needs of their Native communities. The awardees were selected after a competitive review of 29 applications received by the CDFI Fund from organizations across the nation that requested nearly $11 million in funding under the 2007 round of the NACA Program.

Since 2002, the CDFI Fund has made 148 awards totaling $23.1 million through its various funding programs aimed at benefiting Native communities. In five short years, the number of Native CDFIs has grown from 14 to 43 – a 307 percent increase. In addition, the CDFI Fund has awarded over $7.5 million in contracts to organizations that provide capacity-building and financial services training programs that are focused on Native Communities.

Background

The CDFI Fund invests in and builds the capacity of community-based, private, for-profit and non-profit financial institutions with a primary mission of community development in economically distressed communities. These institutions – certified by the CDFI Fund as community development financial institutions, or CDFIs – are able to respond to gaps in local markets that traditional financial institutions are not adequately serving. CDFIs provide critically needed capital, credit and other financial products in addition to technical assistance to community residents and businesses, service providers, and developers working to meet community needs.

In 2004, the CDFI Fund introduced the NACA Program, which was specifically designed to encourage the creation and strengthening of CDFIs that primarily serve Native American, Alaska Native, and Native Hawaiian communities. Organizations funded serve a wide range of Native communities, and reflect a diversity of institutions in various stages of development – from organizations in the early planning stages of creating a CDFI, to tribal entities working to certify an existing lending program, to established CDFIs in need of further capacity building assistance. Two types of funding are available: financial assistance awards, available only to certified CDFIs and primarily used for financing capital; and technical assistance grants used to acquire products or services such as computer hardware and software, staff training, etc.

The CDFI Fund's vision is an America in which all people have adequate access to affordable capital, credit and financial services.

For more information about these awards, or about the CDFI Fund and its programs, please visit the Fund's website at: http://www.cdfifund.gov.

 

HP-482

Secretary Paulson Announces New Latin American and
Caribbean Initiative to Catalyze Private Finance for Infrastructure

Washington, DC-- Secretary Paulson announced a new proposal today to increase investment in infrastructure projects in Latin America and the Caribbean. The United States will partner with the International Finance Corporation (IFC), the private sector arm of the World Bank Group, to create a program to catalyze private investment in infrastructure in Latin America. This initial $17.5 million infrastructure project development program will include a $4.6 million U.S. contribution, and a $1.9 million contribution from Brazil. The IFC is prepared to seek an increase in funding over time if warranted by demand for its services.

Secretary Paulson announced a new proposal today to increase investment in infrastructure projects in Latin America and the Caribbean. The United States will partner with the International Finance Corporation (IFC), the private sector arm of the World Bank Group, to create a program to catalyze private investment in infrastructure in Latin America. This initial $17.5 million infrastructure project development program will include a $4.6 million U.S. contribution, and a $1.9 million contribution from Brazil. The IFC is prepared to seek an increase in funding over time if warranted by demand for its services.

"The United States' interest in the Americas is strong. We are committed to helping the region reduce poverty, fight corruption, build a middle class, and generate more opportunities, including for those who currently feel excluded from the region's growing prosperity," said Treasury Secretary Henry M. Paulson, Jr.

"Last month I announced an initiative to catalyze market-based bank lending to small businesses in Latin America and the Caribbean. The initiative involves a combination of new lending models, sharing part of the lending risk, and technical, regulatory assistance so that more banks can finance options for small businesses.

"The Americas face another serious constraint to economic growth – that is a lack of critical infrastructure. Latin America, for example, currently spends less than 2 percent of GDP on infrastructure annually. Underinvestment in electricity, transport, and potable water hamstring the region's entrepreneurs and citizens.

"Today I am pleased to announce a new initiative aimed at addressing this constraint. This initiative will attack the information, technical capacity, and regulatory barriers which block the flow of private finance."

Underinvestment in infrastructure has had a direct impact on the quality of life and economic performance in Latin America. 59 million people in the region lack access to potable water and 135 million have no adequate sanitation. Meanwhile, 55 percent of entrepreneurs complain that infrastructure is a serious problem. Improving the region's infrastructure could reduce inequality by as much as 20 percent, according to the World Bank.

59 million people in the region lack access to potable water and 135 million have no adequate sanitation. Meanwhile, 55 percent of entrepreneurs complain that infrastructure is a serious problem. Improving the region's infrastructure could reduce inequality by as much as 20 percent, according to the World Bank.Major investments in infrastructure are needed to boost productivity and competitiveness, connect the poor and small entrepreneurs to markets, and provide them with adequate basic services. Investment in infrastructure is a regional priority and mobilizing private financing is essential given the magnitude of investment needs and the constraints on public finance.

The objective of this program is to target three critical constraints that block the flow of private finance for infrastructure: lack of reliable, objective information identifying good projects for potential investors; lack of know-how on structuring and tendering projects; and problems with the regulatory environment – particularly as it pertains to specific transactions.

lack of reliable, objective information identifying good projects for potential investors; lack of know-how on structuring and tendering projects; and problems with the regulatory environment – particularly as it pertains to specific transactions.

The program, to be managed by the IFC, will help identify productive infrastructure projects suitable for private participation, make information about these projects publicly available, and provide technical assistance on structuring projects, tendering concessions, and improving regulatory regimes. Project proposals can be made to the program by sovereign governments, sub-sovereign governments (including municipal governments), or private sponsors. The program will provide assistance in two phases: first, identifying and analyzing projects through feasibility assessments, and, second, advising project sponsors on how to structure, market, and tender projects successfully.

Project proposals can be made to the program by sovereign governments, sub-sovereign governments (including municipal governments), or private sponsors. The program will provide assistance in two phases: first, identifying and analyzing projects through feasibility assessments, and, second, advising project sponsors on how to structure, market, and tender projects successfully.

Once a project reaches contractual closure, the investor will reimburse the program through a cost-recovery fee. The program can also assist private investors in identifying possible sources of financing in order to move projects to financial closure and implementation. A project manager will be responsible for overseeing all aspects of this process. The program is expected to be fully operable in one year. Interested parties should contact the Advisory Services Department at the International Finance Corporation, http://www.ifc.org/Advisory.

The IFC estimates that the program's impact could be as much as $800 million to $1 billion in creating new investments and $300 to $400 million in fiscal savings to local governments.

President Bush called for this program in 2005 at the Summit of the Americas.

The $4.6 million grant from the U.S. comes from FY06 and FY07 State Department Economic Support Fund appropriations.

 

July 5

Treasury Secretary Paulson to Visit Brazil, Uruguay and Chile Next Week

Treasury Secretary Henry M. Paulson, Jr. will travel to South America next week to reinforce our strong ties with Brazil, Uruguay, and Chile and to stress our stake in the economic success of Latin America. He will meet with finance ministers and heads of state in the region, as well as local business leaders to discuss ideas on how to spread opportunity, reduce poverty, and build the middle class in the region and talk about what the United States is doing to help.

Secretary Paulson will travel to Belo Horizonte on Monday, July 9, where he plans to meet with Governor Aécio Neves and venture capitalists. On Wednesday he will be in Brasilia where he will meet with Brazilian President Luiz Inácio "Lula" da Silva, Finance Minister Guido Mantega, Chief of Staff Dilma Rousseff, Central Bank President Henrique Meirelles, and Minister of Foreign Affairs Celso Amorim. He will also attend a lunch on access to finance and local capital market development.

Paulson will spend Thursday in Montevideo where he will meet with Uruguayan President Tabare Vasquez and Minister of Finance Danilo Astori. From there he will travel to Santiago to hold meetings Friday with Chilean President Michelle Bachelet, Minister of Foreign Affairs Alejandro Foxley, Minister of Finance Andres Velasco, and Central Bank Chairman Vittorio Corbo.

These visits to Brazil, Uruguay, and Chile will be his first to those countries as Treasury Secretary. Secretary Paulson traveled to Mexico in April of 2007, Guatemala and Peru in March of 2007, and Colombia in August of 2006.

 

 

Treasury Secretary Henry M. Paulson, Jr. today issued the following statement on the importance of Trade Promotion Authority to the U.S. and global economies: "America's openness has made our economy the most vibrant and dynamic in the world. To keep our economy strong and competitive, we must continue to push forward on the trade agenda. The 110th Congress has an important opportunity to demonstrate bipartisan leadership and help to strengthen our economy by reauthorizing Trade Promotion Authority. "Trade fosters the environment of innovation and research that leads to better goods and services at lower prices, which in turn helps Americans provide for their families. "Members of Congress should move quickly to reauthorize Trade Promotion Authority. Americans benefit from open markets here at home and open markets abroad for our exports. Together with my colleagues in the Administration, we will fight to keep markets open to the benefit of American manufacturers, farmers, and service providers."

 

Treasury Secretary Henry M. Paulson, Jr. today issued the following statement on the departure announcement of International Monetary Fund Managing Director Rodrigo de Rato: "Rodrigo de Rato brought vision and dedication to his tenure as Managing Director of the International Monetary Fund. He launched the Medium Term Strategy, a plan that provides a foundation for important reforms to ensure the institution reflects today's global economy. Rodrigo helped to strengthen the Fund by creating this road map for reform, which will enable the Fund to remain a strong, relevant institution and resource for the global financial system. His leadership was also instrumental in the Fund's revision of its exchange rate surveillance framework, which is a highly critical piece of the road map. I wish him continued success in his future endeavors."

 

Treasury Secretary Henry M. Paulson, Jr. issued the following statement today on the World Bank's Executive Board approval of Robert Zoellick to be World Bank President: "I welcome the board's action approving Bob Zoellick to lead the World Bank. Bob brings a wealth of experience, a passion for development and a proven track record of working with colleagues around the world to get results. "He has the trust, respect and support of governments in all regions of the world and I have no doubt his leadership will ensure continued support of World Bank members. He will be an aggressive advocate for overcoming poverty, investing in growth, and creating opportunity and hope."

 

Treasury International Capital (TIC) data for April are released today and posted on the U.S. Treasury web site (www.treas.gov/tic). The next release, which will report on data for May, is scheduled for July 17, 2007. Net foreign purchases of long-term securities were $84.1 billion. * Net foreign purchases of long-term U.S. securities were $97.4 billion. Of this, net purchases by foreign official institutions were $25.3 billion, and net purchases by private foreign investors were $72.1 billion. * U.S. residents purchased a net $13.3 billion of long-term foreign securities. Net foreign acquisition of long-term securities, taking into account adjustments, is estimated to have been $76.5 billion. Foreign holdings of dollar-denominated short-term U.S. securities, including Treasury bills, and other custody liabilities decreased $25.9 billion. Foreign holdings of Treasury bills decreased $28.6 billion. Banks' own net dollar-denominated liabilities to foreign residents increased $61.2 billion. Monthly net TIC flows were $111.8 billion. Of this, net foreign private flows were $93.6 billion, and net foreign official flows were $18.2 billion.

 

 June 23

REMARKS BY ANNA ESCOBEDO CABRAL U.S. TREASURER U.S. DEPARTMENT OF THE TREASURY BEFORE THE NEW MEXICO MORTGAGE LENDERS ASSOCIATION Albuquerque, NM- Good afternoon. Thank you, Ryan, for that introduction. I want to thank Dan and the New Mexico Mortgage Lenders Association for your warm welcome. I applaud the important work you're doing here in New Mexico to promote and maintain sound mortgage lending practices. I'm pleased to join you here today with our federal partners and so many others dedicated to fostering the American Dream of homeownership. For many Americans, owning a home is a giant step on the ladder of economic mobility. It's a symbol of hard work, a source of pride, and a foundation for security. I know President Bush is deeply committed to helping all Americans fulfill the dream of owning a home. Today, more and more individuals and families are achieving this dream. Nearly 70 percent of Americans own homes, and the rate of minority homeownership has risen above 50 percent since the President took office. The Departments of Housing and Urban Development and Agriculture do a tremendous amount of work to ensure this success and extend the opportunity of homeownership to more and more Americans. At Treasury, we're equally committed to fostering an ownership society. One of the ways we do this is by empowering individuals to make wise and informed decisions about their finances. In today's increasingly complex mortgage market, often the greatest challenge to consumers is having enough information to navigate through the variety of products available and choose the one that best fits their needs. A 2001 study revealed that homeownership counseling can reduce 90-day mortgage delinquencies by an average of 19 percent. Of course, knowledge is also our best protection against predatory lenders and fraud. When we talk about effective homeownership counseling, we need to think beyond the specific states of pre-purchase, post-purchase, and foreclosure. After all, the goal should be to ensure individuals and families are equipped not just to buy their homes, but also to remain in their homes. Buying a home is often the biggest purchase most of us will make in our lifetime, and information is critical to ensuring that we make this purchase wisely. Homeownership counseling and training provides an ideal opportunity to educate consumers on general personal finance issues such as credit and money management that are critical to helping them manage their new mortgage and avoid foreclosure. Therefore, good homeownership counseling programs take a more holistic approach to address a range of finance topics. Without question, homeownership fuels the economy and enhances quality of life in our communities. It's in the best interest of financial institutions to help their customers continue on a successful and secure economic path once they purchase their homes. In talking with communities throughout the country, we've found the most effective way to deliver this important financial education message is by working together. Grassroots organizations can be extremely successful in reaching their local community members to deliver homeownership counseling. We also know that HUD regional offices across the country as well as programs like NeighborWorks America are advancing homeownership education through innovative outreach, aggressive public awareness campaigns, and intensive counseling. Just this week the Federal Reserve Board announced a new online Mortgage Comparison Calculator that consumers can use to compare what their monthly mortgage payments will be and how much equity they will build up in the future. This is a user-friendly and accessible financial education tool that will help consumers make informed decisions about mortgage options. These are just some of the financial education programs and resources out there. By working together, federal, state, and local governments, financial institutions and community organizations have the potential to empower all Americans with the information they need to achieve their dream of buying a home. Finally, I want to mention another important Treasury-led effort. As some of you may know, in 2003 Congress established the Financial Literacy and Education Commission under the Fair and Accurate Credit Transactions Act. The Commission brings together 20 different federal agencies – including HUD and USDA – with the single goal of improving financial education. Since that time, the Commission has released The National Strategy for Financial Literacy, and launched a financial education web site and toll-free hotline, MyMoney.gov and 1-888-MyMoney in English and Spanish. The Strategy – which can be downloaded from the website looks at a variety of important finance topics including homeownership. In fact, the section of the Strategy on homeownership has been nationally recognized as a valuable source of information. The MyMoney website also offers helpful links such as the Federal Reserve Board's mortgage calculator I mentioned earlier. I encourage those of you who haven't seen the Strategy to go on line and take a look. I think you'll find it offers some truly valuable resources. Over the last year, Treasury and HUD have co-hosted meetings with financial institutions, lenders, policy makers, community organizations, and counseling agencies to discuss the issues surrounding homeownership and build new partnerships to advance this important goal. Treasury continues to work with HUD and our Commission partners to engage in similar discussions throughout the country. We're making great progress in offering homeownership opportunities to more Americans and building a more prosperous future for our communities. But much work remains. I'm confident that working together we will continue to boost homeownership – especially among the nation's most underserved consumers – and create a more financially informed public. I thank you for your continued partnership, hard work and commitment to this important endeavor. Thank you.

REMARKS BY ACTING UNDER SECRETARY FOR INTERNATIONAL AFFAIRS CLAY LOWERY ON SOVEREIGN WEALTH FUNDS AND THE INTERNATIONAL FINANCIAL SYSTEM --The financial crisis that struck East Asia ten years ago had many causes – fixed but adjustable exchange rate regimes, balance sheet mismatches in the financial and corporate sectors, and inadequate financial sector regulation and supervision, among others. Ultimately these causes manifested themselves in large-scale capital outflows and insufficient official foreign exchange reserves. At the time, a number of working groups were established to address issues coming out of that crisis. One group recommended that the international community – largely led by the IMF – improve the coverage, frequency, and timeliness of data on foreign exchange reserves. The idea was to improve financial stability by providing clarity on what had been shown to be misleading data regarding gross reserves. Though much has been accomplished, further progress, particularly on coverage, is needed. East Asia today looks considerably different in many respects, but perhaps none more so than foreign exchange reserve holdings. In East Asia, and around the world, reserve accumulation has sharply accelerated. From 1997 to 2001, global foreign exchange reserves including gold increased at 6 percent per year on average. Since 2002, the annual average increase has been a phenomenal 20 percent. Global reserves currently stand at roughly $5.6 trillion. Many countries with large reserves surpass, by several multiples, benchmarks of reserve adequacy developed after the Asian Financial Crisis. But reserves do not tell the whole story as they generally do not include Sovereign Wealth Funds. Sovereign Wealth Funds are not new – they have existed for over three decades, even if the term as such was only coined to my knowledge in 2005. What is new is the number of Sovereign Wealth Funds and their sheer current and projected sizes. Private analysts put current Sovereign Wealth Fund assets in a range of $1.5 – 2.5 trillion, which would bring total foreign assets held by sovereigns to roughly $7.6 trillion, or 15 percent of global GDP. These trends raise broad, strategic issues for the international financial system. What are the underlying policies driving the accumulation, and should they be adjusted? What financial market and, over the medium-term, financial protectionism challenges could arise from this tremendous increase in sovereign cross-border asset holdings? How can countries in which these funds are invested best promote openness and welcome foreign capital? The common objective should be an international financial system where countries do not accumulate more foreign assets than they want or need, and where cross-border investment remains healthy and open. At Treasury we are actively considering these issues, and potential steps that could be taken multilaterally, bilaterally, and by national authorities. While we clearly do not have all the answers, I would like to walk you through some of our initial thinking. I believe that the IMF and World Bank could take a very constructive step through the drafting of best practices for Sovereign Wealth Funds. Complementing the work of the International Financial Institutions, I would expect that the issue of sovereign foreign asset accumulation will increasingly arise in informal multilateral discussions. National authorities will also have an important role to play. Moreover, the U.S. government itself has responsibilities. Definitions and Differences First let us be clear on what we are talking about. There is no universal, agreed definition of a Sovereign Wealth Fund. I will use the term to mean a government investment vehicle which is funded by foreign exchange assets, and which manages those assets separately from official reserves. Sovereign Wealth Funds generally fall into two categories based on the source of the foreign exchange assets. * Commodity funds are established through commodity exports, either owned or taxed by the government. They serve different purposes, including stabilization of fiscal revenues, inter-generational savings, and balance of payments sterilization. Given the recent extended sharp rise in commodity prices, many funds initially established for fiscal stabilization or balance of payments sterilization purposes have evolved into savings funds. * Non-commodity funds are typically established through transfers of assets from official foreign exchange reserves. Large balance of payments surpluses have enabled non-commodity exporters to transfer "excess" foreign exchange reserves to stand-alone investment funds to be managed for higher returns. There are three key differences between these two types of funds: * First is their asset-liability structure. Commodity funds often derive from foreign currency accruing directly to the government, so the foreign currency is not converted to domestic currency, does not enter the domestic economy, and does not need to be sterilized through the issuance of domestic debt to avoid unwanted inflationary pressures. In contrast, non-commodity Sovereign Wealth Fund assets often derive from exchange rate intervention, much of which is usually sterilized. These funds' net return will depend on the difference between the yield they earn on their investments and the yield they pay on their sterilization debt. So they may be thought of more as "borrowed funds" than traditional "wealth." * A second difference involves how countries have allocated their foreign assets to Sovereign Wealth Funds and reserves. Commodity exporters have typically chosen Sovereign Wealth Funds, while Asian countries have chosen reserves. There are exceptions – Singapore created its Government Investment Corporation back in 1981 and Russia established its oil stabilization fund only in 2003 – but the general trend has stood. Now, though, Asian countries are increasingly establishing non-commodity Sovereign Wealth Funds. * A third difference concerns the future pace of asset accumulation. Oil exporters in particular are essentially replacing a real asset in the ground with a financial asset in an account. If oil prices remain high, these governments are likely to accumulate foreign assets going forward even after the implementation of sensible domestic fixed investment plans. In contrast, the extent of asset accumulation in non-commodity funds will depend heavily on how successful emerging markets are in shifting to increased exchange rate flexibility. Benefits and Risks The creation and expansion of Sovereign Wealth Funds is understandable given the significant increase in official reserves. To be considered reserves, foreign currency must be invested in liquid and marketable instruments that are readily available to the monetary authorities to meet a balance of payments need. The idea of a Sovereign Wealth Fund is to diversify foreign exchange assets and earn a higher return by investing in a broad range of asset classes, including longer-term government bonds, agency and asset-backed securities, corporate bonds, equities, commodities, real estate, derivatives, alternative investments, and foreign direct investment. Some back-of-the envelope math demonstrates why this trend toward higher risk-return management of official assets is to some extent inescapable, or what has been perceptively called "forced diversification." In 2006, official foreign exchange reserves grew by 20% or $843 billion. If we assume for simplicity a similar percent increase in Sovereign Wealth Fund assets, we add $336 billion. Setting aside valuation changes, this brings total 2006 official flows to nearly $1.2 trillion. In comparison, 2006 net issuance of the most traditional reserve assets – U.S. Treasuries, U.S. Agencies, euro area government securities, and UK Treasuries – totaled $461 billion. So even if reserve and Sovereign Wealth Fund managers had purchased all 2006 net issuance of these traditional reserve assets, they would still have had some $720 billion left over. Of course this remainder can be invested in the existing stock of these securities, but part is also likely to find its way to other assets and asset classes. These trends can bring benefits to countries in which these funds are invested. From the U.S. perspective, we unequivocally support international investment in this country – both portfolio and direct investment – and are committed to ensuring that the United States continues to be the most attractive place in the world to invest. Most market estimates, though highly dependent upon underlying assumptions, expect future official flows to have a material though moderate impact in bidding up prices and lowering risk premia of riskier, less liquid assets, while at the same time resulting in continued strong demand for traditional reserve assets. This may contribute to continued benign financing conditions. There are also risks, however. The first concerns these funds' potential impact on financial market stability. To be sure, there is much that is reassuring. Sovereign Wealth Funds are, in principle, long-term investors that can be expected to stick with a strategic asset allocation despite short-term losses. They are not highly leveraged. They cannot be forced by capital requirements or investor withdrawals to liquidate positions rapidly. They have access to, and frequently make use of, well-regarded private fund managers, consultants, administrators, and custodians. Yet it is hard to dismiss entirely the possibility of unseen, imprudent risk management with broader consequences. Sovereign Wealth Funds are already large and projected to get much larger. Little is known about their investment policies, so that minor comments or rumors will increasingly cause volatility as market participants react to what they perceive Sovereign Wealth Funds to be doing. Sovereign Wealth Funds are typically not directly regulated by their domestic financial authorities, and the extent of indirect regulation may also be limited. Investor discipline will depend on what their citizens know and how active they are in monitoring fund activities, rather than the market discipline of savvy institutional investors. Further, the funds' counterparties and any creditors may simply assume a sovereign guarantee and fail to exercise market discipline. The second risk is that, over the medium term, the size, investment policies, and/or operating methods of these funds fuel financial protectionism. It is no secret that globalization, despite its benefits, is raising sensitivities around the world. This is not just a U.S., European, or even industrialized country issue. Emerging markets have also at times expressed sensitivity to certain investments by other emerging markets. There will likely be much public attention to whether Sovereign Wealth Funds exercise the voting rights of their equity shares, and if so, how. If Sovereign Wealth Funds obtain operational control of the companies in which they invest, the fact that they are government entities may invite additional scrutiny. Finally, these sensitivities and pressures to block sovereign investment would worsen if Sovereign Wealth Fund investment decisions were made for non-economic reasons. I think I can identify two other risks, which are largely domestic but could potentially be international. One is that with so much money invested across a wider range of asset classes, Sovereign Wealth Funds will need to have strong fiduciary controls and good checks and balances to prevent corruption. Another is that, while Sovereign Wealth Funds should be managed as professionally and independently as possible, my experience in government suggests that once a bureaucracy is created, shutting it down becomes difficult. Therefore, a fund created to handle what could be a temporary phenomenon should not impede thorough examination of underlying policies and avoid becoming self-perpetuating. The Work Ahead of Us We want of course to maximize the benefits of these funds while reducing the risks. A sound global financial system and the maintenance of open markets are in the common interests of all. Sovereign Wealth Funds raise issues of the appropriate institutional arrangements, governance, operational and risk management, accountability, and – critically – transparency of the funds' rules, operations, and asset management guidelines and performance. So what to do? First, I believe that the IMF and World Bank could take a very useful step by developing best practices for Sovereign Wealth Funds, perhaps through a joint task force. The IMF has the requisite expertise on wider systemic and macroeconomic subjects, such as the link to fiscal policy. The World Bank is knowledgeable about country governance and accounting and fiduciary issues, including the fiduciary duty these funds have to their citizens as investors. The IMF and World Bank also have the broad membership of 185 member countries, including countries that have these funds, countries in which they invest, and countries that simply have a stake in a healthy overall international financial system. One caveat is that I do not think that the International Financial Institutions should be in the business of competing with the private sector to manage reserves or Sovereign Wealth Fund assets on behalf of countries. This is clearly beyond their mandates. Proposals along these lines have been justified by the concern that an individual reserve manager may be reluctant to invest excess reserves more aggressively for fear of disapproval (or worse) if returns are negative in a given year. This issue is best addressed by building support domestically, including through the establishment of a stand-alone domestic institution if appropriate. A country naturally also retains the right to fire asset managers that underperform their designated benchmarks. Finally, it is critical that the International Financial Institutions avoid feeding a misperception that more reserves are necessarily better, both for the countries themselves and the broader system. Second, the subject of sovereign foreign asset accumulation will increasingly arise in informal multilateral discussions, which can complement and provide impetus to the work of the International Financial Institutions. At last April's meeting of G-7 Finance Ministers and Central Bank Governors, the Treasury Department hosted a special outreach dinner with Russia, Saudi Arabia, and the United Arab Emirates to discuss investment flows from oil exporters, including in the form of Sovereign Wealth Funds. In May, Treasury and the Federal Reserve co-hosted with the South African Treasury and Reserve Bank a meeting of G-20 Finance Ministry and Central Bank officials on Commodity Cycles and Financial Stability, where we discussed, among other topics, Sovereign Wealth Funds. Third, national authorities will have an important role to play, and certainly at Treasury we will continue to explore ways to address the challenges and opportunities provided by Sovereign Wealth Funds. Finance Ministries and Central Banks are in increasing contact with these funds to promote common understanding. National securities regulators should treat these funds as they would any large institutional investor. National governments also maintain mechanisms to review foreign direct investment in a manner that preserves national security without creating unnecessary and counterproductive barriers. Long-established and well-run Sovereign Wealth Funds may wonder why they should adjust their practices, particularly on transparency. I hope they will find that transparency is good for the funds as well as the international financial system. Lack of transparency puts heavy demands on the quality of fund administration. Even where fund administration is solid, greater transparency would enhance the likelihood that the fund serves its intended purposes and reduce the likelihood of future governance problems. The experience of large corporations in the industrialized world demonstrates that potential for error and abuse exists even in apparently highly-rated and well-managed organizations. From a systemic perspective, transparency will facilitate the maintenance of openness to investment. What may have been tenable in a world where Sovereign Wealth Funds manage only several hundred billion dollars may not be tenable in a world where Sovereign Wealth Funds manage several trillion dollars. Finally, the U.S. government also has a direct responsibility – which is making our investment regime as open and consistent as possible for welcoming Sovereign Wealth Fund investment. We are doing that by working with Congress to get a sound CFIUS bill and we are doing that by reaching out around the world to explain the U.S. investment climate. Just this week for instance Deputy Secretary Kimmitt has been traveling in Beijing and Moscow meeting with government officials and business leaders to promote open investment policies and to gain clarity on their new investment laws and to better understand the nature and investment priorities of their soon to be established sovereign wealth funds. The message delivered clearly to the Deputy Secretary from officials in both countries is that the funds would focus primarily on portfolio investments such as corporate bonds and equities. When asked about the possibility of foreign direct investment acquisitions, officials in both countries indicated that is not in their current planning but if such an opportunity arose in the future, it would be in non-sensitive sectors. Never Forget the Underlying Issues In considering Sovereign Wealth Funds, we should not lose sight of the underlying issues – the need for increased exchange rate flexibility in many emerging markets and the need for oil exporters to formulate and implement fixed investment plans even if further foreign asset accumulation can reasonably be expected. Otherwise the official sector would be doing the equivalent of treating the symptoms rather than the condition. However, Sovereign Wealth Funds are not going away, and it will be increasingly necessary to work to integrate these funds as smoothly as possible into the international financial system.

 

Testimony of
Treasury Assistant Secretary for Financial Institutions
David G. Nason
Before the U.S. House Committee on Financial Services
Subcommittee on Capital Markets, Insurance
and Government Sponsored Enterprises

Washington - Thank you, Chairman Kanjorski, Ranking Member Pryce, and other members of the Subcommittee for inviting me to appear before you today.

Thank you, Chairman Kanjorski, Ranking Member Pryce, and other members of the Subcommittee for inviting me to appear before you today.

The market for terrorism risk insurance in the United States was significantly changed by the terrorist attacks of September 11, 2001. Of course, prior to September 11, terrorism risk clearly existed in the United States. We experienced the 1993 bombing of the World Trade Center, the 1995 Oklahoma City bombing, the 1996 Centennial Olympic Park bombing, and the "Millennium Bomber's" December 1999 attempted bombing of the Los Angeles International Airport. Despite these events, most commercial property and casualty insurance companies continued to provide coverage for terrorism risk in the insurance policies sold to their commercial policyholders.

The terrorist attacks of September 11 resulted in insured losses of approximately $32 billion, which at the time was the largest single insured loss event in U.S. history. The recognition that terrorist attacks could cause losses of such scale spread across multiple insurance products and concentrated in a relatively small geographic area, caused the insurance industry to undertake a broad reassessment of the likelihood and potential losses associated with terrorism. Immediately following September 11, commercial property and casualty insurers sought to exclude coverage for terrorism risk in many policies. Reinsurance contracts also began excluding coverage for terrorism.

In the months after September 11, there were increasing concerns about potential economic disruptions caused by the unwillingness of many insurance companies to provide terrorism insurance. In response, Congress passed and the President signed the Terrorism Risk Insurance Act (TRIA) in late 2002. TRIA established a temporary federal program of shared public and private compensation for privately-insured commercial property and casualty losses resulting from acts of terrorism. The TRIA legislation stated that the purposes of the legislation were to address market disruptions, to ensure the continued widespread availability and affordability of commercial property and casualty insurance for terrorism risk, and to allow for a transition period for the private markets to stabilize and build capacity while preserving State insurance regulation and consumer protections. While TRIA was largely successful in achieving its original purposes, given some remaining uncertainty surrounding the development in the market for terrorism risk insurance, TRIA was temporarily extended in 2005 for an additional two years by the Terrorism Risk Insurance Extension Act of 2005 (the "Extension Act").

Today, I would like to provide an overview of the key features of TRIA and the Extension Act, the key findings of the President's Working Group on Financial Markets' (PWG) 2006 report to Congress on terrorism risk insurance, and some principles for the federal government's role in the market for terrorism risk insurance going-forward. Our view of TRIA is shaped by the belief that the most efficient, lowest cost, and most innovative methods of providing terrorism risk insurance will come from the private sector. The Administration believes that three elements are critical if TRIA is to be reauthorized for a second time: the program remains temporary and short-term; private sector retentions are increased; and there is no expansion of the program. Treasury cannot support efforts that move the program in a direction that is inconsistent with these key elements.

The Terrorism Risk Insurance Act and the Extension Act

TRIA essentially established a government reinsurance program. Much like typical provisions found in reinsurance, the TRIA program requires that insurers first retain a portion of terrorism risk exposure themselves (referred to as "deductible") with the insurer and government then sharing in the losses above the initial retention (referred to as "co-share" or "co-pay"). Unlike a typical reinsurance policy, however, there is no up-front premium charged for the reinsurance coverage provided under TRIA; but instead, any federal expenditure can be collected, or recouped, after a loss through surcharges applied to premiums paid by commercial policyholders regardless of whether their insurers had received TRIA payments. Some key features of TRIA and the Extension Act include the following:

Private Sector Retentions

An insurer's "retention" under TRIA generally refers to the amount of terrorism risk exposure that an insurer retains. An insurer's retention is comprised of its insurer deductible, its co-share of the insured losses above its deductible, or all of its losses if an attack results in industry-wide losses below an event size threshold, called the "Program Trigger." An insurer's retention under TRIA is a key provision that governs the amount of terrorism risk exposure held by the private sector. The general structure of TRIA and the Extension Act requires increases in private sector retentions over time to encourage development of private market capacity to provide terrorism risk insurance over time.

An insurer's deductible is company specific and is calculated based on the size of the insurer's prior year's premium revenue from the types of insurance covered by TRIA. Insurer deductibles have increased throughout the TRIA program – from its 2003 level of 7 percent of an insurer's prior year's direct earned premiums, to 10 percent in 2004, and 15 percent in 2005. The Extension Act further increased insurer deductibles to 17.5 percent in 2006 and 20 percent in 2007. In the event of a certified terrorist act, each insurer will cover 100 percent of the insured losses up to its deductible before being eligible for federal payments under TRIA. Tying an insurer's deductible to its revenue helps ensure that the amount of insured losses the company itself is responsible for is commensurate with its size and assets. Some of the largest insurers that participate in the program have deductibles in the billions of dollars.

Once an insurer pays insured losses up to its deductible, insured losses above its deductible amount would then be shared between the insurer and the federal government. The federal share of insured losses above the insurer's deductible had been 90 percent through the first four years of the TRIA program, and was reduced to 85 percent in 2007 – thus increasing the private sector's share from 10 percent to 15 percent. This provision of TRIA encourages proper claims adjustment as insurers will have "skin in the game" in deciding and settling insurance claims, much the same as provisions included in private sector reinsurance contracts.

In addition to the deductible and co-share, an insurer retains all of its losses if industry-wide aggregate losses are below the minimum event size eligible for payments under TRIA, or what has come to be known as the "Program Trigger." Under TRIA, in order for an event to be certified as an act of terrorism, the losses suffered by the insurance industry as a whole must exceed at least $5 million in the aggregate. As originally structured, certified acts of terrorism resulting in losses above $5 million would have been eligible for federal payments under TRIA, essentially making the certification and the event's eligibility for federal payments under TRIA equivalent. The minimum event size qualifying an event for federal payments under TRIA was raised beginning in 2006 by the Extension Act, which specifically added the concept of a Program Trigger to TRIA. Under the Program Trigger concept, the Treasury Secretary is directed not to compensate insurers under TRIA unless the aggregate industry insured losses exceed certain "trigger" amounts: $50 million in 2006 and $100 million in 2007. Once the threshold is met, program payments can then be made to an insurer once it has paid claims and met its company-specific deductible.

Lines of Coverage

Insurance coverage under TRIA is limited to commercial property and casualty insurance, which was the primary area of concern in terms of dislocations associated with the September 11 terrorist attacks. TRIA does not apply to personal insurance, such as homeowners, automobile, or life insurance. While TRIA did not specifically define commercial property and casualty insurance, it did specifically include excess insurance, workers' compensation insurance, and during the first three years of the TRIA program, surety insurance. In addition, TRIA specifically excluded certain types of insurance:

· Federal or private crop insurance;
· Private mortgage insurance, or title insurance;
· Financial guaranty insurance offered by a monoline financial guaranty insurance corporation;
· Insurance for medical malpractice;
· Health or life insurance, including group life insurance;
· Federal flood insurance; and,
· Reinsurance or retrocessional reinsurance.

In implementing the definition of commercial property and casualty insurance, Treasury relied on the lines of business ("lines") under which insurers report their premiums in annual statement filings pursuant to forms and rules adopted by the National Association of Insurance Commissioners (NAIC). The specific lines that were included in the program were established by Treasury through regulation, in consultation with the NAIC. With respect to implementing the program, policies whose premiums are reported to the NAIC on designated commercial lines qualify for TRIA coverage.

The Extension Act scaled back the scope of the program so that TRIA no longer covers:

· Commercial automobile insurance;
· Burglary and theft insurance;
· Surety insurance;
· Professional liability insurance (but not directors' and officers' liability insurance); and,
· Farmowners' multiple peril insurance.

Terrorism risk insurance for these lines of insurance, which was covered only during the first three years of the program, was successfully transitioned back to the private market without any signs of market disruption.

Certified TRIA Events

The TRIA program covers losses from certified acts of terrorism. In order to qualify as an act of terrorism, an event must be certified by the Secretary of the Treasury with the concurrence of the Secretary of State and Attorney General of the United States as being:

· a violent act, or an act dangerous to life, property or infrastructure;
· resulting in damage within the U.S., or to a U.S. air carrier or U.S. flag vessel, or on the premises of a U.S. mission; and,
· committed by an individual or individuals acting on behalf of any foreign person or foreign interest, as part of an effort to coerce the civilian population of the U.S. or to influence the policy or affect the conduct of the U.S. government by coercion.

Terrorism coverage is often described as "certified acts" coverage (based on the TRIA definition) and "non-certified acts" coverage (acts of terrorism that are not certified under TRIA because they do not meet one or several of the certification requirements). "Certified acts" are synonymous with foreign acts of terrorism due to the requirement that the act be "committed by an individual or individuals acting on behalf of any foreign person or foreign interest."

Under TRIA, an act committed by a "home-grown" terrorist could currently be certified as an act of terrorism and covered by TRIA so long as the terrorist was acting on behalf of any foreign person or foreign interest, and the other requirements are met. However, purely domestic terrorism, such as eco-terrorist attacks or an attack like Oklahoma City, would not be covered by TRIA. Such non-certified risks generally continue to be insured by the private market.

Recoupment

Unlike a private sector reinsurance company, the TRIA program does not require insurers to pay up-front premiums and does not build up surplus to pay future claims. Instead, the program is funded on a post-loss basis. TRIA provides authority for Treasury to recoup its federal payments through annual surcharges on commercial policyholders of up to three percent of a policy's premium. Certain recoupment is mandatory, while in other circumstances TRIA authorizes discretionary recoupment.

Mandatory recoupment is based on the concept of an "insurance marketplace aggregate retention" amount, which specifies the amount of losses the private sector as a whole must absorb in any given year. If the insured losses that the insurers collectively retain (individual company deductibles plus the co-pay portions paid above deductibles) are lower than the marketplace aggregate retention, Treasury must recoup the difference. In addition, Treasury has the discretion to seek recoupment of up to the full amount paid out based on consideration of specific factors described in TRIA. The "insurance marketplace aggregate retention" amounts have increased each year of the program, going from $10 billion in the first year to $27.5 billion in 2007.

Key Outcomes of the Extension Act

The TRIA program was originally designed as a three-year program set to expire on December 31, 2005. The temporary program structure allowed the federal government to re-evaluate the program in the context of current market conditions.

As the debate surrounding the extension of TRIA took place in 2005, the Administration focused on encouraging the private insurance market to develop innovative solutions and build capacity. This serves to reduce potential exposure to taxpayers. The core changes ultimately adopted as part of the Extension Act – increasing deductibles and co-share amounts, elevating program trigger levels, and eliminating coverage for certain lines of insurance – all focused on encouraging greater private market participation over time. The impact of these changes and an overall evaluation of the market for terrorism risk insurance formed the basis for much of the President's Working Group on Financial Market's (PWG) 2006 report on terrorism risk insurance.

The Findings of the President's Working Group on Financial Markets

The Extension Act required the PWG to perform an analysis regarding the long-term availability and affordability of insurance for terrorism risk, including group life coverage; and coverage for chemical, nuclear, biological, and radiological events. In conducting this analysis, the PWG was assisted by staff of the member agencies who reviewed academic and industry studies on terrorism risk insurance, sought additional information and consultation through a Request for Comment published in the Federal Register, and also met with insurance regulators, policyholder groups, insurers, reinsurers, modelers, and other government agencies. The PWG submitted its report to Congress last September. Key findings of the report are summarized below.

Long-Term Overall Availability and Affordability of Terrorism Risk Insurance

One of the key findings of the PWG report was that overall the availability and affordability of terrorism risk insurance has improved since the terrorist attacks of September 11, 2001. The general trend observed in the market has been that as insurer retentions have increased under TRIA and policyholder surpluses have risen, prices for terrorism risk have fallen, and take-up rates have increased.

Much of the improvement in the terrorism risk insurance market is due to several important factors, including better risk measurement and management, improved modeling of terrorism risk, greater reinsurance capacity, and a recovery in the financial health of property and casualty insurers.

· Since September 11, insurers have made greater use of sophisticated models that allow them to identify and manage concentrations of risk in order to avoid accumulating too much risk in any given location. This improvement in risk accumulation management has allowed insurers to better diversify and control their terrorism risk exposures, which has enhanced their ability to underwrite terrorism risk. In addition, a significant effort has been made by the insurance industry in modeling the potential frequency and severity of terrorist attacks; however, given the uncertainty of terrorism in general and, in particular, the uncertainty associated with these modeling efforts, insurers appear to have limited confidence to date in these models for evaluating their risk exposures.

· In terms of market capacity, the PWG found that the quantity of terrorism risk reinsurance capacity has increased since the period following September 11. In addition, the financial health of insurers has recovered since September 11. As a result, insurers have more available capacity to allocate to terrorism risk as demonstrated by the increased provision of terrorism risk insurance coverage over the past few years.

Despite these overall improvements, the PWG report found that a significant number of policyholders are still not purchasing terrorism coverage – approximately 40 percent of all policyholders do not purchase coverage. Even in major cities, a high proportion of policyholders are not purchasing terrorism risk insurance. For example, in 2004, 46 percent of policyholders in New York City had not purchased terrorism insurance; in Los Angeles, 61 percent had not purchased terrorism insurance; in Chicago, 42 percent; and in Washington, D.C., 40 percent. Recently reported data for 2006 suggests this has improved for some cities; for example, approximately one-quarter of policyholders in the New York metropolitan area are uninsured, as compared to 46 percent in 2004. The PWG's report, Treasury's own 2005 study, and others have found that the primary reasons for non-purchase were price, perceptions of low risk, and perhaps to some degree an expectation that federal disaster aid might be available if a significant attack were to occur.

The PWG report concluded that further improvements in insurers' ability to model and manage terrorism risk will likely contribute to the long-term development of the terrorism risk insurance market. However, the high level of uncertainty currently associated with predicting the frequency of terrorist attacks, along with what appears to be a general unwillingness of some insurance policyholders to purchase insurance coverage, makes any prediction of the potential degree of long-term development of the terrorism risk insurance market somewhat difficult.

Group Life Insurance

As passed by Congress in 2002, TRIA did not include group life insurance in the program. Treasury was required to evaluate market conditions and determine whether to include it in the program if both insurance and reinsurance were not available, or not likely to be available in the future. In 2003, Treasury found that group life insurance coverage was readily available for consumers. Thus, group life was not added to the program. In 2005, when TRIA was extended by Congress, group life was not added to the program.

The PWG report found that group life insurance is still widely available in the private market even though it is not part of the TRIA program. In particular, the group life market is highly competitive and is very price sensitive. Group life insurers concede that competitive pressures have caused them to make coverage available, even in the absence of TRIA protection. In contrast to property and casualty insurers, group life insurers have decided to forgo purchasing reinsurance and to focus less on managing risk accumulations.

Chemical, Nuclear, Biological, or Radiological (CNBR) Coverage under TRIA

CNBR is currently covered under TRIA. However, TRIA does not require insurers to make CNBR terrorism coverage available to policyholders if CNBR coverage for non-terrorism events is similarly not provided. Although not required by TRIA, if CNBR terrorism coverage is provided by the insurance policy, such as with workers' compensation insurance, TRIA covers insured losses from a certified terrorist event involving CNBR.

CNBR is currently covered under TRIA. However, TRIA does not require insurers to make CNBR terrorism coverage available to policyholders if CNBR coverage for non-terrorism events is similarly not provided. Although not required by TRIA, if CNBR terrorism coverage is provided by the insurance policy, such as with workers' compensation insurance, TRIA covers insured losses from a certified terrorist event involving CNBR.

The PWG report found that historically CNBR risks (caused by a terrorist or by any other event) were typically not covered by insurance (except when mandated by state law, such as with workers' compensation). The factors determining the availability and affordability of CNBR coverage have more to do with the nature, scale, and uncertainty of the damage and losses from CNBR events – however caused – and less to do with terrorism specifically. In addition, policyholder expectations regarding their own potential terrorism risk exposure are probably lower and their expectations about the likelihood of post-disaster federal aid are probably higher for CNBR attacks than for relatively smaller-scale conventional terrorist attacks.

The Federal Government's Role in the Market for Terrorism Risk Insurance

As a basic principle, the federal government's role in any market, including the market for terrorism risk insurance, should be limited to those areas where private markets cannot function and hence broader costs are imposed on our Nation's overall economy. In playing such a role at a time when it was needed, TRIA appears to have been successful. TRIA provided time for insurers and others to adjust to the risks made clear by the September 11 terrorist attacks. Subsequently, there have been positive market responses by insurers and reinsurers to the reductions in the federal role over the five years that TRIA has been in place, most notably by assuming additional terrorism risk exposure in each year of the program. And as insurers have increased their terrorism risk exposure as TRIA was scaled back, prices for terrorism risk coverage have declined or remained stable. In some sense, we have conducted a market experiment under TRIA that has illustrated that the private sector is capable of taking on increasing amounts of terrorism risk as the federal government's role recedes. TRIA has generally been effective in encouraging the greater provision of terrorism risk insurance, while at the same time encouraging and supporting private market development. However, by providing a terrorism risk reinsurance without any up-front premiums, it may also have displaced some private sector alternatives.

As has been clear from the outset, TRIA was designed as a temporary program. A permanent or long-term federal subsidy of free federal reinsurance was never intended. We firmly believe that temporary programs should be just that – temporary. Given the success achieved under TRIA to date, the obvious question is should the federal government maintain a limited role in the provision of terrorism risk insurance? It is clear that some challenges remain in the market for terrorism risk insurance almost five years after the passage of TRIA and nearly six years after September 11. Insurers have made great strides in modeling loss exposure and managing their concentration of risk; however, the ability of the insurance industry to model the frequency of terrorism attacks is uncertain, and market participants are skeptical of their current reliability. As a result, insurers are cautious in allocating more capacity to terrorism risk, although it appears that gradual increases have been occurring over time. If TRIA were to expire, our general view is that the market for terrorism risk insurance in much of the country would largely be unaffected, but that there could be some dislocations in certain markets and industries.

Based on where the market for terrorism risk insurance is today, our view is that TRIA should be phased out in order to increase private sector participation. The following three elements are critical if TRIA is to be reauthorized for a second time: the program remains temporary and short-term; private sector retentions are increased; and there is no expansion of the program. Unfortunately, H.R. 2761 does not meet these critical elements.

It is important that the program remain temporary and short-term. When the President signed TRIA in 2002 he said that it should be temporary, and the Administration maintains this position. Given the positive market developments during the last five years under a TRIA program where the federal role has been scaled-back further and further each year, we clearly do not believe the federal government's role in terrorism risk insurance should be made permanent. Similarly, if the program were extended for a long period of time there would be less urgency surrounding the development of private sector solutions, which would lead to market complacency. In considering the length of any extension we must maintain incentives for industry participants to continue to improve their systems (e.g., modeling) and develop private market capacity and innovative solutions. We believe the ten year extension in H.R. 2761 is not consistent with the critical element of keeping the program temporary and short-term.

It is also important to continue the trend of increasing the private sector's participation and reducing the role of the Federal Government. Private sector retentions provide financial incentives for insurers to encourage their policyholders to mitigate risk through such measures as improved physical security and evacuation and business continuation planning. Private sector retentions can be increased through deductibles, co-shares, or program triggers. Any extension of TRIA should not backtrack from current levels, but rather should reflect some real amount of increased private sector participation. As has been demonstrated by the increased willingness of insurance companies to take on terrorism risk exposure during the life of TRIA, there is ample opportunity to continue increasing private sector retentions. In addition, recent increases in the capacity of property and casualty insurers, as evidenced by growing surplus and profit levels as well as increased reinsurance availability, should allow for greater private sector retentions. Unfortunately, a number of provisions in H.R. 2761 move away from requiring increased private sector participation, such as leaving insurer deductibles and co-payment amounts flat and unchanged, lowering the program trigger level, and lowering retentions for subsequent events through a reset mechanism. Treasury would oppose these provisions as they are inconsistent with phasing out TRIA and encouraging private provision of terrorism risk insurance – which is the fundamental goal of TRIA.

The program should not be expanded to introduce new lines or types of coverage willingly provided by the private market. For example, we do not see any evidence of problems in the market for group life insurance or in coverage for domestic terrorism. These markets continue to function despite not having access to the TRIA program. Expanding the TRIA program to include additional coverage for well functioning markets – as H.R. 2761 proposes – is inconsistent with the appropriate role of the federal government in the terrorism risk insurance market. Treasury would oppose any such efforts that move the program in the wrong direction.

Finally, there have been questions raised about the lack of coverage for CNBR terrorism risks. As noted previously, outside of workers' compensation insurance, coverage for CNBR risk has generally not been provided by insurers. However, TRIA does provide coverage for CNBR risk if insurers include such coverage in their policies. If policyholders were to demand CNBR coverage and were willing to pay appropriate prices, we would expect some additional capacity to emerge for CNBR risks. At this time the lack of CNBR coverage does not appear to be leading to any disruptions or imposing any broader costs on our Nation's overall economy. We do not support H.R. 2761's expansion of TRIA's "make available" provision that would require insurers to offer coverage for CNBR risks or its provisions that would lower insurer retentions. Nevertheless, outside the debate surrounding TRIA, we should continue to consider the potential economic implications associated with the limited amount of CNBR terrorism risk insurance coverage that is currently being provided.

Conclusion

We appreciate the efforts of the Chairman and Members of the Subcommittee in evaluating issues associated with terrorism risk insurance and TRIA. Unfortunately, the risk of terrorism is likely to remain a part of our lives for some time to come, but that is precisely why the federal government needs to encourage the development of the most creative and cost effective means of covering terrorism risks. The most efficient, lowest cost, and most innovative methods of providing terrorism risk insurance will come from the private sector. TRIA should be phased out in order to increase private sector participation.

The three critical elements that we have set forth surrounding an acceptable extension of TRIA – (1) the program remain temporary and short-term; (2) private sector retentions are increased; and (3) there is no expansion of the program – reflect the positive experience under TRIA to date, and are grounded in the basic principle of limited government involvement in private markets. Without these critical elements, we would not be supportive of extending TRIA as, in our view, the program would be moving in the wrong direction. H.R. 2761 does not meet our objectives. In Treasury's view, from both a market and economic perspective, it would be better to have no TRIA than a bad TRIA. We are willing to continue to work with Congress toward finding an appropriately balanced solution and to establish the appropriate increases in private sector participation.

We look forward to continuing to work with Congress on this important issue. Thank you. I look forward to answering your questions.

 

Testimony of Treasury Secretary Henry M. Paulson, Jr.
before the House Committee on Financial Services
on the State of the International Financial System

Washington, DC -- Thank you, Chairman Frank, Ranking Member Bachus and Committee members, for the opportunity to appear today to discuss the state of the international financial system.

-- Thank you, Chairman Frank, Ranking Member Bachus and Committee members, for the opportunity to appear today to discuss the state of the international financial system.

The Bush Administration is committed to strengthening U.S. and global economies by promoting domestic and international growth. Our policies encourage openness, competition, financial stability, and development, both at home and abroad.

As countries around the world have reformed and opened their economies, global integration has provided businesses greater access to markets around the world, more choices for consumers, and reduced the prices of goods and services, which is a real benefit, especially to those with lower incomes in the United States and abroad.

Our aim is to help ensure that more people share in the benefits created by economic growth and trade opportunities, to help every nation reduce poverty and build a strong middle class.

To further expand on these points, my testimony will touch on the following:

The economic outlook for the U.S. and the global economy.

Contributions that the U.S. and other economies have made toward global re-balancing and additional steps that are required.

The vital importance of continued U.S. openness to foreign investment and trade, while ensuring national security, to keep our economy dynamic and competitive; and the imperative of addressing anxieties about globalization and successfully concluding the Doha trade round.

Why the international financial institutions are key instruments through which to pursue U.S. economic interests abroad and what needs to be done to maintain their relevance and credibility. On the IMF side, this includes an overhaul of governance structure.

The importance of multilateral debt and development initiatives, which serve U.S. interests – both moral and practical – by lifting people out of poverty, promoting private-sector led growth, helping rebuild war-torn societies.

How the Treasury is working bilaterally and multilaterally to detect and disrupt financial networks related to money laundering, terrorism, WMD proliferation.

How Treasury's international assistance program supports the achievement of many of these goals.

U.S. and Global Economic Developments

A strong U.S. economy benefits the international economy, and the U.S. economy is strong. Most recent data show that employers are hiring more than 100,000 people per month, businesses are starting to invest again and consumers are spending at a healthy pace.

The global economy continues to be very robust, with sustained strong growth from 2003 through 2006. In 2006, global GDP grew 5.4 percent, the highest rate of growth in over 30 years. The International Monetary Fund (IMF) projects continued strong growth, at about 5 percent, in 2007 and 2008. The U.S. and China are key engines of global growth, accounting for over 40 percent of world growth for the past 5 years. Emerging markets and developing countries have made a huge contribution to global growth, growing, on average, 4.8 percentage points faster than the advanced economies from 2003 through 2006. And with both Europe and Japan also experiencing faster growth, the global economy is now firing on all engines in a way that produces better balance, more sustained growth, and expanding opportunities.

At the same time there has been a substantial increase in the amounts of funds invested across borders, a near doubling in cross-border investment flows since 2000 to $6 trillion annually. Not surprisingly, given the depth, liquidity and attractiveness of our financial markets, the U.S. has attracted international investment that has enabled us to achieve higher rates of growth, higher levels of capital formation, and greater job creation than would have been possible otherwise.

The issue of global imbalances remains on the international agenda. Some historical perspective is useful in this discussion. Global imbalances have evolved and developed over a long time period and are the result of a myriad of global forces, including the massive amounts of international investment mentioned earlier and the relative attractiveness of U.S. financial markets to foreign investors. Another reason is the consistently faster pace of demand growth in the United States relative to our foreign partners.

However, progress is being made, as suggested in last week's release of first quarter 2007 data showing the U.S. current account deficit has declined to 5.7 percent of U.S. GDP, down from a peak of 6.8 percent in the fourth quarter of 2005. Our partners are growing faster, particularly in Europe, where demand has strengthened. We continue to seek further re-balancing of global demand through stronger demand growth in Japan and Europe, as well as by oil exporting economies and China.

We are doing our part. The U.S. fiscal position continues to improve. The FY 2006 federal budget deficit was $248 billion, $70 billion less than in FY2005. This is considerable progress and we are on track to further reduce the deficit in 2007. As a share of GDP, the deficit amounted to 1.9 percent in FY 2006, down from a recent peak of 3.6 percent in FY 2004 and below the 40-year average of 2.3 percent. The U.S. labor market remains healthy with a low unemployment rate, steady job gains and solid real wage growth. Core measures of inflation appear to be contained, although energy and food price increases continue to boost the headline inflation figures.

In sum, global economic growth is widespread and moving at a faster pace than in the 1980s or the 1990s. Inflation is down, fiscal positions have improved, and vulnerabilities have been reduced. We still have work to do, however, to further re-balance global demand, expand global trade and open markets.

The Strategic Economic Dialogue with China

Since becoming Secretary, I have emphasized the United States' economic relationship with China. Rapid growth in China has helped power the global economy. And, as a major global economic participant, China must address the need for structural reform.

Our relationship with China is multi-faceted, and we welcome China's growth and integration into the world economy. As our relationship with China matures, tensions will naturally emerge. Less than one year ago, President Bush and President Hu established the Strategic Economic Dialogue, which is a focused and effective framework for addressing issues of mutual concern. The first SED meeting was held in Beijing in December, and the second one was held last month here in Washington. We have tangible results to show for our work so far, such as agreements in civil aviation, energy, the environment and financial services.

Through the SED, which allows us to speak to senior Chinese officials with one voice, avoiding the stove-piping that had sometimes characterized past discussions, we can work to strengthen the U.S. – China economic relationship. It is very important to both of our countries that we get this right.

The United States supports a stable and prosperous China; a stable and prosperous China will be a growing market for U.S. goods and services, even if it will be an economic competitor at times. We are not afraid of the competition; we welcome it, because competition makes us stronger. It is in our interest to support China's continuing efforts to reform and open its economy. Our policy disagreements are not about the direction of change, but about the pace of change.

You recently received the foreign exchange report, which emphasizes the need for stronger, faster action from China. Treasury did not determine that China's exchange rate policy was carried out for the purpose of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade. But, Treasury continues to press the Chinese to increase the flexibility of their exchange rate.

Although they have taken some steps towards greater flexibility in the short term, they need to accelerate that movement and move more quickly to a market-determined exchange rate in the medium term. While currency reform is not going to eliminate our trade deficit, a market-determined exchange rate that reflects the underlying fundamentals of the Chinese economy is an important ingredient to sustainable, balanced economic growth in China, which is critical to continued stable growth around the world. The huge inflow of liquidity under the current exchange rate policy undermines the effectiveness of China's monetary policy and fuels excessive growth in credit, which itself poses significant risks for the Chinese economy's performance. The risk that China now faces is moving too slowly on exchange rate reform, rather than moving too quickly.

Rebalancing China's growth to be less dependent on exports is key to reducing China's trade surplus, and assuring that China can continue to grow in the future without generating large imbalances. Moving more quickly to embrace competition and market principles will also spread the benefits of China's growth to all of China's people. Just as important is addressing the structural reasons why Chinese households save so much and consume so little. Precautionary savings rates would likely decrease, and consumption increase, if there were a stronger social safety net. Competitive retail financial services would allow the Chinese public to insure against risk, finance major expenditures like education, and garner a higher return on their savings. Investments driven by market signals and expected profitability, rather than by administrative guidance, combined with a reduction in precautionary savings, would shift the economy from its infrastructure and export manufacturing focus and spread prosperity more widely. This can only be beneficial, and China's consumption and import level can only increase.

We will have our third SED meeting in December. Between now and then, we will continue to actively work on the trade agenda, on opening markets, increasing transparency and innovation, rebalancing growth and promoting energy efficiency and security, as well as environmental protection measures. We will continue our focus on financial services, moving at a faster pace towards a market-driven currency and expanding U.S. access in the services sector. We have room to be more creative and accomplish a good deal more.

Promoting Open Trade and Investment

A central U.S. policy priority is promoting further opening to international trade while addressing the sources of globalization anxieties. I have been and will continue to be an outspoken advocate for maintaining and extending open trade. This is fundamental to the long term competitiveness of the U.S. economy. As the world opens its doors, we must resist the sentiment that favors economic isolationism; this is not the time to retreat from the principles which have made America so strong and competitive.

We have worked hard to open markets and liberalize trade, in order to promote economic growth and development worldwide. Free trade agreements (FTAs) also bring significant benefits to Americans and the American economy as well as to our FTA partners. Over the last six years, the Administration has put free trade agreements into effect with ten countries. Agreements with the Dominican Republic, Costa Rica and Oman have passed Congress and await implementation.

The Administration is working hard to complete the Doha round, which has the potential to lift hundreds of millions out of poverty. Last month, congressional leaders and the Administration reached bipartisan agreement on labor, environmental and other issues related to pending free trade agreements with Peru, Panama, Colombia and Korea. We are hopeful that congressional approval of these agreements will soon unlock their important benefits.

Openness to trade and competition fuels economic dynamism, innovation, and deployment of new technologies that raise standard of living and productivity across the globe. Countries which have opened up to international competition have prospered, while others have been left behind. But a dynamic economy does create dislocations and change, and we must help workers succeed amidst this change. However, we cannot turn back the clock; the global economy is here to stay.

A successful Doha round would expand trade in agriculture, manufactured goods and services. The World Bank estimates that full liberalization of global merchandise trade alone would increase annual global income by $287 billion (0.7 percent of global GDP) and lift 65 million people out of poverty by 2015. Agriculture in particular is crucial for developing countries, especially for the poorest ones. On average, agriculture represents 40 percent of GDP, 35 percent of exports, and 50–70 percent of total employment in the poorest developing countries

Financial services are particularly important for developing countries because they are linked to increased economic growth and development. A Doha Round without significant liberalization in these areas would be a missed development opportunity. Capital markets are the lifeblood of an economy. They connect those who need capital with those who invest or lend capital. They play a vital role in helping entrepreneurs implement new ideas and businesses expand operations, creating new jobs. Financial sector openness has been shown to increase growth rates by over one percentage point in developing countries and to help the poor disproportionately, making commitments in the financial sector a win-win proposition. Cross-country analysis shows that greater involvement by private and foreign banks leads to more efficient lending and higher growth.

Foreign Direct Investment

On May 10, 2007, President Bush reaffirmed our nation's commitment to "open economies that empower individuals, generate economic opportunity and prosperity for all, and provide the foundation for a free society." A free and open international investment regime is vital for a stable and growing economy, both here at home and throughout the world. Foreign investment in the United States strengthens our economy, improves productivity, creates jobs, and spurs healthy competition.

Thank you, Chairman Frank, Ranking Member Bachus and Committee members for your efforts to improve and strengthen the CFIUS process. Your bill will contribute to creating a sound process to assess national security risks in those limited investments where they may arise, while signaling to the rest of the world that the United States remains open for investment. The CFIUS process has historically applied to less than 10 percent of foreign acquisitions of U.S. firms and the vast majority of reviews take place without controversy.

Modernizing the International Financial Institutions

We have a strong stake in maintaining the credibility, relevance and legitimacy of the IFIs. The IFIs are indispensable to promoting the United States' global economic interests, which cannot be effectively pursued through bilateral means alone.

As you know, the President has nominated Ambassador Robert Zoellick to be World Bank President. Positive feedback from my extensive consultation with foreign ministers around the world reinforced our confidence in Ambassador Zoellick's ability to lead the Bank's vital mission of economic growth. I believe he will rightly keep Africa at the center of the Bank's focus and continue the vital campaign to fight corruption and reduce poverty.

At the IMF, we have reached an important moment for reform. Failure to follow through will undermine the credibility and legitimacy of the IMF. Within the past days, the IMF took action to update its operational framework for its surveillance over members' exchange rate policies. The U.S. has been a strong voice in favor of such reform.

The IMF's exchange rate surveillance framework was 30 years old and badly needed updating to reflect developments such as the tremendous rise in international capital flows and increased prevalence of freely floating exchange rates. The reform will permit firmer surveillance in areas such as insufficiently flexible exchange rate regimes or weak macroeconomic policies which do not adequately support the exchange rate regime. The U.S. will continue to emphasize that for the reform to be meaningful, it must be carried through in the day-to-day surveillance work undertaken by staff. Nothing is more important for the relevance of the IMF than rigorous execution of its most fundamental responsibility.

Firm, multilateral-based exchange rate surveillance has the potential to be a strong complement to bilateral diplomacy. A multilateral approach places exchange rate issues in a broader, less politically-charged context where the win-win aspects of reform can be more persuasively emphasized.

The United States has led the call for reforms of the IMF's governance structure so that it better reflects the world economy in which we live. The chief goal of governance reform must be to boost the voting share of dynamic emerging market economies. Major emerging market economies produce an increasing share of global output, and will increasingly drive global growth. Reform can and should be accomplished while protecting the voting share of the poorest countries. The U.S. has demonstrated its commitment to reform by offering to forego the additional quota which would otherwise be due to us. We continue to call on similarly situated countries to follow our lead.

Supporting Economic Growth in Developing Countries

This administration has pursued a proactive reform agenda on development. President Bush has made a strong case for why international development assistance is squarely in the U.S. interest. Treasury supports these international development objectives through active leadership in the multilateral development banks (MDBs) and international debt initiatives. Lifting unsustainable debt burdens from the poorest countries allows a greater focus on economic growth and frees up resources that can be spent on poverty-reduction priorities.

In 2005 the G-8 agreed to support a multilateral debt relief agreement to cancel up to $60 billion in debt obligations owed to the World Bank's International Development Association (IDA), the African Development Bank and the IMF by countries eligible for the Heavily Indebted Poor Countries (HIPC) Initiative. In response to U.S. leadership, the Inter-American Development Bank has followed suit, agreeing to provide additional debt reduction to its five most heavily-indebted borrowers: Bolivia, Guyana, Haiti, Honduras and Nicaragua, with debts totaling $3.4 billion.

The U.S. seeks to preserve the gains made under these historic debt relief initiatives, and to end the "lend and forgive" cycle that has plagued many of the poorest countries in recent decades. This will require not only prudent debt management by borrowing countries, but greater attention by lenders to responsible lending policies and practices.

A key tool is the joint World Bank/IMF Debt Sustainability Framework, the DSF, for low-income countries, a forward-looking assessment of potential risk of debt distress. DSF must be put to use not only by borrowers to promote prudent management of new debt, but also by lenders, beyond the MDBs. It should include explicit guidance on recommended level of concessionality of lending.

We are concerned that some commercial creditors and non-OECD bilateral creditors have increased non-concessional lending to Low-Income Countries following the extension of debt relief, in effect "free riding" on the debt relief for these countries paid for by others. We are working within various forums, including the OECD Export Credit Group, to explore how use of the DSF might be expanded to other creditors. We are also working to engage the G-20 on a "Charter for Responsible Lending" to promote collaboration with emerging creditors. In this context, we are also working to help HIPCs avoid costly litigation.

Largely through U.S. leadership, the MDBs have been making significant progress in support of our international policy priorities: promoting private sector-led growth, reducing poverty, fighting corruption, and assisting post-conflict countries in rebuilding their war-torn economies.

We are now engaged with our donor partners around the world in replenishment negotiations for the International Development Association, the concessional arm of the World Bank and the African Development Fund. Successful negotiations are particularly important for Africa, which receives half of the IDA's resources. U.S. leadership is essential to advance the following key objectives:

Making sure the institutions measure, report and demonstrate results concretely and consistently; and continue to allocate more resources to countries that are reforming and performing well;

Improved work in fragile states such as Afghanistan and Liberia;

Increased transparency of the Bank's country operations;

Greater attention to debt sustainability in poor, debt vulnerable countries;

Continued efforts to fight against corruption.

The U.S. and the MDBs are strengthening their commitment to the financial sector in Africa, which is critically important for supporting sustainable economic growth. President Bush recently announced the Africa Financial Sector Initiative to provide financial and technical assistance to overcome barriers to capital markets development in Africa. This will complement work of the MDBs to strengthen Africa's financial markets.

The World Bank's new "Making Finance Work for Africa" initiative aims to increase efficiency of financial intermediation, provide greater access to finance for households and small business, and deepen financial markets. The IFC provides financial and technical assistance to help African financial institutions lend profitably to small and medium-sized enterprises. World Bank/IMF financial sector assessments help African countries develop financial sector reform strategies.

The MDBs also play a key role in addressing the needs of fragile states, which complements U.S. policy of helping to rebuild war-torn economies in countries like Afghanistan, Liberia, Haiti and Lebanon. Successfully addressing the special needs of fragile states is critical for advancing global economic and political stability. We are encouraging the MDBs to focus on the core issues of capacity and governance, since shortcomings in these areas often make it difficult for fragile states to effectively absorb aid. We also emphasize the need for the MDBs to achieve measurable results.

The Administration wants to continue to work with Congress on this proactive development agenda. In order for the United States to maintain its leadership in these important efforts, we must address the past payments due to these valuable institutions, as was requested in the President's FY 2008 budget.

Helping Small Businesses in Latin America

In March, President Bush asked the Treasury and State Departments to develop an initiative to "help U.S. and local banks improve their ability to extend good loans to small businesses" in Latin America and the Caribbean. On June 12, Treasury announced a three part program specifically designed to assist the estimated 90 percent of small businesses in the region that are often frozen out of the formal financial sector. The initiative is aimed at helping more people share in the benefits of economic freedom and growth that occur when small businesses thrive.

It is a three-part plan to catalyze market-based bank lending to small, profitable businesses with growth potential in Latin America and the Caribbean, that would be carried out in conjunction with in the Multilateral Investment Fund (MIF) of the Inter-American Development Bank, the Overseas Private Investment Corporation (OPIC) and the IDB Group's Inter-American Investment Corporation (IIC).

Household financial education is also vital to the success of this initiative. Many entrepreneurs get their start using their own savings or personal loans. Treasurer Anna Cabral will host a regional conference this fall to discuss ways we can enhance access to financial services, including financial service access of entrepreneurs in the region.

Strengthening the International Framework against Illicit Finance

In 2004, Treasury became the first finance ministry in the world to develop in-house intelligence and analytic expertise to use specific, current, and reliable intelligence to evaluate potential national security threats. We use reliable financial intelligence to build conduct-based cases, working to achieve a multilateral alignment of interests. Multilateral support is critical to the success of targeted financial measures; this support is also vital to bolstering the integrity of the international financial system and to underpinning sustainable growth and development.

Treasury continues an intensive effort to track and disrupt terrorist financing that has been effective on several levels. Perhaps the best example of a multilateral program of targeted financial measures is evidenced when the target provides support to al Qaida or the Taliban. In