The Global Response to the Financial Crisis: Can We Avoid a Repeat? Robert C. Pozen Chairman MFS Investment Management ® The views expressed in this presentation are those of the speaker and are subject to change at any time

Pozen_Toronto_Jan “Never let a serious crisis go to waste.” — Niccolo Machiavelli, 15 th century philosopher — Rahm Emanuel, current White House Chief of Staff

Pozen_Toronto_Jan Major financial crises — World War II to major banking crises in advanced industrial societies Including Europe, Turkey, Russia, Japan, Canada, U.S., Australia, and New Zealand Source: Carmen M. Reinhart and Kenneth Rogoff, “ This Time is Different: Eight Centuries of Financial Folly”, to 1995 Source: Michael Bordo and Barry Eichegreen, “Crisis Now and Then: What Lessons from the Last Era of Financial Globalization?”, National Bureau of Economic Research Working Paper No

Pozen_Toronto_Jan U.S. exports and imports * $1,071 1, ,020 1,159 1,281 1,452 1,646 1,836 1,411 U.S. international trade in goods and services ($B) $1,450 1,370 1,399 1,515 1,769 1,997 2,212 2,346 2,517 1,752 ExportsImports * Through 11/30/09. ** As of 9/30/09. Sources: U.S. Census Bureau; National Bureau of Economic Research 4.2% ** Current Account Deficit (% of GDP)

Pozen_Toronto_Jan Continuing negative savings by U.S. (Personal and government) Sources: Federal Reserve Bank of St. Louis; Congressional Budget Office; Brookings Institution U.S. Personal Saving Rate U.S. Budget Deficits External debt at end of fiscal year (FY) 2008 $5.8 trillion Budget deficit in FY 2009 $1.4 trillion External debt at end of FY 2009 $7.2 trillion Projected budget deficits in FY 2010 – 2018$9.0 trillion Projected external debt at end of FY 2018 $16.2 trillion + + = =

Pozen_Toronto_Jan Can the Fed be an effective inflation fighter? Maximum and Actual Exposure of Federal Reserve to the Financial Bailout ($B) As of March 25, 2009Maximum Exposure Actual Exposure

Pozen_Toronto_Jan U.S. Treasury — Bailing out institutions Recapitalized too many banks without clear rationale AMEX and State Farm allowed to become bank holding companies Recapitalize troubled banks with preferred stock (+15% warrants) Problem Solution New statute to justify rationale for every bailout of each institution Provide liquidity support, not capital, to non-banks Preferred stock with warrants to purchase 100% of preferred

Pozen_Toronto_Jan FDIC — Government guarantees Short-term liquidity crisis after Lehman’s failure Deposit insurance increased to $250,000 (through 2013) Guarantee 100% of debt of banks, thrifts, and their holding companies Problem Solution Fed did good job in allowing swaps of Treasuries for illiquid securities Stay at $100,000, which covers 98% of depositors Limit FDIC guarantee to 90% of debt of banks and thrifts (not their holding companies)

Pozen_Toronto_Jan Government actions: Executive compensation for financial institutions Legislative limit for assisted institutions –Bonus no more than 1/3 of base –Example: Wells Fargo CEO Special Master for six TARP institutions –Approve compensation specifics of top-25 –Approve compensation structure of next 75 Federal Reserve – for all 8,200 banks –Proposal to ensure appropriate incentive compensation –Will reject arrangements with “excessive risks”

Pozen_Toronto_Jan Improving boards of mega-banks Existing mega-bank board model –Large boards: 12 to 18 members –Lack of industry expertise –Meet 6 times per year Board of “Super-Directors” –Smaller number of directors: 5 to 7 –All directors with relevant experience –Devote 2 to 3 days per month

Pozen_Toronto_Jan Mortgages — Securitization process Brokers sold mortgages without retaining any risk of loss Securitization vehicles: Multilayered and opaque Credit rating agencies have conflicts of interest Problem Solution Sellers of loans should retain at least 5% risk of loss Simpler vehicles with more ongoing disclosures SEC-appointed representative to choose credit rating agency

Pozen_Toronto_Jan Banks — Capital requirements Basle I reduced capital requirements for mortgages, MBS Basle II based on internal risk models of banks Loan loss reserves limited to probable losses Problem Solution Should have distinguished between more and less risky mortgages 12 to 16 categories of risk capital plus subordinated debt Allow contingent loan loss reserves plus disclosure

Pozen_Toronto_Jan Key Canadian virtues Require 20% down payments for most home mortgages and no tax deduction for interest paid on home mortgages Set higher amount and quality of capital for banks Did not buy products without understanding them Combination of commercial banking and securities underwriting: Not a problem for Canadian banks

Pozen_Toronto_Jan Close gaps in U.S. financial regulation Customized financial derivatives exempt from most regulation Hedge funds, aggressive short sellers, grew rapidly Global insurers regulated by 50 states Inadequate regulatory focus on systemic risks Problem Solution More standardized contracts; through one clearing corp Require managers of hedge funds to register as investment advisers Federal charter for a few global life insurers Council of regulators, with Fed, to monitor systemic risk

Pozen_Toronto_Jan Proposed restructuring of financial agencies Merge all four banking agencies into one new agency Create new agency to regulate all retail financial products No merger of CFTC with SEC because of Senate conflict Current Proposal Better Approach Merge Office of Thrift Supervision into Comptroller Limit new agency oversight to home mortgages, nonbank lenders Merge with joint sub-committee from Agriculture and Banking

Pozen_Toronto_Jan Five key recommendations Stop bailing out so many institutions Adopt a totally different board model Revamp loan securitization process Increase and redesign capital requirements Close gaps in federal regulation

The Global Response to the Financial Crisis: Can We Avoid a Repeat? Thank you. The views expressed in this presentation are those of the speaker and are subject to change at any time.