We need to impose disciplines and practices that will foster reasonable, but not excessive, debt creation. We need a regulatory framework that will get the best out of the emerging financial system and ward off the worst.

To bring some discipline into our financial system:* We should centralize the monitoring and regulation of our financial system. Many archaic, vestigial regulatory agencies should be eliminated. The Federal Reserve should be given enlarged powers with direct responsibility over all major financial institutions. Or a national board of overseers of

financial institutions should be established that will monitor them and issue prudential guidelines.

* Financial institutions should be required to disclose more information. Assets and liabilities should not be netted out. Off-balance-sheet items should be prominently displayed. Assets should be stated at the lower of market value or cost. Losses would then be quickly recorded.

* Equity capital should play a larger role in financial institutions.

* Tax and regulatory policies should foster the growth of equity rather than debt. In this connection, there should be no tax on dividend income and on capital gains from equity investments.

* It is time that we recognize the power of international capital flows and the blurring of national borders through the globalization of finance. Variations in financial deregulation and standards among countries are quickly arbitraged by financial participants.

The highly deregulated U.S. financial market and the more restricted international markets encourage U.S. dollar financing and greater activity of foreign institutions in the U.S. markets, while U.S. institutions' access to foreign markets is more limited.

To think of financial institutions as being confined within national borders, and to regulate them in this framework, is unrealistic. A new official international institution should be established consisting of the representatives of the leading industrial nations.

This institution should have the power to, among other things, set uniform accounting, capital and reporting standards for major financial institutions. Without this new framework, national monetary policies will be increasingly handicapped and the debt problem will become more intense and complex.

These proposed changes for reforming the domestic and international

financial system would provide improved footings for dealing with some specific problems confronting us - especially the debt problems of the developing countries. Developing country debt is still a major burden to

financial institutions and a threat to the international financial system, as well as a drag on world economic growth.

The current rescheduling of developing country debt while adding new loans has staved off a widespread liquidity crisis, but the more basic solvency issues persist. Consequently, there is a need for a new approach.

This approach must provide a means for restoring the creditworthiness of debtor countries, so that they can again access markets voluntarily. It must avoid the "moral hazard" problem - that is, rewarding countries that have not undertaken significant adjustment measures or that do not need debt relief. Losses incurred on existing obligations must be shared in a manner that is perceived to be equitable.

There have been many proposals for providing debt relief to the developing countries, but none has attracted widespread support. This is principally

because they have not dealt effectively with the need to combine debt relief with the provision of new sources of finance for the developing countries.

Moreover, U.S. commercial banks have had little incentive to engage in any practice that involved writing down the value of outstanding loans, mainly

because of adverse tax and regulatory treatment.

Nonetheless, a plan to securitize a portion of bank loans based on a more realistic valuation of developing country loans would provide important advantages: It would make the balance sheets of the commercial banks more liquid and provide the basis for attracting new investors. Accordingly, the starting point for providing meaningful debt relief would be to clarify - and most likely change - tax and regulatory treatment.

Specifically, U.S. commercial banks would not need the assurance that losses incurred on developing country loans resulting from securitization would not damage earnings or capital so severely that renewed lending to these countries would be ruled out. For example, if the value of outstanding loans was written down - perhaps on a mark-to-market basis - the losses could be taken over a number of years.

The plan could be created along the following lines: There is currently a secondary market value for outstanding loans to developing countries. For those countries judged to be making an internationally acceptable effort to adjust - as evidenced by a standby arrangement with the International Monetary Fund or a structural adjustment program with the World Bank - the commercial banks could convert a portion of their essentially non-marketable loans and loan participations to marketable securities.

The face value of these securities would be equal to the secondary market value of the original loans. This would provide debt relief to developing countries equal to the difference between the original value of the loans and the face value of the new securities. This amount also would represent a loss to the banks that could be amortized over the life of the security - assuming the appropriate regulatory changes are made.

Under this plan, annual eligibility for debt relief through the securitization process would apply to only part of each country's outstanding obligations. Subsequent relief would depend upon their adjustment performance as determined by the international institutions, which would give the debtor countries an incentive to continue these efforts.

To lessen further the risk of moral hazard, eligibility for debt relief also could be conditioned on the willingness of the debtor country to allow creditors to swap holdings of debt instruments for equity participations.

Despite the debt relief provided by this plan, the debtor countries would not be restored to creditworthiness initially. As a result, the securitized debt still would tend to trade at a substantial discount to face value in the early years.

Therefore, to induce investors to hold these securities, some form of guarantee would be helpful. Such a guarantee need not fully cover the face value of the new security but rather might only cover longer-dated payments.

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