FROM THE OFFICE OF PUBLIC AFFAIRS

Over the last eight years, I have spent a fair amount of time working to promote improvements in financial disclosure practices so that shareholders and creditors receive more meaningful information about the extent and nature of the risks they incur. For all the time I spent in central bank working groups on accounting and disclosure, we somehow never managed to get much media attention for our recommendations. Accounting and disclosure rules just don't seem to rise to the level of sufficient public or journalistic interest. That's unfortunate. It is unfortunate because the thread which connects the events that do seem to get me in the news is the failure of our financial accounting and disclosure practices to keep pace with the rapid evolution of our capital markets and corporate finance.

Today, I am going to ask you to help improve the entire process by which we establish norms of behavior for financial accounting and disclosure. If you in the life insurance industry - with the trillions of dollars of assets that you invest and the long investment horizon that is a function of your liabilities - if you join this effort then we might finally make some real progress. If you don't, and if we don't make real progress soon, then I fear that the financial catastrophes of recent years will continue to haunt our financial markets and questions will continue to be raised about our system of investor-based capitalism on which our economy depends.

Last week, President Bush asked Secretary O'Neill to lead two efforts. First, the President asked the Secretary to work with Labor Secretary Elaine Chao and Commerce Secretary Don Evans to review all of the rules and laws that govern pension plans and retirement investment programs to determine whether changes need to be made to protect employees' retirement savings; they, in turn, have directed the staffs of the Treasury, Labor and Commerce departments to work together to analyze the effectiveness of all retirement security protections.

Now as Secretary Evans made clear: "Our number one priority is the security of the retirement savings of America's workers." And that's why the first effort President Bush directed is focused on pension arrangements and 401(k) plans.

President Bush also asked Secretary O'Neill to lead a working group, comprised of the Treasury, the Federal Reserve, the S.E.C. and the C.F.T.C., to look at corporate disclosure rules and regulations as they affect all investors and the workings of our capital markets. It is this second effort that I want to talk about this morning, focusing on why you should help.

As a society, we face a tremendous challenge. Some how we are going to have to pay for our collective retirements. If we don't start saving more - a lot more - we will end up paying for our retirements in the form of lower standards of living than we otherwise could achieve. For you this is an opportunity.

I am an optimist. I think we are going to find a way to transform ourselves from a nation of consumers to a nation of savers. I think we are going to find a way to put aside the trillions of dollars that we still need to save to pay for my generation's extended life expectancy. This is your opportunity - and your responsibility.

The American people are relying on you to manage our savings and our economy. In our system of investor-based capitalism, you - your asset managers - are managing our economy through the capital markets. Now, I'm a capital markets kind of guy. So I want to be clear that I think it's great that you, and other financial intermediaries, are making most of the investment decisions that drive our economy. I would not have it any other way.

But there is still a standard to which you need to be held and a responsibility that you have to make sure that the system you manage - the system of institutional money management - works on behalf of the shareholders, pensioners, retirees, employees and policyholders whose savings are at risk.

For capitalism to work, the people who control capital have got to behave like capitalists. This means that they need to compete vigorously with one another and they need to care intensely about where and how the capital they control is invested. I want to focus on the second part of this - about caring intensely where and how capital is invested - but let me first touch on the issue of competition.

The objective that we, as a capitalist society, have for our financial services industry is that you continuously improve the efficiency with which our savings are converted into productive investment. The means through which we hope this happens is for each of you to strive to increase your revenues and your profits. However, the end that we are expecting you to achieve, through vigorous competition, is a continuous decline in your collective profits as a share of our savings. It is fine if financial intermediaries' total profits grow in nominal terms but - as a rough approximation for improving the productivity of the intermediation between savings and investment - your profits should grow a little less rapidly than our national savings. This will be the simplest indication that we are improving the productivity of capital itself.

I am sure that you can do even better at competing with your colleagues around the room and with other financial institutions. But I am reasonably confident that you, the leadership of your industry, have sufficient incentive to do so.

My greater concern is whether you are doing enough to make it possible for your individual portfolio managers to behave like real capitalists - to care and care intensely about where and how the capital they control is being invested - by improving the quality of the information they rely upon.

Within your organizations, whose job is it to get up everyone morning and work to improve the accounting and disclosure practices of all the companies in which you invest? Your portfolio managers may think it is their job to scrutinize the disclosures of individual companies. But I doubt they feel much responsibility for the state of accounting and disclosure practices, in general. They are too busy trying to beat the benchmarks that you have set for their performance. I suspect the same holds true for their managers and your risk managers as well.

Your accountants and auditors see their jobs as applying the existing rules, not questioning them. Your chief investment officer may spend some time thinking about the implications of accounting rules for performance and, perhaps, sitting on some industry committee that is pondering accounting principles, and pondering and pondering. Your chief financial officer may spend some time on accounting and disclosure practices. But I fear that the prospect of applying new rules to your own balance sheets and income statements may dampen your CFO's enthusiasm for any radical improvements in transparency to your shareholders.

In the division of labor within the institutionalization of asset management, too many actors have the assignment of accepting the status quo accounting and disclosure regime; too few see it as their job to work systematically to improve the quality of the information you have about where and how the capital you control is invested. So while developments in our capital markets, corporate finance and risk management are racing along at 100 r.p.m., the evolution of our accounting and disclosure regime crawls along at 10 r.p.m. and the gap between them is forever widening.

If I sound a little frustrated, I am.

In 1994, I chaired a working group of G-10 central bankers who recommended that all financial intermediaries - regulated and unregulated - move to disclosing more meaningful information about the risks they incur and their risk management practices. We did this work in the spring and summer of 1994, following the sell off in G-10 bond markets and the decline of the dollar after the Fed's tightening of monetary policy - but before Orange County and long before Long-Term Capital Management. While our work was directed at financial intermediaries, I hope you will agree that, today, these words might apply equally to almost any major corporation. So in light of recent events, humor me while I read you several paragraphs from our 1994 report:

"For shareholders, creditors and counterparties in financial markets to allocate capital efficiently, they need to be able to assess the risks to which firms are exposed and which, in their view, should be reflected in share prices, funding costs and credit decisions.

"The use of derivative instruments has added diversity and complexity to firms' financial assets, liabilities and off-balance sheet commitments. This has rendered the assessment of their risk exposures more difficult. At the same time, derivative instruments have provided firms with new opportunities to assess, price and manage increasingly refined elements of financial risk. The development of methodologies for assessing the riskiness of portfolios or trading positions has increased firms' ability to assess and understand their overall risk exposures.

"However, the evolution of trading and financial risk management practices in recent years has moved well ahead of public disclosures of financial information made by most financial firms. As a result, a gap exists between the precision with which a firm's management can assess and adjust the firm's own risk exposures, and the information available to outsiders to help them assess the riskiness of that firm's activities. Indeed, market participants are increasingly aware of the contrast between their increased ability to assess and manage their own financial risks and their relative inability to assess the riskiness of other market participants on the same terms.

"The lack of transparency of financial intermediaries' trading and risk management activities can cause a mis-allocation of capital among firms and can also amplify market disturbances. When the riskiness of firms' activities are not apparent to outsiders, the market allocation of capital to such firms is unlikely to reflect their actual risk-return prospects. During episodes of market stress, a lack of information about a firm's market and credit risk exposures can create an environment in which rumors alone can cause a firm's creditors and counterparties to reduce their dealings with the firm solely to avoid uncertainty. This may impair the firm's market access and funding at the very time that these may be critical to the firm's survival."

I could keep going, but I won't.

More recently, beginning in June 1999 I chaired another working group, this time composed of representatives of the Basel Committee on Banking Supervision, the G-10 central banks' Committee on the Global Financial System, the International Organisation of Securities Commissions and the International Association of Insurance Supervisors. Our report, published last April, contained specific recommendations for improvement in disclosure practices based on a pilot study in which forty-four private financial firms, including insurance companies, from nine countries voluntarily provided confidential data from the second quarter of 2000 on broad range of financial risks.

Don't worry; I'm not going to read you anything from this report. I will note that it has not been a best seller. Nor has the world rushed to adopt the recommendations of the report known as "Fisher II". You may also understand why I am not very interested in spending the rest of my career producing reports with statistical appendixes on accounting and disclosure - Fisher III, Fisher IV, etc. - and yet still periodically explaining to my children (and, I fear, my grandchildren) why my name keeps appearing in the newspaper in stories about bankruptcy and derivatives.

We've known for a long time, it's not about derivatives themselves. It is about disclosure - more meaningful disclosure of risk to investors and creditors who are supposed to provide the self-regulating mechanism of market discipline. What I have learned in the last few years is that reports prepared by public servants are not going to make enough of a difference by themselves. If we are going to improve accounting and disclosure practices, the private sector is going to have to do some heavy lifting.

You need to engage in the effort to reinvigorate private-sector standard setting for accounting that responds promptly and clearly to changes in business practices. You need to take responsibility for the efforts to improve disclosure practices so that more useful and meaningful information is provided to all investors so that they, and your portfolio managers, can make investment decisions based on accurate risk-return profiles.

What specifically do I think you should do? For a start, put improving corporate disclosure rules on your company's agenda and think of it as the best investment in risk management for the long run. Meet with your CIO and your money managers and ask them what are the five key pieces of information they would like to have to make more accurate judgments about the equity and debt instruments they purchase. Perhaps the ACLI could come up with your own set of recommendations for improving accounting and disclosure practices.

You also need to support Harvey Pitt, at the S.E.C., in his efforts to improve our accounting and disclosure standard setting process. Harvey spelled out a terrific series of ideas in a piece published by the Wall Street Journal on December 11^th. You should read it and then do something about it.

I am particularly impressed with Harvey's idea that public companies and their auditors could be required to identify and disclose the several, critical accounting principles on which their financial results depend and which involve the most complex or subjective assessments. Under such a rule, investors would be told, concisely and clearly, how the three, four or five key principles are applied and given information about the possible impact of differing applications of these principles to a company's financial results. This is a powerful idea. I can already hear the ankle-biters and apologists for the status quo explaining why we could never do anything this radical or that involved such subjective judgments.

I hope that the working group that Secretary O'Neill is leading will consider as many of Harvey's ideas as possible, as well as others, and lay out a way forward so that we move beyond investor protection to investor empowerment, in the sense that knowledge is power.

As Secretary O'Neill has explained, there are a number of investigations going on into the events surrounding the bankruptcy of Enron, and if rules were broken, rule breakers should be punished; if rules were bent, we should improve the means of enforcing those rules; and if loopholes were used, new rules should be written.

My own experience over the last decade has taught me that if we are going to do anything to reduce the risks of financial catastrophes and make real improvements in our financial system, we are going to have to concentrate our efforts on the rules that govern accounting and disclosure practices of all the companies in which the savings and wealth of the American people are invested. If we are going to have any chance for success, the institutional asset managers like yourselves, who control trillions of dollars of investment, are going to have to care and care intensely - and you are going to have to act.