FRBNY's Bill Dudley On The Challenges Ahead, And On Facilitating "Financial Literacy" In Puerto Rico

William C.
Dudley, President and Chief Executive Officer New York Fed

Remarks at the Center for the New Economy 2010 Economic Conference, San Juan, Puerto Rico

Thank
you very much and good morning. Although this is my first visit to
Puerto Rico in my current role, I have been here a number of times,
going way back to a childhood visit with my parents. It's a beautiful
and special place, but I must admit that coming in February has some
special advantages.

I welcome this opportunity to talk with business leaders,
workers and educators. My goals are to hear what issues are on the
minds of people here and to let you know what the Federal Reserve has
been doing to help improve the economy. So I'm very grateful to the
Center for the New Economy (CNE) for giving me the opportunity to speak
to—and learn from—you. As always, what I have to say reflects my own
views and not necessarily those of the Federal Open Market Committee or
the Federal Reserve System.

I want to start by talking about the
implications of the close economic ties between the mainland and Puerto
Rico. Since the economies of the mainland and the Commonwealth are very
tightly linked, what happens on the mainland has important consequences
for Puerto Rico, as well. In the aftermath of the financial crisis, we
anticipate that the mainland recovery will prove to be sustainable, and
that this will ultimately benefit the economy here. But Puerto Rico
faces some significant challenges beyond its ties to the weaknesses in
the broader U.S. economy, including problems in its own financial
sector. Dealing with these problems forcefully and expeditiously is
crucial to ensuring that Puerto Rico benefits fully from the expected
economic recovery over the next few years. The Fed is assisting in
several ways: by setting the stage for a resumption of world economic
growth, by helping to resolve problems in the U.S. mainland and
Commonwealth financial sectors and by partnering with Puerto Rican
groups to make meaningful contributions toward resolving some of the
Commonwealth's other underlying issues.

Puerto Rico's Special Economic Relationship with the Mainland
Puerto Rico has what economists often call an “open economy.” What this
means is that Puerto Rico is especially dependent on external trade, so
what happens to the Puerto Rican economy is greatly affected by what is
going on with its major trading partners. When demand from Puerto
Rico's export customers is weak, then sales and prices for the
Commonwealth's products fall, so jobs and incomes on the island suffer.

In
the recent recession—as in many financial crises—global trade declined
even faster than output. As a result, the shock generated by the
financial crisis spread quickly throughout the world. Economies and
regions far from where the problems began suffered. This was especially
true for economies dependent on trade, such as Puerto Rico's. In fact,
Puerto Rico suffered much more than most because the Puerto Rican
economy was already in recession when the financial crisis struck.

While
Puerto Rico interacts with many other economies, one partner looms
especially large for the Commonwealth. For generations, the mainland
United States and Puerto Rico have had a special economic relationship
in many dimensions. One of the most obvious of these ties is the free
flow of people between the mainland and the island. Indeed, according
to the U.S. Census, about one half of the people who identify their
origin as Puerto Rican lived on the mainland in 2008. The active
migration, return migration and remittances to family members reflect
and reinforce the close personal and economic ties between Puerto Rico
and the mainland.

Another link is our common use of the dollar.
This means that tourists from the mainland can visit without worrying
about changing currencies. In addition, businesses can make long-term
investments in Puerto Rico without worrying that currency fluctuations
against the dollar will undermine their competitiveness. It also means
that when the U.S. dollar falls in value, Puerto Rico's exports become
more competitive around the world, although not, of course, in the
United States.

Somewhat less obvious are the consequences of the
mainland's role as Puerto Rico's largest trading partner. The mainland
accounts for half of the island's imports and three-quarters of its
exports. With such heavy trade flows, when the mainland economy does
poorly—as during the past year—Puerto Rico's economy and job growth
suffer.

Financial regulation also represents an important
linkage. Of course, my presence here representing the New York Fed is
one example of that particular connection—Puerto Rico is part of the
Second District of the Federal Reserve System, along with New York, the
U.S. Virgin Islands and parts of New Jersey and Connecticut. I'll
return to the theme of financial regulation shortly. For now, let me
just say that we share, along with the rest of the world, a commitment
to taking the necessary steps to prevent the type of financial crisis
that we just experienced from recurring in the future.

The Fed's Role in Coping with the Crisis and the Outlook for the United States
The
close ties with the mainland means that the broader outlook for the
United States is very important for Puerto Rico. The U.S. economy has
been through a terrible period, having suffered the worst financial
crisis in 70 years. Extensive study of banking crises shows that they
tend to be “protracted affairs” with surprisingly similar, if
unpleasant, contours. Downturns average four years, during which the
unemployment rate rises an average of 7 percentage points. The
peak-to-trough decline in output averages 9 percent.

Those
statistics point out the risks that we faced. Well aware of the threat
of a second Great Depression, U.S. policymakers took very aggressive
actions to support economic growth in 2008 and 2009. The Fed provided
liquidity facilities and took many other actions to contain and reduce
pressures in financial markets, while the U.S. Treasury supported the
banking system and provided cash and incentives to households,
businesses, and state and local governments to support spending during
2009.

The Fed's “lender of last resort” interventions—including
facilities such as the Term Securities Lending Facility (TSLF) and the
Primary Dealer Credit Facility (PDCF), as well as programs such as
reciprocal currency agreements—are examples of the rapid application of
central banking tenets to the unique challenges we faced as this crisis
evolved. Indeed, in many ways, the crisis has underscored why the
Federal Reserve was created almost a century ago: to provide a backstop
for a banking system prone to runs and financial panics.

Where it
proved necessary and feasible, the Fed also used its emergency lending
authority to forestall the disorderly failure of systemically important
institutions. These actions truly were extraordinary—well outside the
scope of our normal operations—but our judgment was that not taking
those actions would have risked a broader collapse of the financial
system and a significantly deeper and more protracted recession. Faced
with the choice between these otherwise unpalatable actions and a
broader systemic collapse, the Fed, with the full support of the
Treasury, invoked its emergency lending authority and prevented the
collapse of certain institutions previously considered to have been
outside the safety net.

Make no mistake: these necessary moves
were unprecedented and controversial. The U.S. government's financing
of Treasury's actions required federal debt to rise sharply, and
stabilizing the financial system temporarily boosted the size of the
Fed's balance sheet.

The final numbers aren't in yet, but it now appears that the downturn
in real gross domestic product (GDP) in the United States lasted about
a year and a half, much shorter than the typical banking crisis
downturn. Peak to trough, output fell about 4 percent, less than half
the typical decline seen in past financial crises. While there are
still some significant downside risks to the economy, in general, the
outlook is improving. Of particular note, the capital markets—except
for certain securitization markets—are now generally open for business.
In addition, the big banks in the United States have been able to raise
a large amount of equity capital to put themselves in a stronger
position. I believe that Federal Reserve actions over the last year and
a half have contributed very substantially to this improvement.

But there still is a lot of work to do. Smaller
banks—especially those with large commercial real estate exposures—are
under pressure, while households and smaller businesses find that their
access to credit is still constrained.

Moreover, regulatory
reform is essential to prevent this type of financial crisis going
forward. We need to ensure that no financial institution is “too big to
fail.” This means we need Congress to enact a resolution mechanism that
allows large, complex financial firms to be wound down smoothly,
without the need for extraordinary interventions. In addition, we need
to take steps to make the financial system as a whole more resilient
and robust. This requires many steps—some already in train—including
higher capital requirements for large banks, bigger liquidity buffers,
and changes to ensure that compensation practices are consistent with
safety and soundness and financial stability. It's a long list—there is
no single silver bullet—and it will take time, but the regulatory
community and the political leadership will fail to meet our shared
responsibility as stewards if we do not implement the necessary reforms
in a timely and effective manner.

Outlook for the Recovery and Risks from the Financial Sector
The
U.S. economy has begun to recover. Growth in the second half of 2009
was a bit stronger than expected and the pace of layoffs has
diminished. We currently expect that the economy will keep expanding,
but at a somewhat slower growth rate than during the second half of
2009 as the temporary boost from the inventory cycle fades and the
effects of the stimulus bill gradually weaken. With modest growth, we
expect price pressures to remain well contained.

Nonetheless,
it's far too early to pop the champagne corks. While the U.S. economy
is growing, unemployment remains unacceptably high and certain
impediments could restrict growth in the near term. One set of
challenges are current conditions in the financial system.

The
initial stages of the financial crisis have been widely attributed to a
rapid rise in residential mortgage defaults. Many large financial
institutions turned out to have direct exposure—and often indirect
exposure through complex linkages—to residential real estate, and found
themselves facing severe funding problems as the value and liquidity of
their assets sharply diminished.

As the real economy slipped into
recession in 2008 and unemployment began to rise, other financial
instruments came under stress, including commercial real estate loans
and instruments based on these loans. Commercial real estate loans are
frequently originated by medium-sized regional banks that have
significant expertise in their local areas and are often held in the
lending bank's portfolio.

In many parts of the United States,
including Puerto Rico, these commercial real estate loans have now
soured, and many banks are seeing the value of their assets decline and
their revenues shrink. In extreme cases, some banks have become
insolvent. Finding ways to address problem assets and the health of the
exposed banks is fundamental to restoring the banking industry to the
firm footing that is needed to properly support economic growth.

To
bring this point home, let me step back and offer some observations on
the importance of a well-functioning financial system. A healthy
banking sector is crucial for economic growth because banks and other
parts of the financial system play a key role in determining how
savings are allocated among competing projects and users of credit. If
households and businesses cannot get credit on reasonable terms, then
the economy sputters. To underline this point, the Fed and Treasury did
not intervene during the recent crisis to save the financial system
(and with it, some big financial firms) for its own sake. We intervened
because a collapse of the financial system would have done irreparable
harm to Main Street. With the limited tools at hand, we made our
choices (often between unattractive options) with the goal of
supporting the economy, households and small businesses.

A
well-functioning financial system is also crucial in fostering economic
development. History shows that substantial risks to the economy come
from a persistently weak banking sector. Economists have debated
whether healthy banks drive real economic growth, or vice-versa, but a
wealth of recent evidence suggests that the causality runs at least
partly from banks to growth, and not just the other way around. So,
from my perspective, getting Puerto Rico's banking system back onto
solid footing is “job one” for supporting growth here.

Preparing Puerto Rico to Benefit from Recovery in the World Economy
Of
course, that isn't the whole story. Growth may also be impeded by
factors that are specific to particular regions or policies.

I
work in New York and live in New Jersey, where we know a thing or two
about fiscal problems. Puerto Rico's large public debt has the
potential to reduce its growth prospects as the world economy recovers.
Puerto Rico's fiscal situation has deteriorated sharply over the last
five years as the Commonwealth's recession has deepened. Throughout
this period, public debt has risen quickly as revenues that are
sensitive to economic activity—such as income taxes—have declined.

But
the fiscal problem in Puerto Rico pre-dates the current crisis. Even
when the economy was growing, public debt was growing even faster. This
structural imbalance is difficult to sustain in the long run, and
requires attention if Puerto Rico is to prosper.

A critical
factor here is ensuring that the Commonwealth's tax system is designed
to generate the revenue required to sustain government operations.
Furthermore, any good tax system should satisfy three important
criteria: simplicity, fairness and neutrality. The current system
suffers from some problems that make it difficult to meet these tests
and generate adequate revenue. In particular, high rates are levied on
a narrow tax base.

One of the key public services funded by these
taxes is education. Workers need skills to produce the complicated
technological products of the future. There is clear evidence that
workers with the sort of flexible thinking skills not easily duplicated
by computers have seen their productivity and earnings rise, a trend
that is likely to persist in the future. Thus, technology and skills
are essential for healthy economic growth and for the financial health
of workers and their families.

As the economy and financial
system become more complex, financial literacy is also increasingly
central to family financial well-being. Improved understanding of
budgeting, saving, financial products and planning for retirement is
not only a high priority for people in their own lives, but also for
the Fed with its responsibility for monetary policy.

Education
thus plays a key role in fostering upward mobility for future
generations. All of this underscores the importance of achieving the
best possible education for all of Puerto Rico's young people and
making lifelong learning and skills development a part of everyone's
future. Yet, about half of Puerto Rico's low-income students drop out
of high school. Reducing this dropout rate will not be easy, but should
also be a priority for the Commonwealth.

The private and public
sectors both need accurate, timely and comprehensive economic
statistics to perform effectively. It is impossible to make good
decisions without a solid factual basis for those decisions. For
example, the government needs good economic information to develop
effective fiscal, economic development and regulatory policy. Likewise,
to make the best production, investment and pricing decisions,
businesses need accurate and timely information on things such as
wages, income and prices. Poor quality information increases
uncertainty and this uncertainty inhibits well-considered risk-taking
and investment decisions.

Although Puerto Rico's statistical
system was once a model for other countries, now there are major
opportunities for improvement in comparison with the mainland and other
countries. In recognition of this need, the government of Puerto Rico
recently established the Institute for Statistics to work with its
statistical agencies.

One key example of these efforts concerns
the Consumer Price Index (CPI) as a measure of inflation. A recent
study by the Institute, aided by the Department of Labor, found that
the island's official inflation rate was overestimated by more than
double between 2001 and 2006. Overestimating inflation can have
tangible consequences, such as excessive wage increases in certain
sectors that can damage the island's global competitiveness and cause
unnecessary job loss.

Also thanks to the Institute, the government of Puerto Rico now has a release schedule, called the “calendario,”
for its statistical publications. This basic tool helps people,
businesses and investors by ensuring that they use the latest available
data for their decisions. It also boosts confidence in the data, which
reduces economic uncertainty.

How the Fed Is Helping
There are many challenges ahead, and we are committed to being an
active partner in confronting them. The Fed's most important roles in
helping Puerto Rico, of course, emanate directly from our
responsibilities for economic growth, stable prices and a resilient
financial system. We continue to take the actions required to promote
maximum sustainable growth in the U.S. economy. These efforts have and
will continue to benefit the mainland and the Commonwealth.

In
addition, we are working very closely with all of the banking
supervisors and other key parties to facilitate an effective resolution
to the current problems facing the island's banking sector. Some
consolidation is likely needed to produce stronger, healthier
institutions more able to make the sound lending decisions that support
economic growth.

Let me also tell you a bit about how we are contributing “on the ground” here in Puerto Rico.

I mentioned financial literacy a few minutes ago. The Federal
Reserve System and the New York Fed have taken a great interest in
economic education and financial literacy and will continue to do even
more in the future. I, personally, believe that financial literacy is
essential so that households can make the type of good financial
decisions that help to ensure better futures.

The New York Fed, along with many financial institutions and
foundations in Puerto Rico, has created and supported the Economic and
Financial Education Alliance of Puerto Rico. Over the past ten years,
the Alliance has trained more than 400 high school teachers in
economics and financial literacy. I would like to personally thank all
the institutions whose devotion to this Alliance has made these
education efforts possible.

These teachers take what they learned back to the classroom
and many of their students enter the Federal Reserve Economics
Competition. The students apply analytical skills to a local problem of
their choosing and work as a team to create a presentation outlining
their solution and responding to questions. The winning team develops
skills—in analysis, presentations and teamwork—that will help them in
their future studies and careers in the knowledge economy.

The New York Fed is also supporting the Office of the Commissioner of
Financial Institutions in its two-week expo, where last year 20,000
people saw presentations and received financial counseling.

We have also had a productive relationship with our good
friends at the Puerto Rico Bankers Association. Each year during
“Community Reinvestment Act Week,” our staff highlights new ideas and
products especially suited to the Puerto Rican market.

For
example, this November we held a forum for Puerto Rican and U.S. Virgin
Islands financial institutions, state and local governments, and
nonprofit organizations to introduce “Bank On,” a financial product
proven to attract under-banked people into the financial mainstream.
Since then, several local banks have formed a group to explore how to
best implement it here.

Another example of collaboration is our
work with the Bankers Association and local universities. During the
fall, we held a “Financial Awareness Video Contest” for college
students. This pilot project explores building peer-to-peer financial
awareness among young adults by having contestants create a 90-second
video. We look forward to hosting the first place winners during their
trip to New York in the spring.

To improve our understanding of
the Puerto Rican economy, the New York Fed has joined a group of local
businesses—including some represented here—to sponsor and fund a
household survey, undertaken by the Center for the New Economy, our
hosts today, to benchmark Puerto Rican consumer finances. As of today,
the data have been collected and Fed economists are collaborating with
the CNE to provide technical assistance, to make the results of this
study public and to make these data available for further research.

To
help businesses and government in Puerto Rico, we have also been
providing technical assistance to Puerto Rico's new Institute for
Statistics. We recognize the importance of this work and applaud its
efforts to improve Puerto Rico's inflation measures, national income
accounting and business activity measures, just to name a few.

All
of these activities, from monetary policy and financial regulation to
fostering community development and economic literacy and measurement,
complement and reinforce each other. Our policy actions are most
effective when people understand how financial markets work. Our
decisions are always better when we are well informed about the
concerns of families and businesses. Thus, outreach to the region and
communities we serve is an important part of my job. Thank you for your
kind attention. I would be happy to take a few questions.

Comments

[E pluribus unum]

Well now there are 400 Puerto Ricans who know that the Fed is fucking the American public. 300 million more and maybe we can audit the Fed.

[mikla]

Actually, that's 400 Puerto Ricans indoctrinated to accept and support what the Fed is doing.

Economics, as presented by the Fed, is a discussion of how Central Planning is A Good Thing.  The Fed should exist, should fiddle, and should even have more tools to fiddle.

You can call it "Economics" if you want, but it's mere policy indoctrination.  Sadly, these "trained" people are likely now more stupid (or more wrong) than when they had no indoctrination.

[Anonymous]

Bingo!

[Dixie Normous]

No problems, nothing wrong here on the mainland, I'm gonna go lecture them there Puerto Ricans on financial literacy.

What a tool.

[Hephasteus]

Oh LUCY you got some conomy splaining to do!!

[Anonymous]

3 words for bill dudley: fuck you asshole

[Ripped Chunk]

+ !

I think the Fed is trying some of the ideas Apple designers used a while back:  Take some acid and see what concepts come to mind.

[buzzsaw99]

They did it for the people, not for the bonuses?

[Anonymous]

Puerto Rico has what economists often call an “open economy.” - Yes, but open mainly to the flow of drugs. And you do need aspiring cartel members to have some basic fiscal literacy, i.e. don't blow all your "blow" on bling (unless we're talking real gold bars) and 24" rims, put some in your Roth IRA and s**t like that.

[Anonymous]

"It's a beautiful and special place". Just don't leave the resort area Dudley because according to every person I have ever talked to who has lived there, once you leave the beautiful resort areas it is a real "special place"!

[slovester]

"Facilitating "Financial Literacy" In Puerto Rico"

I 'spose that means the goal is to teach those misguided folks that they need to be spending the same dollar ten times over, just as their more "educated" bretheren in the the continental US do.

[Anonymous]

"It's hard to get a man to understand something if his salary depends on him not understanding it." - Upton Sinclair.

[carbonmutant]

 Obama gave presentation on financial literacy in Nevada today.

He showed how to save the Housing Markets in the 5 hardest hit states with only $1.5 Billion.

Voters were encouraged not to look at this as a bribe to vote for Harry Reid.

[Anonymous]

As a Puerto r r ican that has been reading this and other blogs for a year or more, I find surprising that the Federal Reserve includes Puerto Rico in any of their "Remarks". Puerto Rico has a GDP of $88Billion, a budget of $9.6B and Tax revenues of $6.7 Billion. Employs 200,000 people in government to offer a terrible service to a population of 4 Million; and the unemployment continues rampant at 16%, highest in the country. Estimating a salary of $20k per employee, 60% of the tax revenues goes to public employees’ salary. The people cheat on their taxes and our local IRS SUCKS. The leaders in gov are all trying to get advantage of their power for personal purposes. The residents live on credit on a day to day basis. I have started to believe that Puerto Rico is a model, an experiment of strategies that could be implemented in the US.

Anyways, that’s it for the bad things. The good things are that we have the warmest people, best parties, most drunks per capita, best beaches, best boxers and best Supply Chain Drug Dealers in the world. Gotta love my territory.

[Tom123456]

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