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. BIS Review 18/2010  3  To bring this point home, let me step back and offer some observations on the importance of a well-functioning financial system.
HB: What needs to be changed? Trichet: We certainly do need change in Europe – fundamental change. Not only in the area of surveillance and monitoring of fiscal policy, but also as regards structural reform policies and competitiveness policies. HB: Examples? Trichet: We need to improve drastically everything: the quality of the diagnosis and recommendations by the Commission, much more stronger procedures – and where necessary automatic procedures and tools – to prevent ex ante bad policies, and much more effective sanctions ex post. I will make all these points with the greatest energy in the Van Rompuy Committee. HB: Will the measures adopted by the ECB now dampen growth in Europe? Trichet: No. It is a complete fallacy to say that fiscal soundness dampens growth. It is exactly the contrary. It is the absence of fiscal credibility which dampens growth. Medium term sound and credible fiscal policies are a major prerequisite for confidence. And confidence of the households, confidence of the entrepreneurs and confidence of the investors is what is indispensable for the recovery. HB: Did you ever think that you would have to take such difficult decisions as President of the ECB? Trichet: I have had to take difficult decisions throughout my career – including as President of the Paris Club in the 80’s and Chairman of European Monetary Policy Committee in the 90’s as well as Governor of the Banque de France.