How Insurance Works

“Ten Years After the Financial Crisis” Conference at Georgetown Law

– Okay. Okay good morning everyone. I’m Bill Treanor. I’m the Dean of Georgetown Law and it’s a privilege to welcome you to 10 Years After The Financial Crisis, Closing Loopholes and
Avoiding Blind Spots. Actually if I could have
everyone’s attention. We were originally going to
have as our opening speaker Paul Volcker who’s of
course two-term chair of the Board of Governors
of the Federal Reserve and one of the great figures
in the history of the country but we just found out that
for reasons of health, he would not be able to be here today. So please keep him in your thoughts and we’re here beginning a little late but it’s really it’s an
extraordinary program and it’s a topic of the greatest import. As I was I was coming in today, I was thinking back on 10 years
ago when I was in New York and I think everybody can remember it was a time of almost palpable panic. I lived in Manhattan and I just remember in the second half of
September and October, walking down the streets
and how eerily quiet it was, people weren’t shopping, they
weren’t going out to eat. There was a sense that we were on the cusp of a Great Depression and
it affected everybody. I think every sector was
grappling with the day that Lehman Brothers filed for bankruptcy, the Dow went down four and a half points, later in September it went down
actually basically this day, 10 years ago the Dow
went down seven percent and we all thought this might
be the next Great Depression. It didn’t just affect finance, it didn’t just affect industry. I remember meeting 10 years
ago as a university leader where we thought we budgeted on the basis of endowment spending out and now, not only is the endowment cut in half but under state laws we
can’t touch the endowment because all of the
accounts are underwater. So every great university
in the country was thinking are we going to be able
to pay make our payroll? Are we going to be able to
pay the people who work here and if we can’t, what happens? So it was something that was pervasive and powerful and touched everyone and has had an extraordinary
legacy for a decade. It obviously has transformed economics, it’s transformed economic regulation. It’s transformed politics. Most of the commentators think that the people who lost out in
2008 who have never come back. Industries, sectors of the
country, vulnerable people were the key to president
Trump’s election in 2016 but I think it was also the key to President Obama’s election in 2008. I actually looked this morning. If you look at the polls in the first half of September of 2008, actually in most of the polls, Senator McCain was in the lead
in the first half of 2008. He was ahead in by 10
points in the Gallup poll and then after October first
there was then Senator Obama in literally every poll. So it’s had the most
profound economic change, it has the most profound
political ramifications and this is the moment in
which 10 years afterwards we’re now grappling with where are we now. What are the lessons we’ve learned? What are the lessons we’ve forgotten and what’s the path
forward for the economy, for justice, for nation and for the world? And we have really an
extraordinary group of speakers and participants today and I just want to thank
everybody here in this room. It’s really it’s extraordinary for me to look at the list of participants and I particularly want to
thank and I’ll turn matters over professor Emma Jordan. I think we’re all so privileged
to have professor Jordan as a colleague. I’d like a round of applause
for Professor Jordan. (applause) She is one of the great
voices in our time for justice in every dimension she has
fought throughout her career, her career to make this
world a more just place and one great focus of her work, one area in which she’s had
the most powerful influence has been in economic
justice and civil rights. So she put together this
conference brilliantly and it’s a privilege to
call her to the stage to lay our groundwork for the day. Professor Jordan. (applause) – With a brilliant Dean
like that and support, how can you fail? You really can’t. It’s amazing. He’s remembering his
experience in New York which was in fact the center
of the crisis on Wall Street. We know things Dean
Treanor has reminded us of all the cross-cutting impacts of the failure of Lehman Brothers but we also know that there is a period between March of 2008
and September of 2008. Bear Stearns nearly
bailed in 2008 in March and there was a hastily structured rescue in which that firm was
sold to a Wall Street firm, JP Morgan Chase and
the sale was structured to take away all of the bad assets, put them on the government books and give the good assets
at a fire sale price to JP Morgan Chase. This structure was done by way of a trust, it was the Maiden Lane
trust and that trust was an ad hoc structure that was created because at that point, the
government didn’t quite know what its powers were under Section 13-3 of the Federal Reserve Act. So they were just experimenting
and trying to do something that would stave off sure disaster. Now the record of Bear
Stearns at that time showed signs for anybody
who was paying attention, they were doing what is
called taking haircuts on repo transactions. They were taking less
than their ordinary fee. Now you know on Wall Street they don’t leave money on the
table unless there’s a reason and so that fact that Bear
Stearns leading up to this period in March of 2008 was taking these haircuts was a signal that something was wrong and then the intervention
of the government. First there was a bit
of two dollars a share, then there was a bid
when the employee said that’s not even enough to
cover the headquarters building that it went up to $10 a share will be. So we have in fact of a
harbinger of the total collapse with Lehman Brothers
and so this anniversary is one that many in the industry said they could not have foreseen. Let me just remind you
about some of the voices that we heard in this period. There were those who said, oh
we couldn’t have foreseen it. We heard from Prince who
was then head of city bank, oh we couldn’t have foreseen it. There were those who used the
natural disaster metaphor. Even Chairman Bernanke
said in his testimony to the Financial Crisis
Inquiry Commission, he said, “This was like a
storm, unpredictable storm,” and there were others who used the natural disaster metaphor. Well, the Financial
Crisis Inquiry Commission when it published its report said, this crisis was completely unavoidable. Completely avoidable and it
wasn’t a natural disaster. It wasn’t an unexpected storm. It was instead the product of
many variables, many forces. Here, 10 years later our collective memory of the damage caused by
that crisis has faded and that is the genesis
for this conference. I’ll get to introduce Sheila Bair later and my introduction of Sheila,
I’ll give you a preview of one of the things I’ll say about her is she is an unindicted co-conspirator for the creation of this conference. She and I talked and you
know when somebody says why don’t we do X or Y, you should really go on
the opposite direction. Even at my age I was not smart
enough to take that wisdom. I said, sure we can do it and of course we put it together and she
was an important collaborator and supporter of this project. So we were concerned that
an amnesia had set in that the deregulatory philosophy that was so much a cause of
the collapse and of the crisis where the non-banking sector had assets that were higher in value
at one point in 2007. Higher than the regulated banking sector and all of that data is in the Financial Crisis
Inquiry Commission report. So that unregulated sector is
the product of a philosophy. It wasn’t accidental. It was a philosophy and
the philosophy was that markets work and let
them work their magic. There were people from the consumer sector who came to Alan Greenspan
who was chair at that time of the Federal Reserve and told him about the targeting of minority
communities with bad loans, told him about problems that
were cropping up in California and he said that’s not
evidence, those are anecdotes and kept going with the
deregulatory philosophy. And I use the word
philosophy very loosely. It was more like a religion. It was a commitment in the
face of contrary evidence and so Sheila and I are concerned that it appears that crisis amnesia is bringing back the
deregulatory commitments. The Consumer Financial
Protection Board is under attack in its structure and with the departure of the Richard Cordray the
original head of the agency Brickmill Vanie has come in
temporarily to set the agenda but it’s a deregulatory agenda and a commitment to
deregulation is a part of it. You heard the Dean
express our disappointment that Paul Volcker won’t be here but Paul Volcker is a
legendary former chair of the Federal Reserve
and Paul has a rule. You know you’re famous when
the rule is named after you. There’s no rule named after most of us but the Volcker rule is
a rule that expresses a contrary philosophy which is that if you as a financial intermediary are getting insured deposits
as your source of funding or at least one of your
sources of funding, you should not be in the business of putting investments
gambling on Wall Street and so he set up a series of rules that were designed to address that issue. Well, that’s now being rolled back slowly and we’ve yet to see
maybe coming in the future this may be a problem. Let me give you a few facts about what the searing political economic and emotional losses of the crisis that every American has sustained. More than 23 trillion
dollars of wealth disappeared during the crisis years. By 2010, 42 million citizens
had fallen into poverty. This is the largest number
since the Census Bureau first published these estimates in 1959. The San Francisco Federal
Reserve just this summer published a study looking at the crisis and what did they find? The crisis had imposed
losses, economic losses on every single American. Not every family, not every adult. Every single American of $70,000 and it was the judgment
of the Federal Reserve in San Francisco that
this $70,000 of losses would be permanent. So those are the economic losses. The crisis in addition
to the economic losses brought emotional damage. We have the study that was
done by Case and Deaton. They did a study looking
at excess morbidity and mortality rates. Here’s what they found
that there was a pattern of increased deaths. This started before the crisis but spiked during the crisis years. They found that there were
increased deaths from suicide, opioid addiction and
alcohol-related liver disease among middle-aged Whites with less than a high school education. That’s startling. Dean Treanor referred to
the political consequence. This emotional damage is
still there in our society and we are in a state of
amnesia as we go forward that we’ve recovered from the crisis even as new deregulatory
initiatives are being launched. So these deaths of despair
identified by Case and Deaton are a part of the fabric of our nation. We’re in a fragile point in our
politics, need I remind you. Here in Washington as we sit here today, there are consequential
decisions being made about appointments that
show deep fractures in political philosophy, political
commitments in our nation and in our conversation today, we are going to explore whether or not we are headed for another financial panic. There have been valuable
changes that have been made but those changes have not been tested in the crucible of financial panic. So this is a conversation. It’s not intended to be the solution but I’m hoping that our
brilliant contributors, including our moderators who are here representing Georgetown Law Center will in the course of their discussion, produce some ideas that will
be valuable as we go forward. So here are some questions
that we should consider. One of them is will the
Volcker Rule be diluted? Will this pose risk to
the financial stability of institutions with insured deposit? What about one of the interventions and restructuring efforts? The stress test. This was designed to diagnose
institutional weakness, initially to restore public
confidence during the panic. So we have reason to be
concerned about the stress test. Wall Street Journal reported
that some of the largest banks, two of the largest financial institutions were coached to pass the test. That doesn’t give me confidence. I don’t know about you. It didn’t give me confidence
that particular mechanism is one that’s going to be a fail-safe, a protection against future collapse. So the capital requirements, the preparation of living wills, these are all things that were adopted to make sure that we don’t
have another collapse. Well, I want to say that this conference has the unindicted
co-conspirator of Sheila Bair but there is an indicted
co-conspirator sitting in the room and you see the banners, the Institute for New Economic Thinking was a generous supporter and
sponsor of this conference and more than money but we
don’t laugh at the money, more than the financial support, the moral support of the Institute
for New Economic Thinking under the leadership of Rob Johnson. So I want to thank the Institute
for New Economic Thinking and while I’m at it, I want
to thank my Dean, John Mikail was the first one to get
my visit to his office and say how about this
and he gave me free rein to do what I could as long
as it didn’t cost any money. But we managed to pull this together and with the indicted co-conspirator of the Institute for
New Economic Thinking, we’ve been able to make this work. So let me stop and we’ll turn
to the first of our panels, our moderator is Adam Levitin, one of our esteemed colleagues here who is in the field of banking contracts, financial and consumer regulation and I’m sure I’ve left something off. He is prolific. He does bankruptcy, so many things but he is going to lead the
panel and I’ll leave it to him to tell you more about that. But we have a fabulous
day here in store for you. One of the things that I
mentioned to every moderator is be ruthless in keeping the
speakers to their timeslot. Leave enough time for
questions and answers. I want everyone here to
participate in this conversation. I am a senior colleague, aha and I know that when people are involved in subjects about which
they’re passionate, it’s hard to get them to stop talking and so that’s the role of our moderators. Don’t think they’re being rude. They’re following my guidance. So Adam, would you come up and we’ll start looking at the rules. What are the rules that were adopted? Adam knows better than anyone. Let’s give Adam a round of applause and we’ll get started. (applause) Panelists, come up. – So we’re really honored today
to have this wonderful panel batting lead off. We have Rob Johnson who
needs no introduction especially since Emma has
already introduced him. We have professor Edward
Cain from Boston College and we have Jesse Eisenberg from Publica and this panel is really meant to kind of lay some
groundwork for the discussion in the remote where the discussion for the remainder of the day
and there’s a lot of stuff… There’s just so much stuff to cover because the crisis laid
bare a range of problems in US financial markets, in
the regulation of those markets and in the rule of law more generally and Rob is going to start off by providing really kind of a big
picture overview of I think where he thinks things went wrong and the degree to which
we’ve been addressing them then I think the order will be
that Ed will be talking about the madness of doing the
same thing over again and the degree to which we have not, he thinks we’ve not really changed things and I think that some of Ed’s comments set up Jesse’s comment
really about law enforcement and its role in regulation. So with that, I will turn it over to Rob. Do you want to come up here? – While I’m setting up here,
I know there’s a Volcker rule. I don’t think there’s a Johnson rule but there is a guy named
Robert Johnson that has lyrics and so I thought long and hard as I was coming down here last night and everybody on the Amtrak train was watching these hearings
about the Supreme Court and I kind of came to the conclusion that no good deed goes unpunished and I couldn’t conceive of
how with the echoes of history and that yesterday and this today that Emma Jordan was able to
juggle all these dimensions and carry all of this and
I’m very grateful to you. So but the lyric that came to mind from Robert Johnson’s crossroads was, “You can run, you can run. “Tell my friend Willie Brown. “You can run, you can run. “Tell my friend Willie Brown “but I got the cross
blues this morning Lord “and babe I’m sinking down.” Like the Supreme Court and
the Senate Judiciary Committee should be singing that along with me. I wanted to chat with you a little bit. It is haunting that the Supreme Court placed such a large role in rulemaking and rule interpretation
and that sits like a cloud over these conversations
but I think there’s I guess what I want to dwell on here a little bit is the history of how
people came to the place where we are. Let me see if I can make this. This is about a month ago
Steve Bannon was asked what did he think was the legacy of 2008. I don’t know if the font is large enough but said from long-term
credit crisis in the late 90s to the implosion of the stock
market in 2000 on the Internet to then the financial crisis. Every couple of years we’ve
had another financial crisis and they’re building in intensity. The one in 2008 was three
orders of magnitude worse than the crash at 29. So write this down, he was
speaking to his interviewer. The match that got lit
led to November 9th. This was 2016 at 2:30 in the morning when Donald Trump was named
president of the United States. He very clearly believes that
the disintegration of trust and the disintegration of legitimacy and faith in the United States government, was the precursor, was the catalyst that led to Donald Trump’s election. George Soros and I co-founded IET in reaction to the crisis of 2008 and I would say to you
that I don’t often agree with Steve Ban about anything but if I’m pulling back the blinds, we sat together the night
the Trump legislation passed and George said to me, “I grew up in the after-effects “of the Austrian and German
banking crisis of 1931 “and when the best and the brightest, “when the people who are
said to be most disciplined “and farsighted make a
mistake of this scale, “nobody knows what to believe in “and things can come unwound
and we have to do something.” The process went on for a
better part of nine months before we crystallized with
the help of other scholars including George Akerlof who’s here to begin our endeavor. But it’s very hard now 10 years later. John Kenneth Galbraith
wrote a wonderful book I’m gonna recommend to y’all. It’s called, The Short
History of Financial Euphoria and in the book he says, “Everybody makes the same
mistakes, crisis after crisis “but you do get a little window of time. “You get about 20 years
before everybody forgets “what happened previously.” Well, allegedly it we’re at half time but if I watch the
legislative agenda right now it feels like we are
forgetting that half time. We’re accelerating our forgetting but we have a problem in society. When the best and the
brightest are unmasked and when the damage is enormous and when people don’t pay the price, the polluters don’t pay. Tomasa Patia Skillpa gave
our first concluding speech at our conference in
2010 and he talked about how long it took to
sort out the separation between church and state at the time of the Industrial Revolution that led to what I’ll call a scientific administrative technocracy. (country music) ♪ Love what you’re doing ♪ ♪ I’m feeling blue and low ♪ ♪ Would be it be too much to ask of you ♪ ♪ What you’re doing to me ♪ Tomaso concluded his
speech by talking about that there were three types
of sustainability in society. Financial sustainability,
resource sustainability and social sustainability. He sat down next to me
and he had not written the text which is before you. That came a couple months later at the Carl Jacobson lecture
but it was the same speech and he looked at me and he said, “You’re at this conference April, 2010, “everybody’s concerned about
financial sustainability. “It’s all gonna flow into
social unsustainability,” and he sat down. As he framed it in his lecture “The Emperor and Croesus are now fighting “like the church and state
used to have to fight,” and he concludes that
for a successful exit of the present problems can only be found rethinking the relationship
between markets and government in a global world and
that global world peace I think is very important
because the nation-state is not insulated from
things beyond its borders as we all know. (country music) That was Bob Dylan
singing world gone wrong. Sevigny Burzynski gave
a speech in Montreal I attended in 2010. What he said I’m sorry this
font is probably not dark enough for you to be able to see is that global political leadership had become much more diversified particularly with the rise of
China as a geopolitical power and in the context of leadership, the G20 was lacking an internal unity. There were different philosophical
and historical traditions at the table as distinct from the G7 that was largely run by the
Judeo-Christian tradition, the Enlightenment framework
in the North Atlantic and then Brzezinski went on to talk about how the financial crisis
had awakened everyone to the importance of politics and he said for the first
time in all human history, mankind is politically awakened and that’s a totally new reality. It has not been so far
for most of human history. Now what he’s essentially saying and I was there to watch this and you can see it on
film on the internet, he’s saying the capacity of leaders to restore coherence and order
is going to be challenged at precisely the time
when people are anxious about whether there can be such an order and when there is a need for
a reestablishment of order because people are quite happy. So this was my critique. I actually gave this speech to the Tuesday group here in Washington the day after tarp
passed and I talked about how I’ve changed to the past
tense here in the slides but 2008 wasn’t just a crisis
in the financial sector and the money politics the influence of lobbying campaign
contributions and so forth in capturing the rules was very important. By the way this is a little asterisk. It relates to some of the
debates I’ve been involved in in project syndicate in recent days. I don’t think this is
about demonic people. I think this is about systemic failure and whether you’re a
Democrat or a Republican and we all have moral license in the small in between certain cracks but we have a systemic
failure on our hands that was unmasked in 2008
and it is somewhat unfair and I know if Paul Volcker was here today I know Ryan Garthe will be here. I haven’t seen him but I
know he’s gonna join us. We did an event with Paul recently and his view right now
and I’ll come back to this when we join another
panel later in the day. His view right now is that
everybody is so afraid of another financial crisis because the Congress wouldn’t do anything. They’d let us go over the cliff and then the responsibility would fall to the Federal Reserve
which is at the intersection between markets and the body politic and the displeasure that people feel in support of a financial system when people are not
buying municipal bonds, are not buying, supporting the
means to keep police force, infrastructure, schools
and health together leads to a very very high level of stress on the Federal Reserve
and its independence which has been cherished for many years. It would be very much at risk. Paul also said something
very funny to me recently. He said, “When I came to Washington, “there was one five-star hotel “and one three-star restaurant. “Why are there so many now?” but I’ll let him address that. Going back in history, Adam
Smith had some thoughts about when government worked right. Adam Smith who cited as a free marketier he said a government or the
exclusive company merchants is perhaps the worst of all governments for any country whatsoever. Now he didn’t get to watch
the Soviet Union disintegrate before he said that. The proposal of any new law
or regulation of commerce that arises from merchant class ought always beat listened
to with great precaution and I believe both those things should be listened to
and great precaution. At the time, this is
another of my older slide from a work I did with Tom Ferguson comparing the New Deal and now is that the Democratic Party
which administered this bill and has really lost its
mass-based credibility and as we saw when Edward
Kennedy seat went to Scott Brown before Elizabeth Warren
rebounded and took it back. Right after Wall Street
bonuses were paid in 2010, they elected a Republican in Massachusetts and the pollster Selinda Lake
was a good friend of mine, called me and said she’s going down and it’s all about the bank bailouts. (country music) The piece that you see
there’s a graph up here, horizontal axis is voter turnout. To the right side these countries at the time of a financial crisis that had a higher level of turnout. Vertical axis is the
percentage that the labor or Socialist Party exists as a proportion of the body
politic and what we tend to see is that clustered to the
northeast with high voter turnout and the high labor presence
are stronger reforms that have to do with
controlling the moral hazard and too big to fail like issues and this is a scatter
plot of the 30s, the 90s, 2000 Japan in the 90s and 2008. If you look all the way in the southwest corner of
that diagram is one dot. That’s the United States of America with almost no labor or socials party and very very low voter turnout and I think this is not
necessarily a cause, it may be a result but it is symptom of the sickness of our political system. Another thing that is difficult and this also comes from
work with Tom Ferguson. We called it the opportunity
cost of doing good is how regulators are compensated in relation to high income people. Very very sophisticated incapable people working inside the Fed
the SEC and so forth are underpaid and undersupported. I always use the Singapore
government in contrast but you can’t tell people
not to finance their children going to a good college
in the United States and to continue in the name
of the goodness of society to how do I say, just ignore
the fortunes of their family. I don’t think this is to be rectified necessarily by taxing the wealthy but I do think society
would benefit tremendously from support for the not so
much the design of the rules but for the enforcement of the rules. I’ll come back later
today when we talk about what the new rule should be but I don’t think there’s ever
been a better advertisement for the importance of public
financing of elections. When I started in Washington DC in 1984, I worked with Pete Demedici which meant during budget deliberations I got to sit down and talk to Bob Doyle on the floor late at
night and we used to argue about whether public
financing of elections would save money for the American people. I think this crisis alone shows that it could have saved probably decades worth of public budgets
and economic losses. Finally, I don’t want
to be too despairing. I barely found a blues music and the archetype of blues music is a song called troubling
mind and the song goes ♪ Troubling mind ♪ ♪ I’m blue but I won’t be blue always ♪ ♪ The sun’s gonna shine out my back door ♪ ♪ Again someday. ♪ James Cohen, a theologian at
Union Theological Seminary who passed away this year and
a very dear friend of mine talked about in his book, The
Cross and The Lynching Tree. How was it that the wives and
mothers of African-Americans who were being lynched, engaged in reform, they didn’t have recourse
to the police chief or the sergeant or what have you but at one point society, in this case, African-American society decides
it cannot live in indignity and be what economists call rational and as David Brooks says in this article, you’ll fall through the floorboard, you fall to a place where you’re suffering it’s like a coiled spring and
helps the society to overcome what you might call a heinous chapter and I think that’s where we sit right now. Thank you. (applause) Somebody else with an… (mumbles) So somebody that helps with the AB. – That might be me. – I’m not seeing the whole
series of PowerPoints there. – What’s the file called? – Madness. – Let’s just use the flash drive. (mumbles) Probably might get madness three. Okay, the sour and my keep. From the beginning. – Alright, thank you very much. I’m grateful for this help and I’m grateful to be on this program and grateful to Rob especially
for supporting my research on these issues. Let me explain in title first of all. We talk about too big to fail banks and it’s not that they’re too big to fail. They failed in some important way but we’re unable to unwind them. They’re too complex, it just
scares everybody to death who might step in to the
task of unwinding them and so that’s the first point
and next point is madness. We all know the definition
that Einstein gave us of doing the same thing again and again. Now what I’m saying is that
these so-called new rules are only slightly different
from the old rules and just enough to try to
convince us as Emma Jordan said, these are important rules and would really make a difference. I don’t believe this and I’m gonna try to convince you of that. Now my first slide here
just gives you a framework for analyzing the rules that are supposed to come
out of this Dodd-Frank Act which was so incredibly large that you probably had to have a wagon to carry it around the halls of Congress. Anyway every changing regulation or laws has extensible purposes. That’s what everyone is bragging about and hidden purposes
which go unacknowledged and you get punished
even for mentioning them. Now all laws have loopholes
and the capital requirements focus on a ratio of
assets minus liabilities divided by net worth. Each of those definitions,
each of those items is badly full of loopholes. So you can think a little
bit about speed limits. We have very clear laws
here in DC 25 miles an hour unless posted otherwise. Alley seven miles per hour, school districts 15 miles per hour. All right are those the enforce limits? Of course not. There are these bright-line limits and then additional supervisory leeway. So if you’re stopped just
to give you some history I was talking this to George beforehand. As a teenager growing up in Washington DC, the first time I was
stopped by the police, their first question was did you know how fast you were going and say where’s your father work? This was a sexist question. Actually my mother worked in Congress but I didn’t have sense to
understand that question as a 17 year old. I would have answered it
by saying what she did and I would have gotten off. So this is important
to learn these things. So part of it is the norms
of regulatory culture, the regulatory in the United States, the bank regulatory culture is to be friendly to the big banks. To help them out, help them
to compete with foreign banks and to be merciful when
they get in trouble. You’re not supposed to just
step in and punish them when they violate in various ways. In fact you cooperate with them. Now the penalty structure
tells us a lot about it too. Think of the kinds of
penalties you can have. Administrative sanctions, civil liability for the corporations and for the bankers and then criminal exposure and of course in the United States, everything has been this is required for real justice. Yes rights of appeal so
here’s the applications. These complex capital
requirements and the stress tests. The ostensible purpose is what? People been praying, Emma Jordan praised to avoid future financial crises by preventing dividends and stock buybacks from driving bank leverage
to dangerous levels. The hidden purpose is to
bullshit the citizenry about the long-run effectiveness
of these post-crisis tweaks in this basically defective
framework of control. You can make capital ratios
meaningful and higher but you cannot keep them that way. Not in the regulatory culture we have, not in the government we have
here in the United States. So the basic loophole
is in the definitions that are used to deal
with the capital ratios that are supposed to be enforced. What we’re supposed to
have in the numerator the difference between
assets and liabilities, something called loss-absorbing capital. In fact, there are some
bogus intangible assets such as tax loss, carry forwards and core deposit intangibles
that are not available in case of a creditor run. They’re not being used. So if you trying to measure
the ability of institutions to withstand risk and runs which is always a bomb in banking, banking is inherently unstable. If people want to test
where they bank and pay and that’s what we have a safety net. So we had a lot of
trouble but it turned out the people discovered
it when we lower taxes, lower taxes we greatly lower the capital at the biggest banks in our country because much of their capital
was tax loss carry forwards. So the tax rate goes from say 40% the 20%, these are half as valuable
as they were before and so the government went and
said see that’s not important but what’s important
is the rest of the 20% is still on the books
and still being treated as part of their capital and
we had this permission blanket. If anybody failed the stress
test was led to do a retake knowing what the questions were and this usually doesn’t
turn out in a failure. Those that had a little
trouble they promise you things will be better
if they could just give some dividends, stock
buybacks is another way to get capital out of the bank. Now the risk weighting of
assets used in the net worth to risk weighted assets fraction, denominator under weights
politically sensitive assets such as mortgages and sovereign bonds. So you are creating
loopholes by which to avoid intent of these higher
capital requirements. And then the other
questions where do they get these buy-line standards? We know something about
miles per hour and cars and how certain speeds
are inherently dangerous but this is all negotiated. These are negotiated ratios
and who has all the power in the negotiations? The very largest banks. So what we should have is meaningful and reproducible techniques related to the definitions were using. So finally penalties are very important and all we have now are
administrative sanctions which are softened by norms
of mercy and helpfulness. We offer retests to allow
diffidence and buybacks based on hot air and
there are simple fines for the corporations but
almost none of our big bankers, none of the people who made the decisions that ultimately brought on
the crisis have been punished. There are no criminal
standards for exposure for reckless endangerment, what
I call theft by safety net. That is putting all the
responsibility on taxpayers to save them in tough
times it’s a form of theft. We aren’t paid anything
for those guarantees considering the value and
as for the appeal rights, they’ve already begun to lobby fiercely in this political climate in Washington DC they’re gonna win and we’re going to lose. One of the points to consider, I didn’t bring this slide along but what has been the effect of the crisis on the banking industry? Well the very biggest
banks and investment banks have become way bigger. Their proportion of assets
that’s going up about 50% of the assets in the industry. So you can say that this
whole system is designed to help the big banks which would simplify the tax regulation. Look at so many but the table value of free taxpayer capital
it doesn’t go well so I’m certainly in Rob’s can. I have a cartoon here just illustrate what I’ve just said if
you didn’t understand it. This is the point. Let’s look here you’ve got
economy and running a shell game looks awful like an elephant. I’ll let you figure that out and this is the Tom Cowell’s cartoon. You see we’re putting
new regulations on banks to protect the world’s ordinary citizens. That’s the extensible purpose and underneath this little
ticker Tom tows away includes and says now
what I shall demonstrate which is to say there’s
no capital being put under any of these shells no
matter which shell you live, you won’t find any real capital there. You’re gonna find the government supporting the banking system. So here’s my major point that banks don’t abuse the
safety net, bankers do. This is the current control framework exemplifies the fallacy
to misplace concreteness. We punish banks because banks do things but it’s bankers that
make these decisions, these reckless decisions that
increase their tail risk, increase the systemic risk of the country. So average the monitor and
sanction risky bank behavior, we see that have met with little success. Rob was saying things are
getting worse, not better in terms of vulnerability and
if I can talk about Europe, I would really be able to scare you. The European banks are
walking down the same roads we walked with the SNL industry but the stakes are much higher. Alright so the incentives
of bank decision makers to avoid the rules are strong. All of this change doesn’t touch that idea that they still have the incentives to find the way around the rules in order to take money from taxpayers and pump up their profits,
distribute those profits quickly so they’re not on there to absorb losses when times get hard. So if we’re gonna have
any success in regulation, we must create some links
between the regulation and the justice system. That just if we tell drivers,
you can’t drive recklessly. Recklessly isn’t terribly well defined but we can sort that
an accord if we have to but the rules must discipline behavior by the individual bank executives that conceive and control
the level of the bank’s risk. Thank you. (applause) – Thank you Ed. Before Jesse we hear Jesse’s remarks, I just wanted to say a brief comment based on what you said. It made me really think about
the fundamental moral hazard that exists throughout
the financial system and there’s there’s sort of a parallel to what happened in
the corporate law space around 100 years ago when we saw the rise of limited
liability for corporations and with limited liability, shareholders have unlimited
upside and a cap downside. That creates a heads I win
tails you lose environment where it encourages greater risk taking and it’s you can see this sort
of being like a call option where actually the value
of the option goes up with greater volatility. So economically this is as
if financial institutions actually do better if
they’re too big to fail in a volatile environment that it’s not just that they
may not want to be regulated because it’s annoying. Lack of regulation increases volatility and actually increases the
value of being too big to fail because you get all the upsides
when the market does well and you’re not having the downside and there’s another layer to this which is there is essentially
a too-big-to-fail tax that’s on the non
too-big-to-fail institutions. That having a more volatile economy means that there’s going to
be a systemic risk premium placed in the economy but it doesn’t fall on
the big institutions because they’re going to
always get be bailed out. It falls on the smaller ones. So this further encourages
larger institutions to push for deregulation and I
think there’s a real question about how can we break out of that cycle and I think Jess some of Jesse’s comments may I think point to at
least one tool for doing so. – Great well thank you Adam and I don’t have any slides,
I don’t have any music so I might as well just
sit for my initial comments but yes, I’ve been focused
on a narrow question, narrow but important question
since the financial crisis which is why don’t we put
people in jail anymore? Why didn’t any bankers go to prison? And to sort of take off from
Professor Cain’s comments a little bit I have explored
this question for a while because in my journalism and in others, we found evidence of crimes and one of the great lies
of the financial crisis is there were no crimes committed. It was just from Dick Fuld and Jamie Dimon and Lloyd Plank finding, Jimmy Cane. We were just really stupid and reckless which is such a great
relief to all of us I think and causes us perhaps to reflect on why we’re paying
these guys so much money but in fact it wasn’t just
stupidity and recklessness. There were crimes committed. There were crimes committed by the bankers in the lead up to the financial crisis, schemes to defraud investors, my colleague and I explored
a series of those schemes and the CDO business with hedge funds, particularly a hedge fund called Magnetar, building CDOs secretly in
schemes conspiracy with the banks to stuff them with toxic
mortgage securities and then selling them unwittingly, going on and having the banks sell them to unwitting customers who
had no control over the assets and didn’t really even
know what the assets were and the assets were
misrepresented to them. That’s just one thing that I think could have been potentially criminal but you have a whole host
of other potential crimes. Basic traditional crimes
like lying to the public, lying to your banks about your liquidity, about your asset values, about your debt. Lehman brothers made a still whole series of misrepresentations from
experts about their liquidity saying they had billions
of dollars in liquid assets readily available assets and they were circulating
charts internally saying these are actually
pledged to other people and are not actually
something that we can call. In any common understanding
of the word liquid, they were not remotely liquid. I consider that a potential crime. So this was a puzzle to me, a puzzle that was nagged at me. How did this happen? Why did the Justice
Department not prosecute any top bankers in the wake
of the greatest calamity since the Great Depression? And what I found was what I think of as actually a much larger
problem which is that we have lost, the Justice
Department in this country has lost the will and ability to prosecute top corporate executives
and this was a problem that was building before
the financial crisis and persists today and
involves not just the big banks which of course is the subject today, but large companies of every stripe. Industrial companies,
pharmaceutical companies, tech companies. We do not have the ability
to prosecute these people and in fact I think this
is what my book is about but I think I underestimated the problem and it turns out when you
look at the investigation that Robert Muller was pursuing, what he is revealing is that there are whole swaths of the economy outside the large corporations
that have gone unpoliced like lobbying corporate
and political lobbying like campaign finance
and high-end real estate. Just three things that he’s revealing. So I think we have a
white-collar prosecution crisis in this country that has yet to be solved. So the old Warren Buffett adage, when the tide goes out get
to see who’s swimming naked, tide went out in 2008 and we got to see that our prosecutors are swimming naked. And so I’ll just very briefly go through how this happened. First I’ll give you a few statistics just to give you some
framework in the early 1990s, white-collar crime made up about a fifth of the DOJ prosecutions. Today it makes up less than 10%. We’re doing fewer prosecutions of individual white-collar
criminals at any time in about 22 years today. What prosecutions of
corporations have gone down about a third in the last decade and that really overstates the issue because most of the companies
that get prosecuted, get convicted, get charged are small inconsequential companies. And so we don’t go after
the large corporations with any degree of ferocity
or large corporate officers, executives, CEOs. No CEO, CFO or chair of
a fortune 500 company has been prosecuted in over a
decade in the United States. Now maybe you think that
those many thousands of people are all innocent of crimes who served in those positions but I don’t. So what happened to create
this enormous problem? Well very briefly there
was a successful wave of prosecutions in the wake
of the Nasdaq bubble bursting and almost all the top
corporate executives from almost all the companies
that were involved in that were prosecuted, Enron,
Worldcom, Adelphia, Tyco, Global Crossing, some of you
will remember these names and then there was an enormous
backlash and lobbying effort from corporations and the white collar bar to depict those prosecutions
as out of control. The prosecutors were cowboys. They made aggressive
business decisions illegal or labelled aggressive
business decisions as crimes and focused particularly
on the prosecution of Arthur Andersen which
was the accounting firm for Enron undermining the
legitimacy of that prosecution. In my book I seek to
rehabilitate that prosecution. The Department of Justice
was going through a period where they were shifting resources away from white-collar crime. The FBI was shifting resources
away from white-collar crime to terrorism so there was a move away from focusing on this. The Department of Justice
had a series of losses, marquee losses in the courts and also fiascos, internal
kind of bureaucratic fiascos that undermine their ability to prosecute and then the largest
thing is there was a shift and this panel is about the rules and we were sort of asked to talk about the rules that were in place
around the financial crisis and beyond but actually a lot of this is about practices and norms. The tools and rules that prosecutors have to prosecute white-collar
criminals are there. The statutes are written. The prosecutors don’t use
them and what instead today we have is a practice where instead of prosecuting corporations or prosecuting individuals, we settle with corporations for money. They pay in dollars instead of liberty of their top executives
and so this was a regime that did not exist before the 1990s. We have a series of names for
these kinds of settlements, deferred prosecution agreements,
non prosecution agreements. Sometimes we have guilty
pleas that have no effect, no consequences for the
ongoing consequences for the companies and then
the companies pay big fines and so in the first
decade of their existence, the DOJ does about 18 of these and then since the mid to early 2000s, they’ve done about over 425 of them. So this is the way we prosecute. The way we enforce corporate law breaking in the United States
is through settlements and the way settlements are reached is that the Department
of Justice has outsourced and privatized this system. So what we do in this country is when a company has run into problems, the company investigates itself. It hires a law firm and
the law firm conducts an internal investigation. It’s sort of if you imagine this just to take a random
example would be like if the president of a
large Western Democracy was being investigated for
colluding with a foreign power and decided to hire Rudy Giuliani’s firm to investigate the question and then Giuliani presented his report to the body politics. I don’t think it’s regime
that would work necessarily. This is what we do with corporations. So corporations provide
an internal investigation to the Department of Justice. It is a dazzling piece of work. It’s very impressive, it looks thorough. It was produced by some
of the brightest minds and best paid young associates with their blood, sweat and many hours but they’re studiously
curious about culpability at the top and designed to be that way and they’re presented to prosecutors. So who are these prosecutors? Well the prosecutors are by
and large extremely capable, well-intentioned, devoted public servants, very smart people mostly
from the best law schools in the country and they got there by going to the best elementary
schools and middle schools and almost Cavanaugh-like resumes. The most important thing to understand about these young prosecutors is that they’re going to be future
corporate defense lawyers. Most of the them are going to leave to go to the top law firms in the country. The Department of Justice
today has effectively become a training ground for future
corporate defense lawyers. It’s a broken system. It’s unfortunately a racket
corrupt system that doesn’t work and it doesn’t work fundamentally to the police corporations and we know this because the
corporations are recidivists. They repeatedly break the law
even though they pay fines. Wells Fargo, BP, Pfizer,
the list goes on and on of companies that have
run into legal problems and continue to break the law. So what are the
consequences of this regime? Well we’ve sort of all
alluded to them here but we undermined the reform efforts when we didn’t send anybody to prison. I don’t think anybody… It corroded the belief that Dodd-Frank was reining in the banks by
the average Joe on the street saw the reform efforts
as fundamentally weak because there was no accountability
piece that went to it. I think it has eroded the rule of law. We have a two-tier justice
system in this country as most of you understand. Most of that has been
focused on account of our mass incarceration problem,
punishing disproportionately the poor and people of color
often for nonviolent crimes. Well this is the flip side which is that we have a system where a
certain class mostly wealthy, mostly powerful, mostly white, mostly male can commit crimes with impunity and so we have a system
that lacks legitimacy and I think that it is
certainly one of the things that contributed to the populist uprising that eventually led to
Donald Trump’s presidency. (applause) – So I know Emma tasked me to be ruthless and keep the trains on time. I have trouble channeling my
inner Charles Grassley though. So I think we might have
time for a couple questions. – [Female] If we don’t get all of our questions in this section, what you would do is pose
some of the questions at the end of the next one. (laughs) Questions? Seeing no questions, time for the next. – Okay. (laughs) (applause) – I’ll sit here. (mumbles) – Do you want to go in program order or? – In program order, yeah exactly. So Dennis and then Peter. Peter is last. – Does anyone else have any slides? (mumbles) – I know, I do too. You have to be over a certain age. – Are we good? Alright, fantastic. Good morning everyone,
my name is Anthony Cooke. I’m a law professor here
at Georgetown Law Center and I am delighted to be able
to moderate this second panel which will focus on persistent
and pervasive predation. Our panelists consist of
the following individuals: Anupam Chander is a professor
here at Georgetown Law. Much of his scholarship focuses on the global regulation
of new technologies. His book, The Electronic Silk Road seeks to dismantle the logistical
and regulatory barriers to trade while at the same time ensuring that public policy objectives cannot easily be evaded
through a simple jurisdictional sleight of hand or keystroke. Professor Chander will
focus on what he calls, the racist algorithm. Anne Fleming is an associate professor here at Georgetown as well. Her research interests
include commercial law and American legal history with a focus on the relationship
between law and poverty. Her first book, City of Debtors,
a century of Fringe finance explores the history of French lending and its regulation in the 20th century. She will focus her
remarks around her work, City of Debtors. Dennis Kelleher is the president
and CEO of Better Markets and independent nonpartisan nonprofit that promotes the economic
security, opportunity and prosperity of American people by advocating for the public
interest in financial reform, the markets and the economy and Mr. Keller will talk on hiding risk
and the predatory aspects of subprime loans. Finally Peter Warrinski
has been a staff writer for The Washington Post since 2001, covering a wide range of topics including financial inequality, the pharmaceutical
industry and the recession. His series on the role of
pharmaceutical companies influencing drug research won
a George Polk Award in 2013 and his previous coverage
of Hurricane Andrew was awarded at Pulitzer
Prize for Public Service and resulted in an overhaul of the federal construction
standards for mobile homes. Mr. Warrinski will take a brief
look at monetizing poverty with pre-printed checks. So each of the panelists will
take about seven minutes or so to present at which time
we hope to have much time to engage the audience
in lively discussion. Anupam. – Thanks very much professor Cooke. So a decade ago computer models helped precipitate a global crisis. The entire market of structured
finance and derivatives depended on finely honed computer models which turned out to be
divorced from reality. That’s the words of the Financial
Crisis Inquiry Commission. So a decade ago, we relied too heavily on poor computer models to
assess the creditworthiness of financial instruments
and what I want to do is ask a slightly different question. What about a reliance on computer models to assess the creditworthiness
of individuals and especially in the context
of the particular moves today. Frank Pasquale, Frank is
in the back over there and he has labeled the computer models that are driving decisions about us as invisible black boxes. So they’re promoted by
companies to hold them secret using law to protect their
proprietary algorithms and datasets and Daniel Citron and Frank have worried about the
emergence of a scored society where we’re all subject to
ranking by secret algorithms that make decisions about
whether we can access credit, jobs or even dates. The risks of such systems are not likely to fall equally on all members of society. So I want to return to the
dawn of the computer age and when large databases were first beginning to be assembled to discuss how we might
approach these things. So we realized then that
credit scoring systems were unlikely to treat
men and women alike. Women were more likely to have changed their names upon marriage and thereby lose any credit
history they might have had or do not have have
credit histories at all even if they were the ones who ensured their households excellent credit rating. So at times credit sewers were
based on explicit decisions by credit bureaus that resulted
in disadvantages for women such as refusing to permit
separate credit accounts for married couples or
discounting the earnings of women who were of childbearing age. So the original law literally
the Federal Reserve proposed in implementing this law
that I’m going to talk about, proposed banning the collection
by financial institutions by creditors of your
birth control practices. And the idea was that if
you are of childbearing age and a woman that meant
that you were likely to be leave the workplace
and thereby have no income. That was the theory of
lenders at the time. So after a campaign by women
to give credit to a woman where credit is due, Congress enacted the Equal Credit Opportunity Act in 1974, banning sexist and marital
status discrimination in the awarding of credit. In 1974, I might note in the hearings, it’s not even clear
what to call databases. They are called by one
congressman data banks and so we haven’t even come up
with a consistent vocabulary for what we’re dealing with. Two years later, Congress
would expand the restrictions, the bars to include additional categories of discrimination such
as race, religion and age and of course this was long overdue but a simple ban on such discrimination is not enough by itself. How do you know if you were denied a loan while an equally qualified man or person with different skin
color received the loan? The risk is that the
algorithm will produce systematically biased results
but that you may not know about the fact that there
is in fact this difference. The possibility of creating
an invisible apartheid by algorithm, a society
of second-class citizens who receive fewer
opportunities and are subjected to more serious punishments
for their mistakes. The fact that these decisions
are produced by computers will allow their owners
to claim that the results are not discriminatory but really, the result of science,
some impartial computer. This has the makings of an
ultimate Kafkaesque nightmare where there’s no one to blame except the ghost in the machine. But the reality is that
even if the machine was not programmed to be racist or sexist, it can learn racism and sexist
from the world at large. So here’s a little model
of a very simplified model of these kind of machine
learning algorithms where the algorithm is functioning, it’s trained to make
decisions, classifications and it’s trained on real-world data and then it operates on the real world. In both those sets of data, it’s of course replicating the inequalities
of the real world and so the possibility
is that like a virus, the discrimination spreads and
unfortunately in this context the virus is hidden and
it becomes invisible and it’s made invisible by the operation of these black boxes. So all of this will require
so how should we respond? So I first think that
companies should practice a kind of algorithmic affirmative action, actively designing and
reviewing their persistence to ensure that they are egalitarian. Second, government
agencies and individuals should actively monitor
what these companies are doing to hold them to account. All of this will require
active collection of data. Now, this data will include the very stuff that we might think that the algorithm should not be operating upon. Things like race and gender or age. So this is the kind of
irony in this space. In order to find out whether
you’re discriminating on the basis of race you
have to find out the race or the gender of the people involved. Now so the Equal Credit Opportunity Act takes a kind of infused
approach to data gathering. It tells companies at the same time that they must collect information, that they can collect information and they must not collect information. In kind of unclear and largely
unreasoned distinctions. So originally the drafters
thought that banks should inquire about
gender or marital status. So this should just be
prohibited and so 1974 this was the original idea. We’ll just prohibit the
collection of this data. So they wrote that into
the law but so anyway, I’ll conclude very quickly, thank you. What happened is that subsequently, they decided that you should
be able to allow companies to collect the data so
they can test themselves for how they are performing
along these metrics. Finally in Dodd-Frank and this will be your first positive thing that you heard about Dodd-Frank this morning. The Congress passed a law
that is part of Dodd-Frank that said you must collect information and so this was with respect
to small business loans. Unfortunately that Dodd-Frank provision has not yet been implemented
in actually a CFPB regulation. The controversy has raged
on over the last eight years as to how to implement this
and I will leave it at that and we’ll come back to this. – Okay. Can you hear me? Maybe I’m just not close enough to it. Okay, so even though I was working in foreclosure prevention in 2008, my research really
relates to smaller loans which was as we know were not the source of the financial crisis in 2008 but I think they’re worth thinking about because the history of the
small some lending industry and its regulation holds some lessons for how we think about financial predation and preventing it. So in my book, I describe how Americans over the past century have struggled with how to regulate small dollar loans and to me, this is really
a particular instance of a broader struggle
which is the struggle to define the meaning of
justice within capitalism. Well, we could also think of it, the flipside is to define
the meaning of predation within American capitalism. The term predatory lending is
actually a relatively new one. I haven’t found any evidence
of its use before the 1980s but Americans have always
had a similar concept. So in the early 20th century, we referred to it as loan-sharking which today can convey illegal lending but can also just mean lending that while it may be technically legal is in some way objectionable
that we view it as predatory. So with consumer financial
products like mortgages or small dollar loans, I think there are really two questions that regulators need to address and the first is just defining
what does predation mean within the context of a
particular industry or market and then second, how to prevent that kind of predatory behavior. So what I want to focus on this morning is this first question of
how we actually go about defining what constitutes predation and also who gets to define it. So one of the major changes
since the the 2008 crisis has been the increased
involvement of federal authorities in defining what predation is for consumer financial
services and particularly for small dollar loans and
for most of the past century, certainly before the 1960s,
the task of figuring out what constituted predatory behavior was a state-level issue and so each state got to decide for itself what
types of loans were acceptable and what types of lending
was going to be illegal or out of bounds. So there were some efforts before 2008 to create national standards
in the small dollar loan market but those efforts were really at the level of adopting or proposing
uniform or model legislation. So there was an effort for
example in the 19 teens and the 1920s was a joint project by the Russell Sage Foundation
and the Trade Association for Small Dollar Lenders to put together what they called the
uniform small loan law which they drafted and
then went state by state attempting to get states to adopt it. And at that point in time pretty much all small-dollar lending
loans of less than $300 was essentially outlawed in most states because states had strict Ussuri laws that said you couldn’t
charge more than six or seven percent interest per year and those low levels of interest were just not feasible for
loans of such small amounts. So the uniform while normal was an effort I think to shift the national conversation on a state-by-state basis about
what predation looked like and to argue that for a
particular category of loans, that those rules didn’t make sense and so what they proposed
and many states adopted was that the industries should be put under state supervision,
it should be licensed and that lenders should
be limited to charging no more than three and a half percent of the principal balance per month and that the loans
would be capped at $300. and so many states adopted these rules but even at that time, this definition of what should be legal was contested. So you had people like New York City Mayor Fiorello Laguardia saying
that this was too much that he could not understand why anyone should be able to charge what he called 42% interest per year. So he referred to the
uniform law as the swine law and viewed those who
argued for its passage as predators, as loan sharks. So at a certain point
in time by the 1930s, there was some national consensus about what the standards should be, what the boundary between predation and acceptable conduct was but then as with many financial products,
the regulatory landscape and the industry shifted. So by the time we get
to the 1970s and 80s, states have to revisit this question again because as a result of the
deregulation of interest rates in the late 1970s and 80s through the Supreme Court
decision in Marquette and then through congressional action, suddenly there’s
competition between states to get rid of their Ussuri
laws to attract banks to locate there and so
states have to decide again what is the boundary and so you see new forms of lending developing, payday loans start in the 1990s, states have to decide if they’re
going to allow these loans or not which by the point we get to 2008, it remains a state-level issue and there’s still a
split between the states as to what constitutes
predation and what’s acceptable. Which is when we get the financial crisis and one of the outcomes of that crisis, Dodd-Frank creates the Consumer
Financial Protection Bureau. So we could think that
maybe this is a moment at which there’s going to again be some sort of national consensus about what the boundaries are, what constitutes predatory
behavior and what is acceptable and we do for the first time
have a federal rulemaking A federal rulemaking
which sets new boundaries saying payday lenders have to consider the ability of borrowers to repay the loan if they want to extend this form of credit but even after this
moment in October 2017, by January 2018 the CFPB
has changed its position. So under new direction even the CFPB cannot agree on what constitutes predation and are going to revisit this rulemaking. So I think the lessons that
we can take away from this are first of all, that the
challenge for policy makers is not merely in figuring out how to stamp out predatory behavior. In some ways that’s the easy task. The harder task is reaching some agreement on the meaning of predation which I think has always been a contested idea. – Okay thank you. Dennis. (applause) – Hi everybody, I’m like Jesse. I don’t have slides or music. I need to coordinate better
with Rob Johnson in the future but thanks for inviting me and
thanks for this conference. At the beginning of it
never talked about this was the amnesia. Unfortunately we think
of it at Better Markets as a created in purchased amnesia, not actually clinical amnesia but if you know anybody
who’s getting amnesia or you’re having amnesia
I don’t have a book. I didn’t write a book but I have a book. You’ve got to read Crashed by Adam Tooze. It will remind you in laborious
detail of what happened and some very novel and good
theories about why it happened because what’s remarkable
is when you read about what he talks about is
happening and being said in the 1990s, in the early 2000s, the exact same things
are being said today. The exact same things are being done today for the exact same bogus reasons. I could quote my friend Ed Cane and say for the same bullshit reasons but I won’t. So Better Markets is an advocacy group. We participated in… I was Jesse a defense lawyer
at ARPS for about 20 years, participating in many of the
things that he talks about in a very different era though, pre-crash, pre Enron, pre Arthur Anderson
and then I spent eight years in the United States Senate. We founded Better Markets in 2010 after the Dodd-Frank law was passed because we realized
there was no organization that was professional to be a
counterweight to the industry. Because when you talk about
there can’t be agreement on what predation is,
that’s because the predators are at the table helping define that their conduct is not predation. And so you alluded to it very quickly but it was a very important comment about how somebody got
together with the trade groups to define how they’re making
their money and their profits. So since 2010, we participated
in over 200 rule makings in about 30 litigations and in
those 250 rule makings or so, about 70% of them we’re the
only non industry participant. When you get into derivatives
in the complicated issues, over 90% of the time were the only non industry participants. Who’s writing these rules
and for what purpose? So I’ve been asked to
talk about hiding risk. So you want to talk about hiding risk. There is a massive deregulation going on not 10 years as was alluded to earlier, not 10 years after the crash
and there’s been some studies that say usually it takes 20 years so I was with Ken Rogoff
from Harvard recently who made the comment that
this is who and Ken knows. I mean he’s only looked
over 800 years or something. I forget what it is that crashes. He said this is the fastest in history, in history between a major crash and the time at which the rules that was supposed to
prevent the next crash were already being taken down
before they were implemented. Makes you think over half the
rules aren’t even implemented. I mean it’s just shocking
how fast this has happened. It’s not shocking if you
think about the money that’s at stake though. So hiding risk is really
the flip side of bonuses. Profits and bonuses on the
other side of hiding risk. So why do I say that? Well later on you’re gonna
hear a panel about innovation with some of my good friends
on it Gary and some others. Innovation in my view is
one of the primary words and tools for hiding risk because nobody wants to
be against innovation. Innovation, what’s better than innovation? Nothing but I have to admit
that innovation in finance is very different than
innovation elsewhere and red flags should always
go up when you hear them. Most financial innovation
turns out to be another way to separate you from your money. Often it’s just another
way to get somebody else to take the risk of the
innovation they don’t want. I’m not going to go into this much but I don’t know if they’re
going to talk about it later but credit default swaps
is a wonderful innovation. CDOs, collateralized debt obligations Jesse alluded to Magnetar
and synthetic CDOs by the way because they say we
couldn’t milk enough money by ripping people off with CDOs so we created a synthetic CDO. It’s just astonishing when you go through and you look at the
innovations in finance. Paul, my good friend Paul Volcker who was talked about earlier today has a line widely quoted
usually meaning to dismiss him where he said the only
financial innovation in the last 20 years I
can think of as the ATM and all the smart guys in
the suits on Wall Street go ho, that guy old guy doesn’t
know he was talking about. If he’s wrong, he’s not wrong by much. There may be another
innovation besides the ATM that makes sense but
most of the innovations are meant to hide risk and shift risk and when you hear innovation,
a red flag should go up. Hiding risk happens in a lot of places. There’s three primary arenas
that you should look on only one of which gets any attention. There’s a legislative,
regulatory and judicial arenas. The legislative arena
gets all the attention because it’s big clash between Republicans and
Democrats and you get to see it and the cameras love following it around. Some hiding risk happens there. The recently passed
deregulation bill 21-55 that was signed earlier this year deregulated a whole bunch of things. Importantly, banks poor little banks between 100 billion 250 billion in assets. You know your little neighborhood bank. Everybody here who’s
hanging out with somebody with 250 billion dollars, raise your hand. So that bill was focused on
when you look at asset size there are 5,800 banks in
the United States roughly let’s call it and I’m leaving aside the shadow banking system
and other financial decisions look at banks and this bill was focused on deregulating banks. At the time the bill was
considered and passed, there were only 41 banks
in the entire country with more than 50 billion
dollars in assets. All the energy really 90% of the energy and all of that bill is
focused on deregulating 23 of those 41 banks
and what does that mean? When you’re deregulated, you move not only away from regulation, you move away from transparency, accountability and
oversight hence predation. Quickly and everybody knows what it is. Frankly it’s not how they
do it may be a mystery but you just look at the bonus numbers. That’s where you find out
where often, not always, there’s a lot of legitimate
financial services being provided that
support the real economy. The problem is that
that is not as lucrative as the high risk, high leveraged trading, non social aspect of finance and that’s where the real money is. So you’ve got this massive deregulation that kind of hides risks, juices bonuses, creates leverage and
create systemic instability that leads to both predation, it leads to the corruption
of the judicial system, that leads to the corruption
of the political system, it leads to the
delegitimization of all of it because you end up with
two tiers in this country where the people have got a lot of money and get away with it
and the people who don’t and that has as Rob
pointed out pretty well, social, political cultural consequences that we’re seeing in the
election among other places and that’s it. – Thank you very much. (applause) Last but not least, Peter. – Good morning. I am going to talk
about one of the glories of 21st century capitalism,
a project we put together and published I think it was a summer. For my soundtrack I didn’t bring any but I prefer Sex Pistols
something angrier than Bob Dylan or Ghostface Killah. You have to imagine it. I wrote out a company and I should say my story touches on
many of the issues here although it takes a
little bit to get to them. It touches on amnesia, it touches on faith and free markets and predation. What we wrote about was a company that was giving out millions
free checks every year or just sending checks
to millions of people and say for 1,200 bucks
sometimes they’re 2,400, they’re really big ones were about $3,000, millions of them every
year and if you cash them, you were obliged to pay
fairly high interest rates. Sometimes it was 36%,
sometimes it was 33%. If you defaulted on the
loans you were required to pay their attorney fees to sue you. There was also other punitive fees and they were almost
always targeted people of very modest means. Among the people that
I talked to and I think the argument from that company was we’re just helping people. They can sign the check or not sign it. They are rational actors but
when you take a closer look and I think there is, that argument is not completely without
merit but if you look as I did at the people who are getting these checks and why they signed them, the circumstances that they
were in when they signed them, you begin to look
askance at that argument. I’m just going to give
you some of the examples of the people that I talked
to who got into big trouble, dragged into court, had
their wages garnished and I would ask them why in the world did you sign this dumb check? There’s so many different
stories, all of them sad and you realize people
don’t have the choices that the people making the laws have in their financial lives. There was one woman from Southeast Asia who said, “My mom died,
I had to go back there.” A $6,000 dollar trip so she
gets $3,000 in the mail, she did it. She got to go to her mom’s funeral. There’s another guy whose truck,
he gets the check he says, I’m not gonna sign it this looks dicey. He has a problem with his
truck, goes into the garage. He needs to the truck to get to work. He needs to take his kids
to work, he signs a check. There’s another old
woman in Prince William, she’d been a janitor or whole
life in the school system. She didn’t have teeth and she needed teeth and she had hospital bills. So I said, “Why did you sign it?” She said, “I needed teeth.” And finally I mean the
one that kind of summed up the sadness of it for
me and I did not use it because the woman was so ashamed she didn’t want her name used
and the paper was this woman Nashville and I said why’d you sign it and she said, “Well I was
having trouble paying my rent “and so I prayed on it and
I cried a lot that night “and then the next morning
the check came in the mail “as if it was like a sign from God “that this predators cheque
had arrived in the mail,” and she signed it and she
admitted in retrospect that this might not be
the way the Lord works. So these are the kinds of people that when they talk about rational actors, we should keep in mind I think. The part of the story that
has to do with amnesia is who owns this firm. This is a very large firm by the way and it’s getting bigger very quickly. It had 50 outlets in 2013. It’s over 450 outlets. They have super shopping
malls all over the country. So they’re growing very fast. The owner of this is a private equity firm called Warburg Pincus
and who was the president of Warburg Pincus? Our former Treasury Secretary Tim Geithner who as we all know
criticized predatory lending when he was Treasury secretary. So if that’s not amnesia,
I’m not sure what is and many people who
commented on this story in our comment sections had
much harsher words than that. Some of the arguments that you hear about from the economists, I
studied economics as well and there is this idea and
Anne brings it up in her book. Where is justice and capitalism and if you’re an economist, you say oh it’s right where the price
and quantity lines meet. That’s the price that
everybody’s willing to pay and it’s fair and that’s the argument here that look, we have to charge this much because these people are risky but it reminds me so much of… I’m actually more of a
math guy than anything else was the Euclidean geometry
which we had so much faith in until this century when they decided that actually there are other ways of construing geometry than Euclidean. It’s the same thing with capitalism. I don’t think that these
free-market arguments that you hear over and over
again will prove to be credible or the only way to approach these issues. That’s all I have. Thank you. (applause) – So we do have time for questions. We finished very
efficiently on time I think. So please questions, discussion. Yeah. (mumbles) – Hi, my name is Doshka Delaconia. I’m a professor of law here at Georgetown and Emma’s invitation to try to connect the two panels together
with a question to… (mumbles) So Anupam you talked about algorithms and how algorithms may be
used to put people into boxes and how creditworthy there are. Are they eligible for
certain loan and so forth and you reflected on how algorithms can build in persistence biases that disadvantage people versus others but algorithms when they’re used, they’re not used sort of in the absence. They’re replacing some other
person who is making a decision who also might be biased perhaps
more so than the algorithm. So I’m wondering here
whether using algorithms is not so much a problem of
biases even though that it is but a bigger concern is one that I believe Jesse Eisenger raised in the earlier panel which is did they deflect responsibility. That algorithms allow
those who make choices to say hey it’s not me, it’s the algorithm who made that decision
further diffusing liability and further making it
difficult to go after people who made the choices. Thank you. – Okay so great question
and I totally agree that the algorithms are replacing racist and sexist decision makers typically and so you have to compare the baseline, compare them against the baseline. The worry of course is that
the algorithms are doing so one at larger scale and so
they’re making more decisions than humans have made before. Second which is the one
that you’ve pointed out, they are doing so in ways that
make it harder to identify where the problem emerged
and it makes it easier as you’ve just pointed
out, for those responsible, the human beings responsible
to avert responsibility for this behavior. So I think that’s exactly right. I do think it’s important when
we criticize these algorithms because at the time I didn’t have much. I think it’s important that we recognize that there are times that algorithms can be better than humans
but we have to be… That’s why getting information is like the most important
thing and to figure out whether or not they’re
actually doing things and we may be able to find
out what algorithms are doing more than we can find out what humans are doing in some cases. Anyway I’ll leave it at that. – Thank you. My name is Alexander Marconi. I’m was class of 15 here at Georgetown. What I wanted to ask is
something that Mr. Risby you sort of alluded to
in your last comment. So it’s a general question. One of the counter arguments
towards stricter regulations especially in the lending space is that if you have tighter
rules about what’s predatory and what’s not, people
especially low-income people will lose access to necessary credit for any number of sort
of important life items and you sort of wind
up hurting people more if you have this sort of
restriction to access. I’m not sure if I’d buy
that trade-off myself but I wonder if you think that is an accurate
description of the trade-off and then if there’s a way around that. They have better protections
and still help people who are in low-income situations and may need access to credit to get involved in the
financial system in a safe way. – Yeah I think that’s a
really important issue and one that we have to
give a lot of thought to. It’s a great question. The way I’ve looked at it is that I wanted to mention this
when I was speaking. The states regulate these. These are called consumer
installment lenders by the way. The ones that I’m talking about not payday which is a different you know regime but if you look at
consumer installment laws across the states,
they’re all over the map. They’re like whatever interest rate you want to charge is fine. Some are 36%. I think Maryland might be 28%. And they measure interest
rates differently. It could be APR, it could
be and what I noticed is that these companies are
eager to go into any state no matter what the current rules. Nobody’s veering away
from the the Marylands which might have in my
reporting was the strictest. They’re probably others
that are even more strict maybe Massachusetts but it tells me that there’s money to be made even at the strictest level of regulation. So if we’re making an error right now, it’s in the direction of being too lenient and to open to these lending. – Quick comment on that too which is not all predatory actions the same. So I think you have to think about it in context so subprime lending
and the lead-up to the crash is very different than
the predatory lending that you’re talking about
and it’s different actually than a small dollar lending too. So I think we have to
put it more in context to really think about how we regulate it or if we regulate it what
the rules are and what level. – Okay, Chris. – [Chris] Thanks. Chris Romer, I’m a professor
here at Georgetown. I want to follow up just
a little bit on push… (mumbles) – You’re good. (mumbles) – So I spend a little bit of my summer going through East and
West Africa and Brazil and given talks to Bogota
thinking about financial inclusion and one of the things
that I think people see is that financial innovation can take all kinds of forms in the world. You have mobile banking, micro-finance. Crowdfunding it’s different kinds of… Crowdfunding in different iterations and for the relevance I think
of this panel in particular you have this question of alternative data and the question is
not just the algorithms in terms of the programming
of the causal relationships sort of between different inputs for the purposes of programming but also what the actual
substitute inputs are and so I was just wondering if you had any thoughts about that and it looks like you did. – So then the question here I think to interpret it in one way at least, there are ways that we
can measuring credit that might not be the traditional ways to measure your creditworthiness so rather than look at
your credit history, we might look at your social network or we might look at your activities and this is the kind of activities that machine learning algorithms tell us are likely to be associated with, highly correlated with
better credit risk folks. So I do think that actually
that kind of innovation can be useful. So I’m not against changing
the complex of things that the credit bureaus have used. I find the stuff that
the credit bureaus use often incredibly stupid. The fact that I’ve opened
up another credit card or closed a credit card. How the hell does that mean
that I’m suddenly become… Closing an old credit card is
reducing your credit standing like what so anyway so I think that we need innovation in these spaces because the current models are broken. – Okay we have time for
one last question, Steve. – I actually wanna I think follow up on what Dennis just said. I’d like comments on your
panel seems to be concerned with individuals whereas
the previous panel was concerned with the behavior of banks. Jamie Dimon. I don’t really see how an individual taking a payday loan
because they need teeth and dealing with that
issue has a lot to do with how we should be dealing
with banks buying CDOs or synthetic CDOs. It seems to be a totally
different mechanism. I mean an individual might
be able to protect themselves but an investment bank
deciding whether to buy a CDO, they may be following the
Ponzi scheme of the market and just assuming that
they’re gonna get out first. So I’d like you to
comment on the difference between the type of regulation
that you guys are calling for and the type of regulation
that would be called for to prevent the next meltdown. – It is a great question and in fact, it’s a continuum and at the same time they’re quite distinct. So if you think about the
subprime mortgage bubble when subprime mortgages
really started taking off like most mass consumer predatory action, it gets addressed at the
municipal and state level and that happened in subprime loans when whole neighborhoods
were being victimized in this country, including
in the state of Georgia. And so Georgia and other
states started enforcing their state consumer protection laws on these individual cases
and then what happened is the federal banking regulators came in, stomped on the court, claimed preemption and shut down the state
enforcement across the country of their consumer protection
laws of the sub-prime that massive predatory subprime lending activities in the country and that then took off like
crazy but to be expected because the feds did nothing. I know there’s some who disagree with that but I think the objective
evidence is pretty clear and then what you have is
you have subprime mortgages being poured into the system
and then on top of that, you have the originate
the distribute model which incentivized fraud and crime and then you have it all up streams and then the big banks
want to make money off them so they then start creating
maybe at the beginning, legitimate CDOs but very
quickly fraudulent CDOs that were literally built to blow up as we put in detailed in
the SECV Citigroup case in front of Judge rake-off
how that particular CDO was literally designed to blow up and was also structured to fraudulently induce the purchasers to purchase the CDO. So the layer of fraud
happens there at the CDO and then of course they built
fraudulent worthless CDOs on top of them. Now that’s a way a continuum can happen from what you have is predation, consumer protection
predation at the local level but in fact has serious
systemic implications and the same thing happen if
you look at this over history when you look at major financial crashes and you go all the way back, you often find that they begin with basically consumer fraud. Look at dot-com it was
inducing people fraudulently to buy stock in a company
and it worked so well, they just started selling a bunch of more based on companies that
didn’t have earnings, didn’t have profits and you can
only get so much money there so what did you do? It just amps up. Once the money starts coming in, if the predatory conduct
at this level isn’t stopped it amps up all the way. Sometimes it’s a crash and sometimes not. – I would add the company
that I wrote about issued bonds based on the
loans that they issued. So it goes from the person who needs teeth through the bond system
up to Warburg Pincus. – And the wholesale funding system, right. I mean these this takes an
enormous amount of money to actually put out 1,000
2,000 3,000 dollar loans through 450 outlets and
same thing in subprime. This money is coming from Wall Street. The biggest banks on Wall Streets are providing the funding ultimately. They may do it through
bankruptcy remotes, SIBs or companies like this but
there is an interlocking network that funds the predatory companies have to get this massive amount of funding which Warburg Pincus doesn’t
even have a balance sheet. – I know we’re out of time but Anne with your work on French financing. Any reflections on the bridge between the micro and the macro? – I mean I just wanted to sort
of acknowledge Steve’s point that in some ways these two
concerns do diverge at a point. So consumer protection versus concern about the systemic risk and the safety and soundness the financial system, I mean part of the reason
for the creation of the CFPB was the sense that there
was no federal agency that was looking after the
consumer protection concerns and the extent agencies
were charged with that, they were also charged with looking after safety and soundness and when pursuit of those two goals diverged, they were more concerned
with safety and soundness which is why in the logic
of Dodd-Frank is that you need an agency whose sole concern is the focus on the consumer transactions even if they do have ripple effects for the system as a whole you can’t trust those who are looking out for the system to look out for the individual. – Okay, great discussion guys. Join me in thanking the panelists. (applause) (mumbles) (murmuring) – As we’re making the transition
from this wonderful panel, thank you very much for being so mean. I loved it. We are setting up a conversation
that I had with Jack Bogle, a legendary investor, financial leader and a man who’s focused his
life, his values on ethics as well as limiting the expectation of excessive compensation. He is from a wealthy family
that suffered severe losses when he was a child during
the Great Depression and as a result, he had
to work in high school and in college and he had
a number of student jobs that several of which were being a waiter, athletic department manager,
a runner at a brokerage, reporter on a police beat and a pin setter at a bowling alley which
he says was a terrible job. So he is someone who’s
worked with his hands but he invented in the
67 years in the industry he invented the Mutual
Fund with shared profit and the Index Fund. The combination of those two has done away with the idea of the highly
compensated star stock picker, superstar stock picker using index funds instead of the superstar stock picker. So he’s received loads of accolades. I won’t go through all of them but he did get one from Warren Buffett. He said that if the Warren Buffett said if there was ever a statute erected to the person who has done the
most to protect the investor, Jack Bogle would get that hands down. Well, he’s also been called a lot of names by people in the industry. His index fund and his idea
of having star stock picker, a hedge fund manager last year called him and the idea of the index
fund worse than Marxism. Bogles Folly is another
name he’s been called and you will see in this conversation. I went up to Vanguard campus headquarters in Melbourne Pennsylvania,
spent time talking with him. I’m looking for Alex Marton. He must have stepped out. Jack Bogle has been
generous to Georgetown. He gave address to the
undergraduate school, he came here at my invitation
and spoke to a conference on public-private partnerships and when I asked him to do this interview, he said of course. So you’ll see that Jack
and I are having fun. Our views converged quite a bit. So we’re ready to start that and we will hear that
conversation about values in finance the financial crisis of 2008. Should we, Jack we’re
here to talk with you, have a conversation. Let’s start with your
background and experience. You’re a business person and
you’ve been that for 67 years. – [Jack] That sounds awfully long. – Well, it’s a short time when
you’re having fun as you did. So what do you see going forward? What are your thoughts about the future in our current financial system? – [Jack] Well professors Jordan, it’s great to be with you Emma and all of you that in Georgetown. I’m sorry I can’t make that trip. It’s not that bad but I’m
just don’t move so well. So I’m glad to be here
be with you by video and I enjoy doing that. I’ve known professor
Jordan for a long time. (mumbles) – Jack, we’re here to talk
with you, have a conversation. Let’s start with your
background and experience. You’re a business person and
you’ve been that for 67 years. – That sounds awfully long. – Well, it’s a short time when
you’re having fun as you did. So what do you see going forward? What are your thoughts about the future in our current financial system? – Well Professor Jordan, it’s
great to be with you Emma and all of you down in Georgetown. I’m sorry I cat make that trip. It’s not that bad but I
just don’t move so well. I’m glad to be here and
be with you by video and I enjoy doing that with Professor Jordan for a long time. So it’s fun doing it with you Emma too. So where are we now? Let me take a look at
very quickly where we were and what caused the crisis. Of course it was human beings. It doesn’t take any genius to figure out and it was largely mortgages
that were sold to people that couldn’t afford to have mortgages and that is still with us today. The down payments of the
Fannie Mae and Freddie Mac were US government agencies runs about three percent on houses. That’s not enough and back then, the credit was much
worse than it is today. I don’t want to make
any mistakes about that but anybody that had going out on the road with the mortgage sellers and seeing the loans they were making
with no backing at all would have been scared to
death of what was happening. The problem is all of us in financial were up in this ivory
tower and didn’t see that. That was the proximate cause and leverage is almost always the cause
of financial breakdown. – High debt to capital liquidity. – Yep capital and liquidity
going all the way back in time and as far as we can go in measuring it. Even in the Roman Empire
for heaven’s sake. So we still have how are things today. Let me first say if you look
at where we are at this moment, it’s hard to be anything
but completely bullish about the stock market and about America. Our gross national product is
starting to grow more rapidly than most expected. Our unemployment rate is
down to an all-time low. We’re very close to an all-time low. Wages at last started
to rise a little bit, the stock market is a bulliant
and so what’s the problem? The problem is that we don’t
live in the short-term, we live for the long-term. I don’t know about anybody else but I don’t know what
the long-term is for me but for most of you in the audience the long-term is a long way down the road and we are cultivating
a series of problems that the market seems to be able to ignore which is kind surprising
but when on the other hand the stock market has always
ignored the long-term and focused on the short-term and that’s a very
unfortunate aspect of it. So what do we have here
today in the long-term that’s troubling me? Number one we have a diminution
of consumer protections. Number two, we have some of the
things in the Dodd-Frank Act that are being taken away from us, some protections that were put in there to make sure we didn’t have
a crisis like the last one including particularly
sadly the Volcker rule trying to in the most tentative way, trying to separate banking
from Investment Banking and a lot of risk and investment banking that was thrown over into banking and that’s why I think every bank. – With deposit insurance backing it up. – Sure. – That has to be issue for Paul Volcker. – I think just about every bank in America eliminated their dividends back in 2008 and that’s something that ever
happened before in history. So I don’t think we’re back at that point but we’ve given up some of the things that we that came along there and then when you look more broadly, some of the long-term
problems affect our nation are being I think ignored. One of course is climate change. There’s a lot going on out there we hardly need to belabor that and it seems to be accelerating and there’s a point of no return. That’s a very scary thing
and maybe in a little softer or a more subtle way, two things that should
not happen in our country or three actually are happening. One is the division between
the wealthy and the not wealthy or even those that are
in poverty has widened. We should be narrowing that
gap but it’s been widening and part of the reason it’s been widening is because we have done something that’s great for corporations
and wealthy people but means actually negative
for the average taxpayer. I read a piece of data the other day. – You mean the recent tax cuts. – Yeah the recent tax cut. The recent tax cut for corporations. – That are permanent.
– Yeah that are permanent and over the next 10 years,
that saves the corporation something like 50 billion dollars. How do we individuals come out of that because the present tax cuts are gonna be repealed in a few years. – Temporary.
– Assuming that happens and that is the corporations
got 50 billion dollars of tax benefits over the next 10 years and individuals would get a benefit of minus 83 million dollars. I mean that is shocking, it’s inexcusable, it’s I think more hidden than it should be and yet you see the Treasury Department talking about another two trillion dollars of tax savings when– – That they’re gonna do by regulation and there’s a legal opinion
in the Bush administration that says that is illegal. You can’t do it that way. – No well to me, I’m very unhappy with what’s going on in Washington, not so much as a political matter, there’s an economic matter. This is not good for America. The situation with Social
Security and Medicare has gotten even worse there seems to be no backbone to stand up
and be counted and fix it and it would take so little. If I could add a little
anecdote about that, I was interviewed a few years ago and Paul Volcker was on the stage with me and I was asked about Social Security I said look if you’d
make me and Paul SARS, we could fix Social Security
in a matter of hours. Just little fixes here and
there and Paul looked up and he said, “Couldn’t we fix everything?” (laughs) – That’s good. – So we have that going on. – Can we appoint you as SARS
just by Fiat among friends? – I think we’re both getting
a little old for SAR ships but we might be able
to name some candidates and then another thing
that’s deeply troubling is the seeming growth in
racial division in the country. This is a multicultural country, it is getting increasingly so and yet we seem to be fighting to
keep things the way they were and the way they are going to be here, it’s gonna be different
than the way they were and I’m not taking any position on whether I like the old way
better or the new way better but the world is going
to change and this nation is just gonna have to
do it, change with it. – Well we’re a nation of constant change. From the beginning that momentum is the renewal of the American purpose. – And we’re also trying
to seem to be limiting America’s greatest strength
in terms of population growth and this nation has had for a long time virtually no if not no population growth and we’re trying to make
immigration much tougher. All these things have seemed
to me to be kind of surprising and just one more thing
talking about the debt side, the federal government
is gonna have a deficit of a trillion dollars this year. A trillion dollars. – What does it consist of? – Well debt consists of
bonds and owed often by 60% of I think the Treasury bonds
are owned by foreign countries so there’s a lot up in the air and the long-run outlook
is quite concerning unless we summon the courage to act on it and the political will to act on it and it doesn’t look like
that’s gonna happen today or tomorrow or this
year but at some point, we have to reconcile the
problems of the country with the realities that we face. – Going back to 2008, where
were you in September of 2008 when Lehman failed? What were your thoughts
and sources of information about this dramatic failure? – Well I was probably
sitting right in this office just as I am today and
that’s where I usually am although I do some traveling. That’s probably a good guess and I didn’t think the fallout
would be as great as it was to be honest with you and I didn’t think, I don’t hold a position that the Lehman should
have been bailed out. Why? They have all this leverage,
they made all mistakes. It really troubled me back then. I think is a quote I gave
to Gretchen Morgenson for the New York Times. We got to all this public
policy of too big to fail and yet the people were hurt by all this were if you will too small to bail. People with the– – That’s a wonderful way
of capturing the contrast. – And that’s still a big
problem in the country because the highly wealthy, the top, probably not even the
top tenth of one percent, the top one hundredth of one percent have such influence,
such political influence and we’ll see what happens
in the fall election, money is being poured into it
and a power that is shocking and far greater than it ever
should have been allowed to be and we see this in a lot of places. See a lot of it in the financial business, we see chief executive
salaries that are a joke, an absolute joke. Their salaries in say last
25 or 30 years in real terms have been going on maybe
three or four or five times and the average wage of the people that are doing all the hard
work to be honest with you have gone up zero in real
dollars in weekly compensation and that spread. Why are we holding back wages
in order to pay off executives and stockholders too? I always thought and I
felt like they feel like they stole from Vanguard. The most important asset we have is the crew that comes in
here to work every day, committed to our mission and wanting to do the best job they can, having
a high level of integrity. That’s the way to build a business and yet corporations ignore that. Why? Because again I keep coming back to this, because it’s a long-run problem and not so much a short-run problem. It’s called right sizing. – Absolutely and I know
one of your pet peeves is the carried interest deduction. Could you say a few words about that and your thoughts about that? – Carried interest I think everybody in the audience knows this is the ability to turn
what any normal person would call income into capital gains and it stretches your credulity
as well as stretches the law and there have been efforts to change it. At some point both sides
of the aisle in Congress were in favor of changing it but somehow it didn’t make it through
this last tax law. I think there may have been
some small adjustments in it but that why? First it makes no economic
sense and no logical sense but second as a matter of public policy, it enriches the rich and I don’t see what the point of that is. – I want to go to that
period of March to September. We have one failure, don’t
know what’s happening next. What were your thoughts and looking back what are your thoughts about what could have
been done in that period? what is the meaning of that period? – Well, a couple of things. One I don’t remember at my
age exactly what happened from one month to the next back then but I do remember a
couple of things very well and that is at Bear Stearns
there was some funny business for the one of a better word
among the hedge fund managers were able to get out their own money out and leave the money in for their clients and they got in no trouble at all which takes me to a broader issue. Well all this I would
say in criminal behavior. I can’t cite chapter and verse in the law but certainly an extremely bad behavior by the executives and even
all the way down the line, department heads, nobody
went to jail, nobody. – Vanguard is a major
institutional investor. You’ve talked about the
long term and I must say, I’ve grown wealthy with Vanguard. I believed in Vanguard from early age and it’s been wonderful but the Index Fund combined with the
patient investor approach means you don’t do proxy fights, you don’t get rid of the CEO but you have a policy of engagement. Could you talk a bit about that? It’s not you but the– – I can talk about it. – Yeah, engagement. What is that? What would be included? – For at least a decade,
I have been talking about the lack of governance by funds. I have a speech I gave some years ago called The Silence of The Funds and it was deeply disturbing to me to see that these canoe
controllers of American business were doing essentially nothing and I tried to get a group
of institutional investors who were long-term holders
and let me pause there and say the most mutual funds are
more like renters of stocks and owners of stocks. – Because they’re trading. – Yeah and when you rent stocks, you really don’t give a darn
about corporate governance and I must argue shouldn’t give a darn. What do you care if you’re
only holding the stock for a week or a month or a year? So we need the long
term holders, the owners to really step up and I
wanted to try to create an association of mutual fund
and a long term mutual fund people and I tried very
hard to put one together and that Warren Buffett told me that if I could get the group
together, he would join. That would have been a huge asset but I couldn’t get a single
fund to join the group. – Why not? – Well vested interest. Probably because the
idea comes from Bogle. This is not something that’s would win out president and American business. You don’t like the
deliverer of the message, you don’t like the message
but that went aborting but since then and that’s probably eight or nine years ago anyway,
maybe 12 years maybe 15. We’ve come a long long way here. I had the temerity to
be a little critical, not very critical of our own proxy votes and even led a fight to make sure the mutual funds under a new SEC proposal, that the proposal got implemented and the mutual funds would be required to report to their own shareholders how they voted their shares. – [Emma] That’s a start. – There was a huge
outcry from the industry. This will ruin the industry. I mean it’s so hard if you’re all you and the audience you’re lawyers are familiar with agency theory and if the mutual fund
manager is the agent and you’re shareholder is the principal but the agent to tell the principal I’m not gonna tell you how
I voted would be laughable. So since then, Vanguard has
come a long way, a positive way and in corporate engagement
and we vote the proxies normally for the management
no question about that. I don’t see any matter with that but when there’s a proxy fight
like the Hewlett Fargo one, we stand up and be counted
for what we believe. I think we stood up with the management if you looked at that I can’t remember who wanted to do a merger and turned out not to be a good idea
but that’s another story and we report in the
stewardship report every year, must be 15 or 20 pages
exactly how we voted and entering all the
areas we’re working it. So I love that improvement
and other people are gonna have to engage and I don’t know if your audience realizes how
substantial this control is and that Vanguard owns
eight and a half percent of every company in America. – [Emma] That’s right. – And Blackrock probably owns about eight and a half percent, that’s 17% and State Street probably
owns four percent. That’s 22% that’s a quarter
of all the stock in America in three firms and that
has its own dangers. It has its own dangers. – [Emma] What would those be? – Well the danger is a
concentration at economic power and it hasn’t been abused yet but we want to be with a very watchful eye because all these three firms
that’s three biggest firms are essentially the three biggest firms with or index firms and you
know the old Wall Street rule if you don’t like the
manager, sell the stock but the index fund can
not follow that rule because they own the stock. So it’s ruled in logic
well logic would tell you, if you don’t like the management,
change the management. Let’s work to improve the management and that’s logic and we’re
not starting to do that. – You’re starting to do that. – Grow and grow and grow. – You have five dreams for the future for our nation based on trust, ethics and the regulation of the fiduciary role of the finance industry. Tell us about your five dreams. I thought that was just brilliant to lay out what your dreams
are for the future of finance. – Well you have to remake the human soul to get all this done,
let me acknowledge that and so it will not be easy
and it will take time. But sooner or later I mean
what this fiduciary duty mean? It means putting the client first. If you run a hardware
store down the street, you have to put the client first. – Right or you’ll be out of business. – You’ll be out of business. In the financial industry,
that doesn’t seem to happen because the stock market goes like this and let me say I want only arithmetic but if you don’t have an index fund over the last say 35 years,
I can’t remember the number, you would have made 60 times on your money and if you don’t actively managed fund, you would have owned 40
times, a tremendous difference but nobody’s unhappy. Why would I be unhappy if I
made 40 times of my money. So we need people to study this. We need people to realize, see comparisons about how this works
compared to how they’ve done and how they’ve costed that. I’m an idealist. I’ve always been an idealist
and I have lived an idealist and I will die an idealist. I can’t help that so these
rules, these hopes and goals of an integrity latent industry
that puts clients first, fiduciary duty, responsible
corporate voting, long-term focus on your investments, not turn over all the time. We know that that doesn’t work. It can’t work the numbers take. It works for A but not for B. So that will happen someday. – For you the financial crisis of 2008 was an ethical crisis. I want you to give us a bit more of enough in one part of that book you say, enough is one dollar
more than what I need. – That’s a quote from somebody else. Maybe John D. Rockefeller, I don’t know. – Yeah but you picked
it up and included it. What’s your thinking about what is enough and the role of money in
measuring your value in the world? – Well it would be a tragedy if your only objective in
this world were to make money. Work itself is valuable,
work itself is fulfilling. How much you get paid
is part of the system. How much you spend, one reason I don’t care
so much about money is that both Eve and I, my wife and I really don’t like to spend, I
don’t like to go into stores. I do sneak a sweater
of the LL Bean catalog every once in a while. – I hear that you fly
coach, is that right? I hear that you fly coach. – Yes. – Oh my God that is so impressive. Why not? That’s what I do I mean but I’m not you legendary investor but
that’s your thinking. – Yep well the shareholders back there, back in steerage as we used to call it and it suits me fine. I don’t need any more and I
don’t do much flying anymore because airports are troublesome
for me to get around. I just can’t imagine
spending all that extra money for first-class. I just can’t imagine that particularly with the company’s money. I mean I can spend my own
money on anything I want, no one should complain about it but that just seems like
throwing money away. Everybody tells me I’m
totally wrong by the way. One of my pals claims
to have a license plate that says fly first class
or your children will. – Oh boy speaking of children, maybe we can wrap up with this thought. You have six children, 12 grandchildren. What do you see in the democratic process to control finance to
ensure greater equality that every person is born equal? The Declaration of Independence. What do you see as the opportunity for some of your dreams, your
five dreams as starting point to be realized for your family? I know your family is a
key part of your identity in your life. – Well what I’ve tried to do and did try and do with my
family when they were younger and by the way I should
add bragging a little bit. – Go ahead. – We also have six great-grandchildren. – Greatgrands. Oh I didn’t know about that. Six greatgrands. I new about the 12 grandchildren but not the six greatgrands. – My wife is a fabulous
and a fabulous mother. I was always of course doing
a lot of work traveling and maybe doing less family things than I should have been doing. I accept that criticism
but I thought my role was to live the kind of
a life that my children could observe and say that is
the kind of life I wanna live. – Okay I hope you enjoyed your lunch. Our keynote speaker has arrived and assemble yourselves toward the front, if you don’t mind. You can leave those dirty dishes
on the place where they are and come toward the front. That would be great. If you would do that, I know there are people coming in and out. Some are here for part
of it not for others but I’ll give you a
chance to get settled down and then I’ll say a few
words about Sheila Bair. Okay we are pleased to have
Sheila Bair here with us today and Sheila while you were not here, I talked behind your back. I said that you are an
unindicted co-conspirator of this conference. (laughs) And that the two of us
cooked up this project and with your support and
help I was able to go forward. Sheila Bair was chair of the
FDIC between 2006 and 2011. She had the crisis and she
led the agency skillfully during one of the nation’s most challenging financial panics. She is one of the first
officials to warn about the oncoming subprime mortgage failure. She worked relentlessly to represent the interests of
homeowners, bank customers and taxpayers as the crisis played out. She chronicled her five years at the FDIC in this best-selling
book and as you can see, mine is tab front to back. I’ve read every word and underlined it. It is full of wisdom. She said in this book, the year 2008 would bring
with it economic Armageddon. Trillions of dollars
worth of investor losses, the largest bank failures in history and a chokehold on credit
flows to the real economy that would end up costing more than eight million people jobs. It didn’t have to be the that way and she was one of the early proponents of rescuing homeowners first rather than the bailouts of the
large financial institutions and that endeared her to me completely as thinking about homeowners as opposed to the large institutions that the other financial
regulators were so focused on. Now this book, Sheila is
a woman who is strategic and thinks about the future. This book is now published
for younger readers and the title of it is
Bullies of Wall Street. So she’s making the audience in the future as wise as we have become by
reading her work, fearless. In fact she has a chapter in this book called The Audacity of That Woman. She was one of the few women who was in that top
regulatory role at the table and the bullies of Wall Street I’ll let her tell you stories
of her interaction there. So she continues to chair
a Systemic Risk Council, a public interest group that monitors the implementation of financial reforms. We are delighted to have her with us and she will share her wisdom with us. What are the lessons that we must learn from the financial crisis. (applause) – Thank you Emma and let
me apologize in advance. I’ve got a terrible cold so I’m going to try to
make it through this without coughing and hacking in your ear through this microphone hopefully. It’s really it’s nice to be here and when Emma called me with
the idea of having a conference of this nature, I thought
it was a great idea. There have been a lot of funny
it’s a crises conferences as you might have imagined. I was at one last night in Chicago but I think this one is special because of the diversity of
thought it’s trying to elicit and to groupthink really
was one of the things that got us into trouble in 2008. Everybody was all the leaves
were saying it’s fine, how the home prices don’t go down, makes know how to manage risk and boy, did we all get it wrong and so I think having a diversity of viewpoints and listening to a diversity of viewpoints particularly from outside the
financial sector is important. Let me start I want to
talk about the lessons I don’t think we’ve learned. The title of this talk but I don’t want to be too pessimistic. So let me begin with things
that I think we got right in Dodd-Frank because I do think we got a lot of things
right in Dodd-Frank. It was a very important bill. One thing we got was and unfortunately it’s deteriorating now but
we got a bipartisan consensus in favor of strong capital requirements. The general recognition by
both Republicans and Democrats that a key part of the problem
was financial institutions were just relying too
much on borrowed money and relying too much on a
short-term borrowed money so they didn’t have an equity
cushion to absorb losses when the crisis came and
then they had trouble funding themselves
because they were relying, they were having to roll debt in a time when the investors were very skeptical about their financial integrity. So even Republicans and the Republicans do
not support Dodd-Frank. I’m a Republican a lot
of you probably know that The alternatives all feature capital. That was a centerpiece. So there was strong bipartisan consensus that there needed to be more
capital in the banking system that was reflected in
several places in Dodd-Frank and then of course it also
institutionalized stress testing which said well not only
do we need more capital, we need to make sure the capital
is good through the cycles. So sure anybody can look
good anybody’s balanced sheet can look good in healthy
times with a growing economy and very low delinquencies and default but what is that capital
look like in downturns when the value of assets is deteriorating and credit quality is deteriorating. So Dodd-Frank
institutionalized stress test so that large financial
institutions in particular could demonstrate they were
resilient through a cycle, not just in good times. And then we also instituted
better resolution tools. This is something I pushed
for quite vigorously and was pleased it was
included in Dodd-Frank. It’s called Title Two,
Orderly Liquidation Authority and basically it provides the FDIC working with the Treasury and the Fed authority that no one
had during the crisis which was to resolve with
large financial institution. The organization itself. There was authority that the FDIC had to resolve individual banks and we use that for smaller
banks and midsize banks like like WaMu but for the
very largest institutions, they had significant activity going on outside their insured
banks and then of course investment banks like Lehman
Brothers and Bear Stearns their activities were almost completely. They had teeny tiny little strips. So there was no tool that
would allow the government to manage a basically bankruptcy process but it’s managed by the
FDIC where what would happen is what should happen which is the institution gets into trouble, its shareholders and
it’s unsecured creditors take the losses. That’s what they do. That’s the way markets
work and if you invest, you need to have your eyes open and make sure you know
what kind of institution you’re investing in and if
you invest in their shares or buy their debt, you
should assume the risk that institution may
get itself into trouble and guard against that. It’s called market discipline which so we didn’t have a
lot of prior to the crisis. So with Title Two, we now
have a credible process that says okay, the
government is going to take you in a resolution. We understand there’s some tricky thing about financial institutions so we want to have this
backstop tool available to be able to manage your failure but your shareholders
and unsecured creditors are gonna take losses. We’re gonna leave your bad
assets behind with them and let them absorb those losses. We’ll clean you up and
probably break you up too and create a healthy bank
which will to recapitalize and by the way, all your top management and your board leadership
will lose their jobs and we’re going to claw back three years of your compensation as well. So it’s a punitive. It’s more punitive
actually than bankruptcy and I think appropriately
so because one of the things that troubled me most
about all the bailouts was that people were not held
to account for their actions and some of that was just were flying by or you’re just making it up along because really was no
tool, there was no playbook for large non banking institutions but we needed a framework
and we needed something that would be consistently applied too because a lot of the another criticism which I think is fair
is the inconsistency. So we leveraged assistance on Citigroup, we let Lehman fail, we
supported Bear Stearns merger or JP Morgan Chase
acquisition of Bear Stearns but we basically assert
government control of AIG. I mean it was all over the
place, the markets were confused and again I think people
did the best they could because there really was no
playbook but going forward, there was a consistent set of rules now in terms of what should happen. And in conjunction with
Title Two, Dodd-Frank banned the Fed, prohibited the Fed from doing any kind of one-off bailouts with its 13-3 Authority. Now 13-3 is something
that hardly ever been used prior to the crisis and
there’s one tiny situation. It’s basically its authority for the Fed in extraordinary circumstances
to lend to non-bank entities but the Fed really used. They’ve sent trillions of
dollars of credit facilities using 13-3 and those
facilities helped a lot. They felt stabilize the
system and made sure there was enough liquidity in the system but it was also used or
for one-off assistance and the Congress said
they quite rightly said well we have Title Two
now which is basically bankruptcy-type process. So if you have a mismanaged
institution that is insolvent, we want you to use Title Two. We don’t want you to
bail that institution out because that’s bad for markets, that’s bad for economic recovery. They said the Fed could still use 13-3 for generally available support. So if you got in a
truly system a situation where everybody was seizing up, they can provide, make
generally available support to everybody but no one off bailouts and I think that was
completely appropriate. Now probably you’ve heard
that some of my colleagues during that time led by Tim Geithner are very upset about that limitation and want Congress to lift it and I think that’s a very bad idea. They also want to lift the limits on the use of the Exchange
Stabilization Fund and the FDIC debt guarantees which were also two extraordinary tools. The FDIC had never done
that before and we did that and I was uncomfortable
but we did do that. It was a successful
program from the standpoint of we were able to put them
on, put the guarantees on, we were able take them off. There was not… They were not financial losses. There was some financial
gain in the program, not that that justifies that it doesn’t but it was in terms of
addressing the immediate problem of banks not being able
to roll their debt. Right they were relying on
all the short-term financing. They couldn’t access the credit markets to roll their own debt so
we gave them a guarantee on their liabilities. Basically designed limited
so that they could roll what they currently had. They could expand their balance
sheet with that program. So Congress basically said
neither one of those tools can be used now without a
congressional resolution. So whether that’s effectively
still available, I don’t know. I think with so many
members getting in trouble with their tarp boats,
whether they would support it, I don’t know. I will say one thing that first of all, I think I’m gonna spend about
two more minutes on this and get off of it because I think the last thing we should
be talking about right now is bailout tools. We should be talking about
prevention and accountability. We shouldn’t be talking
about bailout tools but I would say that if you’re going to limit something, liability guarantees are
less politically sensitive because they don’t involve the
transfer of government money into an institution so you buy a bill, you guarantee the debt for
a specified period of time, we charged at the take it off that sense. So it doesn’t add to the money supply. It doesn’t involve government
money going into institutions. So ironically, these liability guarantees were somewhat less controversial and certainly the tarp capital investments are all the Fed lending but Congress said, chose to limit those
so I think that’s fine. I’m not sure why they picked those two. It’s not a priority
with me to take them off but I think the most important thing was that they started in the
new paradigm going forward is no more one-off bail-outs
and if you get into trouble, you go into Title Two. So I think those are the
things they think we got right. Now what did we’ve not quite get right? Well capital was something we got right but not enough in my book and I think there are
a lot of other people who agree with me. We still have a lot of
high level of leverage. It just drives me crazy
when I read the press. Sophisticated reporters, the Wall Street Journal the New York Times just kind of take it as fact that we’ve got all this
capital the banking system now. Oh well we’ll capitalize. We’ve got all this new
capital in the banking system so the leverage ratio which in my view is the most credible measure of how well capitalized a bank is, still allows large financial
entities to fund themselves with 95% debt. So only five percent of their funding has to come from common equity. That’s a lot of leverage. So to say that we’ve gone too far on this I think and that is being used now to try to roll back some of these rules which I’m very concerned about. To say that we went too far
on capital is just ludicrous and especially given how well the US banks have been doing visa via European banks where the European banks were
much more thinly capitalized than our banks were going into the crisis, still have not aggressively recapitalized. Still continue to struggle. The EFT had a really good article recently about how US banks have come to dominate the global financial system. So JP Morgan Chase’s market
capitalization by itself is greater than the five
largest European banks. So that was not the situation
prior to the crisis. So why bank lobbyists
are coming to Washington and saying that we are
stronger capital rules are hurting their competitive position when they’re just eating a
lunch of their competition is just I think beyond disingenuous and it’s shocking to me that
there are members of Congress, Republican members of Congress
who are buying into this and trying to put pressure on the Fed to ease up on the capital rules. So I’m very concerned
about that and hopefully, the Fed will hold firm. I hope they do. Housing Finance is another area where we really didn’t address. I don’t know if that’s at
the top of my priority list. A lot of people talk about it, Fannie and Freddie are
still in conservatorship. They’re still a big part
of the mortgage market. People have different ideological views about whether that’s right or not but the mortgage market of all the risks that are out there in the economy, the mortgage market seems to be one of the safer places right now. I don’t know but that’s
why I my priority list for Congress to turn to. Non banks though I think non banks are a significant source of uncertainty. A lot as we’ve enhanced
supervision appropriately on regulated banks, more
credit intermediation has gone into the non-bank sector. Dodd-Frank provided some rules and powers for non banks which really
have not been used much. One was Title One authority to designate non banks as systemic. The current administration has said they’re not wild about Title One so that’s not really
been aggressively used. Then Title Eight has the
ability to regulate activities in the non-bank sector but then again that was invoked to push probably the SEC to do some many market fund reforms but other than that,
we really haven’t seen aggressive use of the new authorities regulators have to oversee non banks. And of course we also have the FSOC, the Financial Stability Oversight Council which is made up of all
the major regulators within the Office of Financial Research which again has kind of been weakened under the current administration. The idea was that you would have coordinating authority along with OFR and research often as mandated
to look across a system for systemic risk there
again, disappointing, we haven’t done much. There’s still a lot of
inconsistency in reports. Regulators aren’t sharing
information with each other as well as they should. So the Volcker rule I think
is a prime example of that where each agency still has
their own trading data reports and they’re inconsistent formats so they’re not consolidating
them and reading them in a meaningful way when they could get some probably pretty
good of data if they did. So those are the things
I don’t think we’ve done particularly well and then more broadly for our economic recovery,
we pretty much used try… Have been using debt
to fuel our recoveries. We had a crisis that was
come by too much borrowing and then we implemented very
aggressive monetary policy to encourage people to borrow
to come back from that crisis. So we used debt to fuel a recovery. Coming out of a crisis that
was caused by too much debt and I just think across the
board assets overvalued, we’ve got more leverage than ever. If you look at it as a percentage of GDP, relatively simple metric
on a nominal dollar basis, we’re way above historic highs
in almost all categories. As a percentage of GDP though we’re at the historic
highs for government debt, for corporate debt. Non-mortgage consumer debt
is also at historic highs so fueled heavily by some
student loans obviously and that student loan concentration is heavily in lower-income families. Subprime auto as well I
think been out of control for a few years now. So we’ve got a lot of debt out there. We’ve been fueling growth with debt and that’s not sustainable. At some point you need grow wage growth and we’re seeing a little bit of that now. This has been a problem for a long time. Finally this recovery
is trickling down a bit. I worry it’s coming at
the end of the cycle but that’s if you want
a sustainable economy, you gotta grow the middle class. You do that with grow wage growth. You don’t do that by
letting them borrow money that they can’t afford to pay back. I thought we learned that in 2008. Maybe, maybe not but anyway, a lot of debt out there, a lot
of inflated asset valuations and I think at some point those chickens are gonna
come home to roost. So what’s Washington doing about this? So people ask me are we
ready for a next crisis and I said well you know the cycle is probably about ready to turn because Washington is deregulating because government policymakers
typically are procyclical. So when you have a crisis
and a deep recession and the economy is crying out for credit, oh golly we just had a crisis. They tighten up on the bags,
they tighten up on lending and that’s when they start regulating it and then when you get into a boom cycle or towards the end of a boom cycle and things started getting frothy and lending standards start to loosen and asset valuations get
into nosebleed levels, they’re saying oh my gosh, we’ve had this recovery for so many years. We don’t need all this regulation and that’s exactly what happened in 2006 and what I sense is
starting to happen now. So they’ve all got rolling with S2155 and in full disclosure, the parts of S2155 that dealt with the
regional and smaller banks, I didn’t really have a problem with. I was always concerned that
for an automatic trigger for enhanced prudential standards, raising that automatic
trigger did not bother me because I think by casting the net so wide for enhanced prudential standards, we were diluting somewhat the focus on the truly systemic institutions. So that didn’t really bother me and I kind of looked the
other way for a while. Wish I hadn’t because lo and behold, once the deal was done and the
bill popped up in the Senate, it had a nice little sweetener
for large custody banks basically reducing their leverage ratio for the three largest custody banks and reducing leverage ratio by
20% and they did it in a way not only did they reduce
their capital buffers by 20% of the capital minimums,
but they did it in a way that really adulterates the integrity of the leverage ratio. Because they basically said well we think that money you have on reserve
in your reserve deposits at the Fed is super safe so you don’t need to have that in your leverage ratio calculation. Well the whole idea of a leverage ratio is to not make risk judgments period. The whole idea of a leverage ratio is to say we don’t care
what your business model is. If you’re a safety net institution, if you’ve got deposit insurance,
you got access to the Fed there’s a certain amount of leverage beyond which we don’t
you think you should go and for big systemic institutions, we’ve set that five percent
minimum equity requirement and is it true that
Mellon or Northern Trust has very little risk in their deposits they have at the Fed? You bet it is but I’ll
bet you dollars to donuts that in their trading books
and the derivatives exposures, they’ve got risks that where five percent is not nearly enough. So to say an isolation, oh I’ve got this money on reserve deposit so they must be safe. We’re gonna take that leverage ratio again adulterated I think that the purity of the leverage ratio is a non risk weighted measure and I think it’s a very
dangerous precedent because now what else we’re gonna start, it complicates the leverage ratio too because another important
benefit of leverage ratio is that it is simple
and it should be simple. It’s the only thing that
markets are looking at in 2008. Nobody trusted these just
risk-based capital requirements. They’re too complex,
we improved them a lot but they’re still heavily
reliant on opaque models both used by the bank and by the Fed. And so it’s very important
I think to maintain the integrity leverage ratio and this was a very bad precedent I think that was set by S2155 and of course then once we had S2155 that signaled the Fed so then they went ahead with
the rule that reduced by 20% the minimum leverage ratio requirement for the eight biggest FDIC insured banks. So that’s 120 billion dollars of capital and they admit that. That’s in there in PR. Nobody’s disputing that number. They say the holding company level, the capital will still say the same but the insured bank level which is where the primary
exposure of the government is and also where the operating subs really essential functions to the economy like payment processing,
lending, financing those are all done in the insured bank. This proposal would potentially
release 120 billion dollars out of those FDIC insured banks. So what is up with that? This is at a time at the end of the cycle where I think other people
like Don Kohn and Jason Furman and a bunch of regional fed Bank heads are saying well actually since
we’re at the end of the cycle maybe we should be raising
capital requirements so they’re talking about
raising the risk face their requirements which would be fine and any metric they want
to use is fine with me but kind of assaulting
the leverage ratio now and what happens is the argument. So have risk-based ratios
and we have leverage ratios and when you get into very
benign economic times, these times where you have
very few credit losses, what happens is your risk weighted measure will start to reflect a
lower capital requirement because your assets look so safe you know. All my delinquencies are
so low and all my car loans and my credit cards etc etc. So this is what happens
at the end of this cycle. The risk-based ratio will let
you lower your capital minimum and the leverage ratio is there
to be a constraint on that. So it’s not surprising leverage
ratio is now kicking in but people arguing well
that’s a bad thing. You got to lower the leverage ratio and no that’s the wrong response. The right response would be what Don Khon and others have said. Let’s increase the risk-based standards through what’s called a
counter-cyclical capital buffer and so far the Fed JPL’s been asking about that several times. He was asking about it this week again. He doesn’t seem to think
the time is ripe yet. I’m concerned that he feels
that we really need to wait until we have some you
know strong warning signs before they institute it and then I think it’s probably too late. I mean you want them to
build the capital buffers well they’re still making profits and their credit losses are low. Once they start losing
money in the downturn, the ability go out there
and raise more capital or retain more capital is going to be much more challenging but I think there’s a
very active debate on that and good for people like Leo Brainerd who’s been talking about this, Eric Rosengrin from the Boston Fed. They’re out there and I really hope that the leadership of
the Fed listens to that and that’s what they should
be worrying about now. Raising capital requirements, not reducing or weakening
the leverage ratio. So I want to talk a little bit
about this Republican effort and I hate to say the Republican effort a weaken capital rules across the board and I am so disappointed in my own party because Republicans should like capital that’s market discipline. That’s skin in the game,
that’s forcing equity owners to put more of their
own money into the bank to fund the bank and
creating more incentives to monitor risk and so
to really be pushing it for Republicans and I understand there are gonna be
disagreements with Republicans on the CFBP, maybe on the Volcker rule, maybe on some other things but capital, I really never thought we
would lose our consensus but it appears that we have and I would just ask those Republicans who have signed some pretty
aggressive letters to the Fed, they’ve been in the press. You’ve seen them go google it if it’s pretty amazing. I’m completely shocked that they’re doing. I would take a second to think
about this a little more hard about who they’re listening to and probably bank lobbyists
were paid in bank stocks so they are a capital you
increase shareholder returns so I just think it’s over the top and I would ask them to think, listen to groups like
the Systemic Risk Council and Americans for Financial
Reform and in Better Markets and others who are speaking out and speaking to the
public of voice in this because this is absolutely the wrong time. We shouldn’t be lowering capital. I think this is just
to talk about amnesia, this is exactly what
happened to be in 2006 when I was at the FDIC. When I got there, the FDIC
had already been fighting a good fight against these new
international capital rules called the advanced approach as the Basel Committee advanced approaches and this is basically a way to let banks use their own models to determine what the risk-based capital
requirements should be. It is as simple as that’s
basically what was going on and our quantitative impact studies showed that the major banks it would be a medium addiction of 30%. It was a huge reduction
in capital requirements. This was 2006 and so we fended it off and fended it off in both
Republicans and Democrats. I was getting hammered, getting
a lot of political pressure. We held our grim. We slow walked it and then the crisis came and nobody was talking about that anymore but you know ironically the
argument they were using then is exactly the argument they’re using now which is that our stronger capital rules, the US does have stronger capital rules hurts our international
competitive position and again if you look at the dominant role that US banks now play in global finance, it’s just it’s laughable that anybody would even
make that argument. I’m embarrassed for them. So again I hope they
would look at the facts and I would also hope
that their constituents since some of them may
be up for reelection, their constituents will ask them what in the world are you doing. You know you represent
us not bank lobbyists. So the other thing that
I’m kind of worried about is this call for new bailout authority and I’m sure you’ve seen Tim Geithner led a group the G30 that
came out with a big report and his main conclusion was that we need more bailout authority and then Brookings did a
10-year retrospective last week and I wasn’t unable to attend
but reading the press events I think the big thing coming of that was government needs
more bailout authorities. So that really is
exactly the wrong message to be sending right now. I think the people who are calling. It’s good faith. I understand they’re proud
of the tools that were used and the fact they were successful in stabilizing the financial system, they weren’t very successful
in helping the broader economy they did stabilize the financial system but we never should have gotten
to that place to begin with. That’s where our priority should be. Preventing it making sure
it doesn’t happen again and so for very prominent
people to be out there saying we need more bailout authority, I really wish what they would be saying is we need to tighten regulations, we need to institute a
counter-cyclical capital buffer, we need to signal to the
banks to be prepared, to be resilient we’re
very long in this recovery where we know a downturn is going to come in the next two years be prepared. The Fed itself is preparing
by raising interest rates. They want some some Headroom
so they can lower again when the next downturn comes. Why are the bank’s preparing as well and that’s the signal
they should be sending and the other signal
they should be sending is not we need more bailout authority. They should be sending you know what, there’s something regulators now we have called Title Two that they
didn’t have prior to the crisis and that means if you have
another Lehman Brothers situation or a Dick Fuld had several
opportunities to raise capital or sell his bank throughout
the summer of 2008 and decided he didn’t want to because I assume based
on the press reports, he thought he was going to get a bailout. If you had Title Two I don’t
think that would have happened. I think he would have sold his bank for very small amount of
money and that was fine because it probably wasn’t worth much. It was a highly leveraged,
had a lot of toxic assets but if he knew the
alternative would be Title Two or he was gonna lose his job and three years of compensation and all of his shareholders and bonds. Your bondholders are gonna probably get their investments wiped out and his board they would lose their jobs
as top management team. I think he would have
resorted to some self-help and this is important because regulation can’t accomplish everything. Ironically I think the people who argue for more bailout authority
secretly or maybe not so secretly are skeptical of the ability of regulation to stabilize the financial system and they kind of threw up
their hands and say oh, can’t do it, can’t do it by regulation. We’re always going to need to do bailouts and the public just
needs to get used to it. I agree that regulation can’t do it all but where that takes me is again more debt market discipline
with higher capital requirements a robust incredible resolution mechanism to signal to banks and their creditors and their investors and
their counterparties to pay attention to how
well that bank is managed because if they fail you’re
going to take losses. The government is not going
to come in to bail you out but if you signal to them
yeah, bailouts are the thing. We did in 2008, worked out so well. we’re probably gonna do it again. We may even double down. We want even more authority now then the signal is gonna be okay, we can just keep doing what we’re doing and taxpayers will come in again
and everything will be fine and that’s basically what happened in 2008 if not for everybody, there were a few that we did let fail and with
appropriate repercussions but mostly we didn’t and that
in of itself is distabilizing. So I think this is very
dangerous right now it sends all the wrong signals. A lot of people talking to me, thank you for acknowledging this that I was very early on on
the subprime mortgage problem. So this issue goes back
to 2001 and 2002 for me when I was the assistant secretary of financial institutions at Treasury and I worked with Nick Gramlich. We were seeing this kind
of an affordable lending, abusive lending really going on. Right then it was targeted
mainly in minority neighborhoods around Baltimore, Boston, Chicago, Ohio. There were pockets where minority
families with home equity. They were the ones that were targeted and actually this idea that
all this was being done to expand home ownership, it did go up by a few percentage points then of course fell back
down to historic lows. Most of these are refinanced. People already had a home and a nice a 30-year fixed-rate mortgage. They got refinanced with this toxic thing they didn’t understand they
pulled all their equity out their house, high
fees, steep payment reset and in the short term
they thought it was fine because they could pull out the cash for a new roof or whatever but longer-term they were eviscerating their safety net. So I did see that early and during 2007 I was the first to call for loan mods and I got beat up and saying oh you’re reacting, it’s
not that big a deal, you can’t help these deadbeat homeowners. You can’t help deadbeat homeowners but we were out there on capital two and we were out there raising deposit insurance premiums early on. I got a lot of flack about that. We had a bank failure in three years why are you erasing deposit
insurance treatments in 2006. So I’m proud of that. It was just me that was
the agency behind me raising these issues and betting them and studying them and helping inform me to make a principled arguments
to my colleagues about this. But I would really
prefer they just listened as opposed to ignored me
and then apologize later and I so fear that this is
what’s going to happen again that there are some fairly
obvious warnings signs but the groupthink is
economy’s great, robust, the over three percent
annualized growth rate. It looks like finally
seeing some real wage growth and in the short term there’s
some really good things but I don’t think we’re looking behind and the drivers of that and
dealing with the core issues of uneven distribution of
wealth and income inequality. More of an wage growth. Those are the things we need to address not trying to help people sustain their standard of living by borrowing. We need real wage growth
and we need to help be more focused on our middle class. We want a sustainable economy and a sustainable financial sector. So sorry to sound so pessimistic but I do think I am very worried you know about what’s
going on in Washington. I know a lot of people in this audience see a lot of familiar faces and I know you’re fighting the good fight and thank you for that. It’s an uphill battle but hopefully don’t back down even if
you go down swinging, go down swinging because I
think it’s important to push and make sure even if they start undoing a lot of these rules that
we’ve draw attention to it and make it painful. So anyway, thanks. I’d be happy to take some
questions if we have time Emma. Right. (mumbles) – The other is pension funds. As this big population
group goes into retirement and these pension plans
have not been earning the interest to support
themselves and then finally student loans, how can
those loans be paid back? – Well, European banks I
think are still struggle, I agree with you. Whether they would catalyze a
global crisis, I don’t know. I think they have a different relationship with their government than we do and they’ve been bumbling
along for along time now. I think it’s a drag on
economic growth in Europe but it being a source of
a financial crisis I hope you maybe wrong but I’m not sure. Pension funds, I do
worry about pension funds related to the other issue I raised which was the inflation
of financial assets. They’re underfunded now,
census rates have been so low, they’ve been trying even going investing in riskier and riskier
assets which I’m quite sure are overvalued to try to get yield. If we have a correction and
there’s a correlated drop in the stock and bond market
which there probably will be. I mean that’s going to
exacerbate their problems and so how that impacts
financial recovery, that could definitely
hit consumer spending if they have to cut back
on current beneficiaries or even future beneficiaries
or it could hit us fiscally if the government has to step
in which it probably would. Same with the student debt. That’s not a bank balance sheet. It’s on the government’s balance sheet but it’s certainly a
crisis at a human level and it will stretch our fiscal resources which are already stretched. So yeah I think it’s just
what it’s doing to families. I was a college president
for a couple of years and there’s so many bad student economic incentives or the student grant program. For one thing they call it financial aid. I hate that. It’s a loan. It’s not financial aid. It’s like they’re doing you a favor. Here’s some financial aid,
here’s a loan for you. Repay it later and the whole paradigm is well to try to help them
borrow as much as they can because this is financial aid. No, it’s a loan and let’s figure out and how much are they gonna be making and is that kind of just basic
better financial education around what the kind
of financial obligation they’re assuming once they graduate I think is one of many many
issues I have with the program and I hope there are good
ideas out there for solving it. I hope they can come
to it but I don’t think that’s a fiscal problem not so much one for the financial sector but it’s a huge problem nonetheless. Anybody else? – Thank you so one idea that
actually I haven’t heard. I’m sorry I’m Alexander Marko and I was a class of
15 here at Georgetown. What I think that it
hasn’t come up much today, you hear a lot more political circles than sort of folks in
industry and in regulation is the idea of breaking out the larger, more complex institutions. We heard talk before about
how people at the top are rarely prosecuted maybe that’s because they seem so remote from things down chain is they are not just too big to fail but too big to succeed in terms of a strong compliance structure and perhaps this it’s
sort of the flip side of stronger capital requirements. You make the banks
smaller more manageable. Is that an idea that has a sort of serious place in discussion or is that more just a sort
of political valium cry? – Well it’s a good question. I don’t see the political
climate now for it. I mean I think an indirect way to do that is to really ratchet up
capital requirements. If you had a 15% capital
requirement non risk-weighted you would force a lot of them to downsize because they just can’t
make their return on equity. They’re too inefficient
and the smaller banks have much higher capital levels on a non risk weighted
basis than the larger banks but that’s because they’re more efficient because they’re traditional. They take deposits, they make loans. They don’t get into all
these other complex areas and this idea that the
diversification creates economies is just wrong and it’s just the opposite. So I don’t think there’s a
political will to do that now. I think if there’s another
crisis, more bailouts, assuming our democracy survives
another round of bailouts and I think that’s a
question I can only assume that it’s going to go
one of two directions. Either they’re going to be nationalized or they gonna be broken up so they’re truly are no threat to anybody. Again I hope the wiser
heads on Wall Street I hope realize that
and whatever government is telling them to do or not to do, they’re responsible for
their own institution. They have to be prepare and
make sure you’re resilient and can handle a downturn
and not manage your bank based on the assumption
you’re going to get bailout problems again. Yeah sir. – [Male] Sheila, student
debt has risen significantly since the start of the financial crisis. Has it become a systemic risk? – Yeah so I think it’s not
for the banking system, no because banks don’t have exposure to it. It’s on the government’s balance sheet. So I do think it’s a source
of stress for young people. I think it’s a source of
stress for the economy because it again it diverts all the money that those
folks are paying back on their student loans
they’re not going out to eat, they’re not buying a car. They’re trade-offs. There’s only so much
discretionary income you have. If you take it a big
chunk to pay off the loan, that hurts the economy too. So I think it’s bad but
it’s not systemic risk with the financial system. – [Frank] Hi, Frank
Pasquale and it’s an honor. I’m a big fan. I just was wondering in
terms of thinking about what the sustainable debt level is for contemporary economies. We know there was the whole controversy over Reinhart and Rogoff
and their findings or lack of finding I guess
about 100% debt to GDP ratio. We see that Japan seems
to be able to keep going even though it’s definitely
higher than that. I’m wondering if maybe the solution to some of these problems
is to ensure that, better ensure and to unite the fiscal and monetary perspective
such that the monetary system tries to ensure that more lending is going towards things that improve the overall ability of the real economy to support the debt. I’m wondering if that has any place in modern monetary policy. – Well I think it’s certainly I guess I would look at fiscal policy. I’ve always been a big advocate
for infrastructure spending and why we didn’t do more and
why we’re still not doing it and I don’t get it
because infrastructure… Look we get it. The global environment is going to be increasingly competitive when we just need to get used to that and we can lash out and point our fingers at other countries and say they’re evil and they’re
ripping us off and all that and I don’t know, there’s
some legitimate trade issues that are being dealt with but
we need to look at internally what can we do to make
ourselves more competitive? Infrastructure, there’s a lot of frictions and our infrastructure
is very bad in many areas and our education system too
we spend a lot of money on it but whether we’re meeting
the needs of young people who are leading the workforce and arming our nation’s labor needs I think that’s really up for discussion. So yeah, better attention to how the money the
government is spending. Are we getting a return
on that investment? I think that would be
good and that’s something that democratically elected people should have some sense of. In terms of fiscal,
monetary policy I don’t know then you get into government
directed lending and we can argue it both ways. I mean we got into a little
bit with quantitative leasing so they picked mortgage bonds to invest in so some people didn’t like
that, created distortions. I think it’d almost be better if you’re getting use monetary policy to just buy the government
debt and let the political apparatus decide the appropriate use of infrastructure or whatever
because I don’t know. Government directed lending
doesn’t have a good history and it sounds great and we
all know where we would put it and we would hopefully
make some good decisions but unfortunately that
hasn’t always worked out with the countries that have experimented. I think with Japan should
be careful with that. (mumbles) The US is we’re so reliant
on foreign investors to buy our debt. If Japan does not… I haven’t checked the numbers recently but traditionally most
of their debt is held by people in their country. So we are heavily reliant
on foreign investors and someone at the mercy of
their continued willingness to buy our debt. So I do think I know there’s
a lot of rhetoric canal. It doesn’t really matter and if we can borrow the money why not? So that’s a seductive argument
but the thing about debt, you become reliant on it. Eventually got to pay
back or refinance it. So right now people may be
willing to lend us money but a year or five years 10 years from now we need to refinance a lot of debt or there could still be a lending us money but we’re still relying on it. It’s cooked into our budget so I do think that there
needs to be some pushback on this idea that the government so long as people will lend
us we can borrow indefinitely. It just it doesn’t work like that and I think it’s really playing by fire. We’ve got away with it for a long time I do worry about it. I think we need to be a little
more fiscally responsible. – Hi Sheila. My name is Veronica and
I’m a 2L here at Georgetown and I was wondering if you
thought that requiring the banks to do these resolution plans
has been helpful with the FDIC really relying on them
and if it came about and should something similar
be required for non banks since you said that they
are a major concern now. – Yeah that’s a really good question. So first yes I do think these
these living with plants have been helpful. When we were trying to
tackle this during the crisis and I joked at this but I think Citigroup is a much better run institution now but they were clearly
having their problems during the crisis and so we were looking at different options on how to resolve them and we joked. We couldn’t even find the bank. We didn’t know and the
bank would basically placed a book assets. There was no bag and so
one of the many good things the title one planning process has done is to force these guys to
think their legal structure and define their legal structure and let us know where
assets are, where risks are where exposures are and
who the counterparties are. So if you get a situation
where you need to break them up you have a severable
operation versus before we kind of just had one big blob. We weren’t quite sure what to deal with. Then yeah it’s a great idea
to have it for non banks but that was the idea of
title one designations to get to do resolution planning and what one of the benefits of it and this administration
just doesn’t seem inclined to use Title One designation. So the tool is there
but it’s not being used. But you’re like Blackrock for instance not that I think Blackrock’s
getting in trouble. What happens. Who knows what’s in there. (laughs) Great, thanks very much. (applause) – Okay we’ll take a
break and our next panel starts at 2:45. Innovation and Risk. Yeah it’s the rude train
conductor, here I am. We’re at the point for the
next part of our program. One of the joys of conducting
something like this I think Sheila and I like I said, she’s the unindicted
co-conspirator with me to arrange this conference
but one of the joys of this is you get to get deep into conversation with George Akerlof and a dispute with him whether there was enough
information to value AIG and we did agree on one
thing that that lawsuit that AIG brought against
the government for takings was the essence of hoods pop. You go bankrupt, you cannot
get loans anywhere else and you get loans from the government and then you sue the government because they took your shares. I weep for you. Okay so that was one of the joys that I was able to have
was standing there, talking to our very own. I know you’re really Berkeley but you’re on to Georgetown. Our very own Nobel Prize
winner in Economics. So that kind of conversation I know all of you are having
those wonderful conversations. Okay so we’re at the point
where we’re going to talk about innovation and risk and I’m
just going to turn it over to our Associate Dean Jim Feinerman to tell you about the panel, what it’s about and
everyone who’s on that panel should just come on up
and Jim’s in charge. – Thanks Emma and I’m
very glad to be here today and to join this distinguished gathering that has so much talent brought together to deal with obviously what’s still very important topic and something that created the recent modern financial landscape because of what happened
10 years ago this month. We have on our panel today
three distinguished speakers each one of whom has had a key role in both dealing with and
writing about what’s happened both in the financial crisis in some cases and definitely in dealing
with the aftermath and I’ll just introduce them in the order that they’re
sitting here on the dais with me. So the first Michael Greenberger who is a distinguished professor at the University of Maryland, Francis King Carey School of Law and he aside from being
the founder and director of the Center for Health
and Homeland Security is also a professor who’s worked and taught a lot in the
area of financial law and financial services. He’s had a distinguished career before coming to the
University of Maryland both working in the government where he was the director
of trading and marketing in the Commodities Futures
Trading Corporation and shares time in that August institution with our next panelist Gary Gensler. But he also was a partner in
the law firm of Shane Gardner and he’s had a great deal of experience working on the issues over the
last several decades actually that have shaped the
nature of modern finance and also with the regulatory bodies that carry on the work
here in Washington DC. Our next panelist, Gary
Gensler is now at MIT but he has also had a distinguished career including his work as a chair of the CFTC in the Obama administration and his resume is equally long but I would just highlight
a couple of things that I think are worth mentioning aside from his Obama administration work. First of all, he’s previously
been the senior advisor to Senator Paul Sarbanes and writing the Sarbanes-Oxley Act which is probably the key financial legislation
of the last two decades. He was Undersecretary of the Treasury for domestic finance and
also assistant secretary of the Treasury and in
recognition of his service, he received the Treasury’s highest award, the Alexander Hamilton award. He’s obviously worked
in political campaigns including most recently as a CFO for Hillary Clinton’s bid
for the presidency in 2016. He’s the author of a number of books and he’s also then prior to his
many years in public service at Goldman Sachs where he was a partner in the mergers and acquisitions department and finally Frank Pasquale
who is a colleague of Mike Greene Burgers
at University of Maryland Francis King Carey School of Law is an expert on many
things including finance but also the law of
artificial intelligence, machine learning and algorithms and he’s in another field, one of the most cited scholars
in the country in health law but he’s here today to talk about things that he worked on in his book, The Black Box Society which
are the secret algorithms that control money and information. This book was published several years ago by Harvard University Press
and it develops a social theory of reputation search and finance and tries to offer suggestions for improving the information economy. It’s been reviewed very highly in the most distinguished
journals of science and economics including the Journals Science and Nature and it’s been published in translation in Chinese, French, Korean and Serbian. He’s also had time in government service working for the House Judiciary Committee of Energy and Commerce and also on the Senate
Banking Committee in the FTC and in the directorates general
of the European Commission. He’s also advised officials in Canada, in the United Kingdom on
law and technology policy. So without further ado, I’m
going to let our panelists speak and I know each of them is going to make a presentation of 10 to 12 minutes and then I hope to have some discussion with the audience that’s here. – Michael, you’re sitting there Michael. Michael Greenberger is gonna go first. – I usually like to go
last because I get… Well thank you very much
and hello to everybody and congratulations on
this excellent conference. Several things have been said already that lead me to want to rewrite my paper which is already very long. I put up for my slides
my paper is quite long. I’ll try and summarize
it in the time allotted. The paper and I have handouts for this if you want to take it with you. The paper is in these links
and when we have bullet points and blogs and we’ve had actually it was shown out for the
first time in June 19th by the Institute for
New Economic Thinking. Paul Volcker was on the panel
and we have the video of that and I have a video of
a terrific interview. I wasn’t so terrific but Rob
was the guy who interviewed me, he was terrific and a lot
of media about the piece. So if I confuse you a lot, please use some of these cliff
notes to give you some help. The panel is Innovation and Risk. I’m not quite sure I know that these two, Gary and Frank are going
to talk about innovation but I don’t know why I’m on here except to say maybe the innovation here is the most clever exception
created by four big banks from the swaps regulation
under Dodd-Frank. 90% of the swaps market
when properly calculated is conducted, the trading is conducted by four very big banks. Goldman Sachs, Bank of America, JP Morgan Chase and Colton. Did I say Colton? There’s one I’ve left out I
forget which one I left left out but four of the big banks. Gary Gensler let me just
say from the beginning was President Obama’s chair of the CFTC and I would never tell
him this to his face but from my view, he
was the most successful progressive regulator that was
appointed by President Obama in his capacity as chairing the CFTC and I’ll tell you a little bit why. (laughs) Hopefully you’ve either read
or seen the movie The Big Short and it’s a wonderful book. I teach a course in derivatives and swaps and I start out by having
the students read the book whether they’ve seen the movie or not and it’s such a funny engaging book that the main thesis that I
think is important gets lost and isn’t contextualized
and the thesis there was where there was these
very bright investors, working separately all over the country who saw the mortgage market about to fail and said how can I short that market? How can I get money as
a result of the failure of that market? I certainly don’t want
to be giving loans out because I’m worried those
loans will never be paid back. Now how do I knowing in 2005 and 2006 that they’re going to be
massive defaults in that market. How do I take advantage of it
and if you’ve seen the movie, you’ve read the book,
these investors separately, some of them from big institutions, some of them from smaller hedge funds decided to use an instrument
that and in this area, the names given to financial
instruments are mind-boggling with a purpose because
if you really understood what they were you’d say
why aren’t they regulated. What they decided they wanted to do was to insure against
the failure of mortgages that they did not own. They in other words if somebody
defaulted on a mortgage that they had decided
they wanted to bet on as being a failure, they would get the full
value of the mortgage. That in the terms that’s called the naked credit default swap. Really it’s insurance. No one ever wanted to call
these things insurance because insurance is
regulated by the states and an interesting scenario
happened after Dodd-Frank was being developed was the
state insurance administrators came in and said hey wait a
minute, this is all insurance. We should have jurisdiction over that which immediately led to the preemption of state insurance regulation. At the same time the
Gambling Association came in and said you’re betting on the
failure of these mortgages. That’s gambling and they preempted state gaming laws as well. So these investors
Paulson not Hank Paulson but another hedge fund investor made three trillion dollars in 2007 betting that these mortgages would fail. In fact, I was talking to somebody earlier about the fact in 2009 or 2010 there were 60 Senate Democrats. Your mortgage, your
default on your mortgage can’t be put into bankruptcy. The Democrats decided we’re
going to help these homeowners by putting more into bankruptcy. So you can work your way out of it. The Democratic leadership
went into the caucus thinking they had 60 votes. When they walked out they had 40 votes. They weren’t going to get it
passed with any Republicans and Senator Durbin who’s the
Majority Whip at the time said “The banks own this place.” Why did the banks not want that people put their mortgages into default? Because if you were betting
that it would be defaulted and you could work your
way out of default, you lost that bet. They didn’t want to lose those bets. Now the fact of the
matter is the funny part of the Big Short is as these investors got closer and closer to the meltdown, they started saying to themselves, oh my God the casino may go bankrupt too. The casino being especially
big Wall Street banks. They are on the other side of my bets. Why were they on the other side? Because they thought housing prices were always going to go up and the idea that there would be defaults on mortgages was naive and silly but it happened. So the Big Short people
sold their investments before the meltdown thinking that the AIG or some of the other banks would never be able to pay off the bet. What they didn’t understand
was that you paid off the bets. The bank bailouts, US taxpayer
dollars, some calculated. I don’t know if Denis is still here but Better Markets some of
the Democratic senators said there was 20 trillion dollars in balance. The irony of course is those
banks who got bailed out are in bigger and better
shape than they ever were and we for the most part are not. Now Dodd-Frank its number one purpose, number one goal was to
prevent future bailouts. It was signed into law in July, 2010. There was a recognition and
I have 50 citations for this including the Financial Inquiry Commission that these naked credit default swaps that were not capitalized, not transparent were a major reason for the market failing and just to carry that through, the Financial Crisis
Inquiry Commission said there were some mortgages
that were bet on nine times. You’re betting through vehicles called collateralized debt obligations but nine times that they would fail. There were no limits to the
bets you placed on failure. My theory is if we had just
had defaults in mortgages and not these multi
trillion dollars side bets that we would have not leaved
have had a financial crisis but not of the time
that we ended up having. Dodd-Frank passes, people
criticize Dodd-Frank but my view is one of good
things Dodd-Frank said was these naked credit default swaps and there all kinds of
swaps, interest rate swaps, currency swaps, energy swaps. These swamps cannot be
private bilateral agreements. They must for the most
part be traded on exchange so we see what their value is. The people dealing in this business must have capital set aside for the day that the debts become bad and this is sort of complicated points where people aren’t
familiar with these markets. The swaps for the most
part have to be cleared which means if AIG is entering
into one of these swaps, they have to go through
a clearing facility that promises AIG or its counterparty will make good when D Day
comes and the way that happens, if they actually starts losing money, the clearing facility goes
back and asks for margin. AIG went on for years
losing money over this. Not only did the public not know about it but the whole AIG holding
company didn’t know about it. So the clearing facility
would be a corrective action and Gary was chairman of
the CFTC through all this, not only was the instrumental and some of the very quick provisions that came out of Dodd-Frank
but under his leadership, the CFTC promulgated about 60
rules to implement Dodd-Frank which has been called by people a Rohit and I agree with that. The last thing the CFTC did and they had to wait to lay the rules was a question what happens
if you trade the swap outside the United States? Are you regulated by Dodd-Frank or not? There was a provision in Dodd-Frank and I think Gary has
something to or his staff writing it which said if you trade a swap anywhere in the world
and that kind of swap could cause economic chaos
in the United States, Dodd-Frank applies. On July 13th. I don’t know what day in July of 2013 the CFTC issues a guidance on how that extraterritorial
provision would apply. It was lengthy, 80 pages
in the Federal Register, 662 footnotes, 563 footnote, 563 said if the subsidiary of a
bank is in another country and it’s guaranteed by
the bank holding company, that subsidiary and the trading will be covered by Dodd-Frank. Now that’s an interesting point because at that point in time
every foreign subsidiary, a trading in swaps under the
standard template of swaps was guaranteed. That comes out July 13. August 14th the association
of swaps dealers under cover of darkness
writes letter to its members and says deguarantee your subsidiaries. That way you’ll be out
from under Dodd-Frank and so not publicly they
don’t tell the CFTC, people start rewriting the templates to deguarantee subsidiaries and then they start moving swaps trading from United States affiliated institutions to the deguaranteed foreign
subsidiary claiming voila, we’re out from under Dodd-Frank. Now there’s a lot of reporting
that’s been done on this, some reporters have said as many of 95% of certain lines of swaps are being traded through
deguaranteed foreign subsidiaries. That means a lot of this
stuff is being moved out from under Dodd-Frank. Now, there was a big
New York Times article done about my paper and
the banks came in to say oh, this is making a big deal not 95%, five percent are being
traded outside of Dodd-Frank. Well even it’s five percent, you must remember the swaps market is a 600 trillion dollar market. So even if it’s true
that five percent is out and I doubt that seriously,
I doubt that seriously. You’re still talking
about 30 trillion dollars in potential default and failures. If it’s not under Dodd-Frank
and say it’s in London or Germany, the answer as well
you got the European Union. If Dodd-Frank doesn’t apply,
the European Union will apply. Well many things have been said today about the status of financial institutions in the European Union and if
the number one protection here was to save the American taxpayer from paying trillions of dollars
in another bailout to banks I can tell you right
now the United Kingdom isn’t going to make that bail-out, the European Union countries
are gonna make that bailout. When Mr. Geithner who wants to get this stronger bailout provision, when somebody like him or in his place wants to do a bailout, the taxpayer is going to
have to do that bailout. Now the two final things
the Obama administration in October of 2016
recognized this problem, proposed the rule and said this
deguarantee stuff is absurd. We’re not looking at whether it’s guaranteed or deguaranteed. Is this theory on the financial
books of the holding company and those of you who know rulemaking know you can propose something in October, it’s going to take a long
time satisfying the APA to make a final decision
on that and sure enough, Trump gets elected president and there is absolutely no interest in doing away with this loophole. In fact I could go into this the new chair has some new theories
that would in its own way make the new loophole worse. So you have huge amounts of money now that we’re thought to be under Dodd-Frank that are not under Dodd-Frank. My paper ends by saying, Trump isn’t gonna solve this problem, the Republican Congress isn’t
gonna solve this problem and my hope is state attorneys general have a Parents Patriot right of action to go into federal court
to support Dodd-Frank and I think given the statute
I’ve described for you, if you’re swap could destabilize, the American economy it’s
covered by Dodd-Frank no matter where it’s transacted, I think that’s a pretty strong case except for the fact I
thought that the nature and makeup of the Supreme Court when I published this thing in June would lead to the fact that
state attorney generals could be successful. I’m not so sure of that now. Thank you. (applause) – Thank you Michael for
including me in your remarks. Should I take your computer down? – Yeah, take it down. – I don’t know. – By the way I have paper handouts of that if anybody’s interested. – I want to thank Georgetown Law for inviting me here to
speak today on this panel. My notes are on this little card saying thank you giving me your card. That’s not my notes. All right so the panel that
we’re here to talk about is Innovation and Risk and so I start with just
thinking about finance. I now teach at MIT. I have the honor of teaching there but I started as the
introduction set at Goldman Sachs and then I worked in the
Clinton administration and the Obama administration
and with Paul Sarbanes. So I’ve been around finance my whole life. I think if finance is
doing really two things, moving money and secondly, moving risk through the seven billion
people that live on this world. It’s no longer just the 320 million here. So in essence, it’s moving money and risk through a distributed
network, seven billion people. Now money itself is
just a social construct or a social consensus and there’s there many
wonderful books written about it and many great debates about what it means but it plays three roles; a medium of exchange, meaning that you can use it in commerce, a unit of account that
in commercial settings somebody says it’s worth this and then if you have extra and that only really started
for the general population probably as we came into the dark ages, it’s a store of value. Earlier it might have been a store value for sovereigns nobility but more broadly. Well the other thing about finance that goes to the core
of innovation and risk is since its beginning
thousands of years ago, it’s had a symbiotic
relationship with technology. It has I mean even if you
go back thousands of years, it’s thought that the first written things were numbers, not words
in the cuneiform tablets that you find are about numbers
and accounts and ledgers. Double-entry bookkeeping is a technology that was done 800 to 1000 years ago and helped us get out of the dark ages. My point of this little bit of history is where we are now is
finance and technology have sort of accelerated quite a bit. We absolutely live in a digital age today and that digital age is
that 90 plus percent, probably 99% of commerce
in developed countries is done electronically and we move money, this social construct
around electronically. So where is innovation in risk today? You’ve heard the word FinTech
or financial technology. It’s usually meant to be about disruptors, companies trying to take on the big banks whether it was PayPal in the 1990s or Robin Hood which is I don’t
know if anybody in the room probably the students might use. Does anybody used Robin Hood by the way? There we go, three and then
there are others in the room saying I wonder what he’s talking about. (laughs) But they have five million users now and it’s an app that’s
only about four years old and it allows you to buy and sell securities in the stock market for free. It’s interesting business model. Now I see somebody’s going
to download Robin Hood. There you go. There you go we can talk offline later as to how they make money but the financial technology
of disruptors are real and it’s around artificial intelligence, it’s around machine learning, it’s around chat bots, my favorite. When you think you might
be speaking to somebody, it’s just a chat bot on the other side. Biometrics just in terms of identity and how things are done,
something called open API. I could go on but the one
thing I’m going to chat about in my three remaining
minutes is blockchain. I teach a course now at MIT
called blockchain and money it’s kind of a popular course. We just stood it up and it’s
about 100 students in there, wonderful graduate students from across the Cambridge community. We’ve got some folks from Harvard and elsewhere coming in too because they want to learn
about this new technology. It’s not the leading
thing that the major banks are thinking about in terms
of their FinTech policy. Artificial intelligence and
machine learning and chatbots and so forth are higher up
their list of blockchain but blockchain was a remarkable innovation that came together really over 20 years. You may have heard about
some paper that was written 10 years ago by Satoshi Nakamoto. Has anybody heard that? Does anybody know who’s Satoshi is? Oh you do? Because you shouldn’t be at
this conference if you do. Nobody knows who’s Satoshi Nakamoto is but it’s important to note
the paper was released on October 31st 2008. Now I’m fairly certain that
Sheila Bair and her role as chair of the Federal
Deposit Insurance Corporation was not thinking about Satoshi Nakamoto on October 31st, 2008 and probably didn’t even think about Satoshi Nakamoto for some number of months later but right in the heart and
the crisis Halloween of 2008 this paper is put out on a
cryptographic mailing list of a bunch of people that
call themselves cypher punks. I don’t make this up, it’s a great story but from a libertarian point of view, the question was how do we
move value on the Internet the way we move information
on the Internet. The Internet has no central authority. I will say that again, the Internet has no central authority. If you send an email now or if you were looking
at that Robin Hood app, the packets of information move around and there’s no central authority. No government can stop. I mean the Chinese government
and other governments tried to partition the Internet but there’s no central authority. Well that was the riddle. How do we do that with money? A new technology can we do it money and Satoshi Nakamoto
came up with something that does that without
a central authority. So what are the issues that it raises? What are the risks that it raises? 10 years one there’s no broad adoption yet of blockchain technology but I do think it could be a catalyst for
change in the financial sector. It’s a new way to keep ledgers, ledgers that multiple
thousands of your innovation that technology. It’s a new way to keep ledgers. It’s a new way to move
value on the Internet and to with something
called smart contracts which was a 19 year old Vitalik
Buddha Rands innovation. A remarkable technologist
but to move computer code and execute computer code on the Internet. So if you just keep that core there, it kind of goes to the core of finance. Finance is moving money and risk amongst a distributed
network, seven billion people. Blockchain technology can
move data which can be money or computer code which can kind of be risk through a distributed network. The Internet and that’s why
the two I think overlap. There’s a bunch of big
public policy issues which we can get into on Q&A. It’s largely a field right now that though compared to the
world capital market is small. It’s about 200 billion to
300 billion dollars in size on any given day and it
bounces around a lot. The worldwide equity
markets are 90 trillion. The worldwide debt and bond markets are closer to 250 trillion. I got to get my T’s and B’s right. So at a quarter of a trillion
dollars this is not yet at this stage kind of
something that’s going to be a systemic issue but it could be. It could grow. The real public policy
issues around right now are around illicit activity that no government wants
to shrink their tax base and have a bunch of activity kind of going outside of the
tax base of that country. In most countries, not all, most countries don’t want
to promote drug running or money laundering or child trafficking and the bikes that you
can do maybe in a suit, in an MS Bitcoin environment. So illicit activity is something that everybody’s grappling with
and then investor protection and this is where most countries haven’t yet sort of gotten
their hands fully around it. J Clayton at the SEC and
Chris Carlo at the CFTC and there’s remarkable
dedicated public servants are trying to get their hands around it but it’s going to take some time. This is not going to all
happen in a few months. It might take a few years but in essence, to bring the same sort of logic of making sure that
the public is protected when they’re investing,
if there’s an issuer and there’s a debate about
when there’s an issuer but if there’s an issuer that they have some additional disclosure and marketing requirements. So I’m going to leave it at that but I think that the financial sector has always been symbiotic with finance and technology go together. Frank’s going to tell
you some of the risks. I’m gonna largely agree with them. The risk of artificial intelligence of biases in the code, the
biases in the machine learning. So there are risks in blockchain, there are risks in
artificial intelligence, there’s risk and even
chatbots and biometrics but I also believe there’s great benefit and that’s just the
nature of finance today is that it’s electronic
and it’s almost like most CEOs of bank should
have a bunch of technologists in the C-suite these days. Frank. (applause) – Thank you. It’s just a real honor to be on this panel with folks I’ve read about
doing fantastic things to try to make the
financial sector more stable and today’s talk I was thinking there’s a lot of points
of attack I’d like to make but I have written on blockchain and I have a piece out on SSR called a Rule of Persons, Not Machines where I offer some critiques
of some applications for positive regulation. I have talked to in my testimony before the Senate Banking
Committee last year about the risks of big
data-driven underwriting and artificial intelligence in some areas but today I’m at the invitation of Emma. I wanted to focus
particularly on looking back on the Black Box book. The Black Box Society
that I published in 2015 and my spin on it is going
to be that part of my book has become I think obsolete or outdated in the past three years and
as an author, that feels bad but it’s important to
take an accounting of it and to describe how it happened I think. So we as people who are
interested in policy, as academics can think about the future and think about what will the
future of financial regulation and policy look like. So just to give a very
brief overview of the book, in Chapter four I talked
about some problems that I saw in the financial sector focusing particularly on
information asymmetries and that sort of the black box problem that a lot of people didn’t understand the degree of interconnection
and the degree of risk that was involved in sophisticated
financial instruments. In Chapter five of the book I looked at particular technocratic
innovations within Dodd-Frank that would empower things like the financial stability Oversight Council, the Office of Financial Research, other entities to better
understand what was going on and that was the result
of a lot of reading, talking to people in
different financial agencies, talking to folks overseas etc but then in Chapter six I said you know, that regulatory infrastructure particularly the degree to which it’s able to keep track of you know what’s going on increasingly complex financial
system is quite fragile and we might need to move beyond it. And I’m reminded of a very
interesting article by Henry who called too complex to depict and the argument of that article I think is that some aspects
of contemporary finance are so complicated that we
really can’t represent them and that’s a fundamental challenge to a financial regulatory regime going all the way back to the
debates during the new deal was really focused more on
disclosure and a disclosure model than on a more substantive vision of what the government should do to either nudge or direct
finance in certain areas. One thing I said in the
book and that I followed up in a 2015 article on
high-frequency trading which was a recently critiqued
by SEC Commissioner Pearce was that to really maintain
this regulatory apparatus in the midst of increasing complexity, we would need three things. First a broad bipartisan consensus on the value of regulatory entities. Second, good funding for those agencies to make sure that they
could actually understand and monitor what was going on and third, real
consequences for violations. Things that would be a slap on the wrist or may only be held on
passed on to shareholders but things that would really matter to decision-makers involved and the realization that I’m having, especially given work
like Jesse Eisenger’s others some of the points that were made by Dennis Kelleher today is that none of these really hold right now. When I think of rulemaking processes where one of 70 or one of 80 people is representing the public interest, hard to see that as legitimate when I think about some
of the ways in which big law in Washington DC in New York has almost become too
good to the point where when a large financial
client comes to them, it’s like the focus is not necessarily on having a fair fight over
an existing regulatory regime but to guard it all together. I think clearly that’s the stakes of the Kavanaugh nomination. There’s gonna be a lot of effort to simply gut to get rid of
entities like the lawsuit to just destroy the CFPB. When that’s out there, when
big law sort of sees its role not as just sort of helping clients when particular disputes but sort of destroying and
undermining agencies altogether, Haley Sweetland Edwards
article on the CFTC with respect to a swaps position was also really good on this. When the consequences seemed
so rare or so fleeting or so small that the deterrent
effect is questionable, then the overall apparatus of technocratic financial regulation based on a disclosure
model, it starts to crumble and when there isn’t a sort
of an agreement on its value. So where do we go from here? Well I’ll preface what I’m going to say which I know will probably
sound a bit radical to some in the room by saying that even if you disagree with what I’m saying, you should probably glad
that I’m in the room because if the debate is
always between centrists that are trying to maintain
the technocratic status quo and libertarians who want
to get rid of it altogether, there will be means inexorable movements of financial regulation
toward deregulation, toward less effective. You need to have a counterweight on the other edge of
the table unfortunately, I think a lot of people are providing that counter way today. I think that particularly
considering the work of on methodological
pluralism, that’s a first step. When we can bring in economic sociology, when we can bring in people
beyond the usual suspects within financial economics etc and extend some
credibility and credentials to individuals beyond the
usual folks, that’s important. We’ve made some initial moves
toward behavioral economics and works of Robert Shiller, that’s great and some other sort of
insights from that group but we need to get even more
methodological pluralistic. We need voices talking about inequality and I think here professor
Coleman Jordan’s work in the Journal of law
Public Affairs last year on the Fed and inequality is foundational particularly both in
terms of the substance of bringing equality in and
also in terms of the methodology in terms of bringing in
diverse methodologies. At this very moment there’s a conference on modern monetary theory
going on in New York City and some of my friends
are at that conference, people like Raul Carrillo and Rowand Gray have been advocating for
a federal jobs guarantee and it’s very interesting to think about what might have bound
the political fallout of the financial crisis of 2008 if instead of “Filming the runway” for the bank’s with
respect to certain forms of highly complex mortgage relief such as what HAMP administered, there had also been further effort put into something like a modern-day Civilian Conservation Corps,
WPA or other things like that and I know that I will get criticized for confusing say
monetary and fiscal policy with such proposals but I think the people who do the job guarantee and
people like Sandy Garrity and Derrick Hamilton who’ve
really theorized this, have pointed out the ways in
which certain decision-making that is in some ways
trying to be characterized as purely procedural or not according to purely financial metrics
does include political values and will continue to do so and that we have to be able to
push certain political values that maybe are undervalued right now in order to make up for systemic biases within the financial system. I think moreover that my work with the Association for the Promotion of Political Economy and Law it’s if anyone’s interested in joining us with some of the folks
in finance in that field has taught me that if we can
expand this conversation, I think we can do a lot more
to promote financial inclusion. I think also for example of
the work of Mehrsa Baradaran and thinking about the unbanked. There’s lots of energy
and perhaps saying that computer technology will expand and will bring in the unbanked and I know when I testified before the Senate Finance Committee,
Tom cotton really believed in that point of view and was pushing it but what Baradaran says that
we’ve also got to be able to learn from other countries
and maybe have postal banking to include and to bring
in people who are unbanked and I think that that’s
the sort of a creative idea that we’ve got to be able to
experiment with and understand and I’ll close with a few
sort of potential objections. One is again if people think it’s not monetary, it’s physical. 10 years ago I was
writing a lot about Google and I was at about the potential
monopoly problems there and virtually every member of
the antitrust establishment I talked to said you’re not
talking about antitrust, you just want to regulate Google. 10 years on Google antitrust is one of the biggest policy
issues around the world and in fact in the United States itself and the whole Open Markets
Institute is working on it. I also think looking at the
work of Mariana Mazzucato and her success in influencing
European policymakers but there’s a lot of room here. So I would just urge everyone in terms of thinking about
the future of finance policy to think big, to think about breaking down some of the traditional barriers between monetary and fiscal policies and to consider that we’ve got to have I think more diverse voices at the table, more diverse personnel as
Professor Coleman Jordan once noted in years and years
of Federal Reserve minutes, the concept of racial discrimination
was not mentioned once. That’s a really damming problem I think with finance regulators. So we’ve got to open it up
and when we do open it up to more diverse perspectives,
more diverse methodologies, I think we can do more to move
beyond the current paradigm. Thank you. (applause) – Now I believe there is
some time for questions although we are running a
little bit behind schedule. So I’d like to invite
people who have a question to come up to one of the mics
and if you have a question addressed to a particular
member of the panel. Please identify him. – I’m curious if any of
you have given thought to the central bank issue digital currency and whether that could work. How it could work on whether that would promote financial inclusion. – So the question is whether
we have a point of view on central bank digital currency and would it promote financial inclusion. Right now by World Bank
statistics 1.7 billion people around the globe are unbanked. What’s interesting when you
sort of peer into the statistics in Africa for instance that half the adult population is unbanked but half of that half has mobile phones. It’s a remarkable thing. So unbanked but not necessarily
without mobile telephony. So in some countries like Kenya, what took off is a means
of payment mechanism that started on mobile phones in 2004 and it’s grown now there’s
20 million customers using something called M-Pesa in Kenya which is basically means of
meth and payment on a telephone. Now how’s this relate to
central bank digital currencies? It does. It’s basically to say
there might be new means that are not sort of doesn’t feel like the traditional banking structure. We have the central bank in the middle and the commercial
banks as we do in the US about 9,000 commercial
banks have digital reserves. So we already have central
bank digital currency. It’s just only allowed that
9,000 banks can tap into it. The question, the policy question for central banks around the world is do they open that up to either broader wholesale merchants
or the retail public? The country that’s closest to it is Sweden and their E-Crona Project. There’s some West African countries that have dabbled but they’ve really had the commercial banks issue it. So they keep it within the
commercial bank structure but I think to Sheila’s question, I think one country will do it. I don’t know that in an sweetened that it’s going to broaden inclusion. I do think though in these
West African countries, Senegal is one of them
that it’s not technically a central bank digital currency because they had a
commercial bank issue it and so it’s almost like
a private bank note of the 19th century in a sense but it’s a digitized bank deposit but it’s on a blockchain. I think that does can promote inclusion but it’s not quite to your question. In the developed countries I
think it’s less about inclusion and more about sort of competition. – I was wondering Gary
had you thought about the implications of blockchain
for financial stability. The distributed ledger
technology is important but it’s also a place where
there’s a hybrid opportunity for the illicit activity,
the quasi licit activity and all of the others. And innovation that is meaningless in the sense that it doesn’t
add value to the real economy. So I wondered if you thought about the implications of this technology. So far we don’t have
enough of it to predict but have you thought about
the stability implications? – Yes and if you’re ever in Cambridge you can come to the class
on Tuesdays and Thursdays but next Tuesday we’re
talking some about this. – [Emma] Send me your
syllabus, I’ll take it. (laughs) – So blockchain technology and then there’s the crypto finance. The blockchain technology itself
there’s two cross currents. It could enhance financial stability because there are fewer
single points of failure. So centralized Clearinghouse
is centralized authorities bring great benefit. I mean there are efficiencies
of scale and so forth but they are also have
single points of failure. So there is an argument and I think it’s a valid economic piece that blockchain technology itself having a distributed
ledger and it does come with a lot of attendant
cost and complexities but it can be more resilient because it’s harder to take any one. You take down some part of the network, the rest of the network is still going. So that’s just purely the
blockchain technology. Having said that, I think
central banks are right to say wait if a large part of the
commercial banking system or a large part of the capital
markets adopt blockchains, they want to be able to know what’s in the black box so to speak. Is it resilient because
you’re really relying on. There is still trust in something, there’s trust in the code. I mean how many people in this
room have ever owned Bitcoin? Okay two people, three I’m sorry but you’ve probably not really went and gone to GitHub and
looked at the underlying code and so forth. You’re trusting the underlying code. In fact these three people
are probably trusting a big crypto exchange as well. So there’s other points of
failure and other points of risk. I do think that if this
market were to grow and if there was leverage in the market when you associate leverage
like the swaps market had, you could have challenges
to financial stability. So the underlying technology
could be positive, the crypto finance world,
it’s too early, it’s too small but if it were to grow and you lay your leverage on it as well,
it could be destabilizing. So those are the things
to watch out for I think. – Just to follow up a little bit. Isn’t it the case that this technology, technology is neutral
but that it would attract higher leverage, more risk-taking or do you think it’s absolutely
neutral on that question? Because I think that the complexity can be a way of masking and
participating in activities that are unregulated. – I think you raise an excellent question. I’m going to broaden
it not just a leverage but illicit activity for a minute. So the question sort of
broadly is does this technology and the crypto finance that its birth somehow raised the possibility
of either illicit activity or just excess leverage. You didn’t use the word excess leverage. My feeling is that criminals aren’t new and even excess leverage isn’t new but they might find a new avenue. And so on the leverage the question is if we bring it inside
the public policy norms, the banking rules, whatever they are of a country are at a time, the capital markets rules
of the country and the time, I think there’s a less
chance of that happening what you’re saying but I
think there’s a great chance of it happening if it stays outside of the public policy envelope. And so if it stays outside of
the public policy envelope, however it’s defined, on
leverage, on criminal activity but if it stays outside of the envelope, then yes, the illicit
activity will flow there, the excess leverage will flow there. – Yeah when you say outside
of the public policy envelope, that’s regulation and as we’re moving to a deregulatory return, the amnesia that we were talking about earlier, why isn’t that impulse toward deregulation when combined with the
availability of this technology going to lead to the risks
that you just identified? Either in the illicit
or the excess leverage. – I think you’re right. I think there’s another impulse
is that around the globe, not just here in the US. There’s a sense to compete for innovation in the name of this panel,
innovation and risk. So you have usually
small population centers like Malta, Liechtenstein, Gibraltar who have all passed legislature. Gibralta’s passed it,
Liechtenstein is about to but they’re looking at legislation to attract the crypto
finance and crypto exchanges and these are sometimes enterprises that are leaving countries
like South Korea and Hong Kong or even Singapore that are not necessarily the regulatory regime we have in the US and moving to Malta because
the Prime Minister says come hither because we
want some of this activity. And so there’s a lot of
regulatory competition in this space right now as well to attract what’s
thought to be innovation. – I just had one concrete example I want to just back up
Gary’s perspective there which there’s this incident where Etherium had a distributed autonomous organization that was gathering money, etc had over hundreds of millions of dollars. – 168 million. – Right 168 million but then it was hacked by someone who figured out a way to sort of drain the overall organization and the question becomes did everybody who put their money and did
they agree that the code was law to the point where if someone figures out how to hack the code, that is the proper
distribution of the money or is there an X something outside of code that’s going to govern
the execution of the code and the manipulation of the
code by someone within it and I think it has to be the latter. I mean it just has to be the latter. I mean my worry is that if you get people that are true crypto true
believers about the power of code, they’re gonna opt for the
former and if they do that, then it becomes extremely unstable and that’s where I think the answer to the stability risks really lie. – And I think that we’re not there yet and we may never be there
but a country that says, I want to adopt code
as my monetary policy, it might be a country in distress who just their currency collapses,
a Venezuela or something and rather than turning to
the USD they turn to code but in that mechanism,
then you’re really over into the hard monetarist
and there are some, there may be some in the room that think that we should have more
hard monetary policy rather than the human involvement and the judgments and so forth and those are great economic debates have gone on for a couple hundred years but this new technology tends towards the immutable hard
monetary policy approach which is kind of an interesting add-on. – I think we have time
for one more question. – [Ted] Gary you saw the
quants helped blow up the financial system and
the financial crisis. Doesn’t that give you
pause now when you see the high tech use of this day and age promoting blockchain and crypto? – I’m at MIT. (laughs) Listen, I’m gonna be light-hearted but Ted I’m gonna say this I think technology, net-net benefits society. That’s just who I am at my core. I think that for thousands of years but it’s not without its challenges. It certainly affects who
gets a job and who doesn’t. It’s a very challenging
thing for our country. This rapid change of technology
in terms of the labor force and really allowing
everybody to get a chance and yes in the terms of
the world of finance, in the terms of the world of finance, yes, every technological innovation comes with additional risks but net-net I would say I would be more
inclined to the positive than the negative but
does blockchain have risk? Absolutely. Artificial intelligence as I
briefly said machine learning, there’s a lot of biases that end up in anybody getting a credit score or getting allocated lending right now could have biases in
that machine learning. The criminal justice
system has biases also using machine learning and
artificial intelligence for judges and speak about in the book, you should read his book The Black Box. But it is a black box
and so there are risks. Ted I would agree with there are risks but I still do believe
that net-net society is better off kind of
exploring moving forward, bringing things in the
public policy debate and in the public policy envelope. – I think we’re out of time for our panel and before we thank
this distinguished group for sharing their wisdom with us today, I just want to thank them
and and professor Jordan for putting this incredible group together and it’s a whole day and a
rich intellectual banquet and I’m very glad to have
had a little part of it. Thank you very much. (applause) – Okay we’re ready for our next panel Anna Galprin, Robert Johnson and one more on that panel, Eric Gerding. (murmuring) – So thank you to Professor Jordan and thank you to everyone
who has stuck around. It has been a very rich day indeed and I am acutely aware of the fact that we stand between you and George Akerlof. So our task and I think
that’s been very much true of the afternoon panels
is to try to look forward, to figure out where exactly
are we 10 years later rather than where were we on that day and to figure out what
our current institutional and political and economic setup means for our ability to tackle the next crisis. And it’s a nice time
to take that look back because and assess where we are. The institutions have matured
so the crisis was 10 years ago Dodd-Frank was in 2010. Rulemaking has happened,
there’s been litigation, institutions have had some
time to get into their routines so we can say in a somewhat
sensible and fact-based way that we have a financial
stability infrastructure of sorts and can try to assess it in
a reasonably meaningful way. But we’re also of course
entering a different stage. We’ve entered a different stage of the financial economic
and political cycle where we’ve had legislation
this past spring that charitably aims to
deliver regulatory relief. We’ve heard it called
less charitable things in the course of the day. We’ve also had regulation, we’ve talked about the Volcker Rule and we’re going to talk about
that some more liquidity rules that have been either put
on hold or rolled back and then we’ve also had
this sort of informal and very much behind-the-scenes
change in attitude, all of it informed by
a very broad and ridge statement of a new regulatory philosophy. All right so the
president’s executive order and the half-dozen
Treasury Department reports really tell us a lot about what the current administration’s view is of what the financial sector should do and also what the role of regulation is and that is quite a different view than what we saw in 2008 and 2010. Moreover, all of these
developments are happening are not happening in isolation but rather in a global
context of regulatory, the push and pull forces between those who want
to preserve resilience and believe that enhancing regulation and strengthening regulation is the way to make financial systems more resilient and those who want to think
that we have overreached. So our panel will try to take
stock of these developments and again see where we are
vis-a-vis the next crisis. We’re very lucky to have a
fantastic panel with us today starting with Gaurav Vasisht
who is senior vice president and director for financial regulation at the Volcker Alliance
and he has deep background in bank and insurance regulation
for the New York State and he has written some very thoughtful… He has done some very thoughtful
work recently in the field but he’s also been at
the forefront of reform while he was in the policy world. Then we’re gonna hear from Eric Gerding who is Professor and Wolf
Nickel Fellow at Colorado Law and Eric is the author
of one of the earliest, actually the earliest and
still the most interesting and creative book on financial
stability regulation– (mumbles) True that he’s also my co-author but not another in that book. In the law literature so Law Bubbles and Financial Regulation. If you haven’t bought it or if you haven’t had your
library buy it, go buy it and then we are going to
wrap up very appropriately with Rob Johnson who of
course helped us start the day and he is president
and co-founder of INET. He is both an economist
appropriately an innovative economic thinker also
a market practitioner, a successful investor in fact I assigned an interview with him from
1998 I believe and it’s still one of my students favorite assignments on the Asian financial crisis. He is also a policy practitioner who has been at the cutting
edge of these developments for a long time. Gaurav will set the stage and then Eric will focus on institutional issues and our financial stability toolkit and Rob will bring us home
with a global perspective as well as considering
how our crisis management has contributed to the economic
and political developments that have led us to this moment. With that, Gaurav. – So just a quick anecdote that while Eric was writing
his very thoughtful book on bubbles I was on the eve of the financial crisis in 2007 May, I was a young lawyer working
in the counsel’s office in the governor’s office
writing an executive order that was going to create
and in fact did create the Blue Ribbon Commission for Modernizing Financial Regulation the members of which included
Lloyd Blankfein, Chuck Prince, Bob Hendrickson and
Martin Sullivan of AIG. So this was three months before the onset of the financial crisis and that’s what people were talking about. This was May of 2007. In August of 2007, you saw problems in the asset back commercial paper market and yet the world was talking about international competitiveness, the same arguments that Sheila
was talking about just now. So in some ways the
world is exactly the same as it was in the eve of
the financial crisis. They’re making the same
arguments back then and that Commission just
out of sheer embarrassment just never came into being
and everybody pretended like it just never happened. Leave the room and don’t talk about it. That’s kind of what happened in those days but I thought I’d give an overview of what the deregulatory
frontiers actually look like and what the specifics are
in terms of what’s happening. So the starting point for
me is the executive order that President Trump
issued in February of 2017 which directed the Treasury Department to do a review of all existing laws, rules, regulations statutes
and financial services to identify those that were inconsistent with certain core principles that the president articulated
in his executive order. That led to a full-blown Treasury review and the Treasury Department
released five reports. The first one on banking, the second one on the capital markets, third on asset management and insurance, the fourth was on the FSOC and the fifth was a sort of a related
not really coming out of the executive order but a
memo that was issued alongside and that was the orderly
liquidation authority and that’s something
that Sheila referred to in her talk as well. Collectively these five reports
are hundreds of pages long. Each report for the most
part is at least 100 pages. Some are more than 200 pages, some are slightly less than
100 pages but collectively, they make close to 1000 recommendations in every aspect of finance
and financial regulation. Simultaneously there was
an effort in Congress that predates the executive order and that was led by Senator Crapo that culminated in the passage of what’s called it’s a very long title, it’s The Economic
Growth, Regulatory Relief and Consumer Protection Act. No that’s right, they
should have attached that, put that in the name as well
but there wasn’t enough room and that legislation was intended to primarily benefit small banks but like everything else in Washington it came with certain sweeteners for the large institutions as well. And then the third prong of
the deregulatory universe is the administrative process through which regulators propose rules and there you’ve got a recent proposal on the supplementary leverage ratio basically pegging it to what’s
called the G-SIB surcharge without getting too technical. It’s a surcharge that the
calculation gets pegged to and some changes to
stress testing assumptions and also a rule to make some changes to the Volcker Rule as well which is a ban on proprietary trading
by banking institutions. So that is the universe
that I’m thinking of. there are other things as well. There are rules the SEC
and the CFTC are working on but primarily that’s the
universe of deregulation that’s out there. My overarching view of this is that while there are some good things
in this deregulatory effort on the whole I think it’s a net negative and the reason I say that
is because it runs afoul of some core principles. Number one, it’s grounded
in the unsubstantiated claim that somehow the post-crisis
regulatory regime is a drag on the economy or
has reduced market liquidity and these are very convenient
talking points for lobbyists but unfortunately, the facts
just don’t bear them out, the data just aren’t
there to substantiate it. It’s very convenient as a
talking point in Washington to get people to act
to say Allah made 2007 when I was writing the executive order. It’s sort of the same
disingenuous argument. Number two, it runs
afoul of the basic notion that we should keep the
historical context in mind. The seeds of banking crises
are sown when things are good, times are good and I think we’re
seeing the same dynamic now we’re in a good phase,
people are making money, there are certainly
some storm clouds ahead, some people are choosing to
ignore those storm clouds but now is the time to implement
counter cyclical policies as opposed to pro cyclical policies and we’ve done this over and over again and it’s perhaps it’s human nature or perhaps it’s just sort
of ignorance of the past but we succumb to the same temptation to reduce the requirements
and then after the fact, we always tighten regulation as if this time we’re gonna get it right but then the cycle
continues it perpetuates and on and on and on. I think we should be policy
makers should be looking inward to see are we at that moment again and are we acting the way we should be. And then finally I think the
third core principle is that you need to recognize that
a resilient financial system is absolutely critical for
sustainable economic growth. You can certainly make politically expedient short term decisions and it might get you some accolades but if your goal truly is economic growth, then you know I think
resilience should really be at the fore of your thinking and unfortunately that’s not the case and so we see that in
the economic growth act with the custodial banks
as Sheila talked about, having the ability to take out
their central bank reserves from the denominator of
they’re supplementary leverage or issuing to take things
out of the denominator. The effect is that it goes
up, the overall fraction. You’re seeing that in the rule on the enhanced
supplementary leverage ratio that the Federal Reserve
and the OCC put out that the FDIC did not join in and I think that that was the right move and you’re also seeing
that on the Volcker rule where some very important protections that were put in place to make sure that certain exemptions
under the Volcker rule are not evaded, that also is being eroded. So we see that. Layered on top of that is the fact that we have a regulatory
structure in this country and others have alluded to this. That is extremely
fragmented and antiquated. It’s a regulatory structure
that no one person or a group of people at
one time put together, it’s sort of accreted over time. It’s the result of political
quid pro quos over generations and the people who put it together didn’t know what the financial
system was going to look like when all of it was put together. It’s extremely fragmented
and so we said in Dodd-Frank, let’s get everybody in a room together and we established the FSOC and I think that that
was very important to do but the FSOC does bring
the underlying dysfunction of the regulatory system into the FSOC and that’s problematic and it’s also a little problematic that if you look at the Treasury report on the FSOC and there’s this talk now about
activities-based regulation which means different
things to different people. To me when I think about
activities-based regulation and this is maybe too good of an example but if one were to say
okay the the repo market was at the center of instability during the financial crisis, can we designate repo as an
activity that’s problematic and I was hoping to
see something like that in the Treasury report but
there was nothing like that. Under the Treasury
report in November 2017, they articulated a three-step plan. The first step is the
FSOC will get together and try to figure out
if there’s a problem. If there’s an activity or
product or an instrument that is problematic. If they decide it is problematic, then they’re gonna go to
the functional regulator back to that functional regulator
to do something about it. Chances are they’re not gonna do anything then they’re gonna write them a letter. They’re gonna say we recommend
under Title One of Dodd-Frank that you do something about
this and if that doesn’t happen, then the third step is
we’re going to designate individual institutions. Well how is that activities
based regulation? It’s not in my mind certainly but there’s some indication
that we’re gonna see some more activity on this front. And so we’re gonna look
forward to seeing that. A related point is the
Office of Financial Research which deals with data
and it’s very important one of the most important
points of the financial crisis was we didn’t really have data, we didn’t know what was going on and so we established the OFR but the OFR is now under attack. It’s not like the CFPB. There’s no political constituency, there’s nobody protecting it. It’s a sort of sits there as an orphan but it plays a very important role and the person heading it up
now is a dual headed employee of the Treasury Department. The person who’s been nominated is someone who’s been hostile
to the agency in the past and I think that that is problematic. So with that, I’ll stop. – Thank you so much. This has been both rich and timely. Thank you and a perfect transition to Erik if you could elaborate on the
institutional developments and where are we and where should we be. – Sure. So I will make five points. I’m told that’s what you’re supposed to do as a public speaker. One of them going to talk
about tiered regulation and ask some questions about
whether the MEI statute if it really makes any sense at all. I’m gonna ask some questions
about the administrative law design of Dodd-Frank and make maybe some of the progressive people in the room somewhat uncomfortable. I’m going to talk about baselines and how we’re going to
be judging regulation and whether we’ve succeeded or failed. I’ll talk about what Dodd-Frank didn’t do and how we’ve sort of left some things completely off the table
and fifth I’ll talk as a segue to our final speaker of the day about incomplete information
and what we don’t even know we don’t know. So let’s talk about tiered
regulation and thresholds. I came to the conference
down from the mountain. So I’m a simple country lawyer and I’d like somebody to explain to me just how Senator Crapo set the thresholds for the MEI statute. We talked a little bit or
the earlier panel talked a little bit about bumping
the CFE designation threshold from 50 billion to 250 billion. I’m not even sure I understand
the 10 billion threshold for smaller community banks and why they receive the
exemptions that they get. I understand the idea of
having a key regulatory system where we regulate riskier
institutions more intensively but that doesn’t necessarily
correlate with size and it doesn’t necessarily correlate with how that statute actually is written. To me, it makes sense that
you would base exemptions on having institutions that actually have simpler banking models but
the statute actually does it kind of backwards. It says we’re going to
allow some exemptions including some that you
mentioned for smaller banks and I guess I don’t
understand why smaller banks are even doing some of these
activities to begin with. So I’d like someone to explain to me why we shouldn’t have tiered regulation that says we’re going to have somewhat easier regulatory standards. You have a simpler, narrower, whatever. Use narrower banking model
rather than just having size and 10-billion be the magic number and I’m also not entirely
sure that it’s right to be focused just on lower regulation for smaller institutions. So I’m only in my mid-20s but I was told that there’s something… – [Anna] ’cause you look so young. – The economic crisis I think taught us that we should be worried
about her behavior by smaller and midsize institutions too. We shouldn’t just be
worried about risky behavior by the biggest of the big
financial institutions. All right so that was about thresholds and questioning whether tiered regulation actually makes sense and
I think tiered regulation is here to stay. We’re going to see this and
the next wave of deregulation having different regulatory
standards based on size and that’s sort of the
political reality here in DC and I think we have to really ask whether the tier there’s
a threshold that we have for regulation are actually protecting us from systemic risk. Okay the second point
and I promise to make some of the people or
progressive uncomfortable is I think we have to ask whether some of the administrative
law design questions that were made or reached
in writing Dodd-Frank actually came back to bite people. So that example is having a
single director of the CFPB. That’s great if you like
who is the president. If you don’t like who is the president, what works very well
in terms of rolling out quickly new rules also works in reverse where you can roll back
rules much more easily if you just have a single director rather than a multi-member commission. So for those of you students who are going to be writing the next wave of financial reform legislation, think about how
administrative law mechanisms work the same regardless
of who’s in the White House and I think you could also
say that for FSOC as well and this is a point that
Anne has questioned. FSOC is really good at
coordinating regulatory activity or maybe I shouldn’t say really good, that’s an overstatement. It got its purpose,
coordinating regulatory actions by all of the major banking and securities and insurance players but it’s also possible and again this is a question Anna raised
that FSOC could also be used as a vehicle for
coordinating deregulation. So students who are
taking Administrative Law, think about how the choices
you make are going to be true no matter who is in the White House and who controls Congress. The third point I want to
talk about is baselines and what I mean by baselines is how are we judging
financial regulation. So in one sense, some of the media reports around the MEI statute or well is better than it could have been. It’s better than the House version and I questioned whether that’s
really the right standard. So it’s quite likely that Dodd-Frank is going to suffer a
guess by a thousand cuts and this leads me to my fourth point which is if Dodd-Frank
using the gold standard because Dodd-Frank like
a pretty complex form of regulatory engineering
and it kicked to another day questions like regulating
the shadow banking system and you seem to like music a lot given your earlier presentation. – Not at all. – To quote Creedence Clearwater Revival, “Someday never comes.” So we never really got around
to regulating shadow banking before the deregulatory
wave really kicked in and I think that’s a
real unfinished business. So I think we have to keep our eye on not only certain
fighting a rearguard action about preserving good things in Dodd-Frank but asking okay what
could we never really get into the 2010 statute to begin with and I think that’s really
important because frankly, it’s just no fun and again,
I’m not from the Beltway so I’ll speak for people who
are a little bit closer to it. It’s just no fun fighting the
rearguard action all the time without some idea of where the vision for financial regulation should be and my fifth point, let’s put a regulation to the side for a minute
and this is a segue to our final speaker of the day. We don’t even have really
good high quality information about a lot of markets
even after Dodd-Frank. So how do you regulate or
how do you even conduct central banking policy if you don’t have all of
the information you need about repo markets, about
over-the-counter derivatives which was a point that was made in the last panel or hedge funds. Now Dodd-Frank made some
progress on all of those fields. We have registration
requirements now for hedge funds. We supposedly move more
swaps to central clearing and exchange training but we still if you try to actually write in this area, it’s hard to get really
high quality information about the size of these markets, about the amount of
leverage in these markets, about what’s actually going on. So even if you don’t want… Even if you’re not looking to
heavily regulate these markets I just don’t understand
how the Federal Reserve or the central bank is
really had a good grasp of even doing monetary policy without that kind of basic information. It’s kind of like flying a
multitrillion-dollar airplane with analog instruments without radar. So to quote one of my favorite
TV shows from the 1980s, knowing that half the battle and we’ve already lost that half. – Thank you Erik. On that cheery note, Rob. – Can you hear me? First of all seeing Sheila Bair today reminds me of years ago
in between the passage of the House and Senate bill of Dodd-Frank I was on a panel with Arianna Huffington and she was right and she said, “Robert, you are quite despondent “about this first bill that’s passed. “If you could wave a magic wand “and do anything you wanted, “one thing to make finance
better, what would you do?” And I don’t know why because
it wasn’t premeditated. I said, “Oh that’s easy. “Only women get to regulate finance,” and then I said, “Janet
Yellen, Sheila Bair, “Elizabeth Warren and Brooksley Warren “been running this place since 1985, “we wouldn’t have these problems.” Sheila as you know because
we couldn’t work it out but we ran a conference that INET called Women Finance in Society
where I said hello and goodbye and everybody else that spoke was a woman and there may be some truth on that but it’s a little bit
how we’re socialized, how we’re educated what feels intuitively holistic to a person and I guess without
making that house a lashed to the mast of gender difference, I think we have to re-educate
ourselves a little bit about what it is we’re
after here as a society. In essence, I think finance is a mechanism and at some level it’s been far
too deified in recent years, relative to what it produces. Going back I’ve been asked
to talk a little bit about international ramifications
and for the young people who are here I will tell you something that has helped me quite a lot. I read the Bank for
International Settlements BIS quarterly report every quarter. I’ve been reading it since I
was in financial speculation in the late 1980s and I
find it very informative. Secondly, just in relation
to recent concerns there are various scholars like Helene Rea and Hion Shin who’s at the BIS now who’ve talked an awful lot
about how monetary policy doesn’t quite work like we suggest it does meaning there are all kinds of problems in developing countries with
incomplete financial markets so that when we shake our
rattle here in the United States or in Japan or in China or the UK or the Eurozone, it makes a
whole lot of ramifications and disruption and that
the traditional notion that if you just floated
your exchange rate you could make it all
work just doesn’t bear out and the evidence is very profound when you find that people
do what currency traders which is what I used to do. We do something called a carry trade where essentially you
buy the high interest and you finance yourself in
the low interest currency and you bear the weight
of the exchange risk while earning that interest differential. A lot of Chinese businesses
in the last few years have funded themselves in dollars and then they deploy that
they transform into renminbi and what happens is in a period when we come out of something
like quantitative easing and start to raise our interest rates, tighten our credit conditions, it starts to make the dollar rise. These people with the
mismatch start to lose money. They then cover their exposure which exacerbates the rise in the dollar and intensifies their losses. So I think that there’s
still a lot of work to do on the interaction between emerging under development financial markets and the behavior or they say emanates from our own attempts
to manage our markets. Moving a little bit now
towards the American challenge, I guess I’m always haunted because we’re 10 years after Dodd-Frank after the crisis not Dodd-Frank about eight years after that and I still don’t feel like because it was such a
controversial circumstance that we really come clean, the
people who were critics then are still critics. The people who implemented
things are very defensive and how they say we’re all humans, we all aspire to have a
powerful experience in life and a legacy that we can be proud of. I mentioned earlier today
and I’m gonna repeat it again now I do not think making
this about personality is productive at all. We had people named Paulson
and Geithner and Bernanke and others Larry Summers,
Sheila Bair and others. People use their moral discretion but the systemic pressures
were enormous at that time and in hindsight is not even 2020 but it sometimes lets
you cheat a little bit in how you judge people and
I think it’s quite unhelpful. I think we have to understand
when we go to that point of going over the edge of a
cliff, how did we get here? We have to learn why we got to the place where these people felt
like they had to exercise something called tarp
and preventive medicine has to be designed. I’m a little distressed
right now I must say personally having just read the group of 30s most recent report
about how to manage bailouts because it acts like the
game starts on the day when you inherit the crisis and what concerns me is
fortifying bailout capability generates the mother of all moral hazards and the bailout that you
can do much more confidently because you have all the tools is bigger than the one you would
have if people had doubts about whether you could deliver. Now I think these people
who have advocated that Tim Geithner played a big role in it come from a healthy place which is they know that
going over the cliff is a lot worse than doing
a bailout once you’re there but I think we have to
spend as much energy on that ex-ante upstream period
of preventing getting there as we do in fortifying things downstream and the more you fortify
things in the bailout realm, the more prior restrictions
you’re going to need to stop that moral hazard
from coming to life. I also would say that
some of what’s insinuated in the group of 30 report is that we need more
discretion for central banks. I think that discretion for central banks given the poisoned atmosphere
about financial bailouts without consequences for the perpetrators, that’s already in the wind is a disaster for the future independence
of central banks. I think that will get carved up and their political
charters will be changed if the next crisis is done essentially buying them away from
the democratic process. I think that will in further
intensify hostilities and I think the repair, the best reason to do a reexamination now
is not like I mentioned, not to harm people and
make people culpable but it’s to put us back on a trajectory towards regaining trust and
legitimacy in governance. You can follow just like I have for years the Gallup poll that’s done every April on all of the government
institutions in the United States. It used to be the Center
for Disease Control and the Federal Reserve right at the top and in basically 2007-8 the Federal Reserve
crashed down to the bottom to the point where one
April I believe was 2009 it was less respected than
the IRS in the month of April. Now that’s a hard result to achieve. Anyway I think the… I think that George Soros and
I recently wrote an article which is not an ex post revisitation. At the time of the tarp legislation, the two of us were working… I used to work with the
Senate Banking Committee so I know a lot of the
staff with Dodd-Frank and we were advocating that
tarp include equity injection coupled with mortgage overhang relief. There were two reasons that
we did that at the time. We thought we got more bang for the buck through equity than asset purchases and second we thought
the distributive justice essentially writing down bank creditors and wiping out bank
equity and giving relief to people who were little
quiddity constrained particularly given this
little funny institution called the Discount Window. The big banks aren’t gonna
be liquidity constrained. The people with underneath
or mortgage overhangs will and so we put this into an
article for Project Syndicate and Larry Summers
recently wrote a rebuttal. I encourage you to read
and he used what I thought was a magic word. Everything that Rob and
George Soros put together is not feasible. Feasible is the word that
we have to unpack now about what we did in 2008 that led me to say earlier today, quote Steve Bannon that it
brought you a Republican House. I used to work for Pete Demedici. I used to cheer for and
be on the Republican side but what you see right now is a change from Democratic control of House Senate and the White House under Obama
with tremendous enthusiasm coming in the door to
Republican control of both and Donald Trump as the president and I do not think that
what happened in that period with all those people I mentioned earlier who are responsible was
a failure of imagination. I think that what you
might call incentives, the vested interests, the
pressures of money politics, cognitive capture, revolving doors are the context and the structure in which decisions are made
and so I think for myself, we’ve got to move in
the technocratic sense. For instance these new
studies by Pasquale Noel and his author, Professor Gannon, Amet Cero the recent book (mumbles) I guess it’s now about two years ago. Atif Mian and Amir Sufi
did called House of Debt about the macro aggregate
demand ramifications of doing mortgage restructuring and whether you involved
which I might call extending maturities and
lower cash flow burden or whether you change the principle. All these things I think
really should be studied so if we get to that brink again with regard to large asset markets, they’re systemically significant. We have a little more confidence in exploring a broader
menu of alternatives than we did last time. But I think it was said
to me in recent months I was preparing for this and a
scholar who came through INET said to me, “Rob the art
of being a great financier “in the 90s and up through the present “is to learn how to work the government “to create one-sided bets for yourself.” And I think that maybe a little strong. We’ve got to make and
enforce rules that make… If we’re going to be a market
system that make people play so I think we need as I advocated
in my earlier talk today public financing of elections, some perhaps media credits. People who own radio
stations, television stations they should sacrifice
some of their bandwidth so you don’t have to pay
as much as Procter & Gamble to run for office by
advertising your candidacy and lastly, in my last and I
think perhaps most important is I think we have to… You can argue about how broad or narrow the mandate of the government should be but you should not argue that
whatever mandate you decide on the personnel, the public
servants are well trained and well paid and well supported and when I go on Fox
News what I always say is you should support financial regulation with the same vigor and intensity that you supported the Navy SEALs that went after Osama Bin Laden. Thanks. (applause) – Thank you so much. I don’t think we have time for questions. I think we’re at our poetic end and we also got this terrificly
rich research agenda. Those of you students taking notes, activities regulation, informing effective fact-based
financial regulation and designing legitimate institutions for crisis prevention
and crisis management I think are worthwhile
things to write about. Huge thanks to our panel
and thanks to all of you for sticking around. – I want to offer you a musical anecdote. (mumbles) I think the theme of this conference should be named after a
song by Sonny Boy Williamson and the song goes a little bit like this It took me a long time
to find out my mistakes. It took me a long long time
to find out my mistakes but I’ll bet you my bottom dollar, I’m not fattening no
more frogs for snakes. – Amen. (applause) – Well this has been a fabulous day. My colleagues who served as moderators made a big contribution to the coherence of this conversation and I want to thank them all. They’re not all here. They went back to their offices
for the most part to do work but Rob you did double duty and the Institute for
New Economic Thinking has been a supporter and
a very important part of the generation of this conference. So I thank him for that
and Georgetown as well. Let’s just take a stand-up
break of a minute or two and then we’ll come back and we have a treat for the
very last set of comments coming up from our Nobel Prize Winner, Dr. George Akerlof. All right he’ll be back. He’s here and you get a stand-up break and then we’ll start with Dr. Akerlof. (murmuring) – Yeah I’m more of a
country law professor. Yeah. (mumbles) (murmuring) (laughs) – Yeah hi, how are you. Nice, you gave a good talk. – [Male] It’s sort of an emergency. – [Female] Do you mind
if I go for half an hour? – We are ready to do the last act and boy is it a doozy. We have George Akerlof here. I love to tell the story about his career. He was at UC Berkeley, he wrote an article called The Market for Lemons. He said that it was turned
down by several publications. I didn’t do too badly. It did wind up in the
Quarterly Journal of Economics and the reason this is such a good story is that in 2001, The Market for Lemons, that article became the
basis for his Nobel Prize. So much for those people who
didn’t accept the article when he first submitted it in 1970. He’s a wiz, a wonder
and someone who has said in his Nobel biography
he’s going to devote the rest of his career to
interdisciplinary focus, sociology and other
disciplines beyond economics. He did give me my marching orders. He said keep it short. So I’ll obey and introduce our speaker. Let’s give him a round of applause. (applause) He’s the last one. – Thank you. So I feel this has been
a wonderful conference. I’ve learned a lot and maybe
I’ll have to change my views on many things. So from all of the speakers. What I’m gonna talk of
today is about a book called Phishing for Phools and let’s see. And so that’s the book and
maybe the best thing on the book is the cover which is by Ed Goren, the New Yorker cartoonist
who does these shaggy animals and you can see some of them up there. Okay so the first and most
fundamental motivation of this book is to challenge
the view of the public and of economists that
whatever markets do is right. Now that has special application
to financial markets. Of course all economists
would take into account income distribution and
such things as pollution but that does not exhaust, that does not exhaust
why competitive markets yield bad outcomes. Contrary to free to choose thinking, the art book shows that there’s not only a good side to free markets, there’s also a very serious downside. It explores the notion that markets are the playing field for
deception and manipulation. Why? Because they spawn what we
call phishing for phools. Now all economists know this and everybody here in this room knows this but that leads to the second
very general motivation. The rule of what can
and cannot be published in economics leaves holes. There are some important things to say but there’s no way to say them that would be acceptable
in any economics journal. For example quite a few economists thought that financial derivatives would lead to something like
the financial crisis of 2008 but economists could not figure out a way to express these views
in the form of a paper. So I believe that phishing for phools is one of those holes in economics because we all know it,
it cannot be published and because it cannot be
published in journal form it is ignored and because it was ignored, we had the financial crisis which is the central event even now of the economic history of our times. But then the book also has a subject. It’s a subtext which gradually becomes increasingly important as it proceeds. The subject leads to a rather
different view of economics. So let me begin there with the theory. The book is based on conversations with the psychologist Danny
Kahneman some 30 years ago. In a conversation then Danny told me the basis for psychologists is
that we humans are machines. We humans are machines
that are prone to error. The job of the psychologist
is to ferret out that error. In contrast he said the basic notion of economics is equilibrium, that equilibrium if there’s
a profit left on the table, someone will take up that
opportunity for profit. You see such an equilibrium every time you go to the supermarket. People sequentially choose what they think is the shortest line and in equilibrium the lines
are almost the same length. That’s why it takes so much time when you go to the supermarket
and you can’t figure out which line to choose. So how to put Danny’s
insight into economics. Danny’s insight says the free
markets will not just provide what we really want. That is only the case if we human machines are making the right choices but free markets will also
provide us wrong choices. They will do so as long as
there’s a profit to be made. To restate, the principal means that if we have some weakness or other, in the equilibrium that
weakness will be taken up if there’s a profit to be made. So that means amongst the
business people looking around and deciding where they’re going to make their next investment
some will look to see if there’s some unusual
profits from our weaknesses. They see such an opportunity for profit, that will be what they choose. So economists will have an equilibrium in which every chance for
profit more than the ordinary will be taken up but that
includes our willingness to make the wrong choices. So let me give you some examples. So first example is Cinnabon. The motto of Cinnabon
is life means frosting but the question is does it
really need that much frosting? All those sales of Cinnabons
are a natural result of a free market equilibrium and you’ll find them wherever
you think you would find them like at the shopping mall or
out there at Dulles Airport. So the second example
comes from a metaphor. It’s invented by Bob Shiller. Ken Keith Chen and thank it, watch Narayan and Laurie Santos
they taught capuchin monkeys how to use money to trade. The monkeys developed an
appreciation of price, they saved and they
did other transactions. But let’s go beyond those experiments. Let’s do a thought experiment. Supposing we open the monkeys
up to trading with humans, we would give a large
population of capuchin substantial incomes and
let them be customers of for-profit businesses run by humans without regulatory safeguard. Well you can imagine that
the free market system with its taste for profits, would supply whatever the
monkeys choose to buy. We would expect an economic equilibrium with concoctions appealing
to strange capuchin taste but in this monkey cornucopia, the monkeys would not be happy. We know from Chen and lecturing
Narayan and Anna Santos that they love sweet
sweet fruit roll-up tacos with marshmallow fluff. So capuchins have limited
ability to resist on temptations and we have every expectations that they would become
anxious, malnourished, exhausted, addicted,
quarrelsome and sickened. So that line comes from Bob. So let’s now see what
this thought experiment has to say about humans. Our view of the monkeys
has analyzed their behavior as if they have two types of
what economists call taste. The first type of taste is what
the capuchins would exercise if they made those decisions
that are good for them. The second type of taste
their fruit roll-up taco taste are those they actually exercise. While we humans are numbered
out smarter than monkeys but we can view our
behavior in the same terms. We can imagine as humans
like the capuchins is also having two
different types of tastes. The first concept of taste describes what’s really good for us but as in the case of the capuchins, that’s not always the
basis of all our decisions. The second type of taste
is the taste that determine how we really make our choices and those choices may not
in fact be good for us. So the distinction between
the two types of tastes and the example the
capuchins gives us an image. We can think about our economy as if we all have monkeys on our shoulders when we go shopping or when
we make economic decisions. Those monkeys on our shoulders are the form of the weaknesses that have been exploited
by marketers for ages. Because of those weaknesses
many of our choices differ from what we really want or alternative stated they determine they differ from what’s good for us. So we’re not only aware of that monkey they’re on our shoulder so in the absence of some curbs on markets we reach an economic equilibrium where the monkeys on the shoulder are substantially calling the shot. So what does that say
about economics generally? This takes us to a further proposition. Adam Smith’s invisible hand statement, that’s the central
proposition of all economics. It says that in the equilibrium of a competitive free market economy, it’s impossible to improve the
economic welfare of everyone. For example a change that
would cause my welfare to go up would caused your welfare
or someone else’s, perhaps Emma’s to go down. The theory of course recognizes
that such an equilibrium of competitive free
markets might be blemished by externalities such as pollution and bad distributions of income but with those qualifications
with those qualifications, the result is believed
by economists to be true. But then think about it with
completely free markets, there’s not only freedom to choose, there’s also freedom to phish. The equilibrium will still be optimal but it will be an
equilibrium that’s optimal not in terms of what we really want. It will instead be optimal
in terms of those monkeys on the shoulder tastes. Standard economics has ignored
this obvious difference for a simple reason because
most economists think that for the most part,
people do know what they want. That means there’s
nothing much to be gained from examining the differences
between what we really want and those monkey on the shoulders tastes. Okay but that ignores
the field of psychology which is mainly about the
consequences of those monkeys and it ignores the fact that markets enable phishing for phools. So the onus on Bob and myself in the book is then to show that in real life, phishing for phools does affect our laws. So we see that in four areas
of nobody could possibly want and all of these were seriously (mumbles) Area one of no one could possibly want is personal financial insecurity. Fundamental fact of economic life has never made it into
the economics textbooks. Economists think it’s
easy for people to spend according to a budget. On the contrary the book
shows that it isn’t. So no one wants to go to bed at night worried about how to pay the
bills and yet most people do. Area two of nobody could possibly want is financial and
macroeconomic instability. So phishing for phools
in financial markets is the leading cause of financial crises and I’m gonna talk about that presently. Area three of nobody could
possibly want is ill health but in this five-year just
to give you an example in his five-year career
Violet alone caused 26,000 to 56,000 cardiovascular deaths in the US. No one wants bad medicine and furthermore, the phood industry, food with a PH fills with sugar, salt and fat. According to the CDC, and
this is a remarkable statistic relative me who wrote this book, 39.8% of American adults are obese. If you go back to the
book it says it was 35% and that’s because
there’s been a difference of four percent or five percent since when I finish this
book which is amazing. No one wants to be obese and
then there’s a course tobacco which has its own. Area four of nobody could possibly want that Rob was talking
about is bad government. Just as free markets worked horribly well under ideal conditions so does democracy but politics is vulnerable
to the simplest phish. Politician silently gather
money from the interest and use that money to show that they’re just one
of the folks back home. Okay so these are preparatory notes. I’ll now give an interpretation of the financial crisis of 2008 as an example of Phishing for phools. Now I believe that the interpretation I’m going to give is 100% standard. I believe it’s something that probably almost everybody in this room knows. I’m not sure whether
you 100% agree with it but I think that most people do. But I’m gonna go over it in detail because I’m gonna use the
details of what I’m going to say to make a point. So that’s going to be useful this detail because it has policy implications. So now interpretation
of the financial crisis. So if I have a reputation, if I have a reputation for selling perfect beautiful avocados,
I have an opportunity. I can sell you a rotten avocado at the price you would
pay for the perfect one. I will have mined my reputation, I will have also phished you for a phool. So such a story lies at the heart of the financial crisis of 2008. The reputation mining in question involved the subversion of the system for rating fixed income securities. The reputations of the ratings agencies such as Moody’s and Standard & Poor’s had been built up over the
course of almost a century. Their task was to rate bonds
on the probability of default but in the late 1990s and early 2000s, the rating agencies took on themselves the test not just of rating bonds but also a rating more
complex derivative securities. The complexity of the payment structures made them somewhat depart to rate and also the underlying
assets such as mortgage. They were even difficult
for the raters to access but the public, the public
out there would believe whatever ratings were given
to them by the agencies and so an industry grew up. An industry grew up to
do a reputation mock. So by analogy rotten avocados
were being labeled perfect. With that label they
commanded premium prices and so a whole central
valley full of growers went into the profitable business
of producing such avocados and this mining of the ratings is the basic story of the financial crisis but that’s not all of the explanation. We must also explain what the production and sales of these overrated Securities brought down the financial system. The answer gets is simple. The ratings of these
securities played a major role in their pricing. That enabled commercial
banks, investment banks and also hedge funds to
borrow huge sums of money short-term and invest in
the overrated securities. Though the interest spreads were small, the high-leverage allowed
these institutions to report large accounting profits. That borrowing was made with the rotten securities as collateral. For the moment they seemed as good as gold and the ratings indicated
little chance of default but then the truth was discovered. Those avocados perfect as
they were on the outside, were really rotten on the inside. They were worth much less than the bankers and the finance
managers had paid for them. So from Frankfurt to
New York to Reykjavik, financial institutions owed
much more than they owned. Without bailout, they were bankrupt. So the four questions. The chapter gives the
theater historical answers to four questions. So how did the ratings agencies initially establish their reputation? Well initially the ratings agencies did not depend upon their
income on the investment banks that owner underwrote the securities and the underwriting investment banks also had major incentives
to oversee the ratings given to the securities they sold. The first incentive, unexpected default on a highly rated bond would cause a loss of reputation to the bank. Second the investment
banks were partnerships and the partners had most of their wealth invested in the partnership. The partnership could then be sued so the partners could lose
their whole investment. To give you an example in
1970 with the bankruptcy of Penn Central, Goldman Sachs was sued for misrepresentation
of Penn Central banks. Its total capital was
about 50 million dollars and the partnership was
threatened with bankruptcy but the underwriters who
selected the ratings agencies had an incentive there to
oversee them for honesty. Question two what then changed? Well then two things changed. The investment banks went private and also the ratings agencies
lost their independence. The ratings agencies
began to charge the banks who were underwriting securities. In the new equilibrium
they count executives at the investment banks had an incentive to see that the securities they issued would be rated as highly as possible. So each person, they’re trying
to sell their investment bank to this other account
executive at one of the and so what they have to promise is I’m going to get
rated high as possible. Furthermore that’s what
the account executive at the investment bank needed because was no longer a case where there was relationship banking in which basically it was
his roommate from college and I say his because it was a he from college who was going
to Ford Motor Company or something like that
and they were friends but it was no longer. It was a competitive market. Furthermore privatization
made a future bankruptcy of an account executive bank
only a marginal consideration. This brave new world both the executives of the credit agencies and
those who commissioned them to do the ratings had a mutual incentive for ratings as high as possible. So it is said and it may be true that the ratings agencies were
just not evilly optimistic but if so, there were also huge incentives to have that naive tech that
somehow somebody who decided that they weren’t going
to be suddenly naive. Well they had to worry about their job. So why were the buyers of those
rotten securities so naive? Well reason is well maybe
the buyers were just naive, so naive that’s one possibility but even for some sophisticates, there were still individual incentives to buy those overrated securities because with the virtually
unregulated market for financial derivatives, there was now a way to purchase insurance. Purchasers of such over rated securities could purchase a form
of portfolio insurance if their bet did not pay off. For example they could
purchase a credit default swap. That meant that the cost of the insurance was sufficiently low, they
could pocket higher spreads as long as those payments lasted and in the event of default, they could collect the swap payments. My question four. Why would anyone sell
such a portfolio insurance at a low cost? Well again the seller of
the credit default swap might just be naively trusting
of the ratings agency. That’s a possibility all right, but even in the absence of such naivety, they account executive who sold that swap might have a great deal to gain if the incoming premium were seeing it as his contribution to the firm’s profits. Now this is the classic example. For example the AIG management
back home in New York failed to see the risk that Joseph Cassano was putting onto the firm in London. Cassano was amply rewarded
with annual bonuses in excess of 38 million per year he made from all of the
years from 2002 to 2007. So the huge liabilities he took on for AIG would then discovered as we know they were discovered in
the week of the crash. Okay so that’s my review. So now I’m going to draw some conclusions. Those conclusions I think differ from what some of you are saying. Perhaps I’m wrong but I
want you to listen at least to what I’m going to say. So I’m sure the story I’ve
told you about the crash that’s familiar I think
probably most everyone knows it but I’ve reviewed it because
it’s details are important for current policy. So I’ve been saying and
I’ve been hearing here at this conference a crescendo reports about current over extension of credit and so forth in various forms. So there’s a fear about a
repeat financial crisis. So economists are not allowed
to talk about this actually. I’m not allowed to talk about this. This is only the second time
I’ve ever said this publicly and I’m saying it much more firmly. So I think that’s a theme of this crisis. I sort of scene of this conference I see in many many
different talks such a fear. So phishing for phools says that if there is an unregulated
opportunity for profit, that profit will be taken whether or not that opportunity is benign. The account I’ve given then has described the equilibrium phish for phools that generated the build-up to the crash. We now come to implications
of this description for economic policy. So I think there’s an erroneous view that financial price pressures occur only because of moral hazard. In this view they only occur because people take on undue risks because they expect to be bailed out in the event of bankruptcy. Based on such view and
we’ve been discussing this, Dodd-Frank now greatly
restricts intervention by the Fed Treasury and
then FDIC in future crashes. It makes it difficult. It’s both cumbersome and difficult. Now but was he saw the
financial crash in my analysis did not occur because of moral hazard. It occurred because of a
version of phishing for phools. Some people were telling
themselves wrong stories. The media profits from taking
advantage of those phools were tremendously juicy. I’m gonna underline juicy for you. The possibility of bailout
then for most of these people I believed that it was a
marginal consideration at most. So AIG serves as a good example whether or not Cassano
personally understood the risk, he still had massive incentive to sell all those credit
default swaps, etc. That means the containment
of policymakers ability to intervene in financial market will not prevent all such
crashes from occurring. So my view is that 2008
would have occurred whether the bailouts were
fully anticipated or not, that at most they played a secondary role thus there’s not only a
need for regulatory powers to prevent such crashes
from ever occurring and I’ve heard many of
you give very good please and I agree 100% 1000%
whenever you see such a thing you want to have regulation
and you want to prevent it. But also if and when
such crashes do occur, there’s a need for additional powers to make emergency interventions. So as we’ve been discussed
has been mentioned, just two weeks Bernanke,
Gartner and Hank Paulson made a plea for additional
emergency powers in the event of another crash, I see such powers as urgently needed. That of course I see
as one of the messages of this conference even
though other people seem to disagree with it. So it may be difficult
to predict where and when the next crash is going to come. I don’t see anybody here
with the clear prediction as to exactly when and
where it’s going to come but people are touching
on the types of things which are going to cause it. So let me give just some history. This is fairly recent history. 1988 gave us the
portfolio insurance crash. 10 years later, long-term
capital management threatened to bring down
the financial system and luckily there was a tough
night at the New York Fed and that was avoided and in the absence of heroic intervention, 2008 is widely believed
that it would have led to the second Great Depression in the absence of that intervention. So natural occurrences. Phishing for phools then I think the theory that we have
here says that such threats are natural occurrences in insufficiently regulated
financial markets. They are a natural outcome
in competitive free markets. This is just what is going to occur. So we need regulations
to prevent such crashes and we also must be prepared
for them when they come. So that’s what phishing for
phools economics tells us. This comes from one of the most
basic principle of economics that you see every time
you go to the supermarket. It’s just as simple as those
lines at the supermarket. (applause) – [Emma] George do you want
to take a question or so? – Yes, if there are questions. – If there questions,
feel free in this format or we will go for our reception here and you can talk to George there but if you have a question
now, we have a mic for you. – Question from Rob. I want to have a question for Rob because I almost always agree with everything Rob has to say. This may be the only time
that I’ve ever disagreed. – [Robert] That’s why I’m
asking you a question. – Okay. – I think I was uncomfortable with your characterization of moral hazard as being kind of like a
deliberate strategic action. What I sense is that when you do things like let Morgan Stanley and Goldman Sachs come into the discount window
one day before the crisis when you do all kinds of
things to show the world that these people will not fail, you take the default risk premium
out of their funding costs and without thinking about moral hazard, they start to gain market share and be able to take more risk because the price system is
not telling them anything but I don’t think it’s a
commission of moral hazard almost an immoral action. I think it’s a consequence
of how the market prices what takes place. – Okay. I agree with that. I mean I believe that the people who were doing this thinking… I think we don’t know whether the people who we thought who did the
bad stuff in the crisis. I think we don’t know whether
they did it intentionally or whether they did it unknowingly but the thing is that
those bad unintentional I think we can’t think that we don’t know why we think what we think so that I think we may
never be able to know whether it was intentional or not. So second part of Rob’s question. Okay so I was thinking
about this talk today and whether I was right or wrong. I decided I was right but I may be wrong. So going back to the savings
and loan crisis of the 1980s, I feel that was 100%
a moral hazard crisis, that the reason the savings and loan, especially the worst ones
were able to get their money that it was guaranteed they
thought by the fizzling. Now this other crisis, I don’t
see that that logic applies and I don’t see that the people who were being loaned that money that it was their, the
people who were loaning, who are taking out the loans I don’t see that the loan the
people were giving them loans were thinking about whether the bailout would be there implicitly or not. So that’s my view. I did think about your question. Yeah. (mumbles) – I think the assumption was the government would not
let these big banks go down and so and I think I agree that that’s where the moral hazard is. It’s not with a bank manager so much make it a constitution is that you lower their borrowing cost decreases then they game it they
take on a lot more leverage just makes them even more unstable and on the bailout authority, I think I only have a disagreement with Tim and Hank and Ben
on the 13-3 authority. I really don’t understand. The liability guarantees
it’s not a priority of me to undo that but the liability guarantees were actually I think more effective in terms of minimizing distortions. You could put them on you
can take them off quickly. They didn’t add to the money supply whereas some of that the credit facilities the Fed put in place, I think some are still being wound down. So there were always neurological
recently 13-3 in place and in limit those two but only way 13-3 is
limited is with a one-off. So that they can’t take a
city or any idea or whatever and say okay we’re going to
give you a loving attention and I think that’s appropriate
now that we have Title Two and I do think that you will have your great incentives for
large financial institutions to rely too much on their
government relationships if they think there is
this discretion at the Fed and I find that very troubling. So I would also say the Dodd-Frank expanded bailout authority and that’s something that
people haven’t talked about but Dodd-Frank expanded the
Fed’s bailout authority. They can now let out to clearinghouses. They could not do that before and they can do that on one-off basis so that doesn’t have to be
generally available support. So I’m not sure they’re huge
lines of disagreements here but I do think it’s fair
to point out that 13-3 is only for it a one-off bailout and the Fed has a lot of authority. – So let me make two points there. First of all I’m worried about the FSOC because as mentioned the FSOC
is a cumbersome institution. Second thing is I think it’s easier to rescue the first domino rather than to wait till
you get to the next domino. Now it may well be that in a crisis you can have a loose definition
of who was the first domino. So let’s in the case of
Lehman you could always say that it was some other thing that had there were other
things that have smaller things as you know which we’re failing. So maybe they could stretch it but if you think of Lehman
as the first domino, I would have liked them to
have come in for Lehman. (mumbles) – I think the first domino
will go to Title Two now. The first domino will
be the weakest domino that would go into Title Two which I think would send
a market signal to others that there was a lot of self-help that could have been done that was not. I think we assumed when we were writing this that there would be a triage and is it a domino? Is it an async credit
versus starting a cascade. If it comes truly system-wide then there would be
system-wide support coming but I think the first domino would absolutely go into Title Two and I think that’s a good result because that sends a signal
that take care of yourself and don’t just rely on
the Fed to now come in and lend you trillions of dollars again. I think to just the economics of this are if you look at
financial crises in the past and they’ve really led to
deep recessions or depressions that’s because government
didn’t do enough. So historically I can understand what their bias would be that but I think for our democratic system, the impact that this had
on people’s attitudes towards their government and
whether the game is rigged and to go through that again and kind of have a financial system where bailout has become the norm that really scares the hell out of me. So I think regardless of whether you agree the technical provisions of Dodd-Frank whether there should be
more or less or whatever just in terms of how we
talk about this publicly I think the direction should
be prepare, be accountable. It shouldn’t be we’re gonna
write big checks again. – Okay I think we’re close to agreement. – I would like to start I’m
Ed Cane from Boston College. I heard this about the supermarkets and I realized that after a little while that I was getting in the wrong line to look at the shortest
line the people moved up. They looked shorter but
there were more people there because the guy was slow. So I look for the spacing. And so I think everybody
should learn that eventually that the spacing tells you a lot more than just the length of the
line but about the SNL mess, you know people I mean I’ve
studied this all the way up. I talk with lots of SNL managers and they understood that
physic could never support the size of the hole in their value. They were sure that politically
they were strong enough to influence the government’s reaction. So I don’t think that’s moral hazard. I think it’s wrong to
call that moral hazard. I think it’s a bargaining
situation where you say I’m moving in this direction
and when I get there, what can I do and I
think that’s illustrated in the last crisis when you big meeting that they’ve described in all these books, the world is going to come to an end. What are we going to do and investment bankers were in charge. – George I had a question
about your phishing definition. You said that the unregulated
opportunities for phishing when there are these
unregulated opportunities, phishing will occur. So if that’s the case then it strikes me that the primary effort should be focused on
prevention, not bailouts. 13-3 is a bailout provision. So why do you put your
solution in a basket that’s not related to your diagnosis which is when there are
unregulated opportunities for phishing, phishing will occur? – Okay so that’s one point. So yes I was careful in what I said. I didn’t put huge amount of emphasis but my view was of course you want to keep this darn thing from occurring. You don’t want your teenage
kid to go out in the car and have an accident but you don’t want to have… You’re so worried about moral hazard that if there is an accident, that there’s not a
hospital or an ambulance to take care of them. So my view is yeah, this
is like the teenagers going out and driving the cars. Some of them will have accidents. You want to have a good
system of medical care for what happens after
the accident occurs. So yeah, I’m exactly where we
don’t want to have any of this but just think about it now and just think about what we
heard from some of the speakers about the extent to which
there’s deregulation occurring that in fact there’s
deregulation occurring which is going to make
this more difficult. There are capital
requirements that are too low. Great. I think there are markets
that we haven’t discussed that are much too frothy
its blah blah blah and so these things are going to occur and then I think I mean arguing
for the ambulance system, for the fire department and so forth. – Okay but Rob’s point is that
this is mispriced information about future rescues
and that that is built into the behavior so
your distinction between whether it’s intentional or accidental really doesn’t make a difference because it is an accident
that causes externalities and that is the question. Who should bear the cost
of those externalities when there is an incentive
built into the structure? Hospitals, comfy beds and
all kinds of other rewards. 13-3. – I can give you my opinion on this. An opinion that not other
people are going to like. My view is I’m a macroeconomist. What I see is if you don’t
have a sufficient system, we’re going to get the Great Depression and we have to remember
that the Great Depression ended up in World War II. I feel that the costs of not coming in at that appropriate moment, of not having the
appropriate ambulance system is going to be so hugely costly that I don’t even care very
much where this cost come from. I think they’re trivial, relative to what. So that’s me I’m a macro economist. If I were a micro economist, yeah I believe yeah I care about those costs but I consider they’re not that. (laughs) – Professor, a quick question. A big-picture question. You mentioned that we are all susceptible for this type of phishing and it seems like all our regulation is based on economic models
that assume rational act or hypothesis right. Do you think given what
behavioral economics brought to light that we will
have in a foreseeable future a better model than the
rational actor model? – Yeah, yes of course. It seems to me that the
behavioral economics is just more general that it
includes rational behavior but then also irrational
behavior and furthermore, I don’t believe that the current state of behavioral economics
is sufficiently inclusive. It’s mainly based on psychology, mainly based on individual thinking where is it I think that that
a much more general story is that what motivates
us, what causes action are the stories that people are telling when they take their actions and we have to incorporate how
those stories are generated and what is being told. And so I think there’s a
much greater generalization of how to do economics
that’s embedded in this. (mumbles) Yep. Yes so I think we’re getting there but one step at a time. That’s one of the things that INET. – [Emma] Okay, Rob this
is the last question and we’re all due to have a glass of wine, a soda, refreshment
after this last question. – Thank you very much for listening. – George you talked about
the Savings & Loan bailout and my sense is there’s a dynamic in the history of financial discipline where at the time of the depression they installed Deposit
Insurance and then they said we got to restrict the asset
side of the balance sheet because we’ve anesthetized the
concerns of the depositors. Then as banks got larger
they started to use what we call wholesale liabilities and then people said well
those are the smart guys, the big wholesale people that own bonds and subordinated debt and what-have-you. They can discipline what
the asset side does. Then we got to the place
where the concentration of big banks were
intertwined with each other and people said we need to do something where we guarantee and stabilize
the entire liability side for these big banks because
it’s systemically dangerous and we had a notion which I know the Minneapolis Fed really promulgated called prompt corrective action. Like we have a goal
line in a football game and knows to put his hands up right as you cross the goal line and then you can stop deep losses. You don’t have forbearance and that’s how you protect the system even though all the
liabilities are anesthetized and that just didn’t bear out. I don’t think but my concern
about the moral hazard of today is that the big guys are treated like they have no default premium. The little guys are
treated like they still do which gives them a competitive
advantage as the big guys and it does misprice risk and lead to I would say excessive capacity without other restraints
being explicitly put in place. – I don’t see… I agree with the risk. I don’t see that we have any choice, any reasonable choices other
than what I’m proposing. – [Emma] And so we’re captive to phishers. That’s what you’re describing. – I want to take that back. What I see as the I think
that what we ought to do is exactly what Sheila said we should do which is we should get be sure the banks, etc are capitalized and that you’re not allowed to be a strategically systemically
important financial institution without regulation. It just seems that that’s promising but then we need the ambulance
or the fire department. Okay so thanks. – Okay thank you. That was the last question.
(applause) Thank you for your patience
staying until the end. Your reward lies at the back of the room. Thank you very much. A wonderful conversation. (murmuring)

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