Financial Services: Re-Privatization of the Financial Sector
Friday, Nov. 13
12:00 noon – 2:00 p.m.
– Mr. John A. Allison, Chairman, BB&T Corporation and Distinguished Professor of Practice, Wake Forest University School of Business
– Prof. William Black, Associate Professor of Economics and Law, University of Missouri-Kansas City School of Law
– Mr. Michael Paese, Director of Government Affairs, Goldman Sachs
– Mr. Alex J. Pollock, Resident Fellow, American Enterprise Institute
– Mr. Andrew J. Redleaf, Founding Partner and Chief Executive Officer, Whitebox Advisors LLP
– Moderator: Hon. Jerry E. Smith, U.S. Court of Appeals, Fifth Circuit
Starting in 2008, govt. took unprecedented steps to intervene in financial sector.
Amount of credit risks borne by taxpayers has risen dramatically over the last year. As we recover, the question is when to re-privatize.
After quoting Hobbes, he asks how we can put the large “leviathan” we have created “on a diet.”
First TARP: equity investments in over 600 companies. Is there hope it can withdraw? Govt. likes having expanded control over financial entities.
Quotes Jesse Jones, who ran RFC in the 30’s and “insisted it be operated on a business basis.” Pollock thinks this role as a fiduciary for the taxpayers is a good idea.
The investments in Freddie and Fannie (F&F) seems to be a dead loss. They must be broken into 3 pieces: dead loss; a truly-private mortgage finance business; and a truly-govt. entity requiring congressional appropriations for whatever it does.
Fed’s balance sheet, which is mostly the balance sheet of the Fed Reserve Bank of NY, looks remarkably like a commercial bank’s balance sheet. Deposits at Fed are higher than $1 trillion, which is the equivalent of putting money in the mattress.
I propose Fed should have negative interest rates in excess reserves. This would encourage private banks to do something else with the money, so maybe the Fed would have to buy fewer commercial assets.
FDIC has liability that exceeds its assets, so it wants all available capital to new banks to be enforced, but we need the opposite. To encourage the idea we need banks to be unencumbered by TARP, regulation, etc. This could help Leviathan lose a few lbs.
Opens with a joke about there being two refugees from federal loan bank system at one end of the table.
I want to concentrate on uninsured portion of financial industry: mortgage bankers. They followed 4 step plan: Grow like crazy, make terrible loans, leverage out the wazoo (sp?), and put no loss reserves on the books. If you do all 4 you are guaranteed to report record profits, no risk, guaranteed as long as bubble is inflating.
If I want to grow rapidly, the standard way is to buy market share by reducing your yield. But, if I grow by making loans to people who can’t repay I can expand demand rapidly and charge them premium interest rates.
Then you must gut underwriting standards and change organization so the rules are that anything goes, instead of encouraging people to block bad loans. People were actively discouraged if they raised objections on loan quality.
This produces bizarre results. Genius of voluntary exchange is that both parties benefit… this is pretty darn good. But, we have the reverse occurring. Both principles were made worse off. No mortgage bankers exist anymore, essentially. People who received loans took a big hit too. There has been no greater destruction of working class wealth than bringing them into houses they cannot afford at the absolute top of a bubble. They are virtually all under water on mortgages from 2005-2007. We showed Gresham’s Law.
Gresham’s dynamic hurts the traditional values and entire moral tenor of business. This is not deposit insurance. What makes mortgage bankers for almost ten years make loans that would destroy the institution? (open question to audience, no takers).
How many agree this is strong evidence against Community Reinvestment Act? (10 hands for, 0 against). No coincidence the “liar loans” were made by this portion of the market.
We need to understand the cause of financial problems
- Crisis is result of govt. policies. U.S. is mixed economy, which varies by industry. Most regulated part of the economy caused our problems… not a coincidence
- Bubble formed and grew and then affected other areas.
- Market participants made serious errors that made crisis worse.
If highway is falling down, government owns it. If financial system is falling, government owns it.
Getting rid of normal, cyclical failures pushes the problems into the future.
Greenspan created a negative real interest rate: rate of inflation higher than interest rate. Bernanke then created an inverted yield curve: short term rates are higher than long term rates – very destructive for banks.
FDIC seems benign but it creates loss of discipline. Gives examples.
Clinton allowed F&F to have half their portfolios in housing market, which woried economists, who said reaching these goals could take out the financial system within 10 years…
F&F could never exist in free market and drove everyone out of prime business, then created broken model, which spilled into capital markets and people copied this model.
Barney Frank is mentioned and some groans and boos can be heard.
So what is the cure? Yes, market participants who screwed up should face consequences, but a better long-term strategy would be to move to private backed banking system based on private monetary system. We should go back to gold standard – it’s harder to find, you can’t just print it (crowd laughs).
We will eventually go bankrupt, there is no reason to believe politicians will impose discipline – this is the real risk of having a Federal Reserve.
We should raise capital requirements for banks, shift risk from taxpayers to shareholders. Choice would be raise capital or shrink. Citigroup has failed to raise capital and been bailed out three times, and each time they’ve come back and done worse.
We need to eliminate about 90% of regulations – this is what makes system so inefficient.
(Prolonged applause, he was definitely a crowd favorite.)
- I see this story as a about a dozen “too big to fail” institutions, about 12 – F&F at the top and Goldman at the bottom.
- We’ve mostly had a policy of “strategic ambiguity” toward too big to fail institutions. We have been deliberately ambiguous about who would get what help in what circumstances. Term used now is “effectively guaranteed,” but what does this mean?
- Disclosure in financial sector is absolutely horrible. Where to start? Bear Sterns’ income statement was about 10 lines long – we don’t know much about their assets. Publishing would put the taxpayer at disadvantage, they said. But they had term financing as long as they need it, so there’s no reason they couldn’t provide line-by-line detail.
- The root of the solution is disclosure, commensurate with public involvement in financial institutions. Move away from strategic ambiguity toward explicitly unguaranteed or explicitly guaranteed money.