>> I'm the acting director this
year of Law and Public Affairs.
I'm also an associate professor
here in the politics department.
It gives me great privilege to host
our panel today entitled which is
"Are Financial Institutions
Too Big or Too Big to Fail?"
We have a very distinguished set of panelists
and I will introduce the moderator momentarily.
But let me first let you know that
our program today is sponsored both
by the Law and Public Affairs program.
We focus on broad range of issues at the
intersection of law and public affairs,
public policy, as well as Julis-Rabinowitz
Center for Public Policy and Finance also here
to the Wilson School, which is one of our newest
programs, a multidisciplinary research center
that seeks to interject cutting-edge
research on financial markets
and macro-economy into policy debates.
I'm now going to introduce
our moderator, Linda Goldberg,
who in turn will then introduce the
rest of our distinguished panel.
Linda Goldberg is the class of '88, is the
vice president of Financial Intermediation
at the Federal Reserve Bank in
New York, a research associate
at the National Bureau of Economic Research.
She's the director of the Center for Global
Banking Studies at the Federal Reserve Bank
in New York City, co-chair of the
International Banking Research Network,
and member of the Council on the International
Monetary System of the World Economic Forum.
She was professor of economics at
NYU, a visiting professor at Penn,
and she has a PhD from here
at Princeton University.
She also, prior to that, received a bachelor's
and master's in Mathematics and Economics
at Queens College at CUNY,
City University of New York.
So please join me in welcoming Prof. Goldberg.
[ Applause ]
>> So thank you all for coming out today
and welcome to this very special event
on Are Financial Institutions
Too Big or Too Big to Fail?
Today, you're going to hear
from a very distinguished panel.
Before introducing the panelists, I thought
it would work to set the stage a little bit
for why we're here today, giving you
some issues and terminology especially.
And just a disclaimer, whatever I say are my
views and not those of the Federal Reserve Bank
of New York, Federal Reserve System.
So, I have to say that.
So, we're here to talk about the
financial system here in the United States.
This has evolved dramatically over time.
One part of it, as has long been the
case, is comprised of many small banks.
These banks take deposits, they engage in
lending and other traditional activities.
In addition to those small institutions, there
are a lot of larger institutions and their size
and scope have change tremendously.
A wave of a bank consolidations and other
changes through the '90s and 2000s resulted
in the growth of some very large
entities with large often taken to be more
than $50 billion in assets per institution.
But the balance sheets of these
institutions can be much larger.
They could be in the hundreds
of billions of dollars,
they could be $2 to $3 trillion per institution.
These institutions take deposits and they lend.
They provided broad range of financial services.
They participate in derivatives transactions,
guarantees, loan syndication, trading activity,
and they can have extensive
international networks as well.
Many of these banks are often viewed as
complex institutions, although the meaning
of complexity is less clearly defined.
These banks are usually part of a larger
corporation called a bank holding company
and these bank holding companies can have--
often have hundreds of separate legal
entities within the organization.
But these numbers too can climb very high, as
high as 2,000 to 3,000 separate legal entities
under a single bank holding company.
They spend-- These entities spend
banking, non-bank financial services,
they include insurance companies, mutual
funds, and even completely non-financial firms
like manufacturing and commodities
to some degree.
So when we think of bank holding companies,
it's much broader than the traditional kind
of bank that you might have in mind.
History is rife with bank failures
and banking crises and these arise
when the banking system itself
becomes compromised.
The most recent event is
fresh in all of our memories.
It's the largest since the Great Depression.
And these come on the peals of the world's
biggest banks having grown in size and riskiness
with lower capital, less stable funding,
more complexity, and more trading activity.
The crises listed as a broad range of
interventions from the US government
and in fact governments around the world to
limit the damage that large bank failures can do
to others in the financial system, but also
to others outside the financial sector,
for example, by disrupting the flow of credit
that's supports all kinds of activities
in the private sector whether it's loans for
business working capital, investment activity,
mortgages, student auto loans and so on.
And evidence from the US and from
around the world shows that these types
of disruptions can be devastating.
Thus, we have the concept of too
big to fail in banking institutions
that has become much broadly
a part of our own lingo.
A criticism in general is that in banks, profits
went on the upside to the industry and losses
on the downside could be
shouldered by the public.
So we've had a lot of reforms in the aftermath
of the crises in part of with the goal
of making financial institutions safer, that
is, reducing the risk of their failures,
but also along the lines of
limiting the damage and the potential
for costly government interventions in the event
that those institutions do
fail and do get into trouble.
So, have recent reforms done away with
the problem of too big to fail or not?
How large-- How should large
financial institutions
and other institutions be regulated?
So we have a distinguished panel
here to give you perspectives.
We're going to-- I'm going to introduce all now
and then we'll have each
give you remarks in turn.
We'll start with Paul Volcker, class of 1949.
That's a big reunion.
Let's give that a hand.
[ Applause ]
Paul Volcker served as-- two terms as chairman
of the Federal Reserved under presidents Carter
and Reagan, where he is credited with bringing
a very high level of inflation to an end.
On the heels of the 2007 financial crisis, Paul
served as economic advisor to President Obama
and chairman of the economic
recovery advisory board.
During his time, he proposed changes to the law
to prohibit proprietary speculative trading
activity by banks or bank-owned institutions
for their own gain rather than
for the benefit of the consumer.
The Volcker rule became part of the Dodd-Frank
Wall Street Reform and Consumer Protection Act.
And in 2013, Paul launched the Volcker Alliance
to adjust ineffective public
policies and distrust in government.
Dick Herring, PhD, 1973, is a Jacob Safra
professor of international banking and professor
of finance at the Wharton School
University of Pennsylvania,
where he is also the founding director of
the Wharton Financial Institution Center.
He is the author of more than 150 articles,
monographs, and books on various topics
in financial regulation, international
banking, and international finance.
Dick is co-chair of the US Shadow Financial
Regulatory Committee and executive director
of the Financial Economists Roundtable.
He's also a member of the FDIC
Systemic Resolution Advisory Committee,
the Systemic Risk Council, and the Hoover
Institution working group on resolution policy.
Martin Gruenberg, class of '75,
is the 20th chairman of the FDIC,
the Federal Deposit Insurance Corporation,
following other senior roles he
held at that institution since 2005.
Marty joined the FDIC board after
broad congressional experience
and the financial service in regulatory
areas including as senior counsel
to Senator Paul Sarbanes on the staff of
the Senate Committee on Banking, Housing,
and Urban Affairs from 1993 to 2005.
Marty advised the senator on issues of domestic
and international financial
regulation, monetary policy, and trade.
He played an active an active role
in major legislation including the
Financial Institutions Reform, Recovery,
and Enforcement Act of 1989, FIRREA, the
FDIC Improvement Act of 1991, FDICIA,
the Gramm-Leach-Bliley Act and
the Sarbanes-Oxley Act of 2002.
Last but not least, Don Bernstein, 19--
class of 1975, is a partner with Davis, Polk,
and Wardwell in New York, where
he's head of the firm's insolvency
and restructuring practice group.
His firm has represented the US Treasury and the
New York Fed in connection with AIG since 2008.
Don was separately representing
their private sector clients,
first trying to pull together
the industry credit facility
for Lehman before the original deal with
Barclays fell apart over the Lehman weekend,
and then helping them to
sort out the mess afterwards.
He works with large systemically
important financial institutions
on developing their resolution plans, that is,
what they would do in the event of failure.
He's a past chair of the National Bankruptcy
Conference, a commissioner on the ABI Commission
to study the reform of Chapter
11 Bankruptcy Code,
a director of the International
Insolvency Institute,
and past director of the
American College of Bankruptcy.
He's been treasurer and member of the executive
committee of the Association of the Bar
of New York City, former chair of
the city's Bar Associations Committee
on Bankruptcy and Corporate Reorganization.
So we have quite a panel
to comment on these issues.
Each panelist will speak for 10
minutes, then we'll have some back
and forth among the panelists and
later take questions from the audience.
So we'll start with Paul and then
move on to Dick, Don, and Martin.
>> Well, thank you, Linda and Princetonians
of all ages and sizes and sex I guess.
You know, this is a reunion period and
we reminisce when you talk reunions,
it occurred to me yesterday that
I would be coming to McCosh 50.
I remember coming to McCosh 50 almost precisely
69 years ago as a freshman at Princeton.
Sixty-nine years ago, my
fellow panelists were not born.
[ Laughter and Applause ]
Now, I remember I was here to take-- you
think I was [inaudible] Economics 101.
Some of you may think, given what's happened
since then, I wasn't listening very well.
[ Laughter ]
But the fact is, and I remember, it was not
what you think it was Economics 101 today
when I'm teaching you all these equations in
consumption and investment, all that stuff.
It was a course in comparative economic systems,
which started several thousand years ago.
And I remember going through
the feudal years and learning
about how the how the law had
maintained control over the service
and how the various guilds
evolved to-- as part of the system.
And eventually at the end of the [inaudible]
of course, we did get up to Karl Marx.
I doubt that's touched upon very often
now in Princeton, but it was then.
Anyway, we had two questions given to
us and let me just begin this colloquy.
First question too big, the bank is too
big, the financial institution is too big.
Well, the obvious answer is some of them are.
And it's also a question of complexity.
If they're very big and very complex, you
have to be a genius to run it correctly,
and not just an intellectual genius,
you have to be a superb manager.
And I don't think they're very [inaudible].
So yes, you've got a problem on the side.
I don't say I have the answers to them but I--
And it's a limited problem in
the center of these institutions.
Too big to fail, now that's
an interesting question.
It's obviously about quite political resonance.
Everybody talks about too big to fail.
That's a bad thing.
But what do we really mean by too big to fail?
If an institution, a financial institution
gets in trouble, the stockholders are wiped
out [inaudible] is that a failure?
If that didn't satisfy you,
suppose the stockholders are
like that and the management is gone.
Is that the definition of
failure we're talking about?
Or do we insist that there be some loss to
creditors too and that really means failure?
Well, I suppose the government comes along
and pushes a merger among institutions.
Is that failure or not?
What are the terms?
Or is it just liquidation?
You got to wipe the institution off the
face of the Earth and get it liquidated.
That is failure.
But is that really what we're talking about?
And what are we talking about?
What are we talking about?
A related question is, what's a bailout?
If there's any phrase used more often
than too big to fail, it's bailout.
What does bailout mean?
That every time a government insists
a financial institution to bailout,
you can't say that because the Federal
Reserve does that almost every day,
Linda, I think, in one way or another.
And the FDIC occasionally helps.
But you would have to be extraordinary
government assistance of any sort.
And is that what makes it a
bailout that we should worry about?
Or does it matter whether the
government gets its money all back,
makes out a profit which sometimes happens?
If the government gets its money back,
is it then put in a different
category, it's not a bailout.
I know all these confusions, I think,
enter into the popular conversation.
And of course, the question is, why
do we care at all about it's too big
to fail or bailouts or all this stuff?
Well, I'm sure the other panelists
will be going into this in more detail.
But if you want to hear a vigorous defense
of government intervention,
you can give us the [inaudible]
recent book, whereby a lot of definitions,
I guess, he gave you there were failures
and there were certainly bailouts.
And he argues for-- this is all necessary
as all bailouts are justified by saying,
we did this to avoid further disturbance in the
market that would have been damaging not
only to other financial institutions,
but damaging ultimately to
economic activity and citizen right
around the country, maybe
right around the world.
And so that's why we justify intervention.
And what is so bad about it when it happens?
Well, we are worried, I understand,
by we help one institution,
and it's likely to be a very large institution,
what about other institutions we don't help?
Will they be adversely affected by the concerns
that are raised by these immediate fears
of the failure of a big institution?
And that may be handled in a way by being
prepared to do more and more bailouts
that shouldn't sound very satisfactory.
More generally, over a period of time, if an
institution is saved, let me use that word,
does that affect their own future behavior or
the behavior of others institutions that said,
well, we've got saved or other institutions that
said, they've got saved, we'll get saved too.
And we will feel free to take more risks than
we ordinarily would take because we will,
as Linda said, will benefit from the upside and
the government will take care of the downside.
And then, finally, I guess we can have
other reasons, but I'll mention one
that became very prominent in the 1980s by a
kind of slogan developed by the small banks.
And they were the ones that really
invented this about too big to fail.
And they said, it's unfair competition
because people will come to learn
or suspect the big important
institutions will be saved.
You'll save Citibank.
You'll save [inaudible].
You'll save Chase.
You'll save Bank of America.
But you're not going to save the First National
Bank of [inaudible] or even [inaudible].
And therefore, we are at an unfair
advantage in the marketplace.
People won't put money with
us because they want to put it
in an institution that's going to be saved.
And I think to anticipate
maybe some of the discussions,
you're going to raise real statistical
measures now, after all that's happened,
that the big banks and the big other
institutions that might seem to qualify
for too big to fail treatment,
to use that terrible phrase,
can actually finance itself more cheaply
than a smaller bank that may in effect be
in a stronger financial position
than the big bank.
So that is a problem.
Now, as we discuss this, I think you want
to be aware that I declare my interest.
I don't know it's a conflict of interest.
But some people associate the beginning of
this talk with the use of a terrible phrase,
too big to fail and bailout with a
large Chicago bank in Chicago, Illinois.
If we talk, it's very large then,
but in today's standards, it's not.
A lot of things have happened.
Anyway, this big bank got in trouble.
It had a possibility of affecting adversely
a lot of other institutions, and indeed,
the economies all over, a
lot of complicated reasons.
But I happened to be a chairman of
the Federal Reserve at that point,
Martin Gruenberg's predecessor
as chairman of the FDIC.
We were two peas in a pod or
something in dealing with this problem.
And the decision was made
for a variety of reasons
that indeed the combination
of a large capital [inaudible]
by the FDIC and a very large liquidity
support by the Federal Reserve,
we would save capital [inaudible].
Now what does save mean?
If we go back to my definition
of what is a failure,
the stockholders were wiped
out, the management was gone.
There was in that case no loss to creditors.
There were very few creditors who have
not deposited, but they were not a loss.
There was eventually a forced merger.
And anyway, it happened.
It happened and was followed by--
or accompanied by a major crisis,
continuing crisis in the
savings and loan industry,
principle supplies and mortgage credit.
They were failing-- individually fairly small
institutions which were failing rapidly.
And then some of the smaller banks,
as I mentioned, were worried.
So that was when this argument became--
this discussion became very
prominent, it became just involved.
But never before have we had such big
intervention as during this recent crisis.
I must say, and I don't know if it's defense
but just in the interest of accuracy,
it is not technically true that cutting
out Illinois was the first bailout.
A few years before that, it was First
Pennsylvania Bank and Philadelphia
and a number of other occasions earlier,
but certainly cutting out
Illinois got the attention.
But there is an interesting comparison
in the 1930s in the Great Depression.
While individual banks were not sold
large relatively as now, there were a
tremendous number of bank failures to the point
when President Roosevelt took
office, all the banks were closed.
And so there's such a panic about
this, there's so much uncertainly.
Well, let's then sit for a week or two or three
until we can get the banking system going again.
They think that the banking system
is going again, well, there may be--
several banks never opened up the window
again, but the economy gradually recovered.
Now, that is the picture that
many people today have in mind.
See what happened in 1933,
following the Great Depression,
beginning of the Great Depression, and it
ended up in a very prolonged depression.
We must avoid this so we
will make more interventions.
That was the case anytime after-- in the
beginning in 1929 but continuing through 1933.
So that we have two test cases.
Some people see it anyway as test cases.
Let the market work its way out.
If they fail, they fail.
Rescue the market with all the
problems that that may entail.
So, I'll leave that to my fellow panelists
to tell you which courses they'll approach.
[Laughter].
>> Thanks a lot.
[ Applause ]
>> Thank you.
Thanks very much.
And thank you, Linda, for
that very kind introduction.
It is never a good thing to
be following Paul Volcker
because he's got the definitive
word on everything.
But I'll try to give a sort of alternate
view of some of the things that happened.
I'm going to date the first use of the
term too big to fail as the hearings
that followed the collapse of
Continental Illinois, when the controller
of the currency [inaudible]
I've spent some awkward weeks
in Congress explaining why
it failed despite the fact
that this institution had given Continental
excellent supervision [inaudible] charter well.
And at some point, he said, well, you
have to be quite honest, 12 of our--
or 11 of our institutions are too big to fail.
And that did wonders for the market
value of at least 10 of them,
but they weren't quite sure
how he was counting size.
And the 12th one was in a lot of trouble because
it raised issues about who would be next.
And it was, I think, really the first example
of really the value of this implicit subsidy
from being perceived as too big to fail.
And I quite agree with Paul that these
sort of things that gone on before.
I have real questions about whether there was
any systemic argument for First Pennsylvania
but neither was responsible for that.
And Continental Illinois, let me remind you,
was $42 billion and the fifth largest bank
in the US, the largest commercial
industrial lender.
Compare that to today where JPMorgan
Chase is somewhere north of 2 trillion
and you see what a different
world we're living in.
You can adjust all the price
inflation you like and not get there.
But what do we really mean by too big to fail?
Well, it's really a catch-all phrase
that is intended to encompass,
as Linda indicated, a wide variety of things.
Some of them surely have to do with complexity.
Several banks have more than 3,000 affiliates.
Both Linda and I have looked
at this pretty carefully,
as carefully as you can with the public data.
And many of them have scores and scores
of countries they're involved in.
Citibank would be a good example of this.
And one of the reasons that presents a problem
is that simply to imagine how you would take all
of those legal entities through some kind
of resolution process is mind-boggling.
And so, that kind of complexity
is very worrisome.
Interconnectedness is another feature.
And that usually applies to
banks that are heavily involved
in dealer markets and derivative swaps,
options, that sort of thing, which
can be very opaque and very difficult
to know exactly who's going to say
ouch if one of the players goes down,
because the interrelationships
are changing rapidly,
and nobody's really quite sure
of what the positions are.
An example of that kind of
bank might be Morgan Stanley.
Other kinds of banks may be on the list
because of the particular importance
of the services they provide.
Bank of New York Mellon is not very large, but
it is crucial in the third party repo market
and in all sorts of clearing and transactions.
And then of course, there is just
sheer size like JPMorgan Chase.
All of these banks were picked not at random,
but because they're on the list that
the Financial Stability Board manages
of these global systemically
important financial institutions.
We have seven of them on the list,
the largest within the country.
I would say despite all of these attempts
to be analytical, as a practical matter,
what determines whether an institution is
too big to fail is the concern of regulators.
And if-- when they look at the abyss, they fear
that if laws were imposed on unsecured creditors
or uninsured depositors, it would
cause intolerable spillovers
that would damage the financial
system in the real economy,
then that institution's too big to fail.
They will do something to try to protect
the economy from those consequences.
So we might ask, what is it
that the regulators fear?
And this is going to be trivializing
it, but I think you'll get the point.
First off, it is sort of a loss of
confidence in the banking system.
This is-- a cartoonist captured this by
having a teller ask a potential customer,
can I interest you in a faith-based
account, which probably is not going to work.
It could also lead to a banking panic of the
sort that the polls talked about in the '30s.
That doesn't happen so much in current days
because of Marty's institution, the FDIC.
You don't see retail depositors
with this kind of anxiety.
But you do see it in the wholesale
markets because they really are very,
very concerned about whether
they can get out in time.
And so the runs happen electronically and
are really not as visible as they once were.
On the other hand, you have
the reverse phenomena which is,
these days, probably even more damaging.
The banks are desperate to
scramble for liquidity.
It doesn't quite happen like this.
The retail customers don't
have enough money to be useful.
But what it does happen is the institutional
markets try to protect each other by
raising the amount of collateral
they want for collateralized loans,
by increasing the haircuts, by selling assets,
which inevitably leads to a fall in prices,
which leads to more demand for collateral.
And you see the Interbank market simply
collapse as it did in August of 2007,
because people know there are a lot
of losses overhanging the system,
but they don't really know who is
going to bear the losses in the end.
And finally, you have just a loss of
confidence in the whole financial system.
And this is very awkward
if you're in the business
of providing advice to the financial system.
UBS may be the poster child
of this kind of problem.
They had the greatest private wealth management
franchise in the world, yet they lost billions
of dollars managing their own money,
and it went to troubling questions
about their competence to
manage other people's money.
We, at Wharton, had a particular point
of view of this because there was sort
of collateral damage that affected
some of our graduates fairly severely.
There was a cut back of sorts,
which has been difficult.
But, the important part that we need to focus
on is exactly what Paul outlined in talking
about the '30s experience and that is where
it really-- where Wall Street hits mainstream.
And this is the manager of a
local bank who said, well, yes,
we used to be called the friendly-loving
company, but now it's the go-to-hell company.
Well, what does it matter if some
banks are deemed too big to fail?
It is an implicit subsidy, we
can, to some extent, quantify it.
And as Paul indicated, it means that
business is going to flow to institutions
that are receiving the subsidy,
not whether they're better managed
or allocating credit better.
And so you're going to have this distortion
of the flow of resources that may lead
to an inefficient allocation
of resources in the economy.
In addition, you're going to
have a loss of market discipline.
Now, Paul had some concerns about
who you want to discipline the banks.
I would argue that it's important for at
least some creditors to discipline the banks
because the regulatory authorities
need that kind of support.
And so, that doesn't tend to happen
when you have the presumption
that is something too big to fail.
Let me only indicate what happened in the run up
to Lehman Brothers which was able to fund itself
until the very end, because
people thought it was certain
to be saved since Bear Stearns was saved.
This enables institutions to leverage and grow.
And it happens that some banks in
some countries have grown so large
that they're really too big to save.
The Netherlands, Switzerland, the United Kingdom
all have individual banks that have liabilities
that are larger than the GDP of their country.
But probably the most obvious example of this
is Ireland, which ran into a banking problem,
guaranteed all its deposits got huge
inflows from the rest of the euro area.
And people began to notice that it was
very, very large compared to Irish GDP.
As a result, they turned a banking
crisis into a sovereign debt crisis
and they're only just now coming up.
The problem, of course, is all of this
can be hugely costly to government.
So they have to make good
on the implicit guarantees.
And you are in this position of distorted
incentives, where you have risky positions
as some people said at the time, the
bonuses were real, though profits were not.
Counting simply doesn't measure
these things very well.
And it leads people to take greater risks.
This is known in the banking
world as moral hazard.
It's not about ethics.
It's all about distorted incentives.
And, probably, if you take Mervyn King, who was
governor with the Bank of England seriously,
we have just gone through the most massive
round of moral hazard in all history.
This is a cartoon from the New
Yorker that often gets it right.
Although I think this young
man is a little optimistic.
He's just smashed the piggy bank and
says, now, we just have to sit back
and wait for the Fed to bail us out.
He may be waiting a while, this
is not big enough, frankly.
Despite the recognition of
the too big to fail problem,
we've seen rapid growth among these banks.
By 2010, the five largest banks held
more than half of all bank assets.
And that's up from 15% of the 1970s.
So the big have gotten bigger
at a very rapid rate.
And I would have to say that in-- to
some extent, that is a result of panicky
over the weekend government facilitated mergers
to try to make the short term more stable
than it would otherwise have been.
But the cost has been a long-term system that
I don't think we would have wanted to have.
It's also very costly, potentially,
and any holding at the Bank
of England actually measured this and found that
at the height-- at 2009, the US, Europe and--
had committed the equivalent of 25% of
world GDP to backing up the banking system.
And one might ask whether, in fact, that is
an appropriate way to allocate world GDP.
Now, oddly enough, despite the
fact this was a well-known problem,
there was really nothing much done about
it, until the most recent legislation.
There was total reliance on the
doctrine of constructive ambiguity.
And I believed it when Paul
Volcker was at the Fed.
There was a story that went
around and it may be apocryphal,
but the important point is
that it was widely believed.
And it was a discussion between Paul and a
banker who headed a very large institution.
And it is said and it may not be true
that the banker asked Paul what kind
of support he could expect
in the event of a crisis.
And Paul said, well, I'll be happy to
speak about that with your predecessor,
with your successor, I'm
sorry, with your successor.
And, that is how you-- In moral hazard.
But I think in general, people
don't have that credibility.
And, just as Paul said, it's very rare to
find anybody who has a talent to manage one
of these huge, complicated institutions.
It's rare still to have a public official
with that kind of integrity and discipline.
I think it's kind of a naive approach.
Because unless the markets really believe that
policy will be determined by a roulette wheel,
that it's actually going to be a random
outcome, they're going to make assumptions based
on the kind of cost benefit analysis, I
think, the regulators will go through.
And it almost inevitably leads to helping
large institutions, not small institutions.
It's an example of the time
and consistency problem
that really plagues the whole policymaking
world in that what you want people
to believe ex-ante may be very different
than what you actually do ex-post.
And that creates a real credibility
problem that can cause difficulties.
I think we tested the policy of constructive
ambiguity seriously during the recent crisis,
and found it was really destructive in the end.
The whole policy came to an end when Lehman
Brothers was sent to bankruptcy court,
and frankly, much of the market was astonished
because Bear Stearns had been
saved less than six months before.
Bear Stearns was half a size, half as complex.
And certainly the manager of Lehman Brothers was
utterly sure that he would be supported and held
out against a lot of attempts
to recapitalize them.
And after that, you saw a string of failures,
which actually led to failures worldwide.
And I would argue, a lot of this happened
because the probability of a bailout went
from about 100% to maybe down to about 20%,
which means that the risk premiums people want
to put money in the banking
system are going to go way up.
Well, we do have a policy
response, and this time,
it is explicitly addressed to too big to fail.
It's multipronged.
And, let me just mention some of the
elements of it and then I will stop.
We have heightened supervision.
Now, we have always said that we're
going to supervise banks more carefully.
This time, it seems to have more substance
to it, especially with the introduction
of the capital adequacy scenarios
in which banks actually are asked
to project their situation
forward under severe scenarios.
We also now have much higher and
better quality capital requirements.
And the capital requirements are
differentially higher for institutions
that are on the list of too big to fail.
In fact, the Financial Stability Board sort of
forms a list for that purpose and it's supposed
to apply to banks everywhere in the world.
We don't have liquidity requirements in place
that also have scenarios underlying them
so that banks should be less
vulnerable to a liquidity problem.
We have activity restrictions,
most notably the Volcker Rule.
And I would say the most important piece of it
all, which really does speak to my definition
of too big to fail, is an attempt to give
policymakers an alternative to causing chaos,
a way to resolve a large insolvent institution
or large near to insolvent institution
because it's really a range, not a
point, without creating financial chaos.
This is written into Dodd-Frank
in titles I and II.
It involves banks making living
wills, which some of them,
sardonically, we call as funeral plans.
But it is supposed to give regulators
and banks information to be able
to deal with a very tough situation.
Now, under Title I, they're supposed
to go to bankruptcy court and, in fact,
the living wills are aimed at bankruptcy.
Don has been one of the leaders
in trying to figure out how
to make our bankruptcy laws better able
to deal with financial institutions
because they do have very
different characteristics
than the normal [inaudible] institution.
And then, finally, you have Title II that
can be used in exceptional circumstances
for very large institutions with a
number of safeguards to get there.
And this is where Marty and his
colleagues have made, I think,
a really substantial and
innovative contribution.
They've actually figured
out how they might do it
for a large internationally active institution
that spans 40, or 50, or 60 countries.
And, we don't know if it will
work, but it's so far the only idea
out there that has any credibility at all.
So I congratulate the organizers
on having assembled a good panel.
Everybody has a major role in it except me.
I'm just a voyeur in the whole system.
Thank you.
[ Applause ]
>> OK. Well, now that I know I'm a funeral
director, it's very heartening to know that.
But, first of all, I want to point out, and I--
and Richard really mentioned it just
now what an extraordinary panel we have.
We have two of the finest public
servants in the United States.
And they've been added for quite a while.
They are in Princeton's tradition
of being in the nation service
and being the service of all nations.
And I really want to applaud them for that.
[ Applause ]
[Inaudible] And we also have one of the
leading experts on financial services
and the business of financial services.
I'm just a bankruptcy [inaudible].
And I'm going to see what I can contribute here.
But, you may have second thoughts
after you hear what I have to say.
But what I'm going to focus on is that list
of things that was in Richard's last slide.
And in particular, on the last item, because
there were really two things that are needed
to at least make an attempt to solve too big to
fail, the first is active prudential regulation.
And all of the items above the last item
in Richard's last slide were
about prudential regulation.
How do we make banks more resilient?
How do we make them less
complex, more easily managed?
How do we reduce their risk profile
so that they are less likely to fail?
When I get to my area, I'm really talking
about what happens when failure occurs.
And I'd like to explore why it is so
difficult for financial institutions
to just go bankrupt the way
other corporations do.
Now, we have the most effective
bankruptcy system in the world.
We discovered in the 19th century
how to reorganize companies.
And what a reorganization of the company
is, is simply a method of passing losses
to the private sector, to
shareholders, to creditors,
and at the same time preserving
the value of the enterprise,
potentially preserving the
jobs in the enterprise.
And today, for large companies that
are not financial services companies,
our bankruptcy system is incredibly successful.
Companies tend to get either reorganized
and owned by the creditors as going concerns
or they get sold to third parties.
Why can't that happen with
financial institutions?
There are several characteristics of financial
institutions that make this very difficult.
And each one of them was a characteristic
that we saw in the Lehman Brothers situation.
Richard mentioned runs, and I'm going
to describe them in a little more detail
because some people in the
audience may not understand them.
But runs on cash are the first thing that
happens when there is a whiff of trouble.
People will protect themselves.
They're risk averse.
And they're ambiguity averse.
And in the context of a financial
services firm, as large and complex
as the ones we're dealing
with, people are so uncertain
that they start pulling their money out.
The second thing is, once people start pulling
their money out, the financial institution has
to find cash in order to satisfy those
creditors, depositors are creditors.
So, it ends up selling assets.
And if it's selling assets in the
context of a financial crisis,
it's engaging in what we
bankruptcy lawyers call fire sales,
because you're usually selling an
asset at the bottom of the market.
And you were incurring a significant
loss when you sell that asset.
So you may have had a loss that started the run.
Now, you're going to have more losses
as you effectively liquidate
yourself in order to meet the run.
Then, something else happens which is
quite unique to financial services.
Financial service companies
have trading contracts,
and we talked about derivatives a few minutes
ago, but other types of trading contracts
as well that terminate if you fail.
So when a financial institution fails,
there is another kind of run that occurs,
which is all of these financial creditors who
have derivatives and commodities contracts
and securities contracts, which may
be forward contracts, maybe options,
maybe a bunch of other types of contracts,
and have collateral for those contracts.
In other words, they are secured by assets,
have the opportunity to shut off those contracts
and run and sell the collateral
in the market which, again,
results in more fire sales and more losses.
So you have this cascading effect of
an initial lack of confidence, a run,
and a loss to meet the run, and a further run,
because once you try to go into resolution,
all of these contracts terminate.
Then you have the additional phenomenon
of this happening in multiple countries.
And it's not just that the runs are happening
in multiple countries, but when you fail,
you are being taken over by multiple parties.
The UK subsidiary will have an administrator.
The US Bank will probably have
Marty and his team of FDIC people.
You will have-- Your securities firm
in the United States will be
taken over by a civic trustee.
And so it goes.
So, you have this balkanization
of the firm as soon as it fails.
And each of the relevant parties
tries to preserve the local assets
for the local creditors,
something called ringfencing.
So, you then have another problem.
You can't even run the firm
cohesively at that point.
So you really can't reorganize it.
And then finally, when all of this is going on,
nobody is about to begin providing new liquidity
or new loans to the financial
services firm that's in this condition.
So it's a perfect storm.
You're liquidating your assets,
you're recurring more losses,
you have suddenly become
balkanized, and no one's able to--
able and willing to lend you money.
And that's what happens under
ordinary circumstances
and what happened in 2008 to Lehman Brothers.
And there was no way of stopping a
meltdown liquidation with huge losses.
So the question is, how do we stop it?
Well, let's talk about runs.
Runs are, you know, if you
think about it, very simple.
Banks are in the business of what's
called maturity transformation.
They take our deposits, which
are short-term obligations.
They take commercial paper.
They take other short-term obligations.
And they convert them into loans to buy houses.
They convert them into loans to
corporations to build factories,
and all of those are long-term loans.
So, what happens when there is a
whiff of trouble and the run starts,
all of those short-term creditors
start pulling their money out.
And we talked a little bit
before about deposit insurance.
But for a large global financial institution,
deposit insurance is just the tip of the iceberg
because most deposits are
above the insurance limit.
Most deposits are from commercial firms or
they're actually short-term borrowings based
on so-called repo transactions
with mutual funds and others.
And all of those creditors are uninsured
and they want to pull out immediately,
they're highly sophisticated,
and the run starts.
You know, you remember, Princetonian
Jimmy Stewart and "It's a Wonderful Life",
he was able to get all the people in town who
wanted to pull their money out of the building
and loan and convince them that their
money was in someone else's house.
You can't do that with a
large financial institution.
And that is why you need tools, and you need
planning, if you are ever going to have a chance
of resolving one of these large financial
institutions without systemic disruption.
And I define systemic disruption
as being a situation
where the market can realize their
value through the enterprise.
And that impact then causes a contagion effect,
where people look around at other enterprises
and are worried that the same
thing is going to happen.
So, unless you have a system where you
have properly planned for resolution
and you have the tools to effectuate a
resolution where that doesn't happen,
you are going to have to be
faced with the need for bailouts
and rescues of financial institutions.
So, what is being done to solve this?
And Richard listed some of the main items.
One thing that's being done is
increasing capital requirements.
Now, capital is very important, but even
at the capital requirements that are--
that exist now, there are some who say that it's
not enough, that you need more loss absorbency.
And, one of the characteristics
of our bankruptcy system is the ability
to transmit losses to creditors.
And if you have long-term sophisticated
creditors who know how to price the risk,
there's no reason where-- why we
shouldn't be able to design a system
where you can transmit the losses of the
firm to that tier of creditors very quickly
and remove the losses from the operating
entities where the short-term liabilities are.
And the effort that's being made in terms of
looking at this both from the point of view
of conventional bankruptcy and from the
point of view of Title II of Dodd-Frank,
which is the extraordinary powers that
the FDIC has to move in if necessary,
involve figuring out how much
loss absorbency there needs to be
and how to transmit those losses very speedily
and very efficiently to the creditors.
And for the creditors who are extending
that credit to know that they're in line
to absorb the losses of the firm the way they
would be in a conventional bankruptcy case.
So that's the second thing that's
being done, looking at loss absorbency.
The third thing that's being done is regulators
around the globe are now
coordinating their efforts, and also,
significant legislation is being passed.
In the United States under the Dodd-Frank
Act, as we know we have Title II of Dodd-Frank
with special tools for so-called our resolution.
In Europe, the bank resolution
and recovery directive was passed
by the European Parliament
a couple of months ago.
It has to be implemented
across the European Union.
But they also have the power to pass
losses, the tools to pass losses
on to long-term creditors very quickly.
The regulators themselves
have been gathering together
in a group called the Financial Stability
Board to identify how resolution should work
and how the resolution regime should work.
And one of their efforts, which
is actively underway currently,
is an effort to remove this termination problem
from certain types of financial contracts.
So that by agreement, the market would,
under certain circumstances, stay in place
and not terminate those contracts and run.
And I think we're going to see
action on that fairly quickly.
And finally, living wills or resolution
planning are exceedingly important.
This is because until you get underneath the
hood at a financial institution and identify all
of the potential issues, whether it's
issues relating to foreign affiliates,
whether it's issues relating to certain types
of businesses that might have to be sold,
and how you would go about selling them
in a speedy way, until you do that,
you are not going to be able to as quickly as
you need to resolve financial institutions.
And I would bet that the
FDIC and the Federal Reserve
who are reviewing the resolution
plans are finding them very useful,
not only for developing a strategy for resolving
these firms under conventional bankruptcy law,
but also under the special
provisions of Title II of Dodd-Frank.
So, in some, there is a lot going on
to try to make firms more resolvable.
A lot has already happened to try
to make firms less likely to fail.
And it's through the efforts of Marty Gruenberg
and his colleagues and their colleagues
at the Federal Reserve and at the Bank
of England and among the regulators
around the world, that we are actually beginning
to make progress to solve this problem.
And I will leave it to Marty to say
whether he thinks it's solved [laughter].
[ Applause ]
>> Talk about being set up.
But let me begin by saying what an honor
it always is to be invited to participate
in a program here back on campus and
particularly with this distinguished panel.
And I'm struck at the turnout
here for this event.
I mean, I think a significant part of it is the
presence of Chairman Volcker here on the panel,
who I think certainly one
of my heroes, if I may say,
and truly one of the consequential
figures of our time.
But in addition, I think this issue of
too big to fail actually struck a chord
in the American public during this
recent financial crisis in 2008 and 2009.
You know, the spectacle of our largest, most
powerful, and privileged financial institutions,
being the recipients really have massive,
massive unprecedented public support
on an open institution basis, essentially
protecting shareholders, and creditors,
and management that cut across the
spectrum of the American people.
And I think the turnout here today is
something of a reflection for that.
It really got everybody's attention.
And I think nobody, nobody
is really happy about it.
So let me just say a few words to try to
put this in perspective and a little bit
about what we've been trying
to do to come to grips with.
Let me tell you a really hard
problem, a really hard problem.
And I want to pick up the story maybe a
little bit where Mr. Volcker left off.
He was talking about Continental Illinois in
1984 and the thrift crisis in the United States,
which herd in the late '80s, early '90s.
Well, when you look back at the financial
system of the United States in 1990,
which is not that long ago, well, just under 25
years, I think most of the people in this room,
not all, but most of the people
can probably remember it.
And that financial system was a very
different financial system than we have today,
even in that relatively brief period
of 25 years, just a couple of numbers.
In 1990, the sixth largest bank holding
companies in the United States controlled
about 18% of all the assets
of the industry, 18%.
It made up about-- Compared to
GDP, it was about 11% of GDP,
so 18% of the assets, 11% of the GDP.
As of the end of last year, at the end of
2013, the sixth largest bank holding companies
in America controlled 54% of
the assets in the industry.
And those assets equaled about 57% of GDP.
That was our big numbers.
Those are big institutions.
And we've never-- Putting
into historical perspective,
we've never really had financial companies
like that in the United States before.
What we have today is really not something
we had 25 years ago or previously.
A small set of large, complex global companies
that really dominate the financial
system of the United States.
I think that is the reality of
what we're dealing with today.
And let me tell you, we did not truly
appreciate the issues those companies presented
when the financial crisis developed in 2008.
I think it's fair to say, the
conventional wisdom before the crisis was
that these big firms actually had
a very low probability of failure.
They were a diversified in terms
of different business lines,
commercial banking, investment banking.
They were not only national in their
operations, but global in their operations.
And then the thought of both
geographic diversification as well
as business diversification made the common
wisdom that these firms had a low probability
of failure that even in a stressful
environment, these companies certainly,
certainly could gain access, sustain
access to capital and liquidity.
That was the conventional
wisdom of going into 2008,
but the lesson we learned
in 2008 was that was wrong.
You know, it's a big mistake.
But it was simply wrong.
The financial market seized up.
There were significant questions about
the exposures on the balance sheets
of these large companies and they--
their ability to raise capital
and attract liquidity dried up.
And we had a mess on our
hands that I think really was
without historic President of the United States.
People talk about this is the
worst crisis since the '30s.
But, you know, again, as Mr. Volcker said, we
had lots and lots of banks fail in the '30s,
but they were pretty small institutions.
It created a big problem, but did not present
the set of challenges and risks to the economy
that these large, complex firms did in 2008.
And we were really fair to say if I say,
by we, I mean that responsible agencies
of our government and I was on the board of
the FDIC during that time so I can remember it.
We were quite unprepared, we did not
appreciate the risks these firms post.
And we were unprepared to manage a
failure of one of these companies.
And given the alternatives available,
the collapse of these firms really posed
the possibility of a catastrophic collapse
of the financial system in the United States.
And as it was, you know, I think this was
the worst crisis in our history followed
by the most severe recession since World War II.
The fact to the matter is I do
believe it could have been far,
far worse with unimaginable consequences for
our economy and the global economy as well.
And so what you had really on an ad hoc
basis was the development of a series
of government interventions,
essentially providing
in various forms massive public support
to our largest financial companies
to maintain the stability of the system
and prevent profound damage to the economy.
I think that's what occurred when we're talking
about trillions of dollars of public support.
You know, the SNL crisis,
they added it up at the end
and it was $140 billion cost to the government.
It was trillions of dollars
of public support provided
to open institutions during
the course of this crisis.
And, you know, I don't sort of second
guess it because I don't think--
it's not clear to me what the alternatives were.
And the consequences were pretty overwhelming.
So I don't second guess it but I think
there are a few people who hope you
that is the optimal way to deal with this.
And in some sense, all of the efforts since
have been to see if we can develop some kind
of an alternative scenario if we're ever
confronted with this sort of thing again.
And just briefly because I want to leave, I
know you all probably have a lot of questions.
But the-- And Don mentioned it, you know,
there have been a series of reforms designed
to lower the probability of
these firms failing and by that,
I mean strengthening the capital requirements,
strengthening the liquidity requirements,
regulating the derivative
relationships with these firms,
which for over-the-counter derivatives are
not regulated at all prior to the crisis,
more stringent supervision of these financial
companies, all of it absolutely essential
to reduce the probability of failure.
But the question remains well, you know,
what if we-- what if all of that, you know,
proves unsuccessful in one of these firms?
Is it a point of failure?
Can we handle that?
Is there anything different
today that existed in 2008?
And I think the answer is yes.
And let me give you just
a brief summary of that,
and then maybe we can open it up for questions.
I'm keen on this point because the
agency of the government responsible
for this is the one that I work for.
So, if this is, you know, if
the things I spend my time on,
people asked me what keeps me up at night.
This is probably the thing.
And the story is this, in 2008,
the FDIC's resolution powers,
our ability to close financial
companies was limited to acts
to ensure financial institutions.
We did not have any authority over the
holding companies or the affiliates
of these institutions of the banks nor was there
any authority for non-bank financial companies,
which might pose a risk to the system, no public
authority for the FDIC or any other agency
of our government to place
them into a public receivership
and try to manage an orderly failure.
And the most obvious example of that
was the failure of Lehman Brothers,
which was left to the bankruptcy process and
in retrospect, that didn't turn out so good.
So what's different today
not to get too technical,
and I should warn you this is a subject
that very quickly descends into language
that people have a hard time following.
But the government was given major
new authorities and the Dodd-Frank Act
that was passed in 2010,
that did not exist in 2008.
Under the Dodd-Frank Act, any financial company,
bank or non-bank holding company, affiliates,
can be placed into a public
receivership managed by the FDIC.
That authority did not exist before.
And it is the nature of these companies,
by the way, and it's one of the reasons
that makes this such a tough problem.
They're not only big, but they are complicated.
And they are diverse in their operations
diverse in terms of their businesses.
And they are global in scope.
Trillions of dollars of assets spread a
lot among hundreds of subsidiary operations
in the United States and elsewhere.
So when a company like this gets into trouble,
you know, well, you saw what happened in 2008.
So the question is what can-- what
may be different the next time around,
and let me just tell you and then
stop the authority we didn't have then
that we do have now.
We can take these companies are
highly integrated in their operations.
And they're generally controlled by a holding
company, at least in the United States.
And what we can do now that
we could not do in 2008,
is take control of the parent holding company.
And by taking control of the parent,
we can effectively oversee the
operations of the entire entity.
And by taking control of the parent, we
are able and placing that parent company
into a receivership process, it's
effectively a public form of bankruptcy.
We can impose the consequences of
failure on the consolidated entity,
meaning we can wipe out the shareholders.
That's the way these companies are structured.
The shareholders are at the parent.
Majority of the unsecured creditors are at the
parent, we can hear that we can impose losses
on the creditors in accordance
with the losses of the company.
The key management is at the top.
We can remove the senior comfortable management
and to impose the consequences of failure,
the discipline of the market on this company,
which was something we could not do in 2008.
And without getting into a lot
more complicated discussion.
By taking control of that company, we can then
manage what we hope to be an orderly unwinding
of the company, managing the
critical issues of capital liquidity,
as well as the derivative relationships,
so the company that can pose enormous
challenges for financial stability.
That's the short story.
If you're-- I'm glad to respond
to questions for the longer story,
but it's a set of powers that didn't exist.
And what is pretty remarkable and Don referred
to it is, you know, we're not the only country
in the world that had this problem.
In fact, if you look at Europe and
Japan, we've got big companies.
They've got relative to the
size of their financial systems
and economies, even bigger companies.
And so, Don mentioned the international
organization has identified 29
of these global systemically important financial
institutions, all of the major jurisdictions all
but one in which those G cities are located,
have enacted legislation similar to the US,
to the Dodd-Frank Act in the United States
are developing operational capabilities
in responsible agencies of their government
similar to what the FDIC has been doing.
And we in the United States and the FDIC
and the Fed have been engaging with all
of these jurisdictions, because
the kicker to all
of the complications here is it's not just
the domestic operations, you have to be able
to have an orderly management of the global
operations of the company if you're going
to actually allow the firm to fail.
It is, as I say, a tough problem.
The question is, have we ended too big to fail?
I would say, I would not-- I would say no.
Have we made some progress in the area?
I think the answer is yes.
Is it fair to say it's a major priority of our
government and have responsible governments
around the world that are the home
governments for these institutions?
I think the answer to that as well.
So it's one of the biggest issues, which
is why I think a lot of you were here.
And I think we'd all take a shot
at answering your questions.
Thank you very much.
[ Applause ]
>> So let me start off with a question and
then we'll take questions from the floor.
So you Paul commented on.
And you've even personally spearheaded
many of the reforms underway.
Is it your view that these reforms
are proceeding quickly enough?
And I put it in context, Christine Lagarde,
Managing Director of the International
Monetary Fund had a critique earlier this week
that it's going too slowly and that industry
lobbying is slowing down and diluting reforms.
So I wonder what your perspective is on
the speed and influence on reform progress?
>> Nobody else is talking, I'll talk.
Let me answer your question this
way or approach your question.
I think we've been talking about too
big to fail and failing out [inaudible].
>> The mic isn't on.
>> When you begin--
>> The microphone.
>> When you begin having those
questions about how we deal
with a failing bank, we've already launched.
We were supposed to be running a system
that doesn't have big failing banks.
You know thank you for possible
jobs or what you do.
So you got to ask yourself,
how do we-- what went wrong?
And how do we deal with it into
[inaudible] don't you talk about.
I think what the FDIC has done, and working
with some foreign countries and trying to deal
with how do in fact liquidate a failing
institution and doing it in a way
that will be least damaging
to the system as a whole.
They're on a very complicated, difficult track.
But people don't appreciate how
much progress has been made.
I think when you get the
FDIC and the Bank of England
and potentially the continental European banks
all working in the same direction on a
problem that is inherently international,
because all these big banks
are spread all over the place.
With Japan too, I think there's a
lot of progress that has been hidden
and so far hasn't affect attitude very much
because there's a certain amount
of questioning and cynicism.
But let me go back we don't want to get there.
So what's going on when we look
back, what do we got to repair?
Well, obviously something was a matter when
the regulatory system both in the structure
of the system and what they
did and they've been a lot
of efforts to change the regulatory system.
But I don't think any regulatory system
is going to solve all of the problems.
Don't forget, couple hundred
yards from here we have a
department in this state university is
raison d'etre is teaching people how to get
around every rule that you can conceive
of, to make a big bonus for a big bank.
I mean that was financial engineering is
all about when it comes right down to it.
And they're very hard to keep up with.
You need some regulations, but
you need some good supervision.
The difference is you need the rules.
You need somebody to apply the rules.
[ Applause ]
And nobody can say there was any brilliant
job in that respect in the past 10
to 15 years, partly for philosophic reasons.
It's also true in this university just
a great at home that the economics,
so that the market would take
care of itself became predominant.
I don't think it came predominant
here, actually,
but predominant in the world of
economics and the discipline.
We didn't need regulation, didn't
need supervision, we go by so clever,
they can take care of all the risks themselves.
But that theory is no longer promulgated.
But you do need supervision and we have
enough, fair enough attention on it.
And then finally, I think you have to look at
not just the oversight, not just the regulation,
what's going on inside these institutions.
And the attitudinal change, I think is sweeping.
I wish somebody mentioned Jimmy Stewart,
mentioned in 33 you know,
financial engineering man.
If you get the customers in a room and
say, look, we're all in this boat together
and we got to get out of it together.
There's no calling the customers into a room
and getting that all out together at this point.
It's too complicated too much is complicated.
There is too much incentive to take
risk and the compensation system.
Twenty, 30 years ago, I know in my memory
but in the 1980s I would say the head
of the principal banks in New York City
may have been making $175,000 a year.
Now they're making $17 million a year,
a $25 million, and forget about them.
What about all the employees that are
doing deals that want to get a bonus
for making some money for the institution?
This way you remember this London
Whale business with JP Morgan Bank?
I don't think Jamie Dimon probably
has the slightest idea what was going
on in his office in London.
But when you look at it and
there's been an investigation,
they say, what was this maturity hearing?
Apparently the email said, hey, we've
got a great speculative opportunity here.
We made a lot of money a year
ago on this fancy derivative.
Let's try to do it again.
There was no substance to the operation
except the desire to take advantage
of some perceived floor or
opportunity in the derivatives market.
Understand these credit default swap continue
playing around with it, supposed to protect
against some loss of a credit with
60 trillion that is outstanding.
In 2008, nominal right, their
insurance policies.
We had $60 trillion worth of insurance policies
then outstanding again $6 trillion a month.
I mean, we had 10 credit
default swaps for every risk.
That was not quite true to banking
defending against particular risks
in a particular portfolio,
it's obviously spectrum.
That's an entirely different attitude than
permeated the banking system 20, 30 years ago
and it's tied up with the compensation system
but it's tied up a lot of other things.
You know, banks like to send
around advertisement saying
the relationship is everything.
The relationship is everything until they
find some opportunity to make a profit,
would account what all the
counterparty, they're not a customer.
They don't have to worry about them.
So I'm venting here, but.
[ Applause ]
I ask my fellow panelists.
You got a professor, you got
a regulator and you got a,
say bankruptcy lawyer intimately involved.
In your judgment, given a crisis, the attitudes
inside a bank is the culture inside these
banking institutions significantly changed
since the crisis, in a more conservative,
judiciary, conscious, [inaudible].
>> I'm usually quite cynical on these issues.
But two or three things that I've
gotten to know pretty well internally,
I think you can see evidence
of a huge change in attitude.
The big hierarchy in the financial
services industry is compliance officers
and lawyers to interpret the regulations.
And Jamie Dimon, for example, has simply gotten
out of the business of serving foreign embassies
because he doesn't want to
take the risk of running afoul
of the anti-money-laundering operations.
But I think you're posing, you know,
really very profound questions.
And the question of compensation,
I think does go back to,
can we really expect supervisors
to do that kind of job?
We have wonderful public servants.
But typically what happens is once we
train them to understand derivatives,
they move right across the street
into an investment banker of a bank.
And until we really figure out a way
to properly compensate such people,
I don't think there's much hope
that they're going to stay ahead.
With regard to Christine Lagarde, I think it
is worrisome that it's taken such a long time.
Dodd Frank was passed in 2010.
We still don't know what the
whole thing is going to look like.
We're but-- Does your firm actually gives you
a daily report, but I think we're somewhere
like 60% through implementing it, which
is a very, very slow rate of progress.
And even the Volcker rule, which you
may want to disown at this point,
it came through with a lot of loopholes in it.
I'm not entirely convinced that the
London Whale, which really did seem
to be proprietary trading mask as a
treasury operation wouldn't still fit
in because there's a pretty big
loophole you can move through.
And I think that is part of the process
of having lengthy, lengthy facings.
Probably the most dramatic example of that is
what happened to the liquidity regulations.
They started out with a really clear
concept, you wanted to look at the ratio
of high quality liquid assets which
were basically cash and treasury bills,
relative to the kind of outflow you could
experience and a stress scenario over 30 days.
Well, it looked good on the first draft,
then the Europeans realized that it was going
to really cause a problem through their banks.
So you kept whittling away, so that
the numerator now has not only cash
and bank reserves and treasury bills, but also
a certain amount of stocks, insurance bonds,
corporate-- you know, it's just really working.
It's not really much of anything.
And the denominator has been we consider it,
it really applies to no particular stress.
It may be an uncomfortable situation.
But heavenly, it's certainly not the kind
of stress we experienced in the crisis.
And that is unfortunately characteristic of a
system where you have a long comment and phase
in period, because the industry really
does have a huge incentive to try
to manipulate the regulators,
and often they do succeed.
On the other hand, I think we have to
worry about being too tough on the banks,
because that is profitable business.
And it's going to be done somewhere.
It sort of goes back to observation that
Peter Cooke, who was the first person
to run the Basel Committee in the
day, do we really want to push crime
out into the alleyways where we can't see it?
Or do we want to keep it on the
street where we can keep an eye on it?
And it's a troubling question, but I
think there are real reasons for concern
that we cannot sustain the
progress that we've made.
I'm very pleased to hear Marty, however,
say that he's firmly committed to going out.
>> If you don't mind if I intervene here,
we're actually past the time unfortunately,
we have a couple of people
standing who have wanted a question.
So actually what I would do is maybe if you
don't mind, privilege them and letting them come
up and ask the questions, and in the
meantime, let me tell all of you,
we have a reception that's
about to begin right outside.
So, let's all-- first of all, a big
round of applause to our panelists.
[ Applause ]
