Ed Conard, Justin Rowlatt, Kai Ryssdal and Eliot Spitzer discuss the scrutiny of financial institutions and consumers on the BBC’s “Marketplace Live.”
Top Ten New York Times Bestselling Author
- “Unintended Consequences is far smarter and more thought-provoking than most economics written for the general public” - Greg Mankiw, Harvard University, Former Chairman of the Council of Economic Advisors
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Ryssdal: It’s four years on since the collapse of Lehman Brothers.
Rowlatt: Yet the world is still mired in financial crisis.
Ryssdal: So who is to blame?
Rowlatt: Welcome to a joint BBC-“Marketplace” production. I’m Justin Rowlatt.
Ryssdal: And I’m Kai Ryssdal. You know, it’s become routine to blame the banks, but for every dollar banks lend, there has to be somebody out there wanting to borrow.
Rowlatt: So surely we the customers, we the people are also to blame. Is the truth that we have got the banks that we deserve?
Ryssdal: We are here in the green space at WNYC New York public radio in front of a live audience, I should say. [Applause.]
Rowlatt: Thank you. And joining us for the next hour are Eliot Spitzer, Former Governor and State Attorney General of New York, where he styled himself as the scourge of shady dealing on Wall Street.
Ryssdal: Bethany McLean is an award-winning journalist. She’s written the definitive history of the Enron scandal. It’s called The Smartest Guys in the Room. She’s also the co-author, with Joe Nocera from the New York Times of a book called All the Devils Are Here about the history of the financial crisis.
Rowlatt: John Taft is a lifelong industry insider. He was CEO of Royal Bank of Canada’s Wealth Management Division and has chaired the American Securities Industry and Financial Markets Association.
Ryssdal: Ed Conard was a partner in Bain Capital with Mitt Romney, the Republican presidential candidate. His book on the financial crisis and the markets in this country in particular is called Unintended Consequences. Thank you all for being with us.
Rowlatt: But let’s start with a couple of voices from elsewhere in the world, first from London and then from Spain.
London: I think banks were lending money to people who had no chance of paying it back, so then when they relied and they paid on that debt to other banks, it was like a domino effect that affected worldwide banks.
Spain: We have [leave our] possibilities. We have beautiful cars, beautiful house when we don’t have the money to pay…to pay it.
Ryssdal: So that sort of sets it up right there, right? Banks, you’re to lend people, you’re to borrow. Here is the central question of this hour. Do we get the banks that we deserve by our behavior? We will do, let’s call it, a lightning round and ask each of the guests to stake out their positions.
Rowlatt: Okay, Ed Conard, let’s start with you. Now banking is a service industry, is it not? Banks create products to serve their customers, so in that sense it’s the customers who created the problem, isn’t it?
Conard: Well, I wouldn’t blame it on the banks or the customers. I think that the U.S. has and the world has a lot of risk averse short-term capital. That capital is highly unstable. It can be withdrawn from the banking system at any time. It’s really an inherently unstable issue inside of all banking systems of how you recirculate short-term money into long-term investments. And if you don’t do that, you will get slow growth, high unemployment and a smaller economy, exactly like the economy we have now, as a lot of money, trillions of dollars in our banking system, in our corporate system and in our households sits idle, unused.
Ryssdal: Which is amazingly unreassuring, I have to tell you. Eliot Spitzer, to the question of do we get the banks that we deserve, are the people to blame? I mean, you know.
Spitzer: Well, look, this is one of those answers. Of course everybody is to blame, but primarily a banking system, a regulatory system that was captured by dedication to short-term profits, leveraged securitization, risk was pushed to people who were not knowing that they were…not put in a position to assess the risk. Bankers made huge profits on short-term loans and then had other people hold the bag and the down side risk. That lack of equilibrium between risk and reward is what drove us over the edge. Leverage is the word that always gets us into trouble, leverage baked into a system where people didn’t have to bear the risk of what they were doing.
Rowlatt: John Taft, it sounds very much like he’s blaming the bankers there. And you represent the bankers, don’t you? I mean, you guys, you know Eliot’s right, aren’t you? You guys are the experts, you lent the money, you’re responsible for turning a blind eye to the real risks, aren’t you?
Taft: One of the things that people overlook is that the financial services industry and system, not just in the United States and globally, is made up of literally hundreds of thousands of institutions, not just the 15 that get referenced every day in the media, and they were every much as outraged and disadvantaged by the financial crisis as were Main Street American investors and borrowers. I personally agree with what I think is the implicit point of the question, and that is that the financial crisis, the malfunctioning of the financial system we saw in 2008 and 2009 was not a problem that was solely caused by banks or financial institutions. Many parties were culpable. But clearly the financial institutions played a major role and the problems that caused the crisis have yet to be fixed.
Ryssdal: Bethany McLean, can we then say we’d be better off without the biggest of the biggest of the big banks, and if we figured out a way to do without Wall Street we’d be all right?
McLean: One of the great myths about the crisis is that it was a myth of home ownership. Everybody says this is what happens when you put people into homes and they can’t afford to pay them back. This was never about home ownership. Most risky loans that were made were so-called cash out refinancing so that people could withdraw equity from their homes in order to spend it. And that casts a more nuanced light on this question, right? It was consumer spending.
But what do you do when you have a consumer spending driven economy where most people are not making enough in salary to spend, and so the only way they were able to spend was by withdrawing equity from their homes? And that’s why this is such a complicated question and one that still haunts us today is because we have to figure out how to make our economy move forward.
And to your question about the big banks, I have not seen a great solution for what is the banking system that we need to have today. There are a lot of people who say let’s take apart the big banks. What should we replace it with? In the wake of the financial crisis we bailed out the big banks. Since then there’s been just a slew of questions and new regulations and new thoughts about this, and yet we haven’t ever paused, sat back and said what is the banking system we need to make our economy function effectively.
Rowlatt: Okay, so we’ve got a range of opinions there. We’ve got a spread of responsibility between banks, the people, government, but the truth is, as some of you pointed out, we were all involved in this. We all bear some responsibility. We were all involved in inflating that enormous credit bubble, weren’t we, living beyond our means, because that’s what credit is. So that leads to a much bigger question, I think. What on earth made us think that we could get away with this over those two decades in which this credit bubble built up? Who wants to take that one?
Spitzer: This is human nature. And if this were the first time this had happened in history I think we might be trying to figure it out as a new issue. Going back to the Dutch tulip bulbs and other instances in history where assets are deemed to have value that is simply not real because we enjoy it as long as it lasts, it’s a narcotic, and that narcotic is very difficult to wean one from.
It is leverage. It is the belief that this time, with credit default swaps, securitization, we have somehow mastered the issue, spread the risk. Remember the Greenspan mythology was that the market is so smart it has properly accounted for the risk. These guys are brilliant risk managers was the greatest myth of all leading into this crisis. It’s always the same: too much leverage, too much debt.
Ryssdal: John Taft, what was going on that let us have these low interest rates and low inflation, and let us believe that all this was true, that home prices would keep going up and that you guys were the smartest guys in the room?
Taft: Well, I’d like to go in a completely different direction here and—
Spitzer: Sounds ominous.
Ryssdal: All right, all right. Well, I’m going to get you back to it, though, but go ahead.
Taft: All right, that’s fine. Well, I’m going to say something that I think is critical here because the reason we got ourselves into this leverage bubble is that we were trying to create artificial growth in some way. The financial system, and in fact all of Western economic thinking and the way the system is constructed is premised on the notion that you can grow at one, two, three, four percent forever. That was the old world. The financial crisis was the end of the old world. My colleague from Bain is going to have a heart attack—
Ryssdal: Yeah, we’ve got the paramedics outside.
Taft: I can see it now. But here’s the thing. We are in a different world. We are in a world where sustainability needs to replace growth, and if you don’t want to have another financial crisis like 2008 and 2009, you have to start thinking differently about the underlying premise of the financial system.
Rowlatt: But listen, there were some fundamental changes in the world economy. It wasn’t just about new financial products, and inflated egos, and Wall Street and the city of London. There were some fundamental changes. The opening up of these huge new pools of labor across the world in China, in the former Soviet Republics, you know, which meant that we could have low, you know, cheap manufacturing in a way that we’d never seen before. So there were real changes in the world economy, weren’t there, that drove this period of low inflation, low interest rates.
Conard: Without a doubt.
Rowlatt: Ed Conard.
Conard: Without a doubt. And if you look back to the commercialization of the Internet, productivity in the U.S. grew to 2% a year, which is almost as high as it was after the Second World War. The rest of the world, Europe and Japan, declined to about 1.2% a year, so asset values, the stock market rose to about 140%, 180% of GDP at the peak of the Internet boom, but 140% of GDP historically. Part of what causes this is real underlying innovation and productivity growth in the world, and primarily in the U.S. economic.
Rowlatt: China as well, come on.
Conard: Well, China, but China is growing from a very low base. We are at the cutting edge. We are the ones who are—
Rowlatt: But exporting the cheap goods, low inflation to America, to the world.
Conard: So the second thing that happens is when asset values rise, we would sell assets to buy production, whether for consumption or investment, asset prices fall, production rises, it brings the system back into equilibrium as the return on investment starts to decline. What happens when you have a trade deficit is that—don’t forget, not only is there massive pools of labor, there’s also massive pools of risk averse capital that comes into our economy.
We borrow that money and so the asset prices don’t fall. In fact they rise from lower interest rates. And the production costs fall from the low cost labor and it spurs the demand on, both the investment and the consumption, to new levels that we had not seen with the closed economy, or largely closed economy.
Ryssdal: Eliot Spitzer, climb in here.
Spitzer: I want to make two real quick points. First, I’m not as negative as to believe that we can’t have growth in the future. It does come back to technology. Technology, the opening of the markets you refer to, more people have moved out of poverty in the past 20 years than ever before in history because of technology and the spread of capitalism and market based economics. All that is wonderful stuff. I don’t think that’s why we had the crisis, though. I think that is a fundamentally different macro trend. The crisis is separate and distinct from that, which was a much more domestically based—
Rowlatt: But didn’t that lower inflation mean that, you know, we had low interest rates, and it appeared that we’d broken, you know, there was a great phrase that was used in Britain, broken the cycle of boom and bust. And people began to believe that that was the case, and—
Spitzer: The boom and—but we still will have boom and busts, but I think the reason that we went over the cliff was just excess leverage separate and apart from—
Rowlatt: Too much borrowing.
Spitzer: Too much leverage. We couldn’t afford it.
Rowlatt: Bethany McLean.
McLean: You also can’t look the past the fact that as early as the mid 1990s consumer activists were going to the government, to Congress, to the Federal Reserve and saying look, people are getting loans they can’t afford to pay back. Now, whether you believe this was predatory lending or predatory borrowing, it almost doesn’t matter. If you hear people are getting loans they can’t afford to pay back, that should strike fear into the heart of anyone who cares about a sound banking system. And you could have seen, even then, that something was going off the rails.
Ryssdal: Well, follow up on that for a second because there were rules and regulations that said no, you shouldn’t lend this person this and this person this, right, Bethany?
McLean: There were supposedly rules and regulations. Consumer activists were going to the Fed saying you need to enforce the statute you have called HOEPA, the Home Ownership Equity Protection Act, which gave the Fed all the power it needed to rein in irresponsible lending, but it didn’t happen.
Conard: I believe the lending is much—
Ryssdal: Ed Conard.
Conard: —less irresponsible than it appears to be, so it’s a misnomer—
Ryssdal: I’m sorry, much less irresponsible?
Conard: Much less irresponsible.
Ryssdal: All right, you have to defend that point because, I mean, come on, right?
Conard: Sure. Because the misnomer is that banks were making no money down loans. Banks found outside investors to make the homeowner’s down payment for them. They sold 20 to 30% of the securitization-subordinated tranches, and mortgage securitizations—and I know I’m getting a little technical.
Ryssdal: Just a hair. Subordinated tranches kind of makes my eyes cross.
Conard: You have triple, A which gets paid back first and then the person who’s going to absorb the losses.
Rowlatt: But the proof is, surely, that at the end of the day people couldn’t afford the loans they’d been given.
Conard: What matters, though, to a bank is how much collateral they have relative to the loan.
Rowlatt: Yeah, well, let’s turn it around. What matters to the people who borrowed that money which they couldn’t pay back?
Taft: Hey, folks, I’d like to—
Ryssdal: Yeah, let’s get the banker in here.
Taft: My company is owned by a Canadian bank, the Royal Bank of Canada, the largest bank in Canada, where Canada is all about too big to fail. There are only six banks. None of them failed during the financial crisis. None of them even cut their dividend. One of the major reasons is that there was a responsible mortgage financing system in Canada fueled by the innovative thought that banks, when they make a loan to an end client, ought to hold that loan to maturity. They ought to therefore know the client and they ought to apply underwriting standards that make sense. In the United States—
Conard: Something else that—
Taft: Could I finish, please?
Ryssdal: Hang on.
Conard: Sure.
Taft: Securitization which permitted clients to engage in behavior that didn’t make sense, that’s the difference between the financial crisis not affecting Canadian banks and almost bringing us to our knees here.
Ryssdal: This is knowing your banker, right? You can walk in and get a mortgage, and if you have trouble you go see him, and listen, can I wait for a month, and that doesn’t happen anymore. Eliot Spitzer, quickly, go ahead.
Spitzer: That last point is exactly correct. The rules against bad lending here were not enforced, intentionally ignored. Hate to say this, but when I was AG, we went to court to try to say to the Fed and to the OCC be careful. The OCC came in against us in courts saying stop, we like what’s going on.
Ryssdal: Hold on, hold on. Let me—
Conard: An important distinction in Canada that has to be made. The hold the homeowner 100% responsible for the loan, okay? We allow the homeowner to walk away from the loan and use the house as collateral. That’s a big difference, okay? You have shoved a lot of liquidity risk and banking risk into homeowners in Canada that has not been pushed onto homeowners in the United States.
Ryssdal: All right, we’re going to move off this topic in one second. John Taft, go ahead.
Taft: We can’t move off the topic because this is critical.
Ryssdal: Really, because we’ve got a whole hour to fill, man.
Taft: I know. I have this deep sense of urgency that I have to—
Ryssdal: All right.
Taft: What should be the point of mortgage lending? To promote responsible home ownership. Sixty-two percent home ownership rate in Canada, 62% home ownership rate in the U.S., what was it all about down here? It certainly wasn’t about serving the end client and promoting the social goal of [home ownership].
Rowlatt: But that’s presuming that it will—
Ryssdal: Bethany.
McLean: It wasn’t about home ownership. You look at these loans and you analyze them, and most risky loans were made to people for cash out refinancings, allowing people to withdraw home equity from their houses. If you had only allowed these risky loans to first time homebuyers, we never would have had a financial crisis. This is not about home ownership.
Taft: And why did we permit people, why were people withdrawing money from the equity value of their homes? It was to spend it. The growth of the economy in the years leading up to the financial crisis was artificially fueled by exactly the practice you’re describing, which makes my point about the growth ethic being one of the causes of the financial crisis.
Ryssdal: So back to—hold on. Back to the root of the presentation in the debate this morning, where to blame, right? We wanted to have that money to spend it.
Taft: I said I agreed with the premise, right.
Ryssdal: Eliot, go ahead.
Spitzer: John, I agree with everything you’ve said until that last point. It doesn’t mean growth as a maxim for the next 50 years is something we have to give up on. The nature of growth we had there, which was being artificially fueled, there I agree with you, you’re correctly diagnosing it, but it doesn’t mean technology and opening new markets will not prospectively permit us to go back to the historical growth of two to three percent a year.
Taft: I agree.
McLean: Can I make a point?
Ryssdal: Yeah, go ahead, Bethany, yeah.
McLean: So I think that without personal responsibility we’re lost, and everybody is to blame for this, and there certainly is a component of this that was homeowners living beyond their means.
But when you research the history of the financial crisis, the event that stood out to me the most was a Washington Mutual presentation in 2003 showing people how to sell people loans, riskier loans than the ones they wanted, so what to do when someone came in and said I really want a 30 year fixed rate mortgage, how you convince them instead to take out a really risky loan, because Washington Mutual could turn around and sell that loan for more money to Wall Street, and how you dissuaded the person from taking out the safe loan they could afford and pushed them into the risky loan instead.
Responsibility is a two way street. People have to be responsible for their financial decisions, yet, but the financial industry also has to have responsibility for the products it sells and markets.
Rowlatt: But is ultimately that, then, about regulation? Is it about the government coming in and making sure that financial institutions behave responsibly?
Taft: No, I don’t think you can get at this issue—
Rowlatt: John.
Taft: You cannot get at this issue—regulation is necessary. I am a pro regulatory reform member of our industry, but it is not enough. You have to, to prevent what happened, get at the culture of Wall Street, which ought to be a stewardship culture. It ought to be, as Robert Shiller says in his book Finance and the Good Society, about the financial system furthering social goals, our goals.
It shouldn’t be about the financial system jacking its own return on equity up through leverage and use of toxic products, as Eliot said earlier. So we need to get back to a stewardship culture where financial institutions wake up every morning and they think about what they’re doing in terms of serving their clients, and in terms of creating net benefits and adding value to society. We lost touch with that culture and we haven’t yet found our way back.
Ryssdal: Ed Conard, you’re sitting there shaking your head. I can’t believe you actually disagree with what he says.
Conard: Well, who can disagree with motherhood and apple pie—
Ryssdal: Well, it—
Conard: The question is what caused the financial crisis and how can we solve it, and this will not solve it, okay? And I agree with what Bethany said, but I don’t think that the conclusion that’s drawn from this is correct. So what did banks do? Banks went out and found investors to make down payments on behalf of homeowners. I would hardly call that predatory lending to homeowners, because what homeowners have at risk more than anything is their down payment. That’s what protects banks from a 20% drop in real estate prices.
So we can put the homeowner at risk. That’s an easy solution to the problem. We tried to do something better than that, which is to find outside investors, hedge funds, sovereign wealth funds, pension funds, Europe banks to make the homeowner’s down payment for them. There’s two sides to Eliot’s equation. Yes, we borrowed money. But somebody has to lend it. Where did that money come from? We ran a 6% trade deficit. Capital flowed into our country, highly risk averse.
It bought government guaranteed debt, which is a fixed amount. It pushed short-term investors into the private sector and shortened up their durations of loans that flows through the banking system, okay, and we have to put that money to work. So when we attack the institutions that are responsible for the very risky business of putting short-term capital to work long-term whether it’s to fund consumption by homeowners—yes, it did, okay—or to fund businesses—yes, it did—we have known this for 800 years that we have to recirculate the short-term capital into long-term loans, consumption or investment, or we will not grow as fast. So we can always suffer permanent recession to avoid intermittent panic. There’s no logic to it.
Ryssdal: We’ll get to the 800-year dilemma in a second, and it’s amazing you did that all on one breath. That was absolutely remarkable. But here’s the thing. We could walk out onto Varick Street out here and ask people what happened in the financial crisis and they will all say—whether they understand it or not, perception becomes reality out there—they will all say, oh my god, we bailed out the big banks.
Conard: If we walked up to NYU, though, they would not think of it the same way as people out on the street would. And if you walked up to Columbia’s economics department there would be much more consensus around what the issue is than appears to be in the media and in the popular…in the world.
Rowlatt: And you are listening to a special broadcast from the BBC and “Marketplace” from New York City.
Ryssdal: So what we had, in essence, was once we got all of this short-term capital, and refi’s, and re-regulations and all of this, we had this thing that went horribly, horribly wrong. Eliot Spitzer, have we at long last—to coin a phrase—learned our lesson?
Spitzer: No. We’ve learned it momentarily; let me amend my answer a little bit. The question isn’t whether you change your behavior; the question is for how long. The way I analogize this is it’s like getting a speeding ticket. You go within the speed limit for about 10, 15 miles and then suddenly you look down and you’re going 75 again.
It’s a question of how long do we remember. And I think we only learned part of the lesson. I think all of the—you know, there’s a kernel of truth in every one of the answers that’s been given here. I obviously agree more with John and Bethany than with Ed in terms of foundation. But we haven’t yet confronted the underlying structural problem in our banking system or our regulatory system.
Ryssdal: Bethany McLean, you wrote a book on this whole thing. Why don’t we learn these lessons? I mean, it’s not like we’ve never had financial crises before.
McLean: Because the whole history of financial crises is the belief of too many people in something that after the fact is clearly going to be revealed as having been too good to be true. And that’s the story of every financial crisis, from the tulip craze, to Enron, to the financial crisis. We all want to believe in something that, after the fact, we’ll all throw our hands up in the air and say why didn’t we see it? That was clearly too good to be true.
Rowlatt: But guys, isn’t that incredibly pessimistic? You’re saying, oh, we’ve just got to sit back and let another one happen.
Conard: Well, I don’t think we do. I think we can strengthen government guarantees of withdrawal risk inside of the banking system. We have to hold banks 100% responsible for loan losses because if we don’t they’ll make unproductive—
Ryssdal: Does that mean let them fail?
Conard: If they fail because of default risk. And they haven’t even come close to failing because of default risk. We have to let them fail. One bank will fail and—
Rowlatt: You mean if they make bad loans?
Conard: If they make bad loans. One bank will fail in isolation. But when the issue is withdrawals, you have—
Rowlatt: So if people are coming to the banks and taking their money out you’re saying they should be protected from that, but if they make bad loans, we shouldn’t—
Conard: If we let all the banks go bankrupt when we have a panic and everybody runs to the banks—
Ryssdal: Protect that.
Conard: —we know what the outcome will be, which is the money will sit on the sidelines available to fund withdrawals, which is why we have trillions of dollars sitting on the sidelines. We learned our lesson.
Rowlatt: You’re listening to a special debate on the BBC World Service with Justin Rowlatt and Kai Ryssdal of America’s leading business program, “Marketplace.”
Ryssdal: Here in New York we’ve been debating the ongoing global financial crisis. Who’s to blame, and haven’t we just ended up with the banks that we deserve.
Rowlatt: In the second half of our debate, we’ll be looking at whether all of us need to change our economic expectations if we are to avoid another, perhaps even more serious, crash.
[Promotion of “Real America” series.]
Ryssdal: Here’s a question we all think we can answer. Who’s to blame for the global economic crisis?
Rowlatt: We’re used to blaming the financial institutions, but shouldn’t we all take a share of the blame? Have we ended up with the banks that we deserve? I’m Justin Rowlatt.
Ryssdal: And I’m Kai Ryssdal of the American business program “Marketplace.”
Rowlatt: And in a special co-production from New York, we’re asking whether it’s not just the bankers who should change their behavior, but all of us.
Ryssdal: Join us after the news.
[BBC News break.]
Rowlatt: Hello and welcome. You are listening to a special debate on the BBC World Service with Justin Rowlatt.
Ryssdal: I’m Kai Ryssdal from America’s leading business program “Marketplace.”
Rowlatt: In front of a live audience here in New York, we’ve been debating the ongoing financial crisis. Joining us are Eliot Spitzer, Former Governor and State Attorney General of New York.
Ryssdal: Bethany McLean is an award-winning journalist. She’s written the definitive history of the Enron scandal. It’s called The Smartest Guys in the Room.
Rowlatt: John Taft is a lifelong industry insider. He was CEO of Royal Bank of Canada’s Wealth Management Division.
Ryssdal: Ed Conard was a partner in Bain Capital with Mitt Romney, the Republican presidential candidate. His book on the financial crisis and the markets in this country in particular is called Unintended Consequences. Thank you all for being with us. John Taft, how do you get people trusting banks again?
Taft: Well, that is a hugely important question. You need people to invest in the markets because that’s the source of patient long-term capital that fuels economic growth, and that’s not happening enough right now. How do you get people to trust again? There is no one simple answer. I personally believe that a lot has happened since the financial crisis to make the system safer, sounder and more secure.
To the former point, and then I’ll wrap it up here on this answer, but there will always be crises, there will always be bubbles. The trick is to contain them so they don’t end up bringing the system down. And since 2008 and ’09 we have done a lot, the U.S. and globally, to put firewalls in that will help contain future bubbles. So I do think the system is safer, people just don’t believe it yet.
Rowlatt: No, the Occupy movement has been very vocal in articulating this issue of trust and the failure, the fact that people have stopped trusting our banks. Now we have somebody from the Occupy movement. I can’t call you a spokesman, can I, Justin? Justin Weedus is with Occupy. Do you think this issue of trust is anywhere near being resolved?
Weedus: Absolutely not, no. The trust has been eroded completely among the 99%, the general public. I think until there’s accountability for those who committed fraud on Wall Street—and the fraud was rampant, we know it—there will be no return of trust to the system until people are held accountable, and that means we’re going to need to see some bankers behind bars.
Ryssdal: Eliot Spitzer, you’re a former prosecutor. What have you guys been doing?
Spitzer: Well, I’ve been stuffing cash into my mattress. [Laughter.] In answer to the last question, I think part of the reason money’s coming out is the interest rates are zero. I mean, that’s another macro issue. But as long as interest rates are zero, people don’t have a compelling reason to put their money into the bank and that’s—
Rowlatt: No, but come on, you’re not denying there’s an issue—there is an issue of trust here.
Spitzer: Of course there is. No, there’s an enormous issue of trust, and I have been very supportive of the Occupy movement at different points in time. I think the accountability issue is very real, both on the regulatory side and on the banking side. Not that every banker was bad. Let’s not get carried away with gross generalizations. There was a gross incentive mismatch to do bad things based upon short-term returns. A lot of the debt that was issued was based upon misrepresentation and bad stuff happening—
Rowlatt: But hold on a second. This isn’t just before the financial crisis. We’ve got all sorts of scandals that have happened subsequently—libel, we’ve got the rogue traders in London; we’ve got money laundering cases. You know, it’s not as if the industry’s cleaned itself up, is it?
Spitzer: I agree. Look, I’ve been rather vocal in saying the prosecutorial world has not been sufficiently aggressive in bringing the cases to say to the world there is accountability. And I think that there has not been—as John said, there’s not been a cultural shift on the Street that yet recognizes the underlying obligation to fiduciary duty.
Rowlatt: Bethany McLean, do you think there has been a failure to hold the right people accountable?
McLean: I think it’s more complicated than most of us would like to believe because I think there’s a big gap between criminal wrongdoing and ethical wrongdoing. You look at Enron, which most people believe was a fraud, and in common sense terms it was a fraud. Very, very difficult to prosecute criminally. Only narrowly prosecutable because most of what they did was actually technically legal, signed off on by accountants and lawyers. I think you face some of the same problems in prosecuting the financial crisis.
To me, I guess I don’t think the call for prosecution is necessarily a solution. I think people; we should all have an explanation for why these things can’t be prosecuted. But look at all the prosecutions—Enron, WorldCom, Quest—the whole idea was this is going to deter future wrongdoing. It didn’t. We had the financial crisis a few short years later.
To me the only solution that’s going to make a difference is compensation. When you look at the amount of money that financial services people made, and they were being paid because they were supposedly great risk managers, so competent, and it turned out they were totally incompetent. And that, to me, is the heist that took place. Hundreds of millions of dollars in compensation paid to people who couldn’t do the jobs they were being paid to do.
And until you fix that dynamic where failure is rewarded, not just in the financial system, but in corporate America, where people who run companies and are at high levels get paid a ton more than average workers for failure—I don’t…I have nothing against people getting paid for success. But getting paid for failure? Until we find a way to fix that, we’ve got a problem.
Rowlatt: John Taft, it’s time. [Applause.] You can hear there’s a lot of support in the audience for that. John Taft, it’s time for the banking industry to make reparations, pay back some of the money that they made in the boom years.
Taft: You don’t think that’s happened?
Rowlatt: Not to a huge extent, has it? Where has it happened?
Taft: It has in many different ways. The idea that shareholders of and management teams in banking institutions didn’t regurgitate vast sums of their net worths as the stock, the value of these stocks went to near zero, in some cases, I mean, people were…they were wiped out. And the banking industry, in spite of—maybe they could have been more zealous, but there are billions of dollars in fines and reparations that the banking industry has paid for behavior that was judged to be criminal or in violation of regulatory behavior. I think, though, that the focus on sending people to jail and criminal convictions is beside—it’s not beside the point—
Rowlatt: That’s not what Bethany is saying. She’s saying—
Taft: No, but that’s exactly right. I want to emphasize what she’s saying. That’s not the problem. There is a whole lot of behavior that has gone on in the financial services industry that shouldn’t be going on, that is not consistent with a stewardship principle. And that’s what we need to focus on, not sending people to jail.
Ryssdal: Well, let’s go to a guy in the audience who knows a little bit something about this. Wilbur Ross is a private equity investor. He’s here with us this morning. He’s a turnaround financier. He is also, according to some polls, one of the most respected people in American finance. And Mr. Ross, I want to ask you this. To Bethany’s question and then to what John was talking about, is our financial system broken, and if so, how do we fix it?
Ross: I think it’s much more complicated than that because I think a lot of the problem has started on the borrower side. Let me give you a couple of statistics. In 1983 the people with the top 5% of income in this country had 80 cents of debt per dollar of income, and the other 95% had 60 cents of debt per dollar of income. Flash forward to 2007. The top 5% had reduced their ratio to 65 cents, but the other 95% now had a dollar forty of debt per dollar of income.
Ryssdal: Borrowing far more than they make. Now…keeping up with the Joneses, right? They want what they want when they want it.
Ross: Yeah. And some of that was predatory borrowing. And people talk about predatory lenders, and there certainly were. There also are predatory borrowers. The guys who falsified their mortgage applications I think are every bit as much at fault as the bankers who didn’t verify and process them.
So I don’t think that the guilt here is confined to the financial sector. It’s a problem endemic to the population. And I think the real root of the borrowing problem is that median family income, inflation adjusted, has gone down almost repeatedly for more than ten years. But everybody wants to live a bit better each year, and the way they accomplished that was by borrowing.
Rowlatt: But on this question of the financial sector, I mean, you’ve invested, you’re a big investor. You’ve known—
Ross: Well, we’re post crash investors.
Rowlatt: You’re post crash investors. What I want to come onto, but you’re a big investor. You’re known as the king of bankruptcy. You’ve invested in the past over decades in steel and other big industries. Now your big focus—correct me if I’m wrong, Wilbur—is the banking sector. Clearly you think there’s something, you know, that there’s some potential in the sector still.
Ryssdal: There’s an up side, right?
Ross: Well, the world can’t function without banks, much as we might like it to. You need banks. You need somebody to take the excess savings and put them to where borrowings are needed. So anybody who thinks he can live without banks is silly.
Ryssdal: What do you make of this, though, that maybe we’d be better off if banking was just boring again instead of, you know, subordinated tranches and all that.
Ross: Well, and we might be healthier if we went back to living in caves as well. [Laughter.]
Ryssdal: Well, we’ve got the Paleo diet.
Ross: I think what we need are banks being what they were when I was a little boy. You walked in, you knew the teller, and the teller knew you. They lent to people they knew and more or less performed—
Rowlatt: So back to a more traditional form of banking.
Ross: Yeah. I think all—
Rowlatt: Justin Weedus, Occupy. Do you agree with that? Is that what we need?
Weedus: I think it’s easy to blame working people for spending beyond their means, but you have to look at why people were spending and are spending in the way that they are. We have a system where inflation is pushing food costs higher and higher; we have an educational bubble happening right now where people are being pushed into more and more student loan debt, healthcare costs are soaring.
We all know this, right? And until those costs are brought down, people are going to continue, students are going to continue to pay for their student loans on credit cards. And it’s unsustainable growth, as many of you have mentioned. It’s completely unsustainable and we need to rein in those costs.
Ryssdal: So here’s the question, Bethany, just because. Can we regulate our way out of this?
McLean: I tend to be somewhat of a skeptic of regulation, I have to admit. I think regulation is backwards looking. We tend to be looking in the rearview mirror saying what went wrong, let’s fix yesterday’s problem, when today’s problem is coming around the corner. And I think that regulation, in the end, relies on the regulators.
And you look today at what happened at JP Morgan Chase this summer, where a trader in London lost what is amounting to almost $6 billion. The regulators were on the premises. They didn’t see it. They didn’t catch it. I think that looking to regulators to catch problems that are coming in a financial system as complex as we have is just an exercise in hopelessness.
Ryssdal: So what are to do, throw up our hands? I mean, come on. Eliot, go ahead, what? All right, John Taft, the banker, go ahead.
Taft: Let me pick up on the JP Morgan thing, and I’ve been public on this. I’m somebody who thinks it’s a good thing that the regulators didn’t catch the JP Morgan problem. They shouldn’t have. That’s not their business. The JP Morgan trading loss didn’t threaten JP Morgan. Because it didn’t threaten JP Morgan, it didn’t threaten the financial system. Regulators should focus on threats, systemic threats to the financial system.
Ryssdal: But wait. Isn’t the JP Morgan thing emblematic of this entire mess?
Taft: No.
Ryssdal: We have banks taking risks that are outsized and irresponsible when other people’s money is on the line.
Taft: This is…that’s the narrative; I’ll give you that, that’s in the media.
Ryssdal: Thank you. [Laughter.]
Taft: But it’s inaccurate, okay? So if you…the thing about the JP Morgan situation—and I wasn’t there, I’m not an insider, but from what I’ve read—you’re looking at losses in a security portfolio that was originally set up to hedge exposures in a lending portfolio. It was a hedge. Now the hedge apparently ran amok and the losses therefore exceeded what the model was. That was a failure on the part of bank management. But the original construct, the biggest risk that JP Morgan takes and any bank takes is lending money. What’s imprudent about hedging the credit risk involved in lending money? That’s what they were doing.
Rowlatt: Okay, but on the wider point, let me come back to somebody that somebody once played a key role in regulating Wall Street said, Eliot Spitzer, who said, “Wall Street titans utterly failed us and they still deserve our disdain and scorn.” Do you stand by that statement?
Spitzer: Wow, that’s tough language. [Laughter.]
Ryssdal: Who said that?
Spitzer: Let me amend it only because some of my colleagues up here—some of them—you don’t want to generalize, it’s impolite, perhaps, but in another context I would. [Laughter.] I think the real point is that you can’t regulate good judgment, and this comes to John’s point. You can’t have a regulator overseeing every trade.
A bank—the lesson I take away from the Morgan debacle this past summer is no good manager—and I give Jamie Dimon credit for being a superb manager—nobody is good enough to manage something that big without kerfuffles every now and again, so let’s understand that. Regulators won’t catch it. You have to hope owners will catch it. I wish shareholders were empowered. That’s a whole separate conversation.
Ownership is going to trump regulation someday in solving the problem. Putting that aside, you’ve got to put in that sort of preventive regulatory system that does in fact cabin risk. That’s what we’ve got to do prospectively.
Ryssdal: Ed Conard.
Rowlatt: Ed Conard, that’s got to be right, though, hasn’t it? I mean, if the banks lose money, that’s the ultimate, you know, disincentive for taking theses kind of risks.
Conard: I think we have to recognize that banks make profits for taking risks. That’s why everybody makes profits. And the risk they take is credit default risk. They make loans. And modern finance allows us to separate the risk underwriting from the funding. And we have a lot of short-term, risk averse capital that’s willing to fund, but unwilling to underwrite the risk.
And what has driven our financial system forward is the ability to disconnect these things. And so the idea that we’re not going to have banks only on the long side of the trade and we’re not going to allow them to go short and long and make judgments about durations and convexity of the curves and all the things that go with managing credit default risk I think is just…it’s very superficial, it’s extremely dangerous, it has extraordinary unintended consequences if we go down this path.
Ryssdal: Bethany McLean on that in one minute. I have to ask you, though, Ed, how much do you count on ordinary, regular people in this economy, based on almost every one of your answers today, not understanding what the heck you are talking about? [Laughter.] No, honestly. I mean, because when you bring out phrases like subordinated tranche and convexity curves, and I know that was tongue in cheek, give me a break.
Conard: I think that our leaders have a responsibility to explain to the American people how the financial system works and what the issues are. And instead of doing that, they have demagogued and demagogued—
Rowlatt: Okay, Ed, in a single sentence explain it in a way that ordinary people would be able to understand.
Conard: Predatory lending and fraudulent securitization was the driving factor behind the financial crisis and that we can, through regulation—and we can through regulation eliminate that problem. But that is not the problem that drove the financial crisis. And so because it’s hard to understand, politicians and many other leaders have seized on this, demagogued, blamed the bankers, made the bankers out to be a bunch of illegal guys, as opposed to thoughtful guys who are trying to get their money back. That’s how you succeed in the banking business, by making loans and getting your money back.
Ryssdal: Bethany McLean, go ahead.
Conard: They’re not a bunch of idiots who just go I could get in and out of this thing and be gone before the problem comes, even though I’d like to have a banking career that extends to my retirement at 65.
Taft: Was that one sentence?
McLean: I think we’re just going to have to… [Laughter.]
Conard: It was with one long run.
Taft: Yeah, one long one.
Ryssdal: It’s that whole one breath thing.
Taft: He’s good with his breath, isn’t he?
Ryssdal: That’s pretty good, one breath.
McLean: I think there’s a disconnect in what you’re saying, though, because if risk underwriting were separate from funding, then we wouldn’t have had a financial crisis.
Conard: Nonsense.
McLean: In other words, the biggest banks needed a government bailout because they couldn’t fund themselves anymore. Despite the fact that losses on subprime mortgages did turn out to be much smaller than everybody expected, particularly on the safe tranches that these institutions were facing, they still had a funding crisis. The reason why, to me, I’d submit an answer, is complexity. Is the financial system too complex? Is the danger in complexity? I don’t have a solution for it, but I worry that that’s the problem.
Conard: I think that people, though, haven’t seen a financial crisis since 1929, so they’re shocked by it. But the history of the world is that we have had them repeatedly, and we understand them very well. And the problem, the reason why banks don’t have funding in a crisis is that think of a simple corn economy.
You can eat the corn, plant the corn or horde the corn in a silo, okay? When you take that corn and lend it out, and people run to the silo to get their corn, there’s no corn in the silo to fund the withdrawals, so you have to sell IOUs, but there’s no buyers in a crisis, when real estate is dropping 30%. Assets fall to fire sale prices and banks cannot sell enough assets to fund withdrawals.
Rowlatt: Ed, I have to applaud, a much more straightforward explanation for…of your case. [Laughter.] But listen, there’s a real danger here that this is becoming terribly self-referential. You know, are we here talking about what are essentially first world problems? You look across much of the rest of the world, you look at China, you look at India, Latin America, Asia, you know, many economies are only, if at all, feeling the financial crisis, indirectly. You know, is this a first world problem?
Ryssdal: Eliot, go ahead. That’s a great phrase. What is that? I don’t know.
Spitzer: I’d have to say I’ve not really thought about that as much.
Ryssdal: Well, the rest of the world, there are parts of the rest of the world that are growing that haven’t had a crisis.
Rowlatt: Doing very well. China’s 7.6%.
Spitzer: We would gladly take China’s growth rate, even though everybody is now—
Ryssdal: We’d take half of China’s growth rate, are you kidding me?
Spitzer: We would take half.
Rowlatt: Listen, in Britain we’d take like, you know, one percent of it would be enough.
Conard: —at a dollar an hour.
Ryssdal: That’s right, yeah.
Spitzer: But it’s a different context, and obviously China is now what we were 100 years ago, perhaps, with huge supplies of labor that is reasonably inexpensive, new markets can be supplied with products. Yes, I think this has been contained, to a certain extent, but…
Rowlatt: But it’s not just contained. It was a problem in, you know, the developed world’s financial market.
Spitzer: But it poses for me—and I think this comes back to a point that Ed made, one of the few, I should say, that is correct, which is that we were being supported primarily by the in flow of Chinese capital. And so if this is, to a certain extent, a first world problem, when China slows down, we are at great risk.
Ryssdal: Let’s go back to Wilbur Ross in the audience. Go ahead.
Ross: Yeah, but there’s another big difference between the first world and the other worlds, and that’s savings rate. We don’t have a savings rate that’s a third the savings rate of China. Unless you change the behavior of the whole population, you’re not going to solve the problem. We are debt druggies as a nation, we really are. At the federal level, at the state level, and at the individual level. That’s the root problem.
Ryssdal: The druggies, that’s a—
Rowlatt: It’s an absolutely, you know, that’s got to be an absolutely core thought. I mean, we’ve talked about responsibility. Clearly responsibility is spread across lots of difficulty actors in all of this—banks, customers, governments. But we all need to change, don’t we? Attitudes and crucially, surely, we all need to change our expectations. We need to begin to learn to live within our means. And an old fashioned word, if I may use it, thrift. John Taft, how do you feel about this question of changing expectations?
Taft: A different word, I think a better word, is sustainability. And one of the most exciting things going on in the world right now is the amount of money flowing into what, you know, currently has had lots of different names over the decades, environment, social and governance forms of investing.
These are enormous pots of money, many of them coming from sovereign wealth funds, that are looking to invest in businesses where the underlying model is sustainable over time rather than a model, as we’ve been talking today, driven by, or based on borrowing money to generate growth that isn’t sustainable. So sustainability, for me, and a financial system built on sustainability, is where we need to go.
Ryssdal: Eliot, go ahead.
Spitzer: I want to pick up on something Ed has been focusing on, which is the difference between long-term and short-term returns, and risk aversion. I think the problem comes back to what Bethany talked about, which is the compensation structure. We have a financial system that became more and more geared to short-term returns because of the way bonuses and other compensation systems were determined. And that’s why I think Wilbur actually stands in rather sharp contrast to that. His opportunities are created because he is patient. I don’t know how patient, but he’s patient. And then that—
Ryssdal: He’s patient enough, man.
Spitzer: That makes it possible for those who are willing to take a longer-term time horizon to invest in a different way. And that’s why I thin Bethany’s right. Compensation has somehow—
Ryssdal: Pay.
Spitzer: —[unintelligible] the banking system.
Conard: We’d all like to have more equity. You know, Wilbur’s an equity investor. Equity investors are patient. More equity, I’m all for it. But that’s not our [product]—
Rowlatt: But is it the patience? If the equity is built up because of his patience, this is decades that you’ve been investing, isn’t it?
Conard: In part.
Rowlatt: You’ve built the money up over decades, Wilbur.
Ross: Well, when you get old, you’re thinking [differently]. [Laughter.]
Ryssdal: Here’s a man who’s [figuring out the best way].
Rowlatt: Then that’s the answer. We all need to get old.
Ryssdal: Bethany, go ahead.
McLean: I want to make a quick point about thrift here because it comes to the title of this panel, do we have the banking system we deserve. In really simple ways, one way to think about the explosion of financial industry profitability has been about the packaging of debt, governmental debt and personal debt. And if we stop creating debt, then the financial industry stops having something to package.
Rowlatt: Ed Conard.
Conard: I think that both of you, Eliot and Bethany, talk only about the borrowing side of the equation. You say borrowing’s bad, we shouldn’t borrow. What we don’t see is there’s a saving side to the equation. The silo is filled with corn. And there are…the people who have put their corn in the silo—
Ryssdal: The savings rate in this country is like in the low single digits. It’s been negative within the past five years.
Conard: A lot of the savings occur from Chinese workers who are employed by the U.S. economy, it’s true, okay? But there’s two sides to this equation, which is when our out put is created and then flows back into the system and it’s risk averse, it won’t take any risks, okay, we can say let’s not borrow it, that’s fine, it’s good. We’ll end up with a lot of unemployment and slow growth because that output sits idle, unused. We have a problem in that we have a lot of short-term capital. And the solution up here is don’t borrow it. Okay, don’t borrow it.
McLean: That’s not what I said.
Ryssdal: That’s actually a mischaracterization of what’s going on.
Conard: We have to find a way to put that capital back—
Ryssdal: And they’re throwing the microphone.
Conard: —to work to keep it flowing . . .to do it.
Ryssdal: Hang on one second. Let me change gears here for a second, and get into something, as we start to wrap it up, that John Taft said early in the program, the idea that we believe we consistently have to grow, right? Growing, in this economy, is what creates prosperity, and that lets us feel better about everything that happens. Are we all ready to change our behavior enough so that we’re fine with one or two percent growth instead of three or four?
Taft: Well, I want to go back to Eliot’s helpful, thank you, clarification of what I meant to say, because… And I want to tie it to what Bethany said, which is thrift and living within our means. There’s no alternative. We are on a planet that is running out of resources, where the population is growing, where clean air and potable water are at risk. We have to change the way we’re behaving. We have to live within our means. And the financial system has to support that, and we have to find a way to grow, and we have to find a way to employ people in a smaller and resource constrained world. That’s the challenge before us.
Rowlatt: Justin Weedus, you’re from Occupy. I’m sure you’re going to agree with most of that. Do you see those changes actually happening?
Weedus: I see changes on the individual level. I see people tightening their belts. I see people exercising thrift. I just don’t see any of that happening on Wall Street. It’s time for everybody to start sharing in that responsibility if we’re going to have, like John said, a sustainable future. Everybody needs to cut back in that way.
Ryssdal: We started with a lightning round. Let’s end with a variation of the same thing, brief answers to the question of this panel. And Eliot Spitzer, we’ll start with you. Do we get the banks we deserve?
Spitzer: No, we don’t yet have the banks we deserve. I’d make Paul Volcker Chairman of the Fed, Secretary of the Treasury, and everything would be fine, and let him craft some rules. I think he understands every side of the equation.
Ryssdal: Bethany McLean?
McLean: I think we have more control in this than sometimes is publicly portrayed, and I do think that living within our means and creating less debt helps you take control both of your own financial life and, by extension, of the financial system.
Ryssdal: Ed Conard.
Conard: I think we get the banks we need. When we run up a large trade deficit, we get a lot of risk averse capital. That capital has got to be recirculated back into our economy to get growth and employment up. The banks were doing that with subprime lending, which increased home consumption, consumption of homeowners.
We don’t have an alternative to that today, and we aren’t going to find one as long as we sit and recognize that that short-term capital carries enormous risks with it, which we didn’t recognize prior to the financial crisis. And the problem is Keynes’s paradox of thrift. It’s not that people aren’t saving, it’s that in the short run we’re all saving way too much. Households aren’t spending, banks aren’t lending. They’re sitting with a lot of money. Corporations have a lot of money sitting on the sidelines.
Rowlatt: John Taft, you’re the banker.
Taft: Wow. I agree with Eliot we deserve better. We all deserve a better banking system. But at the same time, we all have to behave more responsibly. And in my business, which is the investment business, there’s a phrase, which has always been true. If it’s too good to be true, then it probably is. And we all have to keep that in mind as we go in and ask the banking system to help us.
Rowlatt: And on that note we have to draw this discussion to a close.
Ryssdal: It is not a conversation that will end any time soon. Christine Lagarde told me the other day, during an interview, she said, you know, this is an unending process. So there’s more discussion on this to come. That’s it for us now from the green space at WNYC. Thanks today to our guests.
Rowlatt: Eliot Spitzer, Bethany McLean, John Taft and Ed Conard, and of course our audience here at WNYC’s green space. [Applause.] So that’s good night for me.
Ryssdal: Good night for him.
Rowlatt: I’m Justin Rowlatt.
Ryssdal: And I’m Kai Ryssdal. Thanks very much for being with us.
[End of recording.]
