So, you know, there’s nothing for safety and soundness like a comfortable oligopoly. We might think about that and … we’re planning, for those of you who are interested, a conference, coming up in a few months, contrasting the Canadian house finance and financial system with the American system. So there’s a little advert — little preview.

Doom Transcripts: Index & Guide

Well, that certainly got my attention :)

Housing Doom is pleased to present a seventh selection from our under-construction transcript of the American Enterprise Institute’s October 22, 2009 event "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis".1

The event site has a number of resources, including an audio and video of the proceedings. There is as yet no official transcript.

Most of AEI’s "team bear" participated in a brief but lively discussion after the presentations.

Alex Pollock: [1:21:56] Thank-you, Desmond.  Having heard five really interesting presentations, let me give the panelists, if they want, a chance to add something, or react to the others.  Nouriel?

Nouriel Roubini: Just a comment on the last point that Desmond made. In this crisis, regulated banks got in trouble, but also a lot of non-regulated financial institutions — were broker/dealers like Bear and when bust. And so in some sense, suppose we go back to Glass-Steagall and not against it? What does it rule out? And then you’re going to have a bunch of broker/dealers or non-bank Shadow Banks that are going to become too big to fail. They’re going to do crazy things and eventually we’ll have to bail them out.

So do we need to really go back to Glass-Steagall? Or we need to break up every financial institution and make it so small that it can fail and who cares? And we don’t have to bail them out. What’s the appropriate policy choice on that? And I think that’s an open question for everybody else on the panel.

Alex Pollock: Other comments? Chris? … and then I’ll come to Desmond.

Chris Whalen: The most striking thing I heard from the other presentations was that chart of existing homes. [slide 13 (Lachman's deck)] We still have a third of the purchasers in the investor category. In ‘05/’06/’07 we had 40 percent of all home purchases in the US by investors. So that shouldn’t make you feel good.

I mean, homeownership used to be a form of forced savings, as Alex and I have discussed many times. And it’s still a speculative vehicle. So if you go back to the banks and look at the forebearance that’s currently keeping those loss numbers down, and you look at the emergence of yet a new acronym, TDRs, Troubled Debt Restructurings, which is essentially the banks’ way of saying, "Well, we won’t push you into foreclosure, we’ll live with you."

That, to me, is scary. Because if you don’t have a vigorous recovery next year, then transactions like Wells / Wachovia don’t work. They’re all premised on a bounce.

Alex Pollock: Desmond?

Desmond Lachman: My view is that I don’t think that there is a silver bullet on financial reform; that I think that Glass-Steagall by itself, you know, I don’t think really it solves the problem. That I think it helps, but I think that you’ve really got to do a lot more in terms of creating the right kind of incentives; changing the whole compensation scructure on Wall Street would be one way of doing it. Getting the rating agencies not to be paid by the issuers would be another thing; that you can just think of a whole multitude of real reforms that you need.

I think what bothers me now is you’ve just got far too many of the financial institutions have got the whole of the financial … firstly you’ve got far more concentration than we had before. The 10 top banks now are controlling more of the markets, we’ve got a lot less competition. So that breaking these banks up into smaller units, having some kind of competition, I think that that would really be [1:25:00] something that one wanted to go.

I’m also concerned that you’ve just got a huge moral hazard now, that all of these banks have got access to the Fed window, which they didn’t have before. So you really just, I think, encouraging moral hazard on a great scale.

You really need a total overhaul of the system. Otherwise I think all we’re going to do … [1:25:00] …… is we’re going to just repeat the boom / bust kind of cycle that we’ve looked through the last few years.

Alex Pollock: John …

John Makin: I think the comments that I’ve heard everyone make suggests to me a kind of framework that I’m imagining some thoughtful policymakers are contemplating. And that is: We look at the post-bubble situation and we look at the policy response, and they sort of … we had to save the too-big-to-fail institutions.

I think that leaves central banks especially with a very difficult choice. That is, either they reinflate the bubble, and Nouriel suggesting that we’re on the way to doing that, and I think there’s a good case to be made that that’s probably going on. Or they say, "All right, we’re going to get tough and we’re going to consign ourselves to a kind of global lost decade à la Japan where we’re going to do the right thing, we’re going to step up, we’re not … we’re going to kind of create a different attitude toward risk-taking." The problem with that is that it’s very difficult to implement, maybe politically imposible, and very risky.

So I think as … So what’s the outcome? Well, it’s sort of like — damned if you do, damned if you don’t — as Nouriel’s suggesting.

And so it may lead to hesitation — although one reminder: We have had two major burst bubbles in the past 80 years, and in both cases, in the case of the Fed in 1936/37, when we raised tripled reserve requirements, raised reserve requirements 3 times, and tightened fiscally; and then in Japan in August of 2000 when they abandonded the zero interest rate [ZIRP] policy … In both cases the central bank made a feint — that’s f-e-i-n-t — toward the sort of tough medicine and created such a crisis that they had to back off.

So I think that’s something I’m watching as I follow the discussions among central bankers, is that the risk of trying to exit this too aggressively while worrying about the need to not create another bubble. That’s a huge dilemma.

Alex Pollock: Tom? (let me just see) … Tom, anything? … Chris?

Chris Whalen: I want to ask John a question. In the past, reflation has lifted all boats. But the concern that I have and what I want to ask you, because you have studied this for a long time, is: What happens if the reflation doesn’t help the real economy? What happens if it’s only effective on those who have direct access to the monetary authorities?

John Makin: Well, I think that your … it’s a fair description of what’s happening now. The monetary base has been boosted tremendously by the Fed’s activities. The Feds have said, "OK, here’s a lot of cash" to the banks.

The money multiplier has collapsed, so that M2 aggregates, or most credit aggregates, are flat to falling. So in a way, the effort to stimulate the economy went through the usual channel at a … When you’re at zero interest rates you try to do quantitative easing if … and the Fed doesn’t like to call it that …

But so far those efforts have been a total failure. And not only that, but if you look at the behavior of money relative to nominal GDP, velocity has actually collapsed.

So we’ve already failed to affect quantitative easing and interest rates are at zero.

Alex Pollock: A case you might think of there, Chris, would be the reflation and runaway inflation of the late 1970s. We remember the history that it had an inflationary runaway in the early ’70s, a commodity / oil price boom. Interest rates to then unheard-of levels in the US, then a big recession and a big bust — ‘75/’76. And then the inflation, which created inflation, but also created stag-flation and ultimately the bust of the 1980s.

One other point I’d like to make on the question of Glass-Steagall, or of banks that are too big. [1:30:00] Here’s a counter-example.

Canada is now held up as an example of a financial system which has weathered the current bust quite well. And actually, the Canadian banks also weathered the 1930s much better than the Americans did.

Well what’s the structure of the Canadian financial system? It’s 5 big financial companies, big banks, who control the whole system.

So, you know, there’s nothing for safety and soundness like a comfortable oligopoly. We might think about that and … we’re planning, for those of you who are interested, a conference, coming up in a few months, contrasting the Canadian house finance and financial system with the American system. So there’s a little advert — little preview.

Let me come now to your questions …

Nouriel Roubini: Quick question …

Alex Pollock: Yeah, go ahead.

Nouriel Roubini: You know, they are oligopoly, but aren’t they highly regulated? Much more than our financial institutions, so …

Alex Pollock: They’re highly regulated and the oligopoly is more than the banks, it’s the club of the regulators, the central bank, the government and the banks. You know, the traditional in-group system, as I interpret it.

That gets you safety and soundness, but it may not get you a lot of vibrant innovation. [1:31:26]

Notes and References

[1]: "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis", AEI event homepage, October 22, 2009.