Richard Fisher on Too Big to Fail and the Fed
Dec 30 2013

Richard Fisher, President of the Federal Reserve Bank of Dallas, talks with EconTalk host Russ Roberts about the problems with "too big to fail"--the policy idea that certain financial institutions are too large to face the bankruptcy or failure and need to be rescued or bailed-out. Fisher argues that "too big to fail" remains a serious problem despite claims that recent financial regulation has eliminated it. Fisher discusses various ways to deal with too-big-to-fail, including his own preferred policy. The last part of the conversation deals with quantitative easing and monetary policy during the crisis.

Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Dec 30 2013 at 2:20pm

I wish Russ did a little more digging into the Fed’s policy of paying interest on reserves. When Russ brought up the topic, he essentially asked a two-part question: Why does the Fed pay interest and are those interest payments part of the problem? I was disappointed that Mr. Fisher focused on the second question and failed to address the purpose of the policy. Given that the fed has dropped short-term interest rates to zero, it seems bizarre that they are still paying interest on reserves.

I believe I’ve heard Russ present the theory that these interest payments are effectively a back-door bailout to the banks; That seems like a scandalous proposition, but given Mr. Fisher’s non-answer and the incongruity of the policy, what other explanation is there?

Dec 30 2013 at 3:03pm

And I agree with Fischer: Ha Joon Chang is very smart. Also funny! Econtalk would get him on the podcast.

Dec 30 2013 at 4:24pm

Richard Epstein, I think on regulation, said why there’s no lending.

You can’t plan in the uncertain legal environment.

The law and regulation are whatever they say it is today.


Four very determined people on the liberal side doesn’t give you great confidence in your own predictive ability. Think we are in for a very high level of uncertainty. System is aware of the obvious procedural challenges in the name of the rule of law, but it doesn’t understand that to the extent you have highly indefinite property rights, which all of these statutes create, that no system of regulation is going to be able to limit the dangers associated with political discretion. So you will start to see the kind of stagflation that we’ve had today. Continue to generate a modest level of technical improvement, but the regulatory overhang and the judicial response to that overhang remains sufficiently powerful that you cannot jump-start this economy, and it is just frightening to me, when I start reading reasonably smart people like Paul Krugman and Laura Tyson in the NYTimes announcing that the stimulus program has worked because we’ve managed to constrain the increase in unemployment to only 10% when it was supposed to be under 8%. Wishful thinking. Folks for whom it is not possible to falsify a prediction.

Pietro Poggi-Corradini
Dec 30 2013 at 5:24pm

I’m confused:

1. If the problem is Too-Big-To-Fail, how does this central banker’s proposal address this problem? Shouldn’t any proposal address the argument made by the supporters of bailouts, namely that there are systemic repercussions to letting certain large firms fail? Either I missed it, or I didn’t hear this argument being addressed at all.

2. The speaker says he favors market-driven solutions, but then wants to “level the playing field” and thinks that some institutions are “too big to manage”. How does he know when an institution has gotten too big to manage? How can anybody know? What does the industry concentration have to do with TBTF? This was never explained. Let me put it more simply. Say that we cut in half the top 2% largest institutions. Would that alleviate the TBTF problem in any way? It’s not clear.

3. Fisher repeatedly refers to capital requirements as “capital cushions”. I thought that was the wrong way to think about capital requirements, which are really about the relative distribution of equity vs. credit. Again it would have been nice to hear why he thinks more equity will not mitigate the TBTF problem. Unfortunately, as Russ mentioned, bailouts are often extralegal affairs. My understanding was that larger shares of equity would mitigate the so-called “systemic” effects of a liquidity crisis.

4. About monetary policy. Fisher was opposed to driving interest rates down to zero, but does not offer an alternative. I guess he does not think Fed policy has been contractionary, or at least does not worry about that aspect. Instead he worries about inflationary pressures that are nowhere to be seen, not even into the future. Personally, I worry that our monetary policy is in the hands of a few opinionated individuals such as this week’s guest. Talk about “managing a ‘too large’ institution”. If he really thinks that some banks are too large to manage, then maybe he should be more skeptical about his own role in stirring US monetary policy.

Allen Hutson
Dec 30 2013 at 6:37pm

First off, congrats to Russ. I’ve listened to practically all of these podcasts and – at least to my memory – this is the first sitting government official on the program. Given how sensitive fed comments are, getting Ricard Fisher on the program and having a serious discussion is a significant accomplishment – congrats!

While I have a great deal of respect for Mr. Fisher, I am afraid that the proposal may well be seriously flawed. If the money supply (and ultimately the economy) can be maintained by providing liquidity to deposit taking institutions, the I think his policy is a good one. Alternatively if the shadow banking system is a critical element of the monetary system, then his proposal would fail (either by governments not following it, or if they did, then a dramatic decline in the money supply). David Laidler’s comments on econtalk on this subject are the perfect guide to this issue – should the fed save and/or support only commercial banks, or should this restriction be relaxed?

The question of whether the money supply can be maintained through only supporting commercial banks is not a moral one – but rather an empirical one. Unfortunately the answer may well not be convenient if you tend to agree with me that bailing out non-commercial banks is immoral. I do wish this specific issue was addressed, but I’m pretty sure you could get a year’s worth of econtalks from a fed governor and still have topics left to discuss.

Finally, every econtalk on this subject leaves me confused, and I hope I can get a satisfactory response on this now. Fisher discusses how the fed has “extended the maturity of its portfolio,” which is fedspeak for buying assets that have a longer maturity than their typical purchase. For example, they are now buying 10 and 15 year US treasuries/bonds instead of 3-6 month treasuries. There are a few arguments made, but most often I hear that this should “stimulate demand” for loans.

Why isn’t this thought of as smoldering the supply of loans – it is effectively a soft price ceiling on interest rates. If the U.S. government started artificially pushing down the price of gasoline (without a subsidy per gallon sold), economists across the world would call the program a bad idea – why isn’t it the same with interest rates?

A bank’s profit margin reflects the yield curve. Obvioulsy they enhance their returns by taking on riskier loans and then diversifying, charging fees, leverage, and a host of other practices. Nonetheless, the “risk free” (sorry for using that term Russ), return is based on the yield curve.

The Fed’s policy has been to push down long term interest rates – flattening the yield curve. Doesn’t this provide a disincentive for banks to lend? Wouldn’t you expect banks to be holding excess reserves while businesses and consumers seek them creating excess supply?????? Will someone please explain why I’m nuts for thinking this?

Thanks! And great job on this podcast Russ!

Keith Vertrees
Dec 31 2013 at 12:58am

I appreciate Richard Fisher taking the time to join Russ on Econtalk, and I’m glad that he is not in favor of QE taken to the Bernanke limit. That said, he seems to maintain a vestige of faith in the Federal Reserve system.

But if we’ve learned anything from Econtalk, it’s how little we really understand about what we imagine we can design.

To believe that the Fed can really achieve its mandate, or even control the side effects of its own extraordinary actions, is to believe in the Wizard of Oz. The man behind the curtain, wiggling ONE joystick labeled ‘money supply’, can’t control an economy of 300 million individuals. In fact, the man behind the curtain is almost certainly doing more harm than good.

I’d be much more comfortable replacing the man behind the curtain with bitcoins, gold, or Rai stones.

Michael Byrnes
Dec 31 2013 at 7:34am

Pietro Poggi-Corradini wrote:

“1. If the problem is Too-Big-To-Fail, how does this central banker’s proposal address this problem? Shouldn’t any proposal address the argument made by the supporters of bailouts, namely that there are systemic repercussions to letting certain large firms fail? Either I missed it, or I didn’t hear this argument being addressed at all.

2. The speaker says he favors market-driven solutions, but then wants to “level the playing field” and thinks that some institutions are “too big to manage”. How does he know when an institution has gotten too big to manage? How can anybody know? What does the industry concentration have to do with TBTF? This was never explained. Let me put it more simply. Say that we cut in half the top 2% largest institutions. Would that alleviate the TBTF problem in any way? It’s not clear.”

Fisher’s argument is that the banking system looks the way it does because of the incentives facing it. The policy of bailing out “systemically important financial insitutions” is a strong incentive to banks to become systemically important. In effect, it means that banks (and, importantly, lenders to banks) have a free insurance policy courtesy of the taxpayer. Would you rather lend your money to a bank that is more likely to be bailed out if it fails or a bank that is less likely to be bailed out?

Take away the possibility of a bailout (much easier said than done in our political system) and the institutions that happily lend to the big banks would be less willing to do so. This is what Fisher means when he advocates a market-based solution.

“3. Fisher repeatedly refers to capital requirements as “capital cushions”. I thought that was the wrong way to think about capital requirements, which are really about the relative distribution of equity vs. credit.”

Equity is a “capital cushion” in the sense that the equity holders bear the losses. A bank that is funded by $10MM in equity and $90MM by debt can absorb $10MM in losses (wiping out the equity holders) before the bank becomes insolvent. In contrast, a bank funded by $50MM in debt and $50MM in equity can absorb $50MM in losses before it becomes insolvent. So the equity is a sort of cushion.

Michael Byrnes
Dec 31 2013 at 7:50am

While I agreed wholeheartedly with the first half of the interview, concerning banks and bailouts, I disagreed with the latter half on monetary policy.

Russ often refers to Bruce Yandle’s “Bootleggers and Baptists”. In the case of banks and bailouts, the banks and their lenders are the bootleggers, working the system for their own gains. The Baptists are the public.

The rationale for bailouts that is offered to the public is that allowing the banks to fail would wreak havoc on the financial system, in a way that would cause more harm than a taxpayer-financed bailout.

I think one way to disconnect the interests of the public (baptists) from the interests of the bankers (bootleggers) is Scott Sumner’s proposal to have the Fed adopt an NGDP level target.

Ultimately, the risk to the public is that a financial crisis caused by the failure of a SIFI will disrupt credit and markets and put the economy in recession/depression. Under Sumner’s NGDP level targeting proposal, this is a non-issue: there will be no sustained collapse in nominal income in the event of such a failure, thus there are no SIFIs, and any institution can be allowed to fail if it becomes insolvent.

AJ Nock
Dec 31 2013 at 11:26am

Bravo to Russ for pushing on the question of the value of the assets bought by QE. This is the one place in the interview where I thought that R. Fischer became a little unhinged and tried to obviscate. He hid in “complexity,” the famous hiding place of all dubious financial dealings. The way he was quick to bring up the fact that the Fed is making a profit and giving it back to the government was used to block the obvious fact that the Fed will take a bath on this stuff. Furthermore, if you step back and look at the big picture: the government is paying the Fed money (interest) for money the Fed created out of nothing. The Fed takes a slice and hands the rest back. Seems like a shell game designed to hide some very questionable financial dealing (I.e. money printing and a sweet heart deal for the member banks).

Pietro Poggi-Corradini
Dec 31 2013 at 11:32am

Michael Byrnes thank you for your replies, but I’m afraid you’re telling me what I already know. I listened to the podcast while grocery shopping, so I was worried I had missed some parts of his proposal, but then I came home and read the transcript and no it’s a simple as I had thought: his solution is to just wish the problem away, just ban bailouts. I find this very naive, and Russ did push back ever so gently.

As I said before, looking at the concentration levels of an industry tells you nothing about its efficiency. Yet in an effort to sound hyper-populist the guest kept on referring to them as if it was an obvious bad thing.

About capital requirements we’re in complete agreement and I don’t understand why the speaker dismissed them. They directly address the problem of systemic contagion.

Finally let me say that we also agree on targeting nominal GDP, which is an actual market based solution that would remove the discretion of individual bankers such as this week’s guest.

Keith Vertrees
Dec 31 2013 at 4:25pm

Fisher notes that the system is now awash in money. I agree with him that the interest paid on reserves is insufficient motivation for not loaning it out. Which means that the bankers have more money than they know what to do with already; they can’t make enough loans.

How would nominal GDP targets solve that problem?

Pietro Poggi-Corradini
Dec 31 2013 at 5:08pm

Keith Vertrees, the problem with paying interest on reserves is that it signaled a tight policy stance at a moment in time when it was important for the Fed to send the opposite signal. The magnitude of the actual interest paid is not as important as the magnitude of the signal. If the Fed had been targeting NGDP at the time, it would not have started paying interest on reserves. In fact with the right signals at the right time, it’s believed that the Fed would have had to print a lot less money.

Michael Byrnes
Jan 1 2014 at 11:10am

Keith Vertrees wrote:

“Fisher notes that the system is now awash in money. I agree with him that the interest paid on reserves is insufficient motivation for not loaning it out. Which means that the bankers have more money than they know what to do with already; they can’t make enough loans.”

There’s another way to look at this. I think you (and Fisher) are assuming that the level of excess reserves does not affect bank lending activities. An alternate possibility is that if excess reserve balances were much lower, bank lending activities would also be much lower. If you discover that you have 10 times more money in the bank than you thought you had, would it affect your financial decisionmaking even if you chose to hold most of it as “reserves”.

As far as the rate of interest on excess reserves, 0.25% is not a lot. But in the early stages of the crisis, the Fed was paying 2% interest on excess reserves! During first the FOMC meeting after Lehmann’s failure, the Fed chose not to lower the Fed funds rate (and the rate of interest on reserves), citing equal risks of recession and inflation. A monumentally bad call in retrospect. Their 2008 interventions were largely focused on providing liquidity to failing institutions and to the financial sector as a whole, and not focused at all on the broader economy. It wasn’t until December that the FOMC took broader action by cutting rates to zero. Their early focus was on keeping the liquidity they poured into the banks OUT of the economy.

I favor a nominal income target because it would support a “no bailouts” policy. Targeting nominal income is one way to allow insolvent firms to fail while minimizing any spillover effects on the economy as a whole.

Michael Byrnes
Jan 1 2014 at 11:13am


I see where you are coming from and I think you are right. Enforcing a “no bailouts” policy will be a major challenge. In some respects, we might be better off with an explicit policy that defines what the haircuts will be in the event of a bailout.

Taylor Davidson
Jan 1 2014 at 2:32pm

Happy New Year to the fine people at EconTalk! I’m looking forward to another great year of interviews.

Two things left me concerned after listening to Richard Fisher’s response to the question about interest on Fed deposits.

First, Mr. Fisher stated that the interest was “too small” to affect bank decision making. This seemed bothersome because he didn’t say the effect was marginally so small as to be immaterial, he said the effect didn’t exist. I assume Fed presidents are serious economists and this dismissal of any marginal effect seemed non-serious.

However, Mr. Fisher emphasized that he saw his role as a translator of economics for a broader audience so if I’m being charitable I could hear his statement of “no effect” as meaning so small as to have an immaterial marginal effect. Let’s be charitable 🙂

That still leaves my second issue, which is actual the big one. He stated that 25 basis points is a meaningless return when bankers can lend at 3%-6%. Is that true?

Well does “lending” at 3%-6% = “making” 3%-6%?

As a former banker I can tell you our earnings after expenses on most loans was 20-30 basis points. I just asked my wife (a former mortgage underwriting manager) and she confirmed that at the low end of that range, 3%-4%, the bank often was taking a loss.

So with significant risk, cost and complication a bank may have a .25% return out of the 3%-6% charged on market loans. However, with effectively ZERO risk/cost/complication they can realize the SAME GAIN by letting their capital sit on deposit with the Fed (there is a cost to accessing that account but it is essentially a fixed cost of doing business in the US market and has little usage variability).

The marginal benefit to private mortgage lending (vs Fed deposit interest) is thus effectively 0%. Mr. Fisher is claiming this has an effect on decision making so small as to be immaterial??

Even if you include other consumer loans (auto, unsecured, equity, etc) maybe you get up to 1%. That puts Fed returns at 25% of private market lending. At 25% is a bank going to put all of their money in Fed reserves? Of course not. But to suggest that a zero-risk/cost investment opportunity at 25% returns of private market options will not have SIGNIFICANT impacts on a bank’s marginal capital allocation decision making, seems to indicate a shocking lack of understanding of the financial structure of US financial companies.

As I said at the top, that’s a bit concerning when it’s coming from Mr. Fisher, a Fed president and (supposedly) a serious economist and financial expert.

Justin M.
Jan 2 2014 at 11:15am

Great Interview! One of the best I’ve heard on any podcast on the subject of central banking and our emergence from the crisis. Mr. Fisher’s perspective will be valuable to the committee and his input will indeed be valuable.

I too had to re-listen to Mr. Fisher’s response regarding interest paid on reserves. Based on their website, the Fed pays interest on reserves, “to eliminate effectively the implicit tax that reserve requirements used to impose on depository institutions”. However, I haven’t seen any real evidence that shows me that a bank meeting (or exceeding) their reserve requirements is an implicit tax. They should make money when they lend to their customers, not when they sit on their reserves & stockpile them above the reserve requirement(s).

While I wouldn’t consider it a “backdoor bailout” as others have called it in the past, I do think in a ZIRP environment, it is sufficient impetus for commercial banks to keep money on the sidelines. It’s essentially a risk-less trade and incentivizes the slowing down in the velocity of money.

Geoff Harris
Jan 2 2014 at 2:39pm

Fisher’s proposal for removing any implied guarantee from bank debt sounded rather other-worldly to me. And Russ’s addition of public signing ceremonies just adds to it. As far as I’m aware, apart from the postcard declaration and the ceremony, it is little different from the situation that existed before the crisis. Yet when the system looked as if it would implode, legality was jettisoned quicker than you can say “too big to fail”.

My take on the proposal is that it is a fig leaf to cover an ideological inconvenience. The dogma is that government interference with the market is wrong, even if the market has the ability to saddle the public with huge costs. This means that government interference to break up big banks, restrict their activities and reduce the risks they pose to you and me is wrong in principle and must be avoided. Hence we end up with postcards and ceremonies instead of reinstating Glass-Steagall. If it wasn’t serious it would be comical.

Fisher’s claim that he opposed cutting rates to zero “because the question is what bullets do you fire next” also struck me as weak. If rates can never be cut to zero, then 0.25 (or 0.1, or whatever) becomes the new floor. And of course you shouldn’t cut to 0.25 “because the question is what bullets do you fire next”, etc. If you want to have zero in reserve for a rainy day, at some point the rainy day may come – arguably that occurred a few years ago. The only valid argument against cutting to zero would seem to be “it is not raining hard enough”.

Jan 2 2014 at 6:36pm

Why can’t these Systemically important institutions just be forced (taxed) to contribute to a huge bail-out fund (1 trillion) for when the next crisis hits?

Russ Roberts
Jan 2 2014 at 10:45pm


In my view, political outcomes are driven by power (incentives) rather than figuring out the best thing to do, whatever that might be. Given my world view, your question answers itself. The next question is whether there is anything to be done about it. I like to believe, perhaps naively, that an educated electorate and a return to constitutional principle, would limit the ability of cronies to steer resources toward themselves.

Ryan Langrill
Jan 3 2014 at 4:18pm

I really like Leijonhufvud’s proposal: lighten up on the oversight of the activities inside banks, but make sure that the outcomes, especially the downside outcomes, come back onto management. He thinks that we should have management hold multiple liability equity, e.g., double or triple liability, so if there are some massive losses, management’s personal assets are (boundedly) vulnerable. That way, publicly held banks can recreate, to some extent, the incentives faced by partnerships.

Here’s the paper:
It has a brief history of liability rules in banking, and he has a very Hayekian view of the financial system.

Justin M.
Jan 3 2014 at 5:27pm

In response to James,

Essentially, the question you are asking is answered in Dodd-Frank. Under the DFA, all organizations deemed to be SIFIs will pay money to reimburse a a fund that will come to exist only if the federal gov’t has to intervene and effect a “title II” liquidation of another SIFI.

The irony that Uncle Sam will tap these other SIFIs in a time of systemic crisis is not lost on critics of legislation. Simon Johnson at MIT has been one of the most vocal critics of this aspect of the legislation.

SIFI… it’s like YOLO for the 0.1%

Gary A Gordon
Jan 3 2014 at 8:17pm

A fine interview of an admirable individual! I do, however, have a serious reservation regarding President Fisher’s proposed solution to the “too big to fail” problem. While the proposed solution addresses the scope of FDIC insurance and access to the the Fed’s discount window, it fails to address the significant tacit guarantee that also applies to money invested in money market mutual funds. These funds are the source of short-term funding behind most of the “shadow banking” system. When one of the money market funds “broke the buck” in 2007, it set off a chain reaction that caused most of the total market disruption that followed. Any scheme that does not also break the existing public perception that money market funds are not “guaranteed” does not sufficiently address the “too big to fail” problem.

John T
Jan 4 2014 at 5:06am

Is the Fed too big to fail?

Dr. Duru
Jan 4 2014 at 7:13am

This interview was a MAJOR score for you Professor Roberts. Congrats!

I liked this entire interview but my ears perked up when Fisher described QE as printing money. Bernanke has gone to great pains to insist that QE does not involve printing money (for example, watch his series at George Washington University on youtube). The New York Fed has a FAQ on QE that also insists QE does not involve printing money. I think a podcast singularly devoted to describing and explaining the mechanics of QE would be very useful to many of us.

Reason Able
Jan 4 2014 at 8:26pm

I agree with President Fisher’s suggestion that the discount window could be limited to commercial banks taking deposits thinking that making people sign a piece of paper is going to help prevent people from taking risk or take risk knowingly is naive at best and misleading at worst. Financial transactions can be complex with hundreds of papers to sign. Some with short statements others running for pages. In a small way think of the papers you sign when you buy a house. How many of you went through 50 signatures in 25 minutes. When you are ready to close a transaction you just forget about all the formality.

Bankers who take risk don’t really care. They are simply risk takers and will do what gets their adrenaline pumping and their wallets fattening.

Why shouldn’t we bring back Glass-Steagall? President Fisher seemed opposed to it.

John Berg
Jan 5 2014 at 1:03pm

After reading this podcast and its comments, I watched the enormously interesting debate on breaking up banks too big to fail. During that debate I was reminded that we are discussing “treating the symptoms” rather than the problem. Being a tea-party type I want a restoration, not of democracy but of our constitutional republic. The problem is that the Feds have all the nation’s income and uses it to bribe the state officials. “It is more efficient to work with one federal government rather than fifty states” say those who argue for big government.

Surely with new technology and the Internet we need not have states give up control to the feds except for the fact that that is where all the money is now.

John Berg

Bill Gardner
Jan 5 2014 at 2:49pm


what worries me about the long term is we do have and we’ve talked about and we have an exit strategy to deal with this, but it’s a theoretical exit strategy. It’s never been done before. And I’m worried about the long-term consequences of having all that money sitting out on the sidelines. These are in depository institutions as well as significant amounts of money sitting in private equity firms and sitting in hedge funds, etc., outside our purview. That’s a lot of tender. If velocity were to pick up, how do we tamp it down so that it doesn’t lead to inflationary impulses? Right now inflation is not an issue. But our charge, given to us by the Congress, says long run, long run, long run. And that’s what I’m worried about.

This is a very reasonable concern.

Now, consider the previous week’s discussion. We are continually increasing the concentration of greenhouse gases in the environment. There are physical models indicating that this will lead to dramatic increases in global temperature.

Russ, you pointed out that contrary to those models, temperature increases have been flat for a decade. (The claim is disputed, but let’s stipulate that it is true.)

You made this observation with scorn, or so it sounded to me. But these situations seem very similar to me. There are models grounded in science that raise concerns about long term risks. For reasons no one can explain, the short term data do not conform to the model. Isn’t it prudent to act now to moderate the long run risks of both inflation and global warming?

Sri Hari
Jan 5 2014 at 8:10pm

Another very informative podcast. Credit to Russ to have got one the presidents of Feds to air his comments, albeit very guarded, challenging and questioning the establishment’s way of working. I was very impressed by Fisher when he said the banks have gotten so tangled in the modern financial innovations that it has dumped the basic rule of ‘know your customer & know your risk’. Or simply said prudent underwriting!! Criminal prosecution for deliberate and bad underwriting will go a long way to fix the ‘too-big-to-fail’ problem.

Tim Vlamis
Jan 7 2014 at 1:41am

[Comment removed pending confirmation of email address. Email the to request restoring this comment. A valid email address is required to post comments on EconLog and EconTalk.–Econlib Ed.]

Greg Smith
Jan 11 2014 at 2:13pm

It strikes me that the best way to address the whole “to big to fail” problem has already been clearly laid out by Nassim Taleb – make sure there is skin in the game!

The current practice of paying annual bonuses in a 5-7 year business cycle environment borders on insanity when it comes to banks since they have the unique ability to bury problems in their balance sheet that don’t surface until the business cycle turns unfavorable. Bankers take huge bonuses during years that the problem’s are hiding and then nothing when the problems surface. If the bank survives the turmoil, the bonus cycle continues. If it can’t the taxpayer steps in to clean-up the mess and the bank executives find themselves with a huge amount of accrued wealth but no job.

The thought that regulators can detect the build-up of the toxic waste in the bank’s assets has proven wrong so many times I’m baffled as to why anyone thinks “they’ll get it right next time”. More regulation isn’t the fix, skin in the game is.

How does one implement “skin in the game”? From my perspective, you simply mandate that the bonuses of the top three layers of a bank’s management be placed in an escrow account that pays out 10% of the balance in any given year (funds would remain in escrow even after the execs left, or retired from, their positions meaning they couldn’t get all of their money out of the account until 10 years after they left their positions with the bank.). These escrowed funds then stand as funds made available to restore the bank’s health in the event there are problems and drawn to zero before a dime of public money, or even FDIC funds, are used in a rescue.

I’m willing to bet this would result in a substantial shift in the attitudes of the bank’s executive ranks towards risk and the management of it. I would also suspect a significant shift away from short term thinking and towards the long term health/viability of the bank possibly to the point that regulators wouldn’t even be necessary.

Simple fix, but I doubt it would ever be adopted. Regardless of how much bankers like to talk about the importance of “free markets” they really have no interest in subjecting their personal fortunes to it (although they don’t have a problem doing it with everyone else’s money).

John Foster
Jan 12 2014 at 12:35am

I was disappointed to hear Fisher say that the fed could “just let bonds mature” to unwind the balance sheet should selling prove difficult. Isn’t this obvious chicanery? If the Fed lets bonds mature then the US treasury has to pay them off. Where will Treasury get the money when they are already borrowing ~$1T per year? If the Fed can’t find buyers for it’s bonds, how will the Treasury?

Surely Fisher must understand this, yet he makes this glib statement anyway? At that point I decided he’s a shill for the Fed and not some maverick member, independent and honest.

Am I missing something here??

John Foster
Jan 12 2014 at 1:01am

Looking back thru the transcript I think I can answer my own question. Seems that Fisher was talking about holding MBS’s to maturity, not treasuries. And holding them for the purpose of avoiding an accounting loss, not to support prices in the market.

So I guess he didn’t really address the question of unwinding the balance sheet at some point, which to me seems very difficult. Maybe impossible?

Comments are closed.


About this week's guest:

About ideas and people mentioned in this podcast episode:Articles:

Web Pages and Resources:

      • Financial Crisis of 2008. College Economics Topics. Organized list of podcast episodes and other resources on the Crisis. Library of Economics and Liberty.
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Podcast Episode Highlights
0:33Intro. [Recording date: December 2, 2013.] Russ: You've been an outspoken critic of the way policymakers have dealt with the so-called 'too-big-to-fail' problem. I want to start with too big to fail. What is the problem and which banks dos it apply to today? Guest: Well, the problem is that we have banks that are of the size and scale in which senior management of those banks despite their risk management models and highly mathematized ways to try to track things, have in my opinion lost track of the basic principle of banking, which is: know your customer and know your risk. So, we also have institutions that have learned by practice that if they lose track of their risk and track of their customers and make significant errors, they expect to be bailed out by the U.S. taxpayer. These are called 'too big to fails'. Legislation was passed meant to deal with it. It was written by Senator Dodd, who is no longer in the Senate, and Congressman Frank, who is no longer in the Congress. But in the very preamble to that legislation it said that this is to deal with the issue of too big to fail, put it to an end. I don't believe it has. I believe we have created a bureaucratic structure that will continue this process and problem; and the real objective that we have at the Dallas Fed of proposing an alternative, which I'm happy to discuss with you, is to eliminate the risk that the taxpayer will be called upon once again should one of these large institutions get into trouble to bear them out; and also to eliminate the risk that monetary policy becomes a handmaiden of the big, rich institutions rather than of the rest of the country. Russ: Well, I want to get in to your solution, but before we do, I want to have you give us an overview of the industry which you've done in some of your recent speeches. And we'll put up a link to those speeches; they are educational and entertaining. Give us an overview of the banking system and what a small portion of that system we're talking about in terms of number of banks, but what's such a large portion in terms of assets. Guest: We have some 6000 banks in the United States, yet we have concentrated in the hands of literally one handful of institutions of the same amount of assets that you have in the other nearly 6000 community and regional banks. So we have a very highly concentrated sector. And basically what I have been advocating, what we at the Dallas Fed have been advocating, is that rather than be preoccupied with institutions that have been considered too big to fail, because, should they fail--should they get themselves into trouble--it would put the economy at risk because of the high concentration in very few hands; that instead, we structure the law so that we have institutions that are too small to save. That doesn't mean we would not be internationally competitive. There's great specialization that can occur and perform different functions. The markets as you know have been fully developed in terms of the non-depository markets, meaning the bond markets, the stock markets. Large institutions have a great way of financing using markets and not just their bank creditors. But the point is that we have an unlevel playing field. And if you are a small or medium sized bank and get into trouble, you are closed on Friday and opened on Monday. That's the standard FDIC (Federal Deposit Insurance Corporation) rule. Some of them take a little bit longer. But these large institutions, as we learned the last time around, during the panic, should they get themselves into trouble, they are perpetuated. I just don't think that is democratic or fair or proper; nor is it economically sound. Russ: Well, some people would say--I think they are wrong, as a preamble--well, they are not perpetuated. Bear Stearns is gone; Lehman Brothers went through bankruptcy. We can handle it. They didn't get rewarded; their equity holders were wiped out; their management lost a lot of money. What's your position on that? Guest: Well, they were swallowed by somebody else. So you end up with a bigger bank. Like J. P. Morgan or a bigger bank, XYZ Bank. And again I want to make clear that I don't think the management of these companies--I just mentioned one; I think Jamie Dimon is a first-rate individual; he's a personal friend; I hold him in high regard in terms of his personal integrity. It's not a matter of evil individuals. It's just the way these institutions are called upon to rescue somebody else. And in the end receive subsidies in terms of a lower cost of money because of their size and because of their dimensions. And also from the standpoint of an implicit bought[?] that should they get into trouble they will be bailed out. So my biggest concern is these complex financial bank holding companies should all, on the depository side, in the banking side, what we consider commercial banking, should be treated the same way as smaller and regional banks. So this is a subject that we have been discussing at great length. Incidentally, it's a subject that joins both the Left and the Right. It is something that I find is of great interest to, say, Tea Party Republicans, just as it is to the new Senator from Massachusetts--who is by no means a Tea Party advocate. So, it's one issue that unites people from a bipartisan standpoint. I think it's something where the Congress can actually do something about this. And that's the proposal that we've made.
7:11Russ: Now, how much of a role do you think the expectation of a bailout played in the leverage that we saw in the run-up to the Crisis in large financial institutions? Did we see that kind of leverage in smaller institutions that were small enough to fail? Guest: Well, no, because if a small institution gets into trouble, no one is going to bail them out. And we did have banks fail. And there's also a difference in ownership structure. In many of the smaller institutions shareholders themselves are a smaller group, have more direct knowledge of what's happening with the risks that the institution is taking. But in these very large institutions of course they are widely disaggregated in terms of their ownership. But the point is simply this: too-big-to-fail banks don't face a whole lot of external discipline from their unsecured creditors. And an important facet of too big to fail is that funding sources for these megabanks extend far beyond insured deposits. You could see during the period of prices, the CDS (Credit Default Swap) spreads--these are the spreads in terms of the measurement of risk and insurance on these institutions were widening beginning very dramatically very early on, in fact late 2007. So you would expect that some market discipline was being applied. But in the end these institutions were bailed out. Now the law claims that that will not happen again. But experience points us in a different direction. And all we want to make sure of here at the Dallas Fed is that indeed it is clear that the only taxpayer exposure would be through the commercial banking depository institution and the other aspects of a complex bank holding company would be totally at risk. And we believe that if that is made clear and simple that then the market will sort who actually is good, their brokered dealer operation or their insurance subsidy or their other subsidy areas other than the commercial bank. Russ: The CDS you referred to are credit default swaps, which were a measure of how likely it was that a bank would fail. And if I remember correctly when Bear Stearns failed, Lehman Brothers' credit default swaps--that is the expectation that Lehman would fail--rose quickly. But then once at Bear Stearns it turned out that their creditors would get all their money back, 100 cents on the dollar because J.P. Morgan Chase was taking them, they got quiet again. And Lehman Brothers was borrowing money at the same rate as--it would seem--firms that were much less risky. In particular the question I want to get your opinion on--and then we'll move to your solution: The bailouts of 2008--and I'm talking now about Bear Stearns, AIG, Fannie and Freddie--these were large financial institutions that had borrowed enormous sums of money, and the lenders got all their money back, 100 cents on the dollar. The only exception was Lehman, which was quickly decided to be a 'mistake,' to have that happen. Lehman had to go through bankruptcy proceedings. But the question is: Why do you think the government and policy makers were so unwilling to let creditors take any kind of so-called 'haircut'? That they would have to bear some of the price for having funded and financed such bad investments. Guest: That's the $64 trillion dollar question, just to modernize the '$64 thousand dollar question'. Again, very--and bear in mind I'm a tax [?] and look at it from a mainstream perspective--but very New-York-centric; a deep belief that these institutions, especially the big ones in New York, if they were to get into trouble, if they were to fail, then they would bring down the rest of the system. And as you just noted those different names, of course you realize: those institutions that you just cited were not regulated by the Federal Reserve. They were brought into the Federal Reserve System when they were acquired by the kind of institutions that we do regulate. So they went from being subject to what I would hope would have been significant oversight. It appears that they were not. Secondly, market discipline, into a system in which you had a lender of last resort, which is the Federal Reserve. That provides a different level of comfort. So, I think it's important to know that first, we weren't regulating those institutions. They were poorly regulated; they were poorly overseen. Secondly, they were subject to market discipline, and then they were merged into institutions that are overseen by the Fed, and with the Federal Reserve, a central bank, during the time of a panic, as all central bankers have done going all the way back to the early 19th century, are the lenders of last resort. It changes the discipline. And yet the moderate sized institutions, the community banking institutions of which there are nearly 6000 if you add those two groups together, don't have that kind of protection. So, it's an unlevel playing field and it's unfair. Russ: Well, I'm not so interested in the levelness of the playing field. I mean, a level playing field is a good thing in general, but I certainly wouldn't want the smaller banks to get the benefit of the subsidies. That would be the wrong way to make it level. I think the bigger problem is that-- Guest: They are not only not getting the benefit of the subsidies; they are put at a competitive disadvantage. Russ: True. But to me the more disturbing issue is--besides the fact that the taxpayers ended up being on the short end of billions of dollars, equally disturbing to me is that we incentivized scarce capital to be used for stuff that wasn't so productive. Guest: That's a good point. Russ: It drives me nuts when people say, 'Oh, we have to have a competitive banking system.' How about an effective banking system? Guest: You sound like you've been reading my speeches. Russ: Yeah, well I have. Europe is going to take this sector away from us; and my answer is: Let them. Why does American prosperity depend on that? Guest: Let's remember also, Russ: Remember we went through this period where we were all worried that the French would have the biggest banks in the world? This was many, many years ago. It didn't work. Then it was Japan would have the biggest banks in the world. That didn't work. Then I would hear arguments against my position or our position at the Dallas Fed saying, 'But then the Chinese will pick up everything.' Well, let their taxpayer bear the risk. Let other people bear the risk. And by the way, if they do and it's bad business practice, they will pay the price ultimately. I don't want the American taxpayer to pay that price.
14:23Russ: So, let's turn to your solution. There are a lot of solutions out there. After you talk about yours, I'm going to ask you to comment on some of the others that have been put forward. This would be a way to reduce the probability of the kind of bailouts that were "necessary." I'm not even sure they were necessary; but certainly policymakers felt they were necessary; and certainly many economists have justified them, arguing that a catastrophe was prevented. I'm agnostic on that; I'm a little bit skeptical. But put that to the side. What do you see--you have a three-part proposal to try to reduce the odds of having to do this again. Lay it out. How would it work? Guest: Consider, first of all, while we are talking about it, we are talking about very complex financial holding companies. So you have a bank holding company that has a commercial bank and then the non-bank subsidiaries of that bank holding company, say, an investment bank--this is really old[?] terminology--you have security subsidiaries, you have insurance subsidiaries, you have real estate subsidiaries and so on. Under our proposal, only the commercial bank would have access to deposit insurance provided by the FDIC. And only would have access to discount window loans provided by the Federal Reserve. These two features of that safety net would explicitly, by statute as we would propose, become unavailable to any of the shadow banking affiliates--that is the special investment vehicles of the commercial bank, or any obligations of the parent holding company that has these complex other subsidiaries that I mentioned earlier. So, that's the first aspect of our proposal: To make it simple, the only exposure that you would have would be to the deposit-taking institution under a complex bank holding company. And then to reinforce the statute that we propose and the credibility of the proposal, with regard to the other aspects of those large complex holding companies, [?] holding companies, every customer, every creditor, every counterparty of every one of those other bank affiliates and of the senior bank holding company would be required to agree to and sign a new covenant. It's a simple disclosure statement that acknowledges their unprotected status. And we even draft one up. Russ: Fits on a postcard, right? Guest: Yep. And I'll read it to you. It's very simple. Russ: Please do. Guest: It's in my memory. 'Warning: Conducting business with this affiliate of the XYZ Bank Holding Co. carries no Federal Deposit Insurance or other federal government protection or guarantees. I, the counterparty, fully understand that in conducting business with XYZ Banking Affiliate, I have no Federal Deposit Insurance or other federal government protection or guarantees and that my investment is totally at risk.' That's it. Now, I know Congress can't write things that simply. They have to make them horribly complicated. Russ: It's too short. It's too short. Guest: So, by the way: I'm not proposing reinstalling Glass-Steagall. Russ: That was my next question. Guest: What I'm saying is: Let these people operate, and those that--I think if you did this, the market discipline would come to be applied to those other subsidiaries, in a way that would allow some people to continue to practice, because they are good at doing it; and others would sort of fall by the wayside. But I do think this two-part step--it's really a two-part step that I've recommended, a two-part program--would begin to remove the implicit too-easy-to-fail subsidies provided these bank holding companies and their shadow banking operations. Because again, entities other than the commercial banks, in my view and the view of the Dallas Fed, have inappropriately benefited from an implicit safety net. And that safety net is still in place. Russ: Yeah, I know.
18:17Russ: So, let's take an example of an actual institution. I'll use one with an actual name, and you can change it to XYZ Bank if you'd like. But I'm going to use the example of Citibank. Citibank, I can go and I can make a deposit and have a checking account there and have a savings account. And that currently is FDIC-protected. What would change? What parts of these complex institutions would not be protected that currently or that were, say, in 2008? Guest: Well, if my memory is correct, in mid-2012, so a year ago, Citigroup had total non-deposit liabilities of over $800 billion. By the way, that's 5.2% of GDP (Gross Domestic Product); that's a key indicator, but it's an interesting indicator. They had over 3500 subsidiaries and they operated in 93 countries. So $816 billion in non-deposit liabilities. So, remember, under our proposal, [?] only the commercial bank; so the deposit liabilities would have access to the deposit insurance provided by the FDIC. Discount window loans provided by the Federal Reserve would be limited only to that commercial banking operation. So, those other subsidiaries--and by the way, Citigroup has made significant progress in shedding a lot, but at that time--I'm speaking from memory here, and I know those numbers pretty well--all those total nonbank liabilities, over $800 billion, would not be subject to the safety net. And the two features of the safety net would explicitly by statute have become, under our proposal, unavailable to any of those affiliates or special investment vehicles or other obligations of the parent holding company, which I'll refer to as XYZ Bank. Russ: So, the only problem I have with that--and by the way, I think it's a great idea. We'll talk about some of the other plusses and minuses of it in a minute, as well as the competing ideas for making this problem better. But it's kind of the world we lived in in 2006, 2007, 2003. In theory, JPMorgan Chase didn't get FDIC insurance for its activities. Goldman Sachs didn't have insurance on AIG. They thought they kind of did, sort of, maybe, which was they had some Credit Default Swaps to protect them; they could at least say they were protected; but of course those probably would have fallen apart if AIG had been allowed to go through market discipline. And of course those banks wouldn't be allowed to go to the Lender of Last Resort window of the Fed because they are not commercial banks. But they were quickly converted into commercial banks on paper so they could play in the Fed's sandbox. Guest: You're right. Goldman Sachs petitioned us and became a bank holding company. Russ: So, why would this idea, which is basically, 'I'm not going to be naughty any more; I'm going to be a good boy and I'm not going to reward you for your malfeasance banking community'--why would that statute be enforced? Guest: Well, I think it would have to be enforced in practice. And let's not use the word--well, you could use 'malfeasance,' but at least 'misfeasance.' Russ: Sorry. That was a bad choice. I agree. Guest: I've been strong but I don't want to be rude. I think misfeasance and just bad management. So, why should the U.S. taxpayer compensate them for bad decisions? I think it's fascinating. Goldman Sachs came to us, to the Federal Reserve, wanting to become a bank holding company. And then as soon as we got through the process of the crisis, they wanted to shed that status. I think that in and of itself--again, these aren't bad people. They are doing what's best to preserve their franchise. That's the way the system works. But I find it of interest that that was the conduct that they pursued. And if you bring them in to becoming a bank holding company then you are providing this kind of unlimited protection. Now, the way the system has changed under Dodd-Frank is you've created this special body that is chaired by the Secretary of the Treasury that oversees systemically important financial institutions--SIFIs. As you know, my little joke, it sounds like something; SIFIs sounds like you contract through bad behavior. But the point is, that committee--the Chairman of the Federal Reserve serves on that committee and plays a very important role, but it is ultimately chaired by the Secretary of the Treasury. And whether you are a Republican or a Democrat, if the Secretary of the Treasury is facing an institution that is still too large, gets itself into trouble, I doubt any President, Republican or Democrat, is going to let that Secretary of the Treasury allow that institution to fail. So, I don't believe the problem has been solved. Russ: How would your solution make that any better? And let me give you an example of why I worry about it. The 'F' in Fannie Mae and Freddie Mac, that first letter, stands for 'Federal.' But of course on paper, in theory--actually, I think by Congressional dictate-the Congress disavowed any 'F' part of Fannie or Freddie. When they would talk about Fannie and Freddie--and I say 'talk'--when they would have legislation about Fannie and Freddie they would always have the disclaimer that nothing about Fannie and Freddie, the fact that the word 'Federal' was in their name, should be taken to mean that they would be rescued in the event that there was a problem. Of course they were rescued. That statement, which was not quite a statute, but it was an explicit statement, was taken by investors with a wink. And I worry that your solution won't have the same thing. You'll sign that disclaimer, that beautiful, nice, simple warning statement that you understand that your money is at risk there; but you'd be winking when you signed it. Guest: Well, that's always a risk. And I think you just have to have strict implementation. You have to have, as with anything--the way you gain credibility is to practice. Practice as it's been instituted so far has been to bail people out. That's what we saw. Or to merge them into something larger, which then becomes even more too big--if there is such a word--to fail. And the measures that have been taken to address it is a law that is so complicated that we estimate--and others have estimated as well--takes some 24-million men-and-women-hours just to interpret and implement. So in the end it comes down to what you state and the conviction with which you state it. And then the way you follow through and practice it over time. I hope these institutions don't get into trouble. I have seen--you mentioned a specific bank earlier, Citi. They've actually taken action to shed some of their subsidiaries outside of the banking field. I expect that if you state with conviction what we have suggested and you make it clear and it is passed and dealt with by the Congress, whether it's put forward by Elizabeth Warren or it's put forward by the Republican Senator from Louisiana, whoever it may be, the market would begin to price in some of the risks that we actually see. And then we'd have to see what ensues. But again, you don't know until push comes to shove. And all I can tell you right now is despite the honest and good and sincere efforts of the new legislation, I don't believe the system is really significantly changed. We do at the Federal Reserve have more oversight and regulation; we embed more people in these institutions. We have a very strong individual and our governance structure--Dan Tarullo, who is eager to make sure that capital requirements are tight, that liquidity requirements are significant. But in the end you still have these very large, behemoth institutions that put the taxpayer at risk.
26:54Russ: I'm going to make a suggestion that is going to sound like a joke. It's not a joke. I want an honest response. It seems to me that one way to improve the likelihood that these promises would be kept by policymakers and that the expectations would be set for the players--the lenders and the investors involved--I think it would be interesting to think about having a public ceremony where investors of a certain magnitude--so let's say, a bank, a financial institution lending to another financial institution, which is very common, essentially in the overnight market, which part of the problem we get into is you have, say, Citi or J.P. Morgan Chase financing activities by the other. I think a public ceremony where you sign that warning statement and said, 'We recognize that we, by making this investment put our money and those of our investors at risk, and we will not accept money from the Federal government, and we will not accept a bailout,' would at least increase the chances that there would be some shame and other costs--humiliation--that might help it being enforced. Guest: Yeah. It's interesting. In my district, after TARP [Troubled Asset Relief Program] came out, of the second largest bank in this Federal Reserve district, Frost Bank, took out ads that were extremely effective, and billboards, saying 'We turn down and don't need government money.' And it helped them grow market share. So, yours is not a silly idea. And you saw that elsewhere in the country, by the way. Russ: Well, Ford, for a while, a very short while, bragged about the fact that they did not get rescued like GM (General Motors) and Chrysler; and I think there was political pressure on them not to brag about it. And they stopped. Guest: Well, Texans don't bend very much under political pressure. Mr. Evans, who I think was the CEO (Chief Executive Officer) of Frost, was very pugnacious about it.
29:02Russ: Let's talk about some of the other proposals. The two that come to mind are larger capital requirements, which a number of EconTalk guests have advocated for in the past. And also capping the size of banks is a way of avoiding the too-big-to-fail, so putting some sort of cap. What do you feel about those solutions, so-called solutions? Guest: The latter is interesting but I personally want to be careful that we have the least amount of government intervention as possible and have the most market-driven solution. I believe our proposal would lead to more market-driven rationalization, so I would hope it would do that. And I kind of worry about doing things by government fiat. That's just a personal concern that I have. The former proposal is interesting and not unimportant, perhaps necessary, but I don't believe sufficient. When you have a panic or a liquidity run, capital cushions, I'm not sure they are sufficient or could ever really be sufficient to prevent the panic from happening. If someone whispers that the Roberts Bank is going under and it begins to gain credence, you can be as well capitalized as you can imagine. But if you are depending on short-term funding, you can be swamped. This is one of the reasons why, again, the Federal Reserve, and as articulated by Governor Tarullo, has expressed concern about the liquidity profile of many of these institutions and the need to tighten up other requirements for that. It's also one of the reasons that some have proposed, particularly when they take risks with derivatives--the larger the book gets, they need to be subject to higher margins. And I find that somewhat attractive. But I don't think it solves the problem. The problem is you have institutions, a handful, that by the way comprise 0.2% of all the banks in the country--that's 2 tenths of 1 percent--but that are too big to manage. The scale and scope of these institutions are too big to understand. They are too complex. Even, I'm convinced, senior management does not know what is going on in those institutions. So, you can have big capital cushions; that's the approach that's been taken so far. You certainly should have, the bigger their risk is just as you would with a hedge fund, anybody else, you should have higher margin requirements, as they become larger and larger. That would ensure some discipline. But in the end the ultimate root problem is scale and scope. And if you are so big, it's very hard to get back to the basic principle of banking, which is, know your customer, know your risk. And that's what I would like to see achieved. Russ: Before I move on to monetary policy, I want to make sure I've got the full range of what you would advocate. We've talked about two parts. Only the depository, commercial bank part of any institution would be FDIC insured and would have access to the discount window of the Fed. The second part is that people who were creditors of those institutions, these large institutions, would concede on paper and sign a warning that they had received--kind of like when you leave the emergency room; they don't want you to leave and say, look, I'm going against medical advice. You make them sign something that says: It's my money that's at risk and I'm not going to get access to the taxpayer's money. Two questions: Is there a third part to the proposal, and the side-question is on the part about the discount window: how would you monitor that? Guest: First of all, we have 12 Federal Reserve Banks; they all operate discount windows, so it's pretty easy for the Federal Reserve to monitor that. They are the ones that extend the credit. Russ: But how would you decide "who gets it"? Guest: Well, you have supervision, regulatory authority; and you'd make it clear that any violation of this would lead to a cutoff of access to the discount window. I don't think it's that complicated. But that would be the rule of the requirement, and somebody that violated it would be violating the rule of the requirement. It would be a regulatory infraction, and there would be discipline. So, that is our proposal. It is in essence a two-part proposal. The remaining issue is: do you give any government shove in terms of what you suggested, which is limiting size? And although it was suggested that we were--and this is what the banking lobby likes to put out--'the Dallas Fed was saying any bank over $250 billion would be prohibited'--that is not our suggestion and has never been our suggestion. So the question is, does the government need to give a little shove to the marketplace, if you believe governments can give a shove to the marketplace, to make sure we indeed end up with a group of institutions that are too small to save, rather than too big to fail? I'd rather see the market exert its discipline through the two-part proposal we've made before making a judgment as to what other push you might need in terms of government intervention to possibly realign incentives or to reestablish a competitive landscape and a level playing field. But I'm not willing at this point to suggest that step. Russ: My view on it is that until there is a Presidential candidate who makes this a central issue, who stands on this promise, who, after winning, makes it clear that his or her credibility depends on honoring the statute you are talking about, which if it is ever passed, then I think you could get somewhere. Otherwise I worry you get more back in terms of, well, we had to do it because the whole country was going to be destroyed, etc. But it's imaginable that such a political change could occur. And my view has always been that unless there is a simple policy that Main Street understands, it's unlikely any president will get behind any complex, say, Basel III-style regulatory regime. Guest: You're right. Russ: So I think the simplicity of your idea is what recommends it. Guest: May I just add one more thing in terms of that consideration? I was amazed that neither candidate in the last Presidential election picked up this ball. Let me give you a number that's indicative of how this would cut across partisan lines. I engaged in an IQSquared (IntelligenceSquared) debate in New York and in the audience itself--because you know these things are recorded--we garnered 49% of the vote. Russ: Before or after? Guest: After. Russ: In support of your position. Guest: Yes. But here's the important part. Those are the people sitting in the audience, of which I noticed several familiar faces from the clearing house. In fact one came up to me afterwards; I had referred to XYZ Bank; the question had to do with J.P. Morgan; and he said, 'By the way, I'm the Chief Financial Officer of J.P. Morgan.' So how do you think he voted? Now, when you look at the online voting from that debate--that is all the voters--83% voted for our proposal; 17% voted against. Again, as I said earlier, you have Elizabeth Warren, not considered a conservative by any means, proposing exactly what Senator Vitter from Louisiana, who is, say, Tea Party conservative. So this does kind of cut across lines. It's an issue that can actually unify Congress, when they can't agree on anything. And I think it is highly politically palatable. Setting aside the politics, because I am a central banker, not a politician, the point is that it needs to be done. Russ: Well, I think the frightening thing is that, you asked it as a rhetorical--I think you said as a statement it's a surprising thing neither candidate brought it up. And I think we know the reason. And the reason is money. And the reason is where their bread is buttered. And till that changes--I'm a big fan of shame, but that's not what this conversation is about. So let's move on. Guest: Okay.
37:51Russ: Let's turn to monetary policy. Give me your--and you are not a retired central banker. You are very active. You are the President of the Dallas Fed, one of the 12 regional banks; and if I understand it correctly you are going to be a voting member of the Federal Open Market Committee starting some time soon. Guest: That's right; January. Russ: So, I'd like your assessment, as openly as you can give it, as to the last 5 years of monetary policy. It's been an extraordinary time, unparalleled really, in terms of the Fed's balance sheet growth and in some of the discretion that's taken place. What do you think of that? Guest: Well, we have ventured into territory that no central bank has been in before. Others have followed suit. But we have been in the lead. The intentions are sincere; that is, to lift up the economy from a seemingly endemic low-growth period, help, given the franchise we've been given by Congress, which is so-called dual mandate, which means we are responsible for price stability but also achieving--and by the way, the phraseology in Congressional language of the amended Federal Reserve Act of 1978 is "shall maintain long-run growth of monitoring credit aggregates commensurate with the economy's long-run potential", increased production, so it's to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. Russ: Piece of cake. Guest: That's right. Now the key operative word, and my colleague Charles Plosser made an excellent speech the other day on this is 'long run.' But we did have to go to work, as central banks do, as lender of last resort, as I mentioned earlier. During a crisis you open the floodgates; you are supposed to lend against good collateral. We actually did patch together the system when everything failed--from overnight bank lending to money market funds--excuse me, commercial paper market, etc. We did our job. Then we went on to Quantitative Easing, after interest rates were cut to zero. And just to be clear, I was against cutting interest rates to zero, because the question is what bullets do you fire next? Well, the bullets that were pulled out of the holster was Quantitative Easing. We purchased mortgage-backed securities to get the market started. It was an asset allocation decision. I have argued, others have argued, that the Federal Reserve should not be involved in that business of deciding which assets you should invest in, but I admit I supported the very first tranche of our mortgage-backed securities to get that market turned. And we did. But we are now buying $85 billion a month in Treasuries and mortgage-backed securities. I have been against that program. I'll continue to be against that program, and mainly because I don't think the benefits are equal to the costs of our having printed so much money and expanded our balance sheet to over $4.2 trillion. It was a little less than $900 billion before the Crisis started. And now we have a significant portfolio. When we buy a bond, a Treasury bond, or Treasury note, and when we buy a mortgage-backed security, we pay for it; and that puts money out in the system. That money has come back to us in terms of excess reserves. So it's not being lent out, either because there is not sufficient demand for it or because bankers are slowly getting back to have their confidence to lend. Whatever the reason, it's being stored up as excess reserves. And if you think in terms of the language of our amended Federal Reserve Act of 1978, we're required to think in the long term. And what worries me about the long term is we do have and we've talked about and we have an exit strategy to deal with this, but it's a theoretical exit strategy. It's never been done before. And I'm worried about the long-term consequences of having all that money sitting out on the sidelines. These are in depository institutions as well as significant amounts of money sitting in private equity firms and sitting in hedge funds, etc., outside our purview. That's a lot of tender. If velocity were to pick up, how do we tamp it down so that it doesn't lead to inflationary impulses? Right now inflation is not an issue. But our charge, given to us by the Congress, says long run, long run, long run. And that's what I'm worried about. Those are the costs that I'm worried about. And the benefits? Well, I'll be blunt about this. Mr. Druckenmiller said this on television the other day: this is great for rich people; it's great for Warren Buffett. Bless his heart, he's a good investor. Good for Mr. Druckenmiller and others, they get money for free. It hasn't done what we wanted it to do, which is lead to greater job creation for the two middle income quartiles. Some people refer to the middle class--I don't like the word 'class' because I believe America is a classless society. But the middle income quartiles--other than in Texas, by the way--for the last 10 years have had job destruction, not job creation. And that's who we should be working for as a central bank. We work for the American people, not for the rich. Is that outspoken enough for you? Russ: Yeah, that's good. I like the honesty. Much appreciated. Let me ask a naive question: how is there still $85 billion of stuff to buy every month? Don't they have--doesn't the Fed have most of it? Is there still--and who are you buying it from? Who is still holding mortgage-backed securities that they haven't already sold to the Fed? Guest: Well, that's a great question. It's a question of stock and flow. But in terms of flow we are fast approaching 100% of the gross issuance of mortgage-backed securities. And we have about 35% of the stock of U.S. Treasuries. Now, this will sound silly to you, but remember I'm a Texan and I do remember the Hunt brothers; and it's one thing to buy up silver and then to try to sell it. Now, obviously Treasuries are much more liquid, mortgage-backed securities, much more liquid. But what I've talked about at the table and am concerned about: it's different when you are a buyer. When you are a seller then you are on the other side of the market. And if you listen carefully to what you hear, market commentators and so on, it's hard to hear anybody that's really in favor of buying U.S. Treasuries here. We've driven yields to--even though the yield curve has sharpened recently, steepened, we did drive yields across the curve through our Operation Twist and our expansion of the duration of our portfolio, to the lowest rates in, what, 237 years of U.S. history. Lowest rates in memory, certainly. Which direction do you go from here? And how long can you do that? How long can you--even Chairman Bernanke and others have said this doesn't go on indefinitely. And the markets have become so significantly dependent on what is the Fed doing. But I worry as we are just viewed as the ultimate solution. That's not the role central bankers should play. Even Keynes said: we should be thought of as dentists; you only go to us if you need us. But instead we are playing a central role in American capitalism here, and in market-driven side of American capitalism, and I think it's a dangerous place to be. It puts us in jeopardy. So, I'm very worried about this, and I expect that my own voting behavior will reflect this concern that I just stated. I don't think these are programs that should be continued, and I worry about the fact that we've already painted ourselves into a corner which is going to be very hard to get out of.
46:19Russ: So, why do you think the Federal Reserve is paying interest on reserves? One of the challenges of this, stranger parts of this conversation and this episode that we are talking about is that those reserves, those excess reserves, banks are holding much more at Federal Reserve accounts than they are required to by law. They are required by law to hold a certain amount. They have massively more than that sitting at the Fed, not being lent out, not being invested. Now, this idea that somehow low interest rates are going to make it more attractive to borrow and invest is only true if there are good opportunities. Usually there are a lot of opportunities at a quarter percent interest or .5% interest. Why do you think banks aren't lending? Why are they not lending, and do you think that the payment of interest on reserves is part of the problem or irrelevant? Guest: Well, I don't think any banker is happy getting 25/100ths of one percent--that's per year--rather than lending it out at 4 or 3 or 6%. So bankers want to make loans. That's what they are paid to do; that's what they want to do. There either is insufficient demand--which I think is the main thing right now--or there are only, as we see from our senior loan surveys of senior bank officers, there's an increased willingness to take risk. And by the way, some of the risk that's being taken raises some question marks: no-covenant lending, highly risky, particularly by the largest institutions. And we are constantly getting reports from smaller banks and regional banks that the offers being made out there are considered by them to be imprudent. So there's a lot of excess liquidity in the system. I don't think 25 basis points is the reason they are keeping it with us. They are keeping it with us because there is a lot of liquidity out there. I'll give you and example of a very large company that I just spoke with this morning. I survey CEOs on my own; I do it constantly. And I do it across the country, not just in my own Federal Reserve district. So this is a major company outside of my district. So, for 2013-2014, their CAPEX, that is Capital Plan Expansion, for which they hire people, in this very large company's case, is a little over $30 billion. They have placed $40 billion--so more than CAPEX--to work by borrowing cheap to buy back their stock and increase their dividend payment to hold up their stock price. Something's wrong with this picture. Now, their balance sheet is in great shape. And one of the things that's come out of this Quantitative Easing and also the zero interest rate, what's called ZIRP, zero interest-rate policy, has been that U.S. companies are now, their balance sheets are as fit and as top and as clean and as well-structured as I've ever seen them. In my kids' parlance, they are ripped. They are ready to roll. But there are disincentives and great uncertainties out there, either about final demand or health care insurance or regulatory excess or fiscal policy--what will their taxes be, what will the spending be?--that they are disincented [sic] from actually investing in job creation. And many of them have learned that they are so productive and can produce the same amount of goods and services with lesser amounts of people thanks to harnessing IT (information technology)--the game seems to have changed. And there is less need for the constant credit that we are creating in the market system. This is one of the reasons that I don't think we need to continue buying $85 billion. We can reduce that amount. In my opinion, we should reduce it over a clear time frame that's stated in public it's going to end, because there is an enormous amount of excess liquidity throughout the system. That's a longer answer than you wanted, but I wanted to lay it all out on the table. Russ: You've reminded me of something I meant to ask you earlier. With that Fed balance sheet of $4-plus trillion dollars, all said, of assets--a lot of it is mortgage-backed securities, some of it is not--you made a reference to the Hunt brothers, an historic episode where they tried to corner the silver market. So, congrats to the Fed. They have cornered the MBS market, the mortgage-backed securities market. What's that stuff worth? No one talks about--well, they do occasionally, but there's very little public discussion of what kind of gains and losses that the Fed will take on its portfolio. It's usually--it was often claimed in the early days, 'Well, they could make money on it. They could actually make a profit.' I don't hear any of that talk. Guest: Well we did. Well, actually we did. And actually the Chairman has talked about this. I've talked about it, and others. We've returned to the taxpayer, because we are a profit-making institution, but we don't pay our profits out to the public shareholders. We do have banks that are our shareholders, the 12 Federal Reserve banks. We pay them a preferred[?] dividend. And then we pay what would be in a normal business a profit to the Federal government through the U.S. Treasury. So we've returned over $300 billion, as the Chairman has said, and I've said and others have said, to the taxpayer over the last 3 years. That's what happens when interest rates go down and you have a portfolio. A lot of it has been driven by our Federal Reserve New York desk operation, which trades on behalf of all 12 Federal Reserve banks in the system. The question that you raise is an interesting question, which is, if it goes in reverse and interest rates go up because the economy gets stronger or because, in the worst case, people begin to impute some potential inflation--that would be the bad outcome; the good outcome is the economy gets stronger--you are holding a portfolio with an average duration which is out on the yield curve and you begin to take a loss. And just so your listeners understand, the way it's done on the accounting, this business, is it's booked as a deferred asset to the Treasury. Question: Will Congress remember that we made 3 years of substantial profits, if, in fact, interest rates go up, for whatever reason, and the market value of our portfolio declines? I somewhat disrespectfully suggest that Congress has the memory of fish. And fish have no memory. So my suspicion is that if something were to go wrong, then they would turn on us once again, as they did very harshly during the whole TARP and other episodes, put us in the spotlight and say, You lost money for the taxpayer. They'll forget how much money we've made. So I think it's important that the Chairperson of the Federal Reserve and Federal Reserve Presidents like me, remind the public that we did make money for the taxpayer. In fact, we are probably the only people that did make money for the taxpayer. And it's not insignificant. Russ: Well, but--there's some accounting issues on how you measure that, obviously, and what opportunity cost you attribute to the funds, which is ignored usually in those measures. But the part I'm wondering about is a simpler question. The underlying assets of those mortgage-backed securities and what the prices that the Fed paid for them. How is that money going to get reclaimed? Are all of those mortgages that are in those securities good? Are they all going to be paid back? The answer is no. Isn't there going to be a potentially large capital loss? Or maybe a gain? Guest: Well, first of all the accounting for those is very interesting. They are paid down over time. So it's a complex matter. It would take me a couple of days to walk you through my old experience of how [?] been invested in those when I ran a hedge fund and I ran an investment firm. And of course we can sit on them till maturity, and then you don't realize the loss. Your question is the underlying credit-worthiness, and I'm very confident that, again, these are--you go back to Freddie and you back to Fannie and you go to Sallie Mae--these are securities backed by those institutions. Assuming that those institutions are sound, and under the law, we are allowed to buy those securities. We are only allowed to buy two securities. We are unlike the, say, the Bank of Japan that can buy anything. Only U.S. Treasuries or U.S. agencies. And those are the securities that we buy. One more thing, if I may add. Russ: Go ahead. Guest: We are the only business and the only government, quasi-government, institution that posts its balance sheet in terms of what its holdings are, on the internet, every week. So someone can go in, take a look at what we own. They can price them accordingly. And they get a good sense of what the market value is. Even though not everything we hold is [?] at market value. Russ: I have to say, Richard, you remind me of when a friend will say to me--oh, it's easy to install those lights. It's simple. In my house. You don't have to hire somebody. I'm thinking, yeah, but not me. So it may be on the web, but for most American citizens-- Guest: I've changed all my lights this weekend, so you're right; it's not easy. I had to call in a professional to help me with three of them. Russ: Congrats. But I think for most people that task on the web is pretty daunting. It's daunting for me, and I'm an economist.
56:00Russ: We're almost out of time. There is an expected change coming in the Chair of the Federal Reserve. Do you think it matters? Guest: Well, first of all, to be fair to--I think there's sort an underlying question mark there about the new leadership. When you become chairman of something, you have to conduct the committee. There are 19 Members of that Committee. There are 12 Bank Presidents and there are 7 Governors when we have a full complement of governors--which we don't have. And whether it's Janet Yellen or Ben Bernanke or whoever it be, they cannot impose their own personal views on the entire Committee; they have to win the Committee over. Remember, Paul Volker got voted against several times by his Committee, and he's the Moses of central banking. So, I think it's important to understand that being a leader is different than being a proponent of an individual view, as a Governor or as a Bank President. But we'll have to see how things change. One of our big issues here is communicating with some reliability what we will do down the road; and remember the parlance of the Amended Federal Reserve Act of 1978--over the long run. And we have not been able to communicate clearly. That's pretty clear. I view my job as one of the 19 people at the table to demystify as much as possible and speak in the plainest English. I've been trying to explain what we do. And I did take note by the way, and your listeners might want to tap into the great interview done in the FT (Financial Times) with Ha-Joon Chang, who is what they call a Reader at Cambridge U. of economics. He's a remarkable individual. Listen to this quote--and I think it's correct: "Today the economics profession is like the Catholic clergy that refuse to translate the Bible. So unless you use Latin, you couldn't read it." Well, central bankers talk about transparency, but our discourse is still conducted in what I consider to be the economic equivalent of Latin. And I'm doing my best to continue to translate for, let's call it the Fed clergy. We're going to have to figure out a way to first decide what the limits are, make them clear, signal those clearly by clearcut rules to the marketplace. Quantitative Easing, large-scale asset purchases cannot go on forever. You reach a point--if you believe that you were getting benefits--of diminishing returns. I don't believe, by the way, the program was ever beneficial. But you've got to admit after a while things reach diminishing returns. And that will be the task of the Federal Reserve under the new Chairperson. Timing, lend, how you deal with markets that are significantly priced right now; certainly equity markets are, in inflation-adjusted terms, near their all-time highs. And it won't be an easy task. But the Chairperson embodies the Committee, expresses at a press conference and their public testimony for the Committee, and they don't express their own views. And I think that's an important thing to bear in mind.