cc

>> Lorrie Keating Heinemann:

Thank you very much.

I'm really honored to be here,

and I did not know when I took

this position back in 2003 it

would be quite the challenge

that it has become, but indeed

it is.

Tonight I've been asked to talk

briefly about the state of

Wisconsin's banking environment

and to introduce our highly

esteemed speaker.

First, because I am the

Commissioner of Banking for the

state, I have to tell you that

our banks are not exempt from

the economic downturn.

While the majority of our banks,

we regulate 217 state chartered

banks in the state, while the

majority of them remain strong,

many are experiencing a high

percent of loan delinquencies

caused by the decline in real

estate values, and the increase

in unemployment levels, which

I'm sure is a surprise to none

of you.

Our average capital ratio, which

is basically the capital in the

bank divided by the total

assets, is a respectable 9.8%

and is actually better than

the overall national average of

all banks in the United States.

However, our bank earnings are

down.

One out of five banks are now

reporting negative earnings.

Earnings have been under

pressure due to the need for

increased loan losses, because

when a loss is taken, they have

to put more in their loan loss

reserves, tight net interest

margins, and the increased cost

of FDIC insurance premiums.

The weakening economy has also

reduced the number of qualified

borrowers and has resulted in

increased scrutiny by both the

state and the Federal

regulators.

In Wisconsin, we actually

partner with the Federal Reserve

banks of Chicago and the one in

Minneapolis to oversee the

operations of our Fed member

banks, and I know you're going

to hear a little bit about the

Fed today, so I thought I'd

mention that.

But we also partner with the

FDIC as we co-examine many of

the banks throughout the state

of Wisconsin.

I will point out, because I'm

kind of a champion for the

community bankers, that the

life's work of many of our

bankers in the state is being

challenged by the costs of

paying for the excesses of some

"too big to fail" institutions.

Wall Street is impacting

Main Street.

The result is a tightening of

credit on businesses in our

state at a time when the funding

is needed the most.

So as it was asked a little

earlier, how did we get here?

And that's what tonight's

author, Liaquat Ahamed,

is here to talk about.

Quoted just over a year ago,

Mr. Ahamed said that

"nothing brings home the

fragility of the banking system

or the potency

of the financial crisis

more vividly than writing

about these issues

from the eye of the storm."

These words really ring true

today as our country moves

forward with the repair and the

recovery of our global financial

system.

Last year I believe Mr. Ahamed

had a pretty busy year, it

sounds like, from looking on

your reviews on the website.

When he was putting his

finishing touches on his book,

"Lords of Finance: The Bankers

Who Broke the World," he talked

about the book being about a

story of four central bankers in

the years after World War I

and what Mr. Ahamed calls the

"seminal economic event of the

last century," the unprecedented

breakdown of the global economy,

or what is now known

as the Great Depression.

Mr. Ahamed's book, which is his

first, I believe, has been

universally praised and it has

become a best-seller.

The book has also won the

Spear's Book Award for the best

financial history book of the

year.

Mr. Ahamed will tell us tonight

if he saw things coming, what he

knew and when he knew it, and

better yet, what he thinks will

lie ahead.

Known as a lover of words,

a master storyteller, and a

historian, Mr. Ahamed is all of

these.

But he has also been a

professional investment manager

for the past 25 years.

He has worked at the World Bank

in Washington DC.

He served as the chief executive

of a New York investment

partnership, and he is currently

not only an advisor to

investment groups, but a

director of the Aspen Insurance

Company and is on the board of

trustees for the very highly

respected Brookings Institute.

So with that, I would like to

bring up Mr. Ahamed, who will

talk about his book,

"Lords of Finance: The Bankers

Who Broke the World."

( applause )

>> Liaquat Ahamed: Well,

thank you for those kind words,

Secretary Heinemann.

And thank you to the academy for

inviting me to speak.

I should just actually put one

issue to rest, which is, I

started writing this book about

four or five years ago and it

was published in January this

year.

And when it came out, a lot of

my friends said, "You must be

some sort of genius,

you figured this out

four or five years ago."

They would always then end up

by saying, "But if you'd figured

it out that we were going to

have this crash, why didn't you

give us a call and let us know?"

( laughter )

So I didn't figure it out.

We have just been through the

worst financial crisis since the

Great Depression.

It may be of little comfort to

know that financial crises are

nothing new.

Indeed, the first recorded

financial crisis occurred

in AD 33 when there was a run

on the imperial banking system

and the emperor Tiberius

had to inject a million

gold pieces to stabilize

the Roman banking system.

Not only have they been around

for a very long time, but there

have been a lot of them.

In 1721 we had a thing called

the South Sea Bubble, and that

was the first time the word

"bubble" was used to describe an

out of control financial mania.

But since then there have been,

depending on how you count,

anywhere from 40 to 50 different

financial booms and crises.

So I suppose the good news is

that we've always recovered,

because here we are.

I suppose the bad news is that

we keep on making the same

mistakes over and over again.

The frequency of these financial

crises varies.

Starting from the early 19th

century and right through to the

mid 20th century, they seem to

occur every nine to ten years.

In fact, if you're a reader of

the New Yorker, there was an

article, not last week, but the

week before which described

someone who is sort of an expert

in financial cycles, and he

computed that they occurred

precisely every 8.6 years.

The system then went dormant in

the 1950s and '60s, and then

suddenly in the early 1980s the

volcano seemed to reactivate and

we got a sequence of crises.

We got 1982, emerging market

crisis.

1987, the stock market

collapsed.

1990, the SNL problem.

1994, Mexico and the peso

crisis.

1997, 1998 was the Asian crisis,

the Russian defaulted, long-term

capital.

And 2000 was the tech bubble.

So first of all, it looked as if

the frequency of these crises

had increased and we were

getting them every three to four

years.

And that's when I became

interested.

I was in the investment

management industry and I began

to read up about past crises in

order to understand what drives

them, why they start, how they

develop, what to do about them.

There's no better place, or

there's nothing that provides as

much food for thought as the

mother of all crises, which is

the Great Depression that

started in 1929.

Today, I'm not going to talk

very much about my book.

I'm going to really try to focus

on the parallels between what

happened then and what's just

happened.

I'll divide the chronology into

three areas, the lead up, the

handling of the crisis, and the

recovery.

So first the lead up.

The similarities in the lead up

to what has happened just now

and what happened in 1929 are

eerie.

In both cases we had a bubble,

and it was in the stock market,

this time it was in real estate.

In both cases, the bubble was

created by a mistaken Fed

policy, specifically over-easy

credit.

In both cases in my view, the

mistake was exacerbated, if not

caused, by a malfunctioning in

the international financial

system.

Let me spend a couple of moments

on this.

In the 1920s, the problem was

between Europe and the US.

Many people forget, 1929

occurred only ten years after

the end of the first world war.

The most expensive, costly war

in history that essentially

bankrupted Europe.

For four years, the three major

European powers, Britain,

France, and Germany, spend 50%

of their GDP per year fighting

this sort of pointless war.

They financed it by borrowing

massive amounts both from their

own citizens and from the US in

the case of Britain and France,

and ultimately by printing

money.

So they basically destroyed

their financial system.

In the ten years after 1919,

Europe was trying to rebuild

itself and in order to do that,

the US kept credit easy, because

Europe needed foreign financing

in order to reconstruct.

The Fed found itself with a

dilemma.

It had to keep credit easy in

order to rebuild Europe.

That easy credit provoked a

bubble in the stock market.

And as usual, when the Fed's

trying to do too many things, it

accomplished neither.

So the easy credit designed to

essentially revive Europe after

the first world war was what

provoked the stock market

bubble.

The more recent crisis, or this

recent ten years, the bubble was

associated with a slightly

different imbalance, and the

imbalance was between Asia and

the US.

There were two mechanisms that

happened.

Essentially, beginning in the

early part of this decade, Asian

currencies were undervalued.

China embarked on a massive

export push, the other Asian

countries in response to the

Asian crisis of 1997 decided

that they wanted to accumulate a

vast reservoir of dollars.

They basically said, we never

want to get into this position

again.

And so they went out of their

way to accumulate a reservoir of

US dollars.

In order to do that, they

undervalued their currencies and

pushed exports out.

That did two things.

It, one, confused the Fed.

What happened was that because

of this export push from Asia,

inflation was unusually low

because the Asian countries were

underpricing their goods.

The Fed mistook the low

inflation as a symptom of a

domestic economy that was

running out of steam.

So, put its foot on the

accelerator.

In fact, what was happening was,

we had a once in a lifetime

expansion in the supply of goods

and services coming out of Asia.

If you like, it was good

deflation and the Fed was

worried about what it thought

would be bad deflation.

The second thing that happened

was that the accumulation of

dollars in the hands of Asian

central banks overwhelmed the

capacity of the financial system

to handle it.

So essentially these dollars

were put into financial

institutions who then ran out of

lending opportunities and then

channeled them into the worst

sorts of lending, made some very

poor lending decisions.

So the combination of an over

easy Fed and a massive amount of

dollars swimming around the

financial system provided the

fuel for the real estate bubble.

To go back to the story, in both

cases, we had the same debate

about how to react to the

bubbles.

During the real estate bubble

that was occurring in the early

part of this decade, Alan

Greenspan, the chairman of the

Fed, argued four things.

One, that it was impossible for

the Fed to identify bubbles

exactly, that it could only tell

if something was a bubble

exposed, once it burst.

Secondly, that bubbles are an

inherent sort of part of a

dynamic capitalist system, a

product more of human psychology

than easy credit and there was

nothing the Fed could do about

it.

Thirdly, that if he tried to do

anything about it, he would be

overstepping his mandates and

would get himself into a lot of

political hot water.

And fourthly, that the side

effects of trying to deal with

the bubble, side effects of the

medicine, would be worse than

the disease and that it was more

efficient and less costly to

deal with the after effects.

In effect, let the bubble burst,

burn itself out and burst, and

then deal with the consequences.

Every one of those arguments

surfaced within in the Federal

Reserve in the 1920s, so there

was nothing new, and they made

exactly the same decision.

They made the same calculation

that they would step aside and

let it...

I must learn not to mix

my metaphors when I talk

about bubbles.

But let itself blow up.

In both cases, both in the 1920s

and now, we had excess leverage.

In the 1920s there was

development of what were known

as investment trusts, which are

real leverage closed-end funds.

And there was a lot of leverage

by a group of traders on Wall

Street known as Pool Operators,

who were like the hedge fund

managers of the era, who

borrowed extensively in the

broker loan market and in those

days, if you wanted to buy on

margin, you only had to put 10

cents down and you could borrow

the other 90 cents and buy a

dollar of stock.

Recently, the leverage has

occurred in the financial system

and in particular what has come

to be known as the shadow

banking system.

So what is the shadow banking

system?

If you take the total size of

banks in the US, they amount to

about $10 trillion compared to a

GDP of about $15 trillion.

In addition, though, to those

banks, there are a whole series

of other institutions that act

like banks, but are not called

banks.

I'll give you an example that

you all use, which is money

market funds.

What do money market funds do?

You deposit your money in the

money market fund, you often

have check writing privileges,

you can withdraw your money when

you want.

And what does the money market

fund do?

It invests that money in a whole

series of investments, exactly

like a bank does.

Total size of money market funds

is somewhere between

$3 and $4 trillion,

so it's almost half the size

of the banking system.

In addition, we had investment

banks that operated like banks.

They borrowed short-term and

bought long-term assets.

Total size of the balance sheet

of investment banks was another

$3 to $4 trillion.

All of these institutions

operated like banks without two

things.

One is the regulation that banks

are subject to, and in

particular, the capital adequacy

requirements that banks are

subject to.

Secondly, without the sort of

oversight of regulators looking

at what they were doing.

This became, this shadow banking

system, became the most

vulnerable part of the financial

system.

Okay, so, in both cases we had a

bubble.

In both cases, as they always

do, the bubbles burst.

And in both cases the bursting

bubble led to a banking crisis.

In the 1920s, it was a

conventional banking crisis.

You remember those grainy,

black-and-white photographs of

people lining up outside banks

to take their money out.

That was in the days before

deposit insurance.

Now that we have deposit

insurance, there was very little

of that, although we did get

some cases.

We got a run on a bank in

California called IndyMac.

We got a run on a UK bank called

Northern Rock.

We got a run on a Hong Kong bank

called Bank of East Asia.

This time, we had a run on the

shadow banking system and it was

actually more insidious and more

dramatic because the shadow

banking system, aside from money

market funds, largely finances

itself through wholesale sources

of money, not retail sources of

money.

The run occurred, essentially it

was a digital run.

Institutions got on their

computers and with a click of

the mouse pulled out hundreds of

millions of dollars out of

financial institutions.

So we've had a banking crisis.

All financial crises seem to

throw up a signature crook.

This time, the signature crook

is a man by the name of Bernie

Madoff, you've probably been

reading about Bernie's exploits.

The Bernie Madoff of the 1920s

was a man by the name of Ivar

Kreuger.

He was a Swede, he ran a match

manufacturing company.

Because of the conditions in the

'20s, a lot of European

countries, but a lot of

countries in other places, had

bankrupted themselves during the

first world war.

So Mr. Kreuger discovered that

he could borrow on better terms

than most countries.

So he went into the

international banking business,

and what he would do was borrow

money on Wall Street and lend it

to countries.

In return, he would demand a

monopoly over match

manufacturing.

He did such deals in Ecuador,

Peru, Poland, Greece, Hungary,

Yugoslavia, Romania.

In 1926 he did a deal like that

in France, and most famously, in

1929, in Germany.

He made himself the third

richest man in the world.

He was a confirmed bachelor and

he had six or seven residences

around the world in which he

installed different girlfriends.

He went into the movie business

and was responsible for

discovering Greta Garbo.

In 1932 he was found in his

apartment in Paris with a bullet

wound through his heart.

Initially, everyone sort of felt

very sorry for him, saw him as a

victim of the tension of the

time.

It then turned out that he had

borrowed money by forging

government bonds and his last

transaction had been to forge

$100 million in Italian

government bonds.

Eventually, his bond holders

lost a total of $400 million.

Now, one way of converting

amounts from the 1920s to now is

to multiply by 200.

That sort of adjusts for the

size of the economy, so that

works out to about $80 billion

today.

So I think he actually probably

beat Bernie Madoff.

He was interviewed by the

Saturday Evening Post and they

asked him, "Mr. Kreuger, what's

the secret of your success?

You're the third richest man

in the world."

And he said, "Three things.

First is silence,

the second is more silence,

and the third

is still more silence."

You can see why I compare him

to Bernie Madoff.

Then as now, the bursting

bubble, the banking crisis and

the scandals brought discredit

on all those involved in running

and regulating financial

institutions.

If you think that outrage at the

sort of so-called greed and

excesses of Wall Street is

something new, get this.

In 1933, congress decided to

hold hearings on the source of

the financial problem.

The hearings were led by a young

district attorney from New York,

Ferdinand Peccoro.

He got all the chief executive

officers of the major banks to

come and testify, and we

discovered the following.

The president of Chase was a man

by the name of Albert Wiggins.

In October 1929 when the stock

market crashed, he had made

$4 million.

Now remember, the way you

convert it is to multiply by

200, by shorting the stock of

his own bank at the beginning of

October.

Talk about a conflict of

interest.

Charlie Mitchell, who was

president of what is now

CitiBank, and Jack Morgan, who

was the head of JP Morgan, had

both earned a million dollars a

year for three years and neither

had paid a cent of taxes.

Bankers became nicknamed

"banksters."

In 1934, Andrew Mellon, who

had been secretary of the

treasury under three presidents

and had been hailed as the

greatest treasury secretary

since Alexander Hamilton, was

indicted for tax evasion.

The treasury department demanded

$2 million of back taxes.

He, by the way, was the third

richest man in the country.

He eventually settled for

$600,000 and agreed to donate

his paintings to the national

gallery.

( laughter )

So we got something out of it.

There are many echoes of the

past in today's headlines of

Wall Street's excesses.

So if you'd taken a snapshot of

the world, about 16 months into

the Great Depression in the

beginning of 1931, this is what

you would have found.

Stock market was down about 50%,

profits were down about 50%,

global industrial production was

down anywhere from 15% to 20%.

Well, guess what.

In May of this year, if you'd

taken the same snapshot, again

about 15 months into this

current recession, you'd have

found the stock market was down

about 50%, profits were down

about 50%, and global industrial

production was down somewhere

between 15% and 20%.

The difference, of course, is,

in the subsequent 18 months,

from January 1931 to June of

1932, the bottom fell out of the

world economy.

Stocks ended up down, in the US,

down 89% eventually.

World industrial production fell

another 20%, so it went down 40%

all together.

That is not happening this time.

In fact, we're getting a

recovery.

So, what's the difference?

What happened in the 1920s was,

they took, the authorities took

a very sick patient and gave it

exactly the wrong medicine.

They did three things.

First is, they let the banking

system go under.

They essentially argued, the Fed

argued, that our job is to

provide temporary loans to deal

with the liquidity crisis, not

to compensate you for the bad

investments and mistakes that

you've made, not to compensate

bankers.

The problem is that in a

depression, the distinction

between what is known as a

liquidity problem, which is,

you need temporary money,

and a solvency problem, i.e.,

you made bad loans,

begins to erode.

Essentially, if everyone has a

liquidity problem, everyone's

trying to dump assets at the

same time and you convert what

is a liquidity problem into a

solvency problem.

So, the Fed let the banking

system go under.

Secondly, they tried to cut

budget deficits by raising

taxes.

1932, Hoover, they believed that

budget deficits were always a

bad thing.

In 1932, Hoover raised taxes.

And the third thing, the height

of all folly, they even raised

interest rates in the middle of

the Great Depression.

In 1931, Germany raised interest

rates from 4% to 15%.

The UK followed a month later

and the US even raised interest

rates from 2% to 5%.

You ask yourself, why on earth

would they do that?

Well, it was the gold standard.

Essentially what happened was,

the run on the banks caused a

lot of gold to leave the banking

system and all these countries

started scrambling for gold.

The way they competed with each

other was to raise interest

rates to try to attract gold.

It was actually a slightly

crazier system than that.

Gold is incredibly heavy and

expensive to transport.

A cube of about 18 inches

by 18 inches ways about a ton.

Countries, instead of shipping

gold around the world, decided,

what we'll do is, we'll just

keep it in one place and just,

by a bit of bookkeeping, move it

around.

So, when Britain lost gold to

France, what would happen is, a

guy would go down into the

vaults of the Bank of England,

two guys, and they would go to

the vault, and they'd go to one

side of the vault and they'd

load all these ingots on and

they'd put it on a little cart.

Then they'd trundle the cart

over to the other side of the

vault and they'd offload it and

they'd stick a little flag in it

saying, "This now belongs

to France."

So you had this absurd system

where Britain was causing mass

unemployment, raising interest

rates, causing mass

unemployment, because there was

not enough gold on one side of

its vaults and too much on the

other.

It was clearly an absurd system

which then collapsed.

What I do is, I liken these

officials to 18th century

doctors, who thought the cure

for illness was to draw blood

from the patient.

And we haven't learned many

things in economics, but we have

learned that when you've got a

patient who's sick, the cure for

their disease is not to draw

blood.

So we're now doing none of those

things.

No one is letting the banking

system go under.

We briefly, for one day,

experimented with letting a bank

go under, and look at the

consequences.

So we have thrown unprecedented

amounts in to support the

banking system.

Secondly, no one thinks that we

should be trying to raise taxes

or cut the budget deficit at the

moment.

Indeed, we've expanded

collectively, countries have

expanded their budget deficits

around the world by about 5% of

GDP.

And no one's planning to raise

interest rates.

No one has raised interest

rates, and no one's planning to

raise interest rates.

Indeed, they've intervened to

try to get long-term rates down.

The lead up was eerily similar.

How they handled the crisis was

very different.

Let me spend the last few

moments on the recovery.

Contrary to what most

conservatives argue, the

recovery after 1933 was very

strong.

Industrial production doubled in

a four-year period in the US as

it did in Germany.

The first Roosevelt term

represents the strongest

peacetime presidential term of

economic growth.

Where the conservatives are

right is that unemployment

remained obstinately high.

Employment lagged behind, in

part because many of the New

Deal policies in effect raised

the cost of labor so employers

found it more profitable to

expand production without having

more workers.

Second thing, contrary to

popular myth, the recovery

across the world, particularly

in the US and Britain, had very

little to do with deficit

spending or Keynesian policies.

Roosevelt was a victim of the

same dogma at the time, that he

thought budget deficits were a

bad thing.

So while the New Deal policies

did cause some modest increase

in public expenditure, it was

financed by raising taxes.

The only place where we got

massive public works financed by

government borrowing was in

Germany, which is the only place

which had essentially pursued

Keynesian policies and, by the

way, was the only place that did

not face an employment problem

during the 1930s.

So what happened?

Most countries recognized that

the gold standard had become a

straitjacket and broke with

gold.

This allowed them to massively

cut interest rates.

Now, one problem with relying on

easy money around the world as a

way of promoting recovery is, it

works in part by causing your

currency to fall, thus stealing

markets from your neighbors.

We got a spiral of

beggar-thy-neighbor policies and

competitive devaluations.

In response to these competitive

devaluations, plus the high

unemployment, countries

responded by hunkering down

behind high tariff barriers,

imposing import controls, and

putting restrictions on capital

flows.

So the gold standard, which had

been a very rigid sort of

straitjacket, and obviously

needed to be replaced, was

replaced by a sort of chaotic

and disorganized system of

floating exchange rates.

Countries lost confidence in the

international system's ability

to reconcile their conflicting

interests and ambitions.

There was a disastrous backlash

against globalization, and it

was a time of the worst sort of

populism and nationalism.

So far we seem to have learned

the lessons of the 1930s.

We've been, first of all, far

more willing to rely on fiscal

policy, i.e.,

expanding budget deficits

as a stimulus mechanism.

In contrast to monetary easing,

which works by in effect trying

to steal markets from your

neighbors, fiscal expansion

actually has positive spillover

effects.

If you spend money, it causes

your imports to go up and that

helps your trading partners.

There's much more cooperation.

There's much less competition

this time.

There are, however, three

parallels, and these are enough

to keep you worried.

The first is, it's clear in both

cases, global financial

arrangements have become

unsustainable.

In the 1930s, the weak link was

Europe versus the US.

A Europe that had become way too

dependent on US lending and when

the music stopped collapsed.

This time, the weak link is at

home, is the US consumer who's

run out of borrowing room.

That means that the Asian

countries that have centrally

relied on an export-led

industrialization pattern into

the US will have to reevaluate

their strategy.

The danger is, if someone like

China finds it too politically

costly to restructure, we're

going to get trade wars.

Second parallel.

Charles Kindelberger, the

economic historian, wrote a book

where he said, the Great

Depression really came out of a

failure of economic leadership

on the world stage.

By that he meant that what we

needed, the world economy

required a leader.

What he meant by leader was, a

country that was willing to do

more than its fair share.

Stress on "more."

More than its fair share as

the supplier of capital of last

resort during the crisis and

acting as the economic

locomotive.

Excepting the fact that small

countries will freeload off you.

So being a leader means that you

know that people are freeloading

off you.

In the 19th century, Britain had

served that role.

First world war bankrupted

Britain, it was unable to.

The mantle should have passed to

the US.

The US, though, was run by a

group of very parochial,

insolent men, and refused to

accept that mantle, and

essentially we got a vacuum of

world leadership.

After 1945, the US took on that

mantle and for a good 50 years

has essentially acted as the

leader.

The question is now, are we at a

similar transition point in

world leadership?

Has the US been so damaged by

its cumulative borrowings

abroad, the fact that it's had a

banking debacle, its foreign

policy reversals, that it's no

longer able to act as the

leader?

If it can't, who can?

China's too small.

The good thing is, we have more

of a tradition of

multilateralism and countries

acting together, but there's

enough here to keep you worried.

And the third thing is that in

this recession, in contrast to

many other recessions,

unemployment has gone up as much

as output has fallen.

I.e., companies have used this

opportunity to lay off workers

in an unprecedented way.

There used to be a thing that

economists used to refer to

called Okun's Law, which is,

during a recession, for every 2%

fall in output, employment fell

1%.

This time, the relationship is

one for one.

Those are all three things to

worry about.

Ultimately, though, the real

challenge comes from those

aspects of the situation where

we find ourselves in uncharted

territory, where the experience

of the 1920s or '30s or any

other period just cannot provide

any lessons because the world is

so different.

Let me give you one example.

In 1929, the banking system was

about $50 billion and GDP was

$100 billion, so it was about

50% of GDP.

Now, if you take the same

statistics, the banking system

accounts for $20 trillion, which

is about 150% of GDP.

So it's three times as large.

Half of it is securitized, a

system of credit that is now

broken.

We've sort of created a

financial Frankenstein where

we've got a financial system

that's too large, a good part of

it is broken and we don't know

how to fix it.

And unfortunately, the past

offers few lessons.

An important theme in my book is

that the mistakes made during

the 1920s and '30s by central

bankers did not stem from

venality or malevolence or

stupidity.

Their primary problem was, faced

with new realities, they were

unable to break free from the

dogmas of the past.

And that is the challenge that

the authorities face at the

moment.

They're dealing with totally

novel problems and we have to

hope that they have the

imagination and inventiveness to

deal with them.

Thank you.

( applause )

>> We're going to give

Mr. Ahamed just a minute here to

catch his breath while you're

thinking of questions and get

our computers linked to our live

audience so if there are any

questions that are coming in,

they can be sent to

questions@wisconsinacademy.org

and we can ask those as well.

I might just take this quick

opportunity to also call your

attention to the yellow cards

that you received on your way

in.

If you fill those out and leave

your email with us, you are

eligible for a door prize, which

I think I had, a copy of the

book by the Halversons, who are

going to be our next speakers.

I'm told it's right here.

There we go.

So please help us out and fill

out those cards and share with

us future speakers and topics

that you would like to hear

from.

At this time, are there

questions for Mr. Ahamed?

Also, you should know, he will

be available in the lobby after

this presentation if you should

like to have a copy of his book.

Very good.

I will let you repeat the

questions so that our listening

audience can hear, and there

should be plenty of time for

questions, but please use the

microphone so that all can hear.

Thank you.

>> ( inaudible )

>> Ahamed: Yeah, I would draw a

distinction between the

financial crisis, which was sort

of the financial system seizing

up, and we're past that.

That started, gradually building

up from the beginning of 2008,

hit a sort of crescendo in

September 2008 with the failure

of Lehman.

And we're over it now.

All indications are that

confidence in the financial

system has returned.

Banks are lending to each other,

no one's sort of rushing to pull

their money out of banks.

We're now dealing with the

economic aftermath, which is the

real economy.

There it's a mixed picture.

We probably are out of the

recession.

That probably ended,

technically, in June.

Production has started going up.

It's not, as I said, it's not

feeding through to employment

and the most worrying aspect of

this whole thing is that

employment is, unemployment's

going to keep rising and the

sort of social compact between

companies and workers seems to

have broken or seems to have

changed.

In part because companies can

now go and hire in India or

China, wherever.

So it's a mixed picture.

That's where we stand.

I'm not sure where we're going.

( laughs )

And I'm much better

on the past than the future.

( laughter )

>> I'm aware of the fact,

everything you buy seems to be

made in China.

Doesn't that have tremendous

ramifications in our economy?

I would think that our

dependency on China making

everything is just killing our

economic system.

>> Ahamed: Well, you do want

trade.

So, we definitely don't want to

make everything ourselves

because we wouldn't do it very

well.

We clearly want trade.

The question then is, are the

Chinese somehow competing in an

unfair way?

I have to say that my view is

that their currency policy,

essentially, underprices their

goods.

We benefited for a long time,

which is that we got cheap

goods.

It had some terrible side

effects both on their economy

and on the global financial

system.

On their economy, it made them

incredibly vulnerable.

In the last six months of last

year, or the six months starting

September 2008, their exports

fell 20%.

25 million people lost jobs in

southern China as these

factories closed down or had to

cut production.

They have temporarily dealt with

it by a massive program of

government expenditure and by

opening up the spigots of

credit.

That's purely a temporary

mechanism.

They clearly have to reassess

how much they can depend on a US

consumer that's sort of going to

be the locomotive.

The side effect in the US that

was detrimental is that because

of the import competition, the

Fed overeased and kept credit

too easy for too long.

The result was, the US consumer

went into great debt.

And the US consumer is now

probably tapped out.

So for a variety of reasons, I

don't think, we can't go back to

where we were.

After this crisis, we're not

going to go back to where we

were.

Quite how that plays out, I

don't know.

China is going to have to

somehow restructure its economy.

That does not mean we won't be

importing lots of Chinese goods,

we probably should.

We shouldn't be quite so

dependent as we have been.

>> I was wondering if you could

comment on the intersection of

individual personalities and

events.

One thing I was struck by when I

was reading your book was some

of the sketches of guys like

Montagu Norman in Britain and

Benjamin Strong in the US.

These are men of real both

physical and emotional frailties

and challenges and at certain

key points, they would take

breaks for months at a time.

Benjamin Strong died in October

of '28, which is interesting.

I was wondering if you see any

parallels.

The quirks of their

personalities fed into events at

that time, and if you have any

hunches as to the quirks of

individual leaders, of Ben

Bernanke, of Timothy Geitner or

someone else, where it's more

that sort of these huge forces

at work around the globe.

Sometimes it just happens to

boil down to what this

particular person is like and

something about their emotional,

mental makeup that somehow can

have really far-reaching

ramifications.

>> Ahamed: Yeah, I'd be happy to

talk about that.

You got the point of my book

exactly, which is that

personality is a very large part

of the story.

I don't think they're quite like

the 1920 central bankers, I

should say that the main

character in my book is a man by

the name of Montagu Norman, who

was the head of the Bank of

England, and he was quite a

quirky guy.

But he suffered from one major

deficiency as the head of the

central bank.

He was a manic depressive who

would have nervous breakdowns at

times of great tension.

( laughter )

I can tell you, I don't need

to tell you, that's not

a good attribute

for a central banker.

I don't think any of our guys

are quite like that.

Here's my reading of the

personalities.

Let's start with Alan Greenspan.

One of the major problems of

Alan Greenspan was that we put

him on a pedestal and he started

believing it.

( laughter )

( someone applauds )

The way he conducted policy at

the Fed was, if you disagreed

with him, you suddenly found

yourself on the outs.

So he created a climate where

basically the chairman was

everything.

He did not foster a sort of

atmosphere of debate.

Alan Blinder disagreed with him

and found that he was suddenly

not invited to critical meetings

and basically resigned and went

back to Princeton.

That is precisely the sort of

atmosphere that leads to old

dogmas driving policy.

That's the first, that's Alan

Greenspan.

I think the fascinating

interaction was between Hank

Paulson and Ben Bernanke.

If you remember, last year the

crisis sort of seemed to hit

sort of a peak in March, when

Bear Stearns went under.

At that point, the Fed did

something that it really

shouldn't have done, which is,

the Fed is there to provide

short term loans.

What it did was provide equity

capital to JP Morgan, who bought

Bear Stearns.

It did this in a sort of sneaky

way.

It created a special purpose

vehicle called Maiden Lane and

it lent money to Maiden Lane

which then took on the equity

risk.

But they were doing exactly what

we've been accusing the banks of

doing, which is parking things

off balance sheet and disguising

the risks through various

accounting ruses.

They did that really because

they had no alternative.

There was a window from March to

September where the Fed now, the

authorities, I think, though

maybe not Hank Paulson,

understood that they were facing

a solvency problem, not a

liquidity problem.

A solvency problem cannot be

handled by short term loans by

the Fed.

And yet that's what they

continued to do for six months.

That window of opportunity I

think arose because Hank Paulson

had a sort of, well, there are

two possible interpretations.

Either he really did believe it

was a liquidity problem and sort

of miscalculated and thought,

let the Fed do the lending and

eventually they'll get their

money back and everything will

be okay.

Or he was sort of afraid, didn't

think he could get the votes in

congress and in effect was

bypassing the political system

because he didn't have the

political courage to confront

it.

Or he was being sort of very

astute and figured, I'll let a

real crisis develop and that way

congress will give me the $700

billion that I eventually need.

He was only able to do that

because he was able to bully Ben

Bernanke.

Ben Bernanke, I think, saved the

world in September, but was a

bully-able sort of guy.

There was an article in the New

Yorker about four weeks back by

James Stewart on that whole week

and it describes sort of finally

Ben Bernanke losing his temper

and saying, "Hank, I've run out

of ammunition."

And Paulson didn't get it, and

so all the Fed guys got together

and agreed the next morning to

again sort of shout at Hank

Paulson, and Ben Bernanke sort

of screamed at him.

Eventually, that's what got the

$700 billion.

I don't know, those are my

little insights into the quirks

of personality and how they

played out.

>> Mr. Ahamed, I have a question

from an online viewer.

Zack Jones writes in, "How would

you evaluate the impact of the

fiscal stimulus in the US in

response to the current

recession, and also, what are

your thoughts on the proposals

for further stimulus?"

>> Ahamed: By the way,

I should say,

I'm not an economist.

( laughs )

But I can pretend to be one.

Look, the stimulus package

clearly has made that difference

between -3% growth and +1% that

we're going to have this

quarter.

It really only had to operate at

the margin, but seems to have

worked at the margin.

We're a $15 trillion economy.

Of the stimulus package, we've

probably spent, in the second

and third quarter, $200 billion.

That's a tiny amount in a $15

trillion economy, but is just

the amount that you require to

turn from being -3% to +1% or

whatever.

That's the sort of impact it

had.

The goal is, think of these

stimulus packages as, you drive

yourself into a ditch and you

need a tow truck to get yourself

out.

They should be temporary and

they are designed to be tow

trucks to get us out.

It seems to be working.

We've got one wheel out.

We definitely don't want to

rely, again, you're not going to

get in your car and rely on tow

trucks to pull you around.

So I would be against another

stimulus package for another

reason, which is that these

aren't free.

This is not free money and this

is going to cost us in terms of

government interest and

eventually we're going to have

to raise our taxes to pay for

the interest on this debt.

Now, luckily, there's one big

worry when the government

borrows money, which is that for

every dollar the government

borrows, it takes away money

from the private sector.

That's the big worry.

That's not happening.

The first sign that you'll see

that that's happening is if the

government starts competing with

the private sector for money,

you'll see interest rates going

up.

That's the first signal that

this stuff is not working.

We're not there yet.

On the other hand, we could get

there.

So that's what I would keep my

eye on.

That basically, you've exhausted

my macro economics.

>> ( inaudible )

>> Ahamed: Look, I think that

deregulation was, or maybe not

deregulation, but inadequate

regulation of the financial

system that had completely

changed over a 20 year period

was at the heart of this

problem, or converted what

should have been a manageable

problem into a problem that

almost brought the Western

financial system to a halt.

On the other hand, I don't

believe that we can go back to

where we used to be.

It used to be, the two central

things that prevented banking

crises and instability during

the '50s and '60s, were two

things.

One was Glass-Steagall, which

separated commercial banks and

investment banks and made sure

that commercial banks, which

keep our deposits, could only do

very safe things and treated

commercial banks like utilities,

almost.

The problem is, one, we've got a

whole lot of new institutions

like money market funds.

And secondly, the distinction

between loans and securities has

disappeared.

So it's very hard to say, this

is an investment bank that owns

securities and this is a

commercial bank that makes

loans, because loans can be

converted into securities.

So my view there is that we need

to, we just need to make sure

that people who go into the

financial business have capital

and that they don't leverage

themselves 30 or 40 to one.

In the '50s, a typical financial

institution held 10% of its

assets in the form of equity

capital.

We have allowed those numbers to

go down to 4% and then we allow

financial institutions to put

things off balance sheet and

have a second set of books where

they had no capital.

I think it's crazy.

That's the single most important

thing.

There are other things that we

should do, like on derivatives

put them on an exchange.

There are some very simple

things we can do to make the

system much more stable.

>> You had talked earlier about

unemployment and the fact that

we've had a rather severe rise

in unemployment this time,

perhaps a little faster than

expected and it's not expected

to go down dramatically in the

near future.

My question is related to the

debate about national healthcare

going on now.

Can this country continue to

grow its employment base without

doing something about the

problems with the cost of health

insurance on the employer, and

how much effect do you think

that might have on our recovery

vis-a-vis other countries in the

world that we're competing

against who don't seem to have

that problem?

>> Ahamed: Well, it certainly,

just anecdotally, it's certainly

clear whenever you talk to

people about the key things they

worry about when they hire

permanent workers, in

particular, is the benefits

they're required to provide, and

the most important benefit is

obviously healthcare.

It's one of the reasons you see

such a move toward part-time

work, because companies are

required to provide fewer

benefits.

I think that's an element of the

equation.

I think there's an element of

globalization.

I think companies, someone like

Intel, is an American company

and it appears in the S&P 500.

I'd be interested to know where

most of the employees who work

for Intel, including if you

traced it through the supply

chains, where they're based.

Are the majority of them in the

US?

So what is a company, what is an

American company?

The definitions of those things

have changed so dramatically

that it's not always clear that

the categories we used to use

are appropriate or useful in

understanding it.

I can't say I know the solution

to the employment problem.

I just observe it.

But I think it is, one, there's

something about this business

cycle which has been

particularly bad for workers.

And secondly, just my reading of

history is, if an economic

system finds it difficult to

provide full employment, you'd

better watch out.

>> I just had a quick question.

I'm aware of the WPA program

that was implemented during the

Great Depression.

I was wondering, I know it's

often compared to the current

stimulus package.

Do you think that the same

strategy that was used would

work today?

>> Ahamed: The interesting thing

about Roosevelt's New Deal, a

couple of interesting things.

One is, he was clearly a

fantastic publicist.

We had this exaggerated notion

of what the New Deal did.

Actually, in terms of public

expenditure, it was relatively

modest.

There were some public

employment schemes, including

the WPA, which did get some

people back to work, and

unemployment then was 25%.

It's now, even if you count

discouraged workers, it's more

like 15%.

We're only half the way there.

I don't think it's applicable.

The thing that I do think is

sort of striking about Roosevelt

and the New Deal was, he seemed

to figure out, or he seemed to

be very skeptical that anyone

knew anything.

And so he was willing to

experiment and try lots of

things.

Essentially, he stumbled into

getting off the gold standard.

He was listening to this

crankpot economist who was at

Cornell, and all his advisors,

all these Wall Street guys.

He decided, why don't we try

that?

So he sauntered into his office,

well, he didn't saunter,

he came into his office...

( laughter )

And sort of off the top

of his head said, "By the way,

we're off the gold standard."

All of his advisors

were incredibly shocked.

One guy was James Warburg of the

Warburg family and he declared,

"This is the end

of Western civilization."

( laughter )

It wasn't, obviously.

I really got to admire, reading

up on this book, I really got to

admire this sort of capacity for

Roosevelt to try lots of things.

There were two New Deals.

There was the first New Deal,

which did a reasonable job in

stabilizing the banks, got the

economy going, but didn't get

employment going, and did some

stupid things, like raised

prices and raised wages and all

sorts of things which were

completely counterproductive.

Then he came up with the second

New Deal, in which we got social

security, for example.

It's that sort of openness to

new ideas, skepticism about all

of these so-called experts who

tell you they know how it works,

because we've just discovered

that very few people do.

>> Last question.

>> We in the medical profession

live by sort of a central rule,

and that is "primum non nocere,"

above all else, do no harm.

With that in mind, I'd like to

ask, in your view, what is the

stupidest thing our political

leaders could do given the

current situation?

( Ahamed laughs )

>> Ahamed: Well,

the stupidest thing would be

to raise taxes to try

and control the budget deficit

at this moment.

They did that in 1937.

We got this fantastic recovery,

and then in 1936, 1937, the Fed

decided to raise interest rates

because it said, we've changed

the price of gold, now banks are

so flush with cash, this is

bound to lead to inflation, even

though there wasn't a single

sign of inflation.

So they tightened credit, and at

the same time, there had been a

temporary blip up in the budget

deficit in 1936, and I can't

remember why, I think it was the

introduction of social security

or something.

They raised taxes in 1937.

The combination of the two drove

the economy back into recession.

The stock market went down 30%

in one year.

That would be the most stupid

thing to do.

I'm sure if you gave me enough

time I could think of some other

stupid things.

( applause )