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>> 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 )