Latest / Masters in Business / Peter Conti-Brown Discusses U.S. Financial History (Podcast)

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Peter Conti-Brown Discusses U.S. Financial History (Podcast) · Masters in Business

0:02
Speaker 1: This is Masters in Business with Barry Ridholts on Boomberg Radio.
0:09
Speaker 1: This week on the podcast, I have an extra special guest.
0:13
Speaker 1: His name is Peter Conti Brown, and he is an
0:16
Speaker 1: expert on central banks, financial history, and the Federal Reserve.
0:21
Speaker 1: And if you are interested in those sorts of things,
0:25
Speaker 1: as I am and many of you are well, then
0:28
Speaker 1: sit back and get ready to walk out on some
0:31
Speaker 1: really interesting um stuff. He he really has a in
0:37
Speaker 1: depth grasp on not just central bank operations, but on
0:42
Speaker 1: the history of finance and the history of Federal Reserve
0:45
Speaker 1: in a way that most people simply can't do more
0:50
Speaker 1: than scratch the surface. So if you are at all
0:52
Speaker 1: interested in modern banking regulations, the politics at the FED,
0:58
Speaker 1: what Greenspan and bernanke he did or should have done
1:01
Speaker 1: or didn't do, and how the history of the Fed
1:05
Speaker 1: squares up with the modern era, you're in for a treat.
1:08
Speaker 1: So sit back with no further ado. My conversation with
1:12
Speaker 1: Peter Conti Brown. My guest this week is Peter Conty Brown.
1:20
Speaker 1: He is a professor at the Wharton School at University
1:23
Speaker 1: of Pennsylvania and he is the author of the Power
1:28
Speaker 1: and Independence of the Federal Reserve. He comes to us
1:33
Speaker 1: by Harvard, where he was undergraduate. He got his juris
1:36
Speaker 1: doctor degree at Stanford Law School, and then he earned
1:40
Speaker 1: a PhD at Princeton in am. I remembering this correctly
1:45
Speaker 1: legal history is that it's a financial history. Financial history
1:48
Speaker 1: even better for our purposes. Peter Conti Brown, Welcome to Bloomberg's.
1:53
Speaker 1: Such a pleasure to be here. Thanks Barry So. I
1:55
Speaker 1: read one of your columns some time ago, and I
1:59
Speaker 1: kind of cracked up by a line within it which
2:04
Speaker 1: we're all somewhat guilty of to some degree or another.
2:07
Speaker 1: You note something remarkable in the shelves of an old
2:11
Speaker 1: fashioned library which uses the Dewey decimal system. Go to
2:15
Speaker 1: h G section and you right, the shelves variably grown
2:21
Speaker 1: under the weight of the conspiratorial tomes about the Federal Reserve.
2:28
Speaker 1: Why why are we so conspiracy minded about America's Central Bank?
2:33
Speaker 1: In some sense, it's the founding crisis ideologically, right, militarily,
2:40
Speaker 1: certainly politically, and that is what is money? And who
2:44
Speaker 1: gets to decide? Right? The British said money has to
2:48
Speaker 1: consist of such and such and so and so, with
2:50
Speaker 1: tariffs and stamps and this much silver associated with it
2:53
Speaker 1: while starving the colonies of the resources to deliver on
2:56
Speaker 1: that promise, or so asserts the Declaration of Independence. Right, Well,
3:00
Speaker 1: fast forward a few years, the Revolutionary War is over.
3:04
Speaker 1: But then we get the in the Washington administration Alexander
3:07
Speaker 1: Hamilton's one hand, Thomas Jefferson on the other, Lin Manuel
3:10
Speaker 1: Miranda in the middle, right. Uh, And and the reason
3:14
Speaker 1: I think that Hamilton's musical has succeeded to spectacular lin
3:17
Speaker 1: Manuel Miranda is a genius um but his other musicals
3:20
Speaker 1: like In the Heights right, also fabulous. But hamilton musical
3:24
Speaker 1: gets to this question, what is money? Who gets to decide?
3:28
Speaker 1: We thought about that forever, and we fought about it
3:31
Speaker 1: in ways where that become extremely technical very quickly. Alexander
3:35
Speaker 1: Hamilton's certainly very technical expert on these issues, but on
3:38
Speaker 1: like other areas of technical expertise, like you know, hey,
3:41
Speaker 1: how do you get a satellite into orbit? Right? You
3:45
Speaker 1: don't have a lot of ideology around that. You just say, well,
3:48
Speaker 1: either works or it doesn't. Either your trajectory is accurate
3:52
Speaker 1: or it's not, in which case, now, with all respect
3:55
Speaker 1: to the Flat Earth society, and you know, moon Landing
3:58
Speaker 1: was staged and that sort of thing. They're conspiracy theorists
4:00
Speaker 1: there too. But the difference is is that you don't
4:03
Speaker 1: use satellites to buy groceries, right, You do use money
4:07
Speaker 1: to buy groceries. And so that intuition about what money
4:10
Speaker 1: should be and who gets to decide is shared by
4:13
Speaker 1: a lot of different people. And so there's a gap
4:15
Speaker 1: between what experts who themselves don't agree say should be
4:21
Speaker 1: a proper financial system, a proper monetary system, and what
4:24
Speaker 1: we in all kinds of identitarian factions, whether they're religious
4:30
Speaker 1: or political, or or geographical or or whatever else, you say, well, no,
4:34
Speaker 1: that's wrong. And so I think the FED is just
4:37
Speaker 1: this great collision of expertise, of ideology, of history, of politics,
4:44
Speaker 1: of economics, of law, and that just produces a really
4:50
Speaker 1: pungent potion that attracts conspiratorial thinkers and uh and experts alike.
4:56
Speaker 1: So let's talk about that explicitly because it comes so often. Um,
5:02
Speaker 1: the creature from jack All Islands, that book which is
5:05
Speaker 1: now decades old and it goes through a new edition
5:09
Speaker 1: every few years. That seems to be the source amongst
5:14
Speaker 1: the people I see as the conspiracy theorists. Says, hey,
5:18
Speaker 1: this was doomed from the start. But you're a historian
5:22
Speaker 1: of of financial markets. We could go back to the
5:25
Speaker 1: first Federal Reserve or the second Federal Reserve. In each case,
5:29
Speaker 1: there was a tremendous fear and skepticism in the eighteen
5:34
Speaker 1: hundreds about those banks, and each of them were and
5:38
Speaker 1: I'll ask the question to you, each of those were
5:41
Speaker 1: imbued with a finite lifespan. So why did it take
5:44
Speaker 1: so long before America said, Hey, we can't be the
5:49
Speaker 1: only major country that doesn't have a central man. You know,
5:52
Speaker 1: you asked you know, separately. One of the questions that
5:55
Speaker 1: you asked me was, you know, what are some un
5:57
Speaker 1: unnoted periods in financial histor three that people don't think
6:00
Speaker 1: about that matter a lot, And there's one of them.
6:02
Speaker 1: In NTE Congress passed a statue just on uh right
6:07
Speaker 1: before a Great Depression, look at the Federal Reserve Act
6:12
Speaker 1: and said, the Federal Reserve was created just like the
6:14
Speaker 1: first and second Banks the United States, with a twenty
6:16
Speaker 1: year charter. And so let's do some quick math. Federals
6:19
Speaker 1: are BacT nineteen plus twenty ninety three nineteen thirty three
6:24
Speaker 1: in the midst of the Great Depression, right at a
6:27
Speaker 1: time when Franklin Roosevelt was not uh, you know, representing
6:33
Speaker 1: these uh, these what his cousin Theodore had called the
6:37
Speaker 1: malefactors of great wealth. Right, Um, would the FED have
6:40
Speaker 1: been renewed in nineteen thirty three, I think that's a
6:43
Speaker 1: really fascinating question. We didn't have to ask it because
6:46
Speaker 1: seven uh slipped five years in advance, five years in advance,
6:50
Speaker 1: slipped in you know, uh slipped in two As a
6:55
Speaker 1: writer as a to a much more controversial banking bill,
6:58
Speaker 1: they said, you know what we're going to We're going
7:00
Speaker 1: to eliminate the need for a charter extension. This is
7:03
Speaker 1: going to be in perpetuity. Um. What's so intriguing about
7:07
Speaker 1: that is in the Second Bank of the United States,
7:08
Speaker 1: that's exactly what the Second Bank's president, Nicholas Biddle, tried
7:13
Speaker 1: to do. His charter wasn't up until eighteen thirty six,
7:18
Speaker 1: and he slipped it in early because he thought, you
7:21
Speaker 1: know what, the bank is so popular that we can
7:24
Speaker 1: do this, and we should do it early, as opposed
7:26
Speaker 1: to letting it be a big controversial thing. That was
7:28
Speaker 1: one of the best biggest miscalculations right in the nineteenth
7:30
Speaker 1: century because Andrew Jackson was able to harness his own
7:35
Speaker 1: popularity against the bank. But we sometimes forget when the
7:38
Speaker 1: Second Bank of the United States failed. It failed because
7:41
Speaker 1: the Congress came just short at overwriting Jackson's veto. It
7:46
Speaker 1: was still massively popular, just wasn't so popular that could
7:49
Speaker 1: override a presidential vito. What were the politics of President
7:53
Speaker 1: Andrew Jackson that he was against renewing or turning that
7:58
Speaker 1: into a perpetual money machine. This is this is a
8:02
Speaker 1: great question and should remind our listeners a lot about
8:05
Speaker 1: our present political situation. There are two stories that one
8:09
Speaker 1: tells about Andrew Jackson. So one is as this fierce
8:13
Speaker 1: pugilistic populist right. He wanted to take power and tear
8:18
Speaker 1: it down and push it down into the states and
8:21
Speaker 1: away from the federal government. That's certainly the vision that
8:24
Speaker 1: the Jacksonian Democrats carried with them through the rest of
8:27
Speaker 1: the nineteenth century and into the twentie At certainly, at
8:30
Speaker 1: some points what Andrew Jackson saw himself as is representing
8:34
Speaker 1: those who had been disenfranchised, disempowered by Wall Street and
8:39
Speaker 1: the like. Um, I don't even that that far ago,
8:43
Speaker 1: even still the same conversation, same conversation very similar, and
8:48
Speaker 1: I think that that's, uh, that's a bit of of
8:52
Speaker 1: revisionism by Jackson and his descendants politically, who wanted to
8:58
Speaker 1: make a more coherent narrative than actually existed at the time.
9:01
Speaker 1: At the time, Jackson was much more like other politicians
9:06
Speaker 1: that we are probably going to come up in this
9:08
Speaker 1: conversation and just didn't like to have other power bases
9:12
Speaker 1: that threatened his control. Right, So there were times when
9:15
Speaker 1: he would say, uh, Andrew Jackson would say two different
9:19
Speaker 1: things that were were together incoherent about his own monetary vision,
9:23
Speaker 1: sayings very he hated the idea of paper money, while
9:26
Speaker 1: simultaneously saying, let's uh send the economy a wash in
9:31
Speaker 1: paper money but issued by state banks, right, um, where
9:34
Speaker 1: you'd show real hostility to a gold backed currency, while
9:37
Speaker 1: simultaneously saying it's the only mechanism that he would approve of.
9:42
Speaker 1: So I don't think you can put an economic ideology
9:44
Speaker 1: on Andrew Jackson. I think efforts to do so, uh
9:47
Speaker 1: failed to realize that Andrew Jackson, like Donald Trump, frankly
9:51
Speaker 1: UH say you know, I am the source of decision
9:55
Speaker 1: making the idea that there would be another power base
9:58
Speaker 1: that could threaten my control over the UH system that
10:01
Speaker 1: I can't abide, and so he went to war with
10:03
Speaker 1: Nicholas Biddle and UH. And I think that's the that's
10:05
Speaker 1: the source of that conflict. Fascinating. Um, your your students,
10:10
Speaker 1: grad students or undergrads are both everything and executives and
10:14
Speaker 1: PC students, and so we really teach them all. So
10:17
Speaker 1: so much has been going on in the worlds of
10:19
Speaker 1: banks since the financial crisis. I have to ask you
10:23
Speaker 1: about Dodd frank and and the changes to that. But
10:26
Speaker 1: before we get there, we now live in an era
10:31
Speaker 1: of mega banks. All the banks are really relatively giant
10:36
Speaker 1: compared to before the Financial crisis, a number of pretty
10:40
Speaker 1: substantial banks were either required or or moved over. You
10:44
Speaker 1: you have Washington Mutual and WA Kobe, and you know,
10:48
Speaker 1: look at all these different banks, Bank America and Merrill Lynch, um,
10:53
Speaker 1: all these giant conglomerations. How is the modern ear of
10:59
Speaker 1: banking different then the way it existed prior to the
11:03
Speaker 1: financial crisis? You know, Um, we've seen after the financial
11:08
Speaker 1: crisis essentially an unrivaled concentration in the financial system, financial services,
11:15
Speaker 1: the you know, just looking at commercial deposits, for example,
11:19
Speaker 1: which include personal and commercial deposits about seventeen trillion dollars
11:23
Speaker 1: right in the American that's just checking and savings, checking
11:27
Speaker 1: and saving accounts for individuals and businesses and organizations. Um.
11:31
Speaker 1: Megabanks which will call above two fifty billion dollars, right,
11:35
Speaker 1: So that's things like JP Morgan Chase, Bank America, will Fargo,
11:40
Speaker 1: and and much further down. It goes down to you
11:42
Speaker 1: know US Bank, and uh, you know PNC, and you
11:48
Speaker 1: know Fifth Third and other banks that you might think
11:50
Speaker 1: of as regional, but really, have you know a grown
11:54
Speaker 1: grown in into into great size, right, um, because JP
11:58
Speaker 1: Morgan Chase isn't. It's balanced as trillions of dollars right
12:01
Speaker 1: well as far agoes above trillion dollars. So we're taking
12:03
Speaker 1: down almost a more order of magnitude smaller than that.
12:05
Speaker 1: But these are still very very large banks. And they
12:08
Speaker 1: controlled about thirteen trillion dollars, right, thirteen of the sixteen
12:11
Speaker 1: trillion dollars, and in these deposits. That's an extraordinary concentration,
12:15
Speaker 1: especially given that the number of institutions we're talking about
12:19
Speaker 1: as a couple dozen. Right. This changes as banks balance,
12:23
Speaker 1: she exchange in size at the margin. But we are
12:25
Speaker 1: seeing financial services dominated by a handful of institutions. And
12:31
Speaker 1: and we have not seen that really ever before in
12:34
Speaker 1: our history, um, including the great mergery era of the
12:38
Speaker 1: late nineteenth century where you saw trusts around sugar oil, uh,
12:44
Speaker 1: corn harvesting machines, right and fill in the blank. There
12:47
Speaker 1: are these This is the great trust era. Have a
12:50
Speaker 1: great consolidation era. But interestingly enough, because of the structure
12:55
Speaker 1: of the US political economy, banks were extremely decentralist by law,
13:01
Speaker 1: UM each bank that for a very very long time,
13:04
Speaker 1: a bank couldn't have more than one branch. And even
13:07
Speaker 1: after that was changed in the late nineteen twenties, they
13:10
Speaker 1: couldn't have branching across states. Uh. And that wasn't finally
13:15
Speaker 1: abolished where you would have a bank doing business as
13:19
Speaker 1: its own institution across state lines until after nineteen eighty.
13:24
Speaker 1: What about the repeal of Glass de Eagle, What did
13:27
Speaker 1: that contribute towards banks bulking up? It's a contributed a
13:31
Speaker 1: lot so UM. I mean this is this is a
13:33
Speaker 1: point of some debate among economic historians. It's correlated right
13:38
Speaker 1: with banks uh bulking up in in in pretty breathtaking fashion.
13:43
Speaker 1: What some economic historians say, well, that's correlated, but it
13:46
Speaker 1: wasn't caused by this, and we were Glass Eagle was
13:48
Speaker 1: essentially unrelated to this size. Now that's hard to swallow,
13:51
Speaker 1: at least in the short run after around Glass Eagle's
13:55
Speaker 1: final legislative demise, because of course City Group becomes city
13:59
Speaker 1: Group after exact issue of a city comes the first
14:03
Speaker 1: mega back. Uh. And so but then again, you know,
14:06
Speaker 1: a few years after that that was a pretty disastrous merger.
14:09
Speaker 1: They sold most of their insurance business because the synergies
14:12
Speaker 1: weren't present. And then what becomes really the shining example
14:17
Speaker 1: of a mega bank, JP Morgan Chase. And if we
14:21
Speaker 1: were list all of the names of the banks that
14:23
Speaker 1: they acquired along the way, chemical absolutely you know the
14:30
Speaker 1: bank First Um, what was Jamie Diamonds Bank that in Chicago,
14:35
Speaker 1: First Nationals, that what it's called. And he I believe
14:37
Speaker 1: he was at Smith Barney before that. When he was
14:40
Speaker 1: at City, he was Sandy Wild's right hand man in
14:42
Speaker 1: designing the strata, the mega banking strategy. He loses in
14:45
Speaker 1: a power struggle, goes to manage his bank in Chicago,
14:49
Speaker 1: comes back in UH. JP Morgan Chase's acquisition, which was
14:53
Speaker 1: essentially an employment contract acquisition, Jamie Diamond become CEO, and
14:57
Speaker 1: JP Morgan Chase, with help from the federal government, embarks
15:01
Speaker 1: on this strategy of just becoming as big as it
15:04
Speaker 1: can be. And so we are truly in an unprecedented
15:07
Speaker 1: era in terms of banking consolidation the United States. So
15:12
Speaker 1: everybody used to talk about too big to fail. I
15:15
Speaker 1: like to raise the question, have these banks become too
15:19
Speaker 1: big to succeed? Are they even manageable? When you're running
15:23
Speaker 1: trillions of dollars in deposits? Can these things be managed?
15:29
Speaker 1: And that will segue right into our discussion of Wells Fargo.
15:34
Speaker 1: Such a great question, too big to manage, too big
15:36
Speaker 1: to jail to, too big to succeed, And that the
15:41
Speaker 1: way that you phrase that too big to succeed is
15:42
Speaker 1: so fascinating because it calls into question the time horizon
15:45
Speaker 1: and the short and medium term. I say that we're
15:48
Speaker 1: on on leading into a medium term from the financial crisis. Man,
15:52
Speaker 1: has it been good to be Jamie Diamond? Right? That
15:55
Speaker 1: is that balance sheet is that has been an extremely successful? Right?
16:00
Speaker 1: Fortress Diamond is just it's it's an unassailable They were
16:05
Speaker 1: very fortunate. You're a financial historian, you'll appreciate this. Most
16:09
Speaker 1: people don't realize JP. Moore and Chase had their own
16:12
Speaker 1: derivatives crisis. But they were let's call it lucky enough,
16:16
Speaker 1: were smart enough to have it years before everybody else.
16:19
Speaker 1: So they cleaned up their balance sheet while there was
16:21
Speaker 1: still a bid to hit. When it did everybody else,
16:24
Speaker 1: they had no way to go. Yeah, you know there
16:27
Speaker 1: is This is another occasion in financial history that a
16:31
Speaker 1: lot of people don't recognize. And I think this is
16:33
Speaker 1: Tim Geitner's signal contribution to h to finance in his
16:38
Speaker 1: career and happened before he was Secretary of the Treasury.
16:41
Speaker 1: Uh and that was in two thousand seven, noting on
16:46
Speaker 1: a spectacular back up office problem in derivatives trading. Right,
16:50
Speaker 1: So these are all bespoke derivatives, right, even even though
16:52
Speaker 1: they're not very fancy, these are pretty plain vanilla, but
16:54
Speaker 1: they all are bespoke because there's no you know, there's
16:57
Speaker 1: no market place for them to trade on. It's no
16:59
Speaker 1: exchange age for them. And so you would think sophisticated
17:02
Speaker 1: folks in two thousand five we're not talking about, right,
17:05
Speaker 1: So the I T Revolution has already taken pretty deep root. Um,
17:08
Speaker 1: you'd have some sort of oracle based software system where
17:11
Speaker 1: traders with two headsets on, you know, talking to two
17:15
Speaker 1: different people, or at least punging it into a computer
17:17
Speaker 1: that would clear it and would be universally access And
17:19
Speaker 1: you think that and you'd be wrong, right, And what
17:21
Speaker 1: they were doing instead is on scraps of paper with
17:24
Speaker 1: little golf pencils writing down the nature of the trade
17:27
Speaker 1: as though they were signing. There were doctors signing a prescription,
17:30
Speaker 1: handing it back to a runner who would take that
17:32
Speaker 1: piece of paper and put it in a stack. Right.
17:34
Speaker 1: And what Tim Geitner realized, even though he that the
17:37
Speaker 1: New York had had no supervisory authority over these broker dealers,
17:41
Speaker 1: that's a very important point, realized that the back office
17:45
Speaker 1: back log was about nine months. And so if there's
17:49
Speaker 1: a triggering event is a you know, the International Swaps
17:53
Speaker 1: and Drives Association master agreement, there's a default event within
17:56
Speaker 1: that nine months your trader said, hey, you owe me money?
17:59
Speaker 1: Like do I? They had to go literally back into
18:03
Speaker 1: nine months worth of scraps of paper to find where's
18:05
Speaker 1: this trade? Right? Huge mess. Tim Gotton realizes it, and
18:09
Speaker 1: he does a tremendous effort coordinating the banks to clean
18:12
Speaker 1: up modernize their back office. He succeeded right before the crisis. Amazing,
18:17
Speaker 1: absolutely amazing. So let's jump into a fascinating topic that
18:22
Speaker 1: has been in the news for the past year or
18:26
Speaker 1: or more, and that's been this ongoing scandal at Will's Fargo.
18:32
Speaker 1: We we first learned about it when it was revealed
18:36
Speaker 1: the managements of Wills Fargo greatly incentivized the staff to
18:41
Speaker 1: open new accounts, creating new accounts, but they simultaneously penalized
18:46
Speaker 1: people who didn't do it. They would literally fire people,
18:49
Speaker 1: and it turned out the levels at which they were
18:54
Speaker 1: subsequent and significant consequences were exorbitantly high. Any five or
19:01
Speaker 1: so of the staff, we're not meeting the targets. And
19:04
Speaker 1: so when you incentivize people, they do what you ask.
19:07
Speaker 1: And the staff started creating fake accounts. Not one or
19:11
Speaker 1: two here, but literally I think we're up to three
19:14
Speaker 1: and a half million, is that about right? So so
19:16
Speaker 1: tell us how this came about and who should have
19:19
Speaker 1: been overseeing this. How does something as absurd as three
19:24
Speaker 1: million fake accounts come from a major bank like Wells Fargo?
19:28
Speaker 1: And where you framed this in a in a in
19:29
Speaker 1: a very particular way, and I come a little hostile
19:32
Speaker 1: and my two house. I completely agree with your framing.
19:34
Speaker 1: But John Stump, for the former CEO of Wells, would
19:37
Speaker 1: absolutely reject it. Right. So you flame framed it as
19:40
Speaker 1: a compensation structure and cultural problem and a supervisory one. Right.
19:46
Speaker 1: And what Stump and Wells Fargo they initially said is, no,
19:49
Speaker 1: what you're seeing is less than two percent of our
19:52
Speaker 1: employees engaging in some bad practices. That would be that
19:57
Speaker 1: would happen in any organization of banking eployees. That's a
20:01
Speaker 1: bank that employees what was there at their peak a
20:04
Speaker 1: hundred someone godling them? So two is okay? So only
20:10
Speaker 1: three thousand of our employees are engaging in criminal for
20:13
Speaker 1: can happen to anybody? Yeah? No, And that's what's hilarious
20:16
Speaker 1: about that is that that that statistic is just completely
20:19
Speaker 1: made up. Right? Who who cares about if your denominator
20:23
Speaker 1: includes janitors? Right? And what percentage of the personal bankers
20:28
Speaker 1: who are exposed to individuals were engaging in this kind
20:33
Speaker 1: of a legal activity. And what you you're framing where
20:36
Speaker 1: I completely agree with you, is that's not all we
20:38
Speaker 1: care about, but also aggressive behavior a right. So John
20:42
Speaker 1: Stump built this model. Well's far Ago was with with
20:46
Speaker 1: JP Morgan Chase. These were the two banks that nailed
20:49
Speaker 1: it right. These were the ones. This is not City Group,
20:53
Speaker 1: this is certainly not Washington Mutual, and it's not Bank
20:57
Speaker 1: of America. All right, this is Wells Fargo built its
21:01
Speaker 1: brand on being a phenomenal consumer and commercial bank as
21:04
Speaker 1: opposed to investor hundreds of years old. The stage coach
21:08
Speaker 1: is not a coincidence that it's their corporate logo. They've
21:11
Speaker 1: been around for centuries. They've been around for a very
21:13
Speaker 1: long time, and they've been very good at the work
21:16
Speaker 1: that they've that they've done, or so it was was reported.
21:19
Speaker 1: But that compensation structure and that culture, it's so massively
21:23
Speaker 1: important because it created not only the incentives to engage
21:27
Speaker 1: in bad behavior um, but engaged to engage in in
21:31
Speaker 1: practices that I think most people would say, that's zero
21:34
Speaker 1: sum and you're robbing your customers. You're not creating value here.
21:38
Speaker 1: You're just transferring it from your customers to yourself to yourself,
21:41
Speaker 1: and you're doing it in a way that's trying to
21:43
Speaker 1: deceive your customers as to what the value proposition is here.
21:46
Speaker 1: So let me give you the example, right, This was
21:48
Speaker 1: the Mantra eight is great, right, And the idea here
21:51
Speaker 1: is that cross selling it's distinct from up selling. Up
21:55
Speaker 1: Selling is you know, you go in you want to
21:57
Speaker 1: buy a Toyota Corolla and you walk out with alexis.
21:59
Speaker 1: That's that's upselling. Cross Selling is do you want fries
22:02
Speaker 1: with that? Right? So you come in you want something
22:03
Speaker 1: and they say you want that thing, but you also
22:05
Speaker 1: want all this other stuff too. So that was auto insurance,
22:08
Speaker 1: checking accounts, credit cards. Let's count to eight and I'd
22:10
Speaker 1: invite our listeners do the same thing. What are the
22:13
Speaker 1: eight products or services that you need to have in
22:17
Speaker 1: the same financial institution? All right, let me see if
22:20
Speaker 1: I could guess. So we'll start with saving and checking
22:22
Speaker 1: his account to mortgage. Yeah, so again we're gonna reexamine
22:27
Speaker 1: a why you would want your mortgage to be in
22:29
Speaker 1: the same place you have a checking in staving account.
22:30
Speaker 1: But yes, mortgage certainly count credit cards, credit card counts,
22:33
Speaker 1: bank loans, bank loans, personal loans. There we're up to five.
22:36
Speaker 1: Um insurance. They were doing some insurance products. They had
22:41
Speaker 1: some insurance products, including gap insurance, including auto insurance on
22:44
Speaker 1: your insurance. So meaning if you homeowners insurances, motors insurance
22:48
Speaker 1: as well. So now up to seven and uh, the
22:51
Speaker 1: only other thing I could guess is four o one
22:52
Speaker 1: K retirement accounts. That absolutely would be one. So that
22:55
Speaker 1: would be you would be a very good Wells far
22:58
Speaker 1: Ago banker and being able to say, all right, I
23:00
Speaker 1: got to eight. Now I gotta go sell these right now,
23:02
Speaker 1: let me give you an example. Now, let me tell
23:07
Speaker 1: you the story of a of a company that engages
23:10
Speaker 1: in massive cross selling to my utter delight as a customer,
23:15
Speaker 1: and that's Amazon, right, I have if you like X,
23:18
Speaker 1: you will love why I buy in the same day.
23:21
Speaker 1: I've purchased books and chainsaws from Amazon dot com, right,
23:25
Speaker 1: and I've seen myself going to this thing, and they say, oh,
23:28
Speaker 1: if you want that, then you're gonna need this other
23:30
Speaker 1: thing too, And I'll think about and say yes, please
23:33
Speaker 1: and thank you Jeff Bezos, I will want that thing.
23:35
Speaker 1: But they offer that to you, they don't send it
23:37
Speaker 1: to your house and say, by the way, we sent
23:39
Speaker 1: to you, whether you ask for it or not. Right,
23:41
Speaker 1: So there's no fraud here. My point is that, well,
23:43
Speaker 1: this problem is so much worse than the fraud, right,
23:46
Speaker 1: because what Amazon is offering to me is sometimes these
23:50
Speaker 1: other things that I already wanted less for less money,
23:52
Speaker 1: or even if it's more money than I would get
23:55
Speaker 1: it lows or somewhere else. Uh, the sheer convenience of
23:58
Speaker 1: having it all in a single citys them is extremely high. Now,
24:02
Speaker 1: let me ask you and our listeners, if you are
24:05
Speaker 1: shopping for financial services, whether we're talking about a credit card,
24:09
Speaker 1: a savings account, or a mortgage, what do you care about?
24:13
Speaker 1: Care about the best cost and the highest level of service,
24:17
Speaker 1: highest quality of service. So the best cost first, right,
24:20
Speaker 1: that's an interest rate phenomenon. What service do you need
24:23
Speaker 1: for your mortgage? Well, I I want to know that
24:26
Speaker 1: I could set up an auto pay. I want to
24:28
Speaker 1: know that I'll get credited on a timely basis, and
24:32
Speaker 1: that things like insurance isn't going to be forced down
24:36
Speaker 1: my throat, and that I could prepay my real estate taxes,
24:39
Speaker 1: add that to the monthly little things like that to
24:42
Speaker 1: just make our financial life a little easier. Absolutely, and
24:46
Speaker 1: almost all of that is standardized across the industry, almost everything.
24:49
Speaker 1: Then you're talking costs, so you just you're talking cost
24:52
Speaker 1: interest rates. So credit card absolutely, if you carry consumer debt, absolutely,
24:55
Speaker 1: they're going to be issues of service. For most people,
24:58
Speaker 1: what they want is the lowest in trust rate and
25:00
Speaker 1: the most benefits of a credit card for a savings account.
25:04
Speaker 1: What people are looking for are you know, a suite
25:06
Speaker 1: of bells and whistles? Can I deposit a check using
25:08
Speaker 1: my phone? Can I do this? Sort? Can I do that?
25:10
Speaker 1: But again, t a T M S location. All of
25:13
Speaker 1: this ends up mattering, but by far the most important
25:15
Speaker 1: thing is going to be the price point. And that's
25:18
Speaker 1: where Wells Fargo, I think, stepped into an extremely aggressive territory,
25:22
Speaker 1: well short of fraudulently manufacturing services that you never wanted,
25:29
Speaker 1: never asked for, right, that's the fake account scandal. And
25:33
Speaker 1: my point is how do we get here? We got
25:35
Speaker 1: here from a rotten culture that decided we're going to
25:39
Speaker 1: make price point, which is the only thing that most
25:41
Speaker 1: consumers really care about, to be a secondary consideration, and
25:44
Speaker 1: we're going to try and convince them that while they
25:46
Speaker 1: are economies of scale to be had for Wells Fargo
25:49
Speaker 1: and consolidating customers, those economies are not really shared with
25:53
Speaker 1: the customers themselves. That's what makes me uncomfortable about Wells Fargo,
25:57
Speaker 1: and that's why I think I feel a little bit
25:59
Speaker 1: more encouraged. And the post Wells era, there not only Wells,
26:02
Speaker 1: but other banks too are dialing way back on this
26:05
Speaker 1: kind of aggressive marketing because I think that it's pretty
26:08
Speaker 1: hard to justify when the thing that people want is
26:11
Speaker 1: are you going to beat this by a few basis points,
26:14
Speaker 1: Because we're talking about a thirty year mortgage. A few
26:16
Speaker 1: basis points matters a lot of huge, huge difference. So
26:18
Speaker 1: it'sen we're in the middle of the summer. Has Wells
26:24
Speaker 1: Fargo cleaned up their acts because we still see these
26:27
Speaker 1: little eruptions every now and then of more things leaking
26:31
Speaker 1: out that all date back to the same era, but
26:35
Speaker 1: we hadn't previously heard about this to those who are
26:39
Speaker 1: in PR crisis management driven the financial institutions itself, I mean,
26:43
Speaker 1: Wells Fargo has literally become the textbook case. I teach
26:48
Speaker 1: it to my MBA's not to do, What not to do?
26:50
Speaker 1: It was death by a thousand cuts. So they didn't
26:52
Speaker 1: get out in front of it. You want to disclose
26:54
Speaker 1: stuff yourself, so you're beating everybody else from revealing it,
26:58
Speaker 1: and then it would there is never really a believable apology.
27:03
Speaker 1: And then on top of that, at a certain so
27:06
Speaker 1: I've never had a Wells Fargo account. They could be great,
27:08
Speaker 1: they could be terrible. I've never experienced it personally, but
27:12
Speaker 1: seeing the run of news at a certain point, I
27:15
Speaker 1: was saying to a friend, Hey, at this point, if
27:18
Speaker 1: you have a Wells Fargo account, still, you've tacitly given
27:21
Speaker 1: them permission to do whatever the hell they want. Because
27:24
Speaker 1: if they haven't scared you, what what do they have
27:26
Speaker 1: to do to chase your way? And it doesn't look
27:29
Speaker 1: like that many people hit the eject button with them,
27:32
Speaker 1: so they did. Yeah, That's that's what's been so interesting
27:35
Speaker 1: to me. I mean, I am not I'm not an
27:38
Speaker 1: active investor UM for a lot of different reasons, not
27:41
Speaker 1: least because I comment on these things and I want
27:43
Speaker 1: conflicts of interest. Well, if you're talking about cost, I'm
27:46
Speaker 1: gonna assume you're like many other financial professors and your
27:49
Speaker 1: low cost index, Vanguard, et cetera. That's right, that's exactly right.
27:53
Speaker 1: Not that I'm UM. I don't take that as an
27:56
Speaker 1: absolute dogma like some of my colleagues do. UM. There
27:59
Speaker 1: have been time somewhere I've been tempted into markets UM,
28:03
Speaker 1: and one of them was to short Wells Fargo. I
28:05
Speaker 1: didn't do it, but been in two thousand fourteen or
28:09
Speaker 1: some things. It's about a year. The l A Times
28:11
Speaker 1: broke the story in two thousand thirteen. We didn't get
28:13
Speaker 1: the settlement with a CFPB and the control of the
28:16
Speaker 1: currency until two thousand fifteen. So in these two years,
28:20
Speaker 1: that's another very important question about supervisors. What was taking
28:24
Speaker 1: So along with the journalists, knew this right, but it
28:27
Speaker 1: was not. Uh, we didn't get a good sense of it,
28:30
Speaker 1: not just by two fifteen, but we're still getting the
28:33
Speaker 1: news later. But if I had shorted Wells Fargo stock,
28:37
Speaker 1: I would have lost money. Right, Their stock has done well.
28:40
Speaker 1: This has been a boom time. Right. I might have
28:42
Speaker 1: been able to hedge it and still short of the
28:44
Speaker 1: stock relative to places like JP morgan Um or Goldman,
28:48
Speaker 1: and maybe I would have made some money then. But
28:50
Speaker 1: it's been extraordinary how much of their brand, equity and
28:54
Speaker 1: their business has not been compromised by what has been
28:58
Speaker 1: a stunning turn of headlines week after week. The old
29:01
Speaker 1: joke is news as old. By the time it's in
29:03
Speaker 1: the papers, lots of people already figured out and probably
29:07
Speaker 1: made their bets based on that. I think that tells
29:10
Speaker 1: us a few different things. Number One, there's a good
29:12
Speaker 1: version and bad version of what we can how we
29:13
Speaker 1: can interpret those events. The good version for Wells is
29:18
Speaker 1: that it does have an extremely robust balance sheet and
29:22
Speaker 1: business such that this scandal, although lots of people are
29:26
Speaker 1: reading about and talking about it, ends up not mattering
29:28
Speaker 1: that much for the overall value of the franchise. You know,
29:30
Speaker 1: she just keeps people where they are. It's listen, I
29:33
Speaker 1: got everything on auto pay to move my account as
29:35
Speaker 1: a big pan in the butt. I'm not gonna bother.
29:37
Speaker 1: I'm not gonna bother. Right. The bad version, in other words,
29:41
Speaker 1: saying that the size and diversification of their businesses and
29:45
Speaker 1: on whatever parameters you want to choose, geography, business lines,
29:49
Speaker 1: other things, has protected them from scandal. That's the version
29:53
Speaker 1: that's good for Wells. The version is bad for Wells
29:57
Speaker 1: is that the sheer complexity and size of these financials
29:59
Speaker 1: two tions make them totally unaccountable even when the facts
30:05
Speaker 1: are breathtaking. Lee damning right. You will never see a
30:10
Speaker 1: clearer cut example of abject criminality in consumer banking that
30:15
Speaker 1: is as widespread as this. Right, this was absolute fraud.
30:19
Speaker 1: I think You're not cynical enough if you think nothing
30:22
Speaker 1: is going to be worse than this, Because every time
30:24
Speaker 1: I've said that throughout my professional career, what could ever
30:28
Speaker 1: be worse than fill in the blank? Where go from
30:32
Speaker 1: Enron's world? Calm too? You pick it there, seeing every
30:36
Speaker 1: time I I think I'm become too cynical, the rejoinder
30:41
Speaker 1: comes back at me. Just wait, that's pretty great, um,
30:45
Speaker 1: you know to for me to find another example, it
30:47
Speaker 1: would have to be city Groups predecessor National City during
30:51
Speaker 1: the run up to the Great Depression, which which motivated
30:55
Speaker 1: the original passage of Glass Stiegel, where you would get
30:58
Speaker 1: these salesman coming from the banking so or sorry, from
31:02
Speaker 1: the capital market side, looking at bank customers. You see, Okay,
31:07
Speaker 1: I've got a retired couple and their nest ex ten dollars.
31:09
Speaker 1: I've got it in a savings account. Go to their house,
31:13
Speaker 1: swindle them out of it, and make them invest in
31:16
Speaker 1: Latin American mining operations. That's a that's a really exact
31:19
Speaker 1: that's a perfect thing for a young couple's retirement. Yeah
31:23
Speaker 1: right there in there, they're they're gonna live another ten years.
31:25
Speaker 1: And now you're speculating, and of course that goes bust,
31:27
Speaker 1: all their money is gone, right, um. And there's there
31:30
Speaker 1: are these letters that you can read in uh, in
31:33
Speaker 1: the Library of Congress where people just writing to their
31:36
Speaker 1: members of Congress during the Glass Eagle hearings, the Pecora
31:41
Speaker 1: hearings that proceeded Glass Seagull saying please ask Charlie Mitchell
31:46
Speaker 1: why he would target us my I'm sitting now next
31:50
Speaker 1: to my wife's coffin. She died early because of the
31:55
Speaker 1: stress of realizing our nest egg was gone. So that
31:58
Speaker 1: was a big scandal. I see, wells Fargo is being
32:01
Speaker 1: pretty similar in scope. But now compare the difference in
32:04
Speaker 1: the reactions to them, right. I think we've become inured
32:07
Speaker 1: to these sort of things. That was the takeaway from
32:09
Speaker 1: the Great Financial Crisis. My cynicism is whatever you think,
32:13
Speaker 1: it's much worse. Let's talk a little bit about the
32:18
Speaker 1: Federal Reserve and central bankers. And I'm gonna begin with
32:22
Speaker 1: something from Lombard Street, a description of the money market. Uh.
32:29
Speaker 1: A very famous quote is lend freely at a penalty
32:33
Speaker 1: rate against good collateral. That that comes supposedly been called
32:38
Speaker 1: Badget's dictum. The first question is, by the way, the
32:42
Speaker 1: whole purpose of that is an articulation of how central
32:46
Speaker 1: banks should respond to a panic to avoid a full
32:49
Speaker 1: blown crisis. First, who is really the author of that rule?
32:53
Speaker 1: You suggest that it wasn't Badget. No, it's it's it's
32:57
Speaker 1: not Walter Badget. You can read the entire book, uh,
33:00
Speaker 1: you know, because many times you'd like Hill never find
33:02
Speaker 1: Badget's Dictum. He hints around it. He talks about lending
33:06
Speaker 1: freely in liquefying. Yeah, he's got two chapters that are
33:09
Speaker 1: basically about lending freely. Um. He does talk a little
33:12
Speaker 1: bit about what was good collateral, but mostly as a
33:16
Speaker 1: set of shared assumptions that everyone would have about what
33:20
Speaker 1: constituted good collateral, um, which were essentially, you know, uh,
33:24
Speaker 1: good collateral was going to be on these commerce bills,
33:28
Speaker 1: which is basically, here, we've got a contract already set
33:31
Speaker 1: up that refers to real business that's been done. It's
33:34
Speaker 1: not speculative. Right, that's good collateral, and that is not
33:38
Speaker 1: our definition of good collateral. Good collateral can be securities,
33:41
Speaker 1: right good uh today, And that would not have been
33:44
Speaker 1: his definition. He mentioned that just in passing penalty rate,
33:48
Speaker 1: there's a sentence about the idea that you're like, well,
33:50
Speaker 1: you want to you want to make it hurt a
33:52
Speaker 1: little Georgia premium above what you could get if there
33:55
Speaker 1: wasn't a panic, in order to discourage this behavior in
33:58
Speaker 1: the future. But interestingly enough, the rest of the book
34:00
Speaker 1: is about not doing that very thing right because if
34:04
Speaker 1: you make it, if you stigmatize the lending um by
34:08
Speaker 1: a central bank, which a penalty rate would do um,
34:11
Speaker 1: then you've created the very scenario that Badget saying you
34:14
Speaker 1: shouldn't do. So there's no Badget's didictive. He never said that.
34:17
Speaker 1: His book is not about that, and indeed it's ironic
34:19
Speaker 1: because you know, one of the things that he writes
34:21
Speaker 1: in that book is that there are people are so
34:25
Speaker 1: eager for you to say, all right, well, our central
34:29
Speaker 1: banks good things are bad things, and if you say,
34:31
Speaker 1: well it's complicated, they're like, well, I don't care, right,
34:34
Speaker 1: Welcome to the modern world of politics. And he's writing this,
34:37
Speaker 1: you know, in the late eighteen sixties. This is published
34:39
Speaker 1: in eighteen seventy three. And then he also said, you know,
34:41
Speaker 1: people just don't have appetite for long books. They want
34:44
Speaker 1: short sentences. And what's hilarious to me about this is
34:47
Speaker 1: the thing that Badget's book is remembered for is a
34:50
Speaker 1: short sentence that he never wrote. So who did write that?
34:53
Speaker 1: You know, it's it's hard that I would be interested
34:56
Speaker 1: if our if our listeners can track this down. I
34:58
Speaker 1: haven't succeeded. I can tell you to people who have
35:00
Speaker 1: popularized it. Um. One is Paul Tucker, who is a
35:04
Speaker 1: great scholar and practitioner of central banking. He's got a
35:07
Speaker 1: new book, let's just come out. Somebody might consider for
35:10
Speaker 1: for your own, for your podcast, and and uh and
35:13
Speaker 1: for this radio show. He was the Deputy governor at
35:16
Speaker 1: the Bank of England during the crisis, and he has
35:19
Speaker 1: has written a lot about this idea. And he's the
35:21
Speaker 1: one who quoted most often for Badget's victim. It's never
35:24
Speaker 1: Badge being quoted, it's always somebody else quoting Paul Tucker
35:28
Speaker 1: creating Badget's sictam. But again he did Paul didn't create this, right,
35:32
Speaker 1: He's referring to something that came before. Um. Ben Bernanke
35:36
Speaker 1: is the other one who's really popularized that's but only
35:38
Speaker 1: two thirds of Badgett's victim rent free when freely uh, well,
35:42
Speaker 1: maybe one and a half of it when freely against
35:46
Speaker 1: So so so collateral, but don't do a penalty rate. Right. Uh.
35:51
Speaker 1: But you know Brankie's book, his memoir of the crisis,
35:55
Speaker 1: he talks courage to accourage to act. Yeah, right, And
35:59
Speaker 1: he notes when he game FED chair in two thousand six,
36:02
Speaker 1: and the chair has a personal library and uh in
36:07
Speaker 1: his office, and he said, I brought Badget's Lombard Street
36:10
Speaker 1: and put it there. Now. Now, ben BURNANKI is a
36:13
Speaker 1: very sophisticated financial historian. I assume he's read Lombard Street,
36:17
Speaker 1: but I have his book. Would not give you evidence
36:20
Speaker 1: that at the end, did you overlap with Bernanke When
36:23
Speaker 1: you were a princeton, he was the head of the
36:24
Speaker 1: economics department. No, No, I have met him a couple
36:27
Speaker 1: of times before. Um, and you know, we've exchanged views
36:31
Speaker 1: on a variety of topics. I think that he's a
36:33
Speaker 1: remarkable public servant, a terrific scholar. Um. And I always
36:38
Speaker 1: leave reading any paper or even blog post. He's written
36:41
Speaker 1: feelings smarter Um. But we've also had our differences. We've
36:44
Speaker 1: got into an argument about an assertion that he makes
36:47
Speaker 1: that I think is false, which is that the reason
36:50
Speaker 1: that FED didn't bail out Lehman Brothers. Is that it
36:53
Speaker 1: lacked the legal authority to do so. That's been the claim.
36:56
Speaker 1: I have a pet theory on that. I'm curious as
36:58
Speaker 1: to what yours is. Well, it's legally it's false. That's
37:00
Speaker 1: not correct. They did have a legal authority to do it,
37:02
Speaker 1: to bail out a dealer. Oh absolutely. I mean the
37:05
Speaker 1: statute is unusual and exigent circumstances, a term which is
37:10
Speaker 1: sounds very heavy, but it is not defined. Unusual and
37:12
Speaker 1: exigent is Tuesday? Okay, yeah, it could. It could be
37:15
Speaker 1: so long as five members of the Board of Governor's
37:17
Speaker 1: vote in favor, which he had, and the Federal Reserve
37:21
Speaker 1: Bank who's in whose district? Uh? The institution exists in
37:27
Speaker 1: New York is that the loan is secured to the
37:31
Speaker 1: satisfaction of the Federal Reserve Bank. Secured to the satisfaction
37:34
Speaker 1: Does that mean, well, it's not defined. Although quite bluntly,
37:39
Speaker 1: we know there was a ton of fraudulent uh shenanigans
37:43
Speaker 1: going on at Leman Brothers with the famous REPO one
37:45
Speaker 1: oh five and all of that. So you might say, well,
37:47
Speaker 1: then we're not satisfied by that. But that's a discretionary determination.
37:50
Speaker 1: Say we lack legal authority to do so as false.
37:52
Speaker 1: It says we were not satisfied by the collateral presented
37:55
Speaker 1: a different, different, serferent thing, which of course raised the question,
37:58
Speaker 1: then why did they really let it hit the pavement? Well,
38:00
Speaker 1: then why is a I G. Different? Their answer is, well,
38:03
Speaker 1: because they had a good insurance business going, had all
38:06
Speaker 1: kinds of profitable businesses within their twenty thousand corporations under
38:11
Speaker 1: their uh their parent company. So again, was that the
38:15
Speaker 1: right decision or the wrong decision? As a separate set
38:17
Speaker 1: of questions, was it politically motivated or not? Should it
38:20
Speaker 1: have been? Step set of questions. Did they have a
38:22
Speaker 1: legal authority to do so? Well, yes, of course they did.
38:25
Speaker 1: And this isn't just me being an obnoxious lawyer saying,
38:27
Speaker 1: well look at this. The idea that they lacked the
38:31
Speaker 1: legal authority to do so was the single defining idea
38:35
Speaker 1: that motivated the passage of Dodd Frank. That's fascinated And
38:38
Speaker 1: so I think that that ends up mattering a huge amount.
38:41
Speaker 1: It just isn't isn't correct. So I wish I was
38:44
Speaker 1: a fly in the wall when they were having this
38:46
Speaker 1: internal debate. But my pet thesis is simply um at
38:51
Speaker 1: one point. Early in the spiral of Lehman Brothers, Warren
38:56
Speaker 1: Buffett of Berkshire Hathaway had the conversation with Dick Fuld
39:00
Speaker 1: made a low ball offer because he's a value investor,
39:03
Speaker 1: and to everybody who was an employee of Lahman Brothers
39:08
Speaker 1: lasting regret, Dick Folds said, this guy's trying to steal
39:12
Speaker 1: the company for three billion dollars. It was only a
39:14
Speaker 1: small percentage ownership, and he rejected Buffett. And I can't
39:19
Speaker 1: help but think from a moral hazard perspective the debate
39:23
Speaker 1: going on with Bernankee and Guthner, and hey, how could
39:26
Speaker 1: we bail out this guy when he turns down Warren Buffett, who,
39:30
Speaker 1: by the way, later made a much more advantageous um
39:35
Speaker 1: loan to a much better bank, Golden So Folds folly
39:40
Speaker 1: turned out to uh benefit Goldman and and Buffett. Here's
39:43
Speaker 1: my friendly amendment to your your theory. I would call
39:46
Speaker 1: it Folds follies because Buffett was one in a series
39:50
Speaker 1: of suitors who came knocking, and Dick Fold was trying
39:53
Speaker 1: to value the company as though it were two thousand five,
39:55
Speaker 1: not two thousand seven or eight, And so I think
39:58
Speaker 1: it was just spectacle ular Hubris that I think the regulators,
40:03
Speaker 1: including Tim Geitner and Hank Paulson couldn't fathom. So one
40:08
Speaker 1: of the one of the conspiracy theories that a lot
40:10
Speaker 1: of people I think are pretty sophisticated people, and back
40:13
Speaker 1: it was paid payback. It's the Goldman versus Lehman thing.
40:15
Speaker 1: I just don't buy it. I think to the extent
40:17
Speaker 1: that that mattered at all. And by the way, remember
40:21
Speaker 1: that if anybody was payback, there was Bear Stearns go
40:24
Speaker 1: back to long Term Capital Management. They didn't want to.
40:27
Speaker 1: They didn't want to be part of the consortium that
40:29
Speaker 1: rescued who they were the prime broker for. So when
40:33
Speaker 1: when Bear hit the deck earlier than Lehman, the deal
40:38
Speaker 1: that was actually Jamie Diamond stole it right out from under.
40:42
Speaker 1: I think it was with Covia was looking at it,
40:44
Speaker 1: then Um and then to get the Fed to say
40:47
Speaker 1: we'll commit to backstop if this goes over billion dollars
40:51
Speaker 1: worth of junk. You saw some great dealmakers in the
40:55
Speaker 1: crisis and some terrible. Dick was spectacularly not one of UM,
41:00
Speaker 1: and so I think that that ends up having a
41:01
Speaker 1: lot to do with it. But I think the biggest
41:02
Speaker 1: explanation of all does come from Hank Paulson. He's the
41:06
Speaker 1: source for a Wall Street Journal editorial. This is after conservatorships,
41:10
Speaker 1: is after the first weekend September for Fanily Freddie, Senior
41:14
Speaker 1: administration officials assures us, huh, and it's finding quote, there
41:20
Speaker 1: will be no political solution for Lehman, meaning there's going
41:24
Speaker 1: to be no public money for Lehman, all right. And
41:26
Speaker 1: I think at that point, given the bipartisan furor over
41:31
Speaker 1: bear Sterns and Fannie and Freddie, that they had to
41:35
Speaker 1: find someone to say no to and they just didn't
41:37
Speaker 1: recognize that this was going to be the financial cataclysm
41:40
Speaker 1: uh that that ended up happening. See uh, let me
41:44
Speaker 1: let me push back a little bit from fail Out Nation,
41:47
Speaker 1: and I look at Lehman Brothers as merely the first
41:50
Speaker 1: trailer in the trailer park when the tornado came through.
41:54
Speaker 1: Everybody who was leveraged up with bad paper that was
41:57
Speaker 1: relying on either sub prime or alt A mortgages and drivetives.
42:01
Speaker 1: Now they were one of the worst. Bear Stearns was
42:03
Speaker 1: pretty bad, ai g was terrible. Lehman was one of
42:05
Speaker 1: the worst. But whether Lehman was rescued or not that
42:08
Speaker 1: tornado was going through. You had home prices run up
42:11
Speaker 1: so much and now we're collapsing. That that whole derivative
42:15
Speaker 1: unwined was going to take place. Even if, now, if
42:19
Speaker 1: you want to argue Lehman Brothers precipitated the conflagration spreading faster,
42:26
Speaker 1: well you know who knows. It's hard to argue against that.
42:28
Speaker 1: So let me ask you to put you put you
42:30
Speaker 1: on the hot seat. Then, even though I'm the guests
42:31
Speaker 1: and you're the host. Good decision, bad decision on Lehman Brothers,
42:35
Speaker 1: assume they had authority to do so, which I'm telling
42:37
Speaker 1: you they did. I'm the wrong person to ask that.
42:39
Speaker 1: I'll give you the answer. But the reason I'm the
42:41
Speaker 1: wrong person is I believe that see that sort of
42:45
Speaker 1: doric building with the columns over there, called the bankruptcy Court,
42:49
Speaker 1: that's there for a reason. Now, if you want to say,
42:52
Speaker 1: we're gonna take all these banks and have Uncle Sam
42:55
Speaker 1: be dead or in possession. So my favorite example was
42:58
Speaker 1: Bank America, all lynch that whole countrywide. Let's go over there,
43:04
Speaker 1: we take all the debts sticking in to sell it. Um.
43:07
Speaker 1: There's no such thing as toxic assets. There's only toxic prices.
43:11
Speaker 1: So this at a dollar a hundred cents on the
43:14
Speaker 1: dollar as a disaster, but twenty cents on the dollar
43:16
Speaker 1: for something worth thirty seven is is a winner. So
43:19
Speaker 1: you sell that stuff off, you clean up Marylanch, you
43:21
Speaker 1: spin them out, you clean up Bank American, spin it out,
43:24
Speaker 1: you clean up country wide, just spin. You go through
43:26
Speaker 1: this whole process. You do it one after another. Now,
43:29
Speaker 1: maybe the doubt doesn't stop at six thousand, maybe it
43:32
Speaker 1: goes to four thousand, Maybe unemployment gets worse, but you
43:36
Speaker 1: end up on the other end with a much healthier
43:38
Speaker 1: financial system. So I'm in favor of following the law
43:43
Speaker 1: having people suffer the consequences of their actions. By the way,
43:47
Speaker 1: I would claw back all the stock options that all
43:49
Speaker 1: these executives would get, but tear the band aid off.
43:54
Speaker 1: It's really painful in oh seven, oh eight, oh nine,
43:58
Speaker 1: but in you have a healthy economy. Even though what
44:03
Speaker 1: we did ended up saving the system, we're still dealing
44:07
Speaker 1: with ramifications of that. And so my answer is you
44:12
Speaker 1: the reason nobody would come in and buy Lehman Brothers
44:14
Speaker 1: is I think their liabilities vastly out outweighed um their death.
44:20
Speaker 1: The fact that I'm drawing a blank on his name.
44:21
Speaker 1: The guy came in and took over A I G.
44:24
Speaker 1: He did a wonderful job, passed away from cancer. Not
44:28
Speaker 1: A I G had a real business. It had a
44:30
Speaker 1: real cash flow. The four people on the A I G.
44:34
Speaker 1: Financial Product Group were a debacle, but you could have
44:37
Speaker 1: carved that out, and they ultimately did, and that's why
44:40
Speaker 1: I G is now a functional business. Yeah, I mean
44:44
Speaker 1: that's interesting. I mean, the the counterfactual you're you're at
44:46
Speaker 1: you're telling us about, I think is pretty persuasive on
44:50
Speaker 1: the following assumption, and that is that the depths that
44:54
Speaker 1: we would have reached in two thousands of any and
44:56
Speaker 1: nine cleansing would have been cleansing, yes, ra than fatal, right,
45:02
Speaker 1: because we've seen national systems that collapse not to stand
45:05
Speaker 1: up again. Right. Argentina is a great example. If you
45:08
Speaker 1: and I were having this conversation in eighteen ninety, we
45:10
Speaker 1: were in Buenos Aires, right, and we said, hey, let's
45:13
Speaker 1: make a bet America or Argentina hundred years from now,
45:16
Speaker 1: I think both of us would have said, we can't
45:18
Speaker 1: find a counterparty, right, We would have both bet on
45:21
Speaker 1: Argentina as just on much more secure some republic go
45:27
Speaker 1: down the list of whenever there's a crisis, and that
45:30
Speaker 1: was if you like the book The Lords of Finance,
45:33
Speaker 1: that was imposed from the outside, but still it's a great,
45:36
Speaker 1: great example. So my the question really for us in
45:39
Speaker 1: evaluating these counterfactuals is where is that threshold where under
45:44
Speaker 1: which the US doesn't recover ever right where it recovers
45:47
Speaker 1: in something that we don't recognize. That is the four
45:50
Speaker 1: trillion dollar question? Can you stick around a bit? I
45:52
Speaker 1: have a bunch of more questions. We've been speaking with
45:55
Speaker 1: Professor Peter Brown of Wharton. If you enjoy this conversation,
45:59
Speaker 1: we'll be sure come back for the podcast extras. Will
46:02
Speaker 1: we keep the tape rolling and continue to walk out
46:04
Speaker 1: over all things Central Banks. We love your comments, feedback
46:09
Speaker 1: and suggestions right to us at m IB podcast at
46:13
Speaker 1: Bloomberg dot net. You can check out my daily column
46:16
Speaker 1: on Bloomberg dot com. Follow me on Twitter at rid Holts.
46:19
Speaker 1: I'm Barry Ridholts. You're listening to Masters in Business on
46:22
Speaker 1: Bloomberg Radio. Welcome to the podcast, Peter, Thank you so
46:38
Speaker 1: much for doing this. I'm I'm really enjoying walking out
46:42
Speaker 1: on FED stuff and I have a ton of a
46:45
Speaker 1: ton of questions for you that we didn't get to.
46:48
Speaker 1: The Wells Fargo stuff is just fascinating, I mean, and
46:51
Speaker 1: we barely scratching the service. I mean, that's just astonishing
46:54
Speaker 1: to here's here's the thing. The one thing I'll say
46:56
Speaker 1: about What's Fargo, I think that our listeners might want
46:58
Speaker 1: to know is that they made a choice in hiring
47:01
Speaker 1: a new chairman of the board, a chairwoman of the board,
47:03
Speaker 1: Betsy Duke, former governor of the Federal Reserve Board. And
47:07
Speaker 1: this news was the first thing out of Wells Fargo,
47:11
Speaker 1: including their independent directors report about what had happened that
47:15
Speaker 1: made me think this entire thing isn't just a smoldering pile.
47:21
Speaker 1: They finally on top of it. They finally done something.
47:23
Speaker 1: They finally done something real. And so I have high
47:26
Speaker 1: hopes for for Duke. And I think that she's a
47:29
Speaker 1: really first rate banker intellect She understands the government, so
47:35
Speaker 1: I act, she understands crisis. So i'm i'm I think
47:38
Speaker 1: that they might have turned a corner. But again, grab
47:40
Speaker 1: your popcorn. The story is not ever So we we
47:43
Speaker 1: really didn't talk about any of your books. The book
47:46
Speaker 1: that's out, um that came out last year, the power
47:49
Speaker 1: and independence of the Federal Reserve. What motivated you to
47:53
Speaker 1: write that? How much of that is you pushing back
47:55
Speaker 1: at all the crazy conspiracy stuff that we see about
47:59
Speaker 1: the Federals. You know, it's it's me trying to stand
48:02
Speaker 1: in the middle of the conspiracists and the FED apologists
48:05
Speaker 1: who see the FEDS this great temple of reason. Right,
48:08
Speaker 1: that is just doing the same thing NASA does when
48:11
Speaker 1: it sends, you know, the voyager out to Mars. By
48:14
Speaker 1: the way, I call that um economists all have physics
48:17
Speaker 1: penis envy. Yeah, that's this, It's exactly that. And and
48:21
Speaker 1: the problem is that we're talking about an uncertain present
48:26
Speaker 1: with a past that we've not fully understood, making projections
48:30
Speaker 1: about an unknowable future. Right. We're not talking about physics, right,
48:35
Speaker 1: We're talking about something else. And it's not that there's
48:37
Speaker 1: no technical content in what the FED does. And that's
48:39
Speaker 1: where the conspiracists are wrong, right, It's not being taken
48:42
Speaker 1: over by different ideologues. There is technical There is a
48:46
Speaker 1: technical apparatus. It's just that inside the FED that technical
48:51
Speaker 1: apparatus isn't enough and can never be enough to answer
48:55
Speaker 1: some of these big questions, should Lehman live or die?
48:58
Speaker 1: Should we take into straits into negative territory? Right? And
49:03
Speaker 1: all these other kinds of questions, the unknown unknowns nobody
49:06
Speaker 1: can answer because humans are involved, and who knows what
49:09
Speaker 1: we're gonna do. So I saw my role, you know,
49:11
Speaker 1: as a lawyer and as a financial historian, not an economist,
49:14
Speaker 1: although conversant in in monetary economics and finance, to be
49:19
Speaker 1: the guy who says it's I'm going to draw the
49:22
Speaker 1: curtain back. Right, We're gonna look at the man, not
49:24
Speaker 1: the wizard, and it's gonna be okay, Alright, we're gonna
49:28
Speaker 1: do and we're gonna see that this extremely interesting, fascinating, important,
49:33
Speaker 1: powerful central bank is not held hostage by a bunch
49:39
Speaker 1: of greedy bankers. Right, But it's not the wizard. So
49:43
Speaker 1: let's talk about the wizard. Um. I think some people
49:48
Speaker 1: um blame Bernanke for the financial crisis, which I think
49:52
Speaker 1: is sort of um really misunderstanding the timeline. But the
49:58
Speaker 1: question I'll ask you is how responsible do you think
50:02
Speaker 1: Alan Greenspan is for the great financial crisis? That's great, Um,
50:07
Speaker 1: there's a there's Alan Greenspan has the unfortunate status of
50:12
Speaker 1: being pilloried on the left and the right for totally
50:14
Speaker 1: different things. So left sees him as giving away the
50:18
Speaker 1: store from a regulatory and supervisory perspective. Right, well, he
50:21
Speaker 1: said a couple of things where, um, hey, you know,
50:25
Speaker 1: the banks will take care of themselves. They have their
50:26
Speaker 1: reputation to worry about. Or um. In California, where the
50:32
Speaker 1: Democratic Congress Democratic State Assembly purposefully did not regulate any
50:38
Speaker 1: of the private lenders, Greenspan said, hey, these are the innovators.
50:43
Speaker 1: Why do we want to get in their way? So
50:45
Speaker 1: it absolutely is consistent with his ideology. Greenspan also had
50:48
Speaker 1: the misfortune of publishing an extremely candid memoir where he
50:53
Speaker 1: admits completely that yeah, I had no appetite for regulation,
50:57
Speaker 1: and he said that he took care of it by saying, well,
50:59
Speaker 1: I'm as and recuse myself because I ideologically I'm opposed
51:02
Speaker 1: to this. What happens in any organization where the boss says, look,
51:06
Speaker 1: you can do what you want. Here's my vision, but
51:09
Speaker 1: you make your decision. Do people say, okay, great, well
51:11
Speaker 1: I disagree with your vision, so I'm gonna do mine.
51:13
Speaker 1: Or do they say, oh, well, let's guess what his
51:15
Speaker 1: vision isn't implement it? And of course it's the latter,
51:18
Speaker 1: and that's what happens at the FED. So the left
51:20
Speaker 1: sees the FED as the only governmental institution with both
51:25
Speaker 1: the credibility and the perspective on the economy to do
51:29
Speaker 1: anything about the underwriting crisis fair enough, and then does
51:34
Speaker 1: nothing about it. And the right what's the rights criticism?
51:37
Speaker 1: The rights criticism is that he played God and he
51:41
Speaker 1: rather than having a monetary policy rule that would have
51:44
Speaker 1: increased interest rates much more rapidly after nine eleven and
51:48
Speaker 1: the tech bubble implosion, he didn't. He felt like that
51:53
Speaker 1: he knew what was better than uh than monetary policy rules,
51:58
Speaker 1: and as results, he started blowing bubbles. So the thing
52:02
Speaker 1: I love about that, I totally agree with your observation.
52:05
Speaker 1: But there's something deliciously ironic about an iron rand libertarian
52:11
Speaker 1: who says we should not have government intervention in anything
52:15
Speaker 1: unless I have my hands on the wheel, and then hey,
52:18
Speaker 1: watch the whole my beer. Watch this. It's an amazing contradiction,
52:23
Speaker 1: and in real time very few people pointed it out.
52:26
Speaker 1: Milton Friedman was one who did right. So he was
52:29
Speaker 1: as consistent libertarian as you ever find um, with only
52:33
Speaker 1: a couple of exceptions. In his youth wing he helped
52:36
Speaker 1: create the payroll deduction system, for example. It was something
52:39
Speaker 1: that he regretted the rest of his life. Thought taxes
52:41
Speaker 1: should be voluntarily given. Um. That's adorable. Yeah, right, that's
52:45
Speaker 1: that's the libertarian fervor right there. But but Milton Freed
52:48
Speaker 1: was a very smart guy, and he was asked in
52:50
Speaker 1: the ninety nineties, I mean, Greenspan made a decision that
52:53
Speaker 1: is credited um, that is credited with adding you know,
52:57
Speaker 1: a trillion dollars of wealth and countless jobs to the economy.
53:02
Speaker 1: And that is by saying in the nineteen nineties, we
53:05
Speaker 1: should not raise interest rates too early because what we're seeing,
53:08
Speaker 1: in part because the technology, uh, in part because of
53:11
Speaker 1: other factors in the economy, dramatic expansion in productivity, rather
53:18
Speaker 1: than an overheating inflationary economy. And so he convinced the
53:21
Speaker 1: other members of the Federal Open Market Committee in nineteen
53:24
Speaker 1: nineties to hold tight. And one of the hawks on
53:27
Speaker 1: the other side of that was Janet Yellen, right, not
53:30
Speaker 1: the dove on the other side of his funnishness, but
53:32
Speaker 1: the opposite and uh. And he was right in the
53:35
Speaker 1: sense that the economy continued to expand even after him,
53:39
Speaker 1: you know, the stock as stock, the tech stocks fell apart.
53:45
Speaker 1: Where they bottomed out was substantially higher, and of course
53:48
Speaker 1: they went right up again than where others were calling
53:51
Speaker 1: the Um the top of the market. And so that
53:54
Speaker 1: idea was that he's the wizard, right, he's the maestro um.
53:58
Speaker 1: And I think that that ends up be feeding this idea.
54:02
Speaker 1: When it's good, it's great, right, But when it's bad,
54:06
Speaker 1: you have a villain. And again it's a bipartisan villainy there.
54:09
Speaker 1: I think that's a fair assessment, right, he when as
54:13
Speaker 1: long as everything's going well, hey listen, when the party
54:16
Speaker 1: is in full swing, everybody loves an easy bartender. But
54:19
Speaker 1: the next morning, when you hungover in sick to your stomach,
54:22
Speaker 1: it's can't believe what sort of jumped this guy was
54:24
Speaker 1: pouring into my glasses. And I think from the perspective,
54:27
Speaker 1: I mean, there's a lot to say in favor and
54:30
Speaker 1: against both of those narratives on the left and the right.
54:33
Speaker 1: So some of those who critique the critique on the
54:35
Speaker 1: left say, um, there's there was no appetite in America
54:41
Speaker 1: for taking a hard line on bankers. And if Greenspan
54:44
Speaker 1: had done it, he would have been pilloried just as
54:47
Speaker 1: anyone else was. What what about either the tale of
54:50
Speaker 1: rule or any other assessment that, when you play it
54:53
Speaker 1: out to the last steps, says, hey, we should have
54:57
Speaker 1: rates a little higher than these. You know, that's where
55:00
Speaker 1: the Greenspan put more or less can exactly right. And
55:04
Speaker 1: and Taylor himself, although not at the time very much.
55:07
Speaker 1: You know, John has made a big career since the crisis,
55:11
Speaker 1: and uh and really raking the Fed over the coals,
55:15
Speaker 1: but he wasn't doing it at the time. And even
55:16
Speaker 1: the original papers that created the Tailor rule were much
55:20
Speaker 1: more tentative than his certainty today, which makes me uh
55:23
Speaker 1: much less sure about the Taylor rule. I'm opposed to
55:26
Speaker 1: writing the Tailor rule into into legislation. Um. But that
55:29
Speaker 1: is the critique the Taylor rule would have said in
55:31
Speaker 1: two thousand four interest rate should have been higher by
55:36
Speaker 1: same same situation, right, they should have been higher by
55:39
Speaker 1: not just twenty five basins points, but by two hundred
55:41
Speaker 1: basis points, right, um or more. And so the problem
55:45
Speaker 1: with that narrative, though Ben murnike um has pointed this out,
55:49
Speaker 1: is that the real estate bubble started. It predated you know,
55:53
Speaker 1: the initial departure. It predated the monetary policy phenomenon. I
55:58
Speaker 1: disagree with um Bernankee on this. Years ago, when he
56:03
Speaker 1: was leaving the FED, there was a lunch a luncheon
56:06
Speaker 1: that I got to intend, and the conference table was,
56:09
Speaker 1: you know, three miles long. He's in the middle of it.
56:12
Speaker 1: I'm in the opposite corner. So I had to scream
56:14
Speaker 1: my question too, and that came up. And the pushback
56:18
Speaker 1: I gave, and I'll repeat it now, was go back
56:21
Speaker 1: to right. You have the crash, Greenspan comes in like
56:26
Speaker 1: many new bankers, they're tested immediately, and you pretty much
56:31
Speaker 1: had the peak in real estate, at least in New
56:34
Speaker 1: York and other metropolitan areas in that seven to eighty
56:40
Speaker 1: nine air If you bought a condo in eighty nine
56:43
Speaker 1: in Manhattan or a co op, you didn't get back
56:45
Speaker 1: to break even until like the whole concept that real
56:50
Speaker 1: estate never goes down. That's before we're not even talking
56:53
Speaker 1: about the Great Depression. But if you look at a chart,
56:56
Speaker 1: you'll see we peaked, took a while to get back over,
57:00
Speaker 1: and my personal experience has been that in the mid
57:04
Speaker 1: to late nineties. Remember the bullmarket really began in eighty
57:08
Speaker 1: two in the mid to late nineties, a lot of
57:10
Speaker 1: people and this is an anecdote, it's not data, but
57:14
Speaker 1: I saw so much of it that I can't believe
57:16
Speaker 1: there isn't a good data source on this. A lot
57:19
Speaker 1: of people said, Hey, I'm gonna roll out a little
57:22
Speaker 1: bit of my equities and trade up in real estate.
57:25
Speaker 1: I'm in a three bedroom, I want to be a
57:26
Speaker 1: four bedroom on an acre. I'm I'm on an acre.
57:28
Speaker 1: I want to be waterfront, I'm waterfront. I want to
57:31
Speaker 1: be at a bigger house. Whatever it was, And that's
57:34
Speaker 1: what it was, a combination of all this wealth that
57:37
Speaker 1: was created in the eighties and nineties, rates were still
57:40
Speaker 1: relatively attractive, and it it just was the demographic cycle
57:45
Speaker 1: that people started to to roll up and out and
57:49
Speaker 1: then what could have sort of faded in most most cycles,
57:56
Speaker 1: the economy drives real estate. Following the nomination of the
58:00
Speaker 1: dot com crash and nine eleven, when rates dropped, I
58:04
Speaker 1: want to say they were below two percent for about
58:06
Speaker 1: three years, and they were about one percent for a year.
58:09
Speaker 1: That's what started that giant spiral. And following there was
58:14
Speaker 1: no refractory period post uh dot com collapse. You had
58:19
Speaker 1: real estate then driving the economy for the next well
58:23
Speaker 1: five six seven years, and that's when everything kind of
58:26
Speaker 1: went vertical. And then add to that, you start running
58:30
Speaker 1: out of people to buy houses, and you moved to
58:33
Speaker 1: sub prime and all day and you bring in another
58:36
Speaker 1: ten or twenty million potential homebuyers. You know, A buddy
58:40
Speaker 1: of mine used to call that um renters with an
58:43
Speaker 1: option to default, people who really My favorite scene in
58:46
Speaker 1: The Big Short is Steve Correll is talking to the
58:49
Speaker 1: stripper who owns a rental property she's renting out. He goes,
58:52
Speaker 1: you own a house that you rent out? She goes, no,
58:54
Speaker 1: I owned six. And the light goes off. Oh this
58:58
Speaker 1: is a disaster. This is going to collapse. So when
59:01
Speaker 1: I look at when bernanke says that, you know, yeah,
59:04
Speaker 1: you were cut. You had a huge booming economy for
59:08
Speaker 1: a decade plus and you still a good chunk of
59:11
Speaker 1: that real estate was upside down for a while. Once
59:14
Speaker 1: you crossed I want to say nine seven, Yeah, real
59:18
Speaker 1: estate started to move. But you look at O two
59:20
Speaker 1: oh three or four or five or six oh seven,
59:22
Speaker 1: it's exclusion. It went vertical. So it's kind of I
59:26
Speaker 1: find he's the same thing with the excess cash looking
59:29
Speaker 1: for a home. I always thought that argument was a
59:32
Speaker 1: little You tell me how disingenuous is is the there's
59:37
Speaker 1: too much savings, that's our problem around the world gets
59:41
Speaker 1: to um my own ideology, which is that I am
59:44
Speaker 1: a radical uncertain tist. So I love that I don't
59:52
Speaker 1: have a strong view on these questions, but I love
59:55
Speaker 1: doing and structuring those arguments and understanding what would I
59:58
Speaker 1: have to know in order to horse one or another?
1:00:01
Speaker 1: And so here's what I would have to know. I
1:00:03
Speaker 1: would have to know more about the relative availability of credit,
1:00:08
Speaker 1: right that securitization, the explosion of securitization, and then demand
1:00:14
Speaker 1: that securitization I'm talking about second third generated into c
1:00:17
Speaker 1: d O s and beyond that downward interest rate pressure
1:00:21
Speaker 1: was putting on the system. Uh, And how we would
1:00:24
Speaker 1: look at that if the federal funds rate was higher,
1:00:28
Speaker 1: because one view, uh that Taylor and others assert is
1:00:33
Speaker 1: that these move an absolute lockstep. Right, So federal funds
1:00:37
Speaker 1: in two thousand and one to two thousand four, if
1:00:40
Speaker 1: it had been raised two d basis points or three
1:00:42
Speaker 1: hundred basis points, and then we would have seen such
1:00:46
Speaker 1: a dramatic break on the expansion of the housing system.
1:00:49
Speaker 1: I think there's some truth to that, and I want
1:00:51
Speaker 1: to know why, how did you reach that conclusion. I
1:00:53
Speaker 1: don't have a view on that, So I'll give you
1:00:55
Speaker 1: short against the counter factual that interstates were higher and
1:00:59
Speaker 1: we still had that breathtaking enthusiasm that you can make
1:01:03
Speaker 1: this back on capital gains alone, and it will be
1:01:06
Speaker 1: swift and swifter than stock markets right under other equities
1:01:11
Speaker 1: or other asset classes. So so here's the mechanism for
1:01:14
Speaker 1: that specific thing. And I'm literally talking my book again.
1:01:17
Speaker 1: So if you're running a pension fund and foundation, anything
1:01:21
Speaker 1: that a charitable trust, um, anything that has a five
1:01:25
Speaker 1: percent bogu, We're gonna give away five percent of our
1:01:27
Speaker 1: corpus each year in order to maintain our tax exempt status.
1:01:31
Speaker 1: I think if you're a public pension fund, that's not
1:01:33
Speaker 1: a technical issue. But any of the giant foundations and
1:01:37
Speaker 1: charities and what have you have to do that when
1:01:41
Speaker 1: when rates go to and it's easy to do that.
1:01:43
Speaker 1: You expected returns for equities or six percent you're expect
1:01:47
Speaker 1: to return for bonds a three five percent a blended portfolio, Hey,
1:01:50
Speaker 1: five percent is a no brainer. How hard is that? Now?
1:01:53
Speaker 1: You take rates down you have a dot com crash,
1:01:55
Speaker 1: so oops, there's that. Then you take rates down to
1:01:58
Speaker 1: one percent. Now my bond aren't giving me anything. I
1:02:02
Speaker 1: think a lot of bond a lot of fund managers
1:02:04
Speaker 1: went to their bonds, either traders or salespeople whatever, say listen,
1:02:10
Speaker 1: I can't live on two percent. I have to get
1:02:14
Speaker 1: me something that will generate a better return, or I
1:02:18
Speaker 1: have to find somebody who will and so out. At
1:02:22
Speaker 1: the same time, we have a small bit of securitized
1:02:27
Speaker 1: sub prime and suddenly, hey, just as safe as treasuries.
1:02:32
Speaker 1: I remember being pitched in oh three, but look at
1:02:35
Speaker 1: yields a hundred fifty two fifty basis points. Mare, there's
1:02:39
Speaker 1: your five percent but bogey. And then all of a sudden,
1:02:43
Speaker 1: these mushrooms start to pop sprout after rain that the
1:02:47
Speaker 1: business model was not lends in order to get a
1:02:53
Speaker 1: yield on a mortgage, but lend in order to sell
1:02:57
Speaker 1: the papers to securitizers. And now that's what's feeding the
1:03:02
Speaker 1: beast and that process. Now I'm taking some liberties with
1:03:06
Speaker 1: the timelines, and I'm sure skipping some steps, but I
1:03:08
Speaker 1: think that is what led to that massive upswing in
1:03:11
Speaker 1: the I think, and again, I think it's a coherent view.
1:03:13
Speaker 1: This isn't This isn't something i'd call incoherent or or,
1:03:16
Speaker 1: and it's not a place where I've resolved these uncertainties
1:03:19
Speaker 1: for myself. And here's one of the reasons why I'm
1:03:20
Speaker 1: not walking out saying Barry, You're right, bernanke is wrong.
1:03:23
Speaker 1: I buy in the to the Taylor critique. I think
1:03:25
Speaker 1: it's exactly right, and part of it is all right.
1:03:28
Speaker 1: So we've got the soup of factors that contribute the
1:03:30
Speaker 1: financial crisis. Easy money is certainly one, right, and now
1:03:36
Speaker 1: let's talk about the five or six others that are
1:03:39
Speaker 1: contributing to and explain to me why the FEDS easy
1:03:44
Speaker 1: money is the factor that we call causal as opposed
1:03:47
Speaker 1: to just simply part of the soup. Is I agree,
1:03:51
Speaker 1: it is part of the soup. It's that take the
1:03:53
Speaker 1: Commodity Futures Modernization Act that said derivatives don't have to
1:03:57
Speaker 1: be regulated like other insurance products. Absolutely, that's a big
1:04:00
Speaker 1: part of the global The global savings glut is a
1:04:03
Speaker 1: massive factor. Right, So we've got things that unless convinced
1:04:06
Speaker 1: to that, you're like, you don't, you're not convinced that
1:04:08
Speaker 1: there's a massive amount of money flowing unless convinced that
1:04:11
Speaker 1: that is a factor causing a great financial crisis. It
1:04:14
Speaker 1: might have money yield. Yeah, well money seeking return not
1:04:18
Speaker 1: necessarily yield. So in in coming up so with the
1:04:21
Speaker 1: structure of collateralized that obligations. Right, the financial innovation, which
1:04:25
Speaker 1: I still think is a pretty breath taking piece of
1:04:27
Speaker 1: financial engineering in the sense right, being able And it's
1:04:30
Speaker 1: not financial alchemy to say we can actually traditional mortgage
1:04:34
Speaker 1: backed securities are already tranched, but they're trenched in a
1:04:37
Speaker 1: way that isn't about diversification risk, right, it's just about
1:04:39
Speaker 1: pooling rice on geography. How much risk do you want
1:04:42
Speaker 1: to take for how much reward? Yeah, and now cd
1:04:44
Speaker 1: as are saying, well, we're gonna make this in first in, uh,
1:04:47
Speaker 1: first out, and we're just going to If you had
1:04:49
Speaker 1: drawn the lines of c d O S differently, right,
1:04:52
Speaker 1: so that the equity tranch was much larger and the
1:04:55
Speaker 1: trip lay transferable smaller, right, that's one option. The other
1:04:58
Speaker 1: option is is garbage and garbage out? If what was
1:05:01
Speaker 1: going so when again I'm talking to my book, One
1:05:04
Speaker 1: of my most stunning things I discovered on the standardized
1:05:08
Speaker 1: documents for purchases of mortgages to be securitized. There is
1:05:12
Speaker 1: a nine day warranty a toaster. By a toast, you
1:05:16
Speaker 1: get warranty if the thirty day mortgages that go into
1:05:21
Speaker 1: these c d O s, if they default within ninety day,
1:05:23
Speaker 1: you can put it back to it. Now, stop and
1:05:25
Speaker 1: think about that. This is a thirty year obligation, right,
1:05:31
Speaker 1: how many months is that that's that's sixty months. If
1:05:35
Speaker 1: it defaults in the first three months, you can put
1:05:37
Speaker 1: it back now. If that would have been a twenty
1:05:39
Speaker 1: four month put which is hey, after two years, we've
1:05:42
Speaker 1: done our due diligence, it's on you, that would have
1:05:46
Speaker 1: been a big difference. But because of this was so
1:05:49
Speaker 1: complicated in real time, nobody understood the details. You could
1:05:54
Speaker 1: say night by the way, even that put. I think
1:05:58
Speaker 1: there was a great website called mortgage implode dot com
1:06:02
Speaker 1: that tracked all of the mortgage ender waters who went
1:06:05
Speaker 1: belly up, and it was four hundred of them. Because
1:06:09
Speaker 1: even with that short ninety day there were people who
1:06:12
Speaker 1: who they were doing the piggyback loans, they were doing
1:06:16
Speaker 1: the underlying mortgage and the whole equity at the same time.
1:06:19
Speaker 1: So you're lending a d and they never made a payment,
1:06:23
Speaker 1: They lived rent free for five years before they were
1:06:26
Speaker 1: eventually evicted. How could that ever go this? Let me
1:06:30
Speaker 1: take a giant step back and tell you why our
1:06:33
Speaker 1: conversation right now, oh will prove out this truth about
1:06:38
Speaker 1: which I don't have uncertainty. The two thousand eight crisis
1:06:41
Speaker 1: is going to continue to be a master class in
1:06:44
Speaker 1: financial history for decades to come, just as the Great
1:06:46
Speaker 1: Depression has. You and I could have an identically structured
1:06:50
Speaker 1: conversation about what caused the Great Depression, and we'd have
1:06:53
Speaker 1: so many factors to discuss, and you would say, well,
1:06:55
Speaker 1: this thing mattered more than that thing, And I said, well,
1:06:57
Speaker 1: I think that thing is Lewis. It's more complicated than that.
1:06:59
Speaker 1: And the reason why for some people that's just massively frustrating.
1:07:03
Speaker 1: Give me an answer, give me the to identify the problem,
1:07:07
Speaker 1: give me an answer that identifize the solution. Let's move on.
1:07:09
Speaker 1: So I will admit I'm ignorantous to what was the
1:07:12
Speaker 1: Great Depression? Was it was it tariffs and trade? Was
1:07:15
Speaker 1: it was it Herbert Hoover? Was it income in equality?
1:07:19
Speaker 1: I have no idea, and I think that those conversations
1:07:22
Speaker 1: which we can have if you'd like tell us a
1:07:27
Speaker 1: huge amount. And why they call that a master classes
1:07:29
Speaker 1: rather than you know, uh, just a circular track where
1:07:32
Speaker 1: we just chase each other endlessly, is because by really
1:07:37
Speaker 1: digging deep, isolating the mechanisms, ask yourself what you don't know,
1:07:41
Speaker 1: what you'd need to know in order to answer that question.
1:07:44
Speaker 1: That's how we learn about the mechanics of finance. And
1:07:48
Speaker 1: I think that's much. It's not not to dismiss my
1:07:51
Speaker 1: finance colleagues, but I would take that approach to things.
1:07:55
Speaker 1: I have taken that approach to things as a financial historian,
1:07:57
Speaker 1: as a lawyer. Then you know, learning the basics of
1:08:00
Speaker 1: black shouls or a cap emma or whatever else. Well,
1:08:02
Speaker 1: that works. So let's jump into our speed round our
1:08:04
Speaker 1: favorite questions. Let's uh, let's let's run right through these.
1:08:08
Speaker 1: Tell us the most important thing that people don't know
1:08:11
Speaker 1: about you. I'm I'm a poor, scrappy kid from More, Oklahoma,
1:08:16
Speaker 1: and I'm the I'm the sixth of seven kids to
1:08:18
Speaker 1: a single mom. My dad died when I was nine,
1:08:21
Speaker 1: but most of my life, most of his life, uh,
1:08:24
Speaker 1: he just wasn't good at life, wasn't good at being
1:08:28
Speaker 1: a human. Um, So, how do you go from a
1:08:30
Speaker 1: poor kid in Oklahoma to Harvard, Stanford Princeton, and so Um.
1:08:35
Speaker 1: The first was my brother, who is nine years older
1:08:39
Speaker 1: than me. Um was approached. He did well on the
1:08:42
Speaker 1: s A t S. And he was approached by an
1:08:44
Speaker 1: alum of Harvard saying, hey, kid like you shouldn't go
1:08:48
Speaker 1: to the local state school, should go to Harvard, which
1:08:50
Speaker 1: just didn't compute for anyone in my family. And so
1:08:53
Speaker 1: he applied, he got in, he went, and then nine
1:08:56
Speaker 1: years later, none of my other siblings did right well.
1:08:58
Speaker 1: Everybody else went to UH, to the state schools UM.
1:09:03
Speaker 1: And then night years later, I was just like, you
1:09:05
Speaker 1: know what I'm gonna I'm gonna be like my big brother.
1:09:08
Speaker 1: And so I did well in the s A t S.
1:09:10
Speaker 1: And I just from the time I was a kid,
1:09:11
Speaker 1: I was like, I saw what happened to Sam right
1:09:15
Speaker 1: the way that people reacted to him. Whatever Harvard meant,
1:09:19
Speaker 1: it meant something big. And so I applied, I got in,
1:09:22
Speaker 1: and I went, And then I would love to say
1:09:24
Speaker 1: that from there it was just all UH sunshine and buttercups,
1:09:28
Speaker 1: but the but it wasn't the cultural misfit between more
1:09:30
Speaker 1: Oklahomagetitus is so massive. It was harder for me than
1:09:34
Speaker 1: some my friends were from you know, gone to lead
1:09:38
Speaker 1: pipe private schools in Singapore or London, or or Johannesburger,
1:09:43
Speaker 1: Jennie or whatever else. So let me your brother is
1:09:47
Speaker 1: clearly a mentor. Who were some of your other early mentors.
1:09:50
Speaker 1: One of my very favorite mentors is a professor sociology
1:09:53
Speaker 1: professor named Mary Waters. I ended up not studying really
1:09:57
Speaker 1: anything close to what she does. She does studies immigration,
1:09:59
Speaker 1: natural asters, things like that, but she at Harvard University
1:10:04
Speaker 1: was the only professor I ever had that just took
1:10:07
Speaker 1: a keen personal interest in me. And as a as
1:10:11
Speaker 1: a teacher, so not you know, as as a scholar,
1:10:13
Speaker 1: I've gone in a different direction, but as a as
1:10:16
Speaker 1: a teacher, Mary has had a huge influence on me.
1:10:18
Speaker 1: Another one is and not ed Maddi. If you know
1:10:22
Speaker 1: the banker's new clothes, that's her. Um. She had a
1:10:25
Speaker 1: big has and still has a huge impact on me
1:10:28
Speaker 1: as a scholar, because how fearless she is? All right, son,
1:10:31
Speaker 1: this poor kid from Oklahoma, What business do I have
1:10:33
Speaker 1: talking about trillions of dollars? When you say fearless? In
1:10:36
Speaker 1: what way she'll say something? Whether it's popular or not
1:10:38
Speaker 1: well man, she just goes to war against people whose
1:10:42
Speaker 1: resources vastly outstripped her own on something that seems as
1:10:46
Speaker 1: our kane as bank balance sheets. Right, but banks should
1:10:48
Speaker 1: have much more equity, much less debt and uh and
1:10:51
Speaker 1: she's just tireless. We don't agree on everything. Sometimes we'll
1:10:54
Speaker 1: bicker and argue, but she has been just a profound
1:10:59
Speaker 1: Mentor's let's talk about books, because we we just mentioned
1:11:03
Speaker 1: the Banker's New Clothes. What are some of your favorite books.
1:11:05
Speaker 1: When I was a kid, the only book that ever
1:11:07
Speaker 1: made me physically weep was Victor Hugo's Lay miserab Um,
1:11:12
Speaker 1: and I remember reading the unabridged version and just feeling
1:11:14
Speaker 1: like I had been. It was the first time I
1:11:17
Speaker 1: thought I don't have to actually have these experiences to
1:11:19
Speaker 1: experience them. So that was that had a big impact.
1:11:23
Speaker 1: More more recently and perhaps less uh less Sacraine than that.
1:11:27
Speaker 1: Sebastian Malaby is probably my favorite financial journalists. I've read
1:11:31
Speaker 1: everything he's written, so more Money than God and what
1:11:36
Speaker 1: was the one on central banks? He wrote? The Man
1:11:40
Speaker 1: Who Knew, which is the biography of Alan Greenspan. I
1:11:43
Speaker 1: disagree with a lot of it in terms of the
1:11:46
Speaker 1: overall framing. Um, but it's it's just a superb product
1:11:51
Speaker 1: of exposition and research and you know the framing he puts,
1:11:54
Speaker 1: the policy questions where he intervenes. Uh, you can agree
1:11:58
Speaker 1: or disagree, but that's not the main country from the book.
1:12:00
Speaker 1: It's just terrific history. So if you like biography, Alan
1:12:04
Speaker 1: Green's fans biot it should have won a Pulitzer Prize
1:12:06
Speaker 1: in my view. Really, Oh it's so good. Wow, that's impressive. UM,
1:12:11
Speaker 1: tell us about a time you failed and what you
1:12:14
Speaker 1: learned from the experience. So UM, I when I started
1:12:22
Speaker 1: as an undergraduate at Harvard, UM, I was the president
1:12:25
Speaker 1: of the math club in my little Oklahoma high school
1:12:29
Speaker 1: and I just could not do the math in economics.
1:12:32
Speaker 1: And that's so funny you say that because in high
1:12:35
Speaker 1: school I was a mathlete and I then I go
1:12:38
Speaker 1: to Stony Brook for applied mathematics and physics, thinking that
1:12:42
Speaker 1: I'm the sh isnt and I know the stuff, like
1:12:45
Speaker 1: I didn't have to study for cow classes and I
1:12:47
Speaker 1: would get a's. And then you show up with people
1:12:49
Speaker 1: who are really serious and suddenly it's like, oh, I'm
1:12:53
Speaker 1: not as good at this as I thought. These guys
1:12:55
Speaker 1: who actually put in the heavy lefting do the work.
1:12:58
Speaker 1: They're running circles, and that was the barry. You and
1:13:00
Speaker 1: I had exactly the same circumstance. And so what I
1:13:02
Speaker 1: did in the face of that difficulty is I sprinted
1:13:05
Speaker 1: in the other direction and way from economics, away from
1:13:10
Speaker 1: things that were challenging. At least initially, I was like,
1:13:12
Speaker 1: I have to do something that immediately validates my natural strengths.
1:13:15
Speaker 1: I tell my students, I tell my children that that
1:13:16
Speaker 1: is just one of the worst sins that you can
1:13:19
Speaker 1: commit against yourself. Um And so it took me. I
1:13:23
Speaker 1: was in graduate school for ten years, during which I
1:13:26
Speaker 1: I paid for all of my sins and neglect. I
1:13:29
Speaker 1: took a lot of economics classes. Now I'm no brilliant mathematician,
1:13:33
Speaker 1: but there's nothing in in basic economics that's outside of
1:13:36
Speaker 1: my Again, I'm not an economist. I paid for that.
1:13:39
Speaker 1: I'm glad I did. But that failure, that failure was
1:13:43
Speaker 1: so signal, and that is I ran away from what
1:13:46
Speaker 1: was hard, and I wish I'd run in the other direction.
1:13:49
Speaker 1: And I eventually did run in that other direction, but
1:13:51
Speaker 1: took a long time for me to make up for
1:13:53
Speaker 1: that tell us what you do for fun. I love
1:13:56
Speaker 1: racquetball and squash. Um. I love my children. I have
1:14:00
Speaker 1: three children and have a wonderful marriage with their with
1:14:04
Speaker 1: my wife, their mother, Nikki Um. I think he was
1:14:07
Speaker 1: just traveling this week, and so it was daddy owns
1:14:11
Speaker 1: the owns, the solo parenting thing and we had a
1:14:14
Speaker 1: terrific time. But my two year old is h he's
1:14:18
Speaker 1: an angel ninety at the time a terrorist the other time. Percent.
1:14:21
Speaker 1: I was very happy to see Nicky come home last night.
1:14:23
Speaker 1: That was the nine. That's a good So you deal
1:14:26
Speaker 1: with a lot of millennials and kids in college. Any
1:14:29
Speaker 1: of them come up to you and say, I'm interested
1:14:31
Speaker 1: in a career in finance. What sort of advice would
1:14:34
Speaker 1: you give that? Yeah? They I do that all the time.
1:14:36
Speaker 1: I teach a financial regulation financial history course, and I
1:14:38
Speaker 1: always as I say, the same thing. Right, So fintech
1:14:42
Speaker 1: is not a creature of post two thousand eight. Fintech
1:14:44
Speaker 1: is as old as finance. Look for ways in which
1:14:48
Speaker 1: rules have clumped when that should have been more evenly distributed. Right,
1:14:53
Speaker 1: So that's that treats like things unlike. So maybe it's
1:14:58
Speaker 1: that there's a phyco At score that treats people very differently,
1:15:01
Speaker 1: and you see a big difference in interest rates and
1:15:05
Speaker 1: do an arbitrage. So that would be things like so
1:15:09
Speaker 1: far right, that would be things like, um, you know,
1:15:12
Speaker 1: looking at underwriting standards that might be different. Um. So
1:15:16
Speaker 1: that's one thing. So it's where law has clumped people,
1:15:20
Speaker 1: where the margins are basically identical. Build a bridge, right.
1:15:23
Speaker 1: I think that's a really effective business strategy. Second is
1:15:27
Speaker 1: we're all going to be terrible at at calling uh
1:15:31
Speaker 1: bubbles at their at their peak and at their trough.
1:15:34
Speaker 1: But take the Wells Fargo model, nineteenth century version, which is, yeah,
1:15:38
Speaker 1: we're not going to be in the gold mining business.
1:15:40
Speaker 1: We're going to sell stuff to people or in the
1:15:42
Speaker 1: gold mining business. So whether whatever your view a bitcoin
1:15:44
Speaker 1: or cryptocurrency, if you can design system that provides services
1:15:50
Speaker 1: that are portable but that could cater to that, that's
1:15:52
Speaker 1: a good business to be in, just so long as
1:15:53
Speaker 1: it's not so catered that you can't that it's not
1:15:56
Speaker 1: not portable. And our final question, what is it that
1:15:59
Speaker 1: you know about the world of central banks and Federal
1:16:02
Speaker 1: Reserve today that you wish you knew twenty years ago?
1:16:06
Speaker 1: That that's there's no wizard that there are women and
1:16:09
Speaker 1: men behind that curtain of substantial and intellect, talent, technique, ideology,
1:16:16
Speaker 1: judgment values to their people and the humanized Central Banks
1:16:19
Speaker 1: is not to disparage them. Has to say the people,
1:16:23
Speaker 1: and I am too, and I can engage in that debate,
1:16:24
Speaker 1: and I can do it intelligently or I can do
1:16:26
Speaker 1: it stupidly. Um, so let's do it intelligently, and let's
1:16:30
Speaker 1: not just say all right, I'll just trust the wizards
1:16:32
Speaker 1: know what they're doing. Fascinating. We have been speaking with
1:16:35
Speaker 1: Peter Conti Brown. He is an assistant professor at Wharton
1:16:39
Speaker 1: School of Business, both grad and undergrad at the University
1:16:42
Speaker 1: of Pennsylvania. If you enjoy this conversation, then be sure
1:16:46
Speaker 1: and look up an Inch or down an inch on Apple, iTunes, Bloomberg, Stitcher, Overcast,
1:16:52
Speaker 1: wherever finer podcasts are sold, and you can see any
1:16:55
Speaker 1: of the other two hundred or so such podcasts that
1:16:58
Speaker 1: we've had. We love your ammens, feedback and suggestions right
1:17:02
Speaker 1: to us at m IB podcast at Bloomberg dot net.
1:17:06
Speaker 1: I would be remiss if I did not thank the
1:17:08
Speaker 1: crack staff that helps us put together these conversations each week. Uh,
1:17:13
Speaker 1: Medina Parwana is my audio engineer. Producer Taylor Riggs is
1:17:17
Speaker 1: our booker. Michael Batnick is our head of research. I'm
1:17:21
Speaker 1: Barry Retults. You've been listening to Masters in Business on
1:17:24
Speaker 1: Bloomberg Radio.