“Wall Street is the most regulated industry in our country, and the financial crisis could not have happened, ever, without regulation as a contributor. To blame bankers without blaming the authority they operated under is folly. The subprime mortgage boom/bust was primarily caused by Freddie Mac and Fannie Mae, government-sponsored enterprises that would never have existed in a free market.”
In October, Janet L. Yellen did something uncharacteristic for a Fed chair. At the Boston Federal Reserve conference on income inequality, she gave what sounded suspiciously like a campaign speech. For veteran Fed watchers like John A. Allison, her message could not have been clearer. Yellen’s timing and topic looked suspiciously like a not-so-subtle plug for her boss, President Barack Obama, just days before the mid-term elections.
Allison is the former CEO of BB&T, the nation’s 12th-largest bank-holding company with $181 billion in assets, and now president of the prestigious Washington, D.C., think tank Cato Institute.
He is the author of a new book, The Leadership Crisis and the Free Market Cure. His first book, The Financial Crisis and The Free Market Cure(McGraw-Hill, 2013), was described by Forbes as the one book about the financial crisis that “gets both the diagnosis and prescription just right.”
In the interview that follows, Allison comments insightfully, and at times ruefully, on the Volcker Rule (“too big to fail”), the housing crisis of 2007–2009, the unintended consequences of fair value accounting, and the flotsam and jetsam of the financial crisis. He also foresees a U.S. economic disaster in the next 15 to 20 years, an era that may come to be known as the “Imploding ’20s” by historians, after baby boomers turn 80 and begin to consume 90 percent of their lifetime medical expenses. And he adds a tantalizing coda: Lehman Bros. didn’t have to go bankrupt.
What did we learn from our mistakes during the credit crisis, and are we likely to repeat them?
The Dodd-Frank legislation doesn’t deal with most of the issues that caused the credit crisis, so it’s a misapplied remedy, not a cure. I would argue that the Federal Reserve is setting the stage for similar problems in the 2020s.
Janet Yellen raised the issue of income inequality in a speech at the Boston Federal Reserve Bank. Was this within her defined role as Fed chair or just politics?
The topic, while a worthy one for economists, has nothing to do with her statutory role as chair of the Fed board of governors. In that role, she is charged to improve unemployment and stabilize interest rates, and today also to maintain the stability of our financial institutions. The irony is that her policies — and those of her predecessors, by the way — are killing the mom- and-pop saver who invests mainly in CDs and bank savings accounts, and the unintended consequence is that her policies benefit mostly the upper classes.
Regarding the Fed chair role, have Yellen and her predecessors been given an impossible job?
Yes, plainly speaking, the job is impossible especially when you take into account the politics. But, I would add, they’re not doing an impossible job very well. I think they’re all guilty of what’s called fatal conceit, the belief of smart people that they can do the impossible. Let’s start with the targeting of monetary rates. I have talked to numerous members of the Federal Reserve and asked them, could a group of experts in Washing- ton, D.C., set the price for automobiles? To a person, they all said absolutely not. And then I ask, what about setting the price of money, interest rates, which is the most complex commodity in the world? They just look at me. It’s a strange kind of hubris.
Since the Fed is not going away, how can we make it more independent?
We just created the Cato Center for Monetary and Financial Alternatives, which will explore ways to discipline the Fed. At minimum, we think the Fed needs to be guided by fixed rules and proper over- sight. When you consider the Fed authority over our financial services, it is somewhat like having the government’s IT department that created the Obamacare website oversee Google.
Are you still concerned about the impact of mark- to-market and derivative accounting?
Mark-to-market contributed to and worsened the financial crisis, because in an environment where the Federal Reserve is making arbitrary decisions, you don’t really have normal market prices. Assuming that everybody is going to liquidate everything in that kind of environment is an irrational way to evaluate assets. The result was tragic and predictable.
According to a McKinsey study, U.S. debt represents nearly 10 percent of the entire globe’s debt of $186 trillion. Are you concerned?
Our deficits would be $1 trillion a year larger than we are reporting because we don’t account for the fact that boomers are going to retire someday, and under Medicare they will spend 90 percent of their lifetime medical expenses in the last years of life. And we would have a negative net worth of $40 trillion.
There is significant unrest around executive compensation, particularly CEO compensation. Is there a better way?
I believe that the market needs to determine compensation. In financial services, the top tier of regulated companies has to cap compensation now. The result is that many of the best people are leaving firms like J.P. Morgan and Goldman Sachs, and ironically, this means the market will move to the unregulated companies that regulators were most concerned about during the financial crisis.
Could boards of directors have done a better job during the crisis?
I think most boards tried their best, but there are structural and legacy issues that got in the way of better board performance. First, I don’t believe that boards effectively really self-regulated. The whole idea of independent directors is superficial, and has required companies to field boards that are inexpert in the company’s business. What is really needed are objective directors, but genuine objectivity requires a deep understanding of the business. If you put me on the board of a company I know very little about, I might not see the train coming despite the fact that I am a seasoned executive. I’m afraid boards that were overseeing some of our great financial failures lacked the right skills and, in some cases, the depth of experience.
James Stewart, in The New York Times, said that the Lehman Bros. bankruptcy didn’t have to happen. Do you agree?
Before I answer that question, let me pose one that precedes it: why in the world did they save Bear Stearns? Bear was not that big a player and would have easily been digested both because of its size and the timing. So the implication was they would have to save Lehman, because Lehman was much bigger, much more systemically important. That may be what impelled Lehman to double-up their bets on mortgage securities, and by doing so they quadrupled their losses. So, if Lehman had been liquidated the day Bear Sterns failed, the country might have avoided what the crisis became, the Great Recession.
Bankers are still being blamed for the crisis, and if you read the headlines, the man and woman on the street are asking why haven’t bankers gone to jail. Is that fair?
Fair, certainly not, but rational, maybe.To understand that, you have to look at several issues that haven’t been given proper coverage by the media. The first is the never-ending myth that greed on Wall Street and deregulation caused the financial crisis, because the press and government believe so strongly in the power of regulation. Wall Street is the most regulated industry in our country, and the financial crisis could not have happened, ever, without regulation as a contributor. Now, we can get into why regulation didn’t work and why it was misapplied, but to blame bankers without blaming the authority they operated under is folly. In fact, government policy was the primary cause of the financial crisis. The subprime mortgage boom/bust was primarily caused by Freddie Mac and Fannie Mae, government-sponsored enterprises that would never have existed in a free market.
With your new book, The Leadership Crisis and the Free Market Cure, in mind, do you have any thoughts on how boards should be leading?
I argue that ethical principles that are appropriate for an individual — the idea of having a sense of purpose for making rational decisions based on facts, being honest, having integrity — are exactly the things that are appropriate for organizational behavior. One of my concerns is that we’re moving towards a compliance society, which is radically different than the ethical society. Companies comply, but that’s different than having the right ethical principles. In the long term, the lack of ethical principles will overwhelm whatever technical compliance a company or individual might employ. I think we can get back on track, and boards play a very significant role in doing so.