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Bernanke Calls for Overhaul of Financial Regulations

March 10, 2009 at 6:10 PM EDT
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Fed chief Ben Bernanke called Tuesday for a regulation overhaul to prevent future financial crises and monitor "too-big-to-fail" institutions. Analysts weigh the call for reform.
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GWEN IFILL: Jeffrey Brown begins with the market jump and the regulatory overhaul.

JEFFREY BROWN: And for that, I’m joined by David Wyss, chief economist at Standard & Poor’s.

Nomi Prins, a former managing director at Goldman Sachs, she’s author of “Other People’s Money” and a senior fellow at the think-tank Demos.

And Sebastian Mallaby, a senior fellow for international economics at the Council on Foreign Relations, he’s also writing a book about hedge funds.

So, David Wyss, let me start with you. A very big jump today. What were the markets seeing?

DAVID WYSS, Chief Economist, Standard & Poor’s: Well, I think a number of things. Number one, they liked Bernanke’s statements this morning. They even more liked the fact that Citibank said they had profits for the first two months of the year. And although banks don’t usually give two-month statements, you know, they usually wait for the quarter, they want any good news.

JEFFREY BROWN: And this is Citibank. Of course, we’ve been reporting daily on all their troubles.

DAVID WYSS: Right, I mean, they’ve been in serious trouble, probably the most troubled of the big banks that’s left anyway. So people were very worried about it.

And then, in addition, you got some statements about changing, going back to the old uptick rule on short sales, which a lot of people would like to do.

JEFFREY BROWN: Can I — let me stop you there. Explain that. I mentioned it in our set-up piece, but tell people what the uptick rule is, why it’s significant.

DAVID WYSS: On the old rules, you could only go short a stock. You could only sell a stock without owning it, if the previous trade had been with an increase in the price. That was to stop people from piling on when stocks started to go down.

Going back to that uptick rule, which was suspended during the Bush administration, would basically tend to prevent this sudden rush of short sellers getting into the market and really driving the price of the stock down.

Bernanke identifies mistakes

Sebastian Mallaby
Council on Foreign Relations
So I think what Chairman Bernanke was talking about was important in terms of giving people confidence that in the long term we know how to put the system back together again.

JEFFREY BROWN: So, Sebastian Mallaby, let's turn to the longer-term regulatory part that Mr. Bernanke talked about here. One of his focuses was on the notion of these "too big to fail" institutions, and he was suggesting that we need better regulation of them and perhaps even ways to help them unwind if it comes to that, right? What struck you about his remarks?

SEBASTIAN MALLABY, Council on Foreign Relations: Well, I think it was, you know, encouraging that we can think about the long term, as well as just in a panic kind of way dealing with the immediate issues.

And it's clearly true that, when you've got big, systemic institutions which taxpayers can't afford to let fail -- therefore, they are underwriting the risks -- we need to think about how we protect taxpayers from the managers of these institutions, saying, "Gee, you know, I'm going to be rescued if I go wrong, so I'll take as much risk as possible since I have a safety net."

And so I think what Chairman Bernanke was talking about was important in terms of giving people confidence that in the long term we know how to put the system back together again.

JEFFREY BROWN: You were there today for this speech, I understand. It sounds as though -- and even in the clip we heard earlier -- there's something of a mea culpa in all of this, and it was, "We didn't do enough. We clearly failed."

SEBASTIAN MALLABY: Well, I think that, you know, Chairman Bernanke has the advantage of not having been in the chairman's job, anyway, for so long that when he says, "We got it wrong," I mean, it could be "we institutionally" as opposed to "me personally." And so he's probably comfortable making those sorts of statements.

But, you know, even if he'd been in the chairman's office for a long time, what's happened in the last two years would surely compel anyone to say, yes, something went wrong. And I think it's important to get that out there and look beyond the horizon to how you can make things better.

JEFFREY BROWN: Nomi Prins, let me bring you in. What struck you about Chairman Bernanke's statements today about ways of looking ahead on regulation?

NOMI PRINS, Senior Fellow, Demos: Well, I think he definitely knew, whether he was there or not, that things went massively wrong and that the banking system, basically, took on more risk than it's capable of absorbing. It took on more debt than it was able to basically pay back.

And so the payer became the federal government, the taxpayers and international governments, as well. So I think he's realized, "Hey, wait a minute. Everything we're doing isn't really working."

Yes, Citigroup had some OK results today, but in general we're still in a really, really weak situation. And I've got to take a step back -- someone has to do that -- so I can come in and look at how to actually regulate the situation better, stabilize it, and make sure this doesn't happen again.

Defining 'Too big to fail'

David Wyss
Standard and Poor's
Now, they've got be able to coordinate with other countries, because as these financial markets become global, you have got to focus across countries, not just within the country.

JEFFREY BROWN: What do you think about the -- what he said about the "too big to fail" institutions? Is it possible to do -- or how is it possible, rather, to do a better job to regulate them even on the upside, as they were going full guns not that long ago?

NOMI PRINS: Well, I personally believe they shouldn't be allowed to get too big to fail. That would be one way of helping to prevent this situation.

But given that it's what we have, I think you really have to take a look at dissecting the parts of the banks that have piled on all the risks and the parts that are really accountable to the consumer deposits and consumer loans and the parts that the government has a responsibility to back, because consumers didn't think their deposits were going to be used to create these massively risky situations and all of the other types of transactions that banks took on.

So if you're going to look at "too big for fail," yes, you have to have regulators come in and understand how things got too big to fail. You have to make sure it's not allowed in the future, both by segregating the components of the banks to see who has risk and who doesn't and then systemically reducing the risk that any component is allowed to take on. And there was some extent to which Bernanke did allude to that.

JEFFREY BROWN: Well, David Wyss, picking up on that, another term that Mr. Bernanke used is -- he called it macro-prudential approach was needed, which I take to mean a kind of systemic risk approach, looking at the whole system at the same time as you're looking at individual institutions. What are the -- what are the pros and cons of an approach like that?

DAVID WYSS: Well, I think it's necessary now. We've gotten beyond the stage where we can do without it.

We have too many regulators in this country, each of which has responsibility for one part of the elephant. And you can say, "The elephant's leg is healthy. The tail is healthy. But the elephant died along the way." Somebody has got to be responsible for the overall health of the animal, and we don't have anybody.

Now, they've got be able to coordinate with other countries, because as these financial markets become global, you have got to focus across countries, not just within the country.

Complications of regulation

Sebastian Mallaby
Council on Foreign Relations
That becomes risky only when lots of other banks or hedge funds choose to do the same thing and so that they're all borrowing money to pile into one trade and might all have to rush for the exit at the same time.

JEFFREY BROWN: But, Sebastian, how -- as a practical matter, how viable is that to look at the whole system? I mean, the system is set up right now to look at individual institutions. How do you look at the whole thing? And what would you do differently?

SEBASTIAN MALLABY: You know, it's a massive challenge. I mean, it's true to say that risk in financial markets is created not by the actions of one bank -- which, say, for example, might take a big position in Latin American equities.

That becomes risky only when lots of other banks or hedge funds choose to do the same thing and so that they're all borrowing money to pile into one trade and might all have to rush for the exit at the same time. So you don't understand these risks until you look across the whole spectrum of players in one particular market.

And the problem is that, to do that, even if you could get the cooperation of everybody operating in U.S. markets, there would probably still be big players outside of your view, even if you got all the European banks into your net. What about gulf Arab sovereign wealth funds? What about a Thai trading company, a South Korean shipbuilding company with an ambitious treasury operation? All of these people can get into trades and crowd them.

And so I think the point is that, because the government in the U.S. will never know for sure which bits of the financial system are really dangerous, they're going to go with imperfect information to financial market players, you know, like Goldman Sachs and say, "Hello, Goldman Sachs. I'm the government. I think this trade in Latin America is dangerous. You should get out of it."

And Goldman Sachs will say, "Excuse me. We have offices all over the world, and we trade with all these South Korean shipbuilding treasurers and so forth. We know where the risks are better than you do. Who are you to tell us?"

"And once more, if you force us out of this trade, do you know what's going to happen? Deutsche Bank, and SocGen in France, and Credit Suisse, and UBS, all these European rivals of ours, are going to eat our lunch, because you're telling us to get out and you want to hand this business to the Europeans?"

Global regulation questions

Nomi Prins
Senior Fellow, Demos
One of the reasons that we basically deregulated the United States banking system was because of this idea of competing with Europe. Well, Europe is suffering, as well. So is Asia. So is the entire world. It's an integrated financial system.

JEFFREY BROWN: Well, Nomi Prince, weigh in there. I mean, what happens with a challenge like that?

NOMI PRINS: Well, to that extent, I think it does have to be global. One of the reasons that we basically deregulated the United States banking system was because of this idea of competing with Europe. Well, Europe is suffering, as well. So is Asia. So is the entire world. It's an integrated financial system.

I agree it's difficult. I don't know to what extent a super-cop sort of financial regulator in the United States will be able to be useful if the entire rest of the world doesn't have a similar entity.

But at the same time, we do have all these different players. We do have that shipping company. We do have the hedge funds. We do have Goldman Sachs. We do have Bank of America. We should at least understand and regulate the components that we have to protect and reduce the risk of the rest.

If they're going to do transactions, they should be heavily taxed. If they're going to be off-book, they can't be. There are ways to mitigate the systemic risk, as well as focus on protecting the pieces of the banking system that are intrinsic to most citizens.

JEFFREY BROWN: And, David Wyss, the other question that was much on the table today, of course, was, who would be this super-cop, this super-regulator? One question, obviously, is, would that be the Fed? Or is that putting too much power in one institution that, after all, has some other important roles in our economic and financial life? What do you think?

DAVID WYSS: Well, there's two ways to go. One is to give the authority to the Federal Reserve, which has the advantage that you have one agency that you know that has experience -- and, you know, that is eventually going to have to pick up the pieces -- responsible for regulation, as well.

The other way to go is the way the United Kingdom has, by establishing a separate Financial Services Authority that would serve the regulator role and leave the central bank free to just concentrate on monetary policy and the macroeconomic side of things.

There are arguments both ways. Frankly, I think it's less important which way you go as that you do something.

JEFFREY BROWN: All right. Well, we will watch to see what that something is in coming days. David Wyss and Nomi Prins, Sebastian Mallaby, thank you very much.