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Summers: Bank Reforms Would Halt ‘Too Big to Fail’ Mentality

April 22, 2010 at 12:00 AM EDT
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As the Senate prepares to consider new financial regulations, Jeffrey Brown talks to White House financial adviser Larry Summers about whether reform efforts could prevent another financial meltdown.
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JEFFREY BROWN: But, first: back to back interviews on the president’s financial reform plan.

We start with White House economic adviser Lawrence Summers. I spoke with him this afternoon at the Executive Office Building.

Lawrence Summers, thank you for joining us.

The president said today, a free market was never meant to be a free license to take what you can get. Does he see Wall Street as the cause of the financial — Wall Street’s greed as the cause of the financial meltdown?

LAWRENCE SUMMERS, director, White House National Economic Council: Mistakes on Wall Street led to these problems.

Mistakes on Wall Street in the mortgage area led to the subprime bubble that led to houses appreciate, that led to the situation where millions of people got loans that they were no longer able to service and faced foreclosure.

Credit errors made on Wall Street brought financial institutions to the brink of insolvency that left no choice but to commit taxpayer funds.

JEFFREY BROWN: But, today, he was going to Wall Street and, in fairly tough language, saying, talking…

LAWRENCE SUMMERS: Yes, there’s no question that things that happened on Wall Street are the reason we had this financial crisis. And we have got to do everything we can to make sure it doesn’t happen again.

JEFFREY BROWN: One of the critiques is that these — the current approaches towards reform rely on the same regulators and agencies that missed what happened in first place.

So, do you see specific changes that would have prevented a meltdown — the meltdown we had and that would prevent one in the future?

LAWRENCE SUMMERS: I do.

A consumer-oriented regulator, rather than a bank-oriented regulator, would have stopped the predatory subprime lending. Derivatives on exchanges would have meant that it wasn’t taxpayers’ problem when a company made the kind of mistakes that AIG did.

Comprehensive authority for the Federal Reserve would have meant that you didn’t have institutions trading in the shadows hundreds of billions of dollars of money that it turned out that they didn’t have.

Higher capital requirements and lower degrees of borrowing, leverage would have meant that, even if there were losses, they would have been absorbed by shareholders, rather than pushed out to the rest of the economy.

JEFFREY BROWN: And regulators could haven’t done in the past, higher capital requirements?

LAWRENCE SUMMERS: No. Regulators didn’t have the specific mandate for the consumer. Regulators didn’t have authority to, for example, oversee the derivatives activity at AIG.

Regulators didn’t have the authority, in a comprehensive way, to monitor the derivatives market, which caused so much mischief in this place. So, this is an important expansion in — in authority, probably the most important expansion since the invention of deposit insurance in the 1930s.

JEFFREY BROWN: You also have — you have fears on Wall Street and from some Republicans. And Mitch McConnell repeated today that new regulations, new fees on banks can hurt business, can hurt jobs, and specifically at a time when people really are hurting, and that’s the wrong approach to take right now.

LAWRENCE SUMMERS: You know, there’s something ironic about banks who got themselves into problems that led to the largest credit collapse in 75 years, that drove millions of people into unemployment worried that somehow it’s oversight that’s going to cause the problem for their lending, when so much of what could have been lent was dissipated on misguided trading of various kinds.

We are very mindful of the importance of increased lending. We understand very well the importance of business confidence. But I cannot imagine a measure that would do more to impair confidence than to leave our financial system as it stood before this crisis.

JEFFREY BROWN: The too-big-to-fail issue, why not go further? Why not just limit the size of banks?

LAWRENCE SUMMERS: Jeff, that was the approach America took to banking before the Depression. That was the approach that America took to lending in the thrift sector before we had the S&L crisis.

Most observers who study — who study this believe that to try to break banks up into a lot of little pieces would hurt our ability to serve large companies and hurt the competitiveness of the United States.

But that’s not the important issue. They believe that it would actually make us less stable, because the individual banks would be less diversified and, therefore, at greater risk of failing, because they would haven’t profits in one area to turn to when a different area got in trouble.

And most observers believe that dealing with the simultaneous failure of many — many small institutions would actually generate more need for bailouts and reliance on taxpayers than the current economic environment.

JEFFREY BROWN: The president talked today of a failure of responsibility on Wall Street and Washington.

And I wonder how you see your own responsibility going back to days in the Clinton administration, the 2000 act that a lot of people still look to now as having loosened the reins on the deregulatory regime for derivatives and other parts of the financial market.

LAWRENCE SUMMERS: You know, the situation’s changed hugely, Jeff, since 2000. Credit default swaps, which is really the center of the issue now, barely existed at that time. And so people were actually focused on a very different set of issues.

If you look at the context of right now, I think there’s no real question but that we need to propose much more regulation of derivatives, that we need to do what we actually pushed for in 2000, and established permissive authority for, but were not able to overcome congressional opposition and establish a requirement for, which was the clearinghouses that would establish collective liability and would promote transparency, and…

JEFFREY BROWN: But a failure to foresee what would — what would happen, what would come out of that 2000 act?

LAWRENCE SUMMERS: A failure to perceive fully, which I think was very, very widespread at that time, what the spread of credit default swaps would — would mean.

And I think what was unfortunate was that, as credit default swaps mushroomed after 2000, nothing was done.

JEFFREY BROWN: You expect to get legislation with Republican support?

LAWRENCE SUMMERS: I can’t imagine that, at the end of the day, anybody’s going to find it a very attractive position to defend the status quo on Wall Street, to defend the status quo in terms of how we watch over financial institutions.

And, so, I think it’s very likely that we’re going to come together around strong legislation that has a strong mandate.

JEFFREY BROWN: OK.

Lawrence Summers, thank you very much.

LAWRENCE SUMMERS: Thank you.