JIM LEHRER: Next tonight: dealing with the financial industry’s too-big-to-fail problem.
“NewsHour” congressional correspondent Kwame Holman begins our coverage.
KWAME HOLMAN: Since the financial crisis hit last September, the government has injected hundreds of billions of taxpayers’ dollars into firms such as Bank of America, Citigroup, and AIG, all deemed too big to fail.
In the wake of the collapse of Lehman Brothers and the credit crisis that followed it, government officials repeatedly have said they had no other option.
Federal Reserve Chairman Ben Bernanke explained his thinking during a “NewsHour” forum this summer.
BEN BERNANKE, chairman, Federal Reserve: The problem we have is that, in a financial crisis, if you let the big firms collapse in a disorderly way, they will bring down the whole system. We really need — and this is critically important — we really need a new regulatory framework that will make sure that we do not have this problem in the future.
KWAME HOLMAN: Yesterday, House Financial Services Chairman Barney Frank brought forth new legislation designed to provide that framework.
The bill, which was drafted in conjunction with the Treasury Department, would give the Federal Reserve authority to take over firms that are at risk of failing and present a danger to the broader economy. It would allow the government to dismantle a company without sending it through a standard bankruptcy.
To pay for that process, banks and other firms with more than $10 billion in assets would contribute to a special fund. Shareholders and creditors of institutions would take losses, and top management could be removed.
The bill also would strengthen oversight, creating a new regulatory council overseen by the treasury secretary to address risk and toughen regulations on large companies.
Late yesterday, President Obama expressed strong support for the proposal in a letter to Chairman Frank, saying, small changes were not enough to fix the system.
Solving 'too big to fail'
JIM LEHRER: And we get two views about that proposal and what it could mean.
Eugene Ludwig is the former U.S. comptroller of the currency, which regulates and supervises national banks. He's now the CEO and founder of Promontory Financial Group, a global consulting firm. Dean Baker is an economist, co-director of the Center for Economic and Policy Research in Washington. He's the author of several books, including "Plunder and Blunder: The Rise and Fall of the Bubble Economy."
Dean Baker, do you believe the Frank proposal will solve the too-big-to-fail problem?
DEAN BAKER, Center for Economic and Policy Research: No, it's really hard to see how it does that, because, basically, the story of too-big-to-fail problem is that the markets don't believe that the government will actually let a firm like Citigroup, Goldman Sachs, some of these big banks, go out of business.
So, that means there's not effective discipline on their activities. So, the question is, if we had this in place, we do have this commitment where, you know, the government is saying -- Representative Frank is saying that we will let these banks go under, but you're looking at firms that have actually gotten bigger.
And if you go, would the markets believe that the government would let a Citigroup or a Goldman Sachs go under, it's very hard to see that story. So, what I would expect is that you would still have people willing to lend to them, with the expectation, if they got into trouble, the government will, at least in part, bail them out. There won't be full market discipline.
JIM LEHRER: Mr. Ludwig, how do you see it?
EUGENE LUDWIG, former U.S. Comptroller of the Currency: Jim, I think that Chairman Frank has put together a strong proposal here.
I think there are refinements that can improve it markedly. But both Chairman Dodd, who has been focusing on this in the Senate, and Senator Warren have been doing a fine job. And the Frank...
JIM LEHRER: Senator Chris Dodd, who is chairman of the comparable committee in the Senate.
EUGENE LUDWIG: In fact, the Congress has really been looking at these issues hard. And I think we're going to get strong legislation.
The Frank resolution proposals I think are headed in exactly the right direction. I think one can question elements of them and improve them, but I think he's made a strong step forward here.
JIM LEHRER: But what -- Dean Baker, you don't even think it's a step forward, is that right? Or you think the whole proposal is flawed, or do you think there are parts of it that might work?
DEAN BAKER: Well, I think there are aspects of it -- I mean, it's a big proposal. It's close to 300 pages.
JIM LEHRER: Sure.
DEAN BAKER: So, there's aspects. I mean, for example, it requires that issuers of mortgages would maintain a stake in them, even if they sell them on the secondary market. I certainly think that's a good thing. There's other parts of it I would certainly say are positive.
But, in terms of the fundamental problem, you have banks that are too big to fail, the market see them as being too big to fail, does this deal with that, I find that hard to believe. Secondly, the resolution process -- again, it is good to have an orderly resolution process. I don't think that was the big problem here.
I think the basic problem was, we had an economic, we had a financial crisis. And let's and take this -- you know, carry this through for a second. Let's envision. We had this in place. Suppose you had AIG go under, and we realized we needed a lot of money. Would we -- do we really think that the Fed, the Treasury would be about to slap on a special assessment on Citigroup and Bank of America last September to cover the cost of resolving AIG?
That's a little hard to believe. I think it still ends up in the taxpayers' pocket.
JIM LEHRER: Do you think that proposal will not work? Because the guts of the proposal, Mr. Ludwig, is, as we just said, as Kwame just said, this $10 billion -- every company that has $10 billion in assets has to contribute to helping these companies that are too big to fail.
And if they, in fact, fail, instead using taxpayer money, they have to contribute to this fund. You heard what Mr. Baker says. That's not going to work.
Identifying risk and the Fed's role
EUGENE LUDWIG: Well, nobody wants to use taxpayer money. That's for sure.
I think, actually, the part of the proposal that needs a lot of focus and is really moving things forward, which is as important as the resolution mechanism itself is what...
JIM LEHRER: Now, resolution means, the company is about to fail, and somebody -- and the government steps in and does something, right?
EUGENE LUDWIG: Steps in and you might say helps it fail, or takes it apart, or takes the management out, the board out, and then refloats the company. That's resolution, resolving the problem.
But I think the issue here that's even more important is, what do you do before a company gets in this state? And the Frank proposal does -- has two aspects to it that I think are helpful, but I think can use some refinement.
First, there's a systemic council to identify systemic problems. Are we headed for a problem area? And I think...
JIM LEHRER: So, you don't wake up one day and some big company has failed.
EUGENE LUDWIG: Right.
JIM LEHRER: The government should already -- the regulatory -- would be the Federal Reserve -- would already know this, right?
EUGENE LUDWIG: It's a council with the Fed as part of it.
Where I think refinement is helpful is, it's actually, in a lot of ways, government that helps to cause these problems, unwittingly, of course, with policies that don't work.
And I would hope that, as this thing evolves, you would see a separate independent agency, a part of that systemic process that's independent and can identify governmental mistakes.
And, secondly -- and this is very important -- the countries that have been successful with their institutions have had an independent, end-to-end prudential, that is, safety and soundness, supervisor, so that the entities themselves don't get into problems.
We don't have that here. We have an alphabet soup of regulators. The Frank proposal takes a step in that direction, or a half-step. But that's an area in which we have to take a full step, Jim. We have to have in this country the kind of end-to-end prudential supervisor that can really deal with these entities and keep them from getting sick.
JIM LEHRER: In the first place.
JIM LEHRER: Dean Baker, do you agree with that, that the process should begin long before these outfits actually fail?
DEAN BAKER: Well, I would rather see them not get that big.
But just getting back to this issue...
JIM LEHRER: Sure.
DEAN BAKER: ... I think a lot of this ends up being a story of saying, we want better regulators. And of course we do.
But let's just go back to '02, '03, '04, when the housing bubble was building up and these problems were building up. Suppose we had this council in place. Do we think -- Alan Greenspan was out there saying everything was just fine, the housing market was just fine, there are no problems, there is no housing bubble.
Do we think, if we had had this council in place back then, we would have gotten a qualitatively different result? If the housing market was fine, if housing prices didn't fall, there was no systemic risk. There were no big problems.
So, I think it's just sort of unrealistic. Yes, we all want better regulators, but writing legislation that says we should have better regulators doesn't give us better regulators.
JIM LEHRER: Mr. Ludwig?
EUGENE LUDWIG: Dean, you have actually focused on an important area in which I agree with you.
I think the Federal Reserve is a fabulous organization. And the people in our regulatory bodies are tremendous. But what we need here is somebody that is independent that can identify these problems, that, like the GAO, in a way, does in other areas, before they happen.
JIM LEHRER: The accounting office...
EUGENE LUDWIG: Like the accounting office. That's the government accounting office. It's independent.
JIM LEHRER: Yes.
EUGENE LUDWIG: And I think where the Frank proposal takes a great step forward, saying, look, let's look at systemic risk.
But where it can be improved is say, right, it's not the Fed looking at itself. That shouldn't happen. It's really an independent...
JIM LEHRER: Why would the Fed be looking at itself?
EUGENE LUDWIG: Well, if it were in charge of the council. The Treasury is actually in charge of the council, but the Fed is an important element of it.
And it's very hard for any organization, whether it's a governmental organization or any organization, to be self-reflective. And, so, I think this would be improved if one had an independent agency, in effect, that was tasked with the simple responsibility of identifying bubbles.
Had somebody been doing that in the early 2000 era, they would have identified this.
JIM LEHRER: Would you add that to your proposal, if you had one, Dean Baker?
DEAN BAKER: Well, I certainly -- you know, I was one of those people out there yelling about the housing bubble as a big problem. And I was largely ignored, unfortunately, I think.
Yes, I mean, it would be great to have someone who identifies bubbles. Whether we can count on that -- you know, I don't think it was hard to identify the housing bubble. I don't think it was hard to identify the stock bubble.
It should be something that we're on the lookout for. And, you know, again, this is an enormous problem. I know Alan Greenspan maybe has a different view today, but he had the view back a few years ago that bubbles just weren't a big deal. You let them come, you let them go, and then you clean up afterwards.
I think we hope all realize now that that's not the case. They can really be a problem. So, we do have to identify bubbles, whether that's the Fed, whether that's an independent body.
I mean, part of the problem is people make money on bubbles, as we know. So, if you say, you know, there's a bubble, you have got to stop this, that means taking away the punchbowl. And these are powerful financial institutions that don't want you to take away their punchbowl.
JIM LEHRER: Help us lay folk. When you say bubble, what's the simple definition of a bubble?
DEAN BAKER: Well, essentially, a price increase, asset price increases that isn't justified by the fundamentals.
So, you go back to the 1990s, when the Nasdaq hit 5000. I think today it's around less than half that. There was no justification for that. There was no story that underlying profitability of those companies would have justified those sort of prices.
And, in the current decade, of course, with housing, we saw an unprecedented run-up in house prices that couldn't be explained by the fundamentals of supply and demand in the housing market. So, the Fed or some other entity has to recognize that prices have gotten out of line with fundamentals. And, basically, when that happens, they will come back, and usually not in a way that is very pretty.
JIM LEHRER: And, Mr. Ludwig, you agree that somebody should be looking for bubbles?
EUGENE LUDWIG: Absolutely.
I think that is a key element. And they ought to have -- we ought to have an independent identifier of those bubbles and then an independent regulatory agency that is focused on prudential supervision, and is professionalized, much to a greater degree than we have, to actually act when those bubbles are identified.
JIM LEHRER: And you say the Frank proposal is a step that direction; it's not far enough.
And you say, Dean Baker, that it's not -- not even a step that way.
DEAN BAKER: Well, I would say there are some small steps, but it's really not what I would like to see. I don't think it will get us where we need to go.
JIM LEHRER: OK. But we need to go in the meantime.
Thank you both very much.
EUGENE LUDWIG: Thank you.
DEAN BAKER: Thank you.
EUGENE LUDWIG: Great to be on the show.
JIM LEHRER: Thank you.
EUGENE LUDWIG: Thank you.