Treasury secretary. He spoke on the health of the financial industry and the threat of another crisis. This portion of the National Association or business economics conference is 45 minutes. E is 45 minutes. Welcome to our general session for this afternoon. Im the chief economist at ford and im very pleased to be here today to introduce and moderate a discussion with the president of the Federal Reserve bank of minneapolis. He took office as the president chief executive officer on of 2016. St he serves on the federal open the t economy bringing feds committee bringing in washington. However, i want to preface the noting that day by after he accepted our invitation o speak here today, the fed adjusted its blackout period ahead of its Monetary Policy in facts so that we are within the fed blackout period today. Kind to keep his commitment to be with us here today. He will not be able to talk about the Monetary Policy aspect of his position at the fed. That said theres lots we can talk about and i know well have a good discussion on fail. Pic of too big to but before that, background, while all hink that said bios are interesting, his particularly eclectic. As an aerohis career space engineer in California Technology eloped for nasa Space Science missions. Helped aduate stool he Technology Companies raise capital and pursue strategic actions. Very rom 2006 to 2009, a quiet time in terms of the policy and monetary environment of course, he served in several senior positions at of treasury rtment and in 2008 he was confirmed as the tant secretary of treasury and oversaw the troubled assets release program tarp, during the financial crisis. Nd he received the Alexander Hamilton award. Following his tenure in he returned to california in 2009 and was managing director and a member executive office of pimco. In 2013 to firm explore returning to public outlet asd found that a gubernatorial candidate in his state of california. His bachelors and masters degrees in mechanical university of the llinois and an mba from the universityool at the pennsylvania. Thank you for the kind introduction. I want to talk about too big to fail. As soon as i joined the minneapolis fed, i started and our r economists policy regulatory and supervision experts about the fail. M of too big to i lived it firsthand as the guy ho bailed out the banks during 2008, 2009 running the tarp program. Really ion is have we addressed too big to fail, what do sery main, and should we more. So last february we announced tending too big to fail we invited some of the best experts in the world to come to minneapolis and share perspectives. Now, important to our process was we wanted to educate the learning le we were ourselves. So everything that we did was open press, live streameded to of the materials and videos are on our website. If you want to check it out, theyre there for you and else to check out. We wanted to hear all views. Some people came to us and said solved too big to fail. Odd frank worked and they made their case and we said we want to hear it. Done said we have not nearly enough and the government needs to step in and break them up. Said thats ople not a good answer. E need to put so much capital in them and treat them like a utility and thats another alternative. This. Rd all of looked at the analysis. Of the plan draft by tend of the last year and so on what update you weve learned and where we are in that analysis. What i learned is that Financial Stability is a lot like physical security. About the risk of terrorism in in our country. Bet every nd i american knows that we cannot iterally eliminate the risk of terrorism. You can never make it zero. And you intuitively know that safety comes with cost. Safety is not free. Police officers. More homeland security. Detectors. Metal our personal convenience or inconvenience. Safety is not free. As a country, have to decide how much safety are weant and what price willing to pay for that safety. True in Financial Stability. So those tradeoffs are critical and im going to walk you math. H the making those calculations requires an assessment of whats cost of a crisis and what are the costs of more regulation or more capital. So how do you estimate the cost of a crisis or the probability crisis . Im going to show you the data published last year a paper looking at the history of financial crisis all over the world. Used that data to estimate how likely a crisis is going to future and in the thats the core to our cost benefit analysis im going to through. Lets start with how we evaluate what weve come up with. You through walk the details of the plan. This is the tradeoffs. Hat are the chances of a bailout over the next seven which you are sfli some people have said why 100 years . A long time. Well think about the Great Depression. That was the 30s. Or so years ago. Seems like a 100 year time orizon is a reasonable perspective to take on financial crises. The Great Depression in the 30s. Crisis. Financial the next column is going to be whats the total cost of regulation . This is the cost of that safety and then you put those two things together and you end up benefit for society. 2007 . Ere were we in if you look at the imf database, back and say in 80 there was about an chance that there would be a risis requiring a bailout in the next century. Thats remarkable if you just at the Financial System in 2007, you could have said theres an 84 chance of a crisis. Happened the next year. But it just said where the pretty levels were was a risky situation. Now, where are we today . Is as a result of the doddfrank act. The biggest banks have more today. Weve reduced the chance of a bailout from 84 to 67 . Cost to that. 11 . President value of present value of the permanent affect of gdp. Net benefit is 12 . O society is better off by avoiding the crisis or reducing the likelihood of a crisis terms g some up front in of higher capital for the banks. Ow, lets put that in context this is from i think the number for the typical cost of a crisis. 158 of gdp. Thats massive. It intuitively. How costly was the 2008 inancial crisis for the u. S. Economy for advanced economies. Massively costly in terms of losses, et ut, job cetera. Is what were avoid. To again, theres increased cost associated with that. If you look at the right column and multiply this ogether, society is on a net benefit far better off avoiding these terrible financial crises. You m going to walk through what these are. Were going to get to the discussion. We substantially increase the common equity banks to 22. 5 e gdp. Step two, we force the Treasury Department to certify that the 250 billion and up, are no longer too big to fail. I can tell you this, the not going cretary is to want to certify that. Because if he or she certifies and then that bank gets into trouble and they have to bail it out theres a lot of egg secretarys ury face. Thats by design. We want them to be reluctant to certification and if they refuse to certify, we automatically increase the requirements of those banks up to 38 . This will leave most big banks restructure themselves. Step three, a big concern was if increased capital of the biggest banks, all the activity ill just move to hedge funds and shadow banks and then have we really made the system safer . Shadow banks, we apply a tax on their debt that funding. The cost of so theres no longer the run from a big well capitalize bank to a hedge fund. Playing field so theres no incentive for their asset, for the activity to move. We only tax the debt of the shadow banks. 100 a hedge fund is equity finances, we dont see systemic risk. Rereduce ly regulations on Community Banks that are not risky for the country and increase capital for the biggest banks. Level the play body field with shadow banks and reduce on Community Banks. This is the data thats so important. This is a probability chart looking at how long the bailout be as a function of capital requirements. Capital requirements on the x axis. Bailout probitys on the y axis. This is where we were in 2007. High probability of a bailout. This is where we are now. To in step e we get one. This is where we get to in step two. Goals was we want to cut it down to a 10 or less future bailout and then analyze the costs. Systemic two types of risks were targeting. One is the systemic shock in the economy. The 2008 crisis. Housing massive downtu downturn. The biggest banks have taken correlated risks. The shock hits the economy. By increasing the capital level of the biggest banks to 23. 5 protect ck this will against the vast majority of systemic shocks that hit the u. S. Economy. Think about this like a dike against the flood. Dikeould like to build the as tall as you possibly can. There are costs associated with it. To measure how likely these various floods are. Nd you build a wall as high as you can afford considering how likely those floods are. With s what were doing the 13. 5 capital requirement. And then second if a shock hits an Important Bank think about london whale with j. P. Morgan. That was clearly a shock. Unique to j. P. Morgan. Timese if it had been ten big. If a Nuclear Reactor melts down, devastating for society. So governments will spend whatever it takes to try to its ize the reactor if running into trouble because its so costly for society. So we have a choice when it Nuclear Power. E could either ban Nuclear Power or we regulate it so tightly we truly minimize the risk of the failure. What were doing in step two of our plan. Substantially higher levels of and then we tell the biggest banks you can choose to stay large. If your Business Model can support this capital, youre stay large but if not youre going to break yourself up so youre not subject to this mind youequirement and banks love to say theyve got scale. Great economies of if they have these great economies of scale, they can afford higher capital. If not, because theyre trading below book value as many of them havebeen, maybe they dont these great economies of scale nd society is not benefitting from having them remain so large. In our analysis, we assume of higher equity gets passed along in terms of costs. Borrowing there are some who say theres no cost to hire equity and there others who say 100 of the cost is passed on to the economy. Either is ink correct. If you look at the banks, their return on equity has gone down they have not been able to pass on the costs. A more this is reasonable position. Third we follow the imf approach about. Talked we also assume that most banks will choose to restructure so longer systemic rather than facing these big capital requirements. Were the difference is not saying government bureauc t bank has a if a business line that truly benefits from huge scale, they choose to maintain that scale in highly capitalize that business line. How to banks choose respond to the requirements. And then lastly i mentioned the bank tax equalizes various cross the sectors. It. Nt buy nobody has said were underestimating the cost of this. Think we erred on the side of being more conservative in terms of cost which is the position i wanted to take. Some people have said were underestimating the movement overseas meaning if europe follow our lead, wont european banks just gain marketed share . Fair point. Not much we can do about that. Urope seems to be very comfortable having too big to banks. I suggest we implement reforms and regulations sensible in the and show the world that we can have a robust economy without too big to fail isk and encourage other countries to follow our lead. Asked us for more detail in Community Bank regulations which i think is fair. Many people lly have emphasized leverage ratio over risk weights. Are ink that both important. Subjectse just one its gaming. Some recent discussions in the et cetera, press, have been moving in the wrong direction. Some large bank ceos have now to claim that they have too much capital and its holding elending. This is false. Its complete nonsense. The fact of the matter is costs for homeowners, near record lows. Bank credit has grown by twice as nominal gdp over the past 23 years and Small Business surveys report having their credit needs met. The people who are not having to credit today are very credit challenged borrowers. Eaning people with low credit scores, Small Businesses with bad credit ratings. Much tougher g a time. I dont think making loans to records th poor credit for cessarily a good idea banks. Thank you. Look forward to your questions. Applause] i think well have plenty to promised. As i we will be using cards or scraps paper. You wont be marked down for using a scrap of paper for questions. [laughter] moderator, ill start with a couple. So the plan that youve outlined, that would require new legislation. Correct . Yes. A and youve described it as Community Banks are not the risky ones. s,the crisis in the 80 thousands of loans failed, which was terrible for their banks. But there was no risk of a National Economic collapse because of those savings loss. They are not systemically risky. But they are caught up in the politics of too big to fail. Some elected officials are worried that if you just relax regulations on Community Banks, you may relax relations on everybody. For me, i feel like we have to show that we are addressing the risk first if we want to make progress on a relax on Community Banks to give people addressing the art too big to fail. In terms of a framework, where would foreign bank owned subsidiaries that in . You mentioned the possibility of european banks taking share. How would you handle their subsidiaries . If so that he wants to come into the u. S. And do business he would be subject to our regulations. They would be treated equally. I as part of the plan dont know if it is part of that any restrictions on proprietary trading or lending to high risk parties, the shadow bank side of the equation . So we have not called for specific repeal of all of the divinity regulations put in place. But ill say this if we our antially increase capital requirements, then i think we can all relax a little the n some of micromanagement taking place today so we dont have specifics. We dont think it will supply Community Banks but what restrictions you want to put on 2 trillion bank if its as capitalize as i would be, i think we can relax those regulations that maybe have gone so far. Buffer against all these mistakes were going to make. Ask ally why did the bank you and me to put 20 down in our memo . Make a mistake or run into hardship. Its to protect the bank. Same purpose the capital serves if we force the banks to issue more capital. Maybe related to that heres a about whether the government forced all u. S. Banks to be a member of the u. S. Reserve . The biggest banks are all supervision. D thats the focus. I dont have a strong view on banks, some community is that somebody worry about . Honestly, i hear this, and i just dont buy it. Who are the big investors in the country, the big Asset Managers and pension plans, whether it is blackrock, fidelity, calpers . You mean to tell me they are just counting on Morgan Stanley and goldman to make markets, and if they are not there, calpers at black rock wont figure out how to trade with each other . Or there a funny little price move in an asset class in the dealer will stand there and say, these bond Interest Rates dropped 10 , but we will offer you the old price . Of course not. I think these are just banks they are in the business of making money, advocating their own self interest. That is their own job. But dont be fooled by that. I just dont find the argument compelling. Another argument that banks will big is, well, the manufacturers in the u. S. General motors or ford they need us to be this big because they do business in 100 countries, so they need a bank that does business in 100 countries. 100 countries. Think for a second, they manage thousands of part suppliers all around the world. They seem to figure out how to do that. They cant manage a dozen banking relationships . . Banks. Ording to the big again, lets test their selfinterested arguments that making. They dont stand up. What would you think about reserve requirements for larger banks . Alternative an approach . Capital should be there to protect us. And how would you see the influencing the feds supervisory role . Theres a couple of questions on various center issues related to that including whether youlled like to be the chair. Ice you dont have to answer that one. If we have much higher capital requirements, the jobs of Bank Supervisors become a little bit easier. You know, its a true story. First went to treasury in 006, my old boss as soon as we got there, he said we are due crisis. Nancial its not that he saw something on the horizon. Just said markets have been long. Uiet for too n 2006 we didnt even consider a National Home price decline. We were looking. Before the crisis. So the idea that regulators, smart, ning, will see it you they can guarantee wont. Ther the crisis looking for next big economic shock how many people saw oil go from 150 to 30 . Thats a huge economic shock. We all missed it. Assume that were going to miss the next one. The burden on the Bank Supervisors and the regulators. Force them to try to be unmissioned. Going to be omniscient. Theyre not. Theyre human. Couple of questions here thinking through that in the depression and also in the crisis, we had a large number of smaller institutions that actually were problem in f the that case. Would they all be subject to that . R capital for are there any other considerations with a lot of small banks rather than a couple large ones . One of the push backs that well get is a little bit of a man argument where people say if you took a 2 trillion divide it up into 20,100,000,000,000 banks and they all take identical risks and positions and they make the mistake, has safety been improved . Thats a fair question but its because ifal concept you had 20,100,000,000,000 each with their own board of directors and management going to yre not all make the same decisions. So its an artificial decision. Point is taken. Encourage diversity of opinions i think were going to be better off. Thats why our capital standards start at 250 billion and above. Affects the top dozen or america. In this could eliminate a Cottage Industry here but theres a with regard to stress testing. Would that change presumably under this plan it could. I think stress testing is still a useful exercise for the biggestbanks but if the banks all have this much more apital, heres the thing, this innoculation exercise. Its much less likely to spread everybody else if everyone is innoculated. Few questions with regard to liquidity. Already i think that they might become partially expensive depending on what if there were an issue with availability . Know, think it would, you restrict the availability of credit, liquidity lines . So. Ou know, i dont think i think theyll be able to raise on capital and it depends their Business Models. Maybe the most substantive push back weve gotten is that models cannot afford these higher capital requirements. Again, some banks, im not sure the runnup in the stock market the past few months trading banks have been below book value and the question is do they have available Business Models in the Regulatory Environment and would they have them if they were forced to have higher capital. Banks dont vice resident viable Business Models, thats their problem. E should not be creating our Regulatory Environment to support their Business Models if upon taxpayersnt standing behind them. Heres a question regarding of using the iew Bankruptcy Code . Sympathetic but theres the same flaw of hair cutting a crisis. The problem with that is what we in 2008. If youre a bond holder in one big bank and the gentlemen to bond holder ure a of another big bank and a crisis hits and i just hair cut his youre terrified. Maybe youre next. In any ou want to run way that you can and so one leads to yourlity banks instability leading to more instability and thats what faced in 2008. In debtyou call it bail or bankruptcy, none of those preventing re wall that contagion from bank to bank to bank. What made 2008 so difficult to solve and thats why the tarp was so necessary. Tarp was the only Legal Authority in the entire ederal government to put in capital on an unsecured basis to put in equity as that fire wall the dominos from falling and ultimately if you remember in the fall of 2008, 2008, we ended up investing equity in nine banks dayhe same time on the same as a way of once and for all from izing those dominos falling by recapitalizing them all at the same time. Bankruptcy right work. The risk of a domino knocking them over is reduced and then to put the onele bank through bankruptcy without ear of spillovers to other banks. So you provided some fairly ye popping numbers about the cost of the financial crisis and the probabilities over 100 year are a few here questions related to that. I know you were using lot of that or a odeling but could you talk a little bit more about the cost benefit recognizing that very in in the discount rate for example could significantly change the map . Thats true. And i dont have the citations off the top of my head. A number eleased this of independent academic papers have recently come out also for substantially higher capital requirements. And so our numbers are high where the world is right now. But there are other and you are here. E economists there are other papers that are ecently published from reputable economists calling for so i would ers a ourage all of you to take fresh look yourself. E wanted our work to be replicated by you but we also wanted to follow best practices. Thats what we feel weve done. All of our analysis is done and assumptions. Our footnotes are there. Test it yourself. I bet youre going to come up to what ers similar weve come up with. Detailed plan we want analysis. If you change the pass through ifm the banks to the economy you change the losses on default, et cetera, those all there and you can check the robustness yourself. With regard to the shadow banks, you mentioned taxing their debt. S that all debt or just the portion thats maybe mismatched . In other words short determine not against Long Term Assets . Ideally we would want to have standard apply for all types of institutions. Ae first thing we would do in Perfect World is eliminate the tax preference for debt. Thats the first thing that we do. D like to and then you treat whether its a bank or a hedge fund or insurance company, treat them same. E we have capital standards for banks and so we felt it would be complicateded to create a capital standard now for hedge fund, et cetera. So we felt it would be simpler the debt of large shadow banks. 50 billion in assets and above. So if you took a large bank, a traditional bank, applied our capital standards, nd the activity moved to hundreds of little hedge funds, im fine with that because i feel the Financial System is youre ch safer because oing to have these hedge funds taking risks. We dont want all activity to bank to one hedge fund. Thats not a reduction in risk. To e only apply the tax large banks that use debt to activities. I think thats not unreasonable. We just think debt is the source of the instability. And i know there are some of your about sort step one and step two. Going to certify the as do you still need to do step one or could you just it goes back to this inoculation. We take the top dozen banks to 3. 5 capital and then say treasury must certify theyre no important. Emically the reason is the same reason to be inoculated diseases when we were kids. Its because by having all the banks have this much capital, the whole system one re resilient in case bank has a big problem. That way that big domino falling does not knock over other dominos and thats why you need he higher capital levels in those banks. And then we had a question proposal ecific other out there from the House Finance Committee Chair that banks could a higher leverage 10 , or follow doddfrank. More sympathetic with capital for less micromanagement. I think directionally that makes sense to me. The two comments ive offered to staff there and ill offer to requirementsapital need to be higher. 10 leverage. Minimum. D be 15 at a and number two, if they give the choice, theyre going to choose the regulation. Theyre already expressing this which is they just dont want higher capital. They would rather live under the micromanagement of doddfrank. O one problem with the choice is nobody is going to choose door number two. Heyre all going too choose to live under doddfrank. So i think you have to give them live pital act which is with more capital or restructure yourself. Right. And we have just a little bit of maybe one more question. Lot e accomplished quite a obviously in your role. Did you want to talk about maybe outside of Monetary Policy the agenda for fed . Inneapolis i asked what do you think of Economic Risks and challenges we face as a country. It could be anything. Go off and think about it. And hear your ideas. Too big to fail is one of the raised which i agree with and another is issues opportunity. Like lunchtime speaker which was fantastic today. In late january we announced a at theesearch initiative minneapolis fed working with all of our colleagues across the system. To nnounced the opportunity the growth institute. Fed position he has been Monetary Policy is too blunt an instrument. They cant be targeted at communities or different demographics. Anything about it. Even if thats true, if we can o the research with all of our really smart researchers we have across the system, if we can do helps unravel at these challenges and present iscal policy makers with igorous analysis and potential solutions, i feel thats an important contribution for us to make. I was surprised when i learned between, difference for example, white unemployment and black unemployment in america. Two times. Always right. If its a recession and white pretty good is 6 , chance black unemployment is be 12 . Economists. Ot just sociologi sociologists, too big to fail, i said i could come up with the answer to these problems in a year we are not going to come up with the answer in a year. Thank you for being with us. President trumps nominee for director of national intelligence. Tuesday a confirmation hearing for two of the nominees for the justice department. The Senate Judiciary Committee Hears from rob rosenstein, handling doj policies and programs and racial rant for associate attorney general overseeing Civil Justice and law enforcement. What coverage here on cspan. Sciences on health, economic quality, and global poverty rates. His remarks were part of the National Association for business economics conference. It is 50 minutes. Slated for his work on consumption, poverty, and welfare
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