CONNELL MCSHANE, FBN ANCHOR: We welcome you to our special on the future of the banking industry. Along with Jenna Lee, I'm Connell McShane. And it really comes down to this phrase we hear so much, right? Too big to fail. Are banks too big to fail? Should something be done about that going forward?
JENNA LEE, FBN ANCHOR: I have a lot of different ideas on that and we have been hearing about it, as you mentioned, really the most over the last year, right? We're nearing this anniversary of this period where we wonder how far have we come really in a year. So we are going to cover a lot of grounds today. We're going to talk to a few different economists including Simon (ph) Johnson and James Galbraith. We're also going to talk to some people who have some money at work as well. We'll find out what they're thinking and what they're seeing both on Wall Street and also down in Washington but we're going to start off here first.
We're going to welcome in Dick Bove of Rockdale Securities. He's joining us from Florida to talk a little bit about what's going on here and what his thoughts are. So Dick, first of all how would you define at this time at least, too big to fail?
DAVE BOVE, ROCKDALE INDUSTRIES: Well, I assume from the standpoint of the United States government, too big to fail is any bank who could in fact draw upon the taxpayer's resources to keep it in business. In other words, whenever a bank when it got into difficulty, you know, require the use of taxpayer funds and the government is concerned about it and there are those banks that are so big at the present time that they will from time to time require assistance from the government.
MCSHANE: You know, it's interesting, Dick, in a lot of ways -- because we're going to have guests, as Jenna says throughout the hour - some of whom say, hey we got to do something about this as we head into the head of 2009, beginning at 2010, regulatory wise. In terms of regulations say we can't have this, we can't have banks that are too big to fail. It just doesn't work. It's what got us into this mess and so it can happen again. Now, I know you, I've talked to you about it and you disagree. Why do you think it's OK to have banks that are essentially too big to fail?
BOVE: Well, let's take a look at it from two perspectives. Number one, let's take a look at it from a domestic perspective. You know, about 20 years ago, we had 10,000 more banks in the United States than we have at the present time. There were 18,000 banks in the United States and now there are about 8,100. So we've lost 10,000 banks. The reasons that we've lost those 10,000 banks is because they weren't economically viable. In other words, the business model that they were executing was obsolete and it didn't work any longer. As a result of that, within the United States, we've seen, you know, the four biggest banks now having 54 percent of the assets of the American banking system and if you take all the banks above 20 billion in size, they've got about 74 percent of the assets of the American banking system.
So from an economic standpoint, it is clear that we've move towards big banks because they work best for the purchases of their services. Take a look at it from another standpoint. At the present time, every body is deeply concerned about the number of banks that the FDIC will put out a business, OK. Who is going to pay for that? Well, it's not the FDIC. The FDIC charges a deposit premium and that deposit premium is paid by the biggest banks in the main and that deposit premium will pay for the banks that are being put out of business. So the big banks have in fact assisted, you know, if you will, the solutions of getting rid of these weak banks.
Take a look at it internationally. Internationally, the United States is dropping rapidly as a financial power. I do believe that five years from now there will be multiple reserve currencies in the world because you've got Russia, you've got China, you've got France, Japan, Brazil. All of whom believe that there should be a currency basin created in the Far East and they have more money than we do. So therefore they can create a reserve currency that will compete with the dollar. We are in a tremendous competition to maintain our position worldwide in the financial sector and instead of doing what these other countries are doing which is supporting their big banks, and they are a lot of big banks out there, we're trying to kill our big banks. It makes no sense whatsoever.
LEE: So Dick on that, you mentioned some really provocative reasons about why the model of too big to fail is actually the one that exists right now. If we want to accept that term and that definition, which is what we're going to use loosely in the show. But some of those reasons that you mentioned are for the same reasons why some say which is why this model should not exist. It's because it makes the system too vulnerable, not only are these banks, these very, very large institutions really stringing together or the platform in which the U.S. economy stands are also really important for the world economy. So one fail -
MCSHANE: Right.
LEE: -- then suddenly all of us are at a huge amount of risk. What's your response to that?
BOVE: Well, basically speaking that's always been true. In other words, there are guys like Charles Kindleberger who has now passed away, who has a Noble Prize and he wrote a book "Manias, Panics and Crashes." And what he did in that book was he showed what happened in financial crashes and he had over 200 of them going back to 1600. Financial collapses are normal parts of capitalism. They always occur. They always will occur. And therefore in financial collapses, there will be demands on governments to assist the financial system in order to stay healthy. If we choose to walk away from that and become a third rate financial power, I mean we could be the next Austria, Hungary, Spain, or France or Britain. All of whom had banks too big to fail in their period where they control the world's financial system.
We can be one of those countries if we choose but if we choose to compete financially we're going to have to have banks which are too big too fail. We're going to have periods which the government will have to assist the banking industry or we can simply take up the time -
MCSHANE: Right.
BOVE: Hand it to China, walk away and say, hey, you got the game. We're now a minor power, you run with it.
MCSHANE: OK. You're making some key points here Dick that a lot of people, quite frankly are afraid to say. In other words, people that follow the industry or people that analyze and don't come out and say what you just said, that's to be the most competitive country in the world. We need to have this and even if they fail and essentially almost drag every body down along with them that we've got to bail them out again. Those are tough words for people to hear politically aren't they because they bring up things like moral hazards and say, listen, why only allowing this to happen again. I don't know that your plan will ever sell in this political environment that nothing will get done and we could have this - repeat itself in the short term. What do you think?
BOVE: Well, I think you're right. I think that basically, what I'm saying is very unpalatable but the fact is its reality. You know, I can't and you can't and we can't change capitalism. It is what it is. And capitalism goes through periods of great expansion and significant contraction and you can't stop that. And if you can't stop that, you are going to have to salvage the financial system from time to time. Fortunately, it only happens in this country once in a generation but when it happens, it's painful and Congress if it chooses to have the United States compete worldwide is going to do what it did in 1991.
In 1991, then President Bush basically asked Treasury Secretary Nicholas Brady to explain what had happened to the American banking system and where the American banking system should go.
MCSHANE: Right.
BOVE: Mr. Brady came back with a 500 paid report saying, you know, we don't have enough big banks and our big banks are too small and therefore we cannot support the growth of the American economy worldwide.
MCSHANE: There you go. It's an honest defense of banking.
LEE: Now I know Dick Bove is not going to be running for office, right, Dick? I'm kidding. Dave, I want to hear some of your specific thoughts for some specific banks.
BOVE: Yes.
LEE: But before we do that, we want to bring in James Galbraith. He is an economist. Of course, renowned economist and also professor at the University of Texas. And James, I know you've been listening all along to Dick's point that he made. Is capitalism that system overall? Is that really what created this too big to fail model? Is that to blame?
VOICE OF JAMES GALBRAITH, UNIVERSITY OF TEXAS: Well, in that three point spread quickly. First of all Charlie Kindleberger was a great man and a great economist. He didn't actually win the Nobel Prize. Secondly, China and I've been an advisor to the government of China incidentally, is that Chinese banks are publicly owned institutions. They are not really comparable to American banks and they are certainly not close to being major players, let alone to taking the global financial system.
MCSHANE: OK.
GALBRAITH: So, we should not be making our policy decisions based upon the alleged threat from the Chinese.
MCSHANE: All right. That's two. What's the third one?
GALBRAITH: The third point is I'm an economist and I'm enough of an economist to believe to a degree in competition. And the problem with concentrating the banking system so much that you had four or five institutions that dominate half of the industry is that they too no longer compete effectively with each other. And without competition they are not providing the right kinds of services to the broader public.
MCSHANE: OK. This is where the show gets fun. Let me bring Dick back a little bit. Let's have honestly, not a screaming match, but a discussion about this. Dick, he disagrees with you and James brings up, you know, a legitimate point there that it wouldn't be competitive if you go down this system of just making it the big guys that control everything. What's the response to that point in particular?
BOVE: OK. I think the competition is in fact getting more and more tense and you know, if we take the banks around the world, we got the three Chinese banks, you know, the Industrial and Commercial Bank of China, the China Construction Bank, you know, the Bank of China. We got the CICI India. We got Bank Itau Unibanco in Brazil. We have BVBA and Banco Sandia in Spain. We've got, you know, UBS in Switzerland. We got HSBC in Great Britain.
These banks are all growing. They all have the support of their governments. And even though many of them couldn't compete head to head with say, Goldman Sachs or a Bank of America today. They will be able to do so because remember back in 1990. For every dollar valuing gold at $800 an ounce now for everybody. For every dollar that we had in reserves in the United States Federal Reserves, the Chinese had a nickel. Now they got $4.65 for every dollar that we have. They've got $2 trillion in reserves.
You know, when they entered the World Trade Organization, there was a requirement for them to let other financial companies operate within China. What we did was we took these banks that were in disastrous condition and we turned them into very strong public companies that are now doing the biggest IPOs in the world.
LEE: OK.
BOVE: They will compete.
LEE: We're going to get James' response to that in just a second but real quick here, Dick, because we're going to be short on time. Of the big banks, of the ones that some would consider too big to fail, who is the healthiest and who is maybe not quite as healthy?
BOVE: Well, I think JP Morgan is certainly one of the healthiest banks in the United States and I would argue and I know it's open to a lot of discussion that both CitiCorp, that portion of Citi Group which is going to continue and Bank of America, are very strong American banks. You know, these banks are going to be very effective in generating profits and competitive advantages for us in the world for the next few decades.
LEE: So Morgan Stanley?
BOVE: Morgan Stanley, I would consider to be an investment bank which would be different from traditional or universal bank. I don't particularly like the way they managed. I think Goldman Sachs is one of the best managed banks in the world.
MCSHANE: There you go. You know what, Dick, we're going to say goodbye to you. That's a great discussion, by the way. Dick Bove is one of the noted analysts on Wall Street, (INAUDIBLE) bank sector. Thanks again for coming on, as always. Dick, we always appreciate it.
BOVE: Thank you.
MCSHANE: And James Galbraith is also with us and you know what it will do, we didn't even get James to get his thoughts out. We'll keep him around until after the break -
LEE: We will.
MCSHANE: And let him talk about what he wants to do in the future. Good stuff that are out there. Good start, right? All right. That's the only thing we have coming up, by the way. We still have Bill Isaac who is the former head of the FDIC. We have, you know, Simon Johnson at MIT, coming, formerly of the IMF. So a lot more still to come. Fox Business.com and Fox Business. Stay with us.
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LEE: We would like to welcome back in here James Galbraith. He's an economist, of course and a professor at the University of Texas at Austin, Texas, if I pronounce that right. James, I appreciate you coming on and want to let you have a little bit more time to talk about, what's going on with the banking system and why you believe that this model of this too big to fail is not helping us here in the United States? Can you just give us an overall your take on the state of banking and where we are right now?
GALBRAITH: Well, the big problem here is when a bank is too big to fail, it's in a position to abuse its relationship with the government. And that's what happened. That's one of the major reasons why we got into the financial crisis in the first place. The banks were behaving in a way which was exceptionally risky, which is fact better than massive amount of fraud in the mortgage origination of the securitization business.
When the problems with (INAUDIBLE) were revealed, they felt confident, excessively confident that the government would come in and help them out. And that's, of course, with the exception of Lehman Brothers, what the government basically did. So you want to have a system where - and we do have banks which are too big to fail. If banks are too big to fail, they are not too big to regulate, too big to manage internally.
MCSHANE: All right. Let's talk specifics then in terms of how we view that because there's a lot being thrown around in the Congress about what you do with these so-called too big to fail 19 and what types of requirements that you have for them going forward, what should we change?
GALBRAITH: I think the approach was on a case by case basis.
MCSHANE: OK.
GALBRAITH: First of all, the financial system is bloated. It's much bigger now in the share of economy than it was 15 or 20 years ago. It's going to shrink. It's going to continue to earn 40 percent of profits and pay 10 percent of all wages in the country. So the question is strategically, how do you do that? I think you got to approach this big institutions on a case to case basis. Some of them, may be appropriate to break them up and have the number of smaller institutions. In some cases, you might want to operate - if a company runs what's called critical system infrastructure, maybe it's better to run that company as a public utility.
Maybe it's better in the case of a bank which is deeply insolvent for the Federal Deposit Insurance Corporation to take it over and we have non-political professionals who know how to do this and decide after doing a thorough audit and investigation.
LEE: So are there -
GALBRAITH: It's the appropriate thing to do.
LEE: Are those regulators right now, the people that would make those decisions - are those folks already in place or are you talking about creating something else that would be able to make such a decision and in a marketplace like ours?
GALBRAITH: People who can make that decision exists. The Federal Deposit Insurance Corporation downsized radically in the Bush administration. It's being staffed back up now. But when you have a crisis of this kind, there are plenty of very capable professional bankers -
LEE: Will you do it?
GALBRAITH: I'm not qualified.
LEE: OK.
GALBRAITH: But what you get is you get people who are bankers, who know the business and they, in fact, that's who we're called in. That's what the FDIC, in fact, thus call in when it has problems. And there are very good, very capable, very honest people who are able to do this.
LEE: And you'd be OK, for example, I mean, one of the criticisms is that the bankers that have been called in by Washington have all been from Goldman Sachs, a majority of them. So you create -
GALBRAITH: You want a more diverse group for sure.
LEE: OK. So that's an example. I just had to bring that because one of the things we're talking about down in Washington all the time. Hey, we want some Wall Street guys down there and they get more Wall Street guys and then there are Goldman Sachs in there. There is criticism about that. So -
GALBRAITH: There are lot of things that are not said who are not Wall Streets institutions out there. And there are plenty of very capable bankers. You're talking about institutions that provide enormous amount of retail services to household to businesses.
LEE: Right.
GALBRAITH: People who can evaluate loans. They are all over the country.
MCSHANE: You know, what I thought was a legitimate point that Dick Bove, who was with us a little while ago, brought up that we really, none of us will probably argue with is that America wants to still be the biggest financial power in the world and he brought up this idea that if we don't have these biggest banks dominating the world scene that are American base that we're going to become some sort of third rate financial power as he put it. That then this is always in history been true that we have financial collapses. Things happen, in other words, kind of the translation there, why is he wrong about that, James?
GALBRAITH: Well, first of all - there are other great powers in the world who don't have the large banks that we have had. And they are quite happy with the industrial structure and the economic progress that they made. So I don't think the point is valid as a matter of economic history. Secondly, I think that we have put too much emphasis on our financial sector and too little on our knowledge sectors, manufacturing sector, on developing our infrastructure. Our country it really in fairly decrepit shape compared to let's say modern Europe or even the most modern parts of China. And there we have work to do and it's not the banking sector that's going to do it for us.
LEE: Well, and that leaves us there. Unfortunately, this will be our final question here. When we talk about too big to fail, we often talk about it only really in relation to the financial sector but what are your thoughts on the too big to fail in other sectors. Do they, first of all, exists and what are some of your thoughts on that?
GALBRAITH: Well, we have the situation in the auto industry that's just been played out and we put two major companies through bankruptcy. They came out of bankruptcy. They are being operated and that's a much more appropriate model in my view and saying, OK, guys, whatever you do is going to be OK. The government is going to back you up. You're so important that in fact you rather than the government, rather than the public at large is setting national priorities for the economy.
MCSHANE: Right. All right. Professor Galbraith, it's always a pleasure to have you on. Thanks for joining us with your views on this issue.
GALBRAITH: My pleasure. Bye.
MCSHANE: James K. Galbraith, the economist and professor at UT, University of Texas at Austin, joining us. That's different views right at the top, Dick Bove and James K. Galbraith. Those are very, very different in a lot of ways.
LEE: And a little bit later on, we're going to be talking to economist Simon (ph) Johnson. He's from MIT. So we'll get yet another different, another view on this, to say the least.
MCSHANE: Yes.
LEE: From Wall - let's just say from Wall Street, really, from talk about we're going to go to Washington next. So, we'll bring you some perspectives on the political side in just a moment when Fox Business.com Live.
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MCSHANE: All right. Here we go. So I think, as we said, we have covered a lot of grounds here with Dick Bove on one side saying hey, this whole thing about too big to fail, it's OK with me. They should be too big to fail.
LEE: We're number one.
MCSHANE: We're number one. U.S.A.
LEE: I mean, that's the argument.
MCSHANE: Legitimate points made nonetheless.
LEE: Right.
MCSHANE: And James K. Galbraith on the opposite side also making a convincing argument for why we need to do something about these banks that are too big to fail so that it doesn't happen again. That's the argument essentially.
LEE: Well, that's the conversation that many are having including those down in Washington. And that's what we'd like to bring in now, Congresswoman Shelley Moore, not Shelley - excuse me, Shelley Moore-Capito. I'm sorry. The state call you Congresswoman Capito, what will be appropriate?
REP. SHELLEY MOORE-CAPITO (R), WEST VIRGINIA (on the phone): Call me Congresswoman Capito is fine. Yes.
LEE: I mentioned all the names. I appreciate it. I really do appreciate it. Thank you so much. Coming to us from West Virginia. And if we could just get your thoughts overall. I mean, you've come out, you've been very critical of the way that the government handled the too big to fail model that we have without helping to prop up some of these institutions. What are you thoughts then today as we're about a year after what we saw was really the crisis hitting full tilt?
MOORE-CAPITO: Well, I think certainly being home in the heat of the August summer, constituents are very vocal in terms of their bailout fatigue. They recognized, you know, that financial institutions and the economy is tied to this but they don't see government responding appropriately and you know, I was just in a car auction this morning, and that, of course, the talk of GM and Chrysler was big there and I think people just lack space in the government stability and they don't want the taxpayers' dollars going bailing out either these too-big-to-fail institutions or other corporations around the country.
MCSHANE: From where you sit Congressman, the question becomes what are you guys going to do about it, right? And there's going to be this whole debate about regulation and how we handle these institutions that had been deemed too big to fail, what should we do?
MOORE-CAPITO: Well, I think we do need to look closely to make sure that we don't, you know, fall back into the same old patterns and poor decisions should have consequences and we can't reward bad behavior. And I think that the government shouldn't be in the business of picking winners and losers. And so because I do believe as I heard the professor saying that these large institutions - I am concerned that they are going to be put into a special category that's going to disadvantage my community bankers here in West Virginia and the community bankers around the country who didn't engage in this kind of behavior for the most part and are still enormously important to the fabric in the economic community.
And you know, the other concern I have is if you get a troubled financial institution, how are you going to unwind it? We don't want taxpayers' dollars unwinding all of these. And I think that's what we need to make sure that we have and I'm in favor of an early bankruptcy for these large institutions. You know, but I think these are the kinds of things that we're going to be looking at.
LEE: You know, it's a great point about your community bankers in your area, your constituents. But one of the things that we keep hearing statistics like this turnaround, for example, roughly one out of 10 Americans has some sort of tie to Bank of America, sometimes it's actually one out of eight. Somehow one out of 10 Americans have some sort of tie to JP Morgan. So even if there are - the community banks in certain areas still it doesn't matter where they are are somewhat tied back to some of these big banks.
I want to ask you what your game plan is because right or wrong and you make some excellent point, this is also giving those that are in the minority like the Republicans right now in Washington, you know, something to stand behind, saying that these decisions are wrong but you don't have a whole lot of power, at least on the voting side to actually change it. So what's the game plan from your side with your colleagues to promote some sort of change? What would you want instead of what we've seen?
MOORE-CAPITO: Well, we have a bill, as Republicans, on the Financial Services Committee, we put together a bill. But I think the bill is going to hand you on the two major sticking points or I would say overarching concepts of the regulatory reform that the president is in favor of. And that is do we consolidate all the regular or not all of it but a great deal of regulatory power within the Federal Reserve. We as Republicans think that we want the Federal Reserve, you know, to be focusing on their primary purpose of setting monetary policy. We want to have transparency. I think that's one of the issues that has come to light. You know, as you look back and say what happened? Why didn't we know? And I'm not sure we would get that kind of transparency through the Feds. So we want to, you know, bolster up the regulatory regime that we have now -
MCSHANE: Right.
MOORE-CAPITO: And then the other thing is Consumer Product Safety Commission that the president is -
MCSHANE: Yes, you know, it's interesting, Congresswoman, I got to think, you can correct me if I'm wrong on this but I would look in from the outside and say, there's fairly broad support for a lot of these issues for doing something on regulation. You know, when you compare to a polarizing issue like health care, say - for example, on both sides of the aisle, where the controversy comes in and I think you just hit on it, is with regard to the Federal Reserve. We had Congressman Ron Paul on our show saying you should audit the Federal Reserves and others said they are much more supportive of the Fed and say no, let's give the Fed more power to help whine down these banks. Can we find some points of agreement on how powerful the Fed should be and if they're not, who is?
MOORE-CAPITO: Well, I think we can probably reach that if we, you know, some kind of consensus as we were talking about if we are certain and I think Congress is satisfied that we actually know all of the ramifications and what the Fed has actually done. I mean, let's look at - we got TARP money out there that's unaccounted for. That I don't think we've satisfactorily seen where and how this money has been spent and to what kind of results have been achieved. And so, I think that before we want to put more responsibility in that entity.
We got to make sure that, you know, the responsibilities that they have now are transparent to Congress and the American people. And I think a lot of us on the committee, Republicans and Democrats are unconvinced that this is occurring at the moment. So I think we could work through this. This is another one of the things that we're rushing through and well, I think that we still have a lot of unanswered questions.
LEE: And that's for sure. Hey, congresswoman, by the way, we do have a great web site with a lot of great videos and different things out there showing what you guys are doing related to financial services. So we just want to let you know, check that out. It's looking good and we're going to continue to keep up with you. Representative Shelley Capito coming to us from Virginia today, West Virginia. Nice to have you, congresswoman. Thank you very much.
MOORE-CAPITO: All right. Thanks a lot.
MCSHANE: You know that's the view from Washington or one of the views from Washington certainly where this is going to be a hot button issue for the rest of the year. What we do about banking? And what we do about too big to fail? A man that spent a lot of time in Washington but joins us today from Florida is Bill Isaac who headed up the FDIC back in the 80s and is with LECG Global now. Bill, always good to see you. I hope you had a chance to listen in just a little bit of the conversation at least. I know you have your own views.
Not only are we looking at the state of banking but we're looking at just in particular this whole issue of two big too fail. The too big to fail 19 and what should be done about them. Where do we start?
BILL ISAAC, CHAIRMAN OF LECG GLOBAL FINANCIAL SERVICES: Well, I think the first thing we need to just accept is that no government, no major government is ever going to allow its major institutions to fail. So we start with that promise and you don't have to like it. You can complain about it but you might as well accept it. It's the way it always has been and it's a way that will always will be. These major, major institutions cannot be allowed to fail in a disorderly way.
Now, when I was running the FDIC, we had a major institution fail, Continental Illinois Bank, which at the time I think was the seventh-largest in the country. And we resolved the failure in a way that it, in some ways, felt like a failure. We did wipe out the shareholders. We changed the management of the institution and we changed much of the board of directors. But we did not impose lawsuits on the creditors of that institution, whether they were insured or uninsured. And we kept the business going.
And so I think it's very important that when you're dealing with these large institutions that you handle them in a way that is not disruptive to the markets. And we forgot that lesson this time and we made matters a lot worse by the way we handled some of these large institutions, such as Lehman, letting it go. In the case of Fannie and Freddie, we wiped out the preferred stockholders, many of which were small banks around the country and around the world even. We had world-wide investors that loss money on the preferred stock of Fannie and Freddie. When WaMu went down, we wiped out $20 billion in bondholders and we wiped out $7 billion of equity that had just come into that institution a few months earlier to try to rescue it. These kinds of transactions were highly destabilizing.
And at the same time, we did inconsistent things. We bailed out everybody at AIG, including the bank lenders. We bailed out Bear Stearns. And when Wachovia was taken over, everybody got bailed out, including the shareholders. So it appeared to people like it was some of an ad-hoc game plan. There was no coherent strategy. And I think the markets lost confidence in us.
JENNA LEE, FOX CO-HOST: Did we do anything right?
ISAAC: Not much.
LEE: OK, that's fair.
ISAAC: Not during that period.
LEE: Yeah, that's fair.
ISAAC: Probably, the worst thing we did was when the Treasury went up to the Hill and shouted at the top of its lungs that we were facing financial Armageddon if we didn't appropriate $700 billion without hearings, without debate, without justification. And it was to take over $700 billion of toxic assets in these large banks.
Professor Galbraith and I were both up on the Hill during that period arguing against that bill and saying that it wouldn't work. And in fact, we never used the $700 billion to buy the toxic assets.
LEE: Right.
ISAAC: So what the bill was designed to do never happened. And yet, we scared -- we scared people throughout the world when we said, "do this, do this now because the financial world is collapsing." And we rattled confidence in the markets. And that's what brought us this crisis I believe.
LEE: You know, we want -- we'd love your perspective as the former chair of the FDIC. And we apologize. It's a little bit of a delay. We know you're in Sarasota, Florida, today, so just want your perspective on this. You know, we talk about the too-big-to-fail, the banks that are too big to fail, as one entity, and then you have the rest, everybody else. If we know that the too-big-to-fail are going to have the backing of the U.S government in a way that the other banks are not, should those big banks not get the same type of backing from the FDIC, because they're going to have the backing of bigger government than just the FDIC? What do you think about that?
ISAAC: Well, that's a very complicated question. And part of who's paying the cost to the FDIC is up for grabs right now in the political debates. I would say that I agree with those who believe that we ought to be increasing the supervision of these large banks, smarter supervision. And we ought to be increasing the capital requirements. We need to get rid of our pro-cyclical policies. For example, our capital rules, the international capital rules do not allow -- don't require the capital in good times. And then, when the bad times come, you can't have enough capital to satisfy the models they use. We need to change those kinds of rules. We need to change to mark-to-market accounting, which is highly pro-cyclical. It inflates earnings artificially in good times and it takes billions, hundreds of billions of dollars of capital from the banks in difficult times. Same thing with our loan offs (ph) reserving policy.
Same thing with the FDIC. We didn't charge banks FDIC premiums for much of the 1990s because the fund was fat and happy. So banks are not paying FDIC premiums in good times. When the bad times come, we assess them extra money, which takes capital out of the banking system and makes it harder for banks to lend. We've got a lot things backwards. And we've got to get a lot smarter about supervision of banks.
I would tell you that I don't believe the administration's bill does much to address any of these problems.
CONNELL MCSHANE, FOX CO-HOST: OK, so all specific suggestions from you, Bill. And you're doing a good job, which we like to do on this show, looking forward in talking about what we need to do in the future. However, you know, I hate to do this. I'm going to go backwards just for a second to question on the issue of last fall when you said, when Jenna asked you this, we basically did nothing right. And I just want to know the alternative to that. In other words, what would you have done differently? What could have been done that maybe would have prevented all this? How should it have been handled?
ISAAC: Well, we had a lot of it baked in the cake, so there's no question we had a serious problem. But we also had extremely serious problems in the 1980s. We had a 21.5 percent prime rate in 1980 because of years and years of inflation in the 1970s. We had an agricultural depression. We had our big banks bloated up with third-world debt. We had a real estate recession that was quite severe. We had a recession in '81, '82 that was at least as serious, if not more serious than what we're going through today.
And I think the difference -- there's a few differences. But one of the differences is that, this time around, we did not take care of the number-one priority, and that is to maintain confidence in the system. To let Lehman fail, to stick the preferred shareholders of Fannie and Freddie with those losses, those were transactions that just didn't make -- give enough priority to what do we need to do to maintain public confidence in the system?
In the 1980s, we experienced 3,000 bank and thrift failures and including a lot of large banks. Nine out of the 10 largest banks in Texas, for example, failed. And we didn't have the kind of panic in the markets that we had this time around. And I say that's because we didn't get it right this time. We didn't -- we didn't pay attention to the number-one objective in a crisis, and that is maintain confidence in the system. And we didn't make that our number-one priority.
LEE: We could talk to you all day, Bill. It's great to have you again. Really, it's wonderful to have your perspective.
Again, Bill Isaac, he's former head of the FDIC, also chairman at LECG Global Financial Service.
Bill, we'll talk again soon, absolutely.
MCSHANE: Absolutely, Bill.
ISAAC: Nice to be here.
MCSHANE: One of the things that Bill talked about there is the idea that he and Professor Galbraith, who was on earlier, both testified on Capital Hill about this.
LEE: Who knew? You were buddies, huh?
MCSHANE: Maybe. But I'll tell you another guy who has, is Simon Johnson, now at MIT, once at the IMF. That's why we have some great thinkers on this issue. And Simon is up next. So stay tuned for that.
(COMMERCIAL BREAK)
LEE: Well, former chief economist at the IMF, professor at MIT, economist, of course, Simon Johnson, joining us now for his thought on this too-big-to-fail issue, as we drift into now a year anniversary of when we really saw the financial crisis kind of hit full tilt.
Simon, it's great to have you back again. Always good to talk to you. I want to start with one of the things you said in front of the House Financial Services Committee back in July. When you said, "We do not yet have a similarly effective way to deal with the insolvency of large financial institutions." I would assume the ones too big to fail. Why do we not have that yet? And what do we need to do?
SIMON JOHNSON, ECONOMICS PROFESSOR, MIT & FORMER CHIEF ECONMIST, IMF: Well, we obviously need to be able to close them down in the same way that the FDIC can handle small and medium-sized banks, which means without causing massive further financial destruction.
Now, the administration has an idea of doing that through a resolution authority. The Republicans have an idea of modifying the bankruptcy code to try and deal with that. I think both of those ideas are sound but they're not enough. I think you have to make the biggest banks smaller. If you don't, you're going to come to the same point again when the biggest banks say, hey, if you try and stop us, if you try and take over what we're doing and close us down, there will be a massive global financial meltdown. And the government's always going to blink in the face of that. So the biggest banks have to become smaller.
MCSHANE: OK, what does that mean in practice, Simon? You do what, you go into Citigroup and say, "We're splitting you up." If that what you're talking about?
JOHNSON: Absolutely. Standard Oil, as you know, was broken up more than 80years ago, and formed some very good companies. And nobody says that we left the competitiveness or the strength of our oil industry because we broke up this behemoth that had too much political power and was distorting our entire political process. That's what we've got to do with the banks.
LEE: All right, some say we did that. Look, we went into Citigroup. Citigroup is now divided. We have a lot of it invested in Citigroup, for example, whether it's through guarantees or actual real investments there. That process is happening, some say. What do you say?
JOHNSON: Well, I don't think the process we're seeing right now is certainly not one of breaking them up. "The Washington Post" has a nice article today talking about the -- and documented the increase in concentration in our banking system, not focused just on Citi but across the big banks, JPMorgan, Wells Fargo and, of course, Bank of America. So this problem is growing. It's not going away.
LEE: So what do we do?
(LAUGHTER)
SIMON: Well...
MCSHANE: I don't know that you -- Simon's already said break them up. But I wonder if there's really political will for that, that...
LEE: Yeah, but that's the point, right, Simon, is, well, OK, fine. So then what do we do now? Are you saying to us that basically we're at this point of no return where these guys are going to get more and more bloated and there's really no way -- we've tried it. There's not going to be the way. The market doesn't have the power. That Washington doesn't have the power. This is the course we're on. Are you ready to say that right now, or are you saying there's a way that we could change that path?
JOHNSON: Of course, we could change that path. The question though of political will, which you raise, is exactly right. And you have to ask, what's the power of the guys who don't want change? The power of the financial big finance lobby is enormous. It's stronger, I would say, on Capital Hill, than it has been in the past, which is amazing. But that's the way it is. That's the outcome of the crisis.
And as for what will happen, I think it depends on the economy. If the economy recovers nicely, smoothly, people will try to forget about and brush it under the carpet. If the economy continues to struggle, which I hope won't, but I'm just saying, if it doesn't, then I think there will be more petitions for reform, because people are going to understand our credit system is broken much more fundamentally than the administration or the Republicans will currently admit.
MCSHANE: You're a student obviously, Simon, of history, of economic history. And Dick Bove, the banking analyst who was with us earlier, said that throughout history, there have always been institutions that are too big to fail, and it is in our interest, as a nation that wants to be the most powerful financial nation on the earth, to have those institutions. So maybe we don't like it and maybe we don't like bailing them out when there's a financial panic. It doesn't happen often though, was basically his point. And that throughout history it's happened and people have lived and fought another day, so to speak? No?
JOHNSON: No, I think that's just a misreading of history. Andrew Jackson, who -- look at Andrew Jackson against the Second Bank of the United States in the 1830s. We had this debate more than 150 years ago. And Andrew Jackson won. The U.S. ran -- the 19th century -- the period of industrialization, the period of American breakthrough to economic power and then to political power, we ran it without big, global banks, or big international, big national banks even. We had small banks. We never let our banks get out of control. And we faced this issue head on at the end of the 1920s and we re-regulated them. We tightened up the regulation on banks that had emerged in the early 20th century. Now you may or may not like that regulation, but the fact of the matter is, we had a good 40 or 50 years. After that is when the banks became politically powerful again, that's when things started to go array.
LEE: So one of the questions that we posed to a few of our guests was, are the agencies and the individuals in place -- if change is needed, are those individuals and those agencies in place right now that would provoke those changes, or is there something drastically different that needs to be seen in order to achieve some of the changes that you're talking about?
JOHNSON: We need something drastically different than what's currently on the table. I think the individuals in the administration are not pushing hard enough. I think their plan is weak. I think the Republican response to it is also weak and insufficient. And I hope that it doesn't take another crisis. I hope that we don't have to go through this again. And I hope we don't have to face something even worse before we take this problem seriously. The system almost failed. President Obama said we almost ran into another Great Depression. And I agree with that assessment. But why are we not fixing the underlying problem. It's extraordinary.
MCSHANE: So the administration would argue, hey, Simon, we are, we're going to. We're going to have regulatory reform. But what's your point, that the reform on the table doesn't go far enough? I mean, aren't there some measures that are being talked about that would help out?
JOHNSON: The measures are in the right direction but they're very, very small. They're basically tweaks of the system. And you can have any kind of independent experts in here, people who are not being paid on either side of this issue, I think they'll tell you the same thing. These are small modifications to the way we run our existing system. How can it be that we face system collapse and almost complete system meltdown and we're responding with relatively minor tweaking? It doesn't make any sense. That's not what you do when faced with a massive engineering problem or a failure of huge program, engineering-based program. Why is that the right thing to do for a big bank system? It's not. This is a mistake.
LEE: Professor Johnson, let's say you get a call from the Obama administration and they actually agree with everything you're saying right now. Come down to Washington, we want you to head up whatever. It is what you want. You have total freedom. What's the number-one thing you would do, first day in the office?
JOHNSON: Well, I think you need a much clear statement of the problem. We need to say much more publically than the administration has done that -- the size of the problem and that big banks are really the core of what goes into this problem. The big banks need to be broken up. And of course, you need to work with Congress to figure out how to do that. But stating that goal very publically, very clearly is absolutely essential.
LEE: Doesn't that ignite panic?
JOHNSON: No, of course not. You know, the panic comes from loss of confidence in the system, from people feeling they're going to lose their money. We're not saying that creditors have to be wiped out here. We're saying that the ownership structure and the management of these big institutions is deeply, deeply flawed and it needs to be fixed and it needs to be fixed. And we're going to fix it in a responsible manner. That would be welcomed by the market.
LEE: If you get a call like that, we want the next call, if you will, and let us know.
MCSHANE: Tell us you're going down there, right?
Thank you, Simon. Good to talk to you again.
Simon Johnson at the Petersen Institute for International Economics, and MIT as well, and used to be at the IMF. But one of the well-known economists on this issue. He's testified before Congress and everything else.
So we've covered all the bases, don't you think, almost.
LEE: We've covered all the bases, but it brings you to the question that I think we have a lot of times, both on the air and off, as we're talking about these issues is, what do you make of all of it. You have all this information, so how do you sleep at night, right? Because one of the messages we're getting regardless of whether you belie in too-big-to-fail or not is that the system is still under some turmoil. So we're going to break that down, give you an idea of how we can all kind of handle this in just a moment. Elizabeth McDonald is next.
MCSHANE: Who doesn't sleep at night, that's right.
Stay with us.
(COMMERCIAL BREAK)
MCSHANE: Bring it all in, wrapping it all up, bringing it all together.
LEE: Baking it up, letting it marinade and then let's go.
(LAUGHTER)
OK, Elizabeth McDonald is with us.
ELIZABETH MCDONALD, SENIOR STOCKS EDITOR, FOX BUSINESS: Hey.
LEE: You know you've been watching the whole show with us, Liz. And it's always great to have you on "FOXBusiness.com" live because normally we can have our viewers talk to you and we have a way to have a dialogue.
MCSHANE: (INAUDIBLE).
LEE: Yeah, and really have a way to figure out this stuff.
So let's just start there. This stuff, I mean what do you make of this too-big-to-fail situation now a year later, and where are we going?
MCDONALD: Well, we're going -- we're headed in the direction of more too-big-to-fail companies, given the fact that Bank of America bought both Merrill Lynch and Countrywide. You know, Jamie Dimon at JPMorgan-Chase bought WaMu and Bear Stearns. And there's been an -- and Wells Fargo had to pick up Wachovia. So Alan Greenspan though, in his book, says, you know, the idea of a systemic risk regulator -- he actually called it a stability regulator -- the Federal Reserve, being the system risk regulator, as he said, was mission impossible.
Remember in September 2005, Ben Bernanke at that time said, you know, the rise in house prices was due to fundamentals, never mind the fact that subprime loans and also A loans and option ARMS were starting to pick up speed in terms of issuance. So too-big-to-fail, we're coming on the September -- one-year anniversary of the September collapse of Lehman Brothers. AT that time, we saw -- right before that, we saw Fannie Mae, Freddie Mac collapse, too big to fail, right? AIG was collapsing that week. Citigroup was on the verge of collapse, Washington Mutual, Wachovia. And so is there a too-big-to-fail policy in this country? No, there's very expensive after-the-fact refereeing where the Federal Reserve is now the world's biggest junk investor because it took on the bad assets that AIG and Bear Stearns. You know?
MCSHANE: Right.
MCDONALD: And now American taxpayers are going to be starring morosely at this mountain of rotting paper for some time to come because Wall Street hustlers basically would have, at that time, securitized the issuance from fire hydrants if they could have.
MCSHANE: But we've had, over the last hour, just the complete spectrum of suggestions on how we deal with that situation that you've described. Some have come on, Professor Galbraith, for example, earlier, saying, we've got to break these guys up, right? We've got to break these banks up, making them smaller. Simon Johnson, along the same lines in a lot of ways. But Dick Bove -- you know Dick -- was on earlier in the hour saying, you know what, we've always had institutions that are too-big-to-fail and there's nothing wrong with that. That makes us a powerful financial system. And he basically made the case that we should leave the system in place as it is.
MCDONALD: That's infinitely (ph) foolish, at minimum, to say that. And I like Dick Bove. I think he's a very smart man.
And why do I say that? Look, you know, we have massive bailouts, TARP investments, $220 billion, the gross exposures to the bailout, if there is systemic collapse on the part of the government, what is the U.S. taxpayer exposure there? More than $23 trillion. And so that's about 150 percent of U.S. GDP. Now, that's again to the extreme, but the exposures are there.
So I just think what you need is get a backbone transplant in the part of government banking regulators and Wall Street regulators. Now in Washington, the rules have been in place since the S&L crisis to stop systemic risk. The Federal Reserve -- that's on the books already, system risk rules, since 1991. I just think that -- you know, grow a backbone in Washington. And have them set aside proper capital cushions.
LEE: You know, every time you say "grow a backbone," I find myself kind of shifting to sit up a little higher.
MCDONALD: Put a straight...
(CROSSTALK)
LEE: But you know what? That kind of brings an important point here. Because you talk about the regulators having a backbone, but we now, a year later, are used to the idea that there are tens of billions of dollars invested in multiple institutions, taxpayer money, that was used to prop up some of these institutions that were too big to fail. And as time passes, it just becomes more comfortable to think about that.
MCDONALD: Yeah, and that's...
LEE: And it's not just the regulators. I mean, you're talking about a whole generation that's becoming very comfortable with this fact. So on our side, whether we're investing in the market or whether we're investing in the market, you know, what should we do?
MCDONALD: You know, to my mind, that this is the new normal is terrifying, because Wall Street is still talking about the bond market crack up, where there's a bond glut, and bond issuances from around the world, these other countries have embarked on their own stimulus programs, all these bonds have to compete for yields. And because the 10-year Treasury note is key. For mortgage rates, right? You know, rates could go up down the road. We're still waiting to see whether the bond market is really going to test the credibility of the Treasury and the government and the Federal Reserve this year.
You know, the Federal Reserve Chairman Ben Bernanke can keep rates low all he wants. But when you cannot borrow in the capital markets -- I mean, you see China rotating out of our Treasuries, as they're threatened to do, and they have done it on a small scale, $25 billion, in recent weeks, I mean, that's really bad for the U.S. government as it embarks on this massive spending.
So where do we go from here? I think hyperinflation unfortunately. Whether it happens next -- in five years, 10 years, whether we can keep it in check, whether we can grow our way out of the problems, the U.S. government is set to tax us any more.
MCSHANE: You don't think that Bernanke can manage that exit strategy without getting to that situation? No?
MCDONALD: I don't know what -- the way he's talking about it is he needs too -- for example, with bank reserves, he hit the computer button essentially and created about $782 billion in bank reserves, right? That's up from $7 to $10 billion before the crisis began. So he effectively created bank reserves at holding banks, Federal Reserve home loan banks, rather.
Well, how did he do that? He's saying, well, he wrote an editorial, the way to get out of it is keep those reserves with me at the central bank. I'll pay interest on them so they don't flood into the system and create too much money cheap and too few goods, meaning inflation. Or you sell bonds to those banks to remove that cash out of the system and replace it with a paper security, meaning a bond. So again, there you go, a bond glut, again, with the Fed's action. Can he just man out of this quantum leap in the balance sheet at the Fed? It's going to be a heck of a job. I mean, we have never seen this before.
MCSHANE: On the stick, so to speak, as you would say, right, McDonald?
MCDONALD: Yes. On the stick.
(LAUGHTER)
MCSHANE: There's got to be some on the stick.
Thank you, Lizzie.
MCDONALD: You guys are always on the stick. Asking the tough questions. Tough questions.
LEE: We're somewhere. You know, one of our guests recently said, you've got to hit the Control-Alt-Delete button to kind of reset.
MCSHANE: Yes.
LEE: That's what our economy's doing right now, Control-Alt-Delete. We kind of crashed and now we're trying to reset. So we'll see if we can reboot in the right direction.
MCSHANE: Sometimes that's the problem, the thing never boots up again.
MCDONALD: I love it, reboot.
MCSHANE: And that's what you're hoping for.
All right, Liz, talk to you soon.
MCDONALD: Sure.
LEE: I like the way that brings it all together, reboot, "FOXBusiness.com Live," yeah.
MCSHANE: That's Liz's role in all this, bringing it all together.
LEE: It's not a coincidence.
MCSHANE: Now, if this is the first time you've watched this in this format, where have you been? No, we're on every day on the Internet at "FOXBusiness.com." "FOXBusiness.com Live" is the name of the show. We're taking viewers questions as well. We've got these snazzy laptops in front of us and what have you. You can write in, really interact with us. We do a lot of different shows about issues like this and just the news of the day. So it is, as we like to say, the most interactive television show on the Internet.
LEE: And the guests that you saw here have all been guests of our show during the week where we've had a longer period of time to talk to them. We take your questions, ask them directly. So it's interactive at the highest level.
MCSHANE: I think it is. And we've been doing it now for six months or so. We have a lot of fun. So we invite you to join us Monday through Friday, noon eastern time. If you can't come and join us live, this show is always available as a podcast to download on iTunes. And we're there on Hula, which is a great place to be.
LEE: You can just watch it over and over again.
MCSHANE: You can watch it any time you want. Yes.
LEE: Over and over.
MCSHANE: Always available.
(LAUGHTER)
Thank you for joining us on this special look at the banking industry and the issue of too-big-to-fail. Take care, everybody.
LEE: Have a good weekend.
END