What does one make of it when someone whose career has been based on having powerful friends and contacts at the top levels of the financial services industry appears to be acting as a traitor to his class? In this case, the apparent turncoat is one Neel Kashkari, ex Goldman, ex Treasury, ex Pimco employee, now the new President of the Minneapolis Fed, who in his first speech in his new job, said all sorts of unpleasant truths: the financial crisis imposed huge costs on society as a whole, Dodd Frank didn’t go far enough, the authorities won’t be willing to risk using untested new powers in a financial meltdown and will bail out banks again. He also argued that the financial system was now stable enough to make (by implication overdue) transformative changes to end the “too big to fail” problem, such as breaking up banks and regulating them like utilities. Kashkari plans to come up with a comprehensive plan by year end and is seeking public input, including having expert discussions that will be webcast.
Now readers might think I’ve gone soft in the head by virtue of having an insider advocate some of our pet ideas, such as treating banks like utilities, when I tell you there are reasonable odds that Kashakri is serious.
As much as there was a great deal to like in his speech, I feel compelled to comment on a couple of issues before turning to the big question of “What to make of this?”
Kashkari Calls for a “Bold Approach”
This is the guts of Kashkari’s speech:
Now is the right time for Congress to consider going further than Dodd-Frank with bold, transformational solutions to solve this problem once and for all. The Federal Reserve Bank of Minneapolis is launching a major initiative to develop an actionable plan to end TBTF, and we will deliver our plan to the public by the end of the year. Ultimately Congress must decide whether such a transformational restructuring of our financial system is justified in order to mitigate the ongoing risks posed by large banks.
Although TBTF banks were not the sole cause of the recent financial crisis and Great Recession, there is no question that their presence at the center of our financial system contributed significantly to the magnitude of the crisis and to the extensive damage it inflicted across the economy…
I believe we must seriously consider bolder, transformational options. Some other Federal Reserve policymakers have noted the potential benefits to considering more transformational measures.6 I believe we must begin this work now and give serious consideration to a range of options, including the following:
• Breaking up large banks into smaller, less connected, less important entities.
• Turning large banks into public utilities by forcing them to hold so much capital that they virtually can’t fail (with regulation akin to that of a nuclear power plant).
• Taxing leverage throughout the financial system to reduce systemic risks wherever they lie.
Options such as these have been mentioned before, but in my view, policymakers and legislators have not yet seriously considered the need to implement them in the near term. They are transformational—which can be unsettling. The financial sector has lobbied hard to preserve its current structure and thrown up endless objections to fundamental change. And in the immediate aftermath of the crisis, when the Dodd-Frank Act was passed, the economic outlook was perhaps too uncertain to take truly bold action. But the economy is stronger now, and the time has come to move past parochial interests and solve this problem. The risks of not doing so are just too great.
A Few Quibbles
Kashkari, and sadly, this is now conventional wisdom, treats some earlier financial crises as less serious than they were deemed to be at the time. From his speech:
When roughly 1,000 savings and loans failed in the late 1980s, there was no risk of an economic collapse. When the technology bubble burst in 2000, it was very painful for Silicon Valley and for technology investors, but it did not represent a systemic risk to our economy.
While Kashkari is correct that the US was not at risk of a seize-up, the S&L crisis was widely expected to impose much greater macroeconomic costs than it did. The banking system had taken a body blow and experts anticipated it would take a very long time for banks to repair their balance sheets, which in turn would dampen the recovery. The financial system got back on its feet faster than projected because Greenspan engineered and maintained a very steep yield curve, which gave banks big profits, which they used to shore up their capital levels.
Similarly, while I agree that stock market busts, even big ones like the dot-bomb era, have limited macroeconomic impact unless the stock buys were fueled with a lot of borrowed money. However, Greenspan, imprinted by the 1987 crash, thought otherwise, and drove interests rates negative, in real terms, for a full nine quarters, when the past Fed response in a recession was to drive interest rates low only for a quarter or at most two.
This section of the speech is intriguing:
Many of the arguments against adoption of a more transformational solution to the problem of TBTF are that the societal benefits of such financial giants somehow justify the exposure to another financial crisis. I find such arguments unpersuasive.
• Finance lobbyists argue that multinational corporations do business in many countries and therefore need global banks. But these corporations manage thousands of suppliers around the world—can’t they manage a few more banking relationships?
• Many argue that large banks benefit society by creating economies of scope and scale. No doubt this is true—but cost/benefit analyses require understanding costs, too. I don’t see the benefits of scale of large banks outweighing the massive externalities of a widespread economic collapse.
• Some argue that if we limited U.S. banks in size or scope, they would be at a disadvantage relative to banks in countries with looser regulations. If other countries want to take extreme risks with their financial systems, we can’t stop them—but the United States should do what is right for our economy and establish one set of rules for those who want to do business here.
Yves here. Now I could (and have) argued with validity of each of the big banks defender talking points that Kashkari cites. For instance, there is ample evidence that banks show diseconomies of scale above a relatively small size threshold. But Kashkari doesn’t bother arguing whether these claims hold up. He says that even if they are true, they don’t deserve to be taken all that seriously.
What to Make of Kashkari’s Plan to Develop a “Bold” Plan?
Many of my interlocutors were suspicious of Kashkari’s appointment to the Minneapolis Fed presidency, and saw it as Government Sachs or other insiders pulling strings to get a pliant ally a seat at the table. He’s relatively young, 42 years old. He was at Goldman for four years, sought a public service job he did not get (White House fellow) and then went with Hank Paulson to Treasury, where he was moved over from his original role at Treasury to work on crisis matters, most notably administering the TARP on a day-to-day basis.
After Kashkari left Treasury, he joined Pimco and became head of their effort to enter the equities business. This was an odd choice, since Kashkari had been on the investment banking side of Goldman, meaning he had no experience in equity research, stock picking, or the asset management business. The six mutual funds he created all underperformed. Kashkari left Pimco to run for California governor as a Republican and lost to Jerry Brown. This is Wikipedia’s summary of his political positions:
Kashkari has been a Republican his whole life. In a 2008 speech to the American Enterprise Institute, Kashkari described himself as “a free-market Republican.” In 2013 he described himself as a “pro-growth Republican”. He opposes most of Obama’s economic agenda and supports cutting business regulations. He has called for cutting Social Security and Medicare and replacing the Patient Protection and Affordable Care Act. In 2012, he voted against California’s Proposition 30, which raised taxes in the state, and for Proposition 32, which would have weakened labor unions’ political influence. In a March 2014 interview, he praised Wisconsin governor Scott Walker’s controversial policies limiting collective bargaining.
On social issues, he has described himself as libertarian and “a different kind of Republican”, supporting abortion rights, Same-sex marriage, and a path to legal status for illegal immigrants. He voted against California’s Proposition 8, which banned same-sex marriage in 2008…
Kashkari cites Paulson, Mitch Daniels, and Jeb Bush as political mentors. He voted for Obama in the 2008 presidential election and Romney in the 2012 election.
Kashkari’s deep ties to the financial services industry, his support of the internally inconsistent idea of “free markets,” and his libertarian, anti-regulatory stance are reasons aplenty to think his call for bold measures is just a great big Trojan horse.
But the official position of the financial services industry is that Dodd Frank went too far and has hobbled them with all sorts of red tape that has hurt their profits. And senior executives and their mouthpieces have adopted a “take no prisoners” posture, howling over even minor regulatory changes or criticisms of their conduct (remember how loath they are to admit they fight tooth and nail admitting they have done anything wrong?).
Now it could be that Kashkari is trying to develop a plan to compete with Elizabeth Warren’s 21st Century Glass Steagall Act, one that would be weaker and thus easier to get passed. But the banks don’t want another round of reforms, even weak reforms. And Kashkari is messaging to the left of Warren. His mention of breaking up the banks, or the even more radical idea of regulating them as utilities, effectively endorses her and Bernie Sander’s calls for breaking up the banks until he puts a real plan forward, which is nearly a year away, an eternity in politics.
My best guess is this plan is all about Kashkari advancing his career via infighting effectively at the Fed. Fed presidents, except at the New York Fed, have limited authority. In a famous incident in the 1990s, four regional Fed presidents, including Janet Yellen, complained to Greenspan about how they were marginalized and that staff at the Board of Governors had more power than they did. Moreover, the central bank is preoccupied with monetary policy. Kashkari has no expertise on this front and would not be treated with much respect. Many people outside the Fed regarded his credentials as far too thin to deserve the job; he’d be seen as a lightweight internally as well.
But by launching a splashy bank reform initiative, with the explicit aim of developing a legislative proposal, Kashkari has opened up a new front, and one where he has the advantage over Fed incumbents, save bank reformer Danny Tarullo, who presumably will be an ally. Kashkari’s assets are his bully pulpit, which he has made clear he intends to use heavily, and the Minneapolis Fed staff, which historically, and perhaps still, has some insight into “too big to fail” issues. In fact, this is an area where Yellen has performed badly. Recall how Elizabeth Warren dressed her down over the Fed’s repeated failure to make the biggest banks develop viable living wills or take action to force them to divest assets or simplify operations. In other words, Kashkari’s initiative looks like a challenge on terrain where the leaders of the Fed, Yellen, Stanley Fischer, and the power behind the throne, general counsel Scott Alvarez, have not covered themselves with glory.
And Kashkari has devised a process that will keep his initiative in the headlines:
Starting in the spring, we will hold a series of policy symposiums to explore various options from expert researchers around the country. We will also invite leaders from policy and regulatory institutions and, yes, the financial industry to offer their views and to test one another’s assumptions. We will consider the likely benefits, costs, risks and implementation challenges of these options. We will invite the media to these symposiums and livestream them so that the public can follow along and learn with us.
Following the symposiums, we will publish a series of policy briefs summarizing our key take-aways on each issue, so that all can provide feedback. And feedback can start now. We have established a website where anyone can share with us their ideas on solving TBTF. If you are a researcher—if you work in the financial sector—if you just have a good idea for solving TBTF, wherever you are, please share it with us at minneapolisfed.org.
Now we’ll have an idea of how serious Kashkari’s plans really are by who gets invited to these confabs. However, it is worth noting that policy development is just about never done is such a public manner. I’m not sure financial services industry incumbents recognize that the bland talking points they serve up in private discussions to often-not-knowledgeable recipients, like spread-too-thin Congressional staffers, won’t hold up so well when presented before a larger audience that includes lots of people who know how Big Finance actually works.
In other words, Kashkari may have concluded that breaking some financial services industry china is a career-advancing move. How much of a ruckus he really intends to create will become apparent in the coming months.