Rana Foroohar and Sebastian Mallaby, both shortlisted finalists for the 2016 Financial Times & McKinsey Business Book of the Year Award, recently met up for an in-depth Heleo Conversation on the legacy of Alan Greenspan and the future of finance. Rana is an assistant managing editor for Time magazine, recipient of the Peter R. Weitz Prize for transatlantic reporting, and the author of Makers and Takers: The Rise of Finance and the Fall of American Business. Sebastian, the author of The Man Who Knew: The Life and Times of Alan Greenspan, is also the Paul A. Volcker senior fellow for international economics at the Council on Foreign Relations.
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Sebastian: Your book, Makers and Takers, is very critical of financialization—financiers are the takers. My biography of Alan Greenspan tells the story of the making of modern finance from the inside, showing that the decisions Greenspan and his contemporaries made from the late 1960s onward seemed reasonable at the time.
One example of that is the deregulation of interest rates in the 1970s, which was warmly supported by economists who had been close to John F Kennedy, like James Toobin. Deregulation was seen, at the time, as a progressive project.
What would you cite as the best example of a deregulatory decision that was clearly off the mark?
Rana: Well, Regulation Q is fascinating. There was this problem about the rates that savers were getting, about the way savings and loans were not able to compete with other kinds of financial institutions, and so there was this interesting political mix of financiers, consumer advocates, what would have been the Elizabeth Warren camp of that time. These people were all for the deregulation of interest rates for a variety of reasons, so you have this fascinating far right, far left, everything-in-the-middle coalition.
This paved the way for all kinds of financial innovations, and there wasn’t a lot of deep thought. To be fair, it was hard to see the kind of effect those innovations were going to have. This is part of a deeper problem, which is why you had deregulation to begin with. Politicians were at a particular point where growth was slowing for reasonable reasons—more competition from Europe, emerging markets. But policymakers didn’t want to make tough political decisions and upset various interest groups, so they thought, “We’ll just let the markets deal with it.” Then you’ve got a snowball cycle, which carried on through the Greenspan era, in part because he got lucky. So many times when it seems that this financialized bubble was going to burst, it didn’t. The process went on for about 40 years. You end up at a point where the pendulum has swung completely the other way, there aren’t a lot of safeguards, and 2008 showed us what can happen.
Sebastian: In the ’70s, when these interest-rate regulations, Regulation Q, were being dismantled, there was this left-right coalition around that. One of the next big moments in deregulation came when the Glass-Steagall split between commercial lending and securities underwriting began to be eroded in the mid-1980s. After the crisis, we often look and say, “Gee, why did they do that?” My sense, from watching this story through Greenspan’s eyes, is that JPMorgan was making an argument which, at the time, looked not crazy. Right?
Computers had allowed securities to be designed much more cheaply and traded much more efficiently than before, so if you were a company in the real economy—not a taker, but a maker—the makers wanted financing for new factories, and it was better for them to issue bonds than to ask for a bank loan. It would just be cheaper. Big banks like JPMorgan were arguing that, “You either let us underwrite these bonds, or we’re going to be out of business. Do you really want us to be out of business when the Japanese banks can do securities underwritings in their markets, and Deutsche Bank can do it in Europe? Technology is driving this change.”
Although I see the argument now for splitting banks, at the time, in the late ’80s and the early ’90s, Greenspan and his contemporaries thought that allowing JPMorgan to do securities underwriting was reasonable. Maybe you see it differently.
“One of the things I always thought was a problem, in the last political cycle with Bernie Sanders’s financial view, is that it was too simplistic: bring back Glass-Steagall, bring back the big banks, and everything will be better. We know that’s not true.”
Rana: I’ve always had mixed feelings about bringing back Glass-Steagall because if we did bring it back, you’d have to completely rethink it. Banking has changed so much from when the Depression-era regulation was crafted. But let’s say you had a modern Glass-Steagall that separated generally risky trading from commercial lending—it’s not like bringing back Glass-Steagall is going to protect you from every kind of financial disaster. I have a lot of sympathy for people that make that argument.
One of the things I always thought was a problem, in the last political cycle with Bernie Sanders’s financial view, is that it was too simplistic: bring back Glass-Steagall, bring back the big banks, and everything will be better. We know that’s not true. That said, you’re hitting on something important about complexity and technology. Technological innovation plays such a role in this. We know, having spoken to the risk managers of these banks, that post-2008, they didn’t know what was going on. Jamie Dimon, the best risk manager in the business, doesn’t know everything that’s going on. How could you know? There’s trillions of these transactions going on, because of the technology, on a daily basis.
Managing complexity is a part of what the regulatory decision-making process should be. I would flip the whole thing. We talk a lot these days about greater capital requirements, and splitting commercial and investment banking, but I think we need a paradigm shift about how we think about regulation. We need to stop post-facto trying to stop all the bad things banks do, and flip our thinking and say, “What kind of financial system do we want? What do we want to incentivize?” Then let’s figure out a structure that will do that, and whatever doesn’t fit into that structure, whether it be certain kinds of derivatives trading or too much issuance of debt that gets tax preference and creates distortions in the economy, let’s limit that.
Sebastian: It’s harder than people remember to do something about mortgage securities. In 2001, you can see Greenspan debating subprime mortgages. The staff at the Fed estimated that the riskiest subprime mortgage securities would be banned by these new rules. They saw the problem, and they thought they were acting on the problem. The thing is that the financial industry can root around those rules, tweak their products, and escape, and that’s what happened.
Rana: What made Greenspan look at the housing market at that moment? What was he worried about?
Sebastian: The Fed was concerned about consumer protection. It didn’t foresee a systemic meltdown, but it was concerned that people were being ripped off by mortgage products, which had two-year teaser rates that reset radically after two years, and then people wouldn’t be able to afford them. It was a question of abusive mis-selling of complex financial products to people who didn’t understand them.
One of the morals of this story is that central banks might have to look to interest rates and be willing to disincentivize borrowing by making it more expensive. You might have to raise interest rates in the face of a potential bubble and not count on regulation because regulation appears to be so hard to do.
Rana: Yeah. We now have President-Elect Trump who has explicitly said that Janet Yellen was keeping interest rates low to try and help get Hillary Clinton elected. This is fascinating because you talk in your book about the politicization of the Fed and Greenspan being a political figure. But you argued that by being political, he actually allowed the Fed to be less so. Can you explain that?
“Greenspan was fascinatingly Machiavellian. He would leak to the media if he had an enemy and discredit them. He was willing to play all the classic tricks he had learned in an apprenticeship working for Richard Nixon.”
Sebastian: There’s a naïve view that the way central banks get to be independent is just to stay out of politics. Greenspan’s story shows how politics are all around central banks, and they can’t escape that easily. In fact, Donald Trump’s attacks on Janet Yellen during one of the presidential debates reminds me of that. Central banks have to deal with politics by being willing to fight back, by understanding power, not being afraid to wield it. Greenspan was fascinatingly Machiavellian. He would leak to the media if he had an enemy and discredit them. He would go to the Senate, and tell his friends in the Senate not to confirm so-and-so because he didn’t like them. He was willing to play all the classic tricks he had learned in an apprenticeship working for Richard Nixon.
Rana: Wow. How would you compare Richard Nixon and Donald Trump?
Sebastian: In one sense, very different. Nixon had a reputation for being the master of policy, a very deep thinker about America’s involvement in the world. Agree with him or not, he had a serious, wonky image. But, maybe this is where the Trump comparison works—he had this paranoid view of the world, and a very thin skin, a sense that he had to absolutely win everything.
The Watergate scandal is crazy, because he probably would have won the election anyway without cheating. He wanted to get the Fed to cut interest rates ahead of the 1972 election, and so he cooked up a plan to force the Fed to cut rates by leaking a made-up story to embarrass the Fed chairman at the time, Arthur Burns, and then getting his buddy Alan Greenspan to go over to suggest to him that maybe he ought to cooperate more with the White House.
Rana: I don’t think Janet Yellen is quite as able to play the Machiavellian political game, but we’ll see. What would you do? Given your deep knowledge of this, what direction do you think the Fed should be going in now? Particularly at a time when it’s been accused of being openly political.
Sebastian: What the Greenspan model tells us is that there’s something to be said for message unity.
The Fed has been attacked in the last six or 12 months by people who think it’s too tight, then simultaneously by people who think that it’s too loose. Donald Trump thinks it’s too political, some people on the left think that the regional Fed should be restructured to remove the role of private bankers. There have been four different attacks on the Fed. If you ask, “Well, was the Fed successfully defending what it was doing?” I think the problem is there was no one clear signal, because Janet Yellen permits the other governors to speak in a way that Greenspan would have never.
In the Greenspan era, if you asked somebody, “How much of the signal that you’re hearing from the Fed is Alan Greenspan?” the answer would have been 99.9%. Today, if you asked the same question about Janet Yellen, it’s less than 50%. In an era of social media networks and cacophonous public debate, not all of it very informed, you’ve got to cut through that noise by having one clear authoritative message from the central bank. Otherwise, politically, you’re at a huge disadvantage.
Rana: That cuts across any institution in terms of leadership styles. It’s important at a time when institutions are under attack and people don’t believe in them. The Fed has become one of the least trusted institutions in America, in recent polls.
“We live in a time of the revolt against experts, and experts need to figure out how they can contribute and be listened to, because they do know things.”
Sebastian: Right, which does show that you need a leader who understands that problem and is political enough to try to fix it. When Greenspan was advising Richard Nixon in the ’67-68 campaign, he signed on to be the economist, rapidly became the spin-doctor, the messaging guru, the polling analyst. He had this very political side to him. The George HW Bush White House would go around saying, “Alan Greenspan, a bit creepy. He’s 65 years old, lives all by himself, calls his mother every day. Doesn’t this remind you of Alfred Hitchcock’s movie Psycho?” There was a whispering campaign against Greenspan, which was pretty ugly, and yet he turned that around. By the Clinton administration, nobody ever attacked the Fed anymore because if you attacked Alan Greenspan, he would attack you back.
That’s what we need to remember today. Technocrats have been discredited. We live in a time of the revolt against experts, and experts need to figure out how they can contribute and be listened to, because they do know things. Perhaps you have a different perspective.
Rana: I take your point. I was just thinking, though, that you can’t argue that the experts themselves don’t have their cognitive pitfalls. That’s something that I covered a lot in my book.
My opening anecdote, actually, was that I was in a meeting with a former Treasury official who had been pretty involved in the bailouts, talking about banking regulation. Only about 50% of Dodd-Frank had been written, and there was a big debate about whether the financial lobby had been too powerful in terms of getting loopholes put into the rules. We started talking about the goalpost a little, which was to stop some of the riskier trading practices, and one of the financial beat reporters asked the official if he felt they had gotten through what they needed to protect the system, and he said, “Oh, yes. We definitely got that done.”
I had just done a piece looking at how 93% of all the consultation meetings around the crafting of these rules had been taken with the top three banks and their CEOs. I asked him, “How could you say that when the people who are going to be regulated are 93% of the voices in the room?” And he looked at me, truly with complete bafflement, and said, “Well, who else should we have been talking to?” That blew me away. I thought, “Wow. If you’re going to build a bridge, you definitely want a few civic engineers in the room, but you also want some people who are going to be using the bridge.”
Particularly at the Treasury, there has been a tremendous amount of cognitive capture around a certain way of dealing with the financial sector. People really missed things, and so I think that questioning the experts is a good thing. That brings me to one of the fascinating things in your book that I know we disagree on—you talk about Greenspan and that he was pushed, after the financial crisis, into admitting this flaw in his thinking. You felt it had been a mistake for him to admit that.
Sebastian: I think it was a mistake in the sense that it allows people to believe that the reason we had a financial crisis was that Alan Greenspan had a flaw in his worldview. If it were that simple, we could just kick out those guys with the bad ideas, reform our understanding of regulation, and then be safer. I fear that the root problems in financial instability go way deeper, and we’re not going to fix it through saying, “Well, we’ll change the worldview.”
Greenspan understood a lot more about financial instability than people realized. He’d written about bubbles and the need to fight them going back to the ’50s. He was steeped in the experience of living through crises. He understood that markets overshoot. He understood that financiers do not always avoid taking excess risk, and he knew that things could blow up, and they did, on his watch, a lot before 2008. So it wasn’t simply that he didn’t understand this stuff could go wrong. He did understand, but he didn’t act. He was the man who knew, but he was not the man who acted. The reason he didn’t act is basically political.
The root cause of what we get wrong in regulating finance: the guys from Goldman Sachs have too much influence on the Treasury. These political issues prevent us from regulating finance more effectively. It’s the vulcanization of agencies in Washington. SEC, CFTC, FDIC, Controller of the Currency, the Fed, the Treasury, the state insurance regulators. There’s just too many Inspector Clouseau cops chasing around and bumping into each other. In that sense, I’ve got nothing against people admitting that they make mistakes. That’s humanizing. I do have something against admitting mistakes which aren’t the real mistakes, because then you just confuse the debate.
Rana: It’s a sharp point. I do have a lot of sympathy for Greenspan, and I admire the fact that he was at least able to say, “Yeah, I got this wrong.” Maybe there should have been more teasing out whether it was ideological or moral. But there’s so much of a mythology out there, which Greenspan was part of crafting, about the omniscient central banker and the idea that central bankers can fix and control everything. It seems to me that we are at the end of a 40-year cycle of easy money, of debt fueled finance, and of loose central bank monetary policy that allowed this false mythology to build up around central bankers being able to control everything. They may not be able to in the future.