Only a Failure Will Settle the Question of What Is Too Big to Fail, Former Federal Reserve Senior VP Says
April 7, 2009
"One of the best lessons for all of us would be if we see something fail, to see if those things we are afraid of [failing] are worth being afraid of," said Jeffrey S. Kane, former senior vice president in charge of the Charlotte office of the Federal Reserve Bank of Richmond, to the audience gathered April 7th at Catawba College for the third Distinguished CEO Lecture Series.
"Until that time, you’ll have skeptics, and the continuing discussion of what is too big to fail, bank nationalization and who we lend money to," he continued. Predicting that the economic crisis which sent the country into its current recession has public policy implications, he said that the issue with "too big to fail is that we don't have any transparency into how that decision is made."
Kane, who resigned from the Federal Reserve after 31 years of service on March 1st, spoke at the event in Hedrick Little Theatre, sponsored by the Business Advisory Board for the Ralph W. Ketner School of Business. His audience was a mix of area bankers and businessmen, interested members of the public and Catawba business students, and the opinions he expressed, he said, were strictly his own.
He noted that he is now experiencing the fifth recession of his professional career, with his first occurring in 1978. "One of the major differences between then and now is the amount of media coverage being given to it."
Recessions, he joked, are alike in one regard - they cause "people to line up into two camps – the Déjà vu-ers, who say we have been through this before, and the Vuja De-ers, who say we’ve never been here." He noted that he counts himself in the Déjà Vu camp and illustrated his point by reading aloud a short written statement concerning Merrill Lynch losses due to new instruments. He asked the audience where they thought that statement came from and who wrote it. The statement, which could have come from today’s news reports, was one Kane actually wrote as part of his thesis in June of 1988.
He urged his listeners to consider the underlying processes that caused the current economic crisis. One of the processes, he said, is the "fact that we have made consumer credit a commodity in this country – and the commoditization is not only on the initiation end, but on the back end.
"It is extremely difficult for banks to operate in the environment of those small spreads. Look for legislation from Congress to address the fact that lenders were making loans and taking positions on loans that they didn’t have to hold."
But Kane explained that the nation did not arrive at its current economy due to a subprime problem alone, but also due to an overheated real estate market. "The pullback in [building/housing] starts and permits actually started in 2005 and that was a reflection of where we were in the credit cycle."
Noting why the Federal Government interceded in the current cycle, he explained: "Cycles are cycles because there’s a beginning and an end, and if you don’t end the cycle, you go back to the beginning."
Kane spoke of the moral hazards that plague the financial products market. Regarding the bonuses taken by some executives at troubled companies receiving government bailout money, he asked his audience what the lesson for those executives might be as a result of their actions. "The lesson learned is not to not do this activity again, but rather don’t take any money from the federal government."
He nodded to consumer greed as another contributor to the nation’s current economic woes. "In the real estate market, once you start to exceed five to 10% in annual appreciation, you’ll have issues and the market will revert to the five to 10% appreciation."
Kane warned of having "too many economists telling you when we’re going to get out of the crisis," but said he sees "light at the end of the tunnel in equity markets and real estate."
"Whenever you start to see the inventory of homes for sale level off and some upticks in the equity market with people willing to put their own money on the line to purchase equities" were, he said, signs of economic recovery.
A native of eastern Virginia, Kane began his banking career in 1975 as a lending officer for the Bank of Virginia in Tidewater. He joined the Federal Reserve Bank of Richmond in 1977. Prior to relocating to Charlotte he was responsible for banking supervision and regulation in the Richmond office. At the Charlotte Branch facility, his responsibilities include Fifth District cash operations and Reserve accounts and loans functions.
He earned his bachelor of arts degree in mathematics at the University of Virginia and is a graduate of the Stonier Graduate School of Banking at the University of Delaware and the Virginia Bankers School of Bank Management at the University of Virginia.
The April 7th event is the third in the Distinguished CEO Lecture Series. Prior speakers have included Bob Ingram, vice chairman pharmaceuticals, GlaxoSmithKline, and Ellen Ruff, then president of Duke Energy – Carolinas. Sponsors for the event included Gold Sponsors: Duke Energy, Ralph W. Ketner and Walker Marketing, Inc.; and Silver Sponsors: F&M Bank, Charles and Susan Muse, and Dick and Peggy Smith.
Kane Answers Audience Questions
After his lecture, Kane took questions from the audience. Some of the questions and his responses or "viewpoints" follow:
Q - Did Wachovia fail?
A - "I was not a shareholder, but if I had been I would have thought that it did."
Q – What happened to the ratings agency?
A – "We made a loan to AIG in October and the ratings agency changed their rating [of AIG] at the end of November."
Q – Why were economists not talking about this [pending economic crisis] in May and June ?
A – "It’s not a problem with the economists. With a recession, you only know six months after [the fact] looking back at things. And, a lot of people don’t like to be definitive in their position and then be wrong."
Q – Did you think there was a problem when Congress started messing with the Glass-Stegall Act [of 1933]?
A – "The Glass-Stegall Act is an arcane provision Congress enacted that separated banking and commerce. It built a wall between investment banks and commercial banks. When we enact legislation very quickly, some decisions that come out of that aren’t correct. I don’t think this was a Glass-Stegall issue. There was a regulatory downfall in all of this."
Q – What is your forecast for inflation and interest rates?
A – "It’s very easy to lend money, the difficult part is getting it back. We’re willing to take the risk on future inflation for the correction of this."
Q – What do you think of proposed regulations on hedge funds?
A – "There are a lot of black eyes in hedge funds. The issue is about the transparency into what they do."