Question: Could a crash like this happen again?
Justin Fox: Financial markets get nutty. They have bubbles, they crash. That’s part of capitalism. It’s been there from the very beginnings: since financial capitalism started. And sometimes bubbles and crashes are big economic disasters. Sometimes they’re not, and we look back at them somewhat fondly—like the dotcom bubble. It left some in infrastructure in place. It left a lot of people with skills, and startup companies in place. Definitely, there was a hangover, but it wasn’t an economic disaster. When you think about it, the real reason why is because that was not a bubble built on debt—it was a bubble built on people’s expectation and fantasies, or what this companies would be worth—but they were putting equity into it, putting cash into it [when] there was no promise that they’d get it back. And so when they didn’t get it back, they didn’t get it back.
When you build a bubble upon debt, like we did in housing, it leads to this much more difficult situation, where suddenly all these people thought they’d given money to somebody who is promising to pay them back. And suddenly, a huge percentage of those people can’t pay back because their assets weren’t worth what they paid—anywhere near what they paid—anymore and the economy is struggling. So it’s some link between debt and markets, that’s the problem. So it seems like the most important thing is going for some sort of structure that reduces leverage, especially in boom times.
Question: What foreign countries have better economic regulation than the U.S.?
Justin Fox: Well, it’s been interesting in this crisis. A lot of people have looked at both Canada and, to a large extent, India, and to a lesser extent at countries that just kept their banks from getting in too deep. It’s hard to identify whether there are some structures that made that happen, or if there just happened to be the right regulators in place at the right time. Because one of the things that’s interesting—in the US there’s a lot of talk now like, “We need to break down financial institutions, make them smaller. So it’s okay if they fail.” But you look at Canada, which has been very successful at navigating this financial crisis, there they’ve got basically four or five banks that matter. They’re all too big to fail from a Canadian perspective. And yet things worked fine.
Economically speaking, I would say the Scandinavian countries have this wonderful balance of providing a safety net, but at the same time understanding that they are competing in the global economy: you need to have a tax system and other things that are competitive. So at that level, I’d say those are great examples. In terms of financial regulation, I just don’t know. I mean, one of the things all of us funded to the US complain about is how we got a zillion different banking regulatory agencies and they are all sometimes cross-purposed and things fall between the cracks. But then, the UK has a universal regulator that is in charge of every financial system. And they’re the other country that did the worst in this crisis along with us. So I don’t see any obvious model other than people doing their job better, as they did in the few countries like Canada and India.
Question: How will banking in the U.S. change as a result of the crisis?
Justin Fox: A lot of people say that we seem to be moving in the direction of having a smaller group of even bigger banks dominating our financial system. And maybe a couple of years down the road, that will start to change, and [we’ll] decide that it’s too unwieldy to have Bank of America and Merrill Lynch, and start breaking [them] up, and that would partly solve the problem.
I think part of it has been remembering a lesson that was learned in the 30’s and since have been forgotten, which is that if you want to have a banking system that doesn’t collapse every few years, you need to have a government role in it. People have looked nostalgically back to the 19th century where there were rashes of bank failures all the time. On the flip side of that, you [had] far less finance and a much less developed financial system, and [it was] much harder to get financing to start companies to buy houses, to do whatever else. So you could have that kind of system where everybody is just used to failure every few years, but then you probably have a smaller economy [with] much less lending over all.
So I think there has been this understanding by a lot of interesting people on the conservative side. Richard Posner, the federal judge in Chicago and law professor, is the most obvious example. We realize that there’s a reason for bank regulation. There’s a reason why we have it. There’s a reason why we keep banks from taking certain risks. So I think that’s back, and people understands that’s what we’ve got to see looking forward, because what happened over the past 20 years is that banks per se were still restricted from taking risk.
Then, even before Glass Stengal was repealed in 1999, subsidiaries of bank holding companies were allowed to engage in all these really risky behaviors. And I think now there’s this understanding that, “Okay, [what] all these other people were doing is—if it involves lending, it’s basically banking, and it should probably subject to the same set of rules that we had before.” So I guess the big difference is there’s been a reaffirmation that there is a reason for banking regulation, and there has been this realization that all these things that didn’t call themselves banks actually were banks and are subject to the same risks and runs that banks were and therefore we need to think differently how to regulate them.
Recorded on: June 30, 2009