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Thomas F. Cooley is the Richard R. West Dean and the Paganelli-Bull Professor of Economics at New York University Stern School of Business, as well as a Professor of Economics[…]

Dean of the NYU Stern School of Business, Thomas Cooley, on how to navigate an expansive, global regulatory environment.

Topic: Thomas Cooley on Problems and Solutions in an Era of Big Government

Cooley:  I’m Thomas Cooley.  I’m the Dean of the Stern School of Business at New York University.  I’m also a professor of economics.

Question: What is the greatest lesson of the financial crisis?

Cooley:    How you think about responding to a crisis once you’re in it.  So the… the issue is once you’re in a crisis, how do you… how do you fix the system, how do you deal with a crisis without simply creating the seeds of the next crisis.  And that requires a little more thoughtful approach than I think we’ve seen in response to the financial crisis over the past year and a half.  One of the things that we argue is that some of the things they’ve done have just sown the seeds of further problems.  One example, just to take one example, is the large scale intervention of the Fed and the treasury in trying to [prop] up institutions that they deemed to be too big to fail.  And that just postpones a problem, it doesn’t solve the problem.

Question: So the government is making the economy worse?

Cooley:    As soon as you say that an institution is too big to fail, then that’s a promise to not let it fail.  That’s insurance.  And they should be required to pay for that insurance.  Otherwise, there’s an incentive, actually, to be thought of as being too big to fail or too interconnected to fail.  Another example would be the Federal Deposit Insurance Corporation, that’s really… it has always been a fine institution in that.  It provides deposit insurance.  It eliminates uncertainty about whether or not [deposit] in commercial banks will get their money back.  And it does that by charging the banks for the insurance so the people who create the risk pay for the risk.  But when that changes, when you shift that risk to the public, which is something that I believe has been happening more recently with the FDIC, then you’re saying, well… you know, we’re not going to charge the institutions that create this risk.  For creating it, we’re going to shift that cost to the public.  And that just sows the seeds of more problems further on. 

Question: How will the financial sector shake out?

Cooley:    As we acknowledge that some of these institutions are too big to fail and create too much systemic risk by their size and interconnectedness, then they’re going to be more heavily regulated.  And overtime, as they… as they get more heavily regulated, you know, my analogy is they’ll be like the utility companies were in the 1960s and ‘70s, the AT&Ts of the 1960s.  Once that… As that pressure grows to regulate them more, they will find in their interest to break off parts of their business.  So I actually think we’ll see an evolution towards many more medium-size firms and firms that are focused in particular areas.  I think the… sort of the viability of the financial supermarket model is probably in question. 

Question: How would you change the U.S. tax code?

Cooley:    We’re looking at potentially, really staggering increases in tax rates.  And if you look at a person who lives and works in New York, who are looking at higher city taxes, higher state taxes… Many state governments have dug themselves into the big fiscal holes.  And then, clearly, people earning over… what in New York might seem like a fairly modest salary are going to be facing higher federal taxes as well.  So the tax burden on Americans is going to increase enormously in response to this crisis.  And… You know, I think there’re… That one of the things we have to face up to is how we deal with the problems that that’s going to create because that’s going to have… dealing with that is going to have a dampening effect on our economic future.  One of the… One of the biggest problems facing state in local governments are their pension obligations.  And we’re going to face much higher taxes because of that.  So we haven’t begun to… we haven’t even begun to talk about those issues publicly maybe because they’re too scary to talk about.  The good thing about flat tax is… And I don’t… I don’t sort of necessarily endorse the simplest version of flat tax.  But I do think that the… the good thing about flat taxes is that they tax consumption and not investment behavior.  And that’s the part of it that one would like to preserve.  I certainly agree that the tax system should be progressive in some way, but a flat tax can be progressive in the right way.  And, I think that one of the problems with the existing tax code is it’s so complicated and it taxes a lot of the wrong things.

Question: What are the best avenues for stimulus dollars?

Cooley:    I think the size of the stimulus package is so huge it’s hard to… it’s hard to think about how you use it most efficiently.  But my perspective as an economists says that the things that we now pay off really well in the long run are investments in education, investments in science and technology education, investments in research that lead to longer term benefits that can pay off.  There’s actually a lot of research on the effects of early childhood education.  That educating children in their pre-school years, particularly children who are at risk, is enormously helpful.  That children can succeed in school unless their brains develop at an early age.  And early childhood education has the potential to address that.  So those are the kinds of things that at least have the possibility to pay benefits over the long-term that can be realized by the future generations.  You’re going to have to pay the enormous bill for this stimulus package.