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  • Professor Robert Shiller: I wanted to talk

  • today about investment banking, which is a subject of some

  • interest around here. First, I thought I

  • would--there's been so much news;

  • I want to just briefly comment about what's going on in the

  • world today with our financial crisis.

  • Notably, I think that this is the--it could be the biggest

  • financial crisis since The Great Depression and as evidence of

  • that, we're seeing a lot of talk

  • about what changes should be made.

  • I think it reminds me of the very basic fact that we live in

  • a financial world that was created in the wake of The Great

  • Depression. So many of our financial

  • institutions were created in the 1930s because that was a time

  • when everything was being shaken up and it was a time when people

  • were willing to consider something really different.

  • If you just look back where various of our

  • institutions--when they were created--it's most likely to be

  • in the 1930s. We are not yet at such a

  • crossroads. The financial situation is not

  • as bad as it was in the 1930s, but it's getting bad and as a

  • result we're starting to see proposals for big change.

  • Notably, on Monday, the Treasury Department,

  • under Secretary Henry Paulson, announced a proposal for

  • fundamental change in our financial markets.

  • This proposal, if implemented,

  • might be the biggest change since The Great Depression.

  • However, the news is calling it dead on arrival;

  • it's unlikely that the Paulson proposal will be implemented

  • partly because it's being proposed by a Republican

  • administration--well, not just Republican,

  • just an administration that's coming to an end and we're

  • having an election. This Paulson proposal probably

  • has very little chance of being implemented as is,

  • but it's put in to change the discussion and it's going to be

  • talked about a lot and I suppose it will influence what happens.

  • The interesting thing is that the next President of the United

  • States will likely have a mandate for big changes.

  • Maybe it's just as well that Fabozzi, et al.

  • are slow to do a second edition of their book because if they

  • got it out this year it would be a bad year to get it out because

  • everything is changing. I studied the Paulson proposal

  • carefully, since I'm writing a New York Times column about it,

  • which will appear Sunday. Reading the various

  • commentaries about the proposal, I had the impression that not

  • many of them are very--thinking very deeply about it.

  • They typically--they like to talk about the politics of it

  • and this thing, that it's dead on arrival or

  • it's--someone said it's an amateurish proposal.

  • All the groups that stand to win or lose from it are all

  • figuring out what it does to them and they're taking the

  • positions out of self-interest. So, I wanted to write something

  • that was more perspicacious, if I could manage that.

  • The interesting thing is, actually everyone calls it the

  • Paulson proposal, but it was apparently mostly

  • written by a young man who is in his early thirties.

  • You may not consider that young, but I think that is

  • young. He could have taken this course

  • from me ten yearsactually,

  • he didn't go to Yale. I looked it up;

  • he went to American University, both undergraduate and--his

  • name is David Nason--undergraduate and then he

  • got a law degree at American University.

  • Then he just went to work for the government.

  • As far as I know, he doesn't publish;

  • he's not in the newspapers, but he's gotten the ear of the

  • Treasury Secretary. They spent many weekends

  • together figuring out what should be done about the system

  • and they wrote up a proposal. I like many aspects of it;

  • actually, it's an interesting proposal.

  • It's not so much what's in the proposal as it is that this is

  • the time for reconsideration. One interesting thing that they

  • proposed is that we should have what they call "objectives based

  • regulation."

  • We have--this is David Nason and Henry Paulson,

  • although it's not signed by them, it's signed by The

  • Treasury. So, The Treasuryit's

  • called a blueprint, a blueprint for reform of our

  • financial regulation.

  • It's built around what they call "objectives based

  • regulation." That means that the different

  • regulators should each have their own objective,

  • so they have a three-part proposal.

  • The market stability regulator, which would make sure that the

  • markets don't freeze up on us--we don't have a systemic

  • crisis. There would be a prudential

  • financial regulator and then, three, there would be a

  • business conduct regulator, so that's the main part of the

  • proposal. What they're doing is

  • emphasizing the different objectives of regulators.

  • The market stability is going to be the Fed,

  • but it's not just banking. They want it to be--the Fed's

  • role would be broadened so that it's not just a banking

  • regulator, it's the whole financial system.

  • It's supposed to be maintaining the stability of the system.

  • Then the prudential financial regulator is supposed to

  • regulate--it's supposed to aim at protecting the U.S.

  • interest in various institutions that are guaranteed

  • by the government, such as banks that are

  • federally-insured or enterprises that have government guarantees

  • or apparent government guarantees,

  • like Fannie Mae and Freddie Mac. Then the business conduct

  • regulator is supposed to regulate--what I saw is it would

  • be aimed at--consumer protection;

  • that it would make sure that businesses are protecting

  • individuals. I find this interesting because

  • it calls to mind some of the problems we had with the

  • subprime crisis. One very important problem was,

  • in the U.S. we have regulation divided up

  • in crazy archaic ways. Different agencies were formed

  • at different times and they have specific missions.

  • For example, we have the Office of the

  • Comptroller of the Currency. The OCC was founded in 1863 to

  • supervise national banks but it only supervises national banks.

  • Well, why not state chartered banks or why not credit unions

  • or other things? Well, it's just an accident of

  • history. So, what these people are

  • proposing is that we merge various agencies so that--define

  • new agencies of the government that are separated by these

  • different objectives; so, an objective defines an

  • agency--a regulatory agency.

  • What they want to do is merge the OCC and the OTS merger;

  • that's one of the proposals. I wonder why they don't carry

  • it further, but that's the thing they emphasized.

  • The OCC is Office of the Comptroller of the

  • Currency--regulates national banks.

  • The OTS is the Office of Thrift Supervision;

  • it regulates savings banks. So, we put the two

  • together--that sounds sensible, I guess.

  • Why are they separate? Various other things that they

  • talked about had that form. They want to merge the

  • Securities and Exchange Commission and the Commodity

  • Futures Trading Commission. The Securities and Exchange

  • Commission is the principal government regulator for

  • securities. They make sure that everything

  • is on the level and working right.

  • They help prevent fraud, misrepresentation,

  • manipulation of information in stocks and bonds.

  • The CFTC is the Commodity Futures Trading Commission and

  • it regulates our futures markets.

  • There has been, over the years,

  • a lot of turf battles between the SEC and the CFTC because

  • it's sometimes unclear whether something is a security or a

  • futures. For example,

  • when they started trading stock index futures,

  • both these agencies thought it was in their turf because it

  • involved both stock indexes and futures.

  • Anyway, Paulson is proposing merging these.

  • That makes sense and it seems like getting rid of some of this

  • division of regulatory agencies is very beneficial.

  • The division is what hampered regulators from dealing with the

  • financial subprime crisis. People knew that a lot of bad

  • loans were being made or loans were being made to people who

  • shouldn't be getting them. Low-income people were being

  • given adjustable rate mortgages with very low starter rates,

  • called "teaser rates," that would be raised in the future.

  • They were given them with--in such a way that after the rates

  • were raised, they likely couldn't afford to pay the

  • mortgage anymore or they'd be under great stress in trying to

  • do so. So, a family that bought a

  • house--a low-income family buys a house they can barely afford

  • it, then the rates go up on them.

  • The parents would have to take out second jobs to try

  • to--they're just going to go bankrupt when that happens.

  • It was, in some cases, unethical and it was plainly a

  • problem and yet the regulatory agencies in the U.S.

  • weren't stopping it. Another reason why the

  • regulatory agencies weren't stopping these problems was

  • because they often saw their mission in different terms.

  • When I gave a talk at the OCC in 2005, I was asking them

  • about, why aren't you policing these mortgages?

  • Their first answer was, well you have to remember we

  • were set up in Abe Lincoln's day to manage the national

  • banks--that's our mission. I may be overstating their

  • answer, but I got that flavor from them.

  • You want us to go out and protect consumers,

  • well of course that's a nice mission, but that's not our

  • mandate.

  • I think that what Paulson and Nason want to do is to create a

  • separate business conduct agency that is aimed at consumer

  • protection. So, it would be working

  • parallel with these other agencies to--but their job would

  • be to represent the consumer and that sounds like a good idea to

  • me. The thing I stressed in my

  • column was the market stability regulator, which is the Fed.

  • What they want to do is expand the actions of the Fed,

  • so that they're not--you can describe the Federal Reserve or

  • any central bank, traditionally,

  • as a banker's bank. Remember, I told you the story

  • of how the first--the Bank of England was the first central

  • bank and it made banks keep deposits at the Bank of England.

  • In other words, the banks were like customers

  • of the Bank of England; they had to keep deposits there

  • and the Bank of England watched them to make sure that they were

  • behaving responsibly and had authority over them because it

  • had market power. Well, the Fed is like that now,

  • but what Paulson and Nason wanted to do is make it more

  • than a banker's bank. They want it to be a bank for

  • the whole financial system. That's what's already happening.

  • In fact, it's just happening rapidly as we speak.

  • I mean, in this last month, things have changed.

  • The Fed has never given loans to anyone other then a

  • depository institution that is a bank until last month,

  • except they did so in the Depression.

  • There was this long gap in the 1930s;

  • the Fed was making loans to private companies that were not

  • banks and then they stopped doing that, until last month.

  • They created the--I mentioned it last time,

  • the Term Securities Lending Facility and the Primary Dealers

  • Credit Facility, which are lending outside the

  • banking system. What Paulson wants to do is

  • make that official that the Fed is no longer just a central

  • bank; it's a market stability

  • regulator. This is going to be very

  • controversial, but I think it's a good thing

  • to raise. In my opinion,

  • this is the trend anyway and I think we're going that way.

  • The problem is that in a modern financial economy,

  • we have so much instability, which is already built into the

  • system, that we rely on something like a central bank to

  • do things that help stabilize markets.

  • I think that we're probably going that way anyway and I

  • think that in the next presidential administration

  • we'll see an expansion of the role of the Fed.

  • I wish the Fed had behaved better in the recent crisis in

  • the sense--they didn't seem to recognize the bubbles that we

  • had in the stock market in the '90s and the housing in the

  • 2000s. If they are our market

  • stability regulator, you'd hope that they could do a

  • better job. But, they're what we have and I

  • think that we should probably give them the authority to do

  • that job and I think that's what we need to do.

  • I was generally positive about their Treasury proposal.

  • Another thing that they want to do, which has been talked about

  • for some time. Yes?

  • Student: [Inaudible] Professor Robert

  • Shiller: Yeah. He asked, why do the news media

  • think that the crisis is already over?

  • Secondly, why do they think we can prevent--that's

  • paraphrasing. I don't know if the news media

  • are concluding anything, but you do see--we have

  • seen---over recent years, we've seen a lot of suggestions

  • that the turning point is just around the corner and the news

  • media report that. I think there's a bias towards

  • optimism among business economists or among business

  • people in general. It's not considered good form