The U.S. Economy ... What's Ahead
A Talk by L. William "Bill" Seidman at the Gerald R. Ford Presidential Library
April 22, 2009
A video of the program will play as well.
One of the great privileges of my life was to serve Gerald Ford. I had an office in the West Wing during his term as President; I was with him as Vice President. One thing that has always bothered me is that everyone celebrates his ability to “heal” the nation after Watergate. The fact of the matter was that he had one of the most active and serious economic problems during his administration that we had had since the Great Depression. It was something that is at the same level as we have today.
I won’t go through all that but I want to give you a couple of instances why I so admired him. He knew government. He knew how to run the machinery and he knew how to make decisions. As I watch presidents since then, if there is one thing that we have seen, it is that some presidents really have great difficulty arriving at decisions that are well thought out and good for the Republic. Ford, as you know, had been a Republican congressman for 25 years and he really understood the fact that when you were making a decision that affected 300 million people in a $12 trillion economy, it wasn’t like running Goldman Sachs. That’s something our last Secretary of the Treasury never found out, which is an entirely different kind of a ball game. Let me illustrate: when Ford had major economic problem as he did, he wanted to hear every point of view. We had meetings three times a week in which people argued for various types of action that ought to be taken. After one meeting he told me, “Don’t invite that guy back again. He didn’t say anything. I want people who advocate.”
As I’ve watched presidencies since then if there’s one thing that every president ought to have is a way to make decisions after full information. One of the things you can say if you look at the presidency of George W. Bush was that he had a very narrow group that advised him. As a result of that he made some very narrow decisions. His people were the same way. The one thing you could say about Gerald Ford was that he loved to have people disagree with him. I defy you to find anybody else in politics who really enjoys that. He just happened to have learned from being a congressman for 25 years that you need to have an information base, and that it’s very difficult in a huge, diverse country.
Let me illustrate this with when a recession came along. The question was “What should the President do about the recession?” Ford’s two top economic advisers were Alan Greenspan and Bill Simon and--- I don’t want to call them right wing--- but they were way over on the right, conservative Republicans who were devastated by the fact that the government was running, what is it---a $60 billion deficit---not enough today to even bother to look at the numbers. They both took the strong view that Ford could not cut taxes. He could not start new programs. If he would just tell people to take life as it came there would be an upswing based on the natural resiliency of the economy in the United States.
He finally said to me, “I’m getting all this information that’s the same.” I said, “I‘d like to introduce you to some other people who don’t agree with our friends.” So we had in some of the leading economists in the country. They made their presentations. Simon and Greenspan were there and violently objected. But Ford was really one of the first Republicans who cut taxes as a way to try to increase economic activity. That program, in this case, proved to be a remarkable success. At the end of his 2 1/2 years, the economy was heading toward a balanced budget, unemployment had gone down from 9% to under 6%, inflation had gone from 12% to under 6% and every vital sign was going in the right direction.
Now I will show my partisanship--- within two years after his successor President Carter got in office, all of those lines turned around and were going the other way. Inflation was going up. Unemployment was going up. Gerald Ford was far more than a healing president; he was really a president who could handle the situation because he knew government.
I’ll give you just one more illustration. As you know, he vetoed over 50 spending bills---more than any president had ever done in the past Every time he vetoed a bill, some group that thought they were getting a lot of money ended up not getting so much money. I remember talking to him about it. “Aren’t you concerned? You’re alienating everybody in the United States. You’ve vetoed a bill for almost anybody who gets anything from the government.”
He said, “No, that’s not really the way it works. Our government works on the basis of ‘all politics is local’ for the Congress, for the Senate. But there’s one person who has to protect all the citizens and that’s the President of the United States. So when I veto a bill, whoever sponsored that bill probably knows he got too much money, probably knows that really if he could represent the Republic as a whole instead of his constituency, he wouldn’t have gotten so much money. I’m taking the heat for him now so that after the veto he can vote on a lower amount and we can move toward a balanced budget.” The fact of the matter was that those 50 vetoes, as far as anybody can tell, were not an important factor in his losing the election.
How did we get in the financial and economic mess that we’re in today? People may argue a little about what I’m going to say, but there’s no one who won’t argue that we’re in major financial distress and that if we’re not in a recession, we’re in a depression. In my long history, the only time I’ve ever seen an economy like this was in the Great Depression. The optimistic note is that I’m here tonight, so you can live through it.
I’d like to pinpoint for you people, with names and dates, and decisions that were taken that put us where we are today. I think it is quite easy to see decisions that were made by people, who may have made them in the most altruistic way and believed that they were doing right, but when you put them all together, we ended up in the worst economic crisis we’ve had since the Great Depression. I think when you try to classify them you’ll see that they are in two classes.
One is lifting the standards, or reducing the standards by which lenders made loans. Lenders have a lot of rules. You all probably have borrowed and know that if you don’t meet the standards, you don’t get the loans. That was eroded and it almost came to the point that “Here, we’ll give you the money. We don’t care about the standards.” The second thing was that regulation of the financial system, which was supposed to provide a way for the system to work within rules that would protect free enterprise in the system that we had, was badly, or totally ignored. So we had the combination of bad regulation and erosion of standards. Together, they put us where we are today.
Let me say one word about regulation. I was part of the deregulatory movement which came out of the Ford presidency. We clearly had a lot of regulation that hurt the operation of the free enterprise system. Regulation, if it’s done right, is supposed to enhance the competition in a free enterprise system. It’s not supposed to be there in order to tell people they can’t do anything because it’s not socially acceptable. It’s to be there so that we will have a system that works in the private sector. I started out not long ago to write a book. It was entitled “The Free Market Needs an “H” of a Lot of Government in Order to Succeed.”
I often compare it to the difference between a prize fight and a barroom brawl. If you have a prize fight, you’re trying to promote a fight. You have rules. You have to stay in the ring. You can’t pick up the stool. You have to listen to the referee. You try to enhance the competition. In a barroom brawl, there are no rules, and of course in the end, it busts up everything around it, and usually the least socially productive person wins.
Let’s get back to how this all applies to what happened to us. First, let’s talk about the standards problem. As you know, this all developed out of subprime home loans to people who were not credit worthy under the old standards. That was pretty much made acceptable because one of the biggest banks, Hong Kong Shanghai Bank, bought one of the commercial secondary lenders who made, if you will, subprime loans. But that was never considered to be a major interest of the major financial firms because those borrowers did not meet the standards.
Once Hong Kong Shanghai Bank bought that and started to promote that, subprime loans became acceptable. The first thing that happened was that an avalanche of them came to Fannie and Freddie. They securitize more than half of all the home loans in the U.S. Without them, no one can succeed in that business. They are by far the most important factor in home lending. The subprime loans came up to them. Their staff recommended against securitizing them, that is putting them together and giving them a government guarantee. The staff said they don’t have appropriate down payments, the record of the borrower is not sufficiently strong, and therefore, we do not believe that we should be in that business. The head of Fannie then was a fellow named Mudd (there’s a little Dicksonian-type thing going on here). Mr. Mudd [Frank Mudd]--who was not a financial guy--his father was a TV broadcaster for public broadcasting [Roger Mudd] and he’d been over on the PR side--he was a rather new chairman. He said, “This is going to put more people into homes. This is exactly what we’re in business to do.” He convinced his board to override the staff and Fannie and Freddie began to put their name on these subprime loans. That was kind of like number one in the change of the standards in the United States.
Next came the rating agencies, who rate these loans generally in packages called securitizations. The rating agencies faced the same problem. Their rules said we cannot rate anything for which we do not have an experience record to provide us with a basis for rating. They had never rated subprime loans. There hadn’t really been a big market of subprime housing. They faced the question “Shall we rate these--change our rules and rate them even though we don’t have a history upon which to do so?” They testified before the Congress, and this time the leader was Mr. Raiter (so you can see how the names worked out). Mr. Raiter and his group decided that despite their historical tradition, they would go ahead and rate these loans because “that’s where the business was.” And that’s what they said.
So we had the agency that was the biggest guarantor of loans and the rating agencies both changing their standards at a time when obviously, the credit worthiness was going down. Both of these things obviously enhanced the availability of money. Availability of money meant that housing prices were going to go up. That was part of the whole deal—people said “We don’t have to worry about raising the standards because the prices are going up.” We had a housing bubble in this country-I’m sure you are all aware of that. You may not be aware of the fact that out of the 20 top nations, we were actually 14th down the line. There were 13 countries that had faster rising prices than we had. While you can blame certain things on Fannie and Freddie, and so forth, you can’t blame it all on them. What you can blame is what we were doing the other guys did, only they did it better than we did. The net result was an enhanced housing bubble all over the world.
Now let’s look at the other side for a minute---regulation. Most of these loans that were being put together from subprime borrowers took some selling. They were not for people who were used to getting credit. The mortgage brokers went out to find those people and sold them those homes and often said “I know you can’t pay what this loan requires but by the time you have to pay, the housing price will go up so much that you’ll be okay.” They put that together. You’d think that some regulator should have said “You can’t do that, that’s illegal.” Why didn’t that happen? It didn’t happen because the Congress had given the Federal Reserve the power to regulate mortgage brokers.
The Federal Reserve, under Alan Greenspan--who I’ve known for years, and was a great central banker but a lousy regulator--said “I’m not going to regulate these mortgage brokers because they’re operating in a sophisticated market. The market will arrive at the fair prices, so they don’t need any regulation.” He went before the Congress. I remember the Chairman of the House Banking Committee saying “We gave you the power to do this, why aren’t you doing it?” He gave the answer “Because they don’t need it.” So that was one of the places where regulation fell down.
Another place that regulation fell down was in investment banking. The major disasters we’ve had have very much been tied up with the big investment banks, Bear Stearns, Lehmann, Merrill Lynch, and so forth. How do they get to put us further into this kind of a perfect storm, if you will, of things coming together? The five biggest of that group---Goldman Sachs, Morgan Stanley and the other ones I’ve mentioned-- went before the SEC and said “We want to change the capital standards in our industry to what, if you’re in banking, is called Basel II. What it really means is that “we want to set the capital standards based on the experience we’ve had in the last ten years. Since we’ve had a great ten years we aren’t going to need so much capital, because you can see from that that we are protected with much less capital.”
At the time they did that the SEC had a flat rule--that you couldn’t have more than 15-1 leverage—that is, you couldn’t borrow more than $15 for every $1 you had in capital. When they went to new standards, they took that off. Within two years the average in the industry was somewhere in the range of $30-$40 borrowed for each $1 of capital---obviously, increasing the risk by a huge amount. Bear Stearns and Lehmann, but mainly Bear, began to buy these securitizations of subprime loans because they were making a lot of money on them, and the more they owned, the more leverage they had, the more money they made, the bigger their bonus was, etc. In order to grow that fast, they had to get the money. The way they raised the money was by putting these mortgages up in overnight financing. Of their total financing, somewhere between $15-20 billion was overnight financing. In other words, if someone said “no” in the evening, you were out of business in the morning. And that’s exactly what happened in the way Bear Stearns finally went down.
So we had both deregulatory issues and erosion of standards, and together they gave us the problems that we have today. When that starts to happen, credit markets show what credit really is. Credit comes from the word “credo,” and “credo” means trust. If there ain’t no credo, there ain’t no credit, because nobody trusts anybody. They may not trust anybody, not because they think they’re crooked, but they simply don’t know because the market place has become so eroded by these standards and by everything, that it’s very hard to know where anybody is. So, we finally hit the day when the banks suddenly said after these investment banks were busted, “We’re not going to lend any more money until we find out where we are. We know we’ve got big losses because we loaned on these things, and now they’re not going to be worth as much.” So, they just quit lending--absolutely and utterly--quit lending. There was a good, old-fashioned panic. Panic is when reason leaves and emotions take over.
All of our hard-nosed financial guys became panic stricken about what was going on in the system, particularly the banks because the banks are regulated. They have to have a certain amount of capital in order to spur a certain amount of loans. If they have losses on those loans, it reduces their capital. Therefore, they either have to get more capital, or shrink how big they are. Given that people would not make loans, they began to look at what they had in their inventory that they had already made loans on and they saw they would have a lot of losses. In banking, if your capital goes down, the regulators put you out of business. We have what they call “prompt corrective action,” which says that if your capital goes down, to let’s say 1%, the regulator, by law, has to come in and close you down. So that’s the situation in which we found ourselves and the same thing was happening all over the world. In fact, in the U.K. they adopted this Basel II, this kind of a look-back for ten years, for all of their banks. As a result, all of their banks had about half as much capital as we had in the United States, and they were all broken in the first two months. They have, almost all of them except one, in effect been taken over by the government. So, it’s not a pretty scene.
This was happening right at the end of the Bush administration. The Bush administration had Secretary Paulson, former head of Goldman Sachs, as the quarterback to get us out of the problem we were in. Here’s where things get hard to believe, at least for me. I mean, Secretary Paulson and his group--without consulting a wide group and certainly not consulting any of the people who had already been through it---of which I was the chairman back in the S&L days---decided that what they had to do was to go into the banks and buy out all these bad assets, and therefore the bank wouldn’t go bust because the bad assets would be off their balance sheet and be replaced by cash. So they announced that. They told the Congress that “if you don’t pass this, the world is coming to an end, and I don’t want to be here when it does, so I’m leaving.”
The net result was that the Congress passed a $700 billion rescue package designed to buy these toxic assets, as they called them. I wrote a piece for the Wall Street Journal and I said “I don’t think these people really understand. They’re not going to be able to do what they say they will because the banks are not going to sell these assets at market value, because if they do, it will reduce their capital, and they will be taken over. The buyers, if they pay a much higher price, are going to take a tremendous loss.” I was in Japan for six years when they had exactly the same problem In fact, I was hired by the Japanese government to try to get somebody selling and somebody buying. Despite having one of the most capable financial people in the world, I got nowhere. It was not possible to bridge that gap. So there are a lot of people who said “You’re not going to get anywhere this way.”
So Mr. Paulson went to a meeting of the Group of 20. It started on Friday and got over on Sunday. By Monday, he came back and said “We have a whole new plan. It’s going to be like the Europeans’. We’re going to put money in the banks so that they will be able to loan because they’ve gotten new money.” He called in the eight or nine biggest banks and said “We’re putting money into all of you in exchange for preferred stock. We don’t care if you need it or not, or if you want it or not, it’s your patriotic duty to take the money.” The only other place I’ve ever seen anything like that is Japan---where face is everything and in their thing, they said every bank…. [inaudible].
So, we suddenly had a brand new program called the TARP Program, which was not the reason the Congress appropriated the money, and was designed to make the big banks have more money so they could make more loans. But, of course, the big banks were not eager to make loans, because even with this money, it wasn’t real capital and it didn’t really keep them from going broke. And, besides which, by this time we’re in a recession where good loans are much harder to find. In any event, they studied what they did and they decided, “Well, you can’t do this just for the 8 biggest banks, you have to do it for all the banks in the country—5,000 banks.” So, they decided “Okay but we’re only going to put money in good banks which will make loans.” Well, pretty soon they decided those aren’t the banks that need the money; it’s the ones that are in trouble that need the money. So they reversed 180 degrees and went the other way. If you came from Mars and looked at this, you would have thought it was a situation comedy or something. It really is hard to believe. That’s where we are now.
Let me talk about the second part of that. As I said, first there was panic. The system was frozen up. So the Fed did things that they have never done before in history: they began to loan money to support the system wherever it was needed—for commercial paper between banks, between them and the FDIC. They guaranteed practically [everything] in the financial system with federally-guaranteed funding from the Federal Reserve or the FDIC. And that’s where we are today, incidentally. Most every financial transaction of size is guaranteed by one or the other.
Let me just point out that Goldman Sachs is saying “We ought to get out of the government. We’ve got to pay back our TARP money and everything---$14 billion,” but they‘ve got $20 billion borrowed from the FDIC, with an FDIC guarantee. So they don’t want to get out that bad. The law that covers compensation they say covers the TARP but doesn’t cover the FDIC guarantees. This is really hard to believe. That’s about where we are today.
We’re now going to have a new program which essentially is going to get these toxic assets out of the banks by subsidizing the buyers so they can pay a higher price, and the bank will be willing to sell. Now who are the buyers? All these guys who put us where we are today. What we’re doing is saying “If you will come in and form a partnership with us, we will give you a loan of six times what you put in. If the enterprise goes bad, you have no liability. If it goes well, you get half of the profits. With that, you ought to be able to bid a higher price, and therefore you can take these assets out of the system.”
The FDIC has been commissioned to organize these auctions—to get the buyers, and so forth. To get the assets out of the banks, the banks have to agree that whatever price at which they auction, they’re going to get a price that doesn’t break them. So the first thing the banks say is “We want a reserve price. We can’t sell below this.” The next thing is the buyers have to decide whether the subsidy of all this leverage will help them pay a high enough price to get the buyer and seller together. Now it is really strange, but leverage, as I’ve said, was one of the real things that got us into this mess. Now we’re creating leverage, government guaranteed, in order that the private sector participants, mainly hedge funds and so forth, will be able to buy some of these toxic assets. Even then, we don’t know if it will work or not. They haven’t held an auction yet. That’s where we are.
The Fed has similar kinds of systems to buy securitizations, which are in the frozen market because nobody knows what they’re worth. They may have 10,000 of these subprime mortgages, and who knows what they are worth? So, the Fed has set up a system where they are going to lend the money to the private sector to buy those mortgages. The Fed has set up another system so that the banks can borrow anything they want in order to support their operations. If you are a banker today and you don’t have any bad debts, you are guaranteed to make a ton of money, because you can borrow money for practically nothing from the Fed and then loan it to people at market rates.
So where do we go from here? That’s a good question. The New York Times called me yesterday and they said they’d like me to do an op-ed piece on where we are and where are we going? I said, “Well, what would you like to hear?” In any event, they said, “We want to know. What do you think? What are we going to do?” I said, “In effect what we have done is that these markets that were frozen because of panic we will open up by making them government guaranteed. So you don’t have to panic, because you know that whatever you’re buying will have a government guarantee on it. That is, in fact, the way the market is operating today, not on private sector credit but on government guarantees.”
That raises a couple of questions. What will happen when the government takes off all of these guarantees? Will we have re-established credit and trust and so forth that the system will work or, if it doesn’t, will we be right back where we started from? Nobody knows the answer to that question: What happens when you take the government guarantees off? In addition, in order to supply all this credit—and you can get a lot of different numbers, but the government has created somewhere between $9 and $13 trillion worth in guarantees and liabilities which obviously, if they have to make good on, will either break the government or require huge taxes to support.
Now none of this has anything to do with the stimulus package that you heard about—that’s over here. That’s the President’s kitty to make sure that anybody who was in his camp at the appropriate time sees some money. And it’s going to do some other things too. I don’t want to be too [inaudible] but essentially it is in addition to all the rest of the things that we just talked about. So the bottom line now is “Okay, we’ve got a system propped up by the federal government. We’ve got $700 billion of stimulus spending, which I know in a number of cases the people in the community that are getting the money don’t even know what they are going to do with it.” This opens the way for a huge potential for fraud. If you see the report of the supervisor—the internal control guy, if you will—for the banking side--he says this system is made to allow people to commit fraud. It will take a huge effort to keep people from stealing huge amounts of money.
When I ran the RTC (Resolution Trust Corporation), we had the same problem. We had all these assets we had to sell, but we did not do what they have done. We did not give a bank money unless we took it over. It’s called “closed bank” assistance. They gave “open bank” assistance. They gave money, but they took some stock back on it. The net result of all that is that because they gave open bank assistance, the government is now a partner in something like 500 banks, including all the big banks in the country. There are very few private enterprises in which people want to have the government as a partner because, as much as you may love Barney Frank, it’s not liable to have you doing what you really want to do to make money. All the things that the private sector does you have to clear with your partner. They just made this worse by saying “We’re going to convert the preferred stock to common stock,” and that means you are there because you can’t buy that out, you can’t take that out.
I’d like to end on an optimistic note. There are some things that you could say are improving. One of the things is that human nature does not allow you to be in a panic forever. Finally, you don’t have the energy to panic anymore, and you start thinking about what you might do to get out. I think we’ve moving into that stage. The banks have begun to loan more money because they’re less panicked about whether they’re going to get taken over. They’re not feeling really good about it, but they see that the government wants to keep them in business. Other businesses, some of which are not directly dependent on the financial system because they don’t borrow money, have started to show some improvement because they’re not going down as fast as they were. They’re still going down, but not going down as fast as they were. That’s good. You’ve got to be thankful for that. We all know there is a bottom in this. There is a bottom and at some point we’ll start doing better.
But what we don’t really know-- and I certainly don’t know-- is whether all the things the government has done--buying in this, putting money in that, and so forth--is helping or hurting, because we really don’t have any experience from which we can make that judgment. We know the Great Depression. FDR and the Democrats did a lot of the same kind of things. When they withdrew the money in 1936, the economy went right back down again. We don’t know if that’s going to happen here. We don’t know when they’re going to withdraw the money. We don’t know how much the Congress is going to get into trying to run the banks through the Treasury ownership. So this is an exciting time to be watching.
We have a lot of wisdom in this country. There’s no doubt we’re going to recover from this. There’s no doubt in my mind that the government is trying to help us---whether in fact they are or are not, is the question that I’ve raised. We’re going to need a lot of ingenuity and wisdom to get us where we have to go. I would say for Obama, that as far as I can tell, at least, he has a broad group to which he is listening. I only hope he’s as good as the skipper of the destroyer I was on during World War II. He was a real old Navy man. We were sitting in the wardroom one day after a major suicide plane attack. The chief signalman came in and said, “Captain, I have a message for you.” The Captain said, “Read it.” The chief said, “Well, it’s for you sir.” He said, “Read it.” “From Naval Commander to Captain [inaudible]. “Your seamanship today [was] the worst I’ve seen in 20 years at sea.” All of us young officers looked at him and the Captain said, “Very well, Chief, take that in the hole and have it decoded.” So, let us hope we have the ingenious leadership of that nature. Thank you very much.