Financial Innovation: A Risky Business?



people thought they had a way to hide rich but a pet risk along to make disappear every difficult risk management decision you take being subject to second-guessing there is a risk of a significant chilling effect there are a lot of people who are going to be on my board who are going to say we got it we got to shoot for the moon because there is no alternative darkness is someplace where you can make money sellers can't commit fraud but buyers have to take the responsibility in the financial markets but they are the pensioners there are the people who are supposed to receive these pensions that they're not going to receive too big to fail is too big you Bruce Greenwald ed Connor congratulations you both run magnificently successful hedge funds they're so successful in fact that you're in the market for new talent and you're both going to interview the same two people at your firm Chris Smith and Patricia Jones now both Chris and Pat work together at Hamilton Bloom Bank it's one of our most venerated financial institutions a combination between one of our oldest commercial banks and an investment bank they have the same qualifications same experience same background with one difference the way they answered when you asked why do you want to leave Hamilton Bloom Chris said look I just can't stand working at a place where I don't feel good about the way we treat our clients you know just a couple of weeks ago we did a deal where we sold some securities to some small community banks they took these dogs off our hands they paid us fees for the privilege and a couple of weeks later the famous newspaper the Gotham Gazette published a piece explaining that the bankers felt ripped off Chris tells you I just can't live like that anymore Pat gave a different answer Pat said I became a banker because I'm a capitalist I believe in markets and working at a bank like Hamilton bloom today you can't do anything without somebody having a criticism of it just to give you an example a couple of weeks ago we did a deal with some small community banks it ended up in some big spread in the Gotham Gazette and the bottom line of the story was get this the banks wanted to buy stuff we wanted to sell I can't work at a place where every time I make a decision like that it'll be criticized Bruce who are we hiring today Chris DeRose the guy who says he doesn't want to do this anymore it's not a decent thing to do I'll tell you what my immediate honest reaction is how stupid is this character how did he not know what he was getting into I guess if I had the higher one it would be the woman because I think she's got an issue which is probably an issue that worries me at least slightly less which is that when big money is at stake in these firms the competition is relentless and the competition is relentless even beyond the point where there's no material benefit to any of this money I mean these people make absurd amounts of money but it has to do with their standing in this world all right and somebody who sort of can't live with that degree of competition I think is in the wrong business but at least she's not out in out stupid about what she got into okay so Bruce is again stupidity I think you do have to ask some more questions of both of them because I think you're raising a point underneath which is very similar in law which is you have to have prosecutors and you have to have defense attorneys and they have to compete vigorously to get to the truth and so you can't have a system where the sellers are responsible for the buyers sellers can't commit fraud but buyers have to take the responsibility in the financial markets financial markets have to work under the assumption that buyers are highly knowledgeable that they're taking responsibility for themselves and that they are competing as vigorously as the sellers and to confuse those two roles is to suggest that a defense attorney somehow he's gonna adjudicate who he's gonna represent vigorously or she is gonna represent vigorously or not oh and I'm not saying that the banks are guilty they would would you would you feel that way about the spoiled food no because I think you're committing fraud in that case I think that you have to reveal what it is that you're selling you can't be intentionally withholding the fact that the food is spoiled okay but if you said how about buying spoiled food and the buyer said yep I'd like to buy spoiled food I don't think he said well there were ways of describing spoiled food that don't sound so bad and and I would hold some of that and I would agree with you in the case of retail buyers and naive buyers but when you're talking about hedge funds and sovereign wealth funds and other banks and European banks at some point you have to say I don't know how to define what competence is the problem is that the the line is enjoyed between unsophisticated individuals and sophisticated entities there were cities I mean we've had this serious problem with cities being sold this stuff so yeah if you're dealing with sophisticated people okay part of the question was that these were small community banks where they weren't very sophisticated I guess I make two points I think that regulation has to try to draw the line between what is sophisticated and what is not we all agree that retail buyers are not sophisticated but they're way off on the end of the spectrum so when you get into the grade zone it's gonna get very complicated about how to decide that it's also the case that a small community bank or a small town should hire an advisor or they shouldn't be buying the product like with you the argument here is if it's not the business of the people there to worry about fairness then that's an argument for strong regulation I want to take us back to our question you know who's it gonna be Chris or Pat I think I have to take somebody who in this case because the hedge funds a buyer that somebody is really gonna be aggressive and representing their side of the trade so you're gonna take Pat this Chris fellow is out of work nobody wants to hire somebody who's concerned about the implications of what they're selling Gary Gensler you agree well if I was running a hedge fund I'd hire Pat but I think just on Ed's point I think there's something called information asymmetries about a doubt and that the large banks have information that they don't necessarily want to share because darkness is someplace where you can make money and that small community bank might not have that information I'd hire them for the committee you hire hope I know you Chris for our committee to work for your committee let's get back to our world we've got folks who want to leave a bank like Hamilton bloom and want to go to a hedge fund Andrew Sorkin is that a fluke or is there a broader trend oh I think there's a lot of people that don't want to work in Big Bang the Big Bang Wall Street world anymore in part because they don't want to be in the newspapers they don't want to deal with the regulations they don't want to deal with Barney and Gary and all of these issues and they're trying to find a way to still be part of this profession and but to do it frankly with without the lights on them and and that increasingly is in the hedge fund world and that's increasingly in the private equity world Wilson urban is that right is that a real problem that is a real problem I was actually walking outside with a trader senior trader the other day and he says I'm at home my wife is saying I'm reading all these stories about traders going to hedge funds should we be moving to a hedge fund there's this vocal role are you gonna be able to trade anymore that's your job you're gonna have a job in a couple years alive masters you're almost jumping out of your chair yes on the off chance that I worked at Hamilton bloom I'd probably want to dispose of both of these people so I would I would call I would call both of these hedge managed fund managers and give glowing recommendation to the people but it more seriously I think we're missing one interesting point here which is that the things that hedge funds do and the things that banks do aren't and cannot necessarily be the same things the act of working with issuers structuring bonds committing the capital to underwrite them and then distribute them to investors in this case banks if something requires a certain amount of capital and scale that is necessary in the economic system and which banks typically have and so the issue here is how do we motivate people to continue to want to work in this industry providing that valuable service to the economy the person that opts out because they can't take being criticized in an environment where they have made mistakes and where there are lessons that can be corrected for the future is someone I wouldn't want to have working for me because they should have a stronger backbone than that and they should learn how to describe what it is that they do well and how it adds value and if they do that then they won't find the misunderstanding quite so painful and that's the person who doesn't understand what he's selling he certainly shouldn't be selling it is it a bad thing that a bank like Hamilton Bloom is a little less sexy a little less profitable a little less appealing place to work Barney Frank oh no not at all from the public policy standpoint who cares is one of the things that was attracting people there was a degree of compensation far beyond what they could earn in other equally if not more socially useful functions so to the extent that there's a an adjustment of compensation or other reasons I think that even could be healthy for the society Bruce yeah well let's talk about what ed and I do at our hedge fund we invest money in public securities in that business there is an absolute constraint which is the average performance of all investors has to be the average performance of all securities so if we admire above average which we've been for a long time somebody sitting at this table has got to be below average what we do is a zero-sum game only in Lake Wobegon can all the portfolio managers outperform the market what's that got to do with the question about whether I should be upset of people leaving the talent I'm glad you're doing well but I don't understand how that affects so how much of the talent in this economy do you want to funnel towards an enterprise that is extremely individually rewarding and has no net social product as a matter of arithmetic it tell me is it a bad thing if we make big banks like Hamilton Bloom a little less appealing yes I think it's a very bad thing I think that the banks are critical institutions in our economy in our society and we need the very best people to run them so you think it's a bad thing we take a Hamilton bloom and make them and we leave things to do is to become experts which is what they are in that credit default risk and they have a liquidity risk as well and they have to be on both sides of that trade because if we distort the markets and have them only on one side of the trade long only we know that that's a very bad place to be yes banks are very important so a lot of other institutions in this country and the question is if there is some reduction in the relative appeal of banks v2b others that doesn't mean they go to mediocrity got good news your hedge fund not only has a couple of new employees they're thinking of hiring they've got a potential new client it's the city of may burg you guys know maybre it gets a beautiful Midwestern city but they've got a problem the problem is that the city owes pension obligations to its employees that it can't possibly meet in fact even if city workers renegotiate the pensions even if new workers get less generous benefits it just seems like maybe expansion obligations are insurmountable unless they can manage their pension funds and do a little better on returns than they could do with an ordinary old portfolio so the folks in mayor you've been thinking of investing in a hedge fund one in particular called Beechmont now Beechmont you'll remember it's a high-flying famous hedge fund it's macroeconomic strategy has allowed it to have superior returns for the last five years Caroline would you play for me please just for a moment a member of the the may burg pension fund board Bruce what should she do I'll give you an honest answer because I was director of research for a bigger organization we do not want her as a client people who are unsophisticated investors who stretch for extra returns thinking there's not going to be extra risk associated with it are heading for trouble not only that once they start to live that dream they are unsteady money and that's the last thing we want if we're gonna deal with their problems we have to have a reasonable long term strategy and people in this situation are not who we want to deal with David Abrams do you agree I I think it depends I mean McBroom is right that you have to be sophisticated about it you don't want to people who try to chase returns and say we're not getting X we want we want X plus y you may or may not achieve that and you may end up at X minus y that said it's not something that should be completely disregarded so I think they should try to set up get an advisor that might help them to think about how they invest who has some experience in this especially by the way if you're these risky securities that could be being sold by someone who doesn't mind taking advantage of a relatively naive buyer like our employees from before Caroline you're new to the pension fund board you're just trying to figure this stuff out what are your reactions I think if you're not in a position to make those decisions because you're not sophisticated financially there's a fiduciary responsibility to get the information before you make the decision and if I didn't feel comfortable with the kind of investments I would either hire someone or not make them right but you face a pension shortfall and you have a chance to catch up if you double down exactly if you invest in this kind of aggressive approach are you ready to do it let's see Bernie Madoff no I don't think so I don't think that should be the right I don't think that should be the reason in other words I'm behind and so I want to catch up Andrews doing it why here's the problem this is the ultimate too big to fail problem I have to shoot for the moon because otherwise I lose and so I'm gonna lose anyway right you just you told you just told me that no matter what I can't I can't make my obligation unless I do this so either I'm going bankrupt or I'm not the only thing I would say there is that just because you go bankrupt doesn't mean you're going to zero you know you might have you may get going I would like to hire a financial advisor though to help me make this decision and I don't want them to be Commission based I wanted to pay it pay a flat fee okay but Ed you made an important point that I want to draw out a little further Andrew said look I'm gonna lose either way so maybe I should make the bet now Ed's answer is you don't always lose and go to zero necessarily personally on a very human level I probably wouldn't make the investment because I do recognize exactly what he's saying which is you probably aren't going to zero but I think there are a lot of people who are gonna be on my board who are gonna say we got it we got to shoot for the moon because there is no alternative we're looking at this whole thing from the point of view of poor old Carolyn who has to make this decision but there are the pensioners there are the people who are supposed to receive these pensions that they're not going to receive entirely and the question to ask is is a good idea to impose more risk on them to give them the choice of an even smaller pension than they would get or maybe looking out yeah can I speak to this we know a lot about the psychology of people in general and the psychology of people in your situation and somebody's gonna come to you and I'm gonna say you know really Carolyn these guys Conor dan Greenwald they're just they're drunk with success they don't like to deal with small people like you there are opportunities out there in new and emerging companies that you're gonna get on board and we're gonna make you whole they are very sophisticated about your psychology they know that people don't like to think carefully about unpleasant situations where losses are coming and they know that you are prone in your heart of hearts not to understand that there's fundamental uncertainty so we've got these hedge funds it's a well-known high-flying investment strategy many professional investors on Wall Street have used them for years to generate returns we've got these pensioners who have a problem nobody here they hedge funds can help look there are people who we think consistently will outperform but it can't be everybody the average performance of everybody has to be the average the people who consistently outperform understand the limitations of the amount of resources they can do that with they're not going to want to have to do that under the kind of pressure that Carolyn is putting on us all right the people who are going to say yes are going to be the people who understand Carolyn's psychology who have an incentive structure where if they do well they get a ton of money and if they do badly Caroline's Carolyn's workers suffer and are probably going to underperform okay okay despite all these concerns Carolyn and her colleagues on the board decide they need as much bang for the buck as they can get and like Andrew Sorkin they decide to go with Beach bomb I think it's it's cards swinging for the fences they're going to swing for the fences we'll see how that works out in just a minute but in the meantime let's talk a little bit more about Mae burg because you know even if they solve their pension problem like a lot of other American cities they've got other issues to face they've got bridges to build and roads to repair and they're doing this at a time when budgets are extremely tight and getting tighter but fortunately it turns out that there's a new financial innovation that can help cities like Mae burg raise this money maybe generate some savings and the good news is that a bunch of investment bankers at a firm called Atlas and Newsome where Alicia Glen is a partner have been working on a brand new proposal for the city of Mae burg that's going to help them deal with a problem in their schools and at the same time save them some money Alicia tell us what have you and your colleagues been working on we think that there may be a way for us to provide you with some capital to help you maybe cut back some of the things that are costing you extreme amounts of money in the school system like special education or other types of programs that are very for you to run if we can't then come to an agreement with you that if you save money by virtue of having finance these program where you would share the savings with us over the long runs to pay back our loan it could be a real win-win you can finance the project now pay for more teachers etc for that in the long run your children will perform better they won't need as much services and you'll be able to save money and that will help us repay our loan and you'll also save money ok let Linda Gibbs let's have you play a member of the City Council let's suppose there's a program that for sure the City Council wants to do and it's gonna help reduce special education costs and Linda's not sure she's got the money make your pitch Linda if you can show me that over the past five or six years that if you add three teachers to every preschool program and that then you can show me that other result of those preschool teachers being in the classroom 50% more kids get to go into the general education stream and that phase view ten thousand dollars per child then you should want us to help you finance those three extra teachers right now cuz you're gonna realize $10,000 the kid savings over the long run and even if you pay me 50 percent of that $10,000 to pay me back it's a win-win for you let's do business so we should talk and I the the big there's a bunch of really important questions I think it's how cashable are the savings and so yes it's going to hypothetically save some money but can you actually extract those dollars from the system how tied up are they may be those teachers in special ed can't be fired and then how long before you can actually extract the dollars and so if it's something that you can show me that the the savings can happen next year and I can repay you and I can limit your profit to a short amount of time rather than decades of time and I can actually see the savings in in a realistic time frame then maybe we have something to talk about Bob Solow any problem with having an investment bank help a city deal with a problem like this no there's no problem there's no problem if we know exactly what they're doing this looks to me like a case where what finance is all about not edge funds but here's someone who has a productive idea a way of improving education and and all it's needed is or one of the things that's needed some capital when you provide capital for a price that's fine I don't I don't see any fundamental problem there as long as both parties to this transaction know what they're doing and are being honest with each other Barney Frank any problem with this kind of setup yeah there's no free lunch I am very skeptical that the way to improve the revenue stream for good public policy is anything other than taxation and then being efficient and not wasting money that doesn't mean there will never be good but the we have had a lot of bad experiences with people getting in over their heads not fully understanding the risk part of the problem you have is simply the incentive structures are very different the expected time in office for the people making the decision is a lot shorter than the duration of the obligation and you have the temptation of people to do something that have some short-term short-term gains and the problems that may arise come in my part of the deal is that the taxpayers don't have any risk I think you're asking I think you're asking for too much this is a situation in which perhaps the the shape of the timestream of gains is very different from the shape of the timestream of course and what's being proposed here is the way you have to lay out some costs before you get the benefits it's very hard to do that with taxation that's what well I would be very skeptical in the first place we have this you talk about asymmetries of information you have had very bad results for out of the communities who don't have the sophistication if it is properly regulated and there are rules in place against abuse then it might happen Linda Gibbs you're on the City Council what do you think bottom line for me of the deal is that I only have to pay out of taxpayer dollars if this thing that Alicia has brought to us is actually work the problem with this is not the risk for the town here because ultimately if they fail to deliver the savings you don't get repaid so you're taking the risk the real problem with the structure is that it's not scalable to solve the kinds of quantum of problems that cities across this country are facing this is a very nice idea but it isn't going to be large enough to solve these problems in a wholesale fashion it's very unclear where high quality savings opportunities can come from if it was that obvious the cities would have been doing it already but there are real situations like this if you look for example yeah if you look at like heating infrastructure energy savings things there are trillions of dollars of investments that need to be made all across the country that are very very difficult to finance right now we can unlock huge savings from that there are actual free lunches there you may need to hedge some of that with derivatives to make sure you lock it in that can right graze also some interesting issues with municipalities but there are real investments like that that need to be made that right now are very hard to make well I think that's a point it's not a panacea for all of municipal finance problems and it's not in lieu of thinking about correct tax policy it is a waiver they're going to do thoughtful that incremental and good programs in a long-term budgetary it is a toolkit heating may be one of the unique ones where there are some real savings from heating but in a lot of the other stuff in education they are not revenue based I'm all for trying to do some of these things but you can't get away from the fact that in the end those buns have got to be paid off for tax revenue my problem is that all my revenues are tied up in all of the systems that are high cost and producing suboptimal income or outcomes and what what I need is I've got this great idea really creative idea that can produce a better outcome but I don't have any free money to do it and so what I need is a resource in order to get that going once it gets going then the dollars can be freed up to pay for it so got somebody to link okay Barney but if you got something to that money on the grounds that you're going to change the school sister in a way that's going to save you money later on good luck to him and if you get the money run with it I'm convinced that I have a way to get a program off the ground that's going to make improvements in the lives of children and I've got a risk-free investment that I only have to repay if I see savings to my budget so why not I'd like to go back to our friends at the beach Mont hedge fund remember we started tonight with our friends Chris and Pat the two traders who were looking for work and it turns out that Pat after leaving Hamilton Blum Bank has moved on to beach Mont and before she got to beach Monde she took a month a vacation she went to Hong Kong she was gonna have some fun but you know Pat's idea of fun is paying attention to local currency markets when she got to Hong Kong she noticed something her old bosses at Hamilton Bloom had put on a big bet on Asian currency so big that Pat took notice and he told her new bosses let's bet against them let's get opposite this big Asian currency bet and make a little money David Abrams any problem with Beechmont taking the position betting against one of the country's most venerable financial institutions no problem whatsoever as long as it's either public information or not because she was recently employed at Hamilton Blum was it Pat can bet in the currency markets as long as she follows whatever rules are in the Hong Kong currency markets oh think the bit the bigger issue is if what's the purpose of the bank's position by taking this bed I mean if they're just gambling it strikes me as inappropriate for the bank that I mean another party what's the difference it sounds like folks are comfortable with the hedge fund making this bet we'll see in a little bit how this bet turns out but in the meantime the folks at Hamilton Bloom they're starting to think a little bit about the incentives of their traders you know the incentives that might have led the traders to take a big position in asian asian currency in the first place they're starting to wonder what are we rewarding here and how are we rewarding it advice Hamilton Bloom Bank how should they be paying these employees number of things you do not want to have direct drive if you pay a guy purely on direct drive without oversight without any qualitative judgments on the aspects of his or her work they will game you and so you have to worry about your agents behavior and even inside a bank tell me what is direct drive direct drive is if a trader gets paid X percent of what they make right there I think in old-school Wall Street they used to happen a lot I think in new-school Wall Street people realize that was a stupid model that can get you in all kinds of trouble when you're paying these people you need to understand what kind of risk they're taking you need to make sure there's the right controls are on them and I do think deferral is a good idea so that if you pay them a lot of money and you found out that in spite of those controls they were doing something against the firm's interest you can get some of that back so you give them some skin in the game like masters do you agree I agree with the described framework that that was just talked about I think that if we go back five years that's not the way things looked at all and that things have changed very dramatically over over recent years so do they need to change further I would say that it remains to be seen there are requirements today to delay defer compensation there are requirements for clawbacks as described that are typically triggered by subsequent events there's a significant stock or stock option component of compensation which aligns the incentive of the individual employees with that of the institution and that shareholders through time all of those things have changed it Conor do you agree yes but I think Blythe says something very important at the beginning which is critical she doesn't know today whether what she has in place is gonna work in the future and the same thing was true five years ago there's a major x-factor there about where the next problem will arise and why it will arise there okay black so it sounds like Ed's impressed with your advice so were the folks at Hamilton blue and they're going to to pay plan like the one that you suggested but there's one person that Hamilton Bloom was not so happy about it me I'm their top trader I produced a hundred million dollars in profit a year every year for the last six or seven years I understand you want to pay me overtime but I've got a hedge fund who's willing to hire me today and they're not going to make me wait five years for my compensation invest they're not gonna make me defer they're not gonna make me take stock convince me to stay at Hamilton bloom nope well that raises a question doesn't it because why would talented folks stay in a bank like Hamilton bloom if you don't have an argument for keeping them there on the pay plan you just described well let's take a step back here sounds like you're a proprietary trader anyone that's making a hundred million dollars a year purely out of the basis of the genius of the content of his brain and beating markets consistently like that that's essentially proprietary trading that activity is essentially rendered illegal under the new regulatory framework that Hamilton Bloom is operating under for a start now if you're making well-set now now if you're making the hundred million dollars by virtue of serving Hamilton Bloom's clients using Hamilton blooms capital using Hamilton blooms reputation and connections global capabilities probably the hundred million dollars didn't come out of the content merely of your head and you will not be able to pick it up and translate it into an immediately analogous circumstance at a hedge fund well it sounds like you've got pretty convincing arguments I grab reasons for me to stay don't give up so soon no I sense from her very quick responsive no there's there's a cultural element where she's thinking I don't necessarily want to have somebody like that working with me you know it's gonna try to come and hold me up like that did it sound like I've had that conversation maybe once or twice could I point out that this problem would be slightly ameliorated by a decently progressive tax system that sounds like a whole other seminar yeah since everybody on the panel really okay to let this trader go if the law the Volcker role means anything it'd be hard to say that the hypothetical even exists you can you couldn't go to a hedge fund and do straight client business hedge funds don't have the network of thousands of clients that Hamilton Bloom has they would be going to the hedge fund to do effectively proprietary trading which I think like rightly said was banned but maybe hedge funds will start building those hedge funds are getting bigger more capable technologies changing the landscape so if you have a differential world where banks can only have more restrictions and can pay less for the best pitchers and best hitters than the guys at hedge funds you will be pushing activity to the shadows some activity will proprietary I think that's right I think banks which are very good and will continue to be in credit in your mediation and duration intermediate and market making and so forth will continue but I think the hedge funds Jenner generally are not really in that core business the folks at Hamilton Bloom very grateful for your advice on compensation and they're gonna need some more help because we just discovered how that big bet on Asian currencies turned out Hamilton blooms gonna take a five billion dollar loss it's gonna blow a hole in their balance sheet the stock price is going to crater the press are all over them and naturally Congress is going to hold a hearing now that might not sound too surprising giving the events of the last few years but let's back up and think just a little more basic principles no businesses make mistakes big businesses sometimes make big mistakes and restaura can tell me you think of some examples where a significant business has made a big investment for example in an Internet company or in some other area and just made a mistake and it turned out to be worthless AOL bought Time Warner dropped 80 percent donlore Christ Dom Lobot Chrysler for 37 billion dollars sold it couple years later for seven billion dollars Quaker Oats before they were bought by Pepsi bought Snapple for a billion seven sold it 27 months later for 300 million dollars and those are just a few examples now I think a person on the street might say you know I don't understand the difference between all the examples Andrew just gave us and the loss of Hamilton Bloom why is it that when those things happen life goes on but when Hamilton bloom makes a mistake we have a hearing Bob Solow what is it about banks banks of our institutions that lend and lending effects what happens in the economy as a whole and when a bank goes down a whole bunch of transactions are in trouble it can't be contained within the stockholders of the bank if a manufacturing company makes a bad bet the stockholders lose if bank makes a bad bet of a large part of the commercial infrastructure a big bank may may be in trouble and we we allow that to happen Bob don't you I mean if a manufacturer goes down communities suppliers vendors are also hit shouldn't we also have that big banks there's a freedom to fail in this country and whether you're Time Warner or make a bad bet on AOL or Quaker Oats on Snapple or a back shouldn't there be a freedom yes there should be a freedom to fail but the thing to do is to arrange the banking so that the failure of even what's whatsits is a large institution is not doesn't damage the system yeah I agree with that I agree with that is that right Gary is that what makes banks special I think to some extent sovereigns for centuries have backed banks partly because of their sheer size within their economies and partly because what Bob said they're so interconnected but I think it leads to some bad outcomes because when there's not a true freedom to fail then the credit Arrangements the lending to those institutions are different rates they're subsidized in essence incentives to the bank the law now says that the law now says very clearly that the institution's canfell what the distinction we make is this the consequences of the failure can in the case of a large financial institution be greater there's more spread there's more connectivity and therefore what we say now is that the role of the government is to deal with the consequences of the failure but only after the failure I mean I people don't maybe fully understand this the Federal Reserve intervene to keep AIG going the statute under which they did that has been abolished the Federal Reserve could not now do that for AIG that that section is gone as to large other any institution the secretary the Treasury is prohibited by law from providing any funds for the institution's debts as long as it exists once the institution is out of business then there is a provision of provision whereby you try to minimize the consequences with funds ultimately recovered mother institutions the reason why banks are different is because they're the the institution that takes overnight deposits and short term money and lends it out long term and that is an inherently risky endeavor which is critical to our economy and we can leave that money sitting in the bank unused and we can have a smaller economy slower growing with high unemployment well we can take that money as a matter of policy and put it back to work and if we do that we need regulations in the banking district that are very different than what's going on at Quaker Oats Peter stream does the public understand that no it's very interesting that we had a brief mention of the pension who were actually behind what might happen in one transaction but that's really where all this stuff comes back from that's where it ladders back from I remember at one point having a discussion with our CEO where he said oh but you're talking about consumers I'm more interested in what the regulator thinks well the regulator politicians are consumers or voters so I I would think that's one of the first things that I would want to look at if I was if I was trying to advise on how to approach this is there is there is no question in the last few years we talked about the issues that have developed what the way that is played out in the minds of the average person is this enormous hit on trust banks have been devastated that the trust in banks is less than half of what it was before this all started and there are three things that we see that my head of research tells me that we can do to change that they're not necessarily the three things you think I mean one of them is customer centricity you know we can be nicer we can pay more attention to our customers we can phone our institutional clients more often all that sort of thing one of them is all the wonderful CSR activities that you see everybody out there doing it turns out that witness Arpita tell us what CSR a corporate social responsibility you know we're going to contribute to the community we're going to help children we're going to do whatever interestingly interesting those things went down as a result of the recession in comparison to something called performance because what happened is as the Brits say it didn't do what it said on the tin you know all these people had their money in their pensions or a mortgage whatever suddenly found what they were told what they thought was the reality wasn't the reality so that's your first issue if you if you think about how you're going to you know influence the man a street or a woman on the street in in a broader sense is how are you going to convince them again that you can perform so now we understand a little bit about why we're having a congressional hearing over Hamilton blooms loss give us a little background here in 2008 after the financial crisis Congress has passed new rules that address banks like Hamilton Bloom one of them is the Volcker rule prohibitions on banks like Hamilton bloom doing what's called proprietary trading what's the definition of proprietary trading the manner in which proprietary trading in dodd-frank is addressed is by is by carving out and declaring illegal activities January that are taken in pursuit of short-term financial gains with an exception made for underwriting and or market making and an exception for risk management activities so sorry just outright bets are prohibited except correct if it's underwriting such as the issuance of a security something like this or if it's you said management of risk and I think most people think of that as hedging yes you could use that description okay let's so for me I guess what I'm wondering is do you have a good sense as to what the difference is between these three things nope and and the the problem is that whilst I think the concept of arguing that large outright proprietary bets in banks should be prohibited is a is a good simple understandable concept the challenges when you try to translate that into legislation and rules and more important than just the rules the subsequent action of regulators who are engaged in ongoing supervision under those rules it becomes much much more difficult as you try to define something like market making you're taking risk on behalf of clients what about managing that risk on a portfolio basis and once you get into this environment where you're subject to every difficult risk management decision you take being subject to second-guessing there is a risk of a significant chilling effect on Bank risk-taking activity if it goes too far that can have a problem is it that hard to tell the difference between propriety what is proprietary trading and what's not Iran risk for 10 years in our place and defining that with the bright mine is impossible can't be done can't be done I never said it would be done with a bright line these are strong men anytime you make any kind of change in regulation and many people here would have liked this to have made nine I suppose you're going to have a transitional period when there is uncertainty and it is true in the first year of this there will be uncertainty within three years there will be a great deal of certainty there are rules and precedents that are set American law often works that way I do think you will see regulators who are not bloodthirsty not seeking to penalize people there can be a period in which people were told that's not the kind of thing you can do it will not bring down on their heads penalties if you're not poor cowering galley-slaves we're going to get whipped if they miss a a stroke the notion that people will forever be living in uncertainty there's clearly not true on this issue of proprietary trading I think it's one of the hardest thing that we regulators were asked to do by Congress but it's doable it's to prohibit proprietary trading which blithe earlier said she wouldn't keep you Robert you you and the hundred million dollar trader lice that you wouldn't keep you so on some level blithe in Barney and I agree you can prohibit some proprietary trading you all agree about firing me well it's sin it seemed to be the right thing at that moment let's go back to our congressional hearing about this big loss at Hamilton bloom you're not the CEO of Hamilton bloom unless indeed let's make me the CEO of Hamilton I thought I just fired you because you are proprietary training I'm very resilient that way on the CEO of Hamilton bloom I come to you and say I've got to go in front of Congress tomorrow and I've got to explain not what the law is not what it might be what the law should be on proprietary trading lies what do I tell them I would tell them that you support the notion the proprietary trading in banks that are systemically consequential should be prohibited I would tell them that the concept that Barney just laid out of trying to preserve within that prohibition the right and the need for banks to make markets underwrite and hedge themselves is very important and I would offer up some technical suggestions as to how to improve the current wording of both the statute and the proposed rulemakings as to how you might be able to do that without losing the underlying fundamental concept ed Connor tissue right is that what I should tell Congress the law should be on prohibited proprietary sure and she's in a tough spot here sitting right next to off the regulators so yes but I would ask this question which is when a bank makes a loan it's taking proprietary credit to focus it's making a proprietary try it says hey I'm worried about the market so I'm gonna shorten up on that but I can't unwind my loan portfolio I can't necessarily sell it to somebody else so I'll go into the market and I'll take the other side of the trade on credit default swaps and a wine back my credit default risk and then I grow more optimistic about the markets and say oh I'd like to unwind that so is it proprietary trading lend a hedge is it proprietary trading when they unwind I have a hard time understanding where the blurry line is the law clearly says that you can hedge either specific or aggregate risk but it's got to be tied to a position so if those loans or positions and you tie it yeah then it's allowed under so I started with if it's if it's another desk in another city and it's got its own P&L sometimes it morphs into something other than really a hedge well the public ever understand this the other thing I should have mentioned is at the same time that trust in banks dropped trust in regulators and government dropped so I don't think the public understands this at all and I don't think they're very open to hearing about it and I kind of wonder who would you know might be something we we ask ourselves is who was supposed to explain this to be is it is it the bank when they actually you know are dealing with them one-on-one or is it the responsibility the regulator to be more clear about what we're trying to control and how this is all supposed to work this is very complicated I'm listening to it I'm loving it but I'm wondering how I would then turn around and explain that to okay Caroline this hearing just wrapped up you're gonna write an opinion piece on what we just saw what does it say okay what I'm hearing is conceptually should should proper a ders be speculating with insured deposits probably not know in reality is it easy to determine what is a prop trade and what is not know Barney has told us that there's no no red line that this is all a little bit sort of gray and we've also discussed the fact that regulators are human beings and the biggest financial crisis since the Great Depression occurred with anywhere from you know 50 to 60 regulators from the office of the controller of the currency sitting on the desks going to work with the bankers so why should we have any confidence that this is the solution to the problem okay before we get there let me ask maybe Volcker is not the answer is there another way yeah help us steel Bank Haddix hey Wayne Capital we all forget that the goal of regulation is to protect the taxpayer if the shareholder absorbs a loss that's fine so what we need to do is to create a disincentive if you will to getting big the larger the bank I don't know greater the assets the more capital you have to hold you know the the incentives here are misaligned I reread a article that Michael Lewis had written a while back called the end talked about the end of private partnerships you know once it's other people's money you introduce whole new problems and I'm just not convinced that the 2,000 page dodd-frank is going to prevent the next financial crisis Barney well firstly I know why people give but no it's not 2,000 pages it's about 800 pages you talk about legislative pages a lot of limestone secondly when you ask about when you ask about the public by though I tell you this the debate in the public is not between the Volcker Rule and totally unrestricted one of these we what I saw as a major problem in the system was that people thought they had a way to hide risk go to pass risk of longer to make much disappear one of the things I am most proud of is it a crime that you can't secure ties alone without some risk retention that you can't make loans that you don't care if they're ever repaid cause you're gonna you're not going to get them paid back I think that's very important derivatives that had been unregulated yeah those things are very important so is it the answer no I don't know ever that there's been a problem to which there was the answer and I think it's kind of a sell you guys need to be honest with you there's never the answer anything I think we have substantially diminished it and in a major way what we've tried to do is to identify with so that's the constant theme of this bill and I'm sorry it was too long for you and you can wait for the movie version if you I think Andy and the engines both will give ania that the fact is that it is a series of ways of trying to keep people from making risky decisions for which they are not accountable and having other people back them up okay okay the debate among the public is not whether you have a vocal or no vocal it's whether you have the vocal or glass-steagall people in the financial community understand that the number of people who are for any totally unrestricted proprietary trading they may be right but they're not very numerous something I'm hearing from almost everybody is that really the fundamental problem we have with a bank like Hamilton Bloom is that it's so big so interconnected that if it makes a mistake it's inevitable that it's going to send shockwaves throughout the economy David Abrams for me that raises just a basic question which is if we really find ourselves in a situation where we have a bank that's so big that it can create that kind of a problem why don't we just not let them get so big in the first place well we should do that I agree with that I think we should we should we should not too big to fail is too big so you'd break them up yes Andrew Sorkin a very mixed views on this there's part of me that thinks you should break them up and make them smaller and that that will solve the problem but then I look and think about what happened during the financial crisis to some of the smaller institutions and what was the way that we saved those smaller institutions we saved them by merging them with the bigger institutions this is one of those times where I really can tell when I say I have mixed emotions about this I really do have mixed emotions about this I don't know what the right answer is I think about the larger competitive landscape globally and I think to myself we don't have a global regulator and therefore Deutsche Bank and the banks in China are gonna be three and four and five times the size of JP Morgan what does that mean both competitively but also for the risks broadly to the system so there's part of me that says size as a problem and if you told me that I could chop down every single bank in the world and make them all small I actually probably I'd do that but other if that option is not on the table it becomes much more complicated Bob Solow well I don't think there's much evidence that there are real economies of scale real economies of scale at these very large sizes so there would be no harm in making them fail society would lose nothing in the way of the efficiency of the financial system you can't believe that the very law very largest banks were somewhat small or considerably smaller that we wouldn't be able to finance real economic activity efficiently so I don't think I don't think that that cutting down the size of banks will solve all the problems but I don't think that there would be great social cost and everybody agree with that can I ask who it is that people want to have cut down the size of the banks I mean is it something you want the regulator's to do with the government and for those who think the banks should be cut down when do we do it some less like yeah it wasn't a good time with that thing how do we do it and what's the right size I never had an answer those questions don't kid yourself that smaller banks would have solve the financial crisis a 30% drop in real estate will lead to a withdraw of short-term deposits from our banking system whether it's consolidated or small there is a provision in the dodd-frank bill that says no bank can be larger than 10% that was enshrined in the statement for the bright line lovers it's not of these but I have a question for Eddie do you think of Lord I think we have to hold banks 100% responsible for their loan losses because if we don't do it they will make unproductive loans and our economy will not grow but if we hold them responsible for withdraws as we are with this issue of too big to fail we will hold a lot of money sitting idle and we know this from 800 years of financial history it's the corn economy you can eat the corn plant the corn or hoard the corn in the silo and we learned long ago that we got to get the corn out of the silo and if we hold banks responsible for withdraws they will hold a lot of corn in the silo when they do that we will grow more slowly and we will have high unemployment we don't solves our you're saying there's only a freedom to fail but it's an asterisk the government should support a large bank and bail a large backyard so I'm in a different place than you there is no evidence that size alone does it as a matter of fact one of the most destructive banks countrywide was not a very big bank now you talk about ambiguity by the way you if you're against the ambiguity of appeal the antitrust law you ever read the Sherman Act it says you shouldn't be too big and be any competitive there's very little specificity in the Sherman Act people aren't today saying oh my god I don't know what to do there's very little specificity in the Securities Exchange Act you always start out with the broad principles but as to too big to fail the big banks being too big with the problem Canada would have sunk into the sea a long time ago because there were like five really huge banks in Canada and they haven't had the problem I think people are mad at the banks and therefore say you got to break him up in this economic climate that we've been in the last couple years to take on something so disruptive this is not a good idea I don't know who does it but I get answers to those questions I don't take it too seriously one of the things that is I think the least well understood in this country very poorly understood in the media very poorly understood frankly in the financial community is that Ola makes the big banks in this country safe to fail sorry I think you mean here or really liquidation Authority in the dodd-frank act title 2 of dodd-frank if read right and the FDIC I think has currently got the right reading of this of how to recapitalize it like a chapter 11 corporation protecting individuals protecting the the vulnerable in our society protecting the infrastructure and the interconnections that it provides a safe way to fail and it actually makes the biggest banks the easiest to take care of rather than the small banks that is incredibly poorly understood in this country let's get out of these debates in Washington and get back to the people in the city of may Berg remember their pensions are being managed by a hedge fund their deposits and savings are kept at the local branch of Hamilton Bloom Bank their education is being paid for by innovations created by an investment banker and here's the question I want to try and get an answer to how do we strike the balance how do we deliver the benefits of financial innovation to people in may Berg and across the United States but protect them from the risks we know can arise from these kinds of financial products any ideas Gary Gensler you have common-sense rules of the road we don't go out on the roads at night if we don't have traffic lights and so you shine bright lights you address some of the information asymmetries information any symmetry means they've got the information we don't they'll profit off of it we won't so you try to get some of the information more broadly in society we're broadly in the markets which brings what's called market efficiency it does possibly shift from information from the banks to the rest of the economy but let me remind the listeners ninety-four percent of the jobs in America private sector jobs are in the non financial sector ninety-four percent of the other six percent the banks are only a small part of that perform a really vital function in the society but I think and we shift some information and shine the bright lights like the traffic lights and on the roads at night it helps the economy so rules of the road roles in the road and transparency Wilson I think responsibility is key if somebody else is responsible for your downside bad things are going to happen if you can get away with a short-term gain and not pay the price of the downside of your actions you're gonna have a problem where people may not behave in the best way many people behave well most people are good people but if you don't have the lights on in the room and you don't have responsibility for your own actions there's gonna be some bad actors so if you can keep if you can make big banks safe to fail that encourages better behavior if you encourage people who are advising municipalities to be responsible for their advice that gets you better behavior if traders have deferred compensation that makes them more thinking about the long term so that issue of responsibility I think is key like to build on what's already been said I think the other issues what's needed is an attempt to restore public trust and confidence which is really what we've been talking about all evening and is no small order where does trust and confidence come from well passage of time and some stability is needed of course but in addition to that we need to truly endeavor to better communicate the good about the role of the financial services sector and banks that they drive jobs homes education towns countries explain the complex about the industry we've been talking about complicated regulations and capital requirements and proprietary trading and hedging and arbitrage and punting and so on that is meaningless to 99 percent of people who hear it so we have to get rid of that jargon and you asleep explain that these are just these are just the engine parts that drive the good and then we have to acknowledge the ugly the ugly was the lack of accountability the extraordinary mistakes that were made the lack of transparency the interconnectedness that created extraordinary fear and do what we need to do to support regulation and better behavior to address those things we've been critical of Bernie tonight at times but at least 85% of what was in dodd-frank was a massive step forward so I think if we try to tackle all of those things and we don't give up we don't do what pat or chris whatever that person's name was back out of the industry and not take our responsibility to educate reform repay seriously then that's the way forward we talk too much around this table and in general about the financial system as if financial activity is beautiful for its own sake or desirable for its own sake it's not it's not i suspect that we're over financed as a society there's too much financial activity there are too many resources too much highly skilled labor too much capital too much of everything tied up in financial activity that has very little real social productivity in the sense of enlarging the production of goods and services that we all live from and if we had a little less financial activity if made it even if we made it a little less profitable like the handicapped Hamilton Bloom Bank we were talking about it wouldn't do the country wouldn't do the real economy any harm and it wouldn't make the job that that Gary was talking about of boys as well of making it clear what's going on improving transparency making some rules of the improving and scented it would make that much simpler or at least a lot simpler thank you Bob and let me just say thank you to the entire panel for what's been a fascinating discussion you you

32 Comments

  1. 123medinap said:

    I watched this years ago, and I have been astonished that my views have changed very little since then: I still agree with most of their base assertions. If you're not sophisticated in your financial decisions, no one should hold your hand when things go awry; and particularly if you have all of the information available to you to make an informed decision.

    June 16, 2019
    Reply
  2. Francis Ssemaganda said:

    I was tuned every second of it.

    June 16, 2019
    Reply
  3. kathleen smith said:

    Everyone of these people is a criminal of some sorts. Barney Frank is a political whore, and Blythe Masterson is one of the creators of the financial crisis. Sorkin is nothing but a propagandist whore that serves the financial elite by spreading their lies on tv and print.

    June 16, 2019
    Reply
  4. Alexxandro Bloch said:

    This is an interesting discussion. Its really jargony and over my head, but its worth watching for what you can take away from it. Its a real, responsible discussion about democratic economics.

    June 16, 2019
    Reply
  5. Klaus Solberg Soilen said:

    How many think these people would say the same thing if the camera was off and they were working for themselves independently? At best,this is good personal advertising

    June 16, 2019
    Reply
  6. kalidasa said:

    The speakers should regularly watch Keiser Report and try to understand how many aspects of "finance" are currently not quantified.

    June 16, 2019
    Reply
  7. Camille Kirina said:

    j'ai entendu que sa première intervention de la Blythe, , en la regardant Blythe Masters, qui est sans doute une des femmes les plus intelligentes vivante aujourd'hui, on est surpris que cette femme soit dans une bulle fermée, en disant que les Hedge Founds et les produits dérivés sont indispensable à l'économie (sachant les misères que ça engendre).. cette conf… à l'air d'être un putain de tissu de conneries et de blagounettes de Bankers cynique …

    June 16, 2019
    Reply
  8. antimondialistes said:

    belle brochette de putes

    June 16, 2019
    Reply
  9. DavidAKZ said:

    This is disgusting givien the massive debt (not capital) created by these people is now on the public balance sheet – including bonuses.
    Libor manipulation scandal may have cost cities and states millions in losses
    tinyurl . com / c4cfn2v

    June 16, 2019
    Reply
  10. mad asini said:

    D'ailleurs, y a t il une traduction ?

    June 16, 2019
    Reply
  11. lynd scott said:

    why are their body movements so exaggerated? notice the arm & hand gestures, how large their gestures are, flailing arms all over the place. exaggerated body gestures are a sure sign that the speaker is desperately trying to convince you of something, that what they are saying is a scam. BEWARE OF EXAGGERATED BODY LANGUAGE !! IT'S A SURE SIGN OF LYING.

    June 16, 2019
    Reply
  12. skirts365 said:

    Columbia University—Pilgrims Society entity, they're still hiding, so you'll want to be good boy and delete this.

    June 16, 2019
    Reply
  13. DonnyBaker45 said:

    Go tell that long tongued liar, Go and tell that midnight rider, tell the rambler the gambler the back biter, tell 'em that God's gonna cut 'em down.

    June 16, 2019
    Reply
  14. Ccleanerable said:

    La Cène.

    June 16, 2019
    Reply
  15. Roisin O Shea said:

    why you didn't you study english? too bad for you dude

    June 16, 2019
    Reply
  16. Michel06300 said:

    Oui Pierre "Mea-culpa"

    June 16, 2019
    Reply
  17. Leo Stinson said:

    Et oui je trouve ça bizarre aussi le nombre d'intervenant et le fait que Blythe soit au centre…

    June 16, 2019
    Reply
  18. Leo Stinson said:

    J'ai du mal à suivre… vivement la traduction ! Merci à Pierre Jovanovic pour l'info !

    June 16, 2019
    Reply
  19. anticonstitu1 said:

    Vous l'aurez sans doute bientot sur Jovanovic…

    June 16, 2019
    Reply
  20. anticonstitu1 said:

    C'est une étude de cas, méfiez vous de l'apparence, c'est B. Masters qui est à l'origine des CDS et CDO qui ont pourri la terre entière, et s'est arrangée pour vider toutes ses positions pour éviter que cela lui revienne. Elle est plutôt très intelligente en tout cas très avisée!

    June 16, 2019
    Reply
  21. bull ishtar said:

    (suite) Elle est à mon humble avis un des plus grand modérateur de la cupidité des spéculateurs de base. Sans ce genre de personne, le monde serait un grand panier de crabe ou un océan infesté de requin. Maintenant on attend la traduction littérale.

    June 16, 2019
    Reply
  22. bull ishtar said:

    (suite)On y apprend que ces personnes que l'on considère souvent comme des requins et des êtres froids et manipulateurs, sont avant tout les premiers défenseurs farouche de la liberté d'entreprise et de l'économie de marché. On y aborde la question des pensions de retraites des américains très fortement malmenées ces dernières années. Blythe Master, que je découvre, tiens un discours réaliste et responsable, souvent loin de l'image que l'on a tendance à lui coller à la peau.

    June 16, 2019
    Reply
  23. bull ishtar said:

    Avant que la traduction arrive: ce débat se présente sous la forme d'une étude de cas dans le cadre de la banque Hamilton Blum (crée pour l'expérience), l'animateur modérateur Robert Jackson suit la trame d'un scénario et pose à chacun des invités des questions concernant l'éthique et le métier de cette banque dans un contexte d'interpénétrabilité des acteurs sociaux et économiques dans les sphères d'une finance en passe de devenir plus responsable.

    June 16, 2019
    Reply
  24. Philippe Burne said:

    blythe seems to be in deep shiiit .. she'll probably dies in a car accident or whatever .. just like princess diana … run teh fcuk awaaayyy bllyytthe its a traaap :))

    June 16, 2019
    Reply
  25. stefcat7 said:

    Vivement que quelqu'un traduise, ce serait vraiment sympa!!!

    June 16, 2019
    Reply
  26. cyrille161161 said:

    Vu l'importance du document, quelqu'un aurait-il la gentillesse de mettre des sous titres en Français ?

    June 16, 2019
    Reply
  27. pierre jovanovic said:

    Michel06300 on voit que vous avez lu le blog !!!

    June 16, 2019
    Reply
  28. Michel06300 said:

    And look good, the scene reminds furiously "supper" or "Last Supper" by Leonardo da Vinci (Wiki link). And this is Blythe, who is the center figure of Jesus Christ surrounded by his apostles. They were 13, they are 13 here. Who betray Blythe Masters?

    June 16, 2019
    Reply
  29. Michel06300 said:

    Et regardez bien, la scène rappelle furieusement la "cène" ou "dernier repas" de Leonard de Vinci (lien Wiki). Et c'est Blythe, au centre qui fait figure de Jésus Christ, entourée de ses apôtres. Ils étaient 13, ils sont bien 13 ici. Qui trahira Blythe Masters?

    June 16, 2019
    Reply
  30. sportscarsmovies said:

    Do they know how much the entire world hates them ?

    June 16, 2019
    Reply
  31. bull ishtar said:

    Trying a world without Blythe, is like trying to find a secure swimming spot on the australian shore without a risk of a shark biting you. Stop bashing Masters, unless you'll be ready to the deal with "you ain't seen nothin' yet" everlasting chaos. Wars have an end, with chaos "This time it's different".

    June 16, 2019
    Reply
  32. SaravanaSenthil said:

    I wish former FDIC chairperson Sheila Bair was included in this discussion.

    June 16, 2019
    Reply

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