Post Mortem Financial Crisis Speech

[mlmpetert]

First off, sorry it is so long I only have it in a word document, and cant find any links to it. The first half is a pretty good recap of how this whole financial crisis happened. The second half (really third or less) is his beliefs on American ideaology. I think this is a pretty educational, easy to read, and contains some nicely put together thoughts, otherwise I wouldn’t have posted.

2009 Bank Structure Conference

Financial Regulatory Reform

Address

John A. Allison IV

Chairman of the Board

BB&T (Branch Banking & Trust Company)

It's a pleasure to have an opportunity to talk with such an outstanding group. I do wish I had something more fun to talk about than the financial crisis. Also, I know that some of you are going to disagree with what I have to say, which makes me a little apprehensive. I usually get to talk to business groups that almost always agree with what I have to say. What I'm going to do today is to try to compress what should be a thousand page book into about thirty-five minutes, so we're going to go fast. That requires we deal with essentials. This presentation, I give mostly to business groups, so in some ways it's really targeted to well-educated people that aren’t necessarily financial experts such as we have in this room.
Three basic ideas: First, government policies are the primary cause of the financial crisis. We live in a mixed economy, and the mix varies by industry. The technology industry, is about 20 per cent government and 80 per cent free. The financial industry is probably about 70 per cent government and 30 per cent free. Banking is a highly regulated, government dominated industry. It is not surprising that the biggest problems have been in a highly regulated industry.
Secondly, deflation in residential real estate is what started the economic deterioration. Problems in residential real estate created the problems in the capital markets that led to problems in the general economy.
Thirdly, there were lots of other mistakes by market participants that created a perfect storm. However, these errors are less fundamental, and I won't go into a lot of these for time reasons.
How did we get here? We substantially over built the residential real estate market. We built at least $600 billion, maybe $800 billion too much residential real estate. We built too many houses, built houses in the wrong places, built houses that are too big. We should have been investing in technology, education, manufacturing capacity, etc. We should have saved more.
How did we make this mistake? If you think about a mistake of this magnitude, it almost has to be government policy. It's just too big. The primary sources of this problem are the Federal Reserve, the FDIC, government housing policy, (specifically Freddie Mac and Fannie Mae), and the SEC. In addition, the reaction to the crisis took a normal economic correction and made it much worse than it needed to be. Government policy makers created an unnecessary panic. Unfortunately, many things which have been done that may work in the short term will have negative consequences on our long-term economic well being.
How about the Federal Reserve? In 1913, the government nationalized the monetary system. The Federal Reserve was formed to create less volatility in the economic system. However, while it creates less volatility in the short term, by trying to make the system less volatile in the short term, it creates more risk in the long term. If you look at what happened in the Great Depression, a number of Fed economists would agree that the Fed played a very important role in causing and extending the depression. The existence of the Fed has some unintended consequences and this is one reason why it creates more volatility in the long term. The Fed allows the federal government to borrow dramatically more than it could borrow if it did not own the monetary system. If we had a private monetary system, the federal government would be disciplined like a state. A state can borrow based on taxing authority but when you can print money, you can borrow a whole lot more. That's how we've gotten the excessive leverage we have in our economy.
It also has another interesting effect. Since the early 1990’s, where the Fed has been more successful reducing short-term volatility, it has created a perception of low risk. When people don't perceive risk, they save less. Savings are partially about protecting for future unexpected events. In addition, the Fed significantly mismanaged interest rates and monetary policy in the period since 2000. In the early 2000’s, interest rates were kept too low. Many people made bad investment decisions based on too low of rates. Remember there were two beliefs driving economic activity. Interest rates were low and the economic projections coming out from private economists and the Fed were that interest rates were going to stay low and the economy would continue to grow. Due to low interest rates, we made investments that we would not have made, including significant financing of real estate projects, and then interest rates were raised very rapidly. A big negative was the Fed’s creation of the inverted yield curve. This environment was a destructive combination in that we were told by the Fed that because of the new global economic environment the inverted yield curve didn't mean we were getting ready to have a recession. Bank margins were killed by the inverted yield curve, so how did financial companies make money? They took risks. Why would you take the risk? Because the economy was going to keep doing indefinitely well according to the Fed and there were no margins in the traditional banking business because the Fed had consciously inverted the yield curve. This had a very powerful psychological effect, causing financial institutions to take more risk.
The problems with the Federal Reserve are systems design issues. In my experience there are many very bright people at the Federal Reserve. But there is a systems design problem. You cannot integrate what's happening in the global economy. I don't care how good your models are or how smart you are. It's just too complex. Ludwig Von Mises identified this problem back in 1912 in a book called The Theory of Money and Credit and it's exactly the problem we face today. It's a systems design issue.
How about the FDIC? Most people think FDIC insurance is a good thing. In my experience, it creates a lack of market discipline. It's particularly hard on healthy banks. For example, in Atlanta, where we operate there are many start up community banks. We knew they were doing risky things, but what they did to finance themselves was to pay higher rates on CDs. They took our clients because the start-ups could offer FDIC insurance. Because these start-ups were taking higher risks, this encouraged the rest of us to take risks, in order to stay in business. On a bigger scale, Indy Mac, Washington Mutual, Countrywide, who have essentially failed, were also building into our market areas, opening branches, paying higher rates on deposits. The customers did not care what those companies were doing in their loan portfolios because the customer had FDIC insurance. FDIC insurance is a perverse incentive. It makes it hard to be conservative in the banking business.
Government housing policy is what I will call the proximate cause. There's been a tremendous governmental drive to raise homeownership rates above the natural market rate. The theory is that homeownership is a good thing. Well, it's a good thing if people aren't buying houses they can't afford, or where they don't have the discipline to repay the debt, or young people, who don't have savings buying houses, or people buying too big a house, etc. Tax policy has supported excess investment in housing for a long time at the expense of our global competitiveness. But what really put us over the dam was the affordable housing focus that turned into subprime. In September 1999, President Clinton announced a goal for Freddie Mac and Fannie Mae to have half of their loan portfolio in affordable housing, now subprime. At that time there was an article in the New York Times quoting several economists that said the legitimate, affordable housing market is not this big. If they achieve the affordable housing (subprime) goal in ten years, it will break Freddie Mac and Fannie Mae, and it may take down the U.S. financial system. Nine years later, it did.
Freddie Mac and Fannie Mae are government sponsored enterprises which would never exist in a free market. They were leveraged a 1000 to 1 when they went down and owed $5 trillion, that now you owe. Congratulations. The government did have to bail them out, because of the implied guarantee. Politics played a huge role in Freddie and Fannie’s activities. I was on a committee of the Financial Services Roundtable for nine years trying to do something about Freddie Mac and Fannie Mae. You could run the numbers and it was obvious they were going broke. But we couldn't do anything about it because Congress had a huge vested interest in Freddie Mac and Fannie Mae. First, they had almost a religious belief in affordable housing. And second, Freddie Mac and Fannie Mae were huge contributors to the Republican Party and the biggest contributor, I think, to the Democratic Party. So people ignored the obvious warning signs.
Freddie Mac and Fannie Mae are the primary cause of the housing crisis and are the proximate cause of the excess investment in residential real estate, and thereby, the financial crisis. You can look back and say, we were dumb to have believed residential real estate prices would go up forever. But if you look at all these government policies designed to protect housing prices, why wouldn't you have believed that house prices would continue to appreciate?
How did residential real estate become such a huge problem for the capital markets? Ultimately, house prices are driven by affordability. If you compare the peak of home prices to affordability, nationally real estate prices needed to fall 30 percent to become affordable again. That varied a lot by markets. In Southern California, home prices probably needed to fall 50 percent and in Winston-Salem, North Carolina, where I live, maybe they needed to fall 5 percent. But they needed to fall an average of about 30 percent.
The bad news, they have fallen 20 percent, so far. Since financial intermediaries finance housing, the decline in home prices destroyed, by a rough estimate, $500 billion in capital in the banking business. As you know, financial intermediaries are leveraged, and I’ve just used 10 to 1 for banks, 30 to 1 for investment banks. Five hundred billion dollars less capital in banks times 10 equals $5 trillion less liquidity,i.e. $5 trillion less lending capacity. Banks initially tried to replace that capital, and then hit a wall. I'm guessing they may have replaced a couple hundred billion dollars of capital, and we ended up with a $3 trillion liquidity/lending problem.
The losses in the banking industry started to create fear in the capital markets. Where's the bottom to real estate prices? How much more capital is going to be destroyed? Is there another hundred billion to go? That's another trillion dollars of liquidity/lending capacity. The capital markets began to tighten up. However, BB&T was in the capital markets and we were able to issue capital.
Then suddenly, the market closed for financial institutions as a result of the Washington Mutual bailout. You may remember that in the Washington Mutual bailout; the uninsured depositors were paid in full, which is not a typical practice, and which created much higher losses for the debt holders. The debt holders knew they had losses going into the Washington Mutual liquidation, but they had materially higher losses then they expected, because they thought they would be on the same status as the uninsured depositors. They weren’t as the uninsured depositors got 100% covered. The day that happened, the capital markets closed for even healthy banks.
Of course, housing was over built in other countries. And international banks invested in the U.S. housing market which is how the housing problem became an international liquidity problem.
How about Fair Value accounting? One note on fair value accounting. As presently interpreted, it's a new accounting system. It's only two years old. Accounting goes back to the Egyptians. So we went for thousands of years without fair value accounting. Anybody who defends fair value accounting has the burden of proof. They've got to prove it.
Fair Value accounting does not work when markets don't work. It violates the law of supply and demand. I'll give you a simple example. I think my house is worth $600,000. In a stressed market, somebody will only pay me $300,000 for my house. I'm not going to sell it. I don't owe anything on it. I don't have to sell. You can say, well, it's worth $300,000 to somebody else, but I'm a buyer. I own my house. And we just don't have a market price. And that's exactly what happened. We had a lot of markets where there was no market. There was not a right price. Fair value also violates the going concern theory in accounting because it requires that you assume you liquidate all your assets today, which you're not going to do.
Fair Value had a major negative impact. There were corporations like BB&T who had liquidity and could have bought assets. For example, we were looking at the bond market, and we saw a $100 million bond that should have been discounted based on cash flow to $80 million, but the bond was selling for only $50 million, because the only buyers were deep discounters. Why didn't we go buy those bonds? Why didn't we buy them for $50 million? It would have been a great economic deal. The answer is we would not take the accounting risk. Even though the bonds were economically worth $80 million, in a falling market the deep discount buyers may have been willing to pay only $40 million at the end of the next quarter, and we would have faced an accounting write down. We consciously decided not to make great economic deals because of the accounting risk and this happened in the decision making of publicly traded companies. Accounting was driving economics instead of reflecting economic reality.
There are lots of other problems related to Fair Value accounting. It doesn't consider gains. It picks random assets and liabilities. Asset values should be based on cash flow, not “fire sale” values. In 1990, I was CEO of BB&T. I went through the 1990 crisis. If we had had fair value accounting in 1990, the U.S. financial system would have collapsed. If you applied this accounting concept during the liquidity crisis at year end 2008, most businesses in the U.S. would be broke.
We do not have a private accounting system. It's interesting how many people don't realize this. We do not have a private accounting system in the United States. The SEC determines who goes on FASB. It is a government controlled accounting system. I guarantee you we would not have derived this system if we had a private accounting system. I've been in the business since 1970. The accounting system we had in 1970 was far superior to the system today in terms of reflecting cash flows. We've become very detached from cash flows trying to run fluctuations in the balance sheet through the operating statement. It makes it very hard to read financial statements. Financial statements are much harder to understand, and therefore, materially less useful than 30 years ago.
How about “pick a payment” mortgages? You buy a house, you owe $1,000 in interest a month, but you only pay $500. So each month your mortgage gets bigger, great product, right? “Pick a Payment” mortgages were made mostly in high growth markets like California, Florida, etc. The theory was that real estate was going to appreciate for perpetuity and you could refinance 5 years down the road and leverage by buying a bigger home today.
The big players in “pick a payment” were Golden West, Washington Mutual and Countrywide. They could not have funded their loan portfolios without FDIC insurance. One of the interesting questions is why did they get into that business? I'll come back to this question in a minute. By the way, BB&T decided not to offer this product for ethical, not economic considerations. We looked at the product and while, we didn't see the fall in real estate values, we did realize real estate is not going to keep appreciating 10%, 15% a year for perpetuity. We're setting up a lot of people to get in serious trouble with this type mortgage product. They’re going to owe a lot more money on their house five years from now than their house will be worth, and we did not want to do that.
We believe it is not good business in the long term to do things that are bad for our clients. Even if you can make a profit in the short term, it's not good business to help your clients get in trouble. And that's basically what we call the “trader” concept. We think we're in business to help our clients be economically successful and financially secure. We expect to make a profit doing it, but we think we have an obligation to do our best to help our clients. We believe in creating win/win relationships. By the way, a lot of people chose to get “pick a payment” mortgages from Countrywide when we turned them down.
How did government policy create the originate-and-sell model? When I got my first house, and I can see a few of you are in my age group, I went to a savings & loan, I put 20% down, and they held the mortgage in their own portfolio, and they cared a lot about the house price and the risk they were taking. The actual losses in the savings & loan industry on first home mortgages were practically zero for over 50 years.
The industry was systematically destroyed by government policy. It started with Lyndon Johnson, who wanted to finance the Vietnam War and the Great Society. To do that, the Fed moneterized huge deficits. This moneterization resulted in rapid inflation, and then the Fed had to bring inflation down and raised interest rates until the prime reached 21% in the early 1980’s. The savings & loan industry had made fixed rate mortgages for fifty years. They got caught in the squeeze. And then, they got some great advice from their regulator, the FSLIC. We bought lots of thrifts, I saw the effects of this advice. One, they were told to hedge. Well, the hedge didn't work because home mortgages don't have a prepayment penalty, so they got killed by the hedges which were forced on them by the regulators when interest rates fell. And then they were “strongly” advised to get into the commercial real estate business, which they had no expertise in and they got in serious trouble, and most of the remainder of the thrift industry failed in the early 1990s.
Freddie Mac and Fannie Mae took over the “prime” mortgage market. Freddie Mac and Fannie Mae are leveraged 1,000 to 1 and have government guarantees which gave them the lowest cost of capital. They took over the prime home mortgage business before they created the subprime market.. How do you compete with somebody who's got a government guarantee and is leveraged a thousand to one? So Freddie and Fannie drove all other financial institutions out of the prime home mortgage market.
Golden West had to find a niche and that's how they got into the “pick a payment” mortgage business, because they couldn't compete in the A-grade mortgage business, against the government.
Freddie Mac and Fannie Mae created the broker model. They did it primarily to feed their affordable housing goals. They went into business with Countrywide and Washington Mutual and many independent brokers because they couldn't reach the affordable housing goals.
The broker market went bad. When you originate mortgages and you don't hold them, you have perverse incentive because you do not care about the long term credit risk. And so initially, people started fudging, and then it became fraud. A client comes in and says, I made $70,000 last year, when he really only made $60,000. The broker says, well, didn't you actually make $80,000 and then I can get you a much better mortgage and house prices are going up forever. A subtle kind of fraud that went on in the industry. Of course, Standard & Poor’s, Moody’s, and Fitch, which are a government created oligopoly, the only people who can be in the rating business, misrated all these instruments and then investment banks piled on with a bunch of esoteric instruments and made it worse.
One of the big myths is that banks were deregulated. We were not deregulated, we were misregulated. The regulatory environment at the peak of the bubble was the worst in my career. We were just regulated on the wrong issues. The focus was on Sarbanes-Oxley and on the Patriot Act. And we were threatened to go to jail. When you’re threatened to go to jail, you act on those things. Sarsbanes-Oxley was a total redundancy. The banking system already had a Sarbanes-Oxley created around the early 1990’s thrift crisis. The industry spends about $5 billion a year on the Patriot Act. You know how many terrorists have been caught by the Patriot Act – none. You know how many are going to be caught, none. I mean, if you're foolish enough to get caught by one of our tellers, you will get caught any way. And by the way, if we happened to catch a terrorist, do you think we might call somebody, oh, there's a guy in here getting ready to set off a bomb. I think we might call somebody.
I respect mathematical modeling but the belief in mathematical modeling became very irrational. We heard it over and over from the regulators. If we just had models like Wachovia, we'd have great risk management practices. Wachovia, of course, went broke using those regulatory driven mathematical models. When the financial markets initially dislocated, the Europeans were laughing at us for the first six weeks. And then all of a sudden almost all of the European banks crashed. This sudden demise was because they used Basel which is a mathematical model for determining capital, and therefore had no capital.
There are lots of problems with mathematical models, even though they can be useful tools. People think of mathematics as being objective, but mathematical models are not objective because they cannot consider things that are not mathematical. And the biggest thing that is not mathematical is human behavior. If you can't capture human behavior, you have an interesting indicator in a mathematical model, but that's all you've got. The other problem is the assumption about the “tails.” All these models have 1% probability in the “tails”, i.e. unlikely events. It's something I tell people who build in flood plains. If you have a 1% probability of a flood, that means you are going to have a flood. It's certain. In addition, some of the “tails” in the financial mathematical models are realistically bigger than 1%.
The biggest effect of this misregulation was the huge misdirection of management energy. When people start threatening to put you in jail or close your bank down, you forget about everything else. It actually almost closes your thinking process.
At the top of the regulatory structure, today, the regulatory leaders are saying let’s make loans, make loans. At the regulatory operating level exactly the opposite is happening. And I don't know what you're telling your examiners at the operating level, but I can tell you what's happening. The actual examiners in every bank in America are making it much harder to make loans. They’re tightening the standards. We'll turn down some loans at BB&T this afternoon that we would make if the examiners weren't there. The loans we are turning down would not be 100% good, but most of them would have been good. We're not working with borrowers that we would work with if the examiners weren't in the bank today. And that's happening in every bank in America today, because at the operating level the examiners are tightening. The same thing happened in 1990. I was there, and that's exactly what's going on today. You can talk about it at the top, but if the examiners are going to make it harder to make loans, banks aren't going to make loans, because the field examiners are there every day. They're sitting in your office.
There are a number of issues related to the SEC. Fair value accounting, etc. But the most significant was a major change forced on the industry by the SEC for determining loan loss reserves. Traditionally, banks have used some subjective judgment in setting loan loss reserves. Banks increased reserves in the good times because they could afford to. There is an old saying in the banking business that we make our bad loans in the good times. The SEC got very focused on loan loss reserves and wanted to go to mathematical models. The way these models worked, you had to use past history, and future economic projections. Well think about before this cycle started, we had a long period of very low loan losses and practically no economists, including the Fed, projected a recession, much less the kind of recession we have had. So, using the forward-looking models, and the actual history of loan losses, we entered this period with much lower loan loss reserves than the industry would have chosen without the SEC forced guidelines. A lot of the net losses in the banking industry are just getting the loan loss reserves back to where the industry would have been if it hadn't been for this change in accounting forced by the SEC.
Market corrections are not all bad. The world's a better place, to live, after Countrywide and Washington Mutual went out of business. They were destroying capital. Credit standards were too loose. Standards needed to be tightened. We had excessive leverage. We had no savings. We had significant over-investment in housing, which means you can't invest in production. Over investment in housing is one of our international competitiveness problems. We spend way too much on housing. We needed a correction. Markets needed to correct. What we didn't need was the magnitude and the depth of the correction. The magnitude of the problems was created by government policy which had prevented smaller natural corrections to occur all along and by the irrational governmental incentives for residential real estate investment. The policy makers then took a correction and turned it into a “panic.”
Panics are all bad. We saw that in our business. As soon as the Treasury and the Fed started talking about the $700 billion TARP program, our business just stopped. We hit a wall. Things were slow before, but business fell off a cliff. The $700 billion was scary. Also, markets could not handle the inconsistency: fail Wachovia, save Citi, fail Lehman, save Goldman. Unpredictability creates ambiguity which is a market killer. Even the best-run financial institutions are impacted by the economic environment. In addition, if you have to compete with firms taking too much risk, you take more than you wanted to survive in the short term. We've been facing a self-fulfilling spiral down. We've had a real loss of confidence partially caused by the ambiguity and arbitrariness of government imposed solutions.
From a healthy bank's perspective, TARP II is not a subsidy. We have to pay an equivalent rate of 8.5 percent interest before taxes. The government's borrowing at 0.5 percent. That's a great deal for the taxpayers, because we’re going to pay our money back. It's not a subsidy to us. I believe TARP was avoidable if government policy makers had developed a rational strategy beginning with Bear Sterns. It obviously could have been avoided if the Fed and the other government entities had not made their huge mistakes.
All large banks felt like we were forced to participate. The way bureaucracies force you. They made it known that if we didn't, we would have some real problems. And also, competitively we were forced to participate. If everybody else was in and we weren't, we were going to look like there was something wrong with us. This is just like FDIC insurance. I'd like to get rid of FDIC insurance, but you can't get rid of it by yourself. If everybody else has it, you can't not have it.
While TARP was positioned as encouraging banks to lend, I think it was really designed to help the failing banks and justified from a system’s risk perspective. The healthy banks were strongly encouraged to participate because the government didn't want it to look like a bailout of unhealthy banks. You can argue that was a good systems decision. It may have been in the short term, but I think it creates a giant moral hazard that some day is going to come back and really bite us. In my career, Citigroup has failed three times. The government has bailed them out three times, and each time they have gotten bigger and worse. A zebra does not change its stripes.
The government has also created an oligopoly, which concerns me looking forward. There are four giant competitors in the industry, and 9 institutions effectively already defined as too big to fail. Interestingly, remember when they originally did TARP, they invited 9 banks to DC. Why not 5? Why not 10? I mean, what's the meaning of 9? What's the message about the tenth bank, oh, it can fail, that's fine we don't care. Interesting message. Long term – this is a huge issue. What happens in the good times, these government backed “to big to fail” companies will go wild. And they can crush competitors. They can come in and decide to take over the mobile home financing business or any market segment in a geographic area by doing a lot of crazy stuff and drive other competitors out of the market. So it's the good times when this oligopoly becomes dangerous. I think an oligopoly selected by government policy under adverse circumstances is a particularly dangerous kind of oligopoly.
I'm personally opposed to antitrust laws, but if these companies are perceived by the government to be too big to fail, they ought to be broken up, because the long term consequences are huge. By the way, the Federal Reserve anti-trust policy is truly irrational. A couple of years ago, we bought a small bank in the mountains of North Carolina. We had to divest a $20 million branch and then the Fed allowed Wells-Fargo and Wachovia to merge and create a $1 trillion+ institution without any divestures. That's an interesting anti-trust policy.
No question that healthy financial institutions have been hurt by TARP. Before TARP we were seeing a huge flight to quality. TARP kept bad competitors in business. They're doing stupid stuff today. We're going to have to pay a lot more for FDIC insurance. We've lost opportunities to make acquisitions. In the good times, because you're competing with irrational competitors, you drift to do things you don't feel comfortable doing, but you have to do. But you passed on a lot of opportunities and remained relatively conservative. And then in the bad times, the good guys don't get rewarded because the bad guys get bailed out. So what do we do in the next cycle? The message is to take more risks.
So you almost end up being punished for being more conservative, which makes it harder to be conservative. And if it keeps happening systematically, it makes it a very difficult kind of environment.
An early solution that would have been drastically less destructive would have been a real estate tax credit. As discussed, the financial problems started in the residential real estate market. Residential real estate was over built. Residential real estate prices had fallen 20% and have 10% more to fall. What we needed was a 10% adjustment between the market price and what loses financial institutions could afford to take. We could have accomplished this with a 10% tax credit. By the way, I mean a tax credit. A tax credit is for people who pay taxes. If you don't pay taxes, a tax credit is welfare.
You can't really get the economy going until you stabilize residential real estate markets. There was a potential of $100-150 billion left to lose in the banking industry, with a leverage ratio of 10, that's $1.0 to $1.5 trillion dollars in lending capacity to be lost.
A tax credit on residential real estate purchases carefully designed to get people to buy houses who otherwise wouldn't buy houses would have solved the problem. A once in a lifetime “fire sale.”
The tax credit needs to be very carefully designed, because you do not want to incent people to build more houses. So, the program only includes houses under construction, and you want it to be real quick, so you put a cap on the amount of the credit available ($150 billion) and a time limit on availability. You've got to use your tax credit incentive now, or you can't get it. So it's one time, houses under construction, clear the market. It has to have a carry forward tax feature. It has to benefit high income people because they're the people who have the money to buy the houses.
What it really would do is stabilize house prices. And that is important for every homeowner. For the typical individual, security is connected to their home. They don't think about the stock market, even if they may have a mutual fund. They think about their house. And with house prices falling, they have a lot less security, a lack of confidence. The stabilization of real estate values makes equity lines available. The capital market can function because the market can price instruments backed by home mortgages which will create liquidity. The tax credit could have been done relatively cheaply. By the way, the only part of the stimulus package, that's really working right now is the first homebuyer's tax credit. I was in Richmond, VA, yesterday talking to a realtor and he said they were selling houses because of the first homebuyer credit. Unfortunately, first home buyers are a small segment of the real estate market.
How about the long term? Obviously deflation is a huge issue. On the other hand, I personally worry about inflation. In my career, most of the problems have been around inflation. How do we undo what we've done? I know the Fed and the Treasury say they can, except nobody's ever undone what's been done because we've never done anything like this before. And they haven't had a great record of undoing monetary stimulus in the past. I think you can argue that the riskiest asset class is a long term government bond. Not because of credit risk, but because of the interest rate risk. And I've been there and seen how destructive inflation can be.
My greatest concern is the endless attacks on capitalism, on free markets. Free markets have produced the highest standard of living in the world for long periods of time. The perception that capitalism has failed has huge long-term consequences. Obviously, capitalists have made mistakes. Capitalistic economies aren't perfect. Human beings are not omniscient. We make mistakes. In a free market, the market is constantly adjusting. However, government policy is 95% of the cause of the depth of the current financial problems. It all started with so called “good intentions” from government where policy makers have ignored the secondary consequences, and if we continue these trends, we're going to get in worse shape. What we really need is less regulation, not more.
The attack on the wealthy is very dangerous, too. There are some wealthy people who aren't productive, but most of the really productive people are wealthy, so an attack on the wealthy is an attack on the productive. Roosevelt did this during the 1930’s and it materially damaged the economy. I see the effect of this endless attack when talking to business people. They don't go on strike in a dramatic sense, they just do less. Why take the risk if I can't get the rewards for taking the risk? Instead of opening five locations, next year, I'm just going to open two locations. I'm going to make enough money anyway. Why reach out, if I'm going to be under attack? And that's clearly what's going on.
We must privatize and liquidate Freddie Mac and Fannie Mae on the other side of this correction. I think they are a huge risk from a political perspective. We should go back to the origination and hold model for home mortgages, which worked for years.
The Canadian banks are the soundest banks in the world. And one of the main reasons they're sound is they have big home mortgage portfolios that they maintain. They didn't have to compete against Freddie Mac and Fannie Mae. To fund the re-intermediation of the banking business to hold home mortgages, the Fed cannot continue to save mutual money funds. Mutual money funds were taking a lot more risks than they said they were taking. People perceived them to be the same risks as CDs. They were not. Unfortunately from a banking industry and long term economic well being perspective, the government chose to bail out the money funds, which has interesting implications. Banks have been paying deposit insurance since 1933 and one of our competitors who never paid deposit insurance suddenly got bailed out. Amazing.
The Federal Reserve has too many powers. The Fed already had plenty of authority to deal with the financial industry. The Federal Reserve's only goal ought to be a stable growth rate in the money supply, something like a 3% rate, i.e. Milton Freidman. Micro-management of the money supply has almost always been detrimental. Now, you can't tell it because this economic correction is created by the last correction, creating the next correction. Friedman was right, we ought to have a stable growth rate in the money supply. By the way, I think that's a hard job. I don't trivialize the job of managing what's happening in the money supply. However, the micro-management by the Fed has consistently been destructive.
If I were in charge, which I'm never going to be, I would go to a market based monetary standard which would probably be gold. Not because there's anything magical about gold, but because there is a limited amount of gold and it is expensive to dig up. As long as the government owns the monetary system, we're going to have a high risk system. Because the government itself is going to incur huge amounts of debt, and that underlying debt level creates a risk in the system. This is not going to change as long as the government owns the monetary system.
If we don't privatize the banking system, I've got a three-part cure. One, systemically significantly raise the capital level for banks. Two, eliminate 90% of the rest of the regulations. Three, make it explicitly clear that if you aren't a bank, the Federal Reserve is not going to help you if you get in trouble. If GE gets in trouble in the commercial paper market, the Federal Reserve is not going to bail them out. GE's been doing high risk financing and hurting us for years. The federal government chose to bail them out. Not a great long term message to the rest of us. So, more capital in the banking business over time, particularly for start-ups, but for everybody, dramatically fewer regulations, and the Fed’s cannot help non-banks if they get in trouble.
There are also a number of critical public policy issues. We have to stop subsidizing housing. We have to encourage productive investment though our tax laws. Low, neutral tax rates. Tax consumptions, not saving, which will increase productivity. We certainly need free trade. If you look at the Depression, the attack on free trade was a huge destroyer of wealth. The U.S. created tariffs and then other countries responded with their tariffs. Carefully and systematically privatize Medicare and Social Security. They are huge economic risks. Significantly cut the costs of defense by defending the United States, not controlling the world. Encourage immigration. The U. S. has a big demographic problem due to the retirement of baby boomers. In the discussion of Japan’s growth rate, most people miss the obvious. Japan's primary economic problem is demographic. They've got an aging population, and no population growth. Population growth is a huge driver of economic well being. We want smart people. Smart people create jobs. We can keep the smart people in India. And you know what they're going to do in India? Create jobs in India. We need to have them here. We also must save more, spend less and restore discipline.
I want to talk at a different level. Probably something you haven't talked about at this conference. I think the real problems are philosophical. They haven't got a lot to do with economics, except for secondary implications. The source of our problems is the combination of altruism and pragmatism. Where did affordable housing come from? Everybody has a right to a house? Everybody has the right to medical care? Provided by who?? An interesting idea of rights, it's totally contrary to how this country was founded. The United States was founded on a concept of individual rights being the right to your own production. The right to what you create. You couldn't have the right to what somebody else creates. The right to medical care implies my right to enslave a doctor or enslave somebody else to pay for the doctor. This is totally contrary to the American concept of rights.
Altruism leads to redistribution from the productive to the nonproductive. No one has a right to their life. Everybody becomes a slave to everybody else. This philosophic error is then compounded with pragmatism. Pragmatism says, do what works. The problem is lots of things work in the short term that will kill you in the long term. Negative amortization mortgages worked for a number of years. A lot of what we're doing today is working in the short term and is going to kill us in the long term. Pragmatism fundamentally leads to irrationality because rationality demands a long-term perspective. Pragmatism leads to lack of integrity, because integrity demands a long-term perspective.
Look at the Chrysler bail out. Clearly, a combination of altruism – let's help the union workers –and pragmatism – let's do what works now. Unfortunately, it destroys the rule of law, which will have very serious consequences in the long term. The combination of altruism and pragmatism leads to a free lunch mentality. Look at the last election. Neither candidate proposed anything serious to deal with the huge Social Security and Medicare deficits. And if they had, they couldn't have been elected. This combination leads to a lack of personal responsibility. And that, ultimately, is the death of democracy. The founding fathers were concerned about the tyranny of the majority. They were focused on the protection of individual rights – freedom of speech, freedom of religion. But they realized that when 51% of the people find out they can get a free lunch from 49%, the party is over. Pretty soon it's 60% getting a free lunch from 40%. And then 70% getting a free lunch from 30% and then the 30% quit. And that's been the death of democracies.
The United States was founded on a totally different philosophical premise: Life, Liberty, and the Pursuit of Happiness. Each individual's moral right to pursue his personal happiness. Each individual's right to the product of his own labor. These philosophical premises demand personal responsibility. There is no free lunch. These philosophical ideas demand and reward, rationality, integrity, long-term self-discipline
These ideas are founded on the pursuit of each person's rational self-interest, in the long term Aristotelian context of the pursuit of happiness at the deepest level. Also, in the context of the trader principle. In our business, we're committed to helping our clients be economically successful and we expect to make a profit doing it. And in that context, we should pursue our self-interest. Not taking advantage of other people, but not sacrificing ourselves either. Trying our best to create win/win relationships.
My favorite book by far is Atlas Shrugged, written by Ayn Rand in 1957. If you haven't read it, you ought to read it. If you haven't read it recently, you ought to re-read it. Rand wrote the book 50 years ago to try to prevent what's happening today from happening. It's a scary book if you look at what it predicted 50 years ago and where we go from here. It will make you think.
What happens now? Of course, there are better economists here today than me. However, I'll tell you what my own opinion is, having been through a number of these cycles. We're in a really tough recession. Tough as I've seen in my career. We've got real economic problems. We have something I've never seen to this magnitude – lack of confidence. Maybe that's beginning to stabilize. But that's a tough, tough thing to measure. I don't think we're going to have a global financial crisis like the 1930’s. I don't think the kind of mistakes that were made in the 1930’s are likely to be made again. I am in the optimistic short-term category. I think we're probably going to start having a recovery this winter and maybe in 2010 have a decent economic recovery. What I think, however, is that we've done many things that will slow our real growth rate for many years. We'll be paying for a lot of the poor policy decisions for years. We run a huge risk of something that looks like the stagflation of the 1970’s.
I don't know how many in this room were around in the 1970s. A lot of current policy decisions are not new but very reminiscent of the 1970’s. I read the administration's proposal for the budget; it was in the Wall Street Journal this morning. It looked like something right out of the 1970’s, laying the foundation for a destructive economic environment, like the 1970’s.
What happens in the long term? It depends on us. And I have to admit I'm in the very worried category. If we continue the altruistic, pragmatic, free lunch mentality, we have the potential for a real economic disaster in 20 to 25 years. It reminds me a lot of Freddie Mac and Fannie Mae, where we were running the numbers and it was obvious they were going broke. The U.S. has a whopping deficit in Medicare. It's off the chart, $45 trillion dollars. Whopping deficits in Social Security. We are running an operating deficit of almost $2 trillion a year. We have an irrational foreign policy. We have a big demographic problem that's non-trivial, with the retirement of the baby boomers. We have a failed K through 12 education system. But the United States won't go broke with a poof. What we'll do is probably either hyperinflate or have a much slower growth rate and it will take a long time. I think it’s 25 years out, but if we continue our current trends, the U.S. will be a third world country in 25 years. Unfortunately, people just do not want to face the objective facts of where we are going.
What we need is exactly the opposite of what is being done. We need a return to the principles that made us a great country in the first place. Individual rights, limited government, free markets that lead to personal responsibility. We need less regulation, not more. Every time government makes a big mistake, we get more government.
There is one important reason to be optimistic - the American Sense of Life. This is a highly entrepreneurial country. People do respect individual rights. I think that has been the foundation of our success and I hope that will provide a check to the current trends.
In this environment, the importance of principled leadership and principled individual action cannot be over emphasized. I think a lot of our problems result from a lack of leadership on a principled basis. At BB&T we have ten core values. We believe that these values are more important than any strategy we have, any insights or any mathematical models. We think having the right principles is the foundation for personal and organizational success.
Within our ten core values are what I believe are the three great virtues: Purpose, Reason, and Self-Esteem. As human beings, we're purpose-directed entities. We have to know where we're going in order to get there. Organizations are simply groups of human beings. To be successful organizations must have a clear purpose, in which the participants can vest. A meaningful purpose has to have two fundamental components. First, everybody in this room wants to make the world a better place to live. And people who run organizations should realize that they're in the business of making the world a better place to live. However, you don’t have to feed hungry children in Africa to make the world a better place to live. Businesses create better products and services and thereby, improve the quality of life. In fact, much of the difference in the standard of living between the U. S. and Africa is that we have better businesses.
Equally important, everybody has the right to their own life. Each of us should do things that we enjoy doing. We shouldn't be sacrificial. Life is based on creating win/win relationships. Purpose is about making the world a better place to live, while doing something you enjoy doing for you.
The way you accomplish your purpose is through your capacity to think. We use the term Reason. Everything that is alive has a method of staying alive. A lion has claws to hunt with. A deer has the speed to avoid the hunter. And, human beings have the capacity to think. Our capacity to think is literally our only means of survival, success and happiness. There are no short cuts, no free lunches. There are two pillars to the thinking process. The first is Liberty. Freedom is essential to proper thinking. Regulations literally keep us from thinking. Regulation defines the barriers to thinking. The fundamental issue is that given our nature as a human being we must be free to think in order to live. The second pillar is educational systems. Educational systems are so critical to economic well being that we can't afford a failed K through 12 educational systems, which is why we must privatize education.
When you're clear about your purpose and you use your thinking capacity to accomplish your purpose, you raise your self-esteem. Self-esteem is the foundation for happiness and happiness is the end of the game. Money is not the end of the game. Money can be a means, but it is not an end. Happiness, in the deepest sense, is the end goal. Self-esteem is a complex subject, but I’ll share a thought that has social implications. As human beings, most people, and certainly everyone is this room, gets most of your self-esteem from your work. And I use the term work in a broad context. Raising children is important work. So, work drives self-esteem. Something I say to all the employees at BB&T. It's very important to BB&T that you do your job well, but it's far more important to you. You might fool me about how well you do your job. You might fool your boss about how well you do your job; but you'll never fool you. If you don't do your work the best you can possibly do it, given your level of skill and knowledge – you can't do the impossible – if you don’t do your work the best you can do it, you will lower your self-esteem. The flip side is also true. Do your work the best you can possibly do it, and you will raise your self-esteem. And that's more important than whether you get more money or whether you get a promotion.
This concept is true from a societal perspective. Take a man that's an entry-level construction worker, working extremely hard just barely making a living. Very importantly, he gets to earn the self-esteem of taking care of his family and his life. He may not have a lot of money, but he has pride. Take that same man and give him welfare. He may have a better material life, but he loses his self-esteem. And that's a huge price to pay.
America is not the land of security. We care about security, but we're not the land of security. The settlers did not come to Jamestown to be secure. America is the land of opportunity. Opportunity to become extremely successful. Opportunity to fail and try again. America is the land of opportunity, and opportunity requires economic and political freedom. This powerful idea is how we created the most successful and the most benevolent society in history. Unfortunately, this philosophical principle will get lost because of the combination of altruism and pragmatism. And the long-term consequences will be very severe. And that's my message when I go out and talk about this environment. We must protect the philosophical idea that each individual has the moral right to his own life, he is a slave to no man. This is the concept that made America Great. Thank you very much.

[Schneed10]

Yeah I'm not readin that shit.

[GMScud]

Congratulations on the longest post in Warpath history.

[MTK]

I like the part where they open the Ark and the Nazi's get their faces melted off... sweet

[joethiesmanfan]

Financial crisis real simple. Markets value based on speculation. Ooops too many houses have been built we must fill them. Oops can't fill them. Housing prices decline. Oops one of the ten commandments of the free market religion has failesd us. Housing prices can decline. Geronimo I lost it all.

[joethiesmanfan]

Originally Posted by mlmpetert

The settlers did not come to Jamestown to be secure.

Jamestown trivia contest: 2 firsts in the "New" World for Jamestown.



The first representative assembly in the New World convened in the Jamestown church on July 30, 1619. The General Assembly met in response to orders from the Virginia Company "to establish one equal and uniform government over all Virginia" which would provide "just laws for the happy guiding and governing of the people there inhabiting." The other crucial event that would play a role in the development of America was the arrival of Africans to Jamestown. A Dutch slave trader excanged his cargo of Africans for food in 1619. The Africans became indentured servants, similar in legal position to many poor Englishmen who traded several years of labor in exchange for passage to America. The popular conception of a race-based slave system did not fully develop until the 1680s.


Your post is so long I am gonna have fun all day.

[mlmpetert]

Originally Posted by GMScud

Congratulations on the longest post in Warpath history.

Thanks, i was surprised i was able to post it, thought there would be a cut off or somthing.

[joethiesmanfan]

Originally Posted by mlmpetert

We must protect the philosophical idea that each individual has the moral right to his own life, he is a slave to no man. This is the concept that made America Great. Thank you very much.[/COLOR]
[/FONT]

According to Jamestown history this philosophical idea is relativley new.

We have a contradiciton here.

1619 to 1865 is 246 years slavery
1865 to 2009 is 144 years Reconstruction + Jim Crow + Civil Rights + present

Question can anyone answer? Is it easier to make a profit, if let's say you don't have to pay for labor, or your labor costs are tools and boots?