In a highly engaging session during The Future of Finance Summit 2017 in Singapore, Barney Frank, former US congressman and co-author of Dodd-Frank Act; Michael Syn, executive vice president, head of derivatives, Singapore Exchange; and Geoffrey Heenan, International Monetary Fund representative, South East Asia, joined Sam Ahmed, international resource director of The Asian Banker, in discussing what happened behind the scenes of the 2008/09 financial crises and how Trump policies may impact global markets, particularly in Asia.
Here is the transcript of the video:
Sam Ahmed: We’ll start off this conference with Congressman Barney Frank doing a 25-minute chat and focusing on the topics of the financial crisis, Lehman Brothers, and the subsequent implementation of Dodd-Frank. Following that, we will invite Michael Syn from SGX and Geoffrey Heenan from IMF to talk about the new world order with Donald Trump coming in, and various fundamentals that are shifting, and the consequences of America pulling out of the world order and possibly unrolling off the regulations.
Could you tell us a little bit about when you first heard about Lehman Brothers, and could you also tell us, subsequent to the default of Lehman Brothers, why the US government chose to save AIG but let Lehman collapse?
Barney Frank: I became chairman of the committee in January 2007, after the congressional elections in 2006 put the Democrats in charge. The Bush Administration was then in charge, and the Secretary of the Treasury was Henry Paulson, who had taken the job reluctantly. He had turned it down a couple of times, and he then finally agreed to take it, which was relevant because it strengthened his hand.
Over the next couple of years, there was a split within the Republican Party. The large number of the Republican conservatives, dominant wing of the Republicans in the House of Representatives in that area wanted no real intervention into trying to keep things going, as Paulson thought. They were for letting it fall apart, if that’s what happened, etc., and Bush gave complete backing.
It was very interesting. You can’t take this for granted, but there was a complete unity of purpose between Paulson and Ben Bernanke of the Federal Reserve. Now, historically in America there has been tension between the Federal Reserve and Treasury. It was not to be taken for granted, but you did have the two of them working as one throughout this, along with Tim Geithner, who was then the president of the New York Fed.
Essentially, what developed was that, starting in 2007, I started to work with Paulson. We got legislation through that allowed him, ultimately, to put Fannie Mae and Freddie Mac in receivership and stop the bleeding there. We passed a bill to cut off subprime lending, although it didn’t finally become law for another year and a half because of the Senate.
But then, in early 2008, I would hear from Paulson, backed up by Bernanke, about his concern that there was trouble in the financial system and that we had a problem of failure. He and Bernanke came to us in the middle of 2008 and said, “Here is the dilemma,” and it played out. They said if a large institution was unable to pay its debts, they had only two choices: They could pay none of the debts or owe the debts, and those were equally unsatisfactory. What they wanted was some system whereby they could step in, take over, and pay only as much of the debt as was needed to prevent cycling down.
That’s ultimately what was in the bill, and that’s why, while many of the Republicans denounce it, Paulson and Bernanke legitimately take credit for some of the idea.
As the summer wore on, about every other Friday afternoon after the US markets closed, I would get a gloom-and-doom call from Paulson about another institution that was in trouble, and I said, “I’m going to get rid of my phone. All you do is ruining my weekend.” He was staving off trouble.
Early on, the first one, of course, was they got JPMorgan Chase to take over Bear Stearns. At that point, the Republicans in the House started denouncing, and they wanted to have a hearing in which they could denounce the Bush Administration for stepping in and being too interventionist in having Bear Stearns go to JPMorgan Chase.
Interestingly, as the Democratic chairman of the committee, I refused to give them the forum. I wouldn’t hold the hearing. They could say whatever they wanted, but I wouldn’t have a hearing. 1.) I thought they had done the best they could, but 2.) I didn’t think it was a good thing for the stability of our economy to have this haranguing.
As the summer went on, he called and said, “I’m going to take over Fannie and Freddie,” and I said, “Yes, we’ll support you.” And then, this weekend came in September when he called and said, “We have problems with Lehman.” Now, up until that point, they had put Bear Stearns into JPMorgan Chase. They had Merrill Lynch go to Bank of America. They put Fannie and Freddie in receivership. Then, Wachovia was taken over by Wells Fargo. And then comes Lehman.
What Paulson told me – I wasn’t an actor; I was listening to him – he says, over this weekend, was that he was worried about Lehman, and he then figured out that Lehman wasn’t going to make it, but he decided to follow the model that he followed of Merrill Lynch and Bank of America and of Bear Stearns and JPMorgan Chase. His problem was that he was now out of American institutions that could take it over. Wells Fargo, Bank of America, and JPMorgan Chase had all taken something over, and Citicorp was a basket case. Nobody would ask Citicorp to take over anything; they were on life support.
So, he told me that weekend. I think it was Sunday. I was at a Democratic fundraiser north of Central Park, whatever that street is. He said, “I think we’re okay. Barclays is going to do the deal and take over Lehman Brothers.” I woke up the next morning to read the news, and his explanation was that the British regulators vetoed the deal and would not allow Barclays to take over Lehman Brothers.
At that point, he was out of options, he said, because the only option would have been to have the federal government pay all of the debts. Now, to do that, and this is the argument that they make – I simply report what they say – in the ‘30s, Congress enacted a statutory amendment to the Federal Reserve Act, Section 13(3), that said the Federal Reserve can lend to any entity, bank or non-bank, any financial entity, in exigent circumstances – that’s the technical phrase; what “exigent circumstances” means in real words is “whenever they want to” – as long as the entity is solvent.
So, the argument they will give you now is that they believed Lehman Brothers was not solvent. You have liquidity and solvency. Obviously, it wouldn’t have happened if they were liquid. But they said they would only lend to somebody that was illiquid but solvent.
The other thing, though, was the sequence. I do believe that Paulson was trying hard to avoid having Lehman simply go under and not pay its debts, but he then figured that there was nothing else he could do. When that happened, the Bush Administration was surprised by the severity of the reaction. The explanation to us was that the economy, not just in America but worldwide, was not going to function, that nobody was going to lend anybody anything. There would be no more repos, etc.
It is true that some of the Republicans, when that happened, in the committee said, “Good.” They were not happy that Lehman failed. They were happy that their administration did nothing to mitigate the effects of the failure, and they said, “See? We have free enterprise. We finally have free enterprise in America.” Well, this widespread national enthusiasm for free enterprise lasted a day because, by Tuesday, free enterprise? Not so much.
Two days later, AIG came in. We heard this second-hand. They went to the administration. And AIG said to Bernanke, “We are $85 billion in debt, and we can’t pay it off.” They summoned us and said, “Look, here’s what’s happened. Lehman failed, and the world was grinding to a halt.” One argument was that people said, “Well, this was as bad as '09.” It had the potential to be worse because in 1929, you still had geographic particularity. By 2008, the whole world was on one grid, or at least the whole world where finance was relevant.
So, Bernanke then, using the authority I mentioned, decided that AIG, while highly illiquid, was solvent and agreed to pay $85 billion in debts. Now, this became the reality that Paulson and Bernanke had been telling us: They could pay either none of the debts – Lehman – or all of the debts. They had no ability to pick and choose.
They do now. If anything like that happened now, they could pick and choose, and the rule is that the federal government will liquidate the entity and use whatever it can to pay off some of the debt. As for the remaining debt, they will pay off, out of federal funds, as much as they have to in order to stave off a total meltdown, but that has to be recovered by an assessment on other large institutions.
It turned out; by the way, that AIG was wrong. They did not owe $85 billion beyond what they could pay. They owed $170 billion beyond what they could pay. Bernanke was telling us a week later, “I need this. I need $85 billion for AIG.” Somebody said, “You already told us that.” He said, “Oh, no, this is another $85 billion for AIG.”
So, AIG was not only in debt beyond what it could pay, but they also had no idea what they owed. That did not stop the leader of AIG, Mr. Greenberg, from suing the federal government on the grounds that AIG, which got a $170 billion bailout from the Bush Administration, had been unfairly treated. I thought that lawsuit, as I said, was like the arsonist suing the fire department for water damage. A judge finally said, “Well, technically, you have a case because they didn’t follow the rules. You get zero damages,” and even that just got thrown out.
At that point, they summoned the Congress and said, “We now need to come up with a fund to prevent this.” They paid off AIG’s debts, but there was still this fear that people were going to have this terrible contagion, and that’s when they asked Congress to pass what was called the TARP, the Troubled Assets Relief Programme. The name is relevant because their original idea was that they would buy up assets from the banks that were in trouble.
That became a dilemma, though, because these banks were in trouble because their assets did not equal their liabilities. So, if the federal government were to buy up the assets at true market value, you haven’t done anything, but if the federal government paid four and five times what the assets were worth, people would be furious. So, that’s why the TARP then became a capital infusion, and the capital infusion program was still called the Troubled Asset Relief Programme, but it wasn’t about relieving them of troubled assets.
At any rate, that’s the story. As I said, I had people from the FSA in Britain, and the Bank of England say, “That’s right,” that Barclays approached them for permission, but Barclays needed their permission to take over Lehman, and they said no.
Sam Ahmed: I want to move the conversation now to a little bit about Donald Trump, one of your favourite personalities. To do that, I might want to invite Michael Syn, who is head of Derivatives at SGX, on stage, along with Geoffrey Heenan, the head of Southeast Asia IMF.
Michael Syn: So, we’re here in Singapore just a week after last week’s Shangri La dialogue on regional security. So, a logical and relevant framing, I think, for this panel could be about challenges to norms and to consensus in our regional capital markets.
First of all, the big question is: Who can fill the vacuum of a receding dollar, of a receding Euro-dollar? In some sense, we already have a somewhat multipolar international monetary system. The financial depth of the US dollar is unparalleled today, at something like $60 trillion worth of investable securities. But, the euro is about $30 trillion worth. The yen is about $20 trillion worth. Sterling and Aussie amount to about $10 trillion worth. The financial depth of the RMB offshore is still only about half a trillion dollars worth.
So, it could be some time yet before China’s offshore capital and treasury markets are internationalised sufficiently for mercantile Asia to redenominate entirely away from the US dollar.
There is, in fact, currently some conflict in China’s own internationalisation agenda. Firstly, for Chinese government bonds, through Bond Connect or through the IMF Special Drawing Rights, and in Chinese A shares through Stock Connect and through admission to emerging markets indices like the MSCI.
So, China’s capital barriers to offshore investors, right now, are, if anything, higher, but the policy agenda that’s been repeatedly and publicly laid out by the CSRC vice chairman, Fang Xinghai, is even more ambitious than merely internationalisation of the RMB. It is about sovereignty over pricing power in RMB for major strategic imports, including, particularly, oil, gas, steel, and agriculture, and we are back, therefore, to trade-offs.
The dilemma is conflicting economic interests between short-term domestic and long-term international objectives for countries whose currencies serve as global reserve currencies. For RMB to be truly internationalised, China must be willing to offer the world an extra supply of its RMB; in other words, a trade deficit.
So, as Asian capital markets try to navigate this very uncertain evolution, there may well be fragmentation away from one-size-fits-all regulatory priorities and policy priorities appropriate to Western market structures, independently of whether the Trump Administration, in fact, chooses to go rogue, and therefore, a distinction in Asia between onshore domestic markets and offshore hard currency markets will become more interesting and more idiosyncratic.
Sam Ahmed: Maybe I’ll start off again with Barney. To sum up, in two seconds, what Michael was saying, post-World War II, the US has been the bastion of safeguarding the international financial markets and the global economy. Donald Trump, with his recent policies, looks like he’s about to pull back on a lot of those trends that were set by the US. The question, now, is, as Michael alluded to: Will there be a vacuum, and will there be, possibly, someone like China coming in? Before that, could you comment on Trump’s policies? Is it short term, or do you see an actual trend whereby the US is actually pulling out of major initiatives, like the Paris Accord and so forth?
Barney Frank: Let me get to that in a second, but first, I want to express my complete agreement with Michael on what I think he was gentle about, and that is the hypocrisy of America imposing this austerity on Southeast Asia as opposed to ourselves. It is a confession I can make easily because I didn’t think it was right in the first place.
During the ‘90s, I was not worried much about securities. My function on the committee that I chaired was that I spent a lot of time on the IFIs, the international financial institutions, and I was very critical of the IMF. There is a picture of the former head of the IMF, Michel Camdessus, standing arrogantly – well, he’s about 4’3”, so it was hard for him to get much higher – over the head of Indonesia while he signed this agreement that was based on a mistaken analysis because this was not a budgetary excess problem. This was not Greece.
Particularly, there is one victory I will claim, and one reversal. This refusal to allow any capital controls was a contributing factor, and I did say, yes, you have a right to insist that whatever controls you are going to put on capital must have been clear when you put it in. You can’t have Hotel California where you can put it in but can’t get it out. But this absolute barrier on the shortest term capital infusions was a mistake, and finally, both the IMF and the federal government have admitted that, so I felt sort of good about that.
Beyond that, as to Trump, there is no “there” there. That’s what Gertrude Stein said about, I think, Oakland, California. There is no “there” there. There’s nothing. There is no way to describe Donald Trump’s policies without imputing to them a coherence they do not have. I thought there would be a more disciplined conservatism. I don’t think there is logic to what he does. It is very much impulsive. And it’s certainly true that, in his own case – and it’s his political appeal – is a feeling, with some legitimacy, that America has carried too much of the burden. There’s no question. I’ve been pushing for reducing our military expenditures.
The problem with Trump is that it’s incoherent because he tells the Europeans that they’re not spending nearly as much for the military, and we won’t do as much, and then he proposes a $50 billion increase, totally undercutting any threat he might be making to them. Oh, sure, he’s spending the money, so what the hell are we going to do?
I think there is ignorance. He does not understand what is happening. There are people around him. So, I am worried about it. I don’t think it is a conscious choice of cutting back. I think it is just instinct, undisciplined instinct, lashing out, and I don’t know what this will wreak. He hasn’t focused on it too much, yet, with regard to the bank, and the IMF, and other international financial institutions, but there’s just no way to predict what he’s going to do except to say that it’s an angry reaction that does not appear to have a coherence to it.
Geoffrey Heenan: I would first like to say that I think the Congressman’s right, that the Fund and the Washington consensus has adjusted since the Asian financial crisis, and with some of the problems that were misdiagnosed, we’ve learned from them. So, if you look at what we do at the Fund now, it’s a lot more focused on things like inclusive growth, on agenda, and on environment, and I know that sounds like motherhood statements, but we’re actually looking at data that shows that these things are important for sustained growth, and they’re important for actually reducing vulnerabilities of economies.
I think things have changed with respect to the new administration’s agenda. With respect to international financial institutions, it’s not clear. I would say, from the IMF’s point of view, we are not reliant on appropriations from the budget, so we’re a little bit protected, in some ways, but obviously, the US as the largest shareholder can influence policy in that regard. We just don’t seem to be on the radar screen just yet.
The final thing I would say is that I don’t see the pullback. Even if the US is pulling back, I feel that other countries are stepping up to take their place in this multipolar financial system. There’s this ongoing debate about what has been the cause of this economic discontent, political discontent, and economic nationalism, and a lot of the focus has been on globalisation, but clearly, technological change is a huge part of this. I think one of the key points we make is that the type of policies, in terms of improving social safety nets, improving labour market functioning and mobility, and lifelong learning like they do here in Singapore, are important because they also deal with the technological change.
The fact is that if countries retreat from globalisation, they still have to deal with technological change, so then you need these supportive policies even in an isolationist world.
Michael Syn: So, the nexus between the politics of redistribution, which is, I guess, equality, the race for equality of outcome is also anchored in equality of opportunity. So, we’re only seeing the symptom, which is that there is no equality in outcome, but what’s less remarked upon is that the end of history has not brought about a system of society that inherently allows for equality of opportunity.
Barney Frank: That goes the other way.
Michael Syn: It goes the other way, in fact. So, this is, I guess, what Marx was talking about. There is an internal contradiction at the heart of capitalism.
The nexus between the economics of capital control and sovereignty is very much linked to the nexus between the trilemma which also exists in politics. So, the one in economics we all understand fairly well: You cannot have complete freedom of capital movement, as well as control over your currency, as well as control over your interest rates. Something has to give.
But there’s an almost equivalent political trilemma, which is that you cannot have full and free engagement in the global capital markets, and full natural sovereignty, and full democratic representation, which in most places amounts to the rule of the mob. This is what Dani Rodrik at the Kennedy School calls the political trilemma.
And the common solution to both of these things is Balkanisation, capital controls, and each man for himself. Perhaps the legacy in Asia of the Asian financial crisis is that the capital structure of Asia isn’t really that different from 20 years ago – countries which had capital controls then still have it now – and it may well roll along without dramatic changes in its capital structure, and the world may end up looking a little bit more like this as each country starts looking out for itself.
So, the loss of consensus is a dangerous thing, perhaps, because this challenge of the Fourth Industrial Revolution ought to be solved supranationally. It’s very hard to see how that can be solved domestically only.
Sam Ahmed: Is Donald Trump, or the Trump Administration, going to succeed in rolling back key elements of not only Dodd-Frank but also Basel, which the White House has already expressed its intention to?
Barney Frank: The answer is that it’s more likely with regard to Basel. Where you can have these things done by executive action, yes, he will do things, like pulling out of the Paris Accord. I must say as I was telling Emmanuel, in the context of worrying about climate and pollution, that using chlorofluorocarbon as a good thing was a little bit surprising. I hope whatever they come up with for the banks doesn’t damage the ozone, which is why we had to ban the CFCs.
But he will not succeed in doing very much legislatively, particularly with regard to financial reform. You cannot even theoretically do much there through this reconciliation process. Here’s a technical detail. If something has budgetary implications, direct spending implications, or revenue-raising implications, then you can do it in what’s called reconciliation, where you only need 51 votes and they will be able to do that. That’s why they can theoretically do that with healthcare, but they won’t even have the 51.
But with regard to substantive legislation – the requirement of central clearing or no subprime loans below a certain level – that would take a statute. That would take 60 votes. I don’t know if they have 51 votes in the Senate because Senator Collins voted for the bill. She’s one of the Republicans. So, there will be no substantial legislative change in the financial reform bill. There will be some ticks for the medium-sized and smaller banks. What you’ll have is a lessening of the administrative strength of faith, so they will not roll that back.
As far as Basel, though, yes, they can screw that up. Now, it’s going to be interesting to see what Mnuchin and Cohn think and whether they can influence him. What we don’t yet know yet is the most important appointment yet to be made, which will be at the Fed, because that will be a major determinant of what happens over there. So, yes, he could throw Basel into…
If not, what’s working for Basel will be Brian Moynihan of the Bank of America, Jamie Dimon, Lloyd Blankfein, and a few others saying, “Please, don’t screw this up. You may not like it, but we have to live in this world.” I think the leaders in the large financial institutions would be victims if Basel got all screwed up. So, my guess is that they will be able to mitigate the harm to Basel, which he could do unilaterally.