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Pearlstein: Bank Regulatory Structure

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Steven Pearlstein
Washington Post Columnist
Wednesday, April 15, 2009; 11:00 AM

Washington Post business columnist Steven Pearlstein was online to discuss bank regulatory structure on Wednesday, April 15 at 11 a.m. ET.

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Read today's column: Reinventing Regulation.

Pearlstein won a Pulitzer Prize in 2008 and is co-moderater of the On Leadership discussion site.

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Arlington, Va.: Today's story in Metro about the family in Ashburn who are having to cut back really points out how totally out of whack our society has become. When I grew up, not THAT long ago, it seemed like people lived a lot more within their means. We lived 5 people in a 1200 square foot house. My parents worked. We never ate out or took expensive vacations. None of us was enrolled in expensive "activities". We made our own recreation, played games with neighborhood kids, etc. It's almost shocking how self-indulgent we have become. I wonder if this "wake up call" will really last very long.

washingtonpost.com: Pay Cuts Sharpen Family's Focus (The Post, April, 15)

Steven Pearlstein: That was a revealing story indeed. For the last 18 months I've been writing and talking about the inevitable decline in living standards that Americans were facing. People would ask me how much and I said that one good guess would be that consumption had to come down about 10 percent -- from about 106 percent of what we produced as a nation to 96 percent to allow for some savings. Which gets to your point: 10 percent reduction is still a very comfortable lifestyle. Now I know there are a lot of people who weren't living comfortably, and they obviously can't reduce their living standards much. But a lot of us have gotten used to little (and big) luxuries that are just that -- luxuries. It is actually pretty encouraging that so many Americans have come to understand this, have accepted it with relative good humor and begun to adjust.

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Washington, D. C.: Now that FASB has been pressured into easing the requirements of fair value measurements ("mark to market") just in time for the first quarter reports, what valuation can investors trust? FASB 157 allows for "unobservable inputs" to be used in valuation. How do you regulate "unobservable inputs"? Enron kept their debt unobservable by moving it off their financial statements. Then they used "unobservable inputs" to inflate the value of worthless contracts. Jeff and Kenny Boy should have waited for FASB 157.

Steven Pearlstein: I still haven't gotten an answer from FASB on whether companies are required to report their "marks" under the old system in a footnote somewhere in their reports, but I had the impression that is is. The old system, of course, is marking them to the last market price, even in markets that were thinly traded and reflected only distressed sales. In any case, the investor ought to get it both ways, even if the new way is used for calculating GAAP profits. That way investors can calculate things either way -- their choice. That is the best outcome, in my opinion. And if there is a company whose shares you own that doesn't report that material fact, then you ought to complain directly to the Securities and Exchange Commission or conssider hiring a plaintiffs lawyer to file a class action suit to force such disclosure. That is the least you deserve.

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Washington, D.C.: Thank you for being a sober voice, i wonder, Donald Trump seems to be talking down the economy at the same point the President seems to see light at the end of the tunnel, so who's right? Is it a bear market rally or just a "dead cat bounce"?

Steven Pearlstein: Its a bear market rally.

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Princeton, N.J.: As usual I have some questions about your recent article favoring an alternative public health insurance plan.

Will this solve the problem that one loses his health care when one loses his job-kicking a guy when he's down?

While this may slightly reduce the money wasted by the high overhead of private insurance, do the savings compare with the $500 billion a year we would save with a single payer system which would not only reduce overhead more, but also cut down on the many forms physicians have to fill out, high drug cost, and compliance costs of patients fighting with their insurance company?

Will your alternative plan cover people with pre-existing conditions? If so how will you prevent the private companies from picking out the lowest risk people leaving your plan with the poor and the sick, a very high risk pool?

How will you make insuring this high risk pool affordable?

If your plan covers pre-existing conditions, won't this make the self-insurance option more attractive? Why pay premiums until you get sick? This will remove even more low risk people from the pool.

That's enough for now.

washingtonpost.com: A 'Public' Fix for Health Care Need Not Abandon the Market (Pearlstein, April 10)

Steven Pearlstein: Its more than enough. You know, and I know, that I'm never going to convince you of anything until I agree that a single payer system is the only way to go. Many of your questions are actually taken care of in most reform proposals WITHOUT a public option.

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Boston, Mass.: Can you follow the accounting of the AIG counterparty payment (thanks US taxpayers) to Goldman Sachs on Goldman's balance sheet and/or P and L in Q4 of last year (the hidden month) or Q1 this year? The Goldman CFO claimed these were just cash flow issues (nothing to see here) and they didn't affect the P&L. They reported better than expected Q1 numbers which probably helped it raise equity capital this week to try to pay off the TARP money (their "duty" and nothing to do with paying themselves bonuses as they see fit).

Steven Pearlstein: I talked to the guy a few weeks ago because I was thinking of writing a column slamming him for saying they had no material exposure to AIG. Turns out they had double hedged so while they may have had no exposure, they were still entitled to collect on their AIG hedges, so to speak. Why AIG felt the need to honors those in full is another question, but you can't blame Goldman for insisting that a deal is a deal.

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Gilbert, Ariz.: Mr. Pearlstein,

Is mark to market accounting really giving a false picture of banks' balace sheets and was Congress' action to modify it in the best interests of the country's financial system? Thank you.

Robert

Steven Pearlstein: I think I pretty much answered that one already. But I wouldn't jump to the conclusion that just because there is a difference between the depressed market price and the "fair value" based on estimates of long term cash flow, it is the market price that is the true and honest price. These markets are dysfunctional and if the bank uses conservative (i.e. pessimistic) assumptions about future cash flows, probabilities of default and recovery rates, then the fair value might be just that -- a fair value. Don't necessarily assume this is a plot to snooker investors. Because if it is, it won't work for very long, the banks will lose even more credibility and they will wind up in worse shape. I think they know that, as do their auditors.

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Falls Church, Va.: Hi Steven,

I really hope you take my question.... Having lost almost 50% of our 401k in the subprime fiasco, a similar one is brewing in our backyard today - it is called the FHA. The FHA has been making 3.5 percent down-payment loans for homes ($500-600k homes) with no regard to credit scores and mortgage brokers are steering people happily into these products along with speculators that are exploiting it - No-money-down wreaked havoc and destroyed so much of hard-working peoples retirements,

Is $17,500 for a $500k home a solid foundation for a borrower to be on? - I'd really like to know what the regulators are doing today besides pushing the FHA to make more loans - Where is the reform,oversight and regulation ????

Steven Pearlstein: I was unaware of any of that. Sounds like its worth looking into.

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Madison, Wisc.: Steven, thanks for today's column and for taking questions. In today's article, you ended with: "Congress can create a better regulatory structure and can expand regulatory powers, but in the end, the one thing it can't legislate is the good judgment of the regulators."

And that's the problem, isn't it? The next Republican administration may again ease or eliminate regulatory controls under the principle of "faith in the invisible hand of the market." Is there any systemic reform that can assure quality and consistent regulation that is more resistant to political manipulation?

Steven Pearlstein: No, I think I said it pretty plainly: You can' legislate good judgment. But don't necessarily equate bad judgment with Republican judgment. That's not fair. There's been instances of bad judgment by regulators during Democratic times as well.

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Arlington, Va.: Great column today. What about the Frankenstein monsters of this mess, taxpayer-backed Fannie Mae and Freddie Mac? Will they finally be regulated, or taxed, in the same manner as other firms that do similar work?

Steven Pearlstein: I hope they will be regulated according to a public utility model -- not rate regulation so much as regulation of what products they can deal with and how big they can grow their balance sheet during normal times. Right now, they are essentially a ward of the government and it is in everyone's interest to allow them to grow their balance sheet because they ARE the mortgage market for the time being. There are few other players beside Fannie, Freddie and the Federal Reserve.

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Pittsburgh, Pa.: I'm just now reading one of Peter Schiff's books; I'm sure you've answered this before but I couldn't find it on the search engine--so what's your take on his recommendations: no mutual funds, foreign high quality dividend paying stocks, gold or silver. Seems he was correct on much of his predictions but I don't think anybody's made a killing in foreign stocks and has gold been high and low--there are no fundamentals to it, just demand. Thanks for your thoughts!

Steven Pearlstein: He's a pretty radical bear, but at this point you can make an argument for high yielding stocks denominated not in dollars. The dollar is now artificially high because everyone in the world wants to buy US Treasury bonds, but that is going to end at some point and the dollar will resume its descent. That is what Peter is banking on. Gold is another dollar hedge, although it doesn't pay much in the way of dividends. My warning, however, is that you'll have to have a good stomach over the next two years because the future Peter envisions may take a while in coming.

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Gergetown, Md.: Instead of upsizing regulation, what about downsizing the players? Reducing the financial sector to a group of medium and small sized specialists.

Steven Pearlstein: Yeah, my pal Ignatius likes this idea. Many people do. That will happen naturally as a result of the crisis, to a degree, but I'm not sure I see the point of breaking up Bank of American into three different banks. Imagine if you said that no bank could be more than 10 percent of the market. Well, would we let a 10 percent bank fail? Probably not if it had lots of relationships with all the other 10 percent banks. That said, I think that regulators have to do a much better job in assuring that banks have the capability to manage what they have and, if not, force divestitures or require higher capital.

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McLean, Va.: I'm sorry to be a cynic, but the regulatory framework is never going to keep up with the financial institutions. The bankers have real money at stake to create innovative "products" and mechanisms. Even if we prohibit bonuses based on short-term gains, Wall Street should always have monetary incentives in place. They are willing to work around the clock in pursuit of those goals. On the other side, you have an army of career bureaucrats who have no incentive structure in place. They cannot be fired, no matter how incompetent -- and any of us with any exposure to a single government agency knows that there's a significant portion of government workers who truly are incompetent or totally unmotivated. Even if they were fully incentivized, most work their 8-hour day and don't give the issues a second thought until the next day. At best, they'll always be behind. At worst, they'll always be completely in the dark. And if that's the case, it doesn't really matter what the regulatory body is.

Steven Pearlstein: First, I think you sell short government employees at that level, although I agree there is a lot we could do to attract more of the best and brightest to government and give them the training and incentives they need and deserve to go toe to toe with the financial wise guys. Second, even if you are right to a degree, it does not follow that regulation is necessarily useless. If the regulators would just keep an eye on the areas of banking that are growing the fastest and generating the most increase in profits, they are sure to find where the potential problems are. Or to put it another way, they don't have to be a step ahead of the wise guys, they only have to be a couple of steps behind to prevent small problems from becoming systemic disasters.

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Great Falls, Va.: You know, I'm pretty sympathetic to the financial institutions generally, but isn't Goldman just getting more and more brazen in their misrepresentations to the public? They apparently think no one is capable of seeing through their transparent dodges.

First, they are not repaying TARP money out of "duty" but because of the executive compensation limits. Second, their banner "quarter" reported yesterday (using quotes because it was really four months of data) was apparently strong largely because of the mony funneled from the government to Goldman through -the lackluster efforts to unwind the trading book by the unpaid slaves at] AIG. Third, as detailed in the WSJ today, their representation about being fully hedged on their exposure to AIG last fall was disingenuous at best.

Come on guys. It's not enough to take all of the taxpayers' money to build illusory profits, you have to lie to us too?

Steven Pearlstein: Tough words.

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Woodbridge, Va.: So Goldman wants out of the TARP program because they are now profitable. We now learn that they actually lost $780 million, but used an accounting shuffle to claim a $1.81 billion profit. Aren't these financial gimmicks exactly why we are in such a financial mess? The mortgage backed securities and junk bonds were able to get AAA credit ratings through similarly creative accounting practices.

Steven Pearlstein: Can see we've got a lot of Goldman fans in the room today.

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Annapolis, Md.: Maybe I am a bit simplistic but in my view the simplest and most efficient way to regulate would be to limit the leverage a financial institution can have. I don't see any economic sense in having these high ratios other than making a quick buck at the expense of risk taking.

I think Geithner is making this way too complicated by trying to figure out who poses a systemic risk.

Steven Pearlstein: Nobody, including Geithner, disputes the need to limit leverage more than it has been, in addition to having capital requirements. But that's not all you have to do.

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Powell River, Canada: So much of what passed for real economic activity over the last decade happened because of the shadow financial system. Without the SIVs, CDO's, and astronomically leveraged hedge funds there could not have been a housing bubble and the employment that it generated, however briefly.

So my question is ... If you bring these guys out of the shadows and regulate them, is there enough of a genuine economy left to generate full employment?

Steven Pearlstein: Yes. It is always hard, when you are in the middle of a downturn and the economy is shrinking, to figure out how it is ever going to grow again. But it always does, as new products are invented and companies become more productive in what they do and the population grows through births and immigration. And the faster we squeeze the air out of the bubble economy, the sooner we'll have a solid foundation from which to grow again.

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Baltimore, Md.: Do you have reaction to Senator Dorgan's view that the current banking crises is due to the repealing in 1999 of the Glass-Steagall Act which didn't allow banks to also make risky investments?

Steven Pearlstein: That's not, in my opinion, the primary cause.

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Arlington, Va.: I noticed that the big profit announcements by Wells Fargo and Goldman came quickly after the mark to market rule was revised. Do you think that the results or timing of these announcements were changed or influenced by that change?

Steven Pearlstein: No, I think the timing was pretty much their normal quarterly rotation.

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Fairfax, VA: The S and L crisis came about when short rates moved above long rates and taught banks to sell off mortgages to Fannie and Freddie. Now that they appear to be keeping them, isn't there a risk that this will repeat itself when eventually the FED has to raise short rates to deal with inflation? Maybe the bigger risk is the FED won't act timely for fear of hurting the DI's.

Steven Pearlstein: Not sure you've got that exactly right.

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Evanston, Ill.: Why was Lehamn allowed to go bust and two days later AIG rescued? Why was Lloyd Blankfien in the room deciding on whether to rescue AIG? It is easy to say you are fully hedged if you can call on the US Government to bailout the counterparties to the insurance you bought.

Steven Pearlstein: I remain skeptical of the Goldman conspiracy theory.

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Washington, D.C.: "Even worse is Geithner's notion of designating certain banks as too big to fail and then subjecting them to more stringent capital requirements and a special tax that would be used to pay for the occasional government bailout."

It's been suggested here before, and I'll suggest it again: "Too big to fail" should really mean "too big to exist".

It might be easier to legislate and then regulate under a scheme that does not allow institutions to become so large that they jeopardize the entire system.

Steven Pearlstein: Continental Illinois was too big to fail 30 years ago. And by today's standards, it wasn't that big.

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Rockville, Md.: Enjoyed your article today. You mentioned insurance companies but aren't they state regulated? Are you saying they should come under some sort of federal regulation?

Steven Pearlstein: You betcha.

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Bowie, Md.: As long as you're fielding questions about lowering our living standards from 106 to 96 percent, what do you think should be our "lowerage targets" by income strata, given that the top 20 percent of earners have gotten most of the income gains of the last 25 years.

And is there any tool except taxation to target them at the top?

Steven Pearlstein: Its not like there is a committee out there that is going to decide how much each household's or each income class's standard of livingis going to decline. This is a market economy and it is adjusting in a variety of ways right now so that consumption gets more in line with production. Its not particularly useful to think of it the way a Soviet planner would.

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Nashville, Tenn.: Hi Mr. Pearlstein, in your column today on pending regulation changes you write, "What's the rush?" Journalists seem oblivious to the fact that we have gone through a series of these financial crises, Sand L, dot Com, Enron, and the current one, each more serious than the previous one. Wouldn't one obvious fix to "firms becoming adept at getting around regulation" be to restore the original 10 yr. statute of limitations to the Securities and Exchange Act. No government entity is capable of enforcing the financial laws of the country as effectively as the threat of lawsuits brought by thousands of individual Americans

Steven Pearlstein: Spoken like a plaintiff's lawyer.

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Salt Lake City, Utah: Hi Steve,

What is your opinion of Goldman Sachs as the last man standing, thanks in large part to actions/decisions of Hank Paulson, the US Treasury Secretary, who prior to that was the CEO of Goldman? Is Goldman Sachs the epitome of a US oligarchy? Is this exhibit A about what is wrong with the financial system?

Steven Pearlstein: If our little group here is a representative sample, I'd say the public relations folks at Goldman have a problem on their hands.

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Washington, D.C.: It seems that we have to strike the right balance on market efficiency vs. robustness. A highly leveraged financial system is very efficient if everything is working, but it can quickly turn to catastrophe if something goes wrong.

We saw 30-1 (or higher) leverage before this crisis -- how bad would things have been if they had only been leverage 5-1, or 10-1? And what was the level of leverage before the Rubin-era deregulation?

Steven Pearlstein: Leverage obviously was allowed to get too high. How high it got depended on the type of institution and whether something was on balance sheet or off, so more complicated than can be captured in a single number. But again, let me point out that it wasn't the "deregulation" as you put it that opened the doors to this. Regulators had all the power they needed to limit levereage, if they had chosen to use it.

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FHA loans: I have an FHA loan that required 3.5 percent down. They, unlike other mortgage lenders, had me submit my banking records, check stubs and lots of other documentation to prove that I could really afford the house I bought. The house which, by the way, fit into the restrictions on how much house you can buy through FHA. The limits are designed for the region that you're in - $500k certainly woudn't be approved in NH, where I am, but might in a higher market.

Lastly, these loans come with a fixed rate, 30 year mortgage. With PMI insurance if you paid less than 20 percent down. They are actually structured & well-regulated. If I sell the house before the allowed date, I have to pay back the $$ granted through the loan.

I don't understand what that poster's problem with the loans is . . . maybe he/she could do some research independently before getting twisted in knots.

Steven Pearlstein: Thanks for that.

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Bridgewater, Mass.: So how are credit unions doing in all this? The only one I know has always insisted on 20 percent down and they hold their own loans. So far they've only had a few problems (mostly with people losing their jobs).

Would it be a good idea to let credit unions expand beyond the limited groups most of them are limited to?

Steven Pearlstein: They were doing well until recently, when I read that the credit union for the credit unions was in trouble and in need of a bailout. So I guess that there are few high flying credit unions that are now coming back to earth.

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Yucca Mountain: What's happened with all those toxic assets? When and how will they be cleaned up? Seems like it's a Catch-22 of the private sector only interested in stepping in if there is very little downside and a great deal of upside but, on the flip side, this type of deal would open them up to a public backlash down the road for reaping the benefit of a sweetheart deal on the backs of the taxpayers. Where is this headed and how hamstrung will we (and the economy) be until we get there?

Steven Pearlstein: How about this plan: the government buys up all the toxic assets at 66.666 cents on the dollar, puts them in lead containers and ships them out to Yucca Mountain in Nevada?

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I'm never going to convince you of anything: Especially if you do not try.

Steven Pearlstein: This is our friend from Princeton again....

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Washington, D.C.: Steve, I love your work and have read everything you have written over the past couple of years. As a mid-level associate at a D.C. law firm that specializes in banking, financial services and government relations, I was hoping to make a few quick points to your readers since I work on these issues daily, and ask you a question. Also, as a form of full-disclosure I am a progressive sort of guy and predisposed towards Obama already. That being said, there is a lot of misinformation out there still and I was wondering if you agree with the following: 1.) The most important thing for the government to do immediately is to revive the secondary credit market. I know a lot of laypeople feel ripped-off etc, but the bottom line is that all credit of any kind - mortgages, credit cards, student loans, HELOCS, etc - that is obtained by people who make 40,50, 60k a year is financed through the moribund secondary markets, people should realize why Paulson, Geithner, Obama/Bush, et al have been so committed to reviving this market. People see this as a hand out, but it is a necessity. For instance, the death of the student loan market is directly related to the death of the secondary auction-rate securities market that was funding student loans. 2.) Glass-Steagall repeal has NOTHING to do with the current crisis. This is an uninformed, David Sirota-esque talking point. The GLBA permitted I-banking, commercial banking, and a insurance to be conducted under one corporate structure, which was merely a form of modernization that put us in line with the rest of the world. If anything, GLBA was not radical enough because insurance is still regulated by 50 states, with no federal regulator, which puts us at a regulatory and competitive disadvantage against Europe, etc. Prior its passage, mortgage originators could still securitize loans and sell them to investors. Too big too fail firms - ala Conintental Illinois - existed both before and after the GLBA. 3.) When the economy does stabilize, a whole regulatory change will be needed, that permits one or multiple regulators to focus on systemic risks and includes the regulation of leverage of ALL financial institutions. 4.) TARP money has nothing to do with increasing the amount of money loaned by banks. These horrible loans they have on their books are not liabilities as so many people think, they are their assets. The TARP money is basically a means of replacing those asset values while taking write-offs, which in turn allows banks to meet required capitalization standards. Money that banks loan is money taken in through deposits, if credit is tighter, it is because lending standards are much more stringent than 18 to 36 mos ago

My question: Do you think the American public truly has the patience President Obama, Geithner, etc will need to operate? That is, it seems to me they really know what they are talking about and we have adults in charge finally, but even as they try to tell people this could take another year to sort out, people already seem to be turning and demanding immediate results. I worry people are so nervous that they will create a political climate that necessitates policymakers making unwise choices to placate their constituents. Sorry for the lack of brevity! The chats are great!

Steven Pearlstein: Thanks. You make some good points, particularly in your question about grownups and patience.

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Washington, D.C.: Following-up on a previous question, who do you think should be regulating insurance companies? Should the states be out of that business?

Steven Pearlstein: yup.

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Falls Church, Va.: It's interesting that people here are hating on Goldman Sachs for GIVING BACK government money. How dare those rotten cheaters think they can thrive without taxpayer funds!

Steven Pearlstein: There you go.

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Richmond, Va.: So when Goldman successfully repays TARP money, will that mean that it is no longer "too big to fail" and no longer poses systemic risk to the market? If not, should some sort of anti-trust action be taken?

Looking forward to Wells Fargo paying back the TARP funds also.

Steven Pearlstein: Me, too. Then we won't have to listen to the chairman lecturing the government about how assinine it is.

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Washington, DC: How many trained economists do you think will be at today's teabag protests?

Steven Pearlstein: Is this a variation on the lightbulb joke?

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Prescott, Ariz.: So I heard that Goldman Sachs changed their accounting practices so they could use December as some sort of orphan month where they hid a bunch of nasty writeoffs so they wouldn't show up on the quarterly, and they could claim the biggest quarter ever. What is up with that?

Steven Pearlstein: A bit of sleight of hand, don't you think. Except, of course, you know it because it was DISCLOSED.

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Steven Pearlstein: Gotta go. Thanks for a good chat. "See" you next week.

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Editor's Note: washingtonpost.com moderators retain editorial control over Discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions. washingtonpost.com is not responsible for any content posted by third parties.


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