This week, he proposed a radical rethinking of the structure of America’s financial system. In a speech at the Brookings Institution, he argued that the largest banks remain too big to fail and launched a year-long campaign to solicit solutions. Among his ideas: Break up the banks, force them to hold as much capital as utilities or levy a tax on leverage.
The Washington Post sat down with Kashkari to discuss his plans, the risks he sees in the economy and the Fed’s relationship with Congress. This transcript has been edited for length and clarity.
WP: You argue that Dodd-Frank did not go far enough. Big banks still pose a risk to the economy. How safe do you feel the financial system is right now? Do you see any immediate threats to the U.S. and global economy?
NK: The financial system is much safer than it was before we had the financial crisis. Increased capital in the banks is unquestionably a good thing. Deeper liquidity, a good thing. Progress has been made.
The announcement I made this morning is not in response to an immediate risk that I see that is about to manifest itself. It’s the view that we have to make changes while markets are stable, while the economy is stable, so we are ready when the next wave comes. I’m arguing that now is the time we take those steps we need to take, because in my judgment the steps we’ve taken so far do not go far enough.
WP: But are there threats that you worry about, even though this plan may not be a response to that?
If you look around the global economy, there’s a lot of uncertainty. There are people who are concerned about China’s slowdown and whether it’s going to be a hard or soft landing. All of those are out there, but it’s very hard to see crises coming.
Nobody was omniscient enough to call $100 oil or $150 oil a bubble. I’m not saying that it was a bubble; I think it’s supply and demand forces. But certainly nobody forecast it going down to $30. That’s just an example of an exogenous shock. Everybody’s eyes were open. None of the smart people saw it coming. What else don’t we see coming?
WP: What does a hard landing in China look like?
There are all these hedge funds that are trying to pile on to bet against China’s currency. If there was an unexpected movement in the currency in an unpredictable way, that might alarm people.
Let’s take an extreme scenario: If they ended up just moving and floating the currency because they couldn’t battle back against the people who were opposing them, I think that’s something that could add to a lot of anxiety in global markets. And that’s one of the channels where it could come back to the U.S. economy.
WP: What do you make of the stock market’s erratic behavior the last couple of months?
We’re paying attention but we don’t know. The economic data itself doesn’t support some of the concerns that are being expressed by the stock market.
WP: On too big to fail, it just struck me that maybe this whole issue of whether they’re big or broken up is a sideshow, and the real issue is something like a Glass-Steagall question. Why isn’t that really the point as opposed to what size you make the bank?
NK: That’s a little bit like the utility model, where you said, you know what, banks can grow in size, but because they serve this really important role in the economy, we’re going to put so much capital in them that they virtually can’t fail. And then you let the rest of the economy, the rest of the financial system, do what they do as long as they don’t get so big that they’re destabilizing. I have some sympathy with that view. I’m not prejudging whether that’s the correct or incorrect answer.
But to Glass-Steagall specifically, it isn’t clear to me that just keeping investment banking separated from depository lending is necessarily by itself a solution. If we go back to the root causes of ’08, we had a nationwide delusion that home prices only go up. I partcipated in that delusion: I bought a house in California in 2005. Traditional banks made a lot of bad loans based on the premise that if home prices keep going up, these loans are going to be okay. And so Glass-Steagall wouldn’t have prevented that one scenario.
WP: But wouldn’t 10 medium-sized banks under that delusion have been as dangerous as five big ones?
NK: I agree if you have 10 medium-sized banks that are all identical and making the exact same decisions, there’s virtually no benefit to that over one giant one. But that does steer you to the case that if they had much higher capital requirements, then they would be able to withstand the shock of that delusion.
WP: But if you break them up, they wouldn’t be subject to the much higher capital requirements.
NK: It may end up being a combination of some of these different tools. If you go back to the late 1980s, when thousands of little banks failed, there was no systemic risk. It caused a recession. It was painful for those communities.
WP: We did a big bailout, right?
NK: Deposit insurance made the depositors whole, but there was no keeping the banks intact like we did this time. We had no choice. In ’08, we basically had to keep them in their current form. We ended up keeping management teams in place. The small banks went through receivership.
WP: But you might have a situation where non-banks might be so big they cause a systemic risk. That utility model doesn’t solve anything. It just pushes all the risk into …
NK: It doesn’t solve everything.
WP: No, I said it doesn’t solve anything.
NK: I know you did, and I’m saying it doesn’t solve everything. We can come up with 100 reasons why any new plan is imperfect, and we can always come up with a scenario that a new plan does not solve for. But you have to balance that against the real costs and the real risks that we know exist today. And I’m arguing that we have not had that discussion yet.
We could conclude that as a society we are willing to tolerate a crisis every 100 years. We may conclude that that is just too costly, and society is just better off having more lax lending, and then every 100 years we have a crisis.
I’m saying that as a country I don’t feel we’ve had that discussion. Policymakers have been telling Congress, or maybe Congress has been telling the American people, that Dodd-Frank has solved too big to fail. And I’m saying I don’t believe it.
WP: Any of these suggestions would require some type of legislation from Congress. Doesn’t that look like a moot point at this juncture? And is that really the role of a Fed bank president to be petitioning Congress for these types of reforms?
NK: It strikes me there are people on both sides of the aisle who think we need to do more to address the too big to fail issue. Next year we’re going to have a new president, and it’s a big election. Who knows where the country will be and their appetite for taking on more aggressive solutions?
In terms of the role of the Fed, we don’t lobby. I’m not lobbying representatives or senators. But the reason we have a distributed Fed is we’re supposed to bring a diversity of perspectives to the central bank, to monetary policy, to financial stability. Addressing too big to fail is one of the mandates that Congress has given to the Fed. If I weren’t speaking up about risks that I see that aren’t being addressed, then I wouldn’t be doing my job.
WP: One of the things the Fed is already doing is the surcharge they’re about to impose on capital in 2017. That would seem to be pretty much like some of the options you’re talking about.
NK: The question is: Is it enough? Things are moving slowly, and I feel a sense of urgency because societies tend to forget the lessons that they’ve learned. I’ll give you an example. In 1987, President Reagan created the president’s working group on financial markets to look out for financial risks. By the time I started at Treasury in 2006, that committee had already been mothballed, and Bernanke and Paulson resurrected the committee.
We are going to move on. We’re going to forget about this. And 20 years from now, or 50 years from now, or 80 years from now, this movie is going to happen again. And will we look back and think we really did all we should have done, or did we just make changes around the margins?
WP: The bank stress tests look at how these banks would do in bad economies. You seem to be saying you don’t believe it.
NK: To really be strong enough against a shock we haven’t thought of, we would either need much, much higher capital requirements — the banks are already pushing back hard against the capital surcharges — or we need to look at much stronger or more intense stress scenarios.
I’m colored by my experience in ’08. A lot of these tools are eminently sensible and can work if conditions are fairly straightforward. But if you’re actually in a crisis scenario, all bets are off.
When you have multiple banks that are in trouble at the same time, the contagion risk is what’s so vexing. How do you even model that?
WP: Your predecessor Narayana Kocherlakota has already come out with a blog post responding to your speech. He argued that the proposal would be counterproductive to Fed monetary policy at a time when interest rates are so low.
NK: He is highlighting one of the challenges the Fed has. Not only does it have a dual mandate, but it also has a financial stability mandate, and those things may not always be in perfect alignment. If we can take more aggressive action to solve the lingering too big to fail risks, maybe that frees up the Fed so we can really just focus on the core dual mandate of employment and price stability.
WP: If the Fed were to wait [on hiking interest rates] in March, do you think that raises questions about how much faith the public can have in the Fed’s forecasts when just three months ago it was sending a message that the U.S. economy is resilient?
NK: I don’t think so. I think that Chair Yellen has worked very hard, as have other members of the committee, to say that we’re data dependent. And as the data comes in, we’re not dogmatic. We are going to adjust policy based on what economic conditions demand. She’s worked very hard to communicate clearly with the public. I think she herself has earned a lot of trust.
WP: Are you worried about another recession? And would the Fed still have the ammunition to fight it?
NK: I think another recession in any year is always a possibility. I think that’s no different this year.
If things were to turn down, I think the Fed does have additional tools. One could always do versions of additional quantitative easing. We’re looking and learning from what other countries have done on negative rates. There’s no expectation around going to negative rates, but it’s certainly a possibility. And there’s also forward guidance, a stronger commitment to a path of interest rates can also be very powerful in changing expectations.
WP: Over the past seven or eight years, central banks around the world have engaging in unconventional monetary policy, testing the limits of central bank powers. And yet we still have slow growth. we still have really low inflation. What do you make of that?
NK: Some people say it’s just because central banks haven’t shown enough conviction. And if they just showed more conviction they would get inflation up more quickly. I don’t find that argument persuasive yet.
There’s a lot of discussion around the world about the slowdown in productivity growth. That could be part of it. There are also demographic trends. We may see a confluence of several of these things happening at the same time.
WP: How would you rate the Fed’s relationship with Congress right now?
NK: I think it’s improving. I think they appreciate the fact that Janet Yellen is working very hard to be open and transparent. Alan Greenspan tried to confuse people. Janet Yellen speaks plainly, trying to answer questions and be as transparent as possible. She in particular has earned a lot of good will among the members I’ve spoken with.
I went through the experience of testifying. My longest hearing was six hours. Forty angry members of Congress, Republican and Democrat, basically yelling at me for six hours. The remarkable thing that happened was that even though they were venting, they were actually listening. It was years later that I found out that some of the members of Congress who were most angry at the moment -- actually we were winning them over, even though it didn’t seem like it at the time.
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