Good evening everybody. And thank you for that very kind introduction. I hardly recognized myself. And I'm very flattered to share the stage with Ken Lewis and the other luminaries of the banking world being honored tonight.
Several years ago when they lured me out of the serene world of academia to take this job, I was given several promises. They promised me it would be regular hours, nine to five, Monday through Friday, no weekends. They promised me trips to the Swiss Alps to talk about global capital standards. And they said my only headache would be whether Wal-Mart should own a bank. So much for promises backed by the full-faith and credibility of the United States government!
They were right about one thing: I'd be getting a lot of phone calls from reporters at the American Banker. All those calls and interviews resulted in good, solid, well-balanced stories. At least that goes for most of them!
Honestly, the financial press has been great to work with. But now the mainstream media have discovered the FDIC. They want to talk about what we do, and they want it in five-second sound bites. So I can get lost translating the jargon into common English. I was on a TV news show in October talking about the need for our new temporary liquidity guarantee program. I said the program was intended to bring down LIBOR. The interviewer, of course, asks me: "What's LIBOR?" You should have seen the look on the poor guy's face when I said: "about 400 basis points."
Managing the Crisis and Planning for the Future
All kidding aside, I want to take this opportunity tonight to talk about some of the lessons of the ongoing crisis in the financial services industry, how we got here and what the future may look like.
As you all know, it's now official: the U.S. has been in recession for the past twelve months. While most of us suspected this was the case, the announcement formalized for the nation the daunting challenge of how to emerge from what could become the longest recession in post-World War history.
So, how did we get here?
Clearly the two biggest factors are the boom and bust in housing and a dramatic loss of confidence in the financial system. It turns out that securitization — the process that transformed the credit markets — is related to both of these. While securitization has created market efficiencies and broadened and deepened the credit channels, the current crisis exposes a few of its weaknesses.
Chief among these is misaligned incentives. Mortgage brokers, originators, underwriters, ratings agencies and investors all got paid in ways that created incentives for maximizing their own short-term profits, while allowing the accumulation of huge, undetected long-term risks.
Originators and underwriters usually did not retain a financial stake in the long-term performance of their loans. They got paid on day one, when the loan closed or the security was issued.
Securitization drove the boom in housing. Issuance of private residential mortgage-backed securities totaled over one trillion dollars in 2005 and 2006. But as of the third quarter of this year it had declined to virtually zero. Investors have lost faith in many of the market practices that securitization was built on.
