MINNEAPOLIS — Neel Kashkari knows a thing or two about financial crises. As overseer of the Troubled Asset Relief Program in the Bush Treasury in 2008, he was on the front lines of the confused and somewhat improvisational government response to an abrupt meltdown of the global financial system.
In his first public speech as president of Federal Reserve Bank of Minneapolis — a post he assumed late last year — he staked out the provocative position that not enough has been done since the crisis to resolve the biggest banks or avert a similar meltdown if they should fail, and further suggested that those institutions might need to be broken up for the public good. To further explore the issue, he has instructed the Minneapolis Fed to embark on a series of public symposia to consider policy changes that can address the issue, dubbed #EndingTBTF.
In a wide-ranging interview on Tuesday with American Banker, Kashkari rejected critics' assertion that the symposia are a springboard for his pursuit of future elected office (he ran unsuccessfully for governor of California in 2014), saying definitively that he "has no interest" in another job and that he donated the remnants of his campaign coffers to charity late last year. He was also skeptical of the living wills and total loss-absorbing capacity rule, and said he supported calls to increase diversity and transparency at the Fed. An edited transcript of the interview is below.
The Minneapolis Fed just wrapped up the second TBTF forum Monday. Have these discussions proceeded the way you expected they would? Have there been any surprises?
I've been pleasantly surprised that people are paying more attention than I expected they would — I hoped they would pay attention, but it's more attention than I expected. The symposiums — I'm very pleased with the quality of the experts that we've been able to attract. It just shows that a lot of people care about the issue and they want to be part of the process. The first symposium [April 4] was really exciting because you had these very passionate headline speakers who were advocating their views. Yesterday's symposium was much more in the weeds, much more technical, but that's the right next step — going deeper and deeper, and we're going to keep going deeper to learn as much as we can. So I'm very pleased with how that's going.
Supporters of the #EndingTBTF initiative have said that, regardless of the outcome, the program is successful because it has kept the issue in the public eye. Do you agree?
I would aim a little higher than that. I would say, I want to have an honest conversation with the American people, and with Congress, about what we've accomplished and what risks remain. If at the end of all of this Congress has been educated and they say, "OK, here's how much we've accomplished, there are these remaining risks, and we're OK with that," that's fine. I'm just strongly opposed to giving Congress a false sense of security — this notion that this can't happen again and we solved "too big to fail." We can never solve it 100%, but the question is, have we solved it enough? And ultimately that's Congress' judgment. There's huge value in the education aspect of this, so I want to aim as high as possible and see what we can get done.
The biggest banks have mostly chosen not to participate in the forums. Does that hurt the inquiry?
I don't think so. As you could see [at the May 16 symposium] we are able to get representatives from industry to offer views — and at the first one, too. Gene Ludwig [founder and CEO of Promontory Financial Group] very powerfully made the case. We've worked very hard to make this process as balanced as we can. We didn't predetermine the outcome, we said, "Let's have all sides represented." I think people are stepping back and saying, "This is a very balanced process." I think the banks would like to undercut this process, and we're not letting them.
By the way, U.S. Bank did attend yesterday. They asked to attend. We'd reached out to all the trade organizations — whether it's Financial Services Roundtable or the Forum, the Institute for International Finance, the Clearing House, they all declined [for both symposia]. When U.S. bank said, "We'd like to be there," we said, "We'd like you to be there." They were not a panelist, but they were out there in the audience, and there were representatives from smaller banks as well. So we welcome their participation. And U.S. Bank had reached out fairly late, and there may be ways for them to participate in a more formal role in the future if it makes sense, given the topic.
You said that you support the progress that has been made in securing the financial system since the crisis, but that more has to be done. How do you decide when the system is adequately secure?
That's what we're trying to get numbers around. Right now, a lot of what I'm going off of is my experience in 2008, and I'm asking myself, "If we had these tools back in 2008, how much of a difference would it have made?" And I don't feel like it would have made enough difference yet. But we didn't quantify that. So a lot of what we're doing now — the analysis that we're doing, talking to the experts — is looking at how we can quantify it.
It really comes back to costs and benefits. How much safety are we willing to pay for? You could have a very, very safe financial system and may end up with a much lower-growth economy. Where is the trade-off there? So that's what we're trying to put some numbers around, so it's not just my experience or judgment. So I don't know the answer yet.
We're looking at the analysis that's been done, not only at the Minneapolis Fed, but at the Board of Governors and internationally, and let's put it together in a way that we think makes sense. And then let's see if we can offer the American people a better ratio of safety versus cost. So the current plan with Dodd-Frank and all the work that has been done is one cost-benefit assessment. What we're going to try to do is come up with a better ratio and present that option to the American people.
Some of your critics have speculated that this inquiry is really a vehicle for you to lay the groundwork for a future run for public office. Is that true?
Not at all. I have no interest in running for office again. By the way — nobody knows this — but I just thought of this the other day. A lot of time when candidates have money left over from their campaign they save it in an account and use it for a future campaign. I had some money left over in my campaign account, and before I joined the Fed, I donated it all to charity. So I shut down my campaign account. If I had any intention of running for office again, there'd be a little nugget of cash that would be sitting in a campaign account in California that I could then redeploy. So I have no interest in running again.
I view my job — our jobs here — as identifying economic risks and calling them out. If we're not going to step up and call them out, then who's going to do it? I've got a lot of friends who work at the banks, at the big banks, some of my closest friends, and they're good people. This is not about me demonizing anyone. This is just about me doing my job. I see a risk — and it's rare that we actually see a risk in advance — so let's do something about it.
Would the outcome of the living-wills process change your view about whether the current process does not go far enough? Can a "credible" finding itself be credible?
It's hard for me to fathom. You heard [private equity investor] Chris Flowers yesterday — I thought he brought the most grounded perspective. He said, in a crisis, you're kidding yourself if you think you're going to wind down one of these institutions.
That is the sentiment that permeated the Treasury and the Fed during 2008: All of these banks are in trouble. Here's the thing: One bank, while the rest of the system is healthy and stable, it's possible. If it's many banks at the same time, forget it. That's what I want the American people to understand: If there is a shock like there was in 2008, you don't yet know what to do, except to turn to the taxpayers and say, "We just have to stabilize the whole system."
There are some experts who say that it is cheaper to clean up after the fact than it is to build a system that is so resilient that it could never happen again. That might be true — but then let's be honest with the American people about that. Just tell them: "This is what we're doing. We can deal with these types of crises, but if it is this extreme type of crisis, we're going to have to come back to you. And we just don't know what to do about that."
Even if that's where we conclude, I'll be fine, because we will be honest with people about what risks remain and what risks we've really addressed. I'm not comfortable saying to Congress that we've made progress, we're almost there, just give us a little more time. Because that implies that we know how to address that extreme crisis, and we don't.
Is there too much emphasis on resolving the banks and not enough on controlling contagion — that is, stopping a panic?
The whole reason why the Fed exists is because financial panics used to ravage the U.S. economy very regularly. And so if it's a pure panic, there's nothing wrong — people are just spooked. Then they turn to the lender of last resort and they pledge all their collateral to the Fed, the Fed provides cash, the panic passes and everybody's fine again.
2008 was not a pure panic. 2008 was real sickness leading to panic, and you couldn't tell who was sick and what was just fear. And that's why it was not just a lender of last resort function, you had to put capital in to absorb the very real losses in the banking sector. It's like mad cow disease — you can't tell which cow is sick, so you have to slaughter the whole herd. That's what ended up happening in 2008. Investors couldn't tell which of the banks was sick, so they just started pulling back from everybody. Some were truly sick, some were not so sick, but the panic enveloped everybody.
I'm highly skeptical that living wills will work it's in that extreme environment. Or, by the way, total loss-absorbing capacity. It's a mechanism that spreads panic, because if you're a bond holder of Bank X and Bank Y's bondholders just got converted to equity, you think, "Oh my gosh, I'm next, let me get out of here."
So you've got to build all these barriers against a flood and you build a wall as high as you can. Eventually, no matter how high you build that wall, there will someday be a flood that surpasses the wall. Then you need as many emergency tools as possible to protect the people. Some people are angry that we had bailouts, took those tools away from the Fed, and that's a wrong answer. Build the wall higher, but if the unthinkable still happens, you've got to find a way to rescue the people, and that's what the 13(3) authorities are.
You've mentioned before that whatever the conclusions of this inquiry, the political challenge of enacting them will be a separate and significant challenge. Have you heard any ideas through this inquiry that might overcome that stasis?
This is not a partisan issue. When I look at the political landscape, there are a lot of people on both the right and the left who think Dodd-Frank hasn't solved "too big to fail." I think there is a window — it will probably require presidential leadership, whoever the next president is, to solve this. But I think you guys wrote about the strange bedfellows of TBTF — I think that's exactly right. So I think it's very possible. I don't know what the right answer is yet. That's why we're doing the analysis.
How do nonbank SIFIs figure into this inquiry? Should other financial firms face the same scrutiny as comparable banks?
It's an important part of it. Yesterday John Cochrane talked about 100% equity-financed banks, but he also talked about taxing debt, and that's actually what brought us to him. One idea that we've heard, is that if you tax debt across the financial system, then you can capture the shadow banks, too. Maybe it's not perfect, but I do think there's legitimacy to the concern that if you clamp down on banks and you push all these activities to hedge funds, what have you accomplished? That's a part of our thinking as we debate the pros and cons of these various solutions. And it could end up being a combination of these different tools; it may not be just one widget that does everything.
The Treasury last week recommended tighter controls and legislation on marketplace lenders. Does that sector pose any particular risks or challenges to the financial system, in your view?
It's obviously disruptive, and in a lot of ways, disruption can be a good thing. If it makes credit more available, if it makes our financial system more inclusive. But it's something we just need to watch. What I don't want regulators to do is come in and say, "It's new, it's different, it's scary, let's smother it." Let's let the innovation flow and let's pay close attention to what's going on and figure out whether it needs appropriate oversight, or is it somehow undermining some of the controls that we have in other parts of the banking sector. My view is we should all watch it carefully and allow innovation to flourish, but if we need to take regulatory action, then let's make that decision at the time.
I've heard some small banks in the region talk about challenges competing with some of the online services either the bigger banks are offering or pure-play fintechs are offering, and they feel pressure from customers asking for apps and whatnot. But that's competition, that's a good thing. They should have to respond to the marketplace. Obviously what happened with Lending Club last week showed us that nobody is immune to ethics — it's important whether you're a fintech company or a big bank. You need to follow the rules and make sure people have confidence in management. Those are timeless values.
Do you think bank culture has changed since the crisis? Should it? And does the Fed have a culture problem of its own around opacity and accountability?
Yes, it's something that should be focused on, especially if an individual bank is an outlier. But this notion that we're going to change the culture of Wall Street is like saying we're going to change the culture of Las Vegas. Good luck with that.
But there can be outliers, for better or for worse, so as we regulate banks and get to know the management teams, if we see a bank that is an outlier then it is part of our supervisory responsibility to express concerns. The tone at the top matters. It's tough. We can't count on getting culture right; there's got to be structural reforms as well. Culture can be part of it, but there have to be other things that are less vague that we can rely on.
One of my biggest frustrations from coming out of the crisis was how some of the CEOs of the biggest banks said, "We never needed any help." They're lying, and they knew it. They get up there and say we never needed any help, we were fine. They're sending a message to the entire organization that says: Keep doing what we were doing. As opposed to some other banks which took out full-page ads in the papers and said, "Thank You to the American People, we needed your help and you were there, we appreciate it." That's important; that's an important difference in those two examples. Could we be more aggressive with the CEOs to exact a little contrition? I think maybe we could.
[With respect to the Fed's culture] I agree with that criticism. I've called it the Wizard of Oz routine. For decades the Fed adopted this posture of: "We're so mysterious, you can't possibly understand what we're doing. We're the wizards." Chairman Greenspan actively promoted that view, and that really did not serve us well when we needed the American people to trust us during the financial crisis. Monetary policy is really complicated, even for experts, let alone for people who are not experts. We need the American people to trust us, to give us the benefit of the doubt, and so that trust is critical.
I think Chair Yellen is doing a really good job of being much more plain-spoken in how she talks about the Fed and what we do. And I think she's trying to get out there more than other Fed chairs in the past. I think Bernanke started this and Yellen is continuing it. I'm doing everything I can to be completely open and transparent and plain-spoken with people, and I think if we all keep working in this direction, I think we can regain that trust that was lost. So I think it's a fair criticism, and you don't turn an aircraft carrier on a dime; it takes time. But with Chair Yellen in charge and people like me and others marching in the same direction, we can do some good.
Do you think TBTF would still be an issue if executives had been prosecuted?
Probably less so. Let me go back, though — the reason we're doing this "too big to fail" initiative is in response to a risk that I see and making sure that people are informed about that risk. The politics are a coincidence — the political environment we're in happens to be coincident with the need to do this analysis. So I don't think if people got prosecuted, we wouldn't need to do that analysis. I do think part of the anger around the country on both sides of the aisle is the fact that nobody was prosecuted.
Yesterday at the town hall, I was asked why no one was prosecuted. Were they not prosecuted because the Justice Department was looking out for the big banks, or did the prosecutors not have the tools? I'm not a lawyer, but my gut tells me it's the latter. I think prosecutors are a pretty ambitious bunch — if you get selected to that job, you've got some ambition. I think if there were cases that were easy for them to make, I think they would have pursued them. But they don't apparently have the tools.
There's an example of a food industry where they cut corners and their executives are in jail now. They found a way to prosecute people and put them in jail, not just fining the shareholders. What does fining the shareholders accomplish? Nothing. So something needs to change, and if that means Congress needs to give prosecutors more tools to prosecute the executives who are committing fraud or circumventing controls, then we need to look at that. I think if we had a president — of either party — who made it a priority, I think there is interest among both Republicans and Democrats to do something. I think you could get something done.
Congressional Democrats last week sent a letter to Fed Chair Janet Yellen criticizing the process for nominating regional bank heads and generally calling for a more diversity in the Fed system. Is that a problem, and if so how do you solve it?
It's a concern because, for the institution to have credibility with the people we represent, we have to reflect those people. We need to make sure that we earn that trust and we maintain that trust, so I do think it's important. I think the Fed attracts world-class people all across the organization, so what we are all working very hard to do is to maintain the quality and make sure we have more diversity.
I'll give you an example: In the economics profession, African-Americans are massively under-represented. So when the Fed is hiring Ph.D. economists — whether it's in Minneapolis or throughout the system — it's tough, even though everyone genuinely wants to make sure the staff here at every level is more diverse. It's something we take very seriously and we're all working very hard — starting with our board of directors and who gets appointed to our boards. I think we all agree with the spirit of that letter, and we're all going to work very hard to try and make that happen.