and more nuanced than anyone knew at the time that he was rising in florida politics. >> how much does he control his image and his access ability? >> at a certain point you lose control of your image because so many people are talking about you. he is a person who has been able to establish a persona in the political realm and establish it effectively, but when there are dozens of newspapers and magazines taking a crack at training who you are and what you are, his only inevitable staff, the image that the public is to consume would take on more facets than maybe he would like to take on. >> the book is the rise of marco rubio.

>> now on booktv thomas stanton argues the main difference between companies that successfully made it through the 2008 financial crisis and those that didn't was the willingness of upper management to listen to feedback before making decisions. this is about an hour and 15 minutes. >> good afternoon and welcome to the cato institute. i am the director of financial regulation studies at cato. i am also honored to serve as moderator for today's book form. reading press coverage of the financial crisis one comes across phrases such as banks did this and banks did that. these generalities, there was no response to the financial crisis or events that preceded it. to confirm took different approaches and several ceos and their boards made poor decisions, others made good decisions, prudent decisions and sometimes brilliant decision that not only saved their firms but about and to gain market share come out stronger than

ever. in my own riding i tend to place considerable emphasis on the poor public policy choices that caused this crisis it is important to keep in mind not every bank responded in these policies in the same manner. consider for a moment the role of monetary policy leading up to the crisis. the federal reserve engineered a steep yield curve that provided firms with incentive to borrow short and lend long. i wouldn't say it was an exaggeration that bear stearns was largely done in by the extreme mismatch in assets and liabilities. the book discusses the strategy of goldman. it ended up being more stable. the book discussed today, why some firms try and others fail is fundamentally about why different firms made correct decisions while others did not. it is particularly appropriate that the book forum is being held at hayak auditorium and

although the authors does not directly say that, the court issue identified the book as one that is essential to his work, the use of knowledge. at the risk of overgeneralization was separated successful firms from failures was how well management utilize the first information within both their firms and the marketplace, firms that failed were largely those where management was insulated and dependent exclusively on their own knowledge. firms that succeeded were those where management harnessed information within their firm by creating effective feedback mechanisms. the author, tom stenson will provide us with homeland which firms were able to utilize this information, this knowledge dispersed within the firm. when i came to washington after finishing my doctorate one of the first books i was exposed to was calm's 1991 book the fate of risk, the government sponsored residents in the financial crisis. tom was years ahead of his time and his predictions came out to

be all too accurate. he has a long track record as one of the most foremast forecasters of the state of the financial-services industry. when he is not writing a book he spends his time as a fellow at the center for dance governmental studies at johns hopkins university. tom also served as staff from the financial crisis inquiry commission and in my opinion there are a few things i would disagree with the commission's findings one thing i know for certain is the commission's report is stronger because of tom's involvement. the book today is also informed largely by tom's experience on commission staff. we are fortunate to have with us alex pollock to offer his thoughts on the book. he is president fellow at the american enterprise institute. i got to know alex the decade ago when he was president and chief operating officer of the federal bank of chicago, a position he held from 1991 to

2004 and i would say i have found in to be one of the most insightful commentators on the financial service industry so with that i will turn the podium over to tom. >> thanks, mark. good afternoon. i think it is afternoon. it is a real pleasure to join you at the cato institute. i am extremely grateful to kato and want to express my thanks. years ago i wrote a monogram that raise questions about the financial soundness of fannie mae and freddie mac and i wrote the book that mark alluded to, a state of risk:will government sponsored enterprise be the ninth next financial crisis? fannie mae and freddie mac did not like that and they didn't like my book. >> and they didn't like you. >> and suddenly it became a little chilly and catherine england who at the time was head of regulatory affairs at cato invited me in out of the cold and said why don't you present

when you have found and what is happening? came to a luncheon meeting such as this. there were a number of senior federal officials who had taken g f ts for granted and suddenly we were launched to sound the alarm and to reform the structure and oversight of government sponsored enterprises so i am very grateful to kato. unfortunately as peter wallace and has pointed out, our largest financial institutions today are like government sponsored enterprises. they benefit from the belief that government will bail out there-holders. shareholders may like high risk bets, particularly high leverage because they get higher returns from those high risks at least until something goes wrong. by contrast, debtholders have

traditionally been a force for moderation in the marketplace because they only get a fixed rate of interest whatever the debt obligation promises and when the company starts to take more risk, it is managed. but implicit government backing of the deaths of our largest financial institutions mean that this market discipline has suddenly been undermined. so today i want to talk about my new book, while some firms thrive while others fail, this builds on my work at the financial crisis inquiry commission. we studied internal documents. i can't tell you how many, from financial institutions and their regulators, interviewed ceos risk officers, bankers, traders, regulators, publishingmakers and other people to try to understand from everybody's perspective putting it altogether what went on here and in 2010, we were still in a

stage where people on wall street and in the financial system were in shock and pretty ready to tell us their story. i don't need to tell you particularly looking at the younger age of this audience that the financial crisis was immensely expensive, with pervasive effects in the country, maybe ten million households are going to you lose their homes to foreclosure, house prices declined, where almost a quarter of homes are worth less than the mortgages on the property, the unemployment rate doubled, millions of people lost their jobs, median household wealth fell by trillions of dollars, the poverty rate rose to its highest level in 17 years, graduating students have a lot harder time finding appropriate work than ever before. much of this damage might have been avoided or at least

mitigated by better governance, risk-management and better management generally in both the public and private sectors. perhaps the most important task before us, and what i tried to do in writing this book is to understand the expensive lessons of crisis for public and private institutions and how we can avoid these mistakes in the future. in the book i try to understand the differences between four major firms that successfully navigated the crisis and eight that failed or required government support to stay afloat which in my book is failure. i studied four surviving firms, jpmorgan chase, goldman sachs, wells fargo and toronto dimming the bank which since the crisis appeared in washington a number of street corners. jpmorgan chase's story is preparing the company in advance to be strong enough to take

advantage of long-term opportunities. goldman's is a firm wide system with capacity to react quickly to changes in the environment and then of course tripping heavily over reputation low-risk. wells is a company with a culture of customer focus and restraint, and td bank provides a simple lesson, if you don't understand it, don't invest in it. each of these terms apply strong governments, good management, operational confidence and discipline but with different approaches. some of these firms have serious problems and jpmorgan chase actually lost the dollars in a london office in an event that reveals poor risk-management but the point here is these firms have successful strategies for weathering the crisis. there's a huge difference between taking a large loss such

as jpmorgan recently took and having the company failed. the companies that failed the crisis didn't take losses, they went out of business, required massive amounts of taxpayer aid and entered mergers and ended their existence as independent companies. unsuccessful firms included fannie mae and freddie mac, bear stearns, lehman, merrill lynch, citigroup, wachovia, ubs, aig, countrywide, and wamu. with variations they exhibited similar shortcomings in organization governance, and management. many of these institutions have become so unwieldy that they were virtually impossible to manage. managers may have profited from conglomeration into organizations, it is not clear that this massive size benefited market eat fish and sea or the

financial system or firms that failed their shareholders. we forget how large our financial conglomerates actually are. in 2008, citigroup, with 350,000 employees and nearly 2500 subsidiaries, was the largest complex financial institution. aig, smaller than most of the major firms comprise some 223 companies that operated in 130 countries and had 116,000 employees and in my book i try to share with the reader how complex these firms are and the aig organization chart, their small compared to large complex financial institutions, take the four pages of fine print and a huge number of organizational boxes. we governance compound the

organizational shortcomings, overbearing ceos dominated week boards that failed to uphold the duty of since -- respectfully challenging management to provide feedback and proposed limitations and probe limitations of proposed management initiatives. another characteristic of unsuccessful firms was their pursuit of short-term growth without appropriate regard for risk. in 2005-2007 both fannie mae and freddie mac decided to increase their purchases as sub prime in all they mortgages just as home prices peaked and declined. other firms, lehman and wamu decided to increase risk around the same time. some firms, countrywide, aig and citigroup continued the blind pursuit of market share without regard to changing market circumstances. where were the regulators? to say the least government actions before the crisis were

seriously inadequate to protect against the economic debacle. not unrelated is the fact that the financial insurance and real-estate sector was by far the greatest source of campaign contributions to federal candidates and parties contributing almost half a billion dollars in the election cycle 2007-2008 alone. the financial services industry too often used its clout to lobby for government policies that ultimately hurts rather than benefited major financial firms. classic was the way fannie mae and freddie mac fought for years against more capable supervision and better capital standards that might have saved them from making bad decisions that destroyed the two companies in 2008. the industry's political strength impeded other supervisory actions as well such as the efforts of regulators to

try to eliminate excessive lending in non-traditional mortgages for commercial real-estate. the question then becomes whether from the perspective of organization and management there's any major recommendation that if well implemented could have allowed more firms to survive. .. >> requires what my back calls -- my book calls constructive dialogue. if i may borrow a phrase, feedback is a gift. doubts and dissent need to be

seen as offers to rethink a preliminary decision before it potentially causes harm. in the financial sector, successful firms manage to create productive and constructive tension between those who wanted to do deals or offer certain financial products and services and those in the firm who were responsible for limiting risk exposures. by creating a respectful exchange of views among these divergent perspectives, successful firms freed themselves to find constructive outcomes that took the best from each point of view. instead of just simply deciding to do a deal or not, successful firms considered ways to hedge risks or otherwise reduce exposure from doing the deal. successful firms created opportunity for constructive dialogue between ceos and their boards, ceos and their top management and between revenue-producing units and risk officers.

the unsuccessful firms pursued revenue-producing ventures without constructive dialogue with those concerned about risk. my favorite example is a credit officer at fannie mae who went to his boss saying we're buying these mortgages, and we're really paying too much given the amount of risk they contain, and the boss said to him can you tell me why you're the only person many this company who believes -- in this company who believes in your model? they disregard it from the risk officers. freddie mac in 2005 fired his ceo, his chief risk officer just as the company increased its risk taking. lehman's ceo fired its risk officer in 2007, and by contrast because of their application of a constructive dialogue and a robust sense of the risk she reward trade-off, many times they refrain from lucrative but

risky types of products and transactions that seem to be making so much money for their competitors. constructive dialogue was ingrained in the company's culture. this also, this pattern also applies to nonfinancial firms. my book discusses decision making and costly mistakes such as the bp gulf oil spill, fatalities at the massey mining company and hospital medical errors. failures at nonfinancial firms show the same patterns of overbearing or distracted ceos or others such as doctors who make poor decisions without obtaining feedback. cultures that emphasize production without adequate consideration of risk and inept regulators. ceos of large, complex financial institutions need feedback from capable sources. my suggestion here is to apply constructive dialogue to relations between large, complex

financial institutions and their supervisors. while regulators may not have the expertise available to large, complex financial institutions, they're in a position to ask simple questions such as about the amount of capital that a firm has allocated to back potentially risky activities or whether the firm or is lowering standards to meet aggressive goals for growth, or the question someone should have asked about chase's london office while it was making large profits and before it took its $5.8 billion loss this year. are you making all of your money because you're the smartest person in this highly competitive market, or are you simply taking more risk than everyone else? feedback from regulators can improve decisions merely by posing the right questions and pursuing the answers. constructive dialogue is a two-way street.

feedback isn't worth a lot if it comes from an inept source. regulators need to be open to input that examiners who are engaged in checking the box compliance drills without understanding the real risks of the company's business. or that there are too many examiners from multiple regulators on site without a focus on the most important issues. or that particular examiners are not open to constructive dialogue. constructive dialogue can improve decision making all the way around, help to improve quality at both the regulators and the firms they supervise, or as ceo edmund clark who successfully led td bank through the crisis argues, there must be, quote: productive working partnerships between the industry and its regulators enabling both parties to agree in principle on what needs to be done and on the least intrusive way in making it happen.

my book cites testimony of shell oil company marvin odom to the deepwater horizon commission that was investigating the bp gulf oil spill. he said, quote: the industry needs a robust, expertly-staffed and well-funded regulator that can keep pace with and augment industry's technical expertise. a competent and nimble regulator will be able to establish and enforce the rules of the road to insure safety without stifling innovation in commercial success. rex fullerson, chairman and ceo of exxonmobil, told the deepwater horizon commission much the same thing. observations about the petroleum industry apply to the financial sector as well. to improve both our public and private institutions, we need to have higher quality supervision aimed at improving decision making in the industry and, thus, greater economic efficiency.

regular laters are not -- regulators are not always right. rather, we need regular laters that are capable of offering high quality feedback to our largest financial institutions so that through constructive tensions with their regulators firms make improved decisions that take account of long-term sustainability and not merely short-term profits and bonuses. this can free us from some of the sterile debate about whether there's too much regulation or too little. the results of that debate, i respectfully suggest, are thousands of pages of laws and regulations that are unlikely to forestall another financial crisis in the future. indeed, government rescues of large, insolvent firms couple with the the substantial compensation that ceos and senior managers of failed firms manage to keep for themselves mean that once the economy returns to a semblance of

health, incentives to take uneconomic risks may be even greater than before. opening constructive dialogue on thesish b shoes will not -- these issues will not be easy given the current atmosphere in washington but would seem well worth the effort. thank you. >> thanks, tom. [applause] alex is going to offer a few comments. >> thanks very much to mark and cato for giving me the opportunity to comment on tom's very interesting and very useful book. i say that as having been a practicing banking executive. overbearing ceo, eh? i was a ceo for about 14 years. i wonder if i was overbearing? surely not. tom in his book cites frank knight's risk uncertainty and

profit, a deservedly famous work from 1921, and i consider tom's theme to be how to address the reality -- stated thus by knight -- uncertainty is one of the fundamental facts of life. it is ine rad call from business decisions. one interpreter of knight expanded on this a little bit. he said, as knight says, most business decisions -- especially strategic ones -- are to varying degrees steps into the unknown. each of the possible outcomes of a business venture can be considered to have some probability of curing, but these probabilities are not known to the players or to the decision makers. now, b you really to get knight right, you have to change that sentence a little bit. these probabilities are not known and cannot be known.

to the players. and this is knightian uncertain my. indeed. so how some firms thrive while others fail can be thought of as how they deal with such uncertainty. and the fact that many things which were considered impossible by many if not most people have a way of, nonetheless, happening. tom gives us a most valuable exploration of this drawing insightfully from many interviews, as has been said, with the financial crisis inquiry commission. but i would point out it is not only firms who have this problem. it's any and all organizations including governments and central banks dealing with uncertainty and the inability to know what the results of their own actions will be. for example, how should the

federal reserve have considered in the early 2000s its strategy, as mark referred to, of encouraging a boom in housing and trying to cause housing prices to rise in order to produce a wealth effect to offset the then-recession? how, what kind of internal debates and risk management should the federal reserve have had? now, the personal accounts of discussions and arguments about the risk keyness of -- riskness of actions in tom's book is deeply instructive and displays the amount of uncertainty involved in such discussions. it reminds me of my old friend, minsky. tom cites minsky in the book. we used to have very interesting discussions while he was still alive, and he told me one day -- and i think he never published this story, he told me this in

person. he said, look, the economic and financial system is made upover two fundamental -- made up of two fundamental types, and minsky called them entrepreneurs and bankers. he said, now, entrepreneurs are warm, optimistic, energetic, risk-loving, self-confident, able to leap tall buildings in a single bound, and if they're successful, they show that they actually can do all these things. bankers in the minsky world need to be cold, rational, pessimistic, cynical and worried about the risks. said minsky to me, well, a healthy economy or financial system is the result of an ongoing dialectic or balance between these two fundamental types. i think we can see a lot of this in tom's book. now, this is underlined by a

description in frank knight's risk uncertainty and profit of the entrepreneurial type. knight says most men have ab irrationally high confidence in their own good fortune. not the inherent bankers and risk managers, but many people. an irrationally high confidence in their own good fortune, and this is doubly true when their personal prowess comes into the reckoning, when they are betting on themselves. there is little doubt that businessmen represent mainly the class of men in whom these things are most strikingly true. these are the entrepreneurs. they are not the critical and his tax individuals -- hesitant individuals whom they have described as the weak-kneed naysayers and what not. but rather, those with restless energy, buoyant optimism and large faith in themselves in particular. and this is the entrepreneurial type. and these are exactly the

characteristics which allow the entrepreneurs to achieve great things and, also, to go broke. this is, fits in this great quote that's in tom's book about a long history of success is the biggest precursor to failure. well, think of what the successful entrepreneur has learned. he's learned that when i have all these helpers around telling me i can't do this, too risky, it'll never work, and i do it anyway and i succeed. so how does he look at all these advisers in the entrepreneur's eyes who want to tell him next time you can't do it? we have to ask ourselves what happens to minsky's dialectic or balance between the entrepreneur and the banker, which i think is such a nice way to think about this, when the entrepreneurs take over the banks? and this is the point minsky was

making. so when this entrepreneurial type takes over the bank that's supposed to be the risk-avers, cynical, worried about risk type, well, what do you get? well, you might get a, you might get a bubble. and what can you do? well, then you have to reproduce this dialectic of the entrepreneur and the banker or the optimist and the pessimist or the, or the i can do anything versus the worrier and the focuser on risk to reproduce this with a discussion inside the bank or between the bank and others outside. and i think tom's book is really helpful in exploring how one might do this and how important it is to do this. as it happens, there are a lot of -- well, that's easy to say but, in fact, it's hard to do. that's why we had four successful firms and nine

failures? >> actually, there were more of each, but there were -- [laughter] among the big ones, the failures really stood out. >> and one of the problems is this great saying of keynes that the market can stay irrational longer than you can stay solvent. so, for example, if you were betting against housing for a lot of years, you'd have lost a lot of money. and today with the federal reserve's manipulation of the bond market how many times can you be crushed betting against bonds and being sure that bonds will ultimately spike upward in yield, which they will, but how many times can you be crushed as many people have been worried about the risk before you give up? so we have the problem that when you cry wolf a lot of times and the wolf doesn't come, you lose credibility as a warning, as a warning device. but remember that in the great old fable of crying wolf in the

end the wolf does come, and in financial cycles the wolf does come. now, this problem of creating the internal dialectic or balance between the entrepreneur and the banker or the entrepreneur and the risk manager comes out nicely in some memoirs by louis xiv which he called difficulties surrounding kings. he talks about being king and having to confront the number of murmurings to which kings are exposed. force of character, he says, is required to keep always the correct balance between so many people who are striving to make your judgment incline to their or side. each one of them applying himself wholly to give an appearance of justice to what he is seeking. that's true. and as tom suggests, one of the things that you have to do if you're going to do this right as

any organization is to have the right inner circle around the ceo or the chairman or the leader. what is the nature of this circle? it's a circle who's not impressed by the drama with which the leader leads everybody else. you have so surround yourself not with people who love your drama and the great charisma that you have created, but who know you well enough to know that's all nonsense. you may be good, but you're not that good. and they will tell you the truth and will fill in your inevitable gaps and mistakes and the inevitable gaps in your own knowledge. well, that's, you know, that's asking a lot of human character, to build an iper in group like that -- inner group like that. but i think that needs to be done, and that's one of the most important lessons in the book. now to conclude with this thing

that has to be done which is really powerful if done but is not easy to do, tom's book shows that it can be done with the examples he cites. and as tom says, this is completely different from -- as you just heard him say -- thousands of pages of laws and regulations. that isn't what will do it. what will do it is building this minsky-esque dialectic or balance of the fundamental types of thinking around the, around the inevitable and unavoidable uncertainty faced by all organizations, or to sum it up, how do we make sound judgments in the face of uncertainty? >> well, thank you, alex. i wanted to, first, see if tom wanted to have any comment on -- >> should i stand or sit? >> whatever makes you comfortable. >> i'm totally comfortable with either. why don't i stand just so i can

see people on the other side. um, there's a lot of wisdom in alex's discussion, and i'm particularly delighted with louis xiv. [laughter] alex mentioned central banks making mistakes. i personally interviewed a number of senior fed officials, some retired, i guess most of them retired at that point. who said that when chairman bernanke for whom i have a lot of respect for what he and secretary paulson did to deal with the crisis after it occurred, but in spring of 2007 chairman bernanke made a speech, and he said this subprime crisis, this is going to be confined to the housing market. what we found in our interviews was that the economists had all done their calculations within the fed and said, well, these

are small numbers compared to the size of the banking system, the number of subprime mortgages is small enough, everything will be fine. the supervisors, the examiners, the people that go out and oversee safety and soundness of banks at the fed who are really second class citizens in the fed's culture and structure were screaming we've seen the balance sheets of these institutions, they're highly leveraged, excuse me, they can't take the hit. because there was no constructive dialogue or dialectic as alex would put it between the, excuse me, between the economists and the supervisors, came bernanke -- chairman bernanke made his optimistic statement without understanding that the supervisors had an awful lot to contribute to his knowledge and what he should have foreseen. so what i found in a number of

organizations public and private is what i call -- i don't put it in the book this way -- a layer of cork between the top of the organization and the bottom. you can see it in the nasa space shuttle disaster where the front line engineers, both of them, incidentally, where the front line engineers knew there was a problem, and somehow their concerns run into a layer of -- excuse me -- cork. and all of a sudden these people are not able to get their opinions heard or listened to by senior management. and that can be the source of an awful lot of problems. and i think that's the kind of reality that a bank examiner should be looking for rather than all of these formalities that people are insisting on now in terms of dodd-frank. i filed a comment with the fed because they've talked about risk management, and they want

to have a new rule for large institutions that says your board should have a risk committee, and there should be somebody on the risk committee who knows about risk. [laughter] and i said, yeah, exactly. i said, hey, jpmorgan chase had a risk committee and had somebody on the committee who knew about risk, and they lost $5.8 billion. you don't want the formalities of risk management. fannie and freddie had risk management committees with the responsibility for risk management on their board. so did lehman. what you want is to look at the realities. i i have the general counsel of a large successful firm before we were arranging the interview with this ceo sort of downloading on me about how awful it was that their regulator was insisting that they have as a formal risk commander to do things in a certain, formalistic way when they were doing very well, thank you -- and they were doing well.

-- true a quite decentralized structure and quite a different way of doing business. so my bottom line is we've got to look for this dialectic, we've got to look for the quality of the decision making process. in both our or public and private institutions or else we're going to be in trouble, and dodd-frank doesn't really do that. >> thank you, tom. and i would say that's, you know, one of the reasons why maybe a few people would read the book and sort of see hayek in there because it is about the decentralization of knowledge. and i would agree that i think one of the flaws of dodd-frank is that attempt to really just if we just centralize all risk and all knowledge in one place, somehow it'll work. and, of course, has repeatedly not worked. i'll note as an aside, i appreciated the comments about various boards. you know, people forget that enron, for instance, was compliant already with always sarbanes-oxley auditing board requirements, so it would not have made a difference. i do want to ask because i think

it's helpful to get a little background what led you to pick the firms you did for both the failures and successes? was there a process, or was there sort of this is just sort of interesting? >> nice question. um, we started out, and i was looking all over for successful firms. and i remember asking about a number of firms and sort of making preliminary contact. for one reason or another, they weren't relevant to what we were looking at. the commission was looking at a range of firms, so that gave me my opening. so when we interviewed fannie mae and did what we called a deep dive, really going down from the ceo through people in the inside of the organization, that gave me one firm. and then we didn't have time for it, we only had a year to finish our work, and we were on a very tight budget. um, but i insisted that we do some studies of freddie mac, you know, let's find out what the

parallels are. so we interviewed a number of risk officers at freddie mac and the ceo and others. and it sort of built out. and when i sat back at the end, i looked, and the one institution we didn't interview was td bank in canada. and, of course, bb and t as you pointed out. we didn't interview td bank, but i started looking at their financial statements. and in '04 they said we're loading up because america, united states subprime mortgages are a really great deal n. '05 they said we've decided to get out of the american residential mortgage market. in '06 today wrote we've taken losses, over $100 million which was a lot for that company, but we're out. in 2010 edmund clark, the ceo, gives an interview, and he says, you know, we got out of our exposure to subprime, and all the stock analysts wrote that i

was an idiot. [laughter] so i sort of collected as we went some comments are, unfortunately, off the record rather than on the record. i mean, in term ors of alex's point that the market can stay irrational longer, and he has a marvelous twist on that quote in the book, longer than you can stay employed, i interviewed one risk officer of a major company, and she said to me, you know, i had two choices. either i was going to be pain in management's neck, or i was going to be known as a risk officer at a firm that blew itself up. so she left in '06, and the firm cratered in '08. it is really hard to be a risk officer, and that's why i get back to the role of supervisors. cliff rossi, who is, was a risk officer at a number of different organizations that failed -- citi, wamu, countrywide, freddie

i think it was, i think fannie too -- he says that when he finally went to the university of maryland, he was going to get a medal for protecting the financial system. but he basically says what a risk officer needs is air cover. now, if this -- i'm not saying the risk officer's always right. but it's you've got to have this conversation to figure out, to make a robust decision. and if the ceo doesn't want that, then as far as i'm concerned the supervisor's almost the only person left with enough clout to get it done. so what i recommended to the fed -- who knows what they're going to do. what i, i'm used to my recommendations not being heard. >> you and me both. >> what, what i recommend to the fed is that they send their examiners into these institutions, and they say, okay, show us major company

decisions you made over the last year and show us where you adjusted those decisions with input from the board, input from an engaged management team, input from the risk officer, hen forbid -- heaven forbuild, input from the regulator. and look for the realities of decision making rather than just the formalities. >> and i would emphasize i think this is an important factor at any institution. you know, there was some press the last couple weeks about looking at tim geithner's phone log, and it was, you know, the same people repeatedly. and, of course, i've seen similar thicks where they've -- things where they looked at paulson's during the crisis. we have our new president here at cato from bb and t, you know, i talk to commercial bankers, and many of them said they had an impossible time talking to geithner. so i do think it's important you get in these group-think situations and, of course, painful to say this as an

economists, it's one of the problems when the fed is stacked with economists rather than having a diversity of viewpoints that challenges the conventional wisdom on things. i have a number of questions, but i do want to see if there are questions from the audience first. i think we have one over here. and, please, identify yourself and, please, keep anytime the form of a question. -- keep it in the form of a question. [laughter] >> mark -- [inaudible] that little admonition is one, of course, i hear from alex all the time at aei. [laughter] tom, i've just purchased the book and look forward to reading it. but, um, and you and i have had some discussions along this in the past. it seems to me that you feel that at least in the financial services sector that regulation can be made to work. and yet i'm not aware of any instances where it really has worked. in any meaningful way. and i think financial history

not only recent, but going back further in time, is replete with examples of failed regulation. can you point to any situation at any time anywhere in the world where there has been successful financial services regulation particularly with regard to safety and soundness issues? because i'm not aware of any. >> i don't want to get into the discussion of canada versus the united states, but they're probably a decent model. i want to flip it around, burt, because i agree with you. what i struggled with in this book was what would work? i mean people, for example, have recommended wreaking up banks -- breaking up banks. and i don't think it's just size of banks that's important, i think it's the complexity of these institutions that makes them unmanageable as well. but in terms of reality, i just didn't see that happening in the near future. so what i was grappling with was how can we make regulation more

intelligent. it's a suboptimal solution potentially. but if your regulators are worried about improving the quality of decision making, that's a force for greater, not lesser market efficiency. and that's what i was struggling with with this proposed solution. that we had looked and we had tried -- i mean, look where we're at. in the financial crisis, the retail markets -- because we have deposit insurance -- we didn't have lines of people standing outside of pappings trying to get their -- banks trying to get their money back. the panic and the lines of people trying to get their money back was electronic in the wholesale market. because all of a sudden losses occurred. everybody had been on this happy bubble, and losses occurred. i don't know what's on my balance sheet for sure, i don't know what's on yours, so i'm going to get my money back as fast as i can. and so one of the solutions that i see happening now is that with

these large, complex financial institutions government has said, okay, we can't afford that kind of panic again. and so now the whole market is going away from market discipline rather than towards it. so it's that context where i'm trying to grapple with what's a reasonable solution that you can really convince these people to implement, both leaders in the industry and in government, that might work. >> you know, as someone who shares burt's skepticism on regulation, i do think to me there is powerful takeaway of the book, it's the knowledge part of it. it really got me thinking about traditionally we think about the real problem from too big to fail is you're going to get a funding advantage, you're going to run your rivals out of the market, great market share. this is another issue which is if your creditors feel like they have something at risk, they're going to exercise their voice when they talk to you. you're going to get, you know,

the bondholders saying to the management we don't think you're doing things correctly. but certainly in a too-big-to-fail world you've really eliminated that information flow from creditors to management that i think actually makes for a dumber corporation. >> yeah. >> right here. >> my name is stephen short. you did not mention citizens united, and i'm just wondering -- i'm not talking about the legal right of corporations to contribute to the political process, but whether any analysis has been done as to the consequences of such involvement and whether that made the situation worse with. >> with citizens united, i believe, was after '08. so it didn't have an effect on the crisis as such. it may well have -- well, it's campaigns, and we're only just in a campaign cycle being

influenced by it. so i think we're going to have to wait til we're down the road a bit to get the implications in terms of practical results. but it is clear that the financial services industry had a large hand in the writing the rules that we got in dodd-frank. and one of my favorite examples just if you want with a emblematic example is the financial stability oversight council where we finally decided we need one group that is going to be overseeing financial stability, and what do we do? we created a council of 15 members. and each constituency has a regulator on that council either a voting or nonvoting member. that's not a way to run a railroad. and dodd-frank is filled with that. so although we didn't see the effects of citizens united, i think we did see the effects of con

constituency influence. >> there was a question here in front. that microphone to the gentleman in front. >> yeah. i'm the ambassador to barbados, but i'm wearing the hat now of a former chase banker and been through the credit school and worked for several banks and been ceo of a bank. the one thing i thought was very interesting in our discussion, the thing that i would like just to point out, though, is i don't believe you can regulate good decisions. i don't believe you can regulate greed. and what i found is this, is that you talk with the risk person at the bank or the ceo or someone making the decisions. i can assure you the ceo pretty well knows the risk he's taking. but sometimes you get, people get boxed into situations where they don't have choices. by this let me to one step further -- let me go one step further. i've been in a situation where you had a result last year, you made x amount of money, and you had a peculiar situation that

created that situation. so you had a bumpy year. do you think that the board or the shareholders take that in consideration? you've gone from this level of profit to this level. guess what? next year you're going from this level to that. well, that's where these things became problematic. because what's going to happen, the ceo and everyone is going to fiddle here, fiddle there, and at some time it will just explode because of the growth factor. i've had one time the ceo of a largest processing company, and he comes and visits, i was chairman of a little company, and he didn't even ask to look at the financials. he didn't even visit the company. we sat down in a room and made us an offer based on one thing; what are your saleses? because the market had told him that he needs to get more market share. and so he just was going around gobbling up -- so these are

things that, you know, there is the i don't know whether you call it greed or whatever, and that's tough to regulate. >> whether um, i agree. -- um, i agree. one of my chapters asks will it happen again, and that's a question, not an answer. [laughter] i'm just trying to push it off a little and maybe mitigate some of the circumstances. you're absolutely right. there are all sorts of dynamics that make a really hard to govern well, but, for example, we interviewed the chief risk officer at wells fargo who had gone in and found some units that were operating not with a particular fact pattern you talked about, but basically going for a little more returns tan they deserved. and, of course, it's always a red flag if somebody's simply going for market share. pause there's no natural limit to going for market share.

you're always going for more. and today actually replaced a couple of heads of major units because they were concerned about that dynamic. that's a well-run company. now, chase before the crisis was a well-run company. fortunately, um, jamie dimon had a concept of fortress balance sheet, so when there were serious problems in terms of risk management and one worries that-hubris more than anything else after the crisis with the london office, they could take the $5.8 billion hit without going into the kind of problems that caused other companies to fail. but i agree with you, it's really, it's not easy. >> and it seems like to some extent, again related to too big to fail, a lot is driven by the equity holders which tend to have very different interests than the creditors. of course, if we take the creditors off the table by saying you're going to get

bailed out, then you are shifting to that attitude. before we get another question -- >> could i just make a comment, please? >> oh, yes. >> there is this both in the question and the answer from equity markets, but i think it's important to realize the people we call the shareholders or the equity holders, those individuals are, in fact, not shareholders or equity holders, they're hired managers of somebody else's money. >> pension fund money managers -- >> they're managers. or they're union managers, or they're pension fund managers, or they're mutual fund managers. but they themselves are agents running to quarterly returns and liable to lose their job if the market stays irrational. and i don't think our discussion of the interplay between financial markets and financial firms has really understood that fact. >> but i would 100% e agree. i think a big driver in some of this that has not been examined

to the extent that it has is this sort of institutionalization of our retirement system where there are all sorts of governance failings in the pension fund industry that lead to that short termism. i do want to ask what i think is sort of a macro question given that part of the title of the book is fail or failure. um, i depress i want to ask -- i guess i want to ask, we repeatedly see places like citibank where we've bailed it out three times so far. so the economists in there; you know, wants to ask the question are we being overly optimistic thinking that firms are going to be able to change their culture to one that discuss encourage that display of knowledge, or should we sort of rely more on that firm has a bad culture, it will fail in the way we get rid of that culture is good culture expand and take over market share. and, obviously, we short circuit that in the financial services industry by not letting lots of firms fail when they should. so i guess my point would be

what do you really see the role of failure in this? >> failure's really important. the trouble is that when you've got a financial panic that as bernanke said -- and this is in david russell's book, and i, the people we interviewed believed it, that we are about to go into depression 2.0. they're going to bail out everybody. and so at that point failure falls back to the taxpayer and to inefficiencies in the financial system rather than if it's shoe companies or -- >> well, i guess i would say consistent maybe with the theme of the book is that if you only talk to firms that look like they're going to fail, then many of them will tell you, yes, the world's going to come to an end if you don't bail us out. >> the wisdom of what happened after the crisis, we were trying to look at what led to the crisis. in terms of citigroup, charles prince who was the ceo famously said -- he had sort of a sense of humor -- citi doesn't have one good culture, it has five or

six good cultures. and this goes to what i was saying about complexity. particularly these firms wamu, others that grew by acquiring other firms end up with an undie jest bl mass unless to build on your hayek use of knowledge, like jamie dimon, you slap all of your organization into a common information platform so at least you can see enterprise wide what kind of positions you're taking. >> you also have the problem of the -- [inaudible] platform. that is to say you had all this information being shaped by some understanding of what the problem is, and that's where -- as you so nicely say in the book -- we have the problem of cognitive herding. cognitive herding by firms, by governments, by central banks, by anybody. we all think about the problem in the same way with the same

categories. and that's really a hard problem to diversify. it's actually a nice hayekian problem. >> i think we had a e question here in the front. i want to make sure we goat to this gentleman. >> thank you. i'm hans from johns hopkins/sais. if i heard you correctly, what you're arguing is that we should, regulators should be focusing less on the risk management institutions of a bank, but more on the risk-taking culture and the risk management culture, who's talking to whom and so on? now, the problem with that is that as an outsider it's quite hard to even understand what the culture is or even, or even to go in to regulate these things, because it's hard to measure, right? you can't -- how do you -- what criteria would you, would you put in place to accessoriesing management cultures? could you maybe give a couple

concrete examples how regulators could go into banks and prove these cultures to try to prevent bank failures? >> well, my potential takeoff point and one would hope it would evolve was to start at the top and get the bank or the institution to say, okay, in the last year here's a major decision, here's how we modified that decision based on input. you want to show that people are willing to listen. herbertalson, who was of -- allison who was at treasury and a number of private sector positions before recommends for the board that the board undertake, sort of send questionnaires to people at different levels of the firm to try to get an understanding of their culture. and one of the best studies that i saw while i was at the commission was on the regulators' side, and that was the federal reserve bank of new york that published a survey

they did, and it was anonymous that quoted all of their examiners. and when you heard the culture of those examiners like be sure you don't do anything that gets you into trouble, don't rock the boat, et, you knew what that culture was about, and you knew that those aren't the people that can do much more than check the boxes. so, um, it's not easy, but i think we've got to start down that road. and there are tools that one can apply. >> um, right here in the back. >> hi, tom, vern mckinley. want to move on to one of your specialty areas, fannie and freddie, which pops into mind when talking about cultures. i mean, here we are four years later, they're just as big as they were. freddie's slunk a tiny bit. fannie's about three trillion, about where it was a few years

back. no plans on the table to definitely wind either one of them down. i know in the '90s you had proposed some road maps to get them wound down. do you want to update that if possible? the do you see any possible way -- do you see any possible way they could be eased back into the private sector over a six-year, eight-year, ten-year period, or is it kind of a lost cause? >> when i spoke at cato, and i think it was 1989 after coming out with my monograph, bill necessary cannon who was the head of cato at the time, after the talk we sort of wandered in the gardennen. you guys had a different -- not quite as elegant as this, but it was really nice. [laughter] and we were talking, and he said how do we get rid of these guys? and i said, well, once you fail, i'm sure you can do anything you want with them. and i was wrong. hopeless optimism. [laughter] i don't have an answer because

hidden in your question is a question of what the political process thinks about the 30-year fixed rate mortgage. if we were willing to say we don't care about the 30-year fixed rate mortgage which simply is such a long-term instrument with a tail on it at least, um, that can't exist in all phases of the credit cycle, then you can come out with one answer about whether we need fannie, freddie or anybody else. if the political process says we do want a 30-year fixed rate mortgage, then what we've got to look at -- and i go back to my discussion with burt -- we've got to look at second best kind of solutions. and there are some. but in the end this one has to be solved on the very highest level. the way that the 2008 law was written only congress can repeal the charter of fannie may and

freddie mac. so that turns it from a policy issue into much more of a politics issue. >> i will note having worked on the 2008 act, you can impose losses on creditors within the framework that's currently in law which, to me, is certainly one of the more important characteristics of a gse. so that is certainly something treasury could have done, fhfa could have done and, certainly, we would have -- i think, in my opinion -- >> would you have done it? >> i would have imposed losses on creditors, absolutely. >> [inaudible] federal housing finance agents, fhfa can put 'em in receivership, fannie and freddie both. >> i recommended that from the beginning, get shareholders out of the equation. because until you take shareholders out of the equation, fannie and freddie are in this anomalous position where the government has, under law, has stepped into the position of the board and management to try to restore these institutions to financial health. and what that means is that fhfa

constantly gets whip sawed with these demands, gee, we want you to support national housing policy, and they come back, and today say, hey, our legal responsibility is to support the gses, and that means tighter credit standards than other policymakers might warrant. in other words, the public/private mix that made the gses so hard for people to deal with in the beginning is continuing to confound people. but i agree with you, i mean, they should be in receivership, and at that point you can make a policy decision on what your debt holders, what happens to them or the mbs holders, mortgage-backed security holders. but you can also begin selling off assets and doing other things. >> before i go to the next question, i will say that the receivership framework for freddie and fannie that was put in place 2008 before their failure is in some ways very much mirrors dodd-frank. so if you believe the orderly

resolution theory in dodd-frank, you need to explain why it did not explain too big to fail. with that said, the woman in front here who's been very patiently waiting. >> hi. anne stone. and i was one of very few women in the southeast united states that helped start and organize a bank, went through the problems. we started at the height of the s&l crisis in '88 which is sort of interesting, to start a national bank at that time. and we're smart enough, we had problems with the culture of personality in the bank and stuff like that that was causing some concern to make it profitable enough that bb and t eventually bought it. so it ended up being a good investment. but i wanted to ask, a lot of speculation was done when the financial meltdown happened that a couple things were tantamount to the drivers of the crisisment one was with the effect of the gses on the primary mortgage market and the percentage of risk that went up from 20 to 52%

under clinton. and the other was the change in the rule, fas rule 157. and i just wondered, you know, how a change in that rule could be done and nobody saw that it was going to devalue all the portfolios of all the -- >> that,. >> that's the mark-to-market. and how somebody could not see that. and second part, as a female, of course, a lot has been written that there would have been less of a crisis if there were more women in the financial markets. >> well, let me answer the last one first. laugh did i, i mean, given what i saw and the conclusion i reached in the book diversity helps, because you've got people from a multiplicity of perspectives. >> [inaudible] >> huh? >> [inaudible] >> i would not want to betray any percentage by saying what women knew.

but i think a diversity on the board, elsewhere is really helpful in a lot of cases. but you can always point to counterexamples. there's a woman who's on the risk committee of jpmorgan chase when they just took their hit, $5.8 billion. so it depends. mark-to-market is really -- what we saw was that certain tools in the hands of the right managers are really good, and that would apply to all of derivatives. and in the hands of the wrong people really don't work. goldman uses mark-to-market, and they do it every night. goldman almost went out of business in 1994 again because of operations in their london office. i don't know what it is about -- >> london? >> -- london. or maybe the regulatory framework. and they got, they created a parallel structure to their traders of what they call controllers. and every night the controller will mark a trader's position to

market. and what that does is it gives them -- and then they roll it up to management. what that does is it gives them a really good view of what's going on. the trouble with mark-to-market generically is that it can exacerbate your cycle. when you're in the bubble which, incidentally, is when you need the risk management, afterwards everybody gets religion. when you're in the bubble, mark-to-market says, oh, your asset values are going up, everything is great. don't worry, be happy. and then when you're in a crunch, all of a sudden the values drop, and you're done. so it's a tool, and in the right hands it's really wonderful. and in the wrong hands, um, it doesn't work at all. and in the end i don't know the answer and would like to talk with somebody with more practical experience, because that's how i learn is talking with people with different

experiences. but you wonder if one shouldn't keep two different sets of books so that you can benefit the investor. and that was really the party that lost in this whole situation. the investor can get a better sense of, um, the quality of an institution and its books. >> i will note, i mean, i've sort of been on the fence about mark-to-market, but i will note you have always, my understanding as a nonaccountant, have the option of whether you held something to maturity and, hence, mark-to-market or whether you held it in your trading book. and for the most part, and i think this is also a symptom of sort of the group think that you got from treasury, because they talk to investment banks on a regular basis which were largely mark-to-market. i mean, goldman's book is 80-90% mark-to-market. bank of america is maybe 15% mark-to-market. so you talk to only investment banks, you come up with something like the t.a.r.p. where you want to buy assets at

below market values because that doesn't work for commercial banks. again, i think there's more flexibility to it there. we have time for one question left, and gentleman over here. >> thank you, georgetown university. my question refers to all the bubble cycle, and reality of prime market is that a lot of investors relied on the rating agencies' ratings. when it comes to taking this portion or that portion, etc. and when you look at how these products were built by the investment banks, they were built backwards. they were looking at what should they put in order to get that particular rating, because they have clients for that particular rating. in other words, the people, the banks are able to recruit very bright people but also give them all the means in order to be as efficient, in order to be able to do things very quickly, much more than what one can have in

the rating agencies. plus they know exactly how the rating agencies work, and they know exactly what they need to do in other chapters' rating, and they don't want to mislead people, but simply they want to extract as much cash as possible. ha's what their job is. -- that's what their job is. so how do you look at this, and how do you think that the rating agencies should behave in the future and what lessons did you take from what's happened in 2008? >> i tried to deal with the rating agencies at least to some extent in the book because you've got to. and i would add to your list the fact that when a particular analyst was really good and really understood things, then they could triple their salary by going and working for an investment bank to go structure products for another rating. it's a really difficult situation. to some extent, when we looked at moody's, you had a sense that a lot of these firms were more

cautious than the investment banks when they were in partnerships, because in a partnership you can lose everything. and then they turned to shareholder-owned companies, and you had a sense with moody's that when they spun off from dunn and brad street and went on their own, they picked up a lot of incentives to take risk. and i have a chapter in the book on sort of organizational structure and how that can shape risk taking. i'd like to go to the other side of the equation. there's a section in the book, and i'd apply this to the regulators as well, but to everybody, board members, the power of simple questions. in other words, there's certain simple questions you can ask, and when you ask them and pursue the answers, you can learn something. in the late 2000s, fannie mae took a hit -- a large hit for an ordinary company, not large for fannie mae because it was such a big company -- on manufactured housing loans.

and in 2003 the chief credit officer at fannie mae wrote an after-action report saying one of the lessons is you can't trust the aaa rating because these, we bought aaa pieces on these mobile home loans, and they cratered on us. [laughter] again, if somebody starts to ask questions and say why aren't you doing due diligence on what you're buying regardless of whether it has a rating, and, remember, underneath that rating in terms of content are also concentration issues. you know, a aaa of one kind may be really different if it has -- >> we're going to leave this booktv program now. you can find it online at booktv.org. take you live to the floor of the senate, gaveling in. and with an update on the so-called fiscal cliff legislation currently making its