Mr. John A. Allison
Retired Chairman and CEO
John A. Allison - Employment- Distinguished Professor of Practice, Wake Forest University Schools of Business; retired chairman and CEO, BB&T Corporation. Special Mention- Member, Board of Visitors, Wake Forest University Baptist Medical Center, Fuqua School of Business at Duke University, and Kenan-Flagler Business School at University of North Carolina at Chapel Hill; member, Board of Directors, Independent College Fund and Global TransPark Foundation; contributor, The Wall Street Journal, Reuters, News & Observer, and USA Today; recipient, honorary doctorate degrees, Mercer University, Marymount University, Clemson University, Mount Olive College, and East Carolina University. Education- B.S., Phi Beta Kappa, Business Administration, University of North Carolina at Chapel Hill (1971); M.B.A., Management, Duke University (1974); M.S., Stonier Graduate School of Banking (1981). Personal- Married to Betty; they live in North Carolina.
The Financial Crisis: Causes and Cures
Good morning. It's a real pleasure to be here. I want to start by thanking all of you and congratulating you on your very important defense of the principles which have made America great, and that defense is critical in the kind of world we face today.
Our purpose this morning is to talk about the financial crisis, both from an economic but, I think even more important, from a philosophical perspective. I will have to admit I wish I had a more fun subject to talk about, but this is a very important subject, not because of the short-term economic implications but because of the long-term government policy implications.
I will also tell you it is a complex subject. I am going to try to target this presentation at what I call a "knowledgeable business person." I want to assume you have an in-depth understanding of economics, but I will have to assume that you have knowledge of business in general.
Really, to do this subject right, it ought to be a thousand-page book, and I am going to kind of compress it into an hour. So you are going to have to pay attention to what is going on, but hopefully, the value you will get in this is the integration of how all of this happened, because mostly you get piecemeal parts of what happened.
Three basic concepts. Government policy is the primary cause of financial crisis. We do not live in a free market in the United States. We live in a mixed economy. That mixture varies by industry. Technology is probably 20 percent government, 80 percent free. Financial services is 70 percent government and 30 percent free. It is not surprising that the most regulated segment of the economy is where the problem started.
Secondly, government policy created a bubble in the residential real estate market. That bubble deflated, as all bubbles do. That created problems in the capital market and then problems in the economy in general.
It is true that a number of individual financial institutions made very bad mistakes, and I don't like those guys. I am angry at them. On the other hand, their actions were secondary. They were in the context of government policy.
What happened? We overbuilt residential real estate in the United States by at least $800 billion. We built too many houses, we built too big a houses, we built houses in the wrong place. We should have been investing in agriculture, technology, education. We should have spent less and saved more.
How did we make a misinvestment of that magnitude? Well, if you think about it, that kind of error can only happen with government policy. No individual market participant can drive that kind of mistake.
If you look at the four primary causes -- Federal Reserve, the FDIC, government housing policy and specifically Freddie Mac and Fannie Mae (the giant government-sponsored enterprises), and the SEC -- the government policymakers took a natural correction and made it much worse than it had to be by how they handled it. Now, we should never have had as big a problem to deal with, but how they handled it made it much worse.
Maybe most importantly, most of the things we have done since this started may help us in the short term but will be unquestionably detrimental to our long-term economic well-being.
The fundamental cause is the Federal Reserve. A simple interesting observation, in 1913, the monetary system in the United States was nationalized. The government owns the monetary system. If you have problems in the monetary system, which we had that started this crisis, by definition, they are government problems.
It would be like if the interstate highway bridges were falling down, you say that's the government's problem, they own the highways, right? They own the monetary system in the United States.
The Federal Reserve was created in theory to reduce volatility in the economy. In fact, what they have done is reduce volatility in the short term and create bigger problems in the long term.
In a free market, because we are not omniscient, we make mistakes. Markets are constantly in the correction process. Businesses are being created; businesses are being destroyed. If you take out the downside of the correction process, what you do is push problems into the future.
The very existence of the Federal Reserve has created a leverage problem in our economy. States can borrow a lot of money based on their taxing authority, but they run into a limit, as California has run into the limit. The Federal Government can borrow a lot of money based on taxing authority, they also can print money, and because they can print money, they can borrow a whole lot more money. And if you end owing a whole bunch of money, you end up with a huge, vast inflation, because it is better to pay back with cheaper dollars.
That is why the government gets so excited about deflation. We had deflation in the 1890s, and the standard of living was rising. Deflation is an interesting phenomenon. It has got both positives and negatives, but if you owe a bunch of money, you definitely don't want any kind of deflation.
From the creation of the United States in 1783 to 1913, prices were stable. There were ups and downs, but the price level was stable. From 1913 to today, prices have risen 2,000 percent.
In addition, when you take out the bumps in the economy, people start thinking that things are very low risk. Remember the old Greenspan put: Congress gets in trouble, Greenspan is going to save us. When people perceive low risk, they save less. The psychological effect of that was much lower savings rate.
Then, Greenspan and Bernanke made some really big mistakes. Greenspan, during the early 2000s, created negative real interest rate. What a negative real interest rate is, is that inflation is running at 3 percent, but you can borrow money at 2 percent. You cannot create a bigger incentive for people to leverage than that.
And then Bernanke did a very destructive thing. He created what is called a "negative yield curve." A negative yield curve is where short-term interest rates are higher than long-term interest rates. That is not a national phenomenon. It never occurs in free markets. The Federal Reserve, when they create negative real curves, what they do is destroy margins in the banking business.
Banks borrow short, lend long. The only way to make money in the banking business, when you have a negative yield curve, is to go out the risk spectrum. That is why almost all the high-risk stuff that we are paying for, actually the loans were made during the inverted yield curve.
Those of you that follow economics may remember that Bernanke was under attack from a lot of economists saying, boy, this negative yield curve has a huge history of resulting in major recessions, and Bernanke was adamant that that wouldn't happen, said that wouldn't happen.
So the Fed is putting out information, saying, hey, the economy is going to do great, and he is encouraging people to move out on the risk curve.
In a certain basic sense, we couldn't have had a bubble unless the Federal Reserve printed the money. It is not mathematically possible without the Federal Reserve printing the money.
Essentially, about the Federal Reserve and I think one of the kind of dilemmas that fools people, there are a lot of very bright people that work for the Federal Reserve, and they have very sophisticated financial models, but there is no way -- I don't care how smart you are, how great your mathematical models are -- that anybody can integrate the economic activities of 7 billion people on this planet.
The great free market economist, Friedrich Hayek called that "fatal conceit," and the Federal Reserve has fatal conceit in spades.
The second cause, the FDIC insurance. Sounds benign, right? Everybody likes FDIC insurance. It is a huge destroyer of market discipline.
We saw that in our business. We operate in Atlanta, a pretty big market force, and we saw lots of community banks started up, many of which have subsequently failed.
We took over one of those banks. This is a very interesting little story. Ten guys that were in the motel business got together, put in a little capital, leveraged that capital like crazy by buying CDs at above-market rates.
The typical client didn't care about the risk in the bank because they had FDIC. They had government insurance, right? They took that money and lent it to their cronies, and then the bank went broke. And the FDIC lost 50 cents on the dollar, and that happened over and over again.
On a bigger scale, IndyMac, Washington Mutual, Countrywide, all large financial institutions have failed. All built nationwide banking franchises. Their whole strategy was pay a lot for CDs, take it and put it in high-risk loans. You couldn't have financed the high risk and particularly when you pick-a-payment loan business without FDIC insurance. It is a huge market destroyer because of lack of discipline.
The third cause -- and I would call this the proximate cause -- is government housing policy. Now, this goes back a long time where the government is trying to raise the home ownership rate above the natural market rate, under the theory that home ownership is a good thing.
Well, home ownership is a good thing in a certain context; however, there is no evidence that just giving somebody a home actually changes their behavior. It just doesn't happen. In addition, encouraging people to buy homes they can't afford, young people in particular, to speculate in the housing market is very, very destructive.
Tax policy supported home ownership, which sounds good except that you can only measure capital once, and if you build too many and too big houses, then you have less money to put in technology investment, and you reduce your capacity to be competitive, and you reduce jobs in the U.S. economy.
There has been a long focus starting with the Community Reinvestment Act on something called affordable housing, but the real immediate cause of this crisis being in the housing market was a decision made by Bill Clinton in September of 1999, and I remember it. I remember it happening, but Bill Clinton set a goal for Freddie Mac and Fannie Mae, these giant government-sponsored enterprises, to have over half their loan portfolio in affordable housing.
A number of economists -- there was an article in The New York Times, of all places -- a number of economist said, including liberal economists, said, "Boy, this is risky. The affordable housing, now subprime, market is not this big. If Freddie and Fannie meet their goal, it could take Freddie and Fannie out, and it could significantly deteriorate the U.S. economic system," and they said it could happen in 10 years.
Nine years later, it happened. Nine years later, it happened. Freddie and Fannie would never have existed in the free market. They existed because they had a government guarantee on their debt. They would never have existed in the free market.
When they went broke, they were leveraged 1,000 to 1. That means they had $1,000 in debt for every dollar in equity, and they owed $5 trillion. Congratulations, you get to owe that now. The taxpayers have taken over that debt.
Remember that trillion is a million million, so this is a big, big player in the marketplace.
I personally had a very interesting experience on this. I was on a committee for nine years, the Financial Service Roundtable, the 100 largest banks in the U.S., trying to do something about Freddie Mac and Fannie Mae.
We were running the numbers, and it was absolutely mathematically certain they were going broke. I mean anybody in this room, I would say any 15-year-old would have said, "Boy, these guys are going broke."
We met with Congress on numerous occasions trying to do something. We would show them the numbers, and it was a mathematically certainty they were going broke, but Congress refused to do anything about it. And the evil one -- and from personal experience -- is this guy Barney Frank. He is really evil. He is a very smart guy.
He is very smart guy, which is what makes him so dangerous, but the reason they wouldn't do anything about Freddie Mac and Fannie Mae was very interesting. It was a religious belief, and I would call it a religious belief in affordable housing, that it had to be a good thing.
Second, Freddie and Fannie were huge contributors to both political parties. They were major contributors to the Republican Party, and they were the single biggest contributor to the Democratic Party. So they refused to do anything about it.
We would not have had the bubble in the housing market except for Freddie Mac and Fannie Mae. In essentials, the Federal Reserve printed too much money, trying to avoid downsizing the economy. It turned into a bubble, and it ended up in the housing market because of Freddie Mac and Fannie Mae. Lots of other add-ons, but that's the fundamental essentials.
Let me give you some little background to understand how all this happened. Why do banks exist in the first place? Banks allow the ability to pool certain kinds of risk, credit risk, interest rate risk, liquidity risk. That is very important to an economic system because it allows you to extend the investment cycle. There are no healthy economies without healthy banking systems. That is why people legitimately get upset when the banking system is under duress.
I will give you a simple example. Maybe a real estate developer wants to build a subdivision, and he needs $30 million. Too small to go to the capital markets, hard to get his friends to invest in that, maybe they don't want to be concentrating on that one project. It is going to take four or five years to sell the lots.
He can go to a bank. A bank can finance that. A bank can do other projects. They can also do commercial loans to operating companies and to consumers and diversify the risk. So it actually allows an economy to extend the investment cycle, but it does create a very interesting dilemma in the banking system.
Well run banks are solvent. They have more assets than liabilities, but banks are never liquid. They never have all the cash in the bank.
We got an interesting red flag when Bear Stearns failed. Bear Stearns was the first failure in the cycle, and at the time, it certainly appeared on the surface that Beat Stearns was solvent but not liquid. That was a whopping red flag. If the Federal Reserve had actually let Bear Stearns fail, which they actually permitted the natural final end of that process, the rest of the market participants would have reacted much sooner and in my opinion wouldn't have had some of the problems we had later on. But by working through Bear Stearns, they gave a very interesting message to the marketplace, "Hey, we are going to take out part of the pain and the risk; therefore, take your time undoing these risky positions."
Banks are leveraged about 10 to 1. They have about $10 in debt for every dollar in the equity. Investment banks are leveraged 30 to 1. That is why the investment banks went down first. What is interesting, investment banks used to be leveraged less.
Well, Spitzer -- remember the governor from New York? -- attacked the traditional investment banking model. The investment banks were largely investing other people's money, and people like Goldman Sachs started investing their own money and increased their leverage. The SEC let them do that using mathematical models on capital, that I will come back to in just a minute.
What is interesting, before there was a Federal Reserve, banks were leveraged about 1 to 1. That meant when things went bad, the people that lost their money were the shareholders and not the public in general. It is a very different kind of economic system.
In my career, the Fed has systematically encouraged banks to leverage more because, if you want to have inflation at a little level, so you can pay back this big debt you got, you have got to do it through the banking system. So leveraging the banking system has been systematically increasing for the last 50 years or so.
How did the residential real estate crisis get into the capital markets? If you look at the peak of the residential real estate evaluations, prices in the United States were about 30 percent too high, and the reason for that is residential real estate prices are fundamentally driven by affordability. People cannot buy houses they can't afford. If you look across the whole country, prices were 30 percent too high based on people's income.
Now, that varied a lot. In southern Florida, like here, prices were probably 50, maybe even 60 percent too high. In Winston Salem, North Carolina, where I live, maybe prices were 10 or 15 percent too high, but nationally, they were about 30 percent too high.
When this crisis started, residential real estate values failed pretty quickly, about 20 percent. Banks had largely financed that residential real estate across the whole economic system and banks lost about $500 billion when that was going on.
Banks are leveraged about 10 to 1, so that $500 billion in capital turned into a reduction of $5 trillion in liquidity or $5 trillion in bank lending capacity, including the money banks that lend to each other, which is a very big and very important market. So banks could afford to lend 5 trillion less dollars. The banking industry, of course, scrambled initially trying to raise capital to fill in that shortfall. The industry raised about $200 billion, and then it started running into some obstacles.
So they were back to about a $300-billion shortfall, and that meant $3 trillion of liquidity was lost in the U.S. economic system, a real big problem, $3 trillion in lending capacity.
A very interesting phenomenon was going on in the market. Well, prices in residential real estate have fallen 20 percent. They have got another 10 percent to go. That destroys at least 100-, maybe $150 billion in capital in the banking business. Banks are leveraged 10 to 1. That is another trillion, trillion and a half dollars in liquidity. Capital markets get very spooky, very spooky, but the markets remain open.
A very interesting thing happened, a very under discussed phenomena, saw this inside what happened here. The Federal Reserve, the FDIC, and the Treasury made a very destructive decision. Washington Mutual, a large bank headquartered in Washington State, a nationwide franchise failed. When it failed, they chose to cover the uninsured depositors. When banks fail, traditionally, the insured depositor gets 100 cents on the dollar, but the uninsured depositors often got 50 cents on the dollar.
The market assumed that was going to happen. The FDIC was scared that if that happened, there would be another run on the bank. Remember IndyMac and people were in line. They were afraid there were going to be lines. So they said, "We just are going to pay the underinsured depositors 100 cents on the dollar."
What that did was the debt holders from Washington Mutual got creamed. They expected losses, but they had much bigger losses than they had a right to expect. Basically, the FDIC just changed the rule overnight. I mean, this has been a long time, a 30-year, 40-year, 50-year practice. Boom, they basically changed the rule of law overnight. When that happened, the capital markets for banks closed.
Ironically, the FDIC could have chosen to take the losses themselves instead of passing it on to the debt holders, and it wouldn't have closed the capital markets. So they could have dealt with the run on bank issues if they just simply handled it differently.
BB&T had been in the capital markets about two weeks before this happened. Prices were kind of high for capital. We didn't have any trouble. The day this happened, capital markets were closed for banks. Nobody could go to the capital markets.
That is the primary reason that Bernanke and Paulson were so panicky. It wasn't Lehman Brothers. It was that they realized that they had just closed the capital markets for banks, and banks couldn't operate without being in the capital markets.
Globally, housing was overbuilt in other countries, like Ireland and Spain, and also foreign intermediaries had made major investments in the U.S. market, and the U.S. currency is a reserve currency of the world. So our crisis got taken internationally.
Remember this thing started when the big things you heard about were subprime mortgages, and there is still a lot of discussion about subprime mortgage is legitimate, but the subprime mortgage business is nowhere near big enough, as big as it is, to take down the U.S. economy. So, if you had had massive wipeouts in subprime mortgages, the U.S. economy would have limped through, but a very interesting and powerful thing happened. A lot of these subprime mortgages had been securitized, and they had been rated by Standard & Poor, Moody's, and Fitch.
Standard & Poor, Moody's, and Fitch have a government sanction to be in the rating business. They have an oligop. We have the legal oligop because pension funds can only buy assets rated by these three companies, a very interesting situation to be in, and they also implicitly have a government sanction that they know what they are doing, right?
They misrated these subprime mortgages, and they didn't misrate an A. They didn't give someone an A that should have been a B. They gave things A's that should have been F's. I mean, they missed huge.
Well, the market says, okay, if they misrated subprime, they may have misrated everything. And the information system collapsed. Nobody could figure out what anything was worth. All this long-term rating system based on the government sanction, the government created oligopoly failed, and it went places you would have never expected.
The interesting example was called the "auction rate municipal bond market." The auction municipal bond market is where tax-free entities, typically tax-free entities that don't have taxing authority -- a university, hospitals, airport authorities, bridge authorities -- had issued bonds for long-term investments that either were refinanced periodically or had floating interest rates.
Frankly, they shouldn't have done that, but in theory, it worked because they were going to get lower interest rates by accepting those instruments. That market locked, and the reason that market locked is a lot of these entities, these hospitals and universities, had relied on insurance policies from two giant insurance companies, Ambac and MBIA, saying that these risks were low risk, and they had insured the risk. And they were triple-A rated by Standard & Poor's, Moody's, and Fitch. So they brought up the ratings of these companies.
Well, the market very soon figured out they couldn't trust Standard & Poor's, Moody's, and Fitch, and that Ambac and MBIA had done a lot of guaranteeing of subprime debt, and they weren't Triple A. And, in fact, they fundamentally failed, so the market was right to figure that out.
The market, somebody in Hong Kong is looking at the hospital in Emporia, Virginia, and they have no idea how risky that hospital is, so the market locks. A lot of these hospitals and universities literally would have been out of business. They had to pay back debt they didn't have any cash flow to pay back, or they were paying 20 percent interest rates. It was a real disaster, even though they might otherwise have been in healthy conditions. So the market locked.
Now, there is a very interesting thing. This is the funny thing about liquidity crisis. There was a huge flight to quality. BB&T, for example, was perceived as a quality institution. So people were literally paying us to take money. It was a huge flight to quality. So we had tons of cash coming out the kazoo.
We were fortunately in a position, in our case, to issue $6 billion worth of financing to help the hospital in Emporia, Virginia, because we knew they were in sound financial position. We didn't need to Standard & Poor's, Moody's, and Fitch to tell us that. We could figure that out. So liquidity crises are very interesting phenomena.
Fair value accounting. There was some discussion of that last night. A couple of thoughts about fair value accounting. First, it is a new accounting rule. We have had accounting since the Egyptians. So the burden of proof is on those that already think that fair value accounting is a good idea. We have gotten by with it for a long period of time.
It sounds good, mark to market, but it does not work when markets aren't working, and when government screws up, as they did, they destroy the market process.
I will give you a simple example. Maybe I think my house is worth $600,000. In this crisis, the only guy that would buy my house is somebody that wanted to steal it, would only pay $300,000 for it. I wouldn't sell it. I don't owe anything on it. I don't have to sell it, right? And I am a buyer, right? Under fair value accounting, however, my house is worth $300,000, and I would have to write it down $300,000, even though I am a legitimate buyer. It violates the law of supply and demand. You can't base it just on the demand. If the seller is not willing to sell at the price, you haven't got a market clearing price. It is just simply not an economic true phenomenon.
The second thing, it was extremely destructive of capital markets, and it really destroyed a lot of wealth in the United States, totally unnecessary. I will show you how that happened with this personal experience.
There is a market bond out in the marketplace, and it is backed by houses. It was a $100-million bond when it's originally issued, but some of the houses weren't paying, and some of them were projected not to pay, and based on a rational economic analysis, that bond ought to be valued at $80 million. So there was a $20 million lawsuit.
However, in the middle of this crisis, the only buyers were huge speculators that wanted phenomenal returns, and they would only pay $50 million for that bond, which was a phenomenal deal.
Under fair value accounting, even though economically the loss was only $20 million, the bank had to write that bond down by $50 million. That was huge for the economic system, because banks are leveraged 10 to 1. If you lost $20 million, that is $200 million worth of liquidity, but if the accounting system causes you to lose $50 million, that is $500 million loss of liquidity because -- and the $300 million extra loss because of the accounting system.
Why didn't people like BB&T step in? We had plenty of cash coming out the kazoo, but we would analyze these things. They'd say great economic deals, why don't we buy them. Of course, if we had stepped in, the price would have gone back to $80 million. Because we couldn't take the accounting risk. We could take the economic risk. We couldn't take the accounting risk, because we didn't know that the end of next quarter, even though the bonds were still worth $80 million, they wouldn't be valued at $40 million.
So we refused to act on an economically good decision because of the accounting risk, and many large publicly traded companies made that choice. I talked to a lot of CEOs. So the accounting system was struck driving economic activity.
It is all kind of another problem with fair value accounting. It fails in considering gains. It only takes the downside. That is a bizarre system.
If we had fair value in 1990 when we had the last real estate crisis, all the financial institutions in the U.S. would have failed. In fact, I don't care what business you were in. At the end of 2008, if you had had to value your assets based on what you could sell them for -- you couldn't sell anything at the end of 2008 -- and you had to run that through your income statement, I would argue that 95 percent of the businesses in America were broke. There was no liquidity in the marketplace.
Interesting observation. The accounting system in the United States is a government-owned accounting system. The SEC makes the accounting rules. We do not have private accounting. FASB, the members are determined by the SEC. It is a government process.
I don't know of any large business that runs by GAAP. I don't know of any small business that runs based on GAAP accounting. We all have our own internal accounting measures, right?
If we had a market selected system, we may or may not choose fair value. I don't know, but it would be a very different process than we have today. We don't have a market selective accounting system. We have a government-driven accounting system, and there are all kinds of politics in that system.
Pick-a-payment mortgage, one of the more destructive products in the marketplace. Pick-a-payment mortgage is where a borrower, for example, goes and buys a house and based on the interest in the house ought to pay $1,000 a month, but the borrower only has to pay $500 a month. So every month the mortgage gets bigger. So, at the end of five years, he owes a lot more on the house than he did when he bought the house. Very interesting product, right?
Very popular in places like California, Southern Florida, where you had very rapid appreciation, and the theory was go in, leverage yourself to the hilt, particularly if you are a young person, refinance after five years because your house price is going up 10 percent a year for perpetuity, right?
A big player in the pick-a-payment mortgage, the real inventor of the pick-a-payment mortgage, was a company called Golden West that got bought by Wachovia and helped Wachovia fail. Washington Mutual and Countrywide, all failed. All those companies' finances, high-risk loan portfolios, using FDIC insurance. None of them could have raised the cap in the marketplace to finance this high-risk loan portfolio without FDIC insurance.
I will tell you something about BB&T, and then I will come back to a more general philosophical premise. We chose not to offer negative amortization and pick-a-payment mortgages, and we did it over ethics, not economics, because at the time, in theory, you could make these mortgages and sell them to capital markets and make a profit.
Well, one of my fundamental commitments in our mission is to help our clients achieve economic success and financial security. One of the things I tell our employees is never, ever do anything that you know is bad for your client, even if you can make a profit in the short term, because it will always come back to haunt you, and if you do the right things for your clients in the long term, you will be more successful and they will be more successful and we will win together.
We looked at pick-a-payment mortgages, and we didn't see the collapse in the real estate market, but we knew residential real estate values were not going to keep appreciating 10 percent every year for perpetuity, and we knew we would be setting up a lot of young people to get in financial trouble. So we chose not to offer this product over ethical considerations, not economic considerations.
How did the government policy create what is called the "origination and sell model" in the mortgage banking business? The reason I want to tell you this example is to show you how long-term and detrimental policies can be because of some of the stuff we are doing right today.
When I got my first house -- and I can look around here and see a few people in my age group -- back in the early 1970s, I went to the local savings and loan. I put 20 percent down, and I got a 30-year fixed rate mortgage. So did 95 percent of people in America. The savings and loan industry owned the residential finance business. They had basically been in business 70, 80 years, and had almost zero losses in residential finance. It was a very low risk business.
Why was that? When you make a loan and you hold it, you care about the risk, right? You think about it. So they had very low loss ratios.
The savings and loan industry, despite the press, was fundamentally destroyed by government policy, and I will tell you how that happened. It started with 1960s with Lyndon Johnson. Lyndon Johnson wanted to have both the great society and the Vietnam War, but he didn't want to tax people to pay for it because that wasn't popular, so he got the Federal Reserve to print a bunch of money.
Of course, that led to a huge level of inflation. Early 1980, inflation spiraling out of control, basically threatening to destroy our economy, the Federal Reserve finally acts, way too late, raises interest rate. The prime rate goes to 22 percent. I don't know if any of you were borrowing money at that time. It was not much fun. It wasn't much fun to lend money to people at that time, very destructive.
Savings and loans had made these fixed rate mortgages. They had certificates of deposit that are variable rate, financing it. They got killed in an interest rate squeeze. Many savings and loans failed.
Then, after that, the handful that made it through the crisis got some help from their friend, the FSLIC, which is now the FDIC. These were the regulators of the industry. The industry, they did two interesting things. One is pretty esoteric, but it is important. They forced the savings and loans to hedge the interest rate risk in their home mortgages. That is incredibly destructive because there is no prepayment penalty in home mortgages. So, when interest rates started falling, everybody refinanced their home mortgages, and the savings and loan lost billions and billions of dollars in these hedge contracts.
Secondly, they strongly encouraged the savings and loans to get into the commercial real estate lending business, financing shopping centers and apartment buildings and offices. They had no expertise in that business, and in 1990, when we had the next correction, the last correction before this one, lots more savings and loans failed.
That is where Freddie Mac and Fannie Mae got going. They filled in that hole when the savings and loan were driven out of business, and what happened was they first took over the prime market, and then they later took over the subprime market.
What is interesting when that was happening, people like BB&T, we would have loved to have stepped in that hole. We had plenty of financing. We would have taken over that business, but you cannot compete against the government. Same thing is true for health insurance. You cannot compete against the government.
Freddie Mac and Fannie Mae had an implicit guarantee from the Federal Government. They were leveraged to 1,000 to 1. They had the lowest capital costs in the marketplace. You cannot compete against the government. So they drove all the rest of us out of the home finance business, particularly out of the prime home finance business.
I don't like Golden West, but I understand how Golden West got into the negative amortization business. They couldn't compete with the government. So they did the thing they could do, which was the pick-a-payment mortgages. They were driven out of the prime rate business.
Then a very interest thing happens. Bill Clinton sets his goal for affordable housing. Freddie and Fannie can't meet the goal because most of the people that originate and sell mortgages to them aren't in the high-risk business.
They go to people like Countrywide and Washington Mutual and say set up these local broker networks of independent broker and feed me high-risk loans, feed me affordable housing, so I can make Congress happy and meet my affordable housing goals because, if I don't, I am going to lose my guarantee and I am out of business.
Even though the people who were actually running Freddie Mac and Fannie Mae knew it was highly risky and didn't want to do it, they were under so much congressional pressure to meet those goals, that they did that.
A very interesting thing happens when you originate a loan like the old savings and loan, you care about the risk. When you originate and sell and you are the originator, man, you do not care about the risk because it's gone once you get rid of it. So, if you can fool the buyer, you do it.
It led to very perverse incentives. First, I will call it sloppiness and then, at the end of the cycle, a huge amount of what all of us would consider fraud.
The borrower comes in, says, you know, last year I made $60,000, when he really made $50,000. The originator, going through Freddie Mac, through Washington Mutual, whatever, says, well, didn't you really make $70,000, because if you made $70,000, I can make you a bigger loan, and the house will appreciate everywhere, the bigger house you buy, the better off you are going to be, and by the way, we don't check the numbers on all this, because we have got to meet this affordable housing goal. Lots of fraud.
Then, Standard & Poor's, Moody's, and Fitch stepped in and misrated all this stuff on a grand scale, the risk that was being taken, and the investments jumped -- this is what we hear about, the investment bankers jumped in and created a bunch of capital market instruments that I will talk about in a minute.
What is interesting to me, they say the investment bankers were greedy. Well, now, a lot of these guys got fired and lost all their net worth. That is a strange form of greed. I think they were dumb, and I think there is a difference. They were dumb.
What did they do? You hear about these esoteric instruments, and I won't try to get them in detail, but I will kind of give you a flavor for them. They invented these things called CDOs and SIVs and CDO Squares. They sound complex, but the idea was fairly simple.
The way CDOs got started was a legitimate idea. A bank makes a loan to General Electric, and they loan them $500 million, but they don't want to hold all that risk. So they keep $100 million, and they sell $400 million in the capital market, which diversifies the risk, a legitimate idea.
Investment bankers started thinking about this idea and said, "Well, can't we do something kind of like this with mortgage funds?" And let's say we are sitting here with a portfolio of B-rated -- I am trying to make this simple -- B-rated bonds. There are people that like to buy A-rated bonds because they are less risky and maybe they will accept a little bit of lower yield, and the people that buy C-rated bonds, they were more risky, but they get a higher yield.
So we are going to create what is called "tranches." The way the tranches worked is the first losses go to the C's, the next losses go to the B's, and the final losses to the A's. So, in theory, you have no losses in the A's because the losses would be in the B's and C's before you got to the A's.
The same went bad in a very interesting way, went bad in a very simple way. In one category, Merrill Lynch is out selling A's, B's, and C's, and making a reasonable profit doing that. Bernanke inverts the yield curve, "Merrill Lynch, you have got to find some assets to hold. You have got a positive spread in." What are the only assets you have positive spread in? The high-risk assets.
You talk yourself into believing that these C's aren't really that risky, and why don't I hold them, I can sell them someday in the future, and I can make a positive spread. I got this negative inverted yield curve.
Then, of course, the A's, B's and C's weren't A's, B's, and C's. They were D's, D-‘s, F's, and F-‘s, right? So, what happens, when this stuff starts going down, the C's don't lose 10 cents on the dollar. They lose 100 cents on the dollar, and the B's lose 50 cents on the dollar, and even the A's start taking losses. So losses were way, way bigger than anybody anticipated.
An interesting thing. If you go back and look at Merrill Lynch, they were making a fortune on paper under our accounting system a year before they went broke, because they are selling the A's and B's, and they are holding the C's. On paper, that looks like a huge, huge profit.
How about credit default swaps? Another that sounds esoteric. All it is, is insurance policies, that simple.
The way that works, I am Goldman Sachs, and I have got a portfolio of B mortgages. If I can make them A's, the SEC will let me hold a lot less capital, and the way to make them A's is I go over to AIG, which is a triple-A rated company, and AIG insures a risk. And I pay them an insurance premium, but it's worth it to me because now this B becomes an A.
Okay, here's the problems. AIG's models fail. I will get into this. The mathematical models failed, and then B, of course, they were relying on Standard & Poor's, Moody's, and Fitch, and all those numbers were wrong. So AIG underpriced the insurance, that simple.
AIG, by the way -- it's an aside, but it is an interesting aside -- it was also killed by fair value accounting. Go back to that $100,000,000 mortgage that should have been written down by $20 million. AIG, because they had the insurance risk, had to write all of their insurance policies as if they had a $50-million loss, the way the accounting system -- so a lot of AIG's losses were created by the accounting system. Now, they had some bad losses too, a lot of losses created by the accounting system, magnified losses.
An interesting question is why did we save AIG. It is very interesting. BB&T, we are the sixth largest insurance provider in America. We are AIG's largest seller of insurance products.
You say why shouldn't we be happy they saved AIG? No. If you looked at the insurance subsidiaries, they were totally sound. I don't care what Geithner says. They were totally sound. There was no issue in the insurance -- the risk was all on the parent company in these contracts.
The parent company goes. In a certain sense, who cares? Well, the people that care theoretically are the counterparties, the people that have these insurance policies, and the big counterparty is Goldman Sachs.
Well, if you are Paulson and you spent your whole career at Goldman Sachs and you have $500 million worth of Goldman Sachs stock and everybody works for you in the Treasury comes out of Goldman Sachs, whether that is true, whether Democrats or Republicans -- they are all Goldman Sachs, they own the treasury in the U.S. -- then it's easy for you to believe that if Goldman Sachs goes, the U.S. economic system goes.
And you can quote. I honestly believe that. And you can see the nature of that choice because not only did they pay off the counterparts. They paid them 100 cents on the dollar, which is bizarre. Nobody in here would have done that.
Well, what is worse, the other big counterparties were European banks. You paid. You as taxpayers paid European banks between 50- and $100 billion that you didn't need to pay. I mean, if the European banks go, that is not a system problem for the Federal Reserve. So is it a systems risk or crony capitalism? Make your choice.
Another great miss, banks were deregulated. What an absurdity. We were misregulated. The regulatory environment during the peak of this bubble was the worst in my career. I have never seen anything as bad, except for today. It was worse up to today.
And what was going on, though, was the wrong kind of regulations. There was an obsession with Sarbanes-Oxley. Remember Sarbanes-Oxley was supposed to eliminate fraud? Well, that was absurd because the whole thing hadn't done anything on fraud in general, but it is doubly absurd in the banking industry because the banking industry had a Sarbanes-Oxley back in 1990, around the thrift crisis. So this was a redundant system on a redundant system.
Equally important was the Patriot Act. Now, the Patriot Act sounds good. In theory, we are supposed to catch terrorists. The banking industry spends $5 billion a year on the Patriot Act. You know how many terrorists we have caught because of the Patriot Act? None. Do you know how many terrorists we are going to get because of the Patriot Act? None. Anybody dumb enough to get caught by one of our tellers is getting caught anyway, right? Bizarre law.
You know what we are doing, though? You all ought to worry about this. You know what we are doing? We are violating all of your rights. You know who they are after? They are after entrepreneurs on cash. It's an IRS scheme.
You know they got Spitzer over the Patriot Act? Think about that. That's what they got him on. It's a very, very bad law.
By the way, accompanying this was a rational belief in mathematical model which is driven in the economic profession and the finance departments of universities. It's a really bad belief, and the belief is that mathematical models answer all issues, and there is value for mathematical models, but they can be very dangerous.
We were under intense pressure to put in mathematical models like Citigroup and, in our case, Wachovia, who we competed against, both of which failed. We put in the models, but I told our people never to do anything about them, ignore them, because they are very dangerous, very dangerous.
One thing that happened in Europe -- this is a very interesting phenomenon. Remember when this crisis first happened, the Europeans were making fun of us. Then, all of a sudden, all the European banks failed, like boom, what happened. The Europeans had implemented Basel. Basel was an international agreement on how much capital banks can maintain, and it uses mathematical models. Under that agreement, the European banks had no capital. So, when they started having problems, they liquidated their capital overnight, and they started failing on a grand scale.
Now, mathematical models can be useful, but they have a couple problems. One problem is mathematical. They all have tails on them, and if you are doing a mathematical model, you are going to cheat on the tails, because nobody is going to pay any attention to it if it has a very big tail.
Global warming models, they all fail, right? We can say, "Oh, well, if we just did it, they are going to keep failing." They cheat on the tails. The tails are much bigger than they think they are, but even if they don't cheat on the tail, if the tail has a 1% probability, that means at some point, it will be true.
People that build a house in a 100-year flood plain, the bad news is you are going to have a flood. So these things all have tails on them.
The other problem is -- and all the Fed models fail, all the economic models fail -- you cannot mathematically model human behavior, particularly you can't mathematically model human behavior under stress. You cannot mathematically model. So these models are very dangerous.
This was a non-trivial event. This mismanaged all risk management in the whole industry. When they start threatening to put you in jail, which they were under Sarbanes-Oxley and under the Patriot Act, it dramatically impacts your behavior. So all your risk management systems were targeted at the wrong stuff, targeted at the wrong stuff.
The great myth going on right now, you hear that the head of the FDIC and the Feds saying they want banks to make loans? Big lie. Big lie. The FDIC examiners are swarming all over banks in this country, including very healthy banks. They are tightening lending standards.
Well, think about it. You are a local examiner. You have got a 25-year career at the FDIC. What is the only bad thing that can happen to you as a government bureaucrat? Your bank gets in trouble. It is not they have incentives. Their incentive is to protect themselves.
If you are Sheila Bair -- she is lying like crazy. She doesn't want -- I thought at first they just weren't doing what she thought, but she is the head of the FDIC. How does she look bad? If banks get in trouble.
So the FDIC is swarming over healthy -- BB&T today will not make loans we ought to make, that will put people out of business that we don't want to put out of business, because we have got FDIC examiners swarming all over us, even though we are extremely healthy and we met all the capital standards and all of our credit underwriting policies pass.
SEC, we talked a little bit about all these issues. I want to hit one interesting issue: loan loss reserves. Traditionally in the banking business, when banks set reserves, they raise their reserves in good times, and you did it for two reasons. One, you could afford to do it, right? It's nice to have reserves. And then, secondly -- there is an old saying in the business that is absolutely true, "You make your bad loans in good times." So banks in good times traditionally raise their reserves.
The SEC made that impossible. In fact, they attacked some banks. They fired some risk managers in a number of banks because banks had too big of reserves, and here was their theory, the mathematical model. They said you had to do all your reserves. You couldn't use subjective judgment based on past experience. You had to use mathematical models.
Here is what these mathematical models had to have: two fundamental components. You had to look at your historical loss experience, but remember we hadn't had a serious recession since 1990. Going into this recession, banks were having great loss experiences.
And then, secondly, you have to use economic forecasting. We use the blue chip economists, which are 43 of the best economists in America. You know how many of them projected a recession? None. And nobody projected this recession. We use the Fed model. The Fed models were incredibly optimistic. Go back and look at the Fed models. They were projecting robust economic times.
Under those mathematical model forced on us by the SEC -- and personally, I was in huge resistance to it -- banks lower their loan loss reserves. So a lot of the losses taken initially in this cycle were because banks had lower reserves than they would have had, had they been free to make that kind of decision.
Remember the couple early programs? The Hope Program, I don't know if you all even remember it. The $300-billion program was supposed to help homeowners where the bank would write down the mortgage to market and then take a 20-percent haircut. Now, you know, that is a real great product. There is a $300-billion program. I think there have been eight loans made under that program.
The second program is the one that there was this huge argument about in Congress where they were going to buy the mortgage instruments and never did it because they could never establish a price. They keep talking about doing it, but they have never done it, thank goodness, because they cannot establish the price.
This is an interesting thing, kind of a more philosophical question. If you are in the banking business, you do not want to foreclose on people's houses. I mean, we do not want to own homes. You want to work with your borrowers.
There is also an interesting ethical issue here that is non-trivial. Who is the victim here? If you look at a lot of these people that bought these houses, they didn't put anything down; they bought as big a house as possible. You can be mad at Countrywide, and I am mad at Countrywide for doing these pick-a-payment mortgages. However, we had plenty of clients come in to BB&T. We said, "We don't do pick-a-payment mortgages." Particularly young people, "You need to buy a smaller house, get a fixed-rate long-term mortgage. You don't need to take on that kind of leverage." They said, "Thank you. We are not going to do business here. We will go over to Countrywide, and we got a pick-a-payment mortgage, a big mortgage." Do you want to bail those people out?
I will give you another personal example. I have a son living out in California during this boom who chose not to buy a house. He said, "This is crazy. This ain't going to work." I have another relative living out in California that bought two houses, speculated on housing. I don't want to bail him out. Now, maybe you do, but I don't want to bail him out.
Moral hazard is a non-trivial risk. In the fall of 2008, when all this stuff was going on, I visited the BB&T mortgage collection center in Greenville, South Carolina. I was walking through that center, and I have known these people for a long time, worked at the bank a long time. One of the operators, one of the collectors handed me the phone or the headset to talk to one of our clients who was calling in. This client had moved from the Northeast to Florida. He had bought a million dollar house. He had put $400,000 down, and we lend him $600,000. According to him, the house was now worth $500,000, and what he wanted us to do was forgive $100,000 and cut the interest rate, which was already 5 percent, to 3 percent, and he had $800,000 in the bank.
I asked him. I said, "Well, you know, if the house had appreciated from $1 million to $2 million, would you have sent us a check?" Don't think so. Don't think so. Moral hazard is non-trivial.
Market corrections are not all bad things. They are not bad things. The world is better that Countrywide, Washington Mutual went out of business. They were destroying capital. It was good that they went broke, very good.
Credit standards were way too loose. We had excessive leverage in our economy. We weren't saving anything. We had a negative real savings rates. You can't do that forever.
We had an overinvestment in housing, which is actually continuing. Corrections are a natural market process. What we shouldn't have had, we shouldn't have had the magnitude there, because the Fed creating the bubble, and then how we handled the error made it much worse. We created an unnecessary panic.
The way that worked, of course, is, you know, if you have the President -- well, if you have, first, Bernanke and Paulson go to Congress and say we need $700 billion, that used to be a scary amount, right? That was a big number when they said it. And then you have the President say the sky is going to fall. Then you have this very arbitrary -- this is why the market wasn't working, a very arbitrary process. Save Citigroup, let Wachovia fail. Save Goldman, let Lehman fail. How can you figure out what is going on? Creating a spiral down that I think we hit the floor on. We are coming back, but we had an unnecessary panic.
TARP II is the one most people hear about, which was the capital injection into the banking system. Just one interesting aside, one of the main goals in TARP that people don't talk about was to save General Electric. General Electric is basically a finance company -- 50, 60 percent of their business is a finance company. They are very high-risk finance company, financed lots of aircraft. They did it with overnight commercial paper. They were going down the tube, and that is why you see the CEO go kiss ass at the government now because they got bailed out. They got bailed out.
People ask me was TARP II necessary. The answer is no and yes. No, that, first, they shouldn't have bought the bubble. You shouldn't have Freddie Mac and Fannie Mae, but even beyond that, if they had reacted differently to Bear Stearns, we wouldn't have been where we were.
However, you can make the other argument. Once the President said the sky is falling, they had to do something, and so the answer is no. In a big picture print, when you create a panic, there is no good answer. There is no right answer.
I will say this, though, whether there were any short-term benefits, the long-term benefits are hugely detrimental. One of the long-term consequences has been what is happened to the market in the banking business.
It is very interesting also how TARP unfolded. I was personally adamantly opposed to TARP. I wrote Congress. I went and met with tons of Senators. I said it is a really destructive idea. Then, when TARP happened, we took the money. We said, "Well, why did that happen?"
Well, I had a very interesting experience. This has to do with rule of law. TARP passes. The next morning, we get a call from the FDIC. The FDIC says, "Well, you know, we have had these capital ratios for 40 years in the banking business. Under these ratios, you guys are way overcapitalized, no problems. However, we have now decided that we have new capital ratios. We do not know what these ratios are, but we know you don't have enough capital, and we will be in here tomorrow morning, if you choose not to take the TARP money, to look at your capital position," literally the conversation.
We said, "Thank you. We will take the TARP money. I mean, basically, it was a threat to put us out of business.
Why did that happen? One of the problems we have, by the way, is Bernanke is a student of the Great Depression. Whatever this is, it ain't 1930, okay? But he is assuming it is 1930.
In the 1930s, Roosevelt tried to save individual financial institutions, and it didn't work because the market reacted when he tried to save an individual company.
So Bernanke says, well, I can't -- there are three large financial institutions getting ready to fail, and we saw that in the capital market. They were getting ready to go. He said, "I can't save those three companies. I need to save the industry. So I am going to make all the large banks, the $100-billion-dollars-and-over banks" -- BB&T was in that category -- "participate in TARP. The market, therefore, won't be able to figure out who is safe and who is not. We are going to force all the big banks for this failing in the process." That was his decision.
Long-term effect is a giant moral hazard. In my career, Citigroup has failed three times. They have been saved, and every time they have gotten bigger and worse. I guarantee you; they will get bigger and worse because they are a hugely politically connected institution. Lots of capitalists aren't capitalists, right? Not anymore. Unfortunately, lots of capitalists aren't capitalists.
Also, something that anybody in business ought to be worried about, you have created an arbitrary government oligop in the business, five giant institutions too big to fail, long-term, big issue, they will be able to raise capital cheaper because the market knows they are too big to fail, right, which will lead to very destructive kinds of activity.
First question. I don't think they are too big to fail. I would let them fail. I would have let them fail then, and I think we would be better off. They don't disappear when they fail. I would absolutely let them fail.
If the government perceives them to be too big to fail, then they ought to break them up because this implicit guarantee is very, very dangerous.
By the way, the government's anti-trust policies in the banking business are bizarre. Four or five years ago, BB&T bought a bank in the mountains of North Carolina, and we had to divest a $25-million branch.
Wachovia and Wells Fargo merged together, creating a $1.5-trillion company, and they had to do no divestiture. So the anti-trust policy is more politics than it is economics. It is bizarre.
All the healthy financial institutions were hurt by TARP. This was a lousy deal. If you didn't need the capital -- and by the way, they came back and, remember, did the stress test, and we had way too much capital. So we didn't need the capital. We knew we didn't need it, but you got ripped off. The way you got ripped off is you had to pay a very high interest rate, and you had to give them more. It cost BB&T $250 million. It was just a massive subsidy for the unhealthy companies by the healthy companies. That is all it was.
Also, it is an interesting message, and this is a tough message. In the good times, you are foregoing profits by not taking the risks that Merrill Lynch was taking or Citigroup was taking. If Citigroup gets bailed out in the bad times, what is the balancing act, even from a shareholder perspective? How do you balance this act? If there is a reward system to take out crazy risk in good times and then you get saved in the bad times, it's a perverse incentive system.
What are the cures? Short term, the Federal Reserve certainly should provide liquidity. That is what it is designed to do. It absolutely should not bail anybody else out, and one of the ones that I hate the most is GMAC. GMAC is the finance arm of General Motors. They are one of the major problems we have in the automobile finance business, automobile industry.
They invented what is called the seven year 100-percent car loan. So you go in and buy a car, you can get 100-percent financing, and you pay back over seven years. At the end of four or five years when the car wears out, guess what? You owe a whole bunch more on the car than it is worth, and you can't get a new car. They are who the government is bailing out.
The argument is there is no finance for automobiles. That is a lie. BB&T has been in the automobile finance business since the early 1950s. We have got tons of financing available for automobiles. We just won't do the stupid stuff GMAC will do. There is no financing for the stupid stuff, right? And they are back doing stupid stuff again, doing the exact same stuff. I think they have had three bailouts.
You ought to cut government spending instead of increases. This is a real bizarre belief to me. Nobody here that gets in financial trouble thinks you are going to borrow your way out of trouble, do you? But somehow that happens at the economic level, and it is based on a false theory developed by an economist named John Maynard Keynes.
John Maynard Keynes wrote a book called "The General Theory of Economics," and if anybody is interested in economics, you ought to read his book because it is so bad, you will see how a lot of people believe this. And he dominates economics to this day.
In his general theory, one of his suggestions is in hard times, you need to pay people to dig holes in the ground and then pay people to fill them back up.
Now, does anybody really think that is going to raise our standard of living? Do you thinkspending money on things that don't need to be done is going to raise our standard of living? That is a bizarre belief.
If you want to incent anything, cut taxes. We have the highest marginal tax rates in terms of corporate taxes. Cut taxes. Don't introduce any more programs. We need to go back to a cash-based accounting system.
Long term, price instability is a big deal, and in my career, inflation has been much more destructive than deflation has been. Deflation is tough, but inflation is tough too.
The biggest issue, however, is these unending attacks on free markets. This problem is a failure of government policy. Yes, the individual market participants made mistakes. Of course, they always do. We always make mistakes, but markets didn't fail. Government policy failed, and the solution is not more government. It is less government, less government.
One of the most destructive things going on -- and probably a lot of people in this room see this -- is an attack on the wealthy. Let's change wealthy to productive. It is not that every wealthy person is productive, but most productive people are wealthy.
This is an attack on the productive. What do the productive do when they get under attack? They become more cautious. They go on strike in little -- and, boy, by big spades in the medical business, lots of doctors retiring right now. You attack the productive. They become more cautious. That is very bad for the economic system.
By the way, Roosevelt did that through the '30s, very popular. Envy is really a destructive human emotion. It gets you a lot of votes, and it destroys the economy, and that is absolutely what is going on now.
Big issue. Got to privatize Freddie Mac and Fannie Mae. The politicization will never go away. I don't have any issue about having a securitized market, but we don't have to go to the securitized market. Banks can portfolio mortgages.
In Canada, the Canadian banking system, by far the soundest in the world, one of the main reasons they are doing what the old savings and loans do, they make mortgages and they help. Because of that, they care about the risk, and we haven't had a real estate bubble in Canada. No reason the banking system can't do that. Get rid of Freddie Mac and Fannie Mae and put the financing back in the account and the banking system.
If I was in charge -- and they will never put me in charge -- I would go to a market-based monetary system and private bank. A market-based monetary system would probably be gold, not because gold is magical but because it is limited and expensive to get. It is hard to get. You can't just print it.
I will make this statement. Unless we do something about the Federal Reserve, eventually the United States will have serious financial problems. I don't care whether Republicans and Democrats, you cannot trust politicians not to print money, and we have got a long history of saying this. If we keep the Federal Reserve, we will have financial problems in the long term.
If you can't get rid of the Federal Reserve now, one nice move would be to take away a lot of the Federal Reserve's power, make them grow the monetary supply at a fixed rate. That is what Milton Friedman, the great free market economist, proposed, like 3 percent.
In my career, every time they micromanage the economy, they have driven rates too low, driven rates too high, and had 100-percent error rate.
I will tell you something that would work, that could actually be sold today, but it takes all the components of this. Let's shift the risk back to the shareholders of the bank and let the market discipline the banking system. Let's require banks to raise their capital ratios significantly over a period of time. So, if a bank fails, the shareholders take the loss, not the taxpayers.
It would also be a great way in terms of deciding whether Citigroup is too big to fail or not. Either they can raise the capital or not. If they can't raise it, they get the shrink. They get the shrink.
Reduce the FDIC. I would eliminate it, but reduce the FDIC insurance and make it explicitly clear that the Fed can't bail out General Electric. The next time they get in trouble, they get to fail, but you have also got to remember that about 90 percent of the regulations impact the industry, because the industry can't compete with all those regulations and higher capital requirements, that is practically doable.
We have got to stop subsidizing housing. That is an interesting phenomena, but it is very destructive of our economic system, reduce government spending. I love flat taxes too.
An interesting thing that conservatives, I think, sometimes get confused about, we absolutely need free trade. One thing that precipitated the Great Depression, we initiated a trade war, and guess what? The other guys responded. It would be like we couldn't sell things between North Carolina and California. It would reduce the standard of living of both North Carolina and California. Free trade is a good thing. It raises the standard of living.
Carefully and systematically privatize Medicare and Social Security. We have got huge deficits in both of those systems.
This is an interesting thing. Significantly cut the costs of defense by defending the United States. I think our defense budget is huge relative to what we get for it. That is because -- not because we don't have the military ability, we lack the will. If we were morally certain, we could spend a whole lot less on defense and people would leave us alone because we would act aggressively when attacked. So our problem is the lack of moral certainty.
Encourage immigration. We have an interesting demographic problem in the United States. We have all these baby boomers getting ready to retire. People look at Japan and say they have all these economic issues. No. They have a demographic problem. They are getting old, and old people become less productive. We have the same problem in the United States. By the way, this country was built by immigrants too, and smart people create jobs. You keep smart people in India, they are going to create jobs, they are just going to be in India.
Restore discipline, spend less, save more.
Now I want to talk about something far more important. I want to talk to you about the philosophic causes, because the real issues are not economic. They are philosophical, and this is the real battle. This is the battle we have to win.
The real causes of the problems we have are the combination of altruism and pragmatism. Where did affordable housing come from? Everybody has a right to a house provided by whom? Where does free medical care come from? Everybody has the right to medical care provided by whom? My right to medical care is my right to enslave a doctor to provide Medicare to me or to enslave somebody else to pay that doctor. That is an exact inversion of the American concept of rights.
Under the American concept of rights, each of us has the moral right to the product of our own labor, but we don't have the right to what anybody else produces. We don't have the right to what anybody else creates.
Altruism leads to redistribution from the productive to the non-productive, and it basically says nobody has a right to their own life.
And then you combine altruism with pragmatism, and that is what happens in business. In business you can't be an altruist and stay in business, so you become a pragmatist, and what is the rule in pragmatism? Do what works.
Here is the dilemma with pragmatism. Lots of things work in the short term that are incredibly destructive in the long term. Subprime lending worked for years. You cannot be rational and be a pragmatist because rationality requires a long-term perspective.
Interestingly enough, you cannot have integrity and be a pragmatist. That is why a lot of businesses don't have integrity. Integrity requires a long-term perspective.
Combine altruism and pragmatism, and you get what I call the "free lunch mentality." Look at Social Security and Medicare: huge deficits and huge problems. Neither candidate proposed any serious solution, and if they had, they would have been elected, right?
Free lunch mentality leads to a lack of personal responsibility. That is the death of democracies. The Founding Fathers talked about the whole concept of the tyranny and the majority, and what they were really talking about in that case was the abuse of individual rights, the majority taking away freedom of speech, freedom of religion, et cetera. But they also realized that when 51 percent of the people can vote a free lunch from 49 percent, pretty soon it's over, because then it's 60 percent want a free lunch from 40 percent, and then 70 percent want a free lunch from 30 percent, and the 30 percent quit.
The cure is also philosophical. The United States was the first country, maybe the only country ever created on a set of philosophical principles. Life, liberty, and the pursuit of happiness, a brilliant world changing philosophical observation. Under that philosophical principle, each of us has the moral right to our own lives. We have the moral right to products of our own labor. Including if we produce a lot, we have the right to that.
We also have the right to give it away to who we want to on the terms we want to, but that is our right, not somebody else's right to take it from us and give it to who they want to, particularly if they want to give it to somebody that will vote for them. Each of us has a moral right to our own lives, and interestingly enough, that philosophical principle demands personal responsibility because there is no free lunch. There is no free lunch.
The United States, interestingly enough, because of that principle, had a kind of society that actually demanded and rewarded rationale and self-discipline, because you had to be self responsible. You had to be self responsible.
The United States also was the only country ever committed to a fundamental idea, and if you think about that principle, each of us should pursue a rational, long-term self-interest, what I will call properly understood. I use that in the context of the trader principle, back to the example I gave you a while ago. Under the trader principle, we should not take advantage of other people. Taking advantage of other people doesn't work because people won't trust us. It is also self-destructive psychologically, trying to manipulate other people. Bad things happen, and it's self-destruction.
Also, we should not self-sacrifice. Each person in this room has a moral right to your own life. Don't you have as much right to your life as anybody else? Don't your children have as much right to their life as anybody else? Why would you believe anything different than that? So you shouldn't take advantage of other people, and you shouldn't self-sacrifice. What we really are and what underlies capital is we are traders. We create value for value. We get better together.
In our business, we help our clients receive economic success and financial security. It let's us make a profit doing it. We get better together. In fact, life is about creating win-win relationships. Whenever we get greedy and try to create a win-lose relationship, it ends up being lose-lose and where we get self-sacrificial, and set up a lose-win relationship, it ends up being lose-lose.
So life is about creating win-win relationships, and that's the trader principle underlies a free society, underlies free markets, and it is a good, moral principle.
My favorite book by far is "Atlas Shrugged" written by Ayn Rand in 1957. An interesting thing, Rand wrote that book, she said, for the purpose of preventing what she predicted from coming true. Unfortunately, what she predicted became true.
At the time the book was written, people panned it because it couldn't possibly happen. Fifty-three years later, it's happened. If you haven't read Atlas Shrugged, you ought to read it. The villains in today's Wall Street Journal are right there in the book. It is a very interesting book, very thoughtful book.
Where do we go from now? We have been in a serious recession. There is an issue of whether we have a double dip or not. We certainly are not going to have, in my opinion, 1930s kind of global depression. We never should have expected that. That was not an improbable thing.
What I personally think is the most likely scenario is we are going to have something that looks like the 1970s. It looks like stagflation. We are going to have some growth. We are going to have above normal inflation, and we are going to have higher than we should have unemployment. Not a terrible time, but not a good time.
What worries me, however, is the long-term, and the long-term is very scary. If we continue with altruism and pragmatism, the free lunch mentality, we have got some giant economic issues.
If you look at the actuarial liability in Social Security and Medicare, the fact we are running trillion- dollar plus annual deficits, we have a totally dysfunctional foreign policy. We have a real demographic problem with the retirement of baby-boomers, and we have got a failed K-12 education system.
If you run the numbers in the United States, they are scary. It reminds me very much of looking at Freddie Mac and Fannie Mae. When we ran the numbers that said Freddie Mac and Fannie Mae are going broke, you can run the numbers in the United States, 20, 25 years, we go broke.
Now, countries don't go broke the way companies go broke. They either have massive inflation, or they become third world economies. Like Argentina, 1940, Argentina had a higher standard of living than the United States has, and we are headed in that. We are headed towards a third world economy. What we are doing to our children is unconscionable, no matter what the short-term benefits are. What we are doing to our children is unconscionable.
I am in the more optimistic group in a certain sense. I think people are beginning to realize that this is not totally a failure mark. It's that government policy played a big role, and therein the answer is to return to what made us great in the first place: individual rights, free markets, and a capitalist free society. And therein lie the rights. That is consistent with America since -- I think Americans, most Americans, get the idea that big government is not necessarily a good thing. They don't understand it all, but they get that. That gives me some optimism, and it's not hopeless. We can fix it, but if we don't move soon and if we continue in the direction we are going, I would say three, four, and five years -- that is why this is such a pivotal movement, probably why a lot of you are here today. We are one of those inflection points, and that is what makes it so important.
One thing I think we all can do, this is really an ethical fight, and unfortunately, a lot of business people haven't done a good job from an ethical perspective.
Some of that criticism is very well placed, frankly, not because markets fail, but because business people didn't do what they personally should have done.
So I think one thing we all can do, we can live principled lives, and we can be principled leaders to the degree that we are in leadership positions.
At BB&T, well, we have 10 core values. Underlying those 10 core values are what I believe are the three great virtues. The three great virtues are purpose, reason, and self-esteem. As human beings, we are purpose directed entities. We have to know where we are going in order to get there.
Organizations, businesses, civic organizations, churches, universities are simply groups of human beings. For organizations to be successful, the people in those organizations must vest in the purpose of the organization. I believe that the content of purpose varies a lot, but the context, I would argue, is the same for every person in this room and for practically all human beings.
The context has two fundamental components. I believe that every person in this room wants to make the world a better place to live, or I don't think you would be here today. I believe that every person in this room wants to make the world a better place to live. And I believe most human beings want to make the world a better place to live.
Now, the interesting thing is you don't have to go feed hungry children in Africa to make the world a better place to live. There are lots of ways to make the world a better place to live. Good businesses make the world a better place to live. We provide products and services that people need.
The difference between the quality of life in Africa and the United States is primarily we have better businesses. Business is noble work. When businesses forget they are in business to make the world a better place to live, bad things happen to that business.
Good doctors, good teachers, good homemakers make the world a better place to live. There are lots of ways to make the world a better place to live, but I believe every person in this room wants to make the world a better place to live.
There is also a second component and purpose that is equally important and far under discussed. Each person in this room should make the world a better place to live doing something you want to do for you.
You have the moral right to your own life. And even if you made the world a better place to live, if you didn't like doing it, you will have wasted the most precious thing you have, which is you. By the way, if you try to make the world a better place to live doing something you don't want to do, you won't do it very well. So all of us wanting to make the world a better place to live, doing something we should do for us, that we personally enjoy, that sense of purpose is very powerful.
The second interesting thing is the means by which we accomplish our purposes, our capacity to think. We use the term "reason." Everything that is alive has a method of staying alive. The lion has claws to hunt with; deer have speed to avoid the hunter. We have the capacity to think. Our capacity to think is literally our only means of survival, success, and happiness. And no shortcuts, there are no free lunches.
A couple of thoughts about reason, a couple of thoughts about thinking both individually and from a societal perspective-- I say to all the employees at BB&T, I don't know how much we can impact our IQs, but we can choose to be committed to being life-long learners, and to do that, we have to have active minds.
If you look at people that are life-long learners, they tend to read more, take advantage of educational seminars, but they are particularly effective at learning from their experience. As human beings, we are primarily experiential learners, and successful business people are primarily experiential learners.
If you look at the people that are superior experiential learners, they do two simple but profound things well. First, probably everybody in here can associate with learning from your mistakes, right? Making mistakes, it made a big difference. However, unfortunately, a lot of times, we don't learn from our mistakes. We get to do them over and over again. The reason we don't learn from our mistakes is that we not only have to admit we made mistakes, but we have to admit the deepest psychological cause for our mistakes.
A lot of times, we commit the ultimate psychological sin, which is the act of evasion, and evasion occurs when you are presented with some piece of information that at some level you know needs to be examined, but you refuse to examine it because it threatens something you want to believe about yourself and you want to believe about the world, and you don't hear it.
I grew up as a small business lender. My number one reason small businesses fail: the leader of that business evades. Things are going along fine, something happens in the economy, something happens at home, they don't want to hear it and run the business right in the ground.
Citigroup, the largest financial institution in the world, hires a bunch of geniuses to run their affordable housing business, guarantee before we ever heard about subprime lending, those geniuses knew it was going bad, but what did they do? They evaded. They didn't want to give up their bonuses. They didn't want the company to make less money. They ran the company right in the ground. So experiential learners evade less and learn far more rapidly.
The second thing that experiential learners do is recognize life is a constant education if you choose to make it one. There is a lot to be learned just from life.
BB&T had a series of community banks, 33 community banks, and I went many times to visit those banks, had lunches with our advisory board members who were business community leaders. Never had a boring lunch. Always asking me questions, always popping things at me, you could understand why those people have been successful.
So peer experiential learners evade less, stay in focus more, and that is absolutely huge competitive advantage in life. In fact, my observation in business, some business people have really high IQs, that is not necessarily true. Most successful business people evade less and stay in focus more, and that is a huge, huge competitive advantage.
Reason also has two institutional pillars from the societal perspective. The first is liberty. In order to think, you must be free to think. That is why liberty is so important because it is necessary as a thinking being. We have to be free. I think that is one reason entrepreneurs are often more involved in the free market movement than COs are to public companies, because they get at some level that they had to be independent. They had to think differently than the crowd. They had to make their own judgments.
It is interesting. In universities, they talk about academic freedom, and they really think that is precious. And they are right, but somehow they expect business people to be able to think even though we have tons of government rules and regulations that keep us from thinking.
In my career, I have had dozens of opportunities when we could have improved the products for our clients. It's against the law to do it. You can't think unless you are free.
The other institutional aspect of reason is that fundamentally, the productiveness of the human mind comes from knowledge. You have to know how to do something. Knowledge comes from education in the broadest context. So the quality of your educational system ultimately drives the quality of life you have in the economy in general.
That is why we cannot afford to have a failed K-12 education system which, in my opinion, is why we have to privatize it, have the competition reward system, the discipline that markets provide.
An interesting thing, when you are clear about your purpose and you use your reason to accomplish your purpose, you get to do something very, very important. You get to raise your self-esteem. High levels in organization, people almost never fail because they aren't smart enough, but because they aren't educated enough. When people fail, it is usually because they have some subconscious issue based on self-esteem, low self-esteem that causes them to act at a self-destructive level.
In a broader context, self-esteem is the foundation for happiness, and happiness is the end of the game. I use happiness in the broadest context in the sense of a life well lived, not the good time on Friday night, but a life well lived.
Self-esteem is the foundation for happiness, and happiness is the end of the game. Sometimes people in business get confused. They think money is the end of the game. Nothing wrong with money, nothing wrong with money. Money, however, is not an end. It can be a means to an end, but it is not an end. Happiness is the end of the game, and happiness is based on self-esteem.
Self-esteem is a very complex subject, and I will offer you two thoughts. First, self-esteem is fundamentally self-confidence in your ability to live and be successful, given the facts of reality. So self-esteem is earned by how you live your life. Nobody can give you self esteem. You cannot give anybody self-esteem. You cannot give your children self-esteem. They have to earn it. Live your life with integrity. Raise your self-esteem.
The second thought about self-esteem, for people in this room and for most people, most of your self-esteem comes or doesn't come from your work. I use work in the broadest context. Raising children, whatever you have chosen your work to be, most of your self-esteem comes from your work. Something I say to all the employees of BB&T, it is real important to BB&T that you do your job well, but it is far, far, far more important to you. Might fool me about how well you do your job, might fool your boss about how well you do your job, but you will never fool you. If you don't do your work the best you can possibly do it, given your level of skill, given your level of knowledge, you can't do the impossible, if you don't do your work the best you can possibly do it, you will lower your self-esteem.
Now, here is the good news. Do your work the best you can possibly do it, given your level of skill, given your level of knowledge, and you will raise your self-esteem, and that is more important than whether you get more money or whether you get a promotion because it is about who you are.
There is a very powerful societal implication of that. Take an entry-level bricklayer, construction worker. An entry-level bricklayer has a hard job and a hard life; however, he makes enough money to take care of his children and his family. It's a struggle, and that family comes together. And maybe his grandson becomes CEO of a publicly traded company. That happened to happen in my family. Whether it happens or not, that bricklayer gets something very precious from that work. He gets to be proud of himself. He has earned a living, and he gets to be proud of himself.
Take that same bricklayer. Give him welfare. He may be better off materially, but he has lost something incredibly important, spiritually. He has lost pride. He has lost self-esteem, and in some ways, he has fundamentally been destroyed.
The Founding Fathers got that. This was a group of geniuses, a unique event in history. Life, liberty, and the pursuit of happiness. They got it. They talked about happiness. They didn't say life, liberty, and wealth. They didn't say life, liberty, and security. They said life, liberty, and the pursuit of happiness.
There is a lot of focus now on security, and security is important to some degree, but the United States is not the land of security. People didn't get on a boat and come to Jamestown to be secure.
The United States is the land of opportunity, the opportunity to be great, the opportunity to fail and try again, but most important, the opportunity for that bricklayer to be the best he can possibly be, to earn self-esteem from doing what we can do and living his life on his own terms. That is why people come to America, and that is the American sense of life, and that is really what this is about.
We are, you are the defenders of that sense of life, and that is very, very important work.
Thank you very much.
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