All week we are reviewing the year that was — the year that marked the beginning of the financial meltdown and the recession that we continue to live through. Today we’re taking stock of how the nation’s banks are managing, one year after the government spent billions of taxpayers' dollars to bail them out. For a look at what regulations need to be in place to avoid future financial disasters, we talk with Eliot Spitzer. He was New York's attorney general before being elected governor; he first made a name for himself for keeping an eagle eye on the banking industry. We are also joined by Tyler Cowen, professor of economics at George Mason University and author of the new book, Create Your Own Economy: The Path to Prosperity in a Disordered World. (click through for the interview transcript.)
"Look, let’s be very clear. The Fed failed. Everyone says the Fed has saved us by printing trillions of dollars. The Fed is the very institution that was supposed to be monitoring this along with the Treasury Department. They utterly failed to do it."
—Former Attorney General of New York Eliot Spitzer
LYNN SHERR, for The Takeaway: Eliot Spitzer, let me start with you. One year after we bailed out these big financial institutions that were supposedly too big to fail theyre getting bigger and bigger. What's going on?
ELIOT SPITZER: Well, I totally agree with the premise you just said. They were too big to fail before; they are still too big to fail. We have there was no question we were going to bail out the banks and we have put trillions of dollars into the financial system. The question is, are we getting the reform that we need and unfortunately the answer is no, we are not. We are rebuilding the same edifice, the same structures; the same government guarantees implicitly behind what these banks do because if they were to begin to flounder today, once again, we would have to step in. The government has not - and I have not seen a plan that says here is how we are going to fundamentally restructure the financial services sector so the next time around we do not face the same problem.
SHERR: What do you think needs to be done?
SPITZER: I wrote an article a long time ago - and I'm not the only one - many, many people have said: too big to fail is too big. Let us finally take a hard look at a system of financial concentration that became the policy of this government 10 or 15 years ago where banks were allowed to merge so they became these enormous structures. Let us finally say you cannot be that big. You should not be that interconnected, which is the word that is used these days basically the same thing. You can break them down on regional lines; break them down on business lines. You can basically say you will not be guaranteed next time. So the natural course - economic pressure would force them apart. There is nothing that says they have to be this big. This is a conversation going on in other countries.
SHERR: Who should be doing this?
SPITZER: The Federal government. There's no question that the Treasury Department, the Fed ... look, let's be very clear. The Fed failed. Everyone says the Fed has saved us by printing trillions of dollars. The Fed is the very institution that was supposed to be monitoring this along with the Treasury Department. They utterly failed to do it.
SHERR: Were talking to Eliot Spitzer, former Attorney General and former governor of New York State. Let us go now to Tyler Cowan, professor of economics at George Mason University. Mr. Cowan, what do you think? Banks to big to fail? Are they bigger and bigger? Should they be regulated?
TYLER COWAN: The key is to reintroduce market discipline and let creditors know that if their counter parties fail, they will take a loss. Weve been bailing out institutions since at least the 1990s. I dont think making them smaller is the answer. Lehman was not that big. And if you go back to Long-Term Capital Management in 1998, we bailed them out and they were a very small firm. So I dont think shrinking banks is the answer. The most we can do is have some very simple restrictions on leverage and send the message that bailouts will not be automatic.
SHERR: Do you have objections to what Mr. Spitzer is suggesting, about letting about having the Fed get in there and do more?
COWAN: Well, it is the Fed's responsibility. But the key problem lies in congress not the regulators. Regulators respond to their congressional committees. And congress for too long has decided that as long as jobs are being created in their district or more people are buying homes, all is well. And that's a big mistake. But its congress that needs reform. Not the Fed.
SPITZER: I dont think we fundamentally disagree. Congress obviously put pressure on the Fed and the regulatory agencies to act in a particular way, but the Fed was supposed to be the repository of wisdom on this issue and was supposed to look out for systemic risk which is obviously what brought us down. You are correct. It is not only scale; it is the fact of the bailouts. But the bailouts by the Fed were predicated on the notion that Lehman was too interconnected with or so we thought it was too interconnected. We found out that in fact it was. AIG was too interconnected. And so therefore they said interconnected equals big, equals bailout. You're right. The bailouts - what we call the socialization of risk and the privatization of gain so that asymmetry take all the risk you want. If it goes bad we'll bail you out but you can't keep the upside. That has not worked as an economic principle. That is not market discipline.
SHERR: But gentlemen...
SHERR: Isn't what both of you is saying it seems to me, on for all the specifics we need to deal with. Part of it is that we as consumers trusted... We trusted the banks to be in doing what theyre doing. And we trusted the government and the regulatory agencies to do what theywho are we left to trust and where are we at this point?
SPITZER: I hate to jump in, but years ago when I was Attorney General, I said that I would not trust the SEC to do a house closing for me. And now, after we read the report about Madoff and back when I said that of course people said you'ro being too edgy. The fact of the matter is the regulatory system utterly failed. It was captured by the industry. You had bankers and when you look at what they did and you look at the AIG bailout and you're right about the counter parties. AIG got 80 billion dollars, went straight through to the counter parties who were paid 100%. Nobody to this day has explained why Goldman Sachs got a check for $12.9 billion. 100% of the counter party risk that it supposedly had taken. Why? Goldman says it wasn't at risk. Why give them the money? Government bailed out. The Fed failed. The SEC failed. Who do we trust at this point? Very few people in the federal government.
SHERR: Elliot Spitzer, former Attorney General and former governor of New York. And we're also talking to Tyler Cowan, professor of economics at George Mason. Professor Cowan, go ahead.
COWAN: I would just note that consumers were part of the problem. That many of us were caught up in the euphoria and the bubble and many people thought they could take on more debt and buy any house they want and put down maybe zero money. And its easy enough to blame the banks, the regulators; all those criticisms make sense. But the problem was more systemic, was an overall excess of optimism and complacency in the entire economy, including consumers.
SPITZER: Tyler, you're absolutely right. The history of bubbles is that everybody gets swept along and we all buy into the same group-think which is, somehow risk can be absorbed and there will never be a day when we have to pay the price and unfortunately we find out otherwise.
COWAN: That's right.
SHERR: Gentlemen, thanks to both of you. Last question for you, Eliot Spitzer. You've been back in the public eye recently. You've been speaking, writing, teaching. Some rumors any truth that you are going to run for public office again?
SPITZER: No. I enjoy participating in the debate and lending my voice when I'm asked to do so. That's it.'