C. Peter McColough Series on International Economics with Neil Irwin

Tuesday, June 18, 2013
Neil Irwin
Economic Columnist, Washington Post

JEFFREY GARTEN: Good morning, everyone. I'm Jeff Garten and it's my pleasure to welcome you to today's Council on Foreign Relations meeting. Today we have the great pleasure of talking with Neil Irwin, who is an economic columnist for The Washington Post and author of "The Alchemists: Three Central Bankers and a World on Fire."

This is part of the CFR's C. Peter McColough Series on International Economics. And I'd like to remind everyone that this session is on the record. And let me ask you all to please turn off your cellphones now. The program will be -- I'm going to ask Neil a couple of questions and then at 8:30 we're going to open the floor to questions from all of you and hopefully engage in an interesting discussion.

Neil's book, "The Alchemists," for those of you who haven't read it, is an extremely interesting account of three major central bankers, how their thinking evolved, how they worked in their national contexts and how they worked with one another during the financial crisis. And I thought maybe I would start by just asking you, for those who haven't read the book, to just give us your sense, in a -- in a couple of minutes, of what it is that you were trying to do in writing this book. What was your goal?

NEIL IRWIN: Sure. You know, we went through -- we've been through this remarkable six years of crisis and recession and panic and a very slow, sluggish aftermath. There were a lot of great books written on the financial crisis of 2008. The tended to be very much U.S. focused and they tended to be very much Wall Street focused. I -- at the time, I was the Federal Reserve and economics reporter for The Washington Post. And as these last few years have progressed, I felt like there was a real opening.

And what happened in the fall of 2008, as traumatic as it was, was really only the beginning of a much larger story. And that was a story of a panic that wasn't just about subprime mortgages or Lehman Brothers or AIG, but was really the first global panic of the 21st century and something that, you know, jumped across oceans, that was an international story, that was not just about what happened back in 2008, but a -- but a much broader story that -- of a -- of a panic that migrated from subprime mortgages to the banking system to the real economy to sovereign debt to -- and back again, and ping-ponging across the Atlantic and Pacific.

And over and over, it was -- it was one group of people who were the first responders to this spiraling, spreading panic. And that's, of course, the global central bankers. And you know, this is a world I had lived in. I had been to more conferences and more -- you know, spent more time speaking to people in that world than I like to admit. And I thought I had an opportunity to tell that story through the window -- the story of this last six years of panic -- through the window of these powerful central who, again and again, are the ones who are -- who could respond to the -- to the crisis on a scale commensurate with its size.

And as I worked on telling that story, I concluded you also couldn't understand what's happened in the last six years in the U.S., in Europe, in Asia, without also understanding the history of central banking. So I also decided to do a significant section in the front of the book that traces the origins. How did these people -- how did this group of economists and bankers come to exert such great influence over society and have such great power over our collective fates?

And so I tell that story from the -- from 17th century Sweden through Victorian Britain through the Great Depression through the inflation of the 1970s, to kind of set up where we -- where we stand as we began -- as we entered this crisis back in 2007. So that's the story I set out to tell, and through the window of these people who are all too human and have made plenty of mistakes, but have also been the ones who have dealt with things when everything seems to be going to pot.

GARTEN: So you talked about -- you focused really on three men -- Bernanke in the U.S., Mervyn King in the U.K., and Jean-Claude Trichet in European Central Bank. And as you -- you know, as you talked about them, they really came alive. You had a sense of their -- (inaudible) -- you had a sense of their personalities, a sense of their limitations and also a sense of how far they extended themselves.

My question is, when you think about central banking, when you think about it, having written this book, how much does the individual character matter, and how much would you say that these men -- other men put in that position, perhaps with different personalities, different sets of experience, would eventually have had to go in the same tracks, given the -- given the powerful forces at play?

IRWIN: So in the broad thrust of things, directionally, I think the differences are not tremendous. If Ben Bernanke had not been named chairman of the Federal Reserve in -- he started in 2006, and instead, Glenn Hubbard had or Steve Friedman, some of the other contenders for that job back in 2005, 2006, you know, the crisis still would have happened; there still would have been an aggressive response from the Federal Reserve.

Where the differences arise are in the subtleties. And, you know, Ben Bernanke -- and this has been said many times -- he was a leading scholar of the Great Depression. He was someone who spent a lifetime, spent a career learning about what can go wrong when inflation sets in, when a financial system collapses. You know, he spent his academic career not only on the Great Depression but also on Japan. You go back to his speeches as an academic in the late '90s, early 2000s, he was one of the -- one of the American academics saying, what are you doing -- to the Bank of Japan -- you need to ease dramatically, you need to increase inflation expectations, this is in your hands, you can solve this liquidity trap that Japan found itself in in the late '90s.

I think all that has to -- there's no question that informs how Ben Bernanke and the Federal Reserve have responded in the last five years. I think he was a step faster than perhaps some other candidates for the job might have been, when Bear Stearns' about to collapse, when AIG's about to collapse, when the financial system is freezing up in the fall of 2008.

I think since then the story's even more significant. You know, over and over, in these last three years, since the crisis -- so 2009, the recession ends, the economy bottoms out, we finally start clawing out again. You know, there's a question of would a different Federal Reserve chairman have done QE2 back in 2010, now QE3 -- they're doing $85 billion in bond purchases a month. And I think there might have been greater timidity by a Federal Reserve chairman who is not as attuned to the kind of what can go wrong -- you know, who would not spend a lifetime studying Japan and the 1930s. A different Federal Reserve chairman may very well have had a different outlook. And everyone has their own views, but in my view, that would have left us in a worse place. Mervyn King is an example of this. He's also a very good academic. He and Ben Bernanke shared an office suite at MIT back in the early '80s. Same intellectual background in a way, but he's not coming from that prism of what can go wrong, and the Bank of England has been much more timid in a lot of ways in the last few years.

GARTEN: Do you think that -- well, how do you think -- if you just take the financial crisis -- let's leave off the aftermath and the recovery issues because two of men you wrote about are not there anymore --

IRWIN: No, no. Mervyn has one more week.

GARTEN: One more week, OK. (Laughter.) But let's just -- let's just focus on the crisis period. How do you think that history will judge this group individually and collectively?

IRWIN: So I will start that by saying I say this with a great deal of modesty. You know, I think if we were having this panel in 2006 and assessing Alan Greenspan, I think most of us would have a -- whatever you think of Alan Greenspan now, we would have a different assessment of the Alan Greenspan legacy. And I think one thing that's absolutely clear is that there's a lot we don't understand about how an economy works and what can go wrong. And so I -- you know, I attach a lot of modesty to what I'm about to say.

Look, I think -- first things first, the world would be in much worse shape had we not had leaders at the -- at the major Western central banks who could respond with an aggression and aggressiveness and on a scale that they did. I think -- I think Ben Bernanke so far has quite a lot of be proud of. I think he's managed to guide his institution through a defining challenge and a period that could have left the U.S. economy in a much darker place than it is now.

I can see -- I acknowledge that there is a lot we don't know about the what the aftereffects of all this easing will be, this $3 trillion balance sheet the Federal Reserve's built up. Could we have an inflation problem in a few years? Absolutely. Could we be stoking asset bubbles that are going to cause more damage? Absolutely. But I -- but I want to see evidence that those things come true before saying, well, Bernanke was wrong to do all this aggressive easing. And so far, I just don't -- I see reason to think that they can pull this away when the time comes, not there is still (dangerous bubbles ?).

Jean-Claude Trichet, I think it's definitely more mixed. So, you know, he left the European Central Bank on October 31st, 2011, was his last day. That was about the darkest moment you can imagine. That was a time when the very idea of European unity, this half a century of progress toward a united, peaceful, prosperous Europe was absolutely coming undone and ECB, under his leadership -- you know, he was very good at giving, you know, fiery speeches and trying to knock heads and persuade the political leaders to do what they needed to do, but he didn't succeed at it.

I mean, that's -- you know, this was a time when things were really coming unraveled in a way that could have gone in a very dark direction very quickly. Mario Draghi started on November 1st, 2011, and within just his first six months, made remarkable gains in creating about a trillion euro backstop of the European Banking System -- the LTRO, it's called -- and then in summer of 2012, his whatever-it-takes speech in London, saying we will -- we, the ECB, will stand behind Europe and not let Europe -- the European project unravel.

So I think you can absolutely fault Jean-Claude Trichet for -- whatever his many skills and talents -- for failing to -- failing to guide things to a place where Europe was guaranteed as a -- as a -- as a continuing project toward unity.

Mervyn King -- it's funny. You know, I think -- I think Mervyn King comes off the worst in my book of the three, but that's mainly because he spent the last six years pissing off so many people in Britain that they all go on the record and tell you about what a -- what a jerk he is. You know, I think -- actually, Mervyn King has a -- in some ways, a better record than Trichet, even though I concede he might come off as more of a jerk in the book. You know, he's brilliant, he's very, very smart, but he's also highly confident in his own views. And so he has a way of kind of steamrolling opponents, either within the Bank of England or within British politics, or -- in ways that really -- that make him a lot of enemies, and I think, were often counterproductive in the -- in the scheme of his last few years.

And I think some of his personal qualities -- you know, the fact that Alistair Darling, the -- you know, the chancellor during the crisis -- you know, wrote a memoir after he was out of office for six months, calling, you know, Mervyn stubborn and a son of a bitch, I think that's kind of telling. And I think, you know, if you'll read Hank Paulson's memoir, he has nothing but glowing things to say about Ben Bernanke. And I think when Secretary Geithner upstairs writes his memoir, I think it'll also say nothing but glowing things about Ben Bernanke.

And I think the fact that Mervyn King developed some of these toxic relationship -- yeah, it's gossipy, but I think it also had some substantive implications for the success or lack thereof in fixing the British economy.

GARTEN: So just to -- just to sum up on this point, you know, so many books have been written about the response to the -- to the 1930s. And what do you think is going to be the verdict here, collectively, of this group?

IRWIN: I think it's good. You know, there's a lot we don't know about where things go from here. There's -- you know, there's risks of currency wars and plenty of things on the horizon that we can all -- we could talk about more and worry about. But given the options -- (chuckles) -- and given what we know from history, I think what all three of these men did, even for all their faults and warts, is they learned from history. And that's all we can expect from our public servants, is look at what's happened in the past, use your best analysis to understand what's happening in the present and apply those lessons. And I think they did succeed in doing that.

GARTEN: One of the -- one of the points that I found really telling was the way that you described the fraternity of central bankers. You use the -- talk a lot about Basel and the way that they get together. And I think at one point, you said that, when you look at -- when you look at models of international coordination, this may be the epitome of people who not only meet, but get to know one another. And yet, when you actually parse how they approach the crisis, they were prisoners of national context, in many cases.

So my question is, just looking ahead, if you were to look ahead at the next several years -- I'm going to ask you a couple of questions about this -- do you think that central bankers will become increasingly close? Or do you think there is a sort of a political limitation, given the way that sovereignty works and also given the disparity of economic conditions around the world?

IRWIN: You know, I think it's a remarkable thing -- you talk about models of international coordination -- so I tell in the books, these league central bankers, six times a year, they go to Basel, Switzerland, to the Bank for International Settlements. And they have two days of -- they have a weekend of long discussions of economics. They come from all over the world, actually, even a lot of the smaller economies, so there really is this sense of common purpose and a sense that, you know, we're in this together. So I may be American, you may be British or German or Japanese or even Chinese or Indian -- the emerging markets are represented very much, as well -- you know, but we have this common goal of trying to make the world economy more prosperous, trying to understand each other.

And I think that was -- that was tremendously important in understanding this crisis response. They have -- you know, there's the formal sessions, where they have long discussions. On Sunday evenings they have, on the 18th floor of the BIS, what I call the world's most exclusive dinner party. It's the -- it's the -- basically the G-7 nations plus the real emerging powers -- China, India, Brazil and Mexico. Their central bankers have this intimate dinner, they drink very good wine. They call it (Grand Groupe ?) BIS is the -- is the joke.

And, you know, the bonds formed in that kind of setting are -- it's hard to -- you know, it's hard to quantify, it's hard to be definitive about what impact those linkages, those bonds cause. But I'll just stop for one quick example. You know, we think of -- there was -- there was one aspect of the crisis response that you didn't hear much about in 2008 in the U.S. press or in the common discussion here. But if you go to Europe, it was tremendously important, and that was these liquidity swap lines the Federal Reserve created.

You know, the basic deal is they would lend dollars to the ECB or the Swiss national bank or the Swedish bank and get the euros or Swiss francs or kroner back in return. They would unwind it 90 days later. The other foreign central bank would then lend those dollars to banks in their -- in their country. The European banking system had all these dollar asset. They couldn't get dollars on private markets. This was the way liquidities were provided.

These were huge -- at the peak, $580 billion. I don't think most Americans knew in December of 2008 that $580 billion of U.S. taxpayer money was being lent out to foreign banks through this -- through these swap lines. But because of these kind of bonds of kind of common purpose formed over these, you know, long meetings and many opportunities they have to get to know each other, there was absolute conference among the central bankers that they could trust each other, that these were risk-free, that these were completely safe exchanges.

So what's the future of that? To your question -- look, I think -- I think there's no reason that has to unravel. I think -- yes, we have a very difficult situation now. The -- you know, many European countries are in depression. The U.S. economy is no great (shakes ?). The British economy has been stagnant for three years. But I think -- there is -- I see no hint that some of these national strains that -- you know, Japan is making some enemies, especially in Asia, with its currency policies right now. But, you know, from everything I can tell, these kind of linkages and sense of common purpose and common understanding have only deepened since the crisis, not been strained.

GARTEN: And on that -- in that vain, there has been a lot of discussion about kind of deglobalization of banking at the very time all this coordination is going on, not only among the central banks but among regulators. You see global banking kind of retreating to national territory, and you also see the beginnings of regulation that are forcing banks to kind of ring-fencing so that a global bank that may have operated in the U.S. now finds it much more expensive to do that because they have to hold much higher reserves against their operations here. So some commentators are basically saying that, you know, they're not -- they're not talking about all globalization, but when it comes to banking, the beginnings of some kind of retreat to national borders. You put any stock into that?

IRWIN: Yeah. You know, one thing I think we learned -- you know, there's the old Warren Buffet line, you only find out who's swimming naked when the tide goes out. And I think it turned out a lot of the global megabanks were among those swimming naked in 2007.

You know, I think this raised pretty profound questions about how much of -- what our financial sector should look like, and should these banks with a trillion, $2 trillion balance sheet, with, you know, avenues into every corner of the world, what do they bring to the global economy? Are they supporting growth? Are they -- you know, the goal of the financial sector is to funnel savings to productive investment. That's it. That's what we have a financial sector for. It's to give you as a saver a place to park your money that's going to be safe and then lend that out to things that support economic growth. Did we have in 2007 a financial sector that did that in a -- in an effective way? I think there's pretty good circumstantial evidence the answer was no, that there was a lot of bloat and a lot of -- you know, a lot of financial activity in the banking sector, in the megabanks, that was not actually really contributing to growth and not creating a sustainable, stronger economy.

So how do you deal with that? Well, the answer has been Basel III, which is the bank regulatory accords agreed to at the same building in the -- at the Bank for International Settlements, and the U.S. Dodd-Frank. The basic strategy has been, OK, we're not going to on a blanket basis say you have to shut down if you're Deutsche Bank or you're UBS or you're Barclays or JPMorgan. But we are going to make it more uncomfortable if you're going to have -- if you're going to have a 1 (trillion dollars), 2 (trillion dollars), $3 trillion dollar balance sheet, you're going to have higher capital requirements, we're going to be -- as regulators, we're going to be up in your business, we're going to be paying really close attention to what you do. And, you know, if you choose to say, you know what, maybe I don't want to have quite that global footprint, maybe I don't want to be in all these avenues of business, maybe I don't want to have a derivatives book that big -- well, that's fine. If -- you know, if you can't make that work on a 14 percent capital requirement, maybe you shouldn't be in that business to begin with. I -- you know, I think that strategy broadly -- I mean, there's plenty of arguments to have on what the levels of this or that requirement ought to be, this liquidity requirement, this capital requirement. But I think -- as a broad strategy, I think that makes a lot of sense to me.

Because I -- what we don't want to give us is this existence of institutions that are able to finance the very large, very complex very global investments that a modern economy needs. So you know, if you're a company that does trade in -- you know, with South Africa, you want to have, you know, a Citigroup that can finance that trade route and have an office in Johannesburg is a really useful thing for you to have.

So as long as it's a financial system that allows big banks that can support big investments -- you know, there was a -- there was a -- Warren Buffett was able to call Jamie Dimon on the phone and get a $5 billion loan overnight to make some deal happen. In a world without any large banks, that kind of freezes up. But if they're -- but they need to be that big because it's creating economic value. And I think -- I think just higher capital requirements are a good way to get there.

GARTEN: So one final question from me and then we'll open this up. I think one of the startling things about reading your book is that you talked about three people who had massive influence on the global economy, and not one of those three was elected.

And when you -- when you think about what they did, with the exception of a debate here in the Fed -- in the U.S., which you describe quite -- I think quite colorfully, there seems to be very little challenge to the -- to the notion that central banks should have this range of political power as, you know, unelected technocrats. In fact, as you show, many of the decisions they made were highly political.

Having read -- having written this book and thought about it, do you feel that the public in all these countries has basically accepted this? In other words that the real -- the challenge to this kind of unelected political power is one that is not going to really -- it's not going to -- (inaudible) -- you know, we need it, we may not -- a lot of people may not like it, but basically this is the structure that will prevail?

IRWIN: So I'm amazed at, especially in Europe, how little of the discontent and the misery over austerity and high unemployment -- how little of that has been directed at the ECB. I have a story in the book -- so they were trying to -- so Papandreou, the prime minister, was stepping down. He had -- he had lost any kind of confidence of this -- of his government, in -- I guess it was the beginning of November of 2011.

And they were trying to engineer a handover of power, to have a technocrat come in and have a coalition government of the -- of the center left and center right parties, kind of a unity government, a technocrat that would make all these hard choices and do all these hard things. And then they'd have new elections and whichever won would win.

So they were trying to figure out who the technocrat would be. And Papandreou was trying to engineer this deal. He called a man, whose name is very long and I'm not going to try and say, who was the Greek representative to the IMF. And he called the guy. He was he having lunch in Washington at the IMF cafeteria. Picks up the phone and says, hello? He says, we need you to come be the prime minister.

And so he called his wife and said: They want me to come to Athens and be the prime minister. And she says, you can't do that. They'll kill you. (Laughs.) He says, well, no, I have -- it's my country. I have to -- I have to do it. So he hops a 4:00 flight to Frankfurt and then on to Athens. By the time he gets to Athens, they've changed their mind -- (laughter) -- because -- but here's why: They concluded it was too toxic to have somebody associated with the IMF as the prime minister.

Now, he wasn't working for the IMF. He was the Greek representative to the IMF. So instead they get Lucas Papademos, who was at Harvard, he was the former number two -- he was the vice president of ECB just a couple of years earlier. So it's OK to get an ECB guy, but it's not OK to have anybody with any kind of taint of the IMF.

So that's a little thing, but, you know, I mean, I spent a good bit of time in Greece, and some of the other -- you know, Spain, Italy. Very little of the -- of the anger over their economic circumstances seems to be directed at the ECB, for reasons that I don't quite understand.

Anyway, look, I think this is a settled matter in most of the world. Like, there will always be political discontent -- you know, it should concern all of us that we have unelected officials who are, you know, deploying trillions of dollars in euros and yen and pounds, of what are fundamentally taxpayer resources. At the same time, I don't think anybody's come up with a better approach, a better idea.

You know, you can say, oh, we should make the central banks more accountable to politicians. Well, usually when that's happened in the past it leads to a pretty nasty inflation problem. Just ask, you know, the U.S. in the 1970s, Italy in the '70s and '80s. You know, when you put the central bank even closer to the political system, it doesn't tend to lead to better results.

So what are your options? You know, we don't want to have an election for the central banker. We don't want to have, you know, those deeper ties. So I think the best we can hope for is accountability and transparency, and to have, you know, whether it's Ben Bernanke, his successor, or Mervyn King or Mark Carney in England, or Jean-Claude Trichet or Mario Draghi in Europe -- you know, they must be called to account, by parliaments, by Congress, by the people -- by the press, by ordinary citizens. And I think we're -- you know, I think my book and what I do every day at The Washington Post is part of that. I think part of what -- that's what Congress and parliaments overseas do.

GARTEN: When all is said and done, did Dodd-Frank compel more transparency and more accountability on the Fed?

IRWIN: Yeah, there's some stuff in there that I think was constructive in that regard. They now have to disclose -- so it's funny, all the emergency lending that happened in '08, they only disclosed it, first, out of a Freedom of Information lawsuit from Bloomberg and Fox Business that went all the way to the Supreme Court -- or was appealed at the Supreme Court, I should say; and Dodd-Frank, which said you have to disclose all the emergency lending during the crisis; and in the future any emergency lending, with a delay, you have to disclose that as well.

You know, the argument against that was, well, if -- you know, banks won't use the discount window or they won't take this emergency lending when they really need it if there's a stigma attached, if it becomes public. But I think the delays kind of deal with that problem pretty well.

GARTEN: OK, so let's open it up. If you -- remember this is on the record, and if you ask a question, please identify yourself. Yes.

QUESTIONER: Yes. Good morning. Earl Carr, representing HSBC Bank. You talked a little bit about how, after the financial crisis, banks had to improve capital ratios, and you felt that that was a good -- that was a good prescription. From the bank's perspective, a counter-argument to that is that there's less capital to be able to lend to spur that innovation and growth that you talked about. So how do you reconcile that? And is that the only prescription for success in Basel and other policies?

IRWIN: Yeah. I mean, so what I said and what I'll state, it's not popular among bankers, I realize. If you're a bank shareholder, you know, you -- every incentive you have is to lever up as much as possible, to use as little equity and as much in deposits and debt as you can. I would just point to what we've been through. And, you know, if we're in a world where every little downturn creates a financial collapse, that's not healthy for anybody. You know, if the result of this -- if the result of higher capital requirements on the large banks is less financial intermediation, you have to ask yourself the question, well, what was that financial intermediation actually getting done in the first place?

And so I -- you know, yeah, it's absolutely a risk that if you raise capital requirements too high, there's a financial system that isn't supportive of growth, but frankly, its a risk I'm willing to take, as somebody who doesn't want to see a crisis every -- you know, once a decade.


QUESTIONER: Hi. I'm Michele Wucker with the World Policy Institute. Sort of seque from that. Is there any discussion of the possibility of timing of those sort of things? I mean, obviously when you're at the bottom of the crisis, that's when people talk about increasing capital requirements, which is exactly the worst time. That's when it cuts back on lending. But when things are going great, nobody wants to take the punch bowl away from the party. It seems like that's when the higher capital requirements should be kicking in.

IRWIN: Yeah. So a big buzz word among the financial regulators is macroprudential regulation, which is a fancy way of saying -- thinking of regulating banks in the financial system through an economic prism, not just through the point of view of supervision. So the old model of bank supervision is you're looking at this bank and its assets, its book, its controls, its management, and you judge whether it's sound or not. The macroprudential approach is looking at the financial system as a whole and wondering, OK, well, is the debt ratio for the economy as a whole too large? Is there a risk that -- you know, do we have instability because of excessive leverage in the system as a whole?

You know, one example of this is the stress test the Fed is doing of big banks now, where they literally run through, OK, what if we got -- what if we had a recession and we got to 12 percent unemployment? All right, what would happen to this bank and that bank, and understanding in the broader economic context?

I think that's all progress and that's all, you know, making regulation better and I think it's the right thing to do. That said, I think we should be modest about our knowledge of how successful it will be in the long run. One example of that -- so the idea of countercyclical capital requirements was tried during pre-crisis, and the model that everybody wanted to copy of how to do countercyclical capital requirements -- exactly what you say, higher capital requirements during the boom years and then lower capital requirements during recessions -- was Spain. Spain's not doing great. (Chuckles.) So I don't think any of this is a panacea. I think -- you know, I think sorting this out is one of the most important things for the future of the world economy, but I think it's also one of the hardest things for the future of the world economy.


QUESTIONER: Michael Evan (ph). Oops. Breaking the microphones. So my question is maybe from a hundred thousand feet. And I was thinking about some of the comments that Mr. Garten brought up, you know, in the earlier discussion. It seems to me that once upon a time, we had a regular economy, and the regular economy related to the financial economy. And once upon a time people built railroads and, you know, made things, and that was the economy that then was serviced by the financial world. It seems to have inverted. And all the great wealth you've seen in the last few years, with a few exceptions, maybe in technology, have come from the financial community.

So perhaps the -- you know, the sort of this acute -- more acute question of where the central bankers come from and clubbiness of it and the -- you know, the isolation of it is a derivative of the fact that once upon a time, it served other -- is my thought, and I'm asking as a question to see if you agree -- another -- a broader part of the economy. If it's changed, and it's not going to change back, maybe that -- we should look at the broader financial community in a -- in a new light as -- you know, as the enduring source of wealth creation that perhaps the underlying economy was once. And do I have it wrong?

IRWIN: Yeah, well -- I mean, I don't disagree, but let me take that point in a bit of an oblique way.

All right. So the mission of the -- of the central banks -- if you're Ben Bernanke, your job is to worry about the real economy. Your job is not to worry about the health of JPMorgan or Citigroup. Your job is to worry about can people in America find a job, is inflation low and stable, is -- you know, can people make a living and have a prosperous existence. That is -- that is your job.

However, all the tools you have work through the financial system. So if it's -- you know, you have control over the regulatory side, you control capital requirements and all this stuff we were talking about, you also control monetary policy, which itself works for the financial system, because, you know, when the Fed -- I have a scene in the book -- when the Fed does QE, yes, the mission is try to get job growth stronger, but the way QE works is some guys down in Lower Manhattan at the New York Fed building, going to the market every morning, and they say, all right, today we're going to buy $3 billion worth of bonds. And they click, click, click, and the 19 primary dealers who are the biggest banks in the world, they offer bonds to sell, and the Fed buys $3 billion of bonds, and those $3 billion now exist on those bank balance sheet, and the bonds are on the New York Fed balance sheet.

So what I'm saying is the mission of trying to make the real economy happy -- you know, healthier, more prosperous, along with low and stable inflation, happens through these financial avenues. And so in that sense, yeah, the central banks contributed to the kind of financialization of the economy, and that's -- that also speaks to some of the limitations on why monetary policy -- why monetary policy hasn't done more to get our economy out of the rut.

But I don't know what alternative there is, really. I mean, that's -- you know, if you want government policy to do more to help kind of ordinary people, well, you need to work through fiscal channels, and that's decisions for Congress to make and the president to make. You know, the central bankers control what they control, and to the degree that contributes to financialization, you know, I think it is -- you know, a unhappy consequence of this last few years that, you know, Congress has not been really doing anything on the economy, and the Fed has been doing a lot. And that creates all kinds of financial bubbles and inflation and all that, while the alternative is for Congress to do its job, not for, you know, Ben Bernanke and the Fed to sit on their hands.

QUESTIONER: Yeah, could you -- I'm --

GARTEN: Could you just --

QUESTIONER: Sam Halizim (ph) with Morgan Stanley. Could you please compare and contrast the response of the European regulators to the U.S. regulators to our respective financial crises? And in particular, talk about, on the U.S., the banking sector was able to really recapitalize its balance sheets aggressively early on, and that didn't come to pass as well or as aggressively in Europe -- (inaudible).

IRWIN: You know, it's funny, we have a big conversation about "too big to fail" banks in the U.S, but that's -- the U.S. is nothing compared to Europe in terms of the role that the largest European banks play in their -- in their economies, in their political systems. I mean, this goes back -- this really goes back centuries. This goes back -- you know, in the U.S., we have this long-standing kind of skepticism of concentrated financial power and concentrated money. So back in the 19th century, when in Europe, banks were the major source of capital, the U.S. was developing stock and bond markets, which were the major way that large companies -- you know, if you wanted to build a railroad in 1880, you did it by doing a stock issue or a bond issue or a combination on Wall Street, not by going to a national bank because there wasn't a national bank because the regulatory regime wouldn't allow it. In Europe capital is much more widely provided by the enormous banks, and they're much more intertwined in the political systems there. So -- you know, so you have to understand the different responses in those contexts.

In the U.S. -- so, look, the U.S. officials made some pretty big mistakes but, you know, Lehman Brothers -- allowing Lehman to fail was the -- was the biggest. But, A, we were always -- you know, the size of the banking system relative to the economy was never really a problem, was never a constraint. And a lot of the capital provision was happening through non-bank -- through the shadow banking system, through securitization rather than through the banks themselves.

And because we're, you know, a large country with our own central bank and -- there was never a constraint on the ability of the ability of the U.S. government to rescue the banking system. Citigroup did not endanger the solvency of the U.S. government -- the Citigroup rescue.

So Europe, on the other hand, you have, first of all, no banking union, so each country's on its own. I mean, I -- it's a miracle that Switzerland didn't have a fiscal crisis given that it had two banks worth -- each with assets of 200 percent of Swiss GDP. Britain though, that -- you know, that was an issue in Britain. You know, you're -- if you're rescuing these giant banks in Britain, relative to your GDP, those are much larger.

So there's no banking union so they can't kind of share that pool of risk. And the banks are much more clearly -- not wards of the state, but attached to the state. And it's more accepted that, yes, we will rescue the banking system if to comes to it. That's how Ireland got in trouble. You know, they did a blanket backstop of their banks' liabilities in, I think, the end of October '08. And that's why they had a sovereign debt crisis -- same with Spain.

You know, if they'd existed in the U.S. context where there's one central bank, the risks are shared across the country, that wouldn't have happened in Ireland or Spain. There's a reason that we don't have a -- we don't talk about the Florida banking crisis now because the rest of the country was able to stand behind Florida's banks. I don't know where that takes it, but that's -- I mean, that's how I kind of look at the differences in the response between the U.S. and Europe.

GARTEN: Any on this side?

QUESTIONER: Hi. I'm Bill Cohan with Vanity Fair. I assume you're familiar with David Stockman's arguments against Ben Bernanke. He thinks, A, he's an intellectual fraud, not a real historian of the -- of the depression and basically he's followed-up Greenspan's bubble-creating policies with doubling down and creating bubbles of his own. Do you -- do you address that in the book? What's your thinking on that?

I mean, and -- you know, basically Bernanke's policies, which you said are designed to try to help Main Street have really benefited Wall Street at the expense of Main Street, so far -- and savers in particular. So I'm just curious what you think about that.

IRWIN: Yeah, I mean, I -- you know, David Stockman wrote his book. It came out a little before mine. And I just disagree with him pretty fundamentally. I think Stockman seems to have a view that basically everything that policymakers do and have done for 80 years to try to deal with -- to try and deal with the problems the economy is facing, have just sown the seeds for a much bigger panic and a much bigger crisis down the road.

I don't take that dark a view. You know, I think there was clearly a lot of things wrong in our kind of monetary regime heading into 2006, 2007. But I don't think the idea that going to a gold standard or going to something that's -- you know, ripping up the playbook entirely is going to put us in a better spot than what we've experienced.

You know, and I think -- you know, look, is -- I -- so I disagree with the premise that this expansive easing from the Fed has -- I agree that it's helped Wall Street more than Main Street; I don't think it's hurt Main Street. I know it hurt savers. You know, that's kind of the point. The point of easing monetary policy is to make it more advantageous to spend and invest than it is to save.

The point of -- you know, the problem of liquidity trap is too many people are saving at the same time. If everybody -- you know, my spending is your income. If everybody's saving at once, there's no spending, nobody has an income and then it becomes self-reinforcing. The point of lowing interest rates and doing QE is trying to create greater incentive to spend less, to save. So I think it's a net positive, even though it is hard if you're trying to live off of a -- off of a CD or off of your bank account.

You know, I don't know where else -- where else to go, except that I understand where Stockman's coming from, I just think he's wrong about the -- this basic premise that anything you do to try and make the economy better and try and get us out of a -- out of a ditch is going to sow the seeds for something awful down the road.


QUESTIONER: My name is Andrew Gundlach, Arnhold and S. Bleichroeder. I am curious why you think that Bernanke -- actually, all three of them -- but why especially Bernanke and Trichet were so late in recognizing the seriousness of the crisis? And if you about Germany and Hypo Bank going under because of lack of liquidity, despite all the bankers going to Trichet and saying, hey, we can't get any dollars, and Bernanke -- his early speeches talking about the mortgage crisis as just kind of a subprime blip to be ignored and even raising interest rates -- and was it that they failed to understand what was happening and then when they did understand that they didn't have the tools such as, you know, lending directly to Goldman, to -- you know, or to any securities firms directly because they weren't bank holding companies, and if that's the delay, has that now been fixed for the next Stockman-induced crisis?

IRWIN: They, you know -- (laughter) -- they were slow. Here's -- here was some of the thinking within the Fed in 2006, 2007. We now have transcripts of their FOMC for '07. It's a five-year delay. So we've now got those.

You know, they were -- they were nervous. They -- housing was already declining then. Housing peaked in '06. You know, they definitely -- I -- one Fed official told me once that, you know, they'd have these hallway conversation where -- did you see that story in The Wall Street Journal about this covenant-lite loan at -- for commercial real estate at a, you know -- they would see the press coverage of and hear from their contacts about some of the lending that was happening that seemed pretty questionable and pretty -- you know, like something that couldn't end well. They were nervous about that.

They didn't fully put together -- I compare it to that parable of the blind men -- the blind men and the elephant. You know, one person feels the side of the elephant and thinks it's a wall, one person feels the tail and thinks it's a rope, and one person feels the trunk and thinks -- but nobody can put together the full picture. I think the central bankers were very much in that mode.

So within the Fed system, there were people who did consumer regulation, who understood there was lot of shady subprime lending happening on the mortgage side. You know, there was -- there was the New York Fed that was focused on risks in derivative books and off-balance sheet shadow banking vehicles of the -- of the big Wall Street banks. You know, there was -- in Washington, the board of governors, there was a lot of worry about the real economy and how much is a decrease in housing prices going to affect, you know, the real economy through wealth effects and so on. But nobody was putting together how all these were connected -- bad lending on the consumer end; you know, a lot of leverage on the Wall Street financial sector; and all that interrelating with the real economy.

So yeah, there was absolutely a failure in both the U.S. and Europe to put together all these pieces and understand just how badly wrong this could all go.

Would they be better at this time? Well, we'll see. I hope so. You know, they're doing a lot of thinking right now and a lot of analysis into, you know, is -- are there current asset bubbles? So I think the best evidence is maybe on the corporate debt side, especially high-yield stuff. Those spreads look awfully narrow. You know, is that a by-product of QE that's creating risks? And then if it is, what do you do about it? So if you think that high-yield debt is trading at -- you know, the risk premia are too low between, you know, say, Treasurys and high-yield debt, well, is the fact that maybe some people are going to lose some money on those bonds if they buy them now and there's a higher default than they're expecting -- you know, is that a reason to tighten monetary policy or does that mean we need better financial regulation? Those are the arguments that are going on at the Fed right now.

I just -- you know, I -- (chuckles) -- knowing the future is really hard, and I hope they're able to judge those risks appropriately. I don't know what the right answer is, sitting here today.

QUESTIONER: Steve Myrow with ACG Analytics. I was at Treasury in '08 and I remember when Mervyn King came during the spring IMF/World Bank meetings and told Hank confidentially that they were thinking about going to a three-month special lending program at the same time in the U.S. we were struggling with would 30 days be too much. And one of his arguments was they didn't have the resources that the U.S. Federal Reserve have and, you know, they had to be a bit more creative. At the same time, I think they were afraid of going too far out and forcing the U.S. to take actions that it didn't want to take.

The question I have for you is, in light of your comments about Mervyn King -- and I'm not necessarily trying to defend him; I'm just interested in -- is there -- as in gymnastics, does he get a technical difficulty rating?

IRWIN: Yeah, I think that's -- I think that's fair. (Laughter.)

So a thing that hangs over the British economy that -- you know, there's a lot of ways in which the U.K. economy and the U.S. are similar -- you know, similar political systems, similar -- lot of ways we're similar.

The big difference is that we're the global reserve currency and they aren't. So the Bank of England has always had to weigh -- you know, the Fed -- they're doing all this QE; they're doing, you know, $3 trillion and counting; and the dollar's remained stable. I mean, the dollar's about where it was against major currencies a year ago, two years ago, three years ago. Nobody worries that the demand for U.S. Treasury bonds is going to dry up. It's the -- you know, if you're a -- if you're a sovereign well fund in Dubai, if you're a -- if you're a rich guy in India, if you're a company in Japan and you need to park a billion dollars somewhere, you always know that treasury bonds is the place you can do it.

So we have this special privilege as the global reserve currency, as the deepest, most liquid financial market in the world for treasuries, that gave throughout this, Ben Bernanke and Tim Geithner and Hank Paulson, some maneuvering room that smaller countries just don't have. And you know, Britain's very big and it's a very important economy, but it's, you know, one fifth of the population of the U.S., I think. So yeah, I think that's absolutely fair.

You know, the question for Mervyn King and the Bank of England has always been, well, if we did another, you know, X billion pounds in quantitative easing, would there be a run on the pound at some point? Would demands for gilts -- for U.K. treasury bonds -- would it dry up? Would the pound suffer? Would we have a, you know, a run on the pound and a run on British debt?

You know, you can argue, did they overweight the risk of that happening or -- you know, it's easy to second-guess from a distance, but those concerns were very valid and very real in what we're weighing on them as they -- so I think it's a very excellent point that they hesitate -- (off mic).


QUESTIONER: Bob Freeberg (sp).

So central bankers get it right and central bankers get it wrong sometimes. And how do we ensure that this -- their existence in the future? I mean, there are a lot of people going out saying, you know, we should get rid of the central bank, libertarians, et cetera. How do we -- how do we preserve -- (off mic)?

IRWIN: I don't think there's much to -- you know, the fact that -- OK, after everything the Fed did in '08-'09, in the Dodd-Frank debate, you know, there were a lot of people with the guns out to go after the Federal Reserve, not just on the right, you know, the kind of Ron Paul libertarian right, also the populist left. Maybe not -- you know, maybe there was never a momentum to eliminate it entirely, but there were a lot of people who wanted to really clip its wings and you know, get the Fed out of the business of bank regulation, for example, and have them more narrowly focused on just monetary policy.

I think the fact that that went nowhere, that that didn't happen, is telling. You know, I think these institutions, love them or hate them, they are deeply intertwined in the workings of the world economy and the world financial system. And you know, if you want to -- if you want to eliminate them, you have to figure out and replace them with what? OK, so let's say you -- let's say you're Ron Paul and you hate the Fed and you want to get rid of the Fed. Well, we need a monetary system. We need some way to have money and you know, something's going to replace it. And figuring out what that something is is the reason that there's been no serious effort to actually get rid of the Federal Reserve or the Bank of England or the ECB.

Now, you know, will the -- will the current European monetary system survive? That's a different question. But the idea that there will be a central bank, that will be the institution that is in charge of the supply of money in the economy, I don't see that as something that's at tremendous risk.


QUESTIONER: Yeah, just to follow on that theme, I think you referred to the Fed as being a deeply antidemocratic institution, and coupled with that, unelected officials, they have enormous power. And I think the power was increased, rather than decreased, through Dodd-Frank. And it would be one thing if they were like the Japanese baseball governors who want to increase home runs, and so they secretly do something to the baseball and sure enough, get that result. The Fed has demonstrated over the Greenspan and the Bernanke years that they really -- has been pointed out today -- missed their prime function of understanding, identifying the state of the -- the true state of the economy.

Would -- so in other words, they haven't demonstrated a high level of competence in the job they've been assigned to do. So does the dual mandate make sense? I mean, would it be perhaps more useful to limit the powers that they have and limit the focus and see if they can get it right?

IRWIN: So there's a case for that. I mean, the case would be, how can you have -- so the dual mandate of course is that the Federal Reserve is charged with maintaining maximum employment and stable prices. And you know, those do come in conflict sometime, and they have to figure out how to prioritize those at any given moment in time. You know, the ECB, the Bank of England, the -- they have a single mandate. They're going to 2 percent inflation. And the theory is the central bank should control what it can control. And it can control the money supply. It can control the price level. But everything else is kind of outside its control. That's the theory, anyway.

So first of all, I -- I'm not sure that, in the U.S. context, that would actually have made much of a difference the last few years. The Fed has been undershooting its inflation target too. This is a moment -- you know, and the reason the Fed's been as aggressive as it has the last few years is that, you know, the Fed has simultaneously tried to maintain 2 percent inflation and unemployment something closer to, you know, 5 or 6 percent instead of the current 7 1/2 percent.

Well, both of those are pushing at the same direction right now. It needs a little higher inflation and lower unemployment. So that says, if you're a central banker, I got to ease. So I'm not -- it's not entirely clear that if they had a single mandate and it was 2 percent they wouldn't have been easing last couple of years.

That said, over the longer term, I think there's a -- there's a decent case to be made for what you say, that -- you know, keep it simple. You know, it's -- first of all, it's not the case that -- in Britain and Europe -- that the 2 percent inflation target is proving to be any kind of panacea or the single mandate is solving everything. But I think the raw simplicity of it has a certain appeal.

So I have no -- over the longer term, I have no strong opinions on what -- you know, what would be best for the U.S. and whether the dual mandate actually don't make a ton of sense in the modern world.

GARTEN: So we're almost out of time. And let me ask you just a final question.

IRWIN: Sure.

GARTEN: When President Obama -- I guess it's at the end of the year -- thinks about the next Fed chairman, what's going to be utmost in his -- what's going to be utmost in his mind? What factors is he going to weigh in thinking about who should have this critical job?

IRWIN: So it's funny. Ben Bernanke is not qualified to be Federal Reserve chairman right now. And here's what I mean: If you go back in time, the Ben Bernanke who took the job in 2005, I should say, would not be qualified for the job now. It's a much harder job that he's leaving than the one he inherited.

The person in the job needs to be all these things: an excellent economist, or at least economic thinker; a skilled communicator -- you know, this is somebody who has to now do press conferences four times a year; they go before Congress a lot -- a very good regulator. You know, their responsibility over the financial system is much greater than it was five years ago.

You know, I don't think somebody like Bernanke who's -- who is a very good academic economist, had never -- you know, never regulated a bank in his life. I don't know if that's the right fit anymore. They have to be a very good diplomat. They have to understand the international dimension of their job. And they have to be a pretty good politician too. You know, navigating the political winds in Washington is not an easy job and it's an important part of the Fed chairman role.

So that's -- that set of qualities is what President Obama will be looking for. He also needs someone who fits his basic theory of the world and what needs to happen. So I presume that means he's going to want somebody who's very much concerned about getting economic growth on track and getting unemployment down. The president has to make a call on how much he wants the new Fed chairman to be worried about asset bubbles. I'll give you an example.

So two -- you know, one leading candidate and one, kind of, darkhorse candidate for the job -- Janet Yellen is, you know, the vice chair now. She's probably the most -- the single most likely candidate, but I think there's other candidates as well. You know, she is very explicitly and clearly focused on employment. She's very dismissive of this -- of some of this asset bubble talk and think that people are getting ahead of themselves.

Another potential candidate, more of a darkhorse, would be Jeremy Stein, a Federal Reserve governor nominated by the president a couple years ago, very smart Harvard economist. He's been giving speeches where he makes clear he is worried about asset bubbles and he thinks there is the risk that easing monetary policy and QE will sow the seeds of the next bubble. So if he were appointed chairman, it's a safe bet that he would be more attuned to that risk and maybe tighten policy a little sooner than Yellen would because of that risk.

You know, so the president has to decide. You know, it's not the job of the president to decide what the Fed should do at this meeting or next meeting. That would be a very bad idea. But it is the job of the president to decide, all right, what set of priorities do I want in the next Fed chair? What kinds of concerns do I want them to be weighing and really thinking about?

And in choosing between a Janet Yellen or a Jeremy Stein or a Larry Summers or a Roger Ferguson or whoever you want to name, he's going to be setting those priorities. So it's a combination of somebody with the right -- the right mix of skills and the right sensibility on priorities and strategy with -- and again, that's just monetary policy. Forget -- and then there's financial regulation. Having somebody with the right sensibility and the right approach on financial regulation, that's going to be the challenge.

The recent pattern has not been appointing the number two. The Bank of England went outside. They passed over -- the British government passed over any of Mervyn King's deputies in favor of Mark Carney from the Bank of Canada. And the Canadians did the same, passing over the deputy in the Bank of Canada to go for an outside candidate. We'll see whether the -- whether President Obama also wants a sense of change and new blood or goes with continuity, which would be Janet Yellen.

GARTEN: Neil, thanks very much, a really interesting discussion. (Applause.)

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