Last Thursday, John A. Allison visited Wichita to address the annual economic outlook conference produced by the Center for Economic Development and Business Research (CEDBR) at Wichita State University.
Allison is chairman and former CEO of BB&T Corporation, the nation’s 10th largest financial-holding company. Its headquarters are in Winston-Salem, North Carolina. His talk first diagnosed the cause of the crisis. You can read my coverage of it at Causes of global finance crisis explained in Wichita
Having described the cause, Allison told what we need to do to fix the mess we’re in, and to avoid future crises like the present.
One problem is the credit rating agencies and the functional oligopoly granted them by the government. These agencies — Standard & Poor’s, Moody’s, and Fitch — provide ratings for bonds. (These are the “AAA” and other ratings that many people are familiar with.) The oligopoly comes the fact that many institutional investors may purchase only those securities that have been rated by one of these firms.
These rating firms made many mistakes, and not just small mistakes. These companies did a poor job of analyzing the risk of these securities. That lead to insurance firms, most notably AIG, becoming deeply in trouble. The justification for saving or bailing out AIG is that there was a systems risk. AIG’s relationships with other parties such as the investment bank Goldman Sachs lead many to believe that the fall of AIG would lead to the fall of these other institutions.
Allison said that if you’re former Treasury Secretary Henry Paulson, who was once chairman and CEO of Goldman Sachs, it’s easy to believe that if Goldman Sachs goes out of business, the world goes out of business. Allison asked: “Is that a systems risk or is that crony capitalism?”
There was an irrational belief in mathematical models. There is the “tail problem,” which comes from models usually assuming a normal mathematical distribution (the familiar bell-shaped curve). The events out in the tails are usually discounted, as they are rare. But Allison said “For anyone who has built a house in a hundred year flood plain, I’ll give you the bad news: we’re going to have a flood.” Given enough time, these rare events become a certainty.
Market corrections, Allison said, are healthy phenomenon. These events drive companies that are misallocating capital out of business, and the world is better for it.
One of the little-known things is that part of the reason for the Troubled Assets Relief Program (TARP) was to bail out General Electric. GE had done a lot of risky long-term financing using commercial paper, and this lead to trouble.
All the major banks participated in TARP, as there was huge regulatory pressure. There were four very large banks that were on the verge of failure. But the government didn’t want it to look like it was bailing out just those banks, so it forced all large banks to participate, even though many were healthy.
In his career, Allison said. Citigroup has failed three times, and each time they emerged bigger and worse. That, he said, will also be the result of the current bail out.
The five banks that are judged, as is Citigroup, as “too large to fail” will have advantages like lower cost of capital, and they’ll be able to engage in risky activities without the risk of going out of business if investments fail.
Allison said the government should have let these banks fail. Alternatively, they should be broken up, so that none are in the “too large to fail” category.
“We ought to cut government spending, not increase it,” Allison recommended. The belief that wasteful government spending on the wrong things can increase our standard of living is irrational. It’s based on the belief of the economist John Maynard Keynes. He recommended that we pay people to dig holes in the ground, and then pay them to fill the holes. Will that raise our standard of living?
In the long term price instability is a major problem, as it leads to economic miscalculation.
The biggest issue, Allison said, is the continued attack on capitalism. Related is the attack on the wealthy, in terms of both taxation and ethics. Most very productive people become wealthy. If we attack these people, they become more conservative and less willing to take risk.
The government needs to privatize Freddie Mac and Fannie Mae and let banks make mortgages the way the had for many years before the government became involved in the business.
We also need a market-based monetary standard, probably based on gold. “You can’t just print gold,” Allison said. If we can’t do this, we need to do as Milton Friedman advocated, which is to grow the money supply at a slow and predictable rate, probably about 3% per year.
There should also be less FDIC insurance, so that the shareholders of a bank bear risk, rather than the government.
Free trade is also needed, even though many conservatives oppose this. One of the reasons for the Great Depression was trade tariffs. Other countries responded to ours, and there was less trade.
Allison said that the most important problem we have is philosophical. Where does free medical care come from, for example? He said that the idea of rights on which the United States was built is that people have right to what they produce themselves, but not what others produce.
Free medical care and affordable housing are a perversion of this concepts of rights. The right to free medical care, he said, is the right to enslave a doctor to provide the care, or to enslave someone else to pay the doctor. That’s the opposite of the American system of rights.
Under such a system, no one has the right to their own life.
He also addressed the difference between short-term and long-term thinking. Some things that work in the short-term are destructive in the long-term, such as the pick-a-payment mortgages.
The “free lunch mentality” leads to a lack of personal responsibility, and that is the death of democracy. The “tyranny of the majority” — where a majority can vote a free lunch for themselves, eventually the providers quit.
The cure is the opposite. Life, liberty, and the pursuit of happiness demand personal responsibility. Each person has a moral right to their own life.
“The United States is the only country founded on the concept that people should act in their rational long-term self interest, properly understood.” He said that you shouldn’t take advantage of other people, as it doesn’t work. You also shouldn’t self-sacrifice, as you have the right to your own life.
Where do we go now?
We are probably in the beginning of an economic recovery. Allison feels the most likely scenario is a period of stagflation — slow growth, high inflation, and higher unemployment than we should have — similar to the 1970s. This would not be a great time, but not a horrible time, he said.
He is more concerned about the long term. The liabilities in the social security and Medicare systems, our huge operating deficits, a dysfunctional foreign policy, and a failed K through 12 educational system lead to the certainty that in 25 years, the United States will be broke.
What we need to do, he said, is the opposite of what we’re doing. We need to return to individual rights, the incentives that free markets provide, and less regulation.
The “American sense of life,” Allison said, means that we are a very individualistic nation and not collectivist.
Business makes the world a better place to live by providing quality products and services. A primary difference between the United States and Africa is that we have better businesses.
Allison mentioned two pillars that make the human mind productive. The first is Freedom and liberty. He drew a parallel between academic freedom and economic freedom. Those who believe in academic freedom, however, often want to restrict economic and business freedom.
The second pillar is knowledge that comes from education, in the broadest context. We need an environment that encourages competition, discipline, and creativity in our educational system.
Allison encouraged the audience to seek happiness through a “life well-lived.” Self-esteem is developed by doing your job the best you possibly can, he said. Depending on government for security is the European way, but not the American way.