Professor John Allison discusses the primary cause of the United States’ financial crisis

4.14.2010 Article, Faculty News, General

 

Ex-bank CEO: Government caused crisisOriginally Posted on Wednesday April 14, 2010 | By George Hohmann
Reposted from The Charleston Daily Mail

Government policies were the primary cause of the United States' financial crisis, said John Allison, the recently retired chairman and chief executive officer of BB&T Corp.

"Government policy created a bubble in the residential real estate market, it burst and went into the financial markets," Allison told several hundred people gathered Tuesday for his lecture at the University of Charleston.

"We overbuilt residential real estate – we built too many houses, too big, in the wrong place. How did we make a mistake of that magnitude?"

Allison laid the blame at the feet of the Federal Reserve, the Federal Deposit Insurance Corp., and the two big government-backed mortgage lenders, Freddie Mac and Fannie Mae.

"The Federal Reserve is the fundamental cause," Allison said. "In 1913 (the year the Federal Reserve was created) the financial system in the U.S. was nationalized. If you have problems in the monetary system, you by definition have a government problem."

There was significant mismanagement of monetary policy by the Federal Reserve to the point that "people came to believe there was no risk," Allison said. Under former Fed Chairman Alan Greenspan, the real interest rate was held to negative levels, he said.

The Federal Deposit Insurance Corp. contributed to the problem by allowing the bank IndyMac, the savings and loan Washington Mutual and the mortgage firm Countrywide to build national franchises by paying high rates on certificates of deposit. They could sell those certificates because the FDIC insured them, Allison said.

"FDIC insurance caused a real distortion of capital."

The government's housing policy, which emphasized affordable housing, resulted in sub-prime loans that could exist only because the government guaranteed them, Allison said. When Freddie and Fannie collapsed, they were leveraged 1,000 to 1, he said.

When housing prices fell, market liquidity was destroyed. Allison said when the FDIC decided to pay Washington Mutual's uninsured depositors as well as its insured depositors, banks realized they didn't know what the rules were and got out of the capital markets overnight, shutting those markets down.

He said some blame for the crisis also rests with the three rating agencies – Standard & Poor's, Moody's and Fitch.

"They're the only agencies sanctioned by the government to rate financial products. They didn't know what they were doing," he said. "They missed a lot."

When it was realized that the agencies' ratings were unreliable and the market couldn't evaluate risk, liquidity dried up, he said.

Allison described fair-value accounting as "another failure of government policy," since the Securities and Exchange Commission creates the accounting system.

One of the government's programs intended to alleviate the financial crisis is the Troubled Asset Relief Program, or TARP. It pumped federal money into banks.

In 2008 BB&T took $3.1 billion under the U.S. Treasury Department's Troubled Asset Relief Program, or TARP. The company repaid all of it in 2009.

"I was adamantly opposed to TARP," Allison said. "I thought it was bad public policy. But I failed.

"The day after TARP passed Congress, I got a call from the FDIC. They said we (BB&T) had much more capital than needed. But they said, 'We've decided we need new capital standards and we don't know what they are yet but we're confident you don't have enough capital to meet them. We'll send in a regulatory team tomorrow.' We said, 'We'll take TARP.' "

Federal Reserve Chairman Ben Bernanke wanted to force all of the big banks to take TARP money so no one could tell which three big banks were weak, Allison said.

TARP worked in that it quieted the marketplace, "but it created a giant moral risk," Allison said. "It created an oligopoly in the financial industry – there are now five institutions defined as 'too big to fail.' Which in effect means they have a government guarantee."

Allison said market corrections are not an entirely bad thing. He said the United States needs less government regulation, not more. And he said the government needs to stop subsidizing housing; materially reduce spending as a percent of gross domestic product; encourage free trade; privatize Medicare and Social Security; cut the cost of defense; encourage immigration; and restore discipline to the system by saving more and spending less.

He said altruism and pragmatism have led to a "free lunch mentality" and a lack of personal responsibility.

"We need to get back to the principles that made us great – individual rights and free markets," he said.

Allison said his favorite book is "Atlas Shrugged," written by Ayn Rand.

"If you haven't read it, you should, and if you haven't read it in awhile, you should re-read it," he said. "The bad guys today are in that book, written in 1957."

In recent years BB&T has made contributions from its charitable foundation to West Virginia University ($1.75 million), Marshall University ($1 million), Wheeling Jesuit University ($700,000) and the University of Charleston ($350,000). Most of the money involves an agreement by the schools to at least review the free market principles set forth in "Atlas Shrugged."

There are thousands of BB&T stockholders in West Virginia because Charleston-based One Valley Bancorp was bought by Winston-Salem, N.C.-based BB&T in 2000. That deal instantly made BB&T the largest bank in West Virginia.

BB&T has more than $165 billion in assets and operates more than 1,800 offices in 12 states and Washington, D.C.