University Place Madison City Channel Presents "Wisconsin 2050: Lessons from the Great Depression"   cc >> Lorrie Keating Heinemann: Thank you very much. I'm really honored to be here, and I did not know when I took this position back in 2003 it would be quite the challenge that it has become, but indeed it is. Tonight I've been asked to talk briefly about the state of Wisconsin's banking environment and to introduce our highly esteemed speaker. First, because I am the Commissioner of Banking for the state, I have to tell you that our banks are not exempt from the economic downturn. While the majority of our banks, we regulate 217 state chartered banks in the state, while the majority of them remain strong, many are experiencing a high percent of loan delinquencies caused by the decline in real estate values, and the increase in unemployment levels, which I'm sure is a surprise to none of you. Our average capital ratio, which is basically the capital in the bank divided by the total assets, is a respectable 9.8% and is actually better than the overall national average of all banks in the United States. However, our bank earnings are down. One out of five banks are now reporting negative earnings. Earnings have been under pressure due to the need for increased loan losses, because when a loss is taken, they have to put more in their loan loss reserves, tight net interest margins, and the increased cost of FDIC insurance premiums. The weakening economy has also reduced the number of qualified borrowers and has resulted in increased scrutiny by both the state and the Federal regulators. 

In Wisconsin, we actually partner with the Federal Reserve banks of Chicago and the one in Minneapolis to oversee the operations of our Fed member banks, and I know you're going to hear a little bit about the Fed today, so I thought I'd mention that. But we also partner with the FDIC as we co-examine many of the banks throughout the state of Wisconsin. I will point out, because I'm kind of a champion for the community bankers, that the life's work of many of our bankers in the state is being challenged by the costs of paying for the excesses of some "too big to fail" institutions. Wall Street is impacting Main Street. The result is a tightening of credit on businesses in our state at a time when the funding is needed the most. So as it was asked a little earlier, how did we get here? And that's what tonight's author, Liaquat Ahamed, is here to talk about. Quoted just over a year ago, Mr. Ahamed said that "nothing brings home the fragility of the banking system or the potency of the financial crisis more vividly than writing about these issues from the eye of the storm." These words really ring true today as our country moves forward with the repair and the recovery of our global financial system. Last year I believe Mr. Ahamed had a pretty busy year, it sounds like, from looking on your reviews on the website. When he was putting his finishing touches on his book, "Lords of Finance: The Bankers Who Broke the World," he talked about the book being about a story of four central bankers in the years after World War I and what Mr. Ahamed calls the "seminal economic event of the last century," the unprecedented breakdown of the global economy, or what is now known as the Great Depression. Mr. Ahamed's book, which is his first, I believe, has been universally praised and it has become a best-seller. 

The book has also won the Spear's Book Award for the best financial history book of the year. Mr. Ahamed will tell us tonight if he saw things coming, what he knew and when he knew it, and better yet, what he thinks will lie ahead. Known as a lover of words, a master storyteller, and a historian, Mr. Ahamed is all of these. But he has also been a professional investment manager for the past 25 years. He has worked at the World Bank in Washington DC. He served as the chief executive of a New York investment partnership, and he is currently not only an advisor to investment groups, but a director of the Aspen Insurance Company and is on the board of trustees for the very highly respected Brookings Institute. So with that, I would like to bring up Mr. Ahamed, who will talk about his book, "Lords of Finance: The Bankers Who Broke the World." (applause)  >> Liaquat Ahamed: Well, thank you for those kind words, Secretary Heinemann. And thank you to the academy for inviting me to speak. I should just actually put one issue to rest, which is, I started writing this book about four or five years ago and it was published in January this year. And when it came out, a lot of my friends said, "You must be some sort of genius, you figured this out four or five years ago." They would always then end up by saying, "But if you'd figured it out that we were going to have this crash, why didn't you give us a call and let us know?" (laughter) So I didn't figure it out. 

We have just been through the worst financial crisis since the Great Depression. It may be of little comfort to know that financial crises are nothing new. Indeed, the first recorded financial crisis occurred in AD 33 when there was a run on the imperial banking system and the emperor Tiberius had to inject a million gold pieces to stabilize the Roman banking system. Not only have they been around for a very long time, but there have been a lot of them. In 1721 we had a thing called the South Sea Bubble, and that was the first time the word "bubble" was used to describe an out of control financial mania. But since then there have been, depending on how you count, anywhere from 40 to 50 different financial booms and crises. So I suppose the good news is that we've always recovered, because here we are. I suppose the bad news is that we keep on making the same mistakes over and over again. The frequency of these financial crises varies. Starting from the early 19th century and right through to the mid 20th century, they seem to occur every nine to ten years. 

In fact, if you're a reader of the New Yorker, there was an article, not last week, but the week before which described someone who is sort of an expert in financial cycles, and he computed that they occurred precisely every 8.6 years. The system then went dormant in the 1950s and '60s, and then suddenly in the early 1980s the volcano seemed to reactivate and we got a sequence of crises. We got 1982, emerging market crisis. 1987, the stock market collapsed. 1990, the SNL problem. 1994, Mexico and the peso crisis. 1997, 1998 was the Asian crisis, the Russian defaulted, long-term capital. And 2000 was the tech bubble. So first of all, it looked as if the frequency of these crises had increased and we were getting them every three to four years. And that's when I became interested. 

I was in the investment management industry and I began to read up about past crises in order to understand what drives them, why they start, how they develop, what to do about them. There's no better place, or there's nothing that provides as much food for thought as the mother of all crises, which is the Great Depression that started in 1929. Today, I'm not going to talk very much about my book. I'm going to really try to focus on the parallels between what happened then and what's just happened. I'll divide the chronology into three areas, the lead up, the handling of the crisis, and the recovery. So first the lead up. The similarities in the lead up to what has happened just now and what happened in 1929 are eerie. In both cases we had a bubble, and it was in the stock market, this time it was in real estate. In both cases, the bubble was created by a mistaken Fed policy, specifically over-easy credit. In both cases in my view, the mistake was exacerbated, if not caused, by a malfunctioning in the international financial system. 

Let me spend a couple of moments on this. In the 1920s, the problem was between Europe and the US. Many people forget, 1929 occurred only ten years after the end of the first world war. The most expensive, costly war in history that essentially bankrupted Europe. For four years, the three major European powers, Britain, France, and Germany, spend 50% of their GDP per year fighting this sort of pointless war. They financed it by borrowing massive amounts both from their own citizens and from the US in the case of Britain and France, and ultimately by printing money. So they basically destroyed their financial system. In the ten years after 1919, Europe was trying to rebuild itself and in order to do that, the US kept credit easy, because Europe needed foreign financing in order to reconstruct. The Fed found itself with a dilemma. It had to keep credit easy in order to rebuild Europe. 

That easy credit provoked a bubble in the stock market. And as usual, when the Fed's trying to do too many things, it accomplished neither. So the easy credit designed to essentially revive Europe after the first world war was what provoked the stock market bubble. The more recent crisis, or this recent ten years, the bubble was associated with a slightly different imbalance, and the imbalance was between Asia and the US. There were two mechanisms that happened. Essentially, beginning in the early part of this decade, Asian currencies were undervalued. China embarked on a massive export push, the other Asian countries in response to the Asian crisis of 1997 decided that they wanted to accumulate a vast reservoir of dollars. They basically said, we never want to get into this position again. And so they went out of their way to accumulate a reservoir of US dollars. In order to do that, they undervalued their currencies and pushed exports out. 

That did two things. It, one, confused the Fed. What happened was that because of this export push from Asia, inflation was unusually low because the Asian countries were underpricing their goods. The Fed mistook the low inflation as a symptom of a domestic economy that was running out of steam. So, put its foot on the accelerator. In fact, what was happening was, we had a once in a lifetime expansion in the supply of goods and services coming out of Asia. If you like, it was good deflation and the Fed was worried about what it thought would be bad deflation. The second thing that happened was that the accumulation of dollars in the hands of Asian central banks overwhelmed the capacity of the financial system to handle it. So essentially these dollars were put into financial institutions who then ran out of lending opportunities and then channeled them into the worst sorts of lending, made some very poor lending decisions. So the combination of an over easy Fed and a massive amount of dollars swimming around the financial system provided the fuel for the real estate bubble. 

To go back to the story, in both cases, we had the same debate about how to react to the bubbles. During the real estate bubble that was occurring in the early part of this decade, Alan Greenspan, the chairman of the Fed, argued four things. One, that it was impossible for the Fed to identify bubbles exactly, that it could only tell if something was a bubble exposed, once it burst. Secondly, that bubbles are an inherent sort of part of a dynamic capitalist system, a product more of human psychology than easy credit and there was nothing the Fed could do about it. Thirdly, that if he tried to do anything about it, he would be overstepping his mandates and would get himself into a lot of political hot water. And fourthly, that the side effects of trying to deal with the bubble, side effects of the medicine, would be worse than the disease and that it was more efficient and less costly to deal with the after effects. In effect, let the bubble burst, burn itself out and burst, and then deal with the consequences. Every one of those arguments surfaced within in the Federal Reserve in the 1920s, so there was nothing new, and they made exactly the same decision. They made the same calculation that they would step aside and let it... I must learn not to mix my metaphors when I talk about bubbles. 

But let itself blow up. In both cases, both in the 1920s and now, we had excess leverage. In the 1920s there was development of what were known as investment trusts, which are real leverage closed-end funds. And there was a lot of leverage by a group of traders on Wall Street known as Pool Operators, who were like the hedge fund managers of the era, who borrowed extensively in the broker loan market and in those days, if you wanted to buy on margin, you only had to put 10 cents down and you could borrow the other 90 cents and buy a dollar of stock. Recently, the leverage has occurred in the financial system and in particular what has come to be known as the shadow banking system. So what is the shadow banking system? If you take the total size of banks in the US, they amount to about $10 trillion compared to a GDP of about $15 trillion. In addition, though, to those banks, there are a whole series of other institutions that act like banks, but are not called banks. I'll give you an example that you all use, which is money market funds. What do money market funds do? You deposit your money in the money market fund, you often have check writing privileges, you can withdraw your money when you want. And what does the money market fund do? It invests that money in a whole series of investments, exactly like a bank does. 

Total size of money market funds is somewhere between $3 and $4 trillion, so it's almost half the size of the banking system. In addition, we had investment banks that operated like banks. They borrowed short-term and bought long-term assets. Total size of the balance sheet of investment banks was another $3 to $4 trillion. All of these institutions operated like banks without two things. One is the regulation that banks are subject to, and in particular, the capital adequacy requirements that banks are subject to. Secondly, without the sort of oversight of regulators looking at what they were doing. This became, this shadow banking system, became the most vulnerable part of the financial system. Okay, so, in both cases we had a bubble. In both cases, as they always do, the bubbles burst. 

And in both cases the bursting bubble led to a banking crisis. In the 1920s, it was a conventional banking crisis. You remember those grainy, black-and-white photographs of people lining up outside banks to take their money out. That was in the days before deposit insurance. Now that we have deposit insurance, there was very little of that, although we did get some cases. We got a run on a bank in California called IndyMac. We got a run on a UK bank called Northern Rock. We got a run on a Hong Kong bank called Bank of East Asia. This time, we had a run on the shadow banking system and it was actually more insidious and more dramatic because the shadow banking system, aside from money market funds, largely finances itself through wholesale sources of money, not retail sources of money. The run occurred, essentially it was a digital run. 

Institutions got on their computers and with a click of the mouse pulled out hundreds of millions of dollars out of financial institutions. So we've had a banking crisis. All financial crises seem to throw up a signature crook. This time, the signature crook is a man by the name of Bernie Madoff, you've probably been reading about Bernie's exploits. The Bernie Madoff of the 1920s was a man by the name of Ivar Kreuger. He was a Swede, he ran a match manufacturing company. Because of the conditions in the '20s, a lot of European countries, but a lot of countries in other places, had bankrupted themselves during the first world war. So Mr. Kreuger discovered that he could borrow on better terms than most countries. So he went into the international banking business, and what he would do was borrow money on Wall Street and lend it to countries. In return, he would demand a monopoly over match manufacturing. 

He did such deals in Ecuador, Peru, Poland, Greece, Hungary, Yugoslavia, Romania. In 1926 he did a deal like that in France, and most famously, in 1929, in Germany. He made himself the third richest man in the world. He was a confirmed bachelor and he had six or seven residences around the world in which he installed different girlfriends. He went into the movie business and was responsible for discovering Greta Garbo. In 1932 he was found in his apartment in Paris with a bullet wound through his heart. Initially, everyone sort of felt very sorry for him, saw him as a victim of the tension of the time. It then turned out that he had borrowed money by forging government bonds and his last transaction had been to forge $100 million in Italian government bonds. Eventually, his bond holders lost a total of $400 million. Now, one way of converting amounts from the 1920s to now is to multiply by 200. 

That sort of adjusts for the size of the economy, so that works out to about $80 billion today. So I think he actually probably beat Bernie Madoff. He was interviewed by the Saturday Evening Post and they asked him, "Mr. Kreuger, what's the secret of your success? You're the third richest man in the world." And he said, "Three things. First is silence, the second is more silence, and the third is still more silence." You can see why I compare him to Bernie Madoff. Then as now, the bursting bubble, the banking crisis and the scandals brought discredit on all those involved in running and regulating financial institutions. If you think that outrage at the sort of so-called greed and excesses of Wall Street is something new, get this. In 1933, congress decided to hold hearings on the source of the financial problem. The hearings were led by a young district attorney from New York, Ferdinand Peccoro. He got all the chief executive officers of the major banks to come and testify, and we discovered the following. The president of Chase was a man by the name of Albert Wiggins. 

In October 1929 when the stock market crashed, he had made $4 million. Now remember, the way you convert it is to multiply by 200, by shorting the stock of his own bank at the beginning of October. Talk about a conflict of interest. Charlie Mitchell, who was president of what is now CitiBank, and Jack Morgan, who was the head of JP Morgan, had both earned a million dollars a year for three years and neither had paid a cent of taxes. Bankers became nicknamed "banksters." In 1934, Andrew Mellon, who had been secretary of the treasury under three presidents and had been hailed as the greatest treasury secretary since Alexander Hamilton, was indicted for tax evasion. The treasury department demanded $2 million of back taxes. He, by the way, was the third richest man in the country. He eventually settled for $600,000 and agreed to donate his paintings to the national gallery. (laughter) So we got something out of it. There are many echoes of the past in today's headlines of Wall Street's excesses. 

So if you'd taken a snapshot of the world, about 16 months into the Great Depression in the beginning of 1931, this is what you would have found. Stock market was down about 50%, profits were down about 50%, global industrial production was down anywhere from 15% to 20%. Well, guess what. In May of this year, if you'd taken the same snapshot, again about 15 months into this current recession, you'd have found the stock market was down about 50%, profits were down about 50%, and global industrial production was down somewhere between 15% and 20%. The difference, of course, is, in the subsequent 18 months, from January 1931 to June of 1932, the bottom fell out of the world economy. Stocks ended up down, in the US, down 89% eventually. World industrial production fell another 20%, so it went down 40% all together. That is not happening this time. In fact, we're getting a recovery. So, what's the difference? What happened in the 1920s was, they took, the authorities took a very sick patient and gave it exactly the wrong medicine. 

They did three things. First is, they let the banking system go under. They essentially argued, the Fed argued, that our job is to provide temporary loans to deal with the liquidity crisis, not to compensate you for the bad investments and mistakes that you've made, not to compensate bankers. The problem is that in a depression, the distinction between what is known as a liquidity problem, which is, you need temporary money, and a solvency problem, i.e., you made bad loans, begins to erode. Essentially, if everyone has a liquidity problem, everyone's trying to dump assets at the same time and you convert what is a liquidity problem into a solvency problem. So, the Fed let the banking system go under. Secondly, they tried to cut budget deficits by raising taxes. 1932, Hoover, they believed that budget deficits were always a bad thing. In 1932, Hoover raised taxes. And the third thing, the height of all folly, they even raised interest rates in the middle of the Great Depression. 

In 1931, Germany raised interest rates from 4% to 15%. The UK followed a month later and the US even raised interest rates from 2% to 5%. You ask yourself, why on earth would they do that? Well, it was the gold standard. Essentially what happened was, the run on the banks caused a lot of gold to leave the banking system and all these countries started scrambling for gold. The way they competed with each other was to raise interest rates to try to attract gold. It was actually a slightly crazier system than that. Gold is incredibly heavy and expensive to transport. A cube of about 18 inches by 18 inches ways about a ton. Countries, instead of shipping gold around the world, decided, what we'll do is, we'll just keep it in one place and just, by a bit of bookkeeping, move it around. So, when Britain lost gold to France, what would happen is, a guy would go down into the vaults of the Bank of England, two guys, and they would go to the vault, and they'd go to one side of the vault and they'd load all these ingots on and they'd put it on a little cart. 

Then they'd trundle the cart over to the other side of the vault and they'd offload it and they'd stick a little flag in it saying, "This now belongs to France." So you had this absurd system where Britain was causing mass unemployment, raising interest rates, causing mass unemployment, because there was not enough gold on one side of its vaults and too much on the other. It was clearly an absurd system which then collapsed. What I do is, I liken these officials to 18th century doctors, who thought the cure for illness was to draw blood from the patient. And we haven't learned many things in economics, but we have learned that when you've got a patient who's sick, the cure for their disease is not to draw blood. So we're now doing none of those things. No one is letting the banking system go under. We briefly, for one day, experimented with letting a bank go under, and look at the consequences. So we have thrown unprecedented amounts in to support the banking system. Secondly, no one thinks that we should be trying to raise taxes or cut the budget deficit at the moment. Indeed, we've expanded collectively, countries have expanded their budget deficits around the world by about 5% of GDP. 

And no one's planning to raise interest rates. No one has raised interest rates, and no one's planning to raise interest rates. Indeed, they've intervened to try to get long-term rates down. The lead up was eerily similar. How they handled the crisis was very different. Let me spend the last few moments on the recovery. Contrary to what most conservatives argue, the recovery after 1933 was very strong. Industrial production doubled in a four-year period in the US as it did in Germany. The first Roosevelt term represents the strongest peacetime presidential term of economic growth. Where the conservatives are right is that unemployment remained obstinately high. 

Employment lagged behind, in part because many of the New Deal policies in effect raised the cost of labor so employers found it more profitable to expand production without having more workers. Second thing, contrary to popular myth, the recovery across the world, particularly in the US and Britain, had very little to do with deficit spending or Keynesian policies. Roosevelt was a victim of the same dogma at the time, that he thought budget deficits were a bad thing. So while the New Deal policies did cause some modest increase in public expenditure, it was financed by raising taxes. The only place where we got massive public works financed by government borrowing was in Germany, which is the only place which had essentially pursued Keynesian policies and, by the way, was the only place that did not face an employment problem during the 1930s. So what happened? Most countries recognized that the gold standard had become a straitjacket and broke with gold. This allowed them to massively cut interest rates. Now, one problem with relying on easy money around the world as a way of promoting recovery is, it works in part by causing your currency to fall, thus stealing markets from your neighbors. We got a spiral of beggar-thy-neighbor policies and competitive devaluations. In response to these competitive devaluations, plus the high unemployment, countries responded by hunkering down behind high tariff barriers, imposing import controls, and putting restrictions on capital flows. 

So the gold standard, which had been a very rigid sort of straitjacket, and obviously needed to be replaced, was replaced by a sort of chaotic and disorganized system of floating exchange rates. Countries lost confidence in the international system's ability to reconcile their conflicting interests and ambitions. There was a disastrous backlash against globalization, and it was a time of the worst sort of populism and nationalism. So far we seem to have learned the lessons of the 1930s. We've been, first of all, far more willing to rely on fiscal policy, i.e., expanding budget deficits as a stimulus mechanism. In contrast to monetary easing, which works by in effect trying to steal markets from your neighbors, fiscal expansion actually has positive spillover effects. If you spend money, it causes your imports to go up and that helps your trading partners. There's much more cooperation. There's much less competition this time. There are, however, three parallels, and these are enough to keep you worried. 

The first is, it's clear in both cases, global financial arrangements have become unsustainable. In the 1930s, the weak link was Europe versus the US. A Europe that had become way too dependent on US lending and when the music stopped collapsed. This time, the weak link is at home, is the US consumer who's run out of borrowing room. That means that the Asian countries that have centrally relied on an export-led industrialization pattern into the US will have to reevaluate their strategy. The danger is, if someone like China finds it too politically costly to restructure, we're going to get trade wars. Second parallel. Charles Kindelberger, the economic historian, wrote a book where he said, the Great Depression really came out of a failure of economic leadership on the world stage. By that he meant that what we needed, the world economy required a leader. What he meant by leader was, a country that was willing to do more than its fair share. 

Stress on "more." More than its fair share as the supplier of capital of last resort during the crisis and acting as the economic locomotive. Excepting the fact that small countries will freeload off you. So being a leader means that you know that people are freeloading off you. In the 19th century, Britain had served that role. First world war bankrupted Britain, it was unable to. The mantle should have passed to the US. The US, though, was run by a group of very parochial, insolent men, and refused to accept that mantle, and essentially we got a vacuum of world leadership. After 1945, the US took on that mantle and for a good 50 years has essentially acted as the leader. The question is now, are we at a similar transition point in world leadership? Has the US been so damaged by its cumulative borrowings abroad, the fact that it's had a banking debacle, its foreign policy reversals, that it's no longer able to act as the leader? If it can't, who can? China's too small. The good thing is, we have more of a tradition of multilateralism and countries acting together, but there's enough here to keep you worried. 

And the third thing is that in this recession, in contrast to many other recessions, unemployment has gone up as much as output has fallen. I.e., companies have used this opportunity to lay off workers in an unprecedented way. There used to be a thing that economists used to refer to called Okun's Law, which is, during a recession, for every 2% fall in output, employment fell 1%. This time, the relationship is one for one. Those are all three things to worry about. Ultimately, though, the real challenge comes from those aspects of the situation where we find ourselves in uncharted territory, where the experience of the 1920s or '30s or any other period just cannot provide any lessons because the world is so different. Let me give you one example. In 1929, the banking system was about $50 billion and GDP was $100 billion, so it was about 50% of GDP. Now, if you take the same statistics, the banking system accounts for $20 trillion, which is about 150% of GDP. So it's three times as large. 

Half of it is securitized, a system of credit that is now broken. We've sort of created a financial Frankenstein where we've got a financial system that's too large, a good part of it is broken and we don't know how to fix it. And unfortunately, the past offers few lessons. An important theme in my book is that the mistakes made during the 1920s and '30s by central bankers did not stem from venality or malevolence or stupidity. Their primary problem was, faced with new realities, they were unable to break free from the dogmas of the past. And that is the challenge that the authorities face at the moment. They're dealing with totally novel problems and we have to hope that they have the imagination and inventiveness to deal with them. Thank you. (applause)  >> We're going to give Mr. Ahamed just a minute here to catch his breath while you're thinking of questions and get our computers linked to our live audience so if there are any questions that are coming in, they can be sent to questions@wisconsinacademy.org and we can ask those as well. I might just take this quick opportunity to also call your attention to the yellow cards that you received on your way in. 

If you fill those out and leave your email with us, you are eligible for a door prize, which I think I had, a copy of the book by the Halversons, who are going to be our next speakers. I'm told it's right here. There we go. So please help us out and fill out those cards and share with us future speakers and topics that you would like to hear from. At this time, are there questions for Mr. Ahamed? Also, you should know, he will be available in the lobby after this presentation if you should like to have a copy of his book. Very good. I will let you repeat the questions so that our listening audience can hear, and there should be plenty of time for questions, but please use the microphone so that all can hear. Thank you.  >> (inaudible)  >> Ahamed: Yeah, I would draw a distinction between the financial crisis, which was sort of the financial system seizing up, and we're past that. That started, gradually building up from the beginning of 2008, hit a sort of crescendo in September 2008 with the failure of Lehman. 

And we're over it now. All indications are that confidence in the financial system has returned. Banks are lending to each other, no one's sort of rushing to pull their money out of banks. We're now dealing with the economic aftermath, which is the real economy. There it's a mixed picture. We probably are out of the recession. That probably ended, technically, in June. Production has started going up. It's not, as I said, it's not feeding through to employment and the most worrying aspect of this whole thing is that employment is, unemployment's going to keep rising and the sort of social compact between companies and workers seems to have broken or seems to have changed. In part because companies can now go and hire in India or China, wherever. 

So it's a mixed picture. That's where we stand. I'm not sure where we're going. (laughs) And I'm much better on the past than the future. (laughter)  >> I'm aware of the fact, everything you buy seems to be made in China. Doesn't that have tremendous ramifications in our economy? I would think that our dependency on China making everything is just killing our economic system. >> Ahamed: Well, you do want trade. So, we definitely don't want to make everything ourselves because we wouldn't do it very well. We clearly want trade. The question then is, are the Chinese somehow competing in an unfair way? I have to say that my view is that their currency policy, essentially, underprices their goods. 

We benefited for a long time, which is that we got cheap goods. It had some terrible side effects both on their economy and on the global financial system. On their economy, it made them incredibly vulnerable. In the last six months of last year, or the six months starting September 2008, their exports fell 20%. 25 million people lost jobs in southern China as these factories closed down or had to cut production. They have temporarily dealt with it by a massive program of government expenditure and by opening up the spigots of credit. That's purely a temporary mechanism. They clearly have to reassess how much they can depend on a US consumer that's sort of going to be the locomotive. The side effect in the US that was detrimental is that because of the import competition, the Fed overeased and kept credit too easy for too long. The result was, the US consumer went into great debt. 

And the US consumer is now probably tapped out. So for a variety of reasons, I don't think, we can't go back to where we were. After this crisis, we're not going to go back to where we were. Quite how that plays out, I don't know. China is going to have to somehow restructure its economy. That does not mean we won't be importing lots of Chinese goods, we probably should. We shouldn't be quite so dependent as we have been. >> I was wondering if you could comment on the intersection of individual personalities and events. One thing I was struck by when I was reading your book was some of the sketches of guys like Montagu Norman in Britain and Benjamin Strong in the US. These are men of real both physical and emotional frailties and challenges and at certain key points, they would take breaks for months at a time. 

Benjamin Strong died in October of '28, which is interesting. I was wondering if you see any parallels. The quirks of their personalities fed into events at that time, and if you have any hunches as to the quirks of individual leaders, of Ben Bernanke, of Timothy Geitner or someone else, where it's more that sort of these huge forces at work around the globe. Sometimes it just happens to boil down to what this particular person is like and something about their emotional, mental makeup that somehow can have really far-reaching ramifications. >> Ahamed: Yeah, I'd be happy to talk about that. You got the point of my book exactly, which is that personality is a very large part of the story. I don't think they're quite like the 1920 central bankers, I should say that the main character in my book is a man by the name of Montagu Norman, who was the head of the Bank of England, and he was quite a quirky guy. But he suffered from one major deficiency as the head of the central bank. He was a manic depressive who would have nervous breakdowns at times of great tension. (laughter) I can tell you, I don't need to tell you, that's not a good attribute for a central banker. 

I don't think any of our guys are quite like that. Here's my reading of the personalities. Let's start with Alan Greenspan. One of the major problems of Alan Greenspan was that we put him on a pedestal and he started believing it. (laughter) (someone applauds) The way he conducted policy at the Fed was, if you disagreed with him, you suddenly found yourself on the outs. So he created a climate where basically the chairman was everything. He did not foster a sort of atmosphere of debate. Alan Blinder disagreed with him and found that he was suddenly not invited to critical meetings and basically resigned and went back to Princeton. That is precisely the sort of atmosphere that leads to old dogmas driving policy. That's the first, that's Alan Greenspan. 

I think the fascinating interaction was between Hank Paulson and Ben Bernanke. If you remember, last year the crisis sort of seemed to hit sort of a peak in March, when Bear Stearns went under. At that point, the Fed did something that it really shouldn't have done, which is, the Fed is there to provide short term loans. What it did was provide equity capital to JP Morgan, who bought Bear Stearns. It did this in a sort of sneaky way. It created a special purpose vehicle called Maiden Lane and it lent money to Maiden Lane which then took on the equity risk. But they were doing exactly what we've been accusing the banks of doing, which is parking things off balance sheet and disguising the risks through various accounting ruses. They did that really because they had no alternative. There was a window from March to September where the Fed now, the authorities, I think, though maybe not Hank Paulson, understood that they were facing a solvency problem, not a liquidity problem. A solvency problem cannot be handled by short term loans by the Fed. 

And yet that's what they continued to do for six months. That window of opportunity I think arose because Hank Paulson had a sort of, well, there are two possible interpretations. Either he really did believe it was a liquidity problem and sort of miscalculated and thought, let the Fed do the lending and eventually they'll get their money back and everything will be okay. Or he was sort of afraid, didn't think he could get the votes in congress and in effect was bypassing the political system because he didn't have the political courage to confront it. Or he was being sort of very astute and figured, I'll let a real crisis develop and that way congress will give me the $700 billion that I eventually need. He was only able to do that because he was able to bully Ben Bernanke. Ben Bernanke, I think, saved the world in September, but was a bully-able sort of guy. There was an article in the New Yorker about four weeks back by James Stewart on that whole week and it describes sort of finally Ben Bernanke losing his temper and saying, "Hank, I've run out of ammunition." And Paulson didn't get it, and so all the Fed guys got together and agreed the next morning to again sort of shout at Hank Paulson, and Ben Bernanke sort of screamed at him. Eventually, that's what got the $700 billion. I don't know, those are my little insights into the quirks of personality and how they played out. 

>> Mr. Ahamed, I have a question from an online viewer. Zack Jones writes in, "How would you evaluate the impact of the fiscal stimulus in the US in response to the current recession, and also, what are your thoughts on the proposals for further stimulus?" >> Ahamed: By the way, I should say, I'm not an economist. (laughs) But I can pretend to be one. Look, the stimulus package clearly has made that difference between -3% growth and +1% that we're going to have this quarter. It really only had to operate at the margin, but seems to have worked at the margin. We're a $15 trillion economy. Of the stimulus package, we've probably spent, in the second and third quarter, $200 billion. That's a tiny amount in a $15 trillion economy, but is just the amount that you require to turn from being -3% to +1% or whatever. That's the sort of impact it had. The goal is, think of these stimulus packages as, you drive yourself into a ditch and you need a tow truck to get yourself out. 

They should be temporary and they are designed to be tow trucks to get us out. It seems to be working. We've got one wheel out. We definitely don't want to rely, again, you're not going to get in your car and rely on tow trucks to pull you around. So I would be against another stimulus package for another reason, which is that these aren't free. This is not free money and this is going to cost us in terms of government interest and eventually we're going to have to raise our taxes to pay for the interest on this debt. Now, luckily, there's one big worry when the government borrows money, which is that for every dollar the government borrows, it takes away money from the private sector. That's the big worry. That's not happening. The first sign that you'll see that that's happening is if the government starts competing with the private sector for money, you'll see interest rates going up. 

That's the first signal that this stuff is not working. We're not there yet. On the other hand, we could get there. So that's what I would keep my eye on. That basically, you've exhausted my macro economics.  >> (inaudible)  >> Ahamed: Look, I think that deregulation was, or maybe not deregulation, but inadequate regulation of the financial system that had completely changed over a 20 year period was at the heart of this problem, or converted what should have been a manageable problem into a problem that almost brought the Western financial system to a halt. On the other hand, I don't believe that we can go back to where we used to be. It used to be, the two central things that prevented banking crises and instability during the '50s and '60s, were two things. One was Glass-Steagall, which separated commercial banks and investment banks and made sure that commercial banks, which keep our deposits, could only do very safe things and treated commercial banks like utilities, almost. The problem is, one, we've got a whole lot of new institutions like money market funds. 

And secondly, the distinction between loans and securities has disappeared. So it's very hard to say, this is an investment bank that owns securities and this is a commercial bank that makes loans, because loans can be converted into securities. So my view there is that we need to, we just need to make sure that people who go into the financial business have capital and that they don't leverage themselves 30 or 40 to one. In the '50s, a typical financial institution held 10% of its assets in the form of equity capital. We have allowed those numbers to go down to 4% and then we allow financial institutions to put things off balance sheet and have a second set of books where they had no capital. I think it's crazy. That's the single most important thing. There are other things that we should do, like on derivatives put them on an exchange. There are some very simple things we can do to make the system much more stable. >> You had talked earlier about unemployment and the fact that we've had a rather severe rise in unemployment this time, perhaps a little faster than expected and it's not expected to go down dramatically in the near future. 

My question is related to the debate about national healthcare going on now. Can this country continue to grow its employment base without doing something about the problems with the cost of health insurance on the employer, and how much effect do you think that might have on our recovery vis-a-vis other countries in the world that we're competing against who don't seem to have that problem? >> Ahamed: Well, it certainly, just anecdotally, it's certainly clear whenever you talk to people about the key things they worry about when they hire permanent workers, in particular, is the benefits they're required to provide, and the most important benefit is obviously healthcare. It's one of the reasons you see such a move toward part-time work, because companies are required to provide fewer benefits. I think that's an element of the equation. I think there's an element of globalization. I think companies, someone like Intel, is an American company and it appears in the S&P 500. I'd be interested to know where most of the employees who work for Intel, including if you traced it through the supply chains, where they're based. Are the majority of them in the US? So what is a company, what is an American company? The definitions of those things have changed so dramatically that it's not always clear that the categories we used to use are appropriate or useful in understanding it. I can't say I know the solution to the employment problem. I just observe it. 

But I think it is, one, there's something about this business cycle which has been particularly bad for workers. And secondly, just my reading of history is, if an economic system finds it difficult to provide full employment, you'd better watch out.  >> I just had a quick question. I'm aware of the WPA program that was implemented during the Great Depression. I was wondering, I know it's often compared to the current stimulus package. Do you think that the same strategy that was used would work today? >> Ahamed: The interesting thing about Roosevelt's New Deal, a couple of interesting things. One is, he was clearly a fantastic publicist. We had this exaggerated notion of what the New Deal did. Actually, in terms of public expenditure, it was relatively modest. There were some public employment schemes, including the WPA, which did get some people back to work, and unemployment then was 25%. 

It's now, even if you count discouraged workers, it's more like 15%. We're only half the way there. I don't think it's applicable. The thing that I do think is sort of striking about Roosevelt and the New Deal was, he seemed to figure out, or he seemed to be very skeptical that anyone knew anything. And so he was willing to experiment and try lots of things. Essentially, he stumbled into getting off the gold standard. He was listening to this crankpot economist who was at Cornell, and all his advisors, all these Wall Street guys. He decided, why don't we try that? So he sauntered into his office, well, he didn't saunter, he came into his office... (laughter) And sort of off the top of his head said, "By the way, we're off the gold standard." All of his advisors were incredibly shocked. One guy was James Warburg of the Warburg family and he declared, "This is the end of Western civilization." (laughter) It wasn't, obviously. 

I really got to admire, reading up on this book, I really got to admire this sort of capacity for Roosevelt to try lots of things. There were two New Deals. There was the first New Deal,  which did a reasonable job in stabilizing the banks, got the economy going, but didn't get employment going, and did some stupid things, like raised prices and raised wages and all sorts of things which were completely counterproductive. Then he came up with the second New Deal, in which we got social security, for example. It's that sort of openness to new ideas, skepticism about all of these so-called experts who tell you they know how it works, because we've just discovered that very few people do. >> Last question. >> We in the medical profession live by sort of a central rule, and that is "primum non nocere," above all else, do no harm. With that in mind, I'd like to ask, in your view, what is the stupidest thing our political leaders could do given the current situation? (Ahamed laughs) >> Ahamed: Well, the stupidest thing would be to raise taxes to try and control the budget deficit at this moment. They did that in 1937. We got this fantastic recovery, and then in 1936, 1937, the Fed decided to raise interest rates because it said, we've changed the price of gold, now banks are so flush with cash, this is bound to lead to inflation, even though there wasn't a single sign of inflation. 

So they tightened credit, and at the same time, there had been a temporary blip up in the budget deficit in 1936, and I can't remember why, I think it was the introduction of social security or something. They raised taxes in 1937. The combination of the two drove the economy back into recession. The stock market went down 30% in one year. That would be the most stupid thing to do. I'm sure if you gave me enough time I could think of some other stupid things. (applause)