Andrew Olmem (Former White House National Economic Council Deputy Director) joins the podcast to discuss his views on the CARES Act and inflation as well as the state of financial and banking regulation, including everything from deposit insurance to lender of last resort, in the wake of Silicon Valley Bank's failure and over ten years since the Dodd-Frank Act was passed.
Jon: “Today, I'm joined by Andrew Olmen, who is a partner in Mayor Brown's Washington, D.C. office and a member of their Public Policy, Regulatory, and Political Law practice. He previously served as Deputy Director of the White House National Economic Council in the Trump Administration, working under both Larry Kudlow and Gary Cohn. Before that, he worked as Chief Counsel and Deputy Director of the Senate Banking Committee. Andrew is incredibly knowledgeable on all things regulatory and economic policy-related and draws on years of experience in government. Welcome, Andrew.”
Andrew: “Hi, John. Thanks for having me today.”
Jon: “So I want to start by your early career. So, you did your undergrad in law school at Washington, D.C. You spent a lot of your early career in Washington, D.C. in various congressional offices. You spent a couple of years working at the Richmond Fed as an associate economist before joining the Senate Banking Committee staff. How did you first get interested in economics and economic policy?”
Andrew: “Well, I think I was that kid who was always interested in history. And so, I kind of devoured history books as a kid, starting with somehow, you know, I got interested in, I think, the American Revolution as a young kid. And the way that some kids fixated on certain things, that's what I got hooked on. And then just kind of American history, and it just kind of spread from there. And I kind of read voraciously as a kid. And then my parents took us to Washington, D.C. on one of those five, six family trips. And I just had a blast exploring, learning about Congress and the White House and what the president did and the Supreme Court. And so that kind of had a natural kind of evolution into understanding kind of how our government works. And then over time, I think that migrated into economic policy and helped explain how government policies are designed and which ones are successful, which ones are not. And this, you know, this would have been the heyday of the Reagan years. And so, I naturally ended up reading, you know, National Review was something I got introduced to early. I think a lot of people in my generation on the Republican side and watching William F. Buckley on the firing line as a kid. And so, by the time I got to college, I knew I wanted to do something along the lines of politics or economics. I always had a little bit of a business interest, too. But those are kind of my main academic interests. And so, I ended up working on the Hill for a few years in college. I just had just a great time. And then went to, you noted, the Richmond Fed. Read a undergrad where I was an econ major and just had a great experience there. Learned just a ton.”
Jon: “It's great. And you grew up in the Midwest. Is that right?”
Andrew: “I grew up in Minnesota.”
Jon: “So was it were you a bit countercultural, I guess, reading National Review growing up? But were you sort of one of the few sorts of, I guess, conservatives in your class or?”
Andrew: “It was a pretty democratic area. Yeah, I guess I was a little bit. Definitely the outlier. I had an uncle who was just a great influence on my reading and was very serious about the books I read. Not just in a conservative leaning, but just making sure I was reading really good stuff. And so, I think that also helped to help fuel it. And then, like I said, I had this trip out to D.C. that just kind of really, I think I was 10 at the time, really kind of triggered an excitement for it. And so, you know, my my leanings, I think, were more on the conservative side and free market, which we can talk a little bit more. I was just really interested in government and understanding how the world works. So, yeah, I grew up in a place that was certainly very, very democratic. But I was always comfortable just being, you know, having my own views.”
Jon: “Fantastic. You know, many very well-known economic policies hands bank sometime on the Senate Banking Committee. I think a lot of people don't necessarily realize this, but a lot of people go on to run the Fed board or work in the NEC, spend some of their early careers working on the Senate Banking Committee. You work within the Shelby office, Senator Richard Shelby's office, alongside many others who kind of went on to have very distinguished policy careers like Mark Calabria, went on to lead the FHFA and many others. I'm curious, what was your time like as a congressional staffer working on the Senate Banking Committee? Can you explain sort of what some of the key responsibilities of the Senate Banking Committee are?”
Andrew: “Yeah, I love working on the Banking Committee. It was just a great job for me. The team we had there was just superb. And it was also a unique time to be there because I got there right at the ending of what they call the GSC war. The GST wars about what to do about the regulation of Freddie and Fannie, and then that quickly moved into the financial crisis of 2008, and then the Dodd-Frank negotiations and debate about the Dodd-Frank bill. So, it was probably the most active time in the committee since the New Deal, and so we were right at the center of all that, just kind of a little fortuitously. The Banking Committee is always an interesting place to work because it's the committee that's responsible for overseeing all the federal agencies related to financial services, not only banking agencies, but the FTC, and also certain parts of Treasury, export controls, flood insurance, and actually even has a piece in transportation for the overseas transit program. So, it's a pretty broad jurisdiction, and I got to work on a lot of different issues. Ended up staying, you know, seven and a half years there, which is a pretty long tenure, but it was such an interesting place, and we had such a good team.”
Jon: “And what years put that up in, the seven years?”
Andrew: “Those are from 2005 to 2013.”
Jon: “Got it. So you were there during the global financial crisis, and Dodd-Frank, sort of the whole aftermath, you know, the financial regulatory response. Wow. What a time to be there. I guess, like, sort of looking back on it, any thoughts on sort of the legacy of Dodd-Frank here now, like 12 years later, or a big sort of evolving thing?”
Andrew: “Yeah, I think the critiques of Dodd-Frank are largely proven to be right on mark, which was that it was, one, a big missed opportunity to do real reform of the financial system. Two, is it resulting in another layer of bureaucracy and unnecessary costs on the financial system that isn't necessarily making the system safer, and that, you know, we have a kind of risk now of really institutionalizing too big to fail, and that has a real danger in skewing our markets over the longer term? So certainly, there's certain aspects of the financial system that certainly needed to be reformed post-global financial crisis. The way capital was done was certainly really one of those areas. Derivatives reform. There are a lot of areas that I think there was bipartisan agreement that needed to be reformed.”
Jon: “So, like, fossil-fuel capital regulations, and some are, I mean, maybe not ideal in terms of…”
Andrew: “We can talk about the details of capital regulations, which now have recently gotten a little bit more complicated, but I think it was clear that the system was undercapitalized going into 2008, and that there were some regulatory problems on the housing finance system that hadn't been addressed and needed to be. So, and there was, again, pretty strong bipartisan support for a lot of those provisions, but I think the controversy around the CFPB and, in particular, some of the financial regulatory authorities and how institutions are regulated is still problems that we haven't really figured out how to get the right balance on.”
Jon: “Totally. I mean, it's fascinating to see how the CFPB, the Financial Protection Bureau, has evolved over time and been used in different ways for a whole number of things. Like, I can think of things like income share agreements or something that I think the Biden administration really doesn't like, and the CFPB has been issuing a number of income share agreement providers. So, yeah, it's very interesting how the legacy of Dodd-Frank, and we'll get back into some of that later, banking regulation and reforms. I want to now sort of fast forward to you joining the White House. You joined the White House National Economic Council in February 2017, right at the beginning of the Trump administration. And for those, I guess, that aren't aware, the NEC was created in the early 1990s, but it sort of grew out of a few other predecessors as sort of handling economic policy coordination within the White House. Can you explain a little bit how the NEC works in the White House and how it's evolved with other economic policy bodies like the Treasury Department and TA, and how did it function within the Trump administration in particular? Because I know sometimes things can change from administration to administration.”
Andrew: “Yeah, it changed a little bit, but for the most part, the NEC has been pretty stable since it was created under the Clinton administration. The purpose of the NEC is to serve as, one, the coordinator of economic policy decision-making for the White House, right? Under Article II, the president leads the executive branch, so he's the one ultimately responsible for all decisions being made in the executive branch. And there needs to be a process for determining which decisions need to go up and have the president formally be decided upon, which ones need to go down which ones, you know, other senior officials can provide guidance, knowing already where the president's positions are. There's a lot of meetings to making sure that there's coordinating the president's policy throughout the administration. It also does a function in helping devise policy, in bringing the different officials together, relevant officials throughout the executive branch together, to determine, you know, what policies the administration should pursue. And that process usually requires a presidential sign-off. It's usually the stuff that is in the White House are the, you know, kind of most important issues, right? There's only so many hours, and there are a lot of decisions to be made. You have to make sure it's the important ones. So, there's a lot of meetings about what direction policy should go, making sure the president's informed on decisions, briefing the president, briefing, you know, I spend a lot of my time briefing the director of the National Economic Council, and then also working with the other policy councils in the White House, because there's some overlapping jurisdiction. The National Security Council, better known, serves a very similar function for foreign policy. There's also the Domestic Policy Council. My hand is going to go on again. Signified traditional domestic policies. And there's, so you spend a lot of time, particularly when I was deputy, kind of coordinating with the other policy councils to make sure everybody knows what's going on, where we're going, and the appropriate sign-offs are being obtained. So it's a very interesting place to do, and just a fantastic place to do economic policy.”
Jon: “It's fascinating. And also, what a fascinating time to be at the NEC. And, you know, in particular, in early 2020, you know, the COVID pandemic hit, and you were very involved in the U.S. economic policy response to COVID-19, the CARES Act, some of the subsequent economic policy response as well. Can you explain what your role was as deputy director? And also, I want to get into what you think some of the CARES Act's sort of biggest successes and failures were. But can you sort of explain, like sort of take us into the room, or some of the rooms that you were in, in helping to set up and sort of get the CARES Act going? And can you explain maybe some of the details of the CARES Act as well? I mean, there are a lot of pieces, you know, from stimulus checks, unemployment, insurance expansion. There was obviously all this sort of small business oriented, paycheck protection program grants or forgivable loans. Can you explain, like, how did that all come together? And what was the thinking around that being the optimal policy response at the time?”
Andrew: “Well, there's a lot there, John. So let me unpack it. First is the deputy director of the NEC handles the day-to-day management of the NEC. The NEC is a pretty small organization. And so – but it has – so each of its staff members have a pretty significant amount of authority over their issues. And the way we were structured, and I think similar for most White Houses, we had, you know, a special assistant to the president who handles tax policy, one who handles telecom, one who handles agriculture, one who handles health care, financial services, infrastructure, transportation. So you can see kind of the big sectors of the economy. And the deputy's job is to make sure each of them is, you know, understand what each of them is doing and giving them direction on where the director and ultimately the president want policy to move and how they are supposed to help coordinate policy through the administration. And also, just hearing from them the – you know, certainly there's a lot of direction that kind of comes from the White House, but there's also a lot of information that comes in from the executive branch to inform the White House of what's happening and also looking for guidance. So, the constant stream of information. And the deputy director's real job there is to help manage that flow and then also, again, as I mentioned earlier, help coordinate with the other policy councils on issues that have overlapping interest amongst the councils. So that's generally the structure. The COVID presented a particularly unique and challenging policy area or policy response to put together because it involved, first and foremost, a health crisis. And normally, when you think about the most recent economic crises, they involve something within the financial sector. In 2008, put it simply, you had a lot of bad mortgages that were pervasive throughout the financial system and had to be addressed in some way. You can have an inflation scare. You can have a trade dispute, a recession. These are things that are kind of the traditional economic problems or crises. And generally, we have a playbook and also are things that are largely handled within the financial regulatory economic policy realm. With COVID, though, the front lines on addressing the core problem are outside. It's the public health officials. And so, for us, we knew that it was pretty clear early on there was going to be an economic impact. But it was also we were not the ones who would be on the front lines of addressing the root cause, right, which is how to get vaccines, understand how to prevent transmission, those sorts of really important public health response. What we had to do instead was think about what are the secondary effects and what areas of the economy are going to be impacted the most, which workers are likely to be impacted the most, and think about what type of response would be needed to mitigate some of these adverse effects that were about to hit the economy because of the pandemic. There was just a great team that I worked with on a lot of these issues on the economic side. You know, initially a team at the White House, at Treasury, the Small Business Administration, Commerce Department, who all had certain areas, ideas, and certain authorities that they could utilize to help respond to the crisis. And then also I think the U.S. Senate did a great job of helping come up with a means for Congress to quickly consider legislative response. And one thing that's really striking and I think I'm proud of about the CARES Act is that that piece of legislation was passed before the data had even come out of showing how significant an impact the COVID was having on the economy. And as you know, if you look at the historical data now for most economic series, there's a sharp drop in 2020. That really skews all data on the charts, right?”
Jon: “Absolutely.”
Andrew: “On the employment side.”
Jon: “Absolutely.”
Andrew: “It shows you how significant it was. And the fact that we were able to be proactive is pretty remarkable. We often talk about in economic policy, I remember some of my econ classes, the idea that you want policy to be looking ahead and attempting to be providing support as it's needed and not passing legislation after the crisis has already occurred. You end up wasting a lot of money that way and not being effective. Unfortunately, that happens too much in economic policy because it just takes too long to formulate and events move fast. But in this case, we were able to get it out early and I think I take a lot of comfort in the fact that there are millions of people who really benefited and were able to get help.”
Jon: “Absolutely. I mean, it's fascinating just to think. 2020, so many service sector, part-time retail or restaurant workers lost their jobs instantly. And it's incredible how high the unemployment rate went very quickly. And of course, it came back down very quickly as well. So much happening in such a short span of time. It's really amazing how quickly a coordinated economic policy response was able to be put together. I think that's maybe something that people don't quite appreciate as much. So I know there's some stories like I think of how the, I guess, PPP came together, and I know that, like, that was, in part, you know, that was using the Small Business Administration, and there were a lot of, I guess, on the topic of coordination and getting things out the door, yeah, the CARES Act was, you know, passed, you know, in late March of 2020, but then there were sort of a number of questions about, you know, how quickly could you actually get, you know, that economic relief out to people, and, you know, there were certain things like, you know, whether, you know, the stimulus checks could be paid out through direct deposit, you know, versus sent in the mail, and the direct deposit would be much faster in using, for example, people's banking information from their tax returns, and obviously, you know, PPP took some period of time to get out through the banking system, which is how, you know, the Small Business Administration, you know, administered those, those sort of givable loans. I'm curious, like, what do you think about the implementation side of the CARES Act, and where were you sitting sort of amidst all of that?”
Andrew: “Yeah, so one thing I really learned about working at the White House, which is the White House does not do implementation, right? That's what you leave the departments and agencies for, and there are times in U.S. history where the White House has sought to manage particular programs, and usually it doesn't work out well because the personnel involved and expertise is not in-house, right? It's someplace else, so it's very hard to do. So, I think where we started, we had really good teams on, you know, SBA and Treasury who were very capable in getting these programs up and running. There's a lot of work. As you point out, there's a lot of technical difficulties in doing some of these programs so quickly. Some worked faster than expected. Others took more time. Some of that is just the nature of responding to a very unexpected crisis, and certainly, you know, as I look back, there are lots of areas where I probably would have things changed and modified, you know, things you would do differently. One doesn't have the time, and it's very easy to look back retrospectively and say, well, we would have done things differently. But I think overall, the teams did a pretty good job of taking these programs and getting the legislation passed and then getting them up and running. You know, as you want, TPP, I think was a good example, figuring out how to handle the increase in unemployment benefits with another complicated program to actually set up. But ultimately, these programs were within a reasonable amount of time were up and running.”
Jon: “That's fascinating. I do want to talk a little bit more about, you know, both knowing the successes, but also sort of some of the failures, you know, potential failures here too, or maybe how you think things may have been done differently, sort of knowing what we know now and the whole experience that it was sort of had. And in particular, I want to talk a little bit about inflation as well, since it's, you know, in 2022 and 2023, very front and center issue. You know, now in late 2023, we're seeing inflation sort of finally receding. But, you know, over the past few years, you know, we've seen some of the highest inflation rates since the 1980s. And I'm curious, like, what do you think that, you know, government stimulus ranging from, you know, the CARES Act, you know, the $400, you know, $400 a week of the pandemic unemployment insurance supplement on top of, you know, replaced wages, you know, that, you know, PPP to stimulus checks to, you know, and subsequent sort of top-ups to American Rescue Plan, you know, the ARP, you know, so things, you know, stimulus that was, you know, continued throughout the Biden administration. I'm curious, you know, to what degree do you think that, you know, maybe government stimulus sort of overdid it? And to what degree do you think that the inflation that we've been experiencing over the past few years has something to do with government policy? And there's others, you know, there are some people that take the view that, you know, it's largely a supply chain issue, and that government stimulus had very little to do with it. So maybe it's, you know, it's not a monocausal answer, and its multiple things, but I'm curious what your view is on this.”
Andrew: “Yeah, so I would say, well, a couple observations. First, this just shows how difficult it is to finely tune this economy. You know, when we think of, you know, really an academic setting where you think about, well, you know, if only we had policymakers were able to, you know, increase, reduce taxes by X percent and increase government spending by 4 percent, you know, that will get the economy to a perfectly adjusted equilibrium that, you know, and we'll have full employment and low inflation, and this is something that policymakers have been tooled to do. I think, you know, this experience, to me, just reinforced the belief that it is very hard. The economy is just too dynamic. I'll see, even under the best of situations, will involve some delays. And here we were about as fast as could be expected. But certainly, more time would have probably helped us improve the calibration of the programs. It's just the realities of the world, and it's very hard to calibrate these programs correctly. Second is the coordination is also very challenging, and it puts policymakers, I think, and forces policymakers to make some really tough decisions. And you can look at where the Fed was sitting, and they saw, certainly saw this huge increase in government spending, deficit expanded at really unprecedented levels. You have to go back to World War II to see these debt levels. So, you had a lot of government debt going out, a lot of spending, but you also had the economy collapsing too, right? So, you'd think rates would be going down. But the response proved to be very successful, probably more successful than people expected at getting the economy up and running again. As you noted, economic growth jumped back very quickly the following quarter. And suddenly the economy starts to get back on track faster than expected, but you still have this large increase in government spending and debt issues, which by itself is a very inflationary impact. But the Fed at the same time has to figure out to make the judgment call with an incredible amount of uncertainty about where the economy is, given that this pandemic is still going on. And so, it's not surprising to me that through all that, you know, very simply big increases in money supply, suddenly big increases in demand, right? Whether you're a QB or a monetarist, there are reasons to see that inflation coming. But it's also, in real time, hard to react, fast enough to know which to do. So, it's not surprising that it would do that. You know, certainly I think the Fed was too slow to respond. And that's probably a big reason why we got the inflation bout that we did. I do think one lesson I learned both in 2008 and in 20 is really the value of inflation expectations and having anchored expectations by the American public. If you look back in 2008, there was a lot of expectations or concerns that inflation was going to surge in the same way. But it turns out inflation expectations were so anchored that the inflation rate was a lot stickier. And the U.S. government had a lot more flexibility to respond without creating an inflation problem or at least having to respond to one at the same time than was expected. I think in 20 was the same case and that people had confidence that even after 08, inflation didn't surge. And that meant the federal government could take a big response here. The Fed could be more aggressive on lowering rates to respond without sparking an inflation problem. And that certainly helped Aussie. The fact that then we certainly did see this bout of inflation, I think just kind of shows to me that the potential for inflation was always there. And once those expectations got kind of unlocked, right, that they can change pretty little bit faster than we expected. And that is made policymaking over the last couple of years very, very challenging, right? You have a large jump in inflation that the Fed now has to respond to, but you also have a large fiscal deficit. You know, these are, you know, and Congress really should be starting to think about how to get its finances under control at the same time, not an optimal situation. So, it's a little kind of long, a little rambling answer on it, but certainly the Fed needed to get more, should have been more aggressive and probably got a little relaxed because of the success in 2008 and up till then 2020 and that no inflation had emerged.”
Jon: “Absolutely. And I think there's a number of former Fed governors like, you know, Randy Quarles who were on the actual defense board at the time. And even they would say now, and have said publicly that, you know, the Fed should have started raising rates earlier as early as, you know, the autumn of 2021, when it became clear that the uptick in inflation was not just a story about used car prices going up due to the supply chain supply constraints, but you started to see rents and other items in the price basket really start to surge. And that was really the key moment when the Fed should have started to raise interest rates, not, you know, six months later in the first quarter of 2023. I want to now pivot to financial regulation, specifically banking regulation. I kind of want to get back to that and talk a little bit more about the legacy of Doc Frank. He spent a lot of time on center banking and have a lot of expertise in this. And I think also, you know, having, you know, sort of legal background, I think also just brings so much expertise to the sort of the realm of regulation, which is wonderful. So, there was a lot of momentum, you know, I feel like throughout the 2020 the 2010s on the Republican side, a lot of momentum in the 2010s to repeal Doc Frank or certain elements of Doc Frank, you know, while, you know, some like, you know, capital rules for banks, you know, banks were over, over levered in 2008, a lot of sorts of bipartisan sort of agreement on that. There, you know, there are these other parts of the home business and like, you know, the Volcker rule, you know, some of the implementation of the Doc Frank act, you know, CFPB. And, you know, there was also a lot of scrutiny about the impact of regulatory costs on smaller banks that, you know, there weren't any new De Novo banks created for quite a few years in part due to, you know, the regulatory constraints. I'm curious, there's also some changes to 13 three that some people didn't like, you know, the wonder of last resort, only that sort of put more power in the hands of Congress. Some people. I think, even on the left didn't really like that. So, we have Trump then elected amidst, you know, this 2010's momentum to repeal Sir Nelson Dodd-Frank. Trump gets elected in 2016. A Republican House and Senate is also elected that year. And I'm curious, you know, in that time period, you know, where there are two years of, you know, Republican White House and full congressional control, you know, the biggest thing that came out of that in terms of, you know, financial, you know, regulatory reform or, you know, some form of deregulation was really just changing, you know, the SIFI threshold to exempt, you know, some firms. I'm curious if you could sort of maybe speak to a little bit about what that push, which was led by, and then House Financial Services Chair Dept. Pencer Lane. I'm curious. Like, to me, it seems”
Andrew: “Like a lot of things.”
Jon: “Yes, of course. And Senator Crapo on the bank committee. I'm curious, like, what happened to all that momentum? And why did so little get done to peel back some elements of Dodd-Frank, like Republicans had promised for so long in the 2010's after they actually got into power?”
Andrew: “Yeah. So, well, I mean, one word is the filibuster, right? In the Senate, you have to have 60 votes to move legislation. And when the Democrats passed Dodd-Frank, they had the 60 votes and they passed it largely on a partisan basis that way. Republicans, during that time period, didn't. And therefore, there had to, so if anything, the expectation probably really was that nothing was going to happen because there was no way Republicans and Democrats were going to deal together to get the 60 votes to move legislation. But I think we were able to get a bill through for a couple of reasons. One is we focused on the area, one of the areas that needed the most attention, and one that I think even supporters of Dodd-Frank realized needed to be reformed, which was how regulations were tailored, these new enhanced prudential regulations were tailored based on size so that you don't have a $2 trillion bank being regulated the same way as a $300 billion bank. You know, certainly billions of dollars is a lot, but there's a big magnitude between those two types of institutions and the types of activities that they engage in, where they conduct their activities. There's a lot of differences there. And the danger that I think has been well-recognized is that if you want to have a diverse banking system where you have large banks, small banks, intermediate banks, banks with a lot of different business models, which I think is really important for an economy like the United States, as large it is and as dynamic it is, we can't have a cookie-cutter approach to banks where they all look alike, they have the same kind of products, same business models, it's going to result in certain segments of the economy not getting the credit they need, and also not as efficient management of risk. There's an element of having diversity in business models and risk management that provides some resiliency to the system. And that Dodd-Frank, even the original Dodd-Frank recognized this problem, there's some language in there, but it needed to be, the implementation needed to be improved, and Congress had to clarify more what it wanted to see on this. So that we didn't suddenly have the financial system come to a barbell where you have, say, six really big financial institutions and then a whole bunch of really, really small institutions and nothing in between. It also has a competitive element in that these banks from, say, $50 billion up to $700,000,000,000,000 provide a lot of competition for the system. Certainly, that means small banks can grow, that are successful, can grow and then compete with these banks, but they also, those banks also compete with the large G-SIBs and can potentially grow to challenge them. And so, it really brings a really healthy competitive element to our system. And I think members of both parties recognized that there wasn't sufficient tailoring to account for these differences in business models and banks. Again, there's common interest in making sure all these banks are well-regulated, well-capitalized and appropriately regulated, and just trying to make sure that they're appropriately regulated based on the types of activities that they engage them. And as a result, you know, we were able to get a package together that it was 17 Democrats ended up voting for. So, we had a really strong bipartisan coalition. I think it's a good lesson too, is that in financial regulation, in my experience, usually the bipartisan legislation is one that turns out to be more durable. If you look at Dodd-Frank, the areas that were most controversial, a lot of them no longer exist because subsequent Congress has come back and changed the law or they were declared unconstitutional by the courts, you know, there's a lot of changes to Dodd-Frank based on the approach it was passed. And the 2155 bill, I think, has endured pretty well because it had such a bipartisan approach. And it was also just simply common sense, you know, that we want to make sure regulation is appropriate based on the nature of the banking activities a bank is engaged in, as opposed to some kind of cookie cutter. Here's a whole list of things that every bank needs to comply regardless of the activities that it's actually engaged with, right? And there's for a period of time, banks had to prove that they weren't in compliance with the Volcker rule, even if they weren't engaged in any proprietary trading, right? It doesn't make any sense. So, I think it's a good lesson. And again, our system is, you get a bigger point too on this, is that our system is designed not to have kind of radical changes, particularly Congress to Congress. It's designed to have change over time based on successful legislative Congresses with different majorities. And that brings a lot of stability to our system and make sure that when things are passed, they've been usually pretty well vetted. It also means that there's a broad geographic. The broad geographic support for legislation, I think overall, that approach has really served the United States well. The filibuster is pretty much key to that continuing going forward, and I think really on the conservative side, I know there's always frustration about why didn't we achieve bigger successes, right? And I fully understand that, but at core, you have to get the legislative majorities to do that, and Democrats have been very successful over the last, again, 70 years of having several occasions where they were able to actually have the 60 votes needed to do some pretty big bills, and it's been well beyond anybody's current lifetime since Republicans have those kinds of majorities.”
Jon: “Absolutely. I mean, it is fascinating, too, to think also some of the bipartisan legislation that's been passed, particularly more so on the spending side, whether it's some appropriation bills or bipartisan infrastructure bill, just how many pieces of legislation has actually drawn quite a few Republicans to get the 60 votes that's under the Biden administration. Of course, the filibuster is changing a bit, too, in terms of what things need the filibuster and what don't.”
Andrew: “But to your point, this is where the filibuster, there's a movement on the left to undo the filibuster, and we may see that in our lifetime here, and the term actually comes from the past. I think overall, it will not be good for policy because it'll mean policy will shift a lot more from Congress to Congress, but from a Republican perspective, there are things that wouldn't be doable with the filibuster. And so, this is where I actually think folks on the left sometimes should think about what does it mean when they're not in power, and the reverse is also true. So, it's a more complicated issue than I think most people who have debated that issue have really thought. And I think banking regulation is a very good example. If the filibuster goes, you will likely see Congress be much more active and prescriptive with passing legislation on how institutions should be regulated. And there's probably pros and cons to that.”
Jon: “Absolutely. So, let's shift a little bit to regional banks, and it's been several months since Silicon Valley Bank, Signature Bank, were taken into receivership by the FDIC in March of 2023. First Republic Bank was troubled as well, ended up getting acquired by J.P. Morgan. It's now several months later, and it seems like a regional bank apocalypse that many were predicting did not happen. I'm curious, what is your diagnosis of this whole situation? There's obviously Silicon Valley Bank, a large fraction of uninsured deposits. There were also some very serious issues around maturity mismatch, significant amounts of interest rate risk that Silicon Valley Bank was taking, this is sort of classic finance 101 mistake. The duration of your assets should equal the liabilities unless you want to make some big bet on interest rates, and it seemed like they had a lot of duration risk if I was raising rates. But I'm curious, is your take that SEB and a couple of others were just sort of a couple of cases of gross mismanagement and incompetence, or do you buy into this that there is some bigger regulatory issue at play? And I think still there's sort of some big questions that need to be addressed, which is somewhat along the lines of the lender of last resort role here, but also how should deposit insurance be reformed going forward?”
Andrew: “I'm curious what your thoughts are. I'll talk about the lender of last resort after this, because I think, you know, I'm happy to talk about 13-3, because I think there's some interesting stuff you've mentioned that I want to explain a little bit more. But on what happened with Silicon Valley Bank, if you read the GAO reports about it, it reads very much like a lot of bank failures. I think we can go back to the S&L crisis, where you had a rising interest rate environment and a lot of banks misread it or mismanaged it. So, it's not surprising that we've had bank failures when the federal fund rate goes from zero to 5% in the course of the year. What is a little surprising reading it, though, is that the supervisory process, it looks like they caught it, but was not forceful enough to get any one of the banks to address it and take actions? So, it seems like it's pretty clearly a supervisory problem here. When you have a country of 5,000 banks, that happens. And this is why I've always been a believer in having strong resolution mechanisms. Banks are going to fail as part of our capitalistic system works. And that's don't pan out and you have losses and the bank goes belly up. It's impossible to avoid in a healthy financial system from time to time a bank failing. But what you need to have is a really capability to make sure that the failure of one institution doesn't kind of bring down the whole system and that they can't hold the federal government hostage for a bailout because of concerns about the wider impact on the economy. I think what you saw in Silicon Valley Bank was that there are pretty strong authorities and regulators have. And we've been doing bank failures for a long time in this country. They've been a problem since almost day one, going back to the early republic. I think since the Great Depression, we've gotten a lot better at how to resolve banks without them, their failures spreading and having serial bank failures and bank runs. And I think what you saw here was the regulators using the authority they had to make sure that there was, these institutions were resolved. There was some market discipline exercise. You saw unsecured creditors and shareholders take losses and it, for the most part, stabilized the banking system and prevented it spreading. Now, there's an issue about how unsecured creditors are treated, but that's a more technical issue we can talk about if you want. But overall, you know, my take is that the response there was exactly how Congress anticipated the agencies to respond, and I think we should look at that as a good thing. Now, I think that the resolution of institutions is an area that always has to be constantly being examined to make sure that our regulatory system doesn't become outdated by changes in the marketplace, particularly for larger institutions, and I think we've seen, and that was certainly one of the efforts at Dodd-Frank, where there was a lot of bipartisan support, thinking about how we resolve institutions while preserving market discipline, avoiding bailouts, but also making sure there's an orderly resolution. I think that's an area that I still think deserves more work, but I was glad to see that in the case of Silicon Valley Bank and Signature, that the existing authorities work pretty well. Because after all, these were real traditional banks. Almost all the assets were in the bank, so they're not like a large financial institution that has significant assets outside of the bank. Those are much more complicated, or as large as you saw with the GSEs and have special government charter missions, that gets a whole other complicated area as well. So, it looks like, again, we know how to resolve these types of institutions, and they did appropriately.”
Jon: “It's a fascinating take on regional banks. One last question. Section 13.3, a very famous topic. Effectively, the legislation that enables lender of last resort powers on the part of the Fed, I believe it's 13.3, the Federal Reserve Act. It's changed over time a bit, and I'm curious. We're in this world where it seems like there is this de facto, too-big-to-fail issue, where anytime there's a big financial institution that goes down, or even in this case with a regional bank like Silicon Valley Bank, that there are some issues, the potential for spread of contagion, that there needs to be some sort of a backstop. And there's all these issues, things like Bagehot's Rule, which is, I think, lend generously in these sorts of times, but have some sort of a penalty rate. I'm curious, what do you think about the evolution of 13.3, lender of last resort, too-big-to-fail? I do think it is a somewhat recent phenomenon, in the sense that I don't think there were as many big bank bailouts, historically speaking. There haven't been the same kind of crisis that we've seen, at least since the Great Depression. But I'm curious, what do you think that evolution, whether there's been a positive development, a negative development, and I know there's been some sort of reform proposals that have been debated for decades now. I'm curious what your take is on 13.3.”
Andrew: “A couple of observations. First is, you're right, 13.3 is a Great Depression-era statute that was really not used since the Great Depression until 2008. And there it was used very aggressively to provide assistance to banks, but also to non-banks. And that's the authority that it allows. And then it was used, again, during the pandemic, response to the pandemic, and then we saw recently with Silicon Valley Bank. So, we now have three episodes on where it's been used. And that's supposed to be the emergency authority for the Fed. So, you're right to say, what's going on here? Are we seeing an evolution? Well, one is certainly 2008 and 2020 are the kind of cases where you would think if you were ever going to use 13.3. I think the more recent case of Silicon Valley Bank is a more interesting case, and the question is better focused there. And I think that the answer of what's really going on is that we don't have as active a discount window as we should. Remember, the Fed was established to provide liquidity to the financial system. When you got a banking package and it grew to help with seasonal needs, right? That goes all the way back to the founding. Since the federal government controls the currency, they wanted to have that elastic currency to make sure that when banks had needs for money, they were able to get it. And they would pledge collateral to help them get over a short-term liquidity crisis. For a variety of reasons, the discount window has not worked as planned. And that means the Fed sometimes feels, it's become concerned, and this is what you first saw in 2008, that there wasn't enough liquidity. Now in 2008, it wasn't just banks who needed liquidity, it was a lot of non-banks, and so 13.3 seemed appropriate. There was some of that recently with Silicon Valley Bank, but the real target were other banks. And so, it's probably a question to say, you know, why are we using 13.3 and not having a better discount window? And I think this is an area that needs a lot more thought and attention, I think, by the academic community and by policymakers to think of how we can make it work. Right now, the discount window is viewed negatively. There are concerns about stigma by banks that use it, both from a supervisory perspective and also kind of reputational by clients, other banks, public sentiment in general. And so, there's a real reluctance to use it in these types of crises. So, I think this is an area that I think deserves more attention.”
Jon: “I mean, it's so fascinating, you know, this idea that, you know, that there's this sort of lender last resort tool, the discount window there that exists, but, you know, banks are too afraid to use it because, you know, it'll be perceived as, you know, some sort of act of desperation and that could make their troubles even worse, even though it's supposed to be a lifeline. And so, like, instead, you know, banks are opting for these sorts of, like, secretly negotiated sort of bailouts that get announced sort of at the, you know, the 11th hour.”
Andrew: “Yeah, and remember, this discount window is not inherently, like, a bailout, right? You know, good collateral, you're providing the government is not taking really any credit. Ideally, it's not taking any substantial credit. The thing about 13.3 that really has to be recognized is that when 13 .3 is used, the way it has been, particularly in It has been, particularly in 2008, is that's a form of credit policy, where the Fed's moving away from monetary policy to allocating credit in the U.S. economy. And that is the responsibility, historically, of Congress, favoring which industry and institution gets public money. That's something that we've decided would be determined through the democratic process. So Congress has extended that authority to the Fed for emergency uses, but as you read the language, it's very clear that this is a break the glass, we really don't want you to be using this because your job is not credit allocation. And Fed chairs, particularly since Bernanke, have all kind of recognized that and have been very careful to closely consult Congress on how these programs are established, because they are moving outside of their traditional realm. And the real issue there is that, for the Fed, is that once the Fed starts picking winners and losers, it's moving from a technocrat type agency to a very political one. And that can result in questions of legitimacy and politicization of the Fed that can, in its worst case, come back in time for the credibility on its monetary policy, right? So that's why I think one of the better reforms of Doc Frank was you have to have the Treasury Secretary sign off on those loans. That way, you have someone who's directly accountable to the president, somebody who's elected by the entire country, at least have some accountability for how that money is spent. Because remember, when you're using 13-3, even though it's supposed to be on good collateral line, you're still taking some credit risk. And as we saw in 2008, there's some real risk of losses there. So it's very appropriate, in my view, to have that democratic accountability that's a reasonable balance. It is hard for Congress to quickly allocate money in the way that the Fed can do through 13-3. So having that emergency authority there can be very useful. But it's also the risks that come along with using that, particularly from a democratic perspective and being consistent with democratic principles, is really an important plus. As you kind of go into the issues you talk about, what we're talking about, which is it creates expectations of bailouts and creates moral hazard in the economy, that's also there. So it's use, like a lot of big policy decisions, certainly can have some benefits, but they don't call it out real costs that have to be recognized.”
Jon: “Absolutely.”
Andrew: “And I know some folks have criticized that 13-3 change that, at some level, might impede the lender of last resort function to act as quickly as it might need to in a banking crisis if it happened super quickly. But again, I guess it's a trade-off on how much accountability you want. In my experience, it's actually the reverse, which is the Treasury Secretary then can take the political accountability for the use of that money. And when Congress calls up, wants to understand what happened, it allows for somebody who's getting directly accountable to the President to come before the country and explain how the money is being used. Again, as much as the economic profession really focuses a lot on the Fed and there's a little bit of the cult of the Fed, in a crisis, it's actually not the Fed chair who's the center, it's the Treasury Secretary. That is the leader of the executive branch in responding to crises. And that's the person who should be, in terms of what we talked about before, the center of executing the response of the federal government, that's the appropriate official who should be leading those efforts. Again, because this is public money that's on the line and you want to have democratically accountable officials responsible. It also, I think, is a nice division of labor because it allows the Fed to still continue to focus on monetary policy, which is, we thought earlier, really important to continue to your right. And it's very technical policy-making there that Congress has been very clear about what the goals are and how the Fed's supposed to operate. The Fed continues to focus on getting monetary policy right, while then supporting the Treasury Secretary as the Secretary formulates the response of the administration.”
Jon: “Those are some excellent points, truly.”
Andrew: “Division of labor turns out to be good, not only in theory in economics, but also in practice when responding to the financial crisis.”
Jon: “Absolutely, yeah.”
Andrew: “We look at how our system works too now, one last point on that, then you have the FDIC, which largely has the resolution authorities. So, I think one of the other reforms I would say has been good from 2008 was that rather than having the Fed try and manage restructuring entities, those entities now under Title II will go to the FDIC, and that will be the federal government's resolution expert, right? And that means it will have, can make sure it has the on-staff, you know, the best experts in how to resolve complicated financial institutions all in one place. It also, again, gets it away from the Fed and the Treasury. It was a very intensive work that, again, helps divide the labor up of how to respond. You know, Treasury comes out, figures out how to respond, which has to get money. The Fed makes sure monetary policy is going in the right direction, lender-of-last-resort function is working, and then the FDIC is dealing with the institutions that have failed or are near-failing. That's not a bad way to work it out, and particularly if we're going to have a financial system that has so many regulators, which I think is still a problem, but at least here we've taken one of the problems of our systems and turned it into a little bit of virtue.”
Jon: “Absolutely. No, it's such a great point on all those fronts, the division of labor, clear objectives for various regulators. I couldn't agree more. Such an interesting conversation, Andrew. You know, it's been a real honor to have you on here talking about your experience and thoughts on all these really important matters across policy to banking regulation. Thank you so much for joining us today.”
Andrew: “Thanks for having me.”
Jon: “Today our guest was Andrew Orr, who's a partner in Mayor Brown's Washington, D.C. office and a member of their public policy regulatory and public law practice. He previously served as deputy director of the White House National Economic Council. This is the Capitalism and Freedom of the 21st Century podcast, where we talk about economics, markets, and public policy. Thanks so much for joining us.”
