The Bankers Who Warned About 'Too Big To Fail' In their 2004 book, Gary Stern and Ron Feldman, top executives at the Federal Reserve Bank of Minneapolis, cautioned the world about systemic financial risk and the need for more oversight. They admit to a fleeting sense of "I told you so."
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The Bankers Who Warned About 'Too Big To Fail'

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The Bankers Who Warned About 'Too Big To Fail'

The Bankers Who Warned About 'Too Big To Fail'

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STEVE INSKEEP, host:

As we've heard, the largest banks are often called too big to fail. That is also the title of a book, "Too Big to Fail: The Hazards of Bank Bailouts." Sounds like the title of a book written to explain today's crisis. Yet as NPR's David Kestenbaum reports, the book has being out since 2004.

DAVID KESTENBAUM: "Too Big to Fail" was written by two - let's call them ignored prophets: Gary Stern, the president of the Federal Reserve Bank of Minneapolis, and Ron Feldman, senior vice president there.

Okay, the book's not best-seller material, but it has a catchy cover.

Mr. GARY STERN (President, Federal Reserve Bank of Minneapolis): It's a house of cards. That's what it is.

KESTENBAUM: That's Gary Stern. Today, what they wrote about has all come true. The government has stepped in and had to bail out huge institutions seen as too big to fail - AIG, Fannie Mae, Freddie Mac and major banks.

Mr. RON FELDMAN (Senior Vice President, Federal Reserve Bank of Minneapolis): Certainly, I told you so did run through my mind, yeah.

KESTENBAUM: Co-author Ron Feldman. Feldman says he and the folks at the Minneapolis Fed have been worried about this issue for 20 years. And in 2001, something happened in their own backyard. A broker-dealer firm in Minneapolis got into trouble, and the firm's lawyer made that argument. The firm was too big to fail. If it was allowed to go under, the lawyer said, it could disrupt economic activity across the Midwest.

That turned out not to be true, but Stern and Feldman say this very idea, that government might be expected to step in, is dangerous because it encourages people to take risks that they shouldn't.

The book proposed a series of changes that are now being considered at the highest levels of government. Maybe you've heard about that idea of a systemic risk regulator? They wrote about it five years ago. Feldman says regulators need to pay attention to the financial web that ties everything together. How much is one bank lending to another? How interdependent are they?

Mr. FELDMAN: Right now, we don't have an entity — an oversight entity, a government entity — that thinks to itself, what happens if this institution gets into trouble and is going to fail? What would we do about it at that time? The primary focus of most supervision is to prevent them from getting into trouble. And I think it sounds like a generic thing — well, just, you change your focus. But that's not trivial. That's important. Because it's by focusing on what we would do if they got in trouble that this stuff gets revealed.

KESTENBAUM: And if large institutions do fail, they argue, there has to be something akin to the procedures nuclear reactors have when they get into trouble — some way to safely shut down the institution. Gary Stern says if you do that, it will be clear that the government won't be coming to the rescue, and that will discourage risky behavior.

Mr. STERN: Risk will be priced more appropriately, and that sets up a potential for a virtuous circle.

KESTENBAUM: It sounds like you're basically saying, we're not going to do this again. That's what you're going to make clear to them, is that…

Mr. STERN: Oh, no, no, no.

KESTENBAUM: …even though it happened now, we're not…

Mr. STERN: No, not at all.

KESTENBAUM: …going to bail them out again.

Mr. STERN: No, no, no, that's not right at all. Doing - if that's all you did, if you said we're not going to do this again, that's not credible. You have to take real steps to make it credible. That's what we're talking about. You -assertions that we won't do this again are silly. You've got to take real steps.

KESTENBAUM: Stern and Feldman were in D.C. for what amounts to a book tour, a talk at the Brookings Institution. And most of the discussion was on what to do next. But there was some looking back at why their warnings about "Too Big To Fail" hadn't been given more attention.

Alan Greenspan was there. And though too big to fail wasn't something he talked about when he was the Fed chairman, he did think about it.

Mr. ALAN GREENSPAN (Former Fed Chairman): Fannie and Freddie were not too big to fail. How do I know? That's what the law said. On the debentures, when they used to be physical paper, it literally said these instruments are not protected by the full faith and credit of the United States government.

KESTENBAUM: Greenspan says no government official could really say otherwise.

Mr. GREENSPAN: Indeed, I always took the position when I ended up on the Hill that Fannie and Freddie were not too big to fail. Needless to say, my fingers were crossed behind my back. But you cannot have that position and still argue that the federal government has credibility.

KESTENBAUM: The "Book Too Big to Fail" is now being reissued in paperback.

David Kestenbaum, NPR News.

INSKEEP: David's part of our Planet Money team, and you can read part of "Too Big To Fail" at the Planet Money blog, npr.org/money.

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