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Banking, Bailouts and Blind Spots
Neel Kashkari

Banking, Bailouts and Blind Spots

The Minneapolis Fed President on banking, bailouts, blind spots, Jamie Dimon and Donald Trump.

He had only been in his new job as president of the Federal Reserve Bank of Minneapolis for roughly six weeks when Neel Kashkari fired his first shot across the bow of Wall Street. In a February 2016 speech at the Brookings Institution in Washington, D.C., Kashkari charged that the nation’s largest banks remained “too big to fail,” and as such, they could pose a risk for future taxpayer bailouts.

A moderator on the panel expressed surprise: “It’s not what one expects from a Goldman Sachs Republican.”

Kashkari, 43, is not one for doing what people expect. He began by following in his father’s footsteps, earning bachelor’s and master’s degrees in mechanical engineering, and started his career as an aerospace engineer from 1998 to 2000. But he found that he wanted to learn about business and was wary that going for an engineering doctorate would consign him to a career in research. Instead, he earned an MBA from the Wharton School of Business in 2002 and landed at Goldman Sachs in California as an investment banker.

The job turned out to be fortuitous. Hank Paulson, then CEO at Goldman, was later named Treasury Secretary. Kashkari barely knew the man, but he called Paulson, pitching himself and his interest in public service. Paulson was impressed and brought him to Washington in 2006, initially as an advisor on housing issues.

In September 2008, venerated Wall Street financial firm Lehman Brothers filed for bankruptcy, and the aftershocks pushed the U.S. economy into the financial crisis. As the economy spiraled, Paulson tapped Kashkari—then only six years out of Wharton—to oversee the Troubled Asset Relief Program (TARP), a plan for the federal government to spend $700 billion to buy up bad loans and other distressed assets from banks. The goal was to stave off a broader economic collapse. Critics derided TARP as a bailout program for big banks and Wall Street; the program had support from both Republicans and Democrats, but also had critics from both parties.

As the economic crisis deepened, media coverage intensified. Kashkari became a symbol of TARP, which led to nicknames such as “the $700 billion man” and “TARP bailout czar.” At the time Kashkari was only 35 years old. Why was he thrown into the eye of the storm? He had won the confidence of Paulson.

“We had other people who were senior and more experienced,” Paulson later said. “But I didn’t see anyone else on my team who was willing to step up and be accountable and take the responsibility.”

Kashkari left D.C. in May 2009, after seven months overseeing TARP, serving under both George W. Bush and Barack Obama. He later joined California-based investment advisory firm Pimco.

He started mulling a run for governor of California in late 2012, after Mitt Romney lost to Obama. He spent a year testing his ideas with potential donors and average citizens. He was a fiscal conservative but a social moderate who wanted to build a bigger, more inclusive tent for Republicans. Few political observers thought that any candidate stood a chance against incumbent California Gov. Jerry Brown, which likely scared off other contenders. But Kashkari went ahead and came in second in the state’s general primary, which pitted him against Brown in the general election. Media coverage of the campaign often described Kashkari as relentlessly upbeat. But in the end, he lost to Brown by nearly 20 points.

When he was tapped to lead the Minneapolis Fed, members of its board of directors cited his combination of private and public sector experience and said that his leadership skills set him apart from other candidates. Between Goldman and Pimco, his resume at the time included about eight years of private financial industry experience. Looking back on the financial system collapse, he says he believes that the government had no choice but to step in to stabilize the financial system. But today he’s concerned that financial reforms did not go far enough to prevent another financial system meltdown that could be averted only through more taxpayer-funded bailouts. Last year, Kashkari released the “Minneapolis Plan,” which increases capital requirements for the biggest banks, which he argues would reduce the need for those banks to tap government money during a crisis. At the same time, the plan calls for reducing regulations on community banks “which are not systemically risky for the U.S. economy.”

In early April, he blasted JPMorgan & Chase Co. CEO Jamie Dimon in a stinging rebuttal to Dimon’s letter to shareholders. Dimon argued that banks were carrying “too much capital,” contending that capital requirements were restricting the volume of loans that could be made. Kashkari didn’t buy it.

“Mr. Dimon argues that the current capital standards are restraining lending and impairing economic growth, yet he also points out that JPMorgan bought back $26 billion in stock over the past five years,” wrote Kashkari. “If JPMorgan really had demand for additional loans from creditworthy borrowers, why did it turn those customers away and instead choose to buy back its stock?”

Meanwhile, banks are not the only thing Kashkari thinks about. In January he announced the creation of the Opportunity and Inclusive Growth Institute, a research initiative to tackle the issue of wide racial economic disparities in Minnesota and the region.

“I know that monetary policy can’t solve disparities—you can’t target monetary policy on certain communities or certain groups,” says Kashkari. “But if we can do the research to help analyze the sources of these disparities, come up with potential solutions and then put those out to the public for other policymakers to consider, I think that’s an appropriate contribution for us to make.”

What Is ‘Too Big to Fail?’

“Too big to fail” refers to the concept that some banks and other companies are so large that the failure of those firms would damage and destabilize the larger economy. In the interests of protecting the greater financial system, the government steps in to provide financial assistance. During the financial crisis of the late 2000s, the federal government provided assistance to banks, insurance companies and automakers.

Q “Too big to fail”—do you feel like anyone is listening to you?
I do. After every FOMC [Federal Open Market Committee] meeting I go up to Capitol Hill and meet with members of Congress from our region, but also [with] leadership—both sides of the aisle, House and Senate—and they are paying attention. I think they are getting the message that the biggest banks are still “too big to fail.” I feel like one of our biggest responsibilities is to speak up if we see risks.

Q As a candidate, President Trump made comments that suggested he shared your concerns about the largest banks. Do you have any sense of where the administration stands on that issue?
I’m not sure. During the campaign, he did talk about the biggest banks…. We’ve heard different messages coming out of the administration: on one hand wanting to relax regulations, on the other hand still wanting to address “too big to fail.” We think the plan that we’ve put forward can do both. You can really address the risks imposed by the biggest banks and at the same time you can relax regulations on small banks.

Q You recently noted that you thought stock, housing and commercial real estate prices may be somewhat elevated. Do you have any concerns on the horizon about where those prices are?
Our concern is not so much to stop prices from going up or to keep them from falling; but we do care about the potential for a correction to trigger financial instability.

If you think about the tech bubble, when the tech bubble burst it didn’t have the potential of destroying the U.S. economy or plunging us into a depression. … There’s a lot more debt under the real estate market than there is under the stock market. That’s why the housing bubble bursting was so damaging to the financial system and the U.S. economy. We look at these asset prices and then we try to understand what the likely consequences are going to be on the U.S. economy if there is a correction. We’re not particularly concerned right now that it’s going to lead to any kind of economic instability.

Q At the Fed’s March meeting, you cast the lone dissenting vote against raising interest rates. Why?
We have our dual mandate: stable prices and maximum employment. … Core inflation continues to come up short: Right now, it’s around 1.8 percent rather than 2 percent. That doesn’t sound like a big difference, but it’s been consistently below [expectations] and so we’re not yet at our inflation target.

On the job front, If you look at the Fed’s history over the last few decades, the Fed has repeatedly thought, ‘We have reached maximum employment,’ only to find out more people wanted to work. As the economy got stronger, more people entered the labor force. My view was, on both fronts, since inflation is not showing any concerning signs yet, let’s see if the job market continues strengthening without inflation picking up [before raising rates further].

Q The labor participation rate remains historically low. Is that something you track?
It absolutely is. We know that it’s been trending down because of the aging society and demographics, but even if you look at working-age labor force participation, it’s considerably lower than it was in 2005 or 2006. That also suggests that there’s still slack in the labor market.

Q Companies say, “We can’t find anyone to hire. We can’t find good people.”
I hear this too, all around, when I travel. They can’t find people at today’s wages. So I always say, “OK, great. Have you raised wages?” “No.” “Well, talk to me when you’ve raised wages.”

Q Surveys say people’s confidence in the economy has increased, but the economic data doesn’t show a similar uptick. What do you make of the disconnect?
If you look at right after the election there was a boost not just in the stock market, there was a boost in the bond market. Inflation expectations ticked up just a little bit, suggesting maybe we’re getting out of this low-return, low-rate environment that we’ve been in since the financial crisis. The markets were in part betting on legislation coming out of Congress, either tax reform or health care reform or regulatory reform.

My experience is that the markets are lousy at predicting political outcomes. So I ignored the market’s response and said until we have more evidence from Congress or the administration on what they’re likely to enact, there’s no point changing my economic forecast.

Q How did racial economic disparities rise to the top of your list?
The biggest surprise to me about Minnesota and the region is the extent of racial and economic disparities. Given how much we have going for us in this region, that just struck me as surprising. As I started asking economists here at the bank and around the Federal Reserve system, “Can you explain these disparities? What are the root causes of these disparities? How do we address it?’ it surprised me how little we really understood about it.

Q Has anyone questioned if the Fed can have an impact here?
To the extent we’ve heard any criticism it’s been, ‘Hey, this is outside of the Fed’s mandate.’ My pushback to that is Congress has given us a mandate of maximum employment; maximum employment means everybody who wants to work is able to work.

This is going to be a long-term initiative. We’re not going to have quote-unquote an “answer” in a year. We’re just going to get going and do the work so that we can analyze it and see where the research leads us….This is just where we’re starting.

Q Do you see challenging people as part of your role?
I pick my spots. I try to figure out, does drawing attention to an issue advance the policy goal or not? For example, on monetary policy, I don’t go out and give speeches saying, “Here’s what I think we’re going to do next. Here’s how many rate hikes there are going to be this year.” That would draw attention, but I think that does harm by adding noise and confusion to markets.

“Too big to fail” is one where the more attention we can draw to the issue, the more we can educate the public and Congress about the issue, the more likely we are going to address the issue and make a difference on that issue. I’m very thoughtful about which issues I want to raise attention to, and then if I do want to raise attention, let’s be creative to try to do it.

Q Have you ever met President Trump?
I met the president for 10 minutes when I was running for office.

Q What did you talk about?
I was seeking contributions.

Q Did he make any contributions?
He did not.

Q Do you see other sectors of the economy that raise any concerns?
Trade is another one that I talk to our economists about a lot. The traditional approach to thinking about free trade has been “Free trade is good, free trade is good, we will unilaterally free-trade even if our trading partners are not free-trading.” Because our hope is that they’ll wake up eventually that it’s in their interest to pursue free trade.

I think what President Trump is asking is, “Isn’t there something else we could be doing?” When you ask the experts, they’ll say “Oh no, if you do anything less than free-trading, it’s a trade war.” I think that’s a false choice—unilateral free trade or a trade war. I think we, as a country, have to figure out: Is there some reasonable middle ground that’s neither a trade war nor universal free trade? I don’t think we have the answer to that yet.

Q You said of the oil crisis, “None of the smart people saw it coming.” How does that guide your view of the economic outlook?
It’s the lesson that even when we’re on alert, we’re still going to miss things. Coming out of the financial crisis everybody was and still is on high alert looking for economic shocks. And yet oil went from $140 [per barrel] to $30 and nobody saw it coming. That’s a huge economic shock.

The lesson is we have to keep on alert, remain vigilant, but assume we’re going to miss it. Assuming we’re going to miss it, what can we do to make sure the system is strong enough to withstand the shock that we ultimately do miss? That’s why it’s so important that we make sure that the biggest banks have enough capital so that when a big shock comes—that we miss—it doesn’t bring down the system and it doesn’t require taxpayer bailouts.

Burl Gilyard is senior writer for TCB.