Will the Feds actions make any difference in the economy? Alex J. Pollock joins the Boss Business Brief to talk about why the Fed's actions only harms small business. Would we be better off if the big banks failed?

Transcript:
Siegel: Folks, welcome in. This is Mike Siegel. Good to have you with us back here at the BOSS Business Brief, as every week we get involved in conversations with great thinkers in the field of the economy as the economy affects small business through regulation, through politics, through legislation, and through these procedures that really put a dampening on the ability of small business to do its job properly. We try to expose all of that on this program, and that is what we do every single week right here at the BOSS Business Brief. About whether or not the feds are stepping in has any impact on trying to mitigate, trying to stop, trying to deter these crises that we have in the economy – is it going to work, in other words. Alex Pollock of the American Enterprise Institute is with us as we have this conversation.
Pollock: And it is great to be with you.
Siegel: Thank you, Sir. Let's start with the underlying premise. What kind of work have you done in this area in terms of studying whether in fact the Fed doing what it does makes any difference to the economy, or can it stop these crashes, if you will?
Pollock: Well, it certainly makes a difference. I have in my career spent about 35 years in banking one way or another. I ran the Federal Home Loan Bank in Chicago from 1991 until 2004 and then I moved here to the American Enterprise Institute where I study financial issues in general including financial cycles and the role of the Fed in them, and just have a little book out on the topic, in fact, called "Boom and Bust."
Siegel: Well one of the big things we get concerned about is small business, because that is the engine that drives the American economy, in large measure at least, and driving most of the new jobs in the country, and they have not been given any opportunity by at least public policy to do any of what they do in terms of so-called bailouts or so-called support, tax breaks, any of that. So, let's talk about it from that context.
Pollock: Let me say one thing about small business. We have right now a credit market, which is somewhat strangely divided into two completely different pieces. We have a bond market, corporate bond market, which is booming. Which, if you are a big enough company, big enough debt issue, that you can be out on the bond market, the bond market is buying up bonds like mad all the way from across the quality spectrum from super high quality household name big corporations to junk bonds. The other part of the credit market is the bank credit market. That is the one that small businesses are dependent on, and that is all constricted and not functioning well because of three things: (1) the banks are all tied up in their losses from their past mistakes; (2) they are getting extreme regulatory pressure to reduce risk, increase their capital ratios, reduce assets, and that all makes it tougher on small businesses; (3) the third part, which I think is hardly ever realized, is that the best thing you can do, especially for small businesses in the time of after a financial bust, is to have new banks created. You get entrepreneurs who have the capital to set up new banks, who aren't burdened down by all the losses of the past because they are new, and whose natural market is the small business end of the market. Do you know what the response of the American financial regulators has been? They have blocked the creation of new banks.
Siegel: That is an important point because, you are a right, there is a history these banks have in terms of what they have done and the toxic loans they have made. We all know about those elements. But it really hasn't been fair to small business in that regard. I know that the FDIC, I spoke with the major spokesperson at the FDIC a number of months ago, this is going back, and they acknowledged that they are being pretty harsh with the community banks. Of course, they are letting the big banks get away with anything including almost what I think might be criminal activity on these foreclosures and certainly criminal activity by the rating agencies of moodies and standard impoors and fitch that really caused the catastrophe that had the impact of taking money away from small business.
Pollock: I am not sure they were criminal, but they were certainly gigantic blunders on the part of the rating agencies, no doubt about that.
Siegel: I say that because the University of Missouri Professor of Law in Kansas City who I interviewed put it that way. He said, either t hey didn't look at these portfolios of these mortgage backed securitizations to see that these loans were the perfect storm of loans that were going to collapse or they gave them those triple A ratings anyway. But the point being, that it happened. All of these bad actors did what they did and they don't suffer a consequence. The banks get money. Ken Olson at Bank of America gets a ton of money. Merrill Lynch looks the other way as they give 3 billion dollars in bonuses the week before he takes over Merrill Lynch. I mean, we know all the history of those things. I only bring that up because it such a lopsided scale between the latitude given to the major institutions and the harshness towards the small businesses by telling the community banks….I know of specific cases of loans to small business. I know of one case of a listener had a 15 million dollar value on a piece of property with a 2 million dollar loan outstanding. The FDIC regulator comes in in February of last year and says, you got to get rid of that loan, you got to get it off the books. We don't want these land development loans on the books because of the situation in the country. He then comes back in June and it was still there and he actually said, the vice president of the bank told this client, the vice president said, the regulator looked at the president said, "did you not hear me in February? If you don't get this off the books, we are going to triple your fee for the FDIC insurance." So, they had to get rid of a great customer.
Pollock: That is a great story, and we know that that is what is typically happens in the wake of a problem time. Is you get a regulatory clamp down on the banks, and I think it is right to say, as you have, the little banks in particular, although the big banks get a clamp down, too, but the little ones in particular. That actually makes the cycle worse. In other words, you are getting a regulatory reaction which makes it harder to recover from the problems. Now, in addition to that, this other point I was making is you really need new capital coming in in the form of new little banks that work naturally with small businesses and the regulators have completely blocked the ability to form such banks. So, there again you have a regulatory action which makes the problem worse.
Siegel: Well, it is something that could be done, because as I understand it there is at least 1 trillion dollars or more on the sidelines not going into the market but out there with corporate America, sitting there that, if the situation were right, they could open a small bank.
Pollock: There is a lot of money that would like to go into new banking organizations. There is a lot of cash in corporations and the banking system as a whole has a trillion dollars on deposit with the Fed just sitting there.
Siegel: We will come back and do another segment with you, because this is extremely fascinating and I am perplexed about the way we do these policies. Because one of the things that strikes me is that historically we have not seen the country buy its way out of a recession, or for that matter a depression, with money from the government. It is generally and typically been in the private sector. So, I would ask you, Mr. Pollock, if you could stay with us for another segment and talk more about this, if we can.
Pollock: Yes, sure. I would be pleased to.
Siegel: I thank you very much. Alex Pollock is here from the American Enterprise Institute. He has a book out called "Boom or Bust," and all of this has great impact, as we know, on small business, and I contend that small business is the engine that drives this economy, 90% of new jobs being created by small business. This has got to stop. We have got to start helping small business support the economy and themselves. Mike Siegel here. Good to have you with us. More right after this.

Siegel: Alex Pollock of the American Enterprise Institute is with us. Nice to have him here. Again, the book is called "Boom or Bust." It would seem to me, Mr. Pollock, that the implication of the book and what you are talking about is that you have got to have an economy in place that doesn't go through these dramatic highs and lows. It is almost as if it is bipolar or schizophrenic or something. I don't know whether a psychiatrist might help the economy, but certainly, we go back to the point about small business, small business cannot function…matter of fact, let's make one other point about this. I know many small business people who I meet regularly who tell me regularly that even though they have the ability to do more investing, they are not going to do it. The reason they are not going to do it is because they do not know where the economy is going, they are not going to put money into an economy that might cause they harm. They want to sit back and wait and see what happens.
Pollock: Well, that is certainly the case and it is very logical, not only for small business but big business. You want to have pro-economic growth policies in the country not anti-growth, not anti-business, not anti-entrepreneurial policy, so that the confidence, not that you will necessarily succeed but that your investment has a fair chance of succeeding, is there and then you start to employ the money. That is both employ the money as a company investing and also employ the money as a bank being able to make loans.
Siegel: Alright. So, if we have that situation, one of the things I think everyone would like to see….let me ask it another way. Can we put together an economic system that would be more predictable so that any business, big or small, but big business as we have seen can make it through because the government is going to bail them out, but with small business for the benefit of that sector to operate effectively, can we create an economic system that doesn't go through these category 5 hurricanes or category 8 on a Richter scale?
Pollock: Well, let me say this. I do not think it is possible to have an economy, which is an enterprising, free economy, that does not have cycles. The cycles come along with people having the chance to take a risk and to innovate and the future is inherently unknowable and the idea that the federal reserve or the government can know what the future is going to be and therefore do away with cycles is mistaken. However, it seems to be quite plausible that with right ideas and actions you have cycles that didn't get away into huge inflationary bubbles followed by hugely destructive busts. So, you would moderate the cycles and, of course, in an enterprising or capitalistic economy you have to have failure, because you have to have the freedom to take a chance, and out of taking the chances come some fantastic successes but also cone some failures. So, that ability to take a chance on a new idea, a new product, a new process, is what causes the growth. Now, ask yourself, what are the factors, however, which cause this natural cyclicality to get away into the destructive bubbles and busts. Some of them are psychological, and I talk about this in the book, and what lures people into over borrowing and over speculating, but others of them are actually created by the government including the Fed. So, there is no doubt in my mind that one of the causes of our housing and real estate bubble, which was so destructive, was the Federal Reserve intentionally setting out to create a housing boom and they succeeded. They didn't want to create a bubble, but they did try intentionally to create a boom.
If I can just tell a little story on this point. So, now people say, well the Fed should be the regulator of the so-called systemic risk of the whole economy, but as Senator Bunning asked the German Bernacki a couple of years ago, and I thought it was a wonderful question. He said, "How can you be the systemic risk regulator when you are the systemic risk?" When your own actions as the government's central bank are among the most important things causing this ultimately destructive, excessive boom and bust behavior. That is a deeply important point.
Siegel: What about what Congressman Paul is talking about. He is going to chair a subcommittee with the now majority of republicans in the Senate. When he talks about maybe….starting with the premise of 600 billion going into treasury notes that the Fed has approved in the last week to 10 days, that was a big deal. Again, more propping up of the economy artificially by the government and then reducing the value of the dollar, I presume, because the more of these you print, the less the value is going to be. I mean, if there are more in circulation.
Pollock: That is certainly the conclusion that the foreign exchange market drew.
Siegel: So, that is where you have the market place determining that. So, would it be advisable to do two things: (1) audit the fed, as Congressman Paul has been saying for probably a couple of decades, and (2) to have perhaps a gold option? In other words, getting some hard metal, gold or silver, but let's say gold, as a competing force with the dollar internationally?
Pollock: Well, of course, Congressman Paul is a very interesting thinker and he has been a very big skeptic of the Federal Reserve for a long time. You get a lot of debates around the Fed. The gold standard as it was had its problems. The Fed pure paper money standard has obvious problems. You probably cannot design the perfect system, but we also should never think that a committee called the Board of Governors of the Federal Reserve, which is, if thought about in one way, a national price fixing committee for interest rates to try to manipulate the market. We should never think that that is necessarily be successful and, indeed, the history of the Federal Reserve is quite filled with huge mistakes, most recently in this last decade.
Siegel: Well, given that fact then, should we…the other way to look at this, and to maybe make it more predictable, and I think business of all kind, and again particularly small business, would probably benefit from this, if it were to work this way, shouldn't we have a central bank that basically owned the money and not have a federal reserve system where the private banks own the money and lend it to the government. Then, the government ends up paying the interest. What that does, as you know, is to take the money out of t he private sector, because people are investing in treasury notes and interest is being repaid by the government. All of that money gets taken away from the private sector, doesn't it?
Pollock: Well, central banks are a conundrum, because it is hard to live with them but you cannot live without them. I don't know….it is easier to see the problem than it is to see the solution, as so often in life.
Siegel: Well, we have to do something, because clearly what we have done here… it was even to the point, I thought, when this whole thing came down and the Fed did what it did, they weren't sure if any of this was going to work.
Pollock: That is absolutely true. To my own amusement over the years, I have developed a set of things I call "Pollock Laws," and Pollock's 7th Law is in any extremely complex situation you never know what you are really doing. That absolutely applies to this kind of experimental action by the central bank. They are trying this, but they nor any body else know what will actually happen as a result of all of that.
Siegel: Let's go to the key point here. Should there be a change at the Fed, particularly at the FDIC, where small community banks are allowed to loosen up instead of some of them just being put out of business, but loosen up and being able to make loans that look like productive loans? Because the biggest field in this country is real estate at all levels, whether it is commercial, industrial, office, residential. We are in the tank and there is no construction t o speak of going on.
Pollock: A different way to say that is you would like regulatory behavior to be counter cyclical not pro cyclical, to use big words. That is to say, you are trying to help moderate the room, but in the bust you are trying to help recover from the bust not make it worse by constricting credit further.
Siegel: Well, it has been a delight to talk to you, Sir, I appreciate it. Alex Pollock. It is called "Boom or Bust" and I thank you for your time on the program today.
Pollock: Thanks very much.