Wall Street Week - Full Show 03/24/2023

Wall Street Week - Full Show 03/24/2023

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Walking and chewing gum at the same time as central banks that dress the need for financial stability without giving up their battle with inflation. Welcome to Bloomberg Wall Street Week. Time David Westin. This week, special contributor Larry Summers takes us through the Fed decision and what the banking crisis could mean for the real economy. They need to recognize that regulation lost its way over the last year or two routes under Rajan of NYU sorts out the real from the fanciful and chat cheap.

The more people who use the system early on, the better it becomes. And a special Wall Street week roundtable on the banking breakdown with Larry Summers joining former Fed Governor Dan Tarullo and definitely Flanders of Bloomberg Economics. We know first that there was a significant supervisory failure somewhere along the way.

Central banks already had their hands full, fighting inflation. But then a second front opened up with a banking crisis that quickly spread from Silicon Valley to Zurich, where officials began the week announcing that UBS would take over Credit Suisse. A move praised by ECB President Christine Lagarde. I welcome the swift action and the decisions taken by the Swiss authorities. These actions are instrumental for restoring orderly market conditions and ensuring financial stability. But it was a shotgun wedding that left holders of so-called cocoa bonds of Credit Suisse out in the cold.

17 billion dollars of them are now rendered worthless. All of which put pressure on the Fed to explain how it would pursue price stability and financial stability. At the same time, and Wednesday, we got our answer. Inflation remains too high in the labor

market continues to be very tight. We remain committed to bringing inflation back down to our 2 percent goal and to keep longer term inflation expectations well anchored. We will continue to closely monitor conditions in the banking system and are prepared to use all of our tools as needed to keep it safe and sound. My colleagues and I understand the hardship that high inflation is causing and we remain strongly committed to bringing inflation back down to our 2 percent goal. And while global Wall Street was consumed with the stability of the banks and how the central banks would respond, the rest of the world went on.

President Xi of China paid a visit to Moscow for a visit with his good friend, Vladimir Putin. She is there to present himself as a responsible stakeholder and a peacemaker to try to further bolster China's reputation on the global stage. Congress, some of the CEO of ticktock to Capitol Hill for a grilling over his social media. You know, I would also like to talk about national security concerns that you have phrase that we take very, very seriously.

At the end of this challenging week, equities actually held up remarkably well with the S&P 500 up one point four percent, the Nasdaq up one and two thirds percent. While much of the action was over in bonds where the yield on the 10 year started, the week just over three point four percent spiked up well over three point six to end the week back down at three point three, seven, just a handful of basis points from where it all started. Tell us sort all of this out. We welcome now Dennis to Bush. He's founder and president of 22 V Research. And soon I'll decide chief investment officer for fixed income at Franklin Templeton.

So welcome, both of you. Great to have you here. So now we start with you because the action really was largely in bonds. You're our fixed income person. What how do you explain how the bond

market reacted to the news this week? So, you know, I wish it was an equity market equity week, but it is a market week, clearly. I'd say the type of volatility we're seeing in the Treasury yield curve. It is it is very interesting. There is a certain amount in my mind

business that the bond market is asking, pleading with the Fed to cut rates. However, if I look at what is being priced in by the bond market, the number of rate cuts being priced in. It just doesn't make sense. It only makes sense if you're anticipating a really drastic recession triggered by a massive banking crisis. But if that's the case, then the remainder of the bond market doesn't make much sense. I'm talking about credit markets, for example. We haven't seen spreads blow out. All the action really seems to be

driven. All market participants being unhappy with the Fed, not essentially doing what we've seen the Fed do. Frankly, since the global financial crisis, which is use overwhelming force at the first sign of wobbles in any particular piece of the financial sector. So, Dennis, is the equity market basically having a big debate with the bond market right now? Because the bond market is saying we're going to have cuts this week, this year, even though Jay Paul keeps saying we're not going to have guys. But the bond market seems to think as if really we were.

Wouldn't that signal something really bad going on and shouldn't that be hurting equities right now? You would think theoretically that it should be a pretty big drag on equities. I think one of the reasons why equities aren't reacting is because a lot of what's happening in the bond market could be a hedge against a really bad outcome. And at the end of the day, unless the near-term economic data is falling off a cliff when it clearly is not doing lower, rates are not going to be terrible for equities until it becomes very obvious that you're going to see significant earnings degradation. And so there is some chance that, you know, the banking system gets or people have a lot more confidence in the banking system. And if that happens, then deposit risk goes away or significantly reduced. You don't have this drastic tightening of financial conditions or lending standards.

And if that were to happen, then the economy can weather it and maybe even with a lower rate outlook. And that combination at least stabilizes equities until they have a little bit more information because again, the earnings outlook is not terrible to start the year. And that's a really important point. So so now the news was not just about what the Fed did or what Jay Powell said this week. We also have this overhang of of some confusion, even some fear in parts of the banking industry was that reflecting the bond market to the bonds, react to all of that that was going on. To some extent, but the reality is, you

know, if me you know, you started off talking about the banking crises. I would almost take issue with the idea that there is a crisis as such, because I would really distinguish what we are seeing today in banks from what we saw when we had a true banking crisis, a financial crisis, say, 2007 8. We have to recognize that what we're looking at are banks, which by and large are extremely solvent. If you look at banks like SVP, for example, probably was the most fundamental mismatch or duration when not looking at deep, strange and valuable securities where you can't figure out how much they were looking at government treasuries, looking at U.S. treasuries and looking at mortgage bonds where we know the value of the asset by the minute. I think that's one thing to keep in

mind. Every time we hear I hear about the banking crisis and how this is spreading and there's something catastrophic waiting to actually argue that what we heard from Jay Powell, indeed what we heard from Janet Yellen is broadly on point. If they see banks having runs and remember in banking, they're in the business, people are in the business and banking on borrowing short and lending long deposits on loans. It's what banking is. I just think that what they are doing, which is trying to separate out what to do about the banks from interest rates up to a point.

This is a very sensible thing to do. So, Dennis, whether the banks are in a crisis or not, I guess it matters whether they think they're in a crisis. You could go into a crisis because it really affects their willingness to lend to some corporations, and that could really affect equities. That is what the problem is for equities over time. And what we don't know is how much of that trading of lending standards will actually show up over time. No one really knows.

Tightening lending standards is going to be, quote, a good off the screen. So you're not gonna be able to pick it up in the typical type of financial conditions, indices that we would normally look at, you know, on a Bloomberg screen. So it's a really unknown. But, you know, we did a search today of Google Trends, FDIC insurance, and after a giant spike up, it's come down aggressively.

So the broader public is probably not so focused on this as much anymore. I realize we all are. And Wall Street is what people in California that are. And so if you get past that risk, which is the deposit flight risk. Yes. Banks will have tighter lending standards. That might mean that the Fed doesn't have to tighten as much on a go forward basis in aggregate. You still have the same outcome, slowing

economy, lower inflation, but it doesn't mean a recession in the next six months. And if you don't have a recession in the next six months, then you have the case for equities to at least be stable and to have a significant bounce back in some of the more cyclical areas of the market. So the other side. Oh, sorry. Go ahead tonight, please. No, I was just going to just say to Dennis that, in fact, that I've seen so much of talk about how Jay Powell talked about raising rates just two days. You know that rates needed to go up a lot more. Two days before SBB broke.

And then we saw that when we saw the new recipes, the top P crate is still where it was in December. So that's actually what we're seeing is a substitution of higher rates, which would have contracted demand for loans more. Yes. With high lending standards, as you said, which constrains the supply of credit. So overall, I don't think it's too

premature to assume that we're going to see this massive melt down of the economy on the back of what we've seen in the past two weeks. I think that's a really important point. And I don't think investors, broadly speaking, are doing a good job of thinking about different timeframes. We can all talk about six months forward and the tightening of lending standards and what that means for the economy. But it's never 100 percent that you're going to go into a recession. So if you want to invest on a recession, call today in equities. It could work out over a 12 month basis,

but you could also have significant bear markets or rallies in between. It appears exactly to your point that this tightening lending standards takes a very long time to show up. And that's where you end up with some cyclical bounces of the economy. I mean, you probably know this better

than I do, but the economy has a lot of momentum right now. I mean, I get that those headline risk could be an issue. But you've got core personal consumption expenditures really on a three point seven percent annualized rate. The drag from housing is about to actually go away. I mean, like so forget about what going to happen a year from now. But there's a lot of things that could happen within that time frame that leads to these aggressive rallies that, quite frankly, put investors out of business if you're on the wrong side of it.

And that leads perfectly into the next prior discussion now of the side and then special will stay with. Because we're a turn from what happened this week to what it means over the medium and long term. Coming up next on Wall Street, week on Bloomberg. I think we have a lot of individual investors who are on the Internet buying and selling stocks almost every single day.

And as a consequence, their behavior is somewhat different than the traditional institution. And quite frankly, I think the institutions these days are behaving a little bit foolish as well. That was Roger McNamee, much younger, quite frankly, then with Integral Part Capital Partners on Wall Street Week back in February nineteen ninety nine, when the number one movie in the country was Message in a Bottle, starring Kevin Costner and Robin Wright. And the number one song. Well, that was Angel of Mine by Monica. So now the CI A. Franklin Templeton and Dennis, the butcher of 22 V research are still with us. So, Dennis, go back to where you left us. Basically defense at the time horizon.

We were talking about what happened this week. But when you look six months out, 12 months out, if you're an equity investor at this point, given all the uncertainty facing, what do you do? You plan for lower inflation and stocks that benefit from lower inflation. Very simply, we spend a lot of time trying to figure out what the Fed is trying to accomplish. And this is an open secret.

They want lower aggregate demand to lower inflation. They're going to accomplish that goal one way or the other. Maybe the banks tightening lending standards does a forum. If that doesn't do it for them, they're going to tighten a lot. They're going to write more to make that happen. And so the net result of that is companies that benefit from lower inflation are going to outperform. And as we see it, the things that will

probably do the best of that backdrop are your early cyclicals on a relative basis. That's tech communications and discretionary. So that's an area we focus on. Then the main question is as the economy slows. Is it a recession or not? If it's a recession, then more your defensive sectors work that gets you to, you know, staples, utilities, etc..

If it's a mild recession, I think you want to fade defenses. And I think you really need to start thinking about the next cycle, which to me is the most interesting conversation. Are we? And I know you talked to Larry Summers. Are we in a lower savings economy that's going to have consistently higher nominal GDP growth, consistently higher inflation and pressure? A Fed that's never really going back to to letting inflation run a little bit above target and over that longer term.

Right. You know, the defenses are going to be extremely unattractive if you're gonna have a two year rate around these levels for a persistent period of time. Dennis possible lowers it. Dennis always sneaks. And Alan here, because I want to ask you the same question as a fixed income. Unfortunate. We have just a short period of time. What do you do in your investing as a fixed income investor? So right now, listing up and quality, we've been relatively neutral duration because I think we're gonna get a lot more volatility. I don't think tenure rates are going to

go back up before we actually stop coming down because right now markets and fed up being a game of chicken. I happen to think the Fed's going to win. And so eventually we get higher yields. And then I think we set set ourselves up for a pretty good period for fixed income. They're already there as we move into a

slowdown, which allows the Fed to cut sometime next to. That is terrific. Thank you so much to both of you. Sonali Basak of Franklin Templeton and Dennis, the butcher of 22. The research coming up in a week when even Chair Powell was wondering what happened to the banks. We convene on Wall Street Week roundtable of experts on banking regulation and financial markets with special trainer Larry Summers of Harvard.

Former Fed Governor Dan Tarullo. And our own senior executive editor for economics and government. She's Stephanie Family Flanders. That's coming up on Wall Street Week on Bloomberg. This is Wall Street week. I'm David Westin Fed chair. Powell this week said he didn't yet know exactly what went wrong with Silicon Valley Bank, but the vice chair bar was conducting an investigation to find out. We convened our own expert roundtable to discuss what we know at this point, what we don't know and what changes should be on the table to make sure we don't repeat what we saw over the last two weeks.

Here's former Treasury Secretary Larry Summers, former Fed board member Jan Tarullo, and Stephanie Flanders, Bloomberg executive editor for economics and government. I trust that the largest banks truly are in much better capital and liquidity position that Jay Powell referred to yesterday during the press conference. We know first that there was a significant supervisory failure somewhere along the way. Was that failure in the San Francisco Fed's inability to identify problems of growth and maturity mismatches and the like early on? Was it the failure of the second San Francisco Fed team to which did identify some problems to follow up in a sufficiently robust way? Was it a supervisory failure because of the light touch approach to supervision that Federal Reserve Board had put in place over the last four or five years? But I think in the in the most immediate sense, this is clearly a supervisory failure. Other factors may be uncovered as the Fed's own investigation proceeds. Larry, let's put you back at the

Treasury or for that matter, at the White House. If you were looking at this situation, what questions would you be asking to make sure you understood the possible ramifications of what we've seen so far? In a broader financial context, before I answer that hypothetical, let me put a question to my friend Dan Dan. I've heard it said and I don't know that even in 2022, the Fed's stress tests that were applied to the largest banks did not include an analysis of the stress from a major interest rate hike. If that's true, that seems kind of bizarre from the point of view of the world of early 2022, when it certainly many people, certainly me on David's show were emphasizing that there was likely did need to be very substantial increases in interest rates. Can you say some? And if the stress tests weren't considering increases in interest rates, then perhaps the exempting of Silicon Valley Bank from the stress tests was not central to understanding the problem. Can you say something about interest rate hikes and fed stress tests? Sure. So first off, I think, Larry, I agree

with that. The statement you made toward the end of your question, which is I asked if if Silicon Valley had been in last year's stress test for real rather than its dress rehearsal, I don't think it would have made much difference for precisely the reason you say that they weren't stressing the things that were this SBB vulnerabilities with respect to stress testing generally over again over the last five or six years, the stress test has become eminently predictable, but it follows the basic pattern of the scenario that was developed when we began doing the annual stress test. The scenario, of course, includes a reduction in interest rates because of the hypothesis of a recession and the Fed's reaction. So to some degree, the answer to your question is like supervision. Generally, the stress test has become less rigorous over time. And I think more importantly, it's

become too predictable. And the whole purpose of the stress test is that you're trying to stress against the unanticipated, not the anticipated. Stefan, you've worked at the Treasury United States. You also have covered financial markets and other business issues over in Europe for a good long time. One thing we're hearing from both Larry and Dan is rates were going up and they weren't just going up here.

They're going up over in Europe as well, was what we're seeing right now in the banking system, maybe not the specifics of Silicon Valley Bank, but was something like that almost inevitable after we pumped so much money to the system and start taking it out? There's going to be stress, real stress, and there's gonna be some failure. I think that in this conversation, I think it is important when we're thinking about what the implications are. You know, you have to distinguish what is an outlier about not just Silicon Valley Bank, but others that have got into trouble in this episode. What is fundamentally a regulatory stupidity? You know, a very traditional problem, the interest rate risk that was just hiding in plain sight and what is a genuinely new issue, which was not being fully taken into account by anyone looking at the risks. And I think when you look at something like Silicon Valley Bank, you know, clearly it was an outlier in the speed with which deposits have been built up in its massive exposure to Onyx uninsured deposits and reliance on that for funding. I hope it was an outlier in not having a chief risk officer for nine months, which was an extraordinary state of affairs.

What was. But what was very traditional about this and as the discussion with Larry in Dana's suggesting was that, you know, right here was a massive interest rate risk. That was whether or not it was in the stress tests was something that central banks should have been thinking very hard about. And I think it was sort of striking that we had a lot of the debate around this. What are the hidden risks? You know, all the conversations that you would have had, David, when you ask regulators what's keeping you up at night, they would always talk about private equity.

They talk about nonbank shadow banking has been the thing that people were, you know, was was this worry for all these years. And in fact, it was the most obvious problem sitting on bank balance sheets as a direct result of monetary policy actions by central banks. That has actually caused this issue. I would just say, though, one of the

reasons maybe they weren't looking at that so closely, although I'd be interested to know what Dan and Larry think about this. You know, there is an element of this which is new and we see in the speed with which deposits left these institutions, and that's the non stickiness of those deposits. And I think, you know, one of the things that regulators were thinking when they looked considered interest rate risk potentially was that there was this sort of self as a self hedging mechanism in a bank of the fact that deposits would be slow to move if they weren't being paid the higher interest rates. That is no longer the case. And I think that probably does have longer term implications for for regulation and potentially longer term implications for how much we insure deposits. I think that's a question for either Larry or Dan. Does our entire approach to deposits

change given what we're seeing? The fact is they're not as strict as we thought they were. That's what I was alluding to earlier. I'd like to have a sense of. Exactly what the deposit profiles of this group of banks is as a whole, because in theory at least the supervisors should already have been distinguishing among different kinds of uninsured deposits, some of which have always been understood to be eminently run, all others of which have thought, too, were thought to be at least somewhat stickier than insured retail deposits.

If it turns out that those and this is what Stephanie I think was suggesting that those middle categories are have changed, then you're going to need a change in regulation and not just in supervision. That was our Wall Street week roundtable of Larry Summers, Dan Tarullo and Stephanie Flanders. Coming up, artificial intelligence. It's all the rage with the advent of chat G.P.S.. But how much of it is hype and how much of it will transform all of our lives? We're going to ask an authority who's Professor Arun Cinder Rajan of NYU. That's next on Wall Street week on Bloomberg. Artificial intelligence, something that people have been talking about for years, but until Chat GP hit the front pages, no one knew quite what to make of it. Chat GP team Needless to say, David has

the world extremely excited right now. Now some version of A.I. is everywhere. We turn from Financial Times having it take the CFA exam, which it failed to law firms using it to draft contracts to Bank of America, using it to help 18 million of its customers. We have this thing called Erica, which is a virtual artificial intelligence, virtual assistant, natural language processing, predictive technology that we've been running for five years. And 15 million customers use it under forty five hundred fifty million times a quarter.

So we're used to it. But this is now a new one that could change the game. When Bitcoin came along. JP Morgan's Jamie Diamond was a true skeptic, but not so when it comes to A.I., A.I. is real. This is a technology which is staggering and we're fully engaged.

The other thing you have to keep about A.I., you need to be in the cloud. Use the computer now. Fundamentally, you need real. And so that's why the cloud digital, the idea all kind of related that way. But as we know, all the glitters is not gold. And at least in its early stages, some applications need more than a little help, like online travel management company Nirvana. Like any technology, it definitely has its limitations.

So we actually like anything that you implement. We know its limitations. So we are left with the question what can and what cannot artificial intelligence do for us and what industries will it most disrupt? And to help us answer some of these questions about artificial intelligence, we welcome now true expert. He is a runes androgen. He is professor of both technology and entrepreneurship at the NYU Stern School of Business.

So, Professor, thank you so much for coming in. Delighted to be here. Let me start with those basic question. We hear about a lot about generative A.I. and chat, G.P.S. and various chat bots. Is this a difference in kind or in degree compared to what we've already had, frankly, with machine learning? I think it's a difference in a little bit of both. You know, I mean, it's a different in

kind in terms of the quality of output that we're getting. You know, our perception of what the EIA is generating has suddenly crossed a threshold to being really human like. And so from that point of view, from a user experience, point of view, it's definitely a difference in kind from if you look under the hood of the A.I., it's just been an incremental

improvement from all technologies. We've had these kinds of generative AA systems for a really long time. They haven't been performing very well. They've been a couple of new technologies. I think the drug discovery industry helped us progress a lot in generating these molecule combinations or these protein combinations that might lead to successful drugs. But over there it's been more of a difference in degree. But, you know, as you as you cross a certain level of improvement with the same technology, then people suddenly start to see it as a difference in kind, whatever is cheap.

He certainly got everyone talking about this and the speculation about it really replacing humans in various fashions. You know this area well, as you look at it, where are the areas as you look around the business world, the economy that are most likely to be disrupted by this new generation of A.I. and which are the ones that probably won't be so much? Well, the industry is where I expect that generative A.I.

and technologies that are built on GBP Ford and Lamar and, you know, sort of Google's technology, the things that are able to be human like in their interactions and have this massive knowledge base, I'm certainly paying very close attention to healthcare because although healthcare has made tremendous strides in the last 200 years, there was no healthcare industry 200 years ago. Now it's a double digit percentage of GDP. We're still scratching the surface in terms of fulfilling human need. And as a consequence, I think that there are vast swaths of the population who don't have access to the health care when they need it. And so instead of relying exclusively on a human being to deliver that healthcare, there'll be a whole range of technologies based on generative A.I. that will help you fulfill your healthcare needs. Financial advice is another area where I

expect that, like, you know, the population that can gain access to frequent financial advice will expand dramatically. But I think the real opportunity isn't in consumer facing stuff. It's in business to business because for the last 25 years we've been trying to create good knowledge management systems and organizations.

You know, during the early days of the Internet, there was a lot of excitement about these intranets that would, you know, organize your companies information and then made it searchable. But they didn't make it accessible in a way that helps in decision making. I think what the generative A.I. is going to do is going to allow you to take the knowledge that is contained in documents, that is contained in email, that is contained in contracts and create a sort of a digital twin and a sense of key employees so that you are able to access their knowledge more readily.

If they go on vacation and you want to ask them a question, you can ask their digital Twitter question. So knowledge management is where I think there's a tremendous amount of potential. Let's pursue that knowledge management in a moment. As you look forward, assuming success and really taking over knowledge management for a lot of large organizations, is that likely to be proprietary to individual company involved or is it likely to be off the shelf? Is there going to be some provider of knowledge management that everyone will be buying or does each corporation need to develop? Don't I think it's going to be a combination. You're going to need a technological

expert that can take the documents and the knowledge in your organization sort of melded it with the GPL forward or whatever large language model technology, retrain the models so that it can answer questions that are relevant to you. And that's going to be proprietary to you. So the system that's built would be proprietary to you, but there probably will be a few large scale experts who are able to access, for example, the successor of GPA for and retrain it to sort of customize it to your company. And so there will be some concern. Creation, but the eventual system that is built will be proprietary to your organization. When you mentioned health care and financial advisory services, those are two particular areas where you need to get it right. I mean, traffic also really matters. A lot of the reports. Early reports from the chat EPG and

other similar general A.I. suggest it doesn't really have a check against truth. What is actually true out there? These early systems have not been treated with accuracy as a key objective. What they really try to do is to be as

human like as possible, be able to, you know, write a poem in the style of Shakespeare. So it's really sort of the the interactivity and the style that has dominated over the accuracy. They don't even have access to a calculator, for example. And so we've often seen them make math mistakes. I think that's a problem that as you focus the domain of expertise is easily fixable. All you need to do is retrain the system

with a new set of documents and make accuracy one of the key objectives. So it's like you've trained this system to know grammar and to have vos general knowledge. And now you're layering on top of that some expertise in a particular area. You're giving it an advanced degree, so to speak. So the accuracy problem will go away after the point as you focus the domain. Professor, as you look at the potential for General A.I., can you choose between on the one hand,

the larger accusations are already very active. You mentioned Google, for example, or others are really very active in this as opposed to some of the voices in the startups and entrepreneurs. I mean, is this something that is being taken over by the big guys or is there a lot of room for investment in some of the small startups? So some of the big guys, Facebook, Google, Microsoft through Open, I have made massive investments in building the infrastructure, the large language models, the things that, you know, systems like Chad, TPD are built on.

And so it's certainly going to consolidate some of their tech power. But it's important to remember that these are platforms, these are systems that other companies can tap into. And all of these companies have a platform mindset, which is that they realize that, you know, if they open up their system for other people to build on, it increases the entire value of the ecosystem. And Microsoft realized this early on

when they were selling us M.S., DOS and Windows. And so it's in the DNA of these companies to be inclusive. But some of that value will flow to the companies and so will it increase or reduce inequality across the economy? That's a really hard question to answer. I think it will depend on the country. It'll depend on the social and political system wrapped around things. But, you know, I think a little bit of

both, again, about the political or the regulatory system and how it may intersect with what we're seeing in artificial intelligence. What are the issues for the government and the governments and figure out how to regulate this? I think one of the things that we're going to hit up against immediately is section 230. This is the section of regulation that shields platforms from liability for the content that they deliver. They're not publishers, they're

intermediaries. Once you start to create a system like chat. BPT It raises the question of, you know, if you are in fact delivering a single piece of content as an answer through an interface. Are you a publisher or are you an intermediary? Professor, thank you so much for being here. That's a room sudo Rajat. He's from the NYU Stern School of Business.

Coming up, we wrap up the week with our special computer, Larry Summers of Harvard. That's next on Wall Street week on Bloomberg. This is Wall Street. I'm David Westin.

We're joined once again by our very special contributor to Wall Street. He is Larry Summers of Harvard. So, Larry, we now have had another week of turmoil, continued turmoil in the banking sector. What are you looking for going forward from our policy leaders in Washington? I think policy leaders need to be clear and decisive that depositors are not going to lose their money in large banks, in medium sized banks or in small banks. They can do that within their existing

authorities simply by being clear that in the event of failures, given the highly fevered environment with respect to contagion right now, they are prepared to use systematic rate, systemic risk exemptions to allow the FDIC to pay off depositors with assurance that those funds will come from the banking industry. I think by doing that, they can contain a significant amount of the pressures that we're facing to provide confidence. I think they also need to increase the confidence they are providing in regulation. While it is true that the repeat the 2018 Trump era legal changes were passed by the Congress were in almost every respect ill advised and in important respects were driven by special interest pressure. It is also, I think, clear that they are

not the reason why we have had the problems we have had the problems we have had reflect problems of management and a number of financial institutions and reflect major failures of the supervisory and regulatory paradigm as implemented by the Federal Reserve. In particular, the failure to do a stress test in 2022 when interest rate increase interest rates were clearly on the upwards path. The failure to do any kind of stress test about interest rate increases manifests a misunderstanding of what a major source of risk in the system was. And they need to signal an awareness of

duration risk. They need to signal an awareness of solvency as well as liquidity issues in the regulatory paradigm going forward. Larry, we heard, of course, from the Federal Reserve and particularly Jay Paul Allen news conference this week in which they did raise the rates. Again, 25 basis points were a little more vague on where they go from here. At the same time, the chair said that this was an outlier. Silicon Valley Bank was an outlier. I guess my question to you is how confident are we actually the Fed has our arms around the problem now. Now we know there is the problem, the

interest rate risk when it comes to SBB. How confident are you that we know that there aren't other SB BS out there? I think it's pretty clear looking at a variety of ratios that SVP and perhaps a couple of other banks worried, important respects, outliers, but extreme examples tend often in life to point up paradigmatic issues. And as I've been pointing out, is a world of high interest rates with digital banking click of a finger ability both to move accounts out and to open new accounts is going to be a different kind of world in terms of risk, and it's going to be a different kind of world. In terms of what banks can rely on, in terms of the stickiness of deposits and to what extent that's true is something we're likely to learn in the next year or two.

That's why I think it's appropriate. Ahead of the curve to be sending clear signals of assurance with respect to bank deposits because. It is better to err on the side of overdoing it when you're talking about protecting against bank runs than it is to erred on the side of under doing it. There are profound issues raised about the banking supervision here in the United States, in particular with the stress test. There are also questions being raised over in Europe right now. They had the approaches, those 81 bonds

or Cocos that did not hold up so well for Credit Suisse, certainly. And now as the week has progressed here, we've seen Deutsche Bank come under siege. What questions are being raised about the European approach to protecting the bank's? It's important to recognize that, as Christine Lagarde said, there are very important differences, both between the way the terms of the Swiss banks are written, a key ones are written and the way the terms are written in other parts of Europe. And also to recognize that the ECB made clear that they're operating in a different paradigm than the Swiss authorities were. But I think it's also clear that there's going to need to be some fairly systematic rethinking of these contingent capital instruments and how they work and on what occasions they are going to be bailed in and on what occasions they're not.

Despite many years of legal discussion, it's clear that there were not sharp and shared understandings in the marketplace. I suspect and hope that European authorities, with the support of the United States and Secretary Yellen and Chair Powell, will send strong signals of support over the weekend for the European banking system, because given the scale of European institutions, there are potentially global consequences if problems spread from them. Larry, we have been understandably really focused on the banking situation where the United States or in Europe. In the meantime, the war in Ukraine proceed. You had an op ed piece in The Washington

Post specifically on Russian assets. Take us through what you think would be a good step forward on the economic front as opposed the military front in Ukraine. I've been working with former World Bank President Robert Zoellick on this and with a noted policy academic, Philip Zelikow, who's a real legal expert. We are going to have to put billions of dollars, probably ultimately over 100 billion dollars into Ukraine to win the war and then to win the peace. And the question is how that's going to

be financed. And we believe there is both precedent, moral right and appropriateness to the financing coming from the Russian reserve assets that we have frozen. And right now, those assets are frozen. But there is not yet a willingness to deploy them to finance the ongoing support for the economy and the ongoing compensation for damage that Russia has caused to the Ukrainian economy. And we believe that there needs to be appropriate and creative lawyering, along with strong political leadership to get past that and to be able to deploy those Russian reserves for that purpose at a time when we are declaring that President Putin is a war criminal. It seems to me almost inconceivable that we should be stopping short of using what are the currently immobilized assets of his state to deal with the damage that he and the Russians are causing. Larry, thank you so very much, our special contributor here on Wall Street.

He's Larry Summers of Harvard. Coming up, he was a week that called for courage and we found it somewhat unlikely place. That's next on Wall Street on Bloomberg. Finally, one more thought. One man with courage is a majority. So said Thomas Jefferson. And through the years, we've seen some notable examples of a single person being a man or a woman standing up for what they believe in, despite all the odds.

Like Army Secretary Joe Welch back in 1954, going toe to toe with Senator Joe McCarthy during the Red Scare. Until this moment, Senator, I think I never really be a pure pro. These are your reckless men. You look down and not have, you know, stand about them safe there or in the 1980s. Johnson and Johnson CEO Jim Burke taking the bold and expensive decision to pull all Tylenol off the shelves across the country until he could be sure of the absolute safety of his product. And that brave student we saw stand up to the tanks in Tiananmen Square in 1989.

Never to be seen again. Vice President Pence on January 6, 2021, stood up to his boss, President Trump, and a rampaging mob calling for him to be lynched as he insisted on doing his constitutional duty to certify the election of President Biden. President Trump is wrong. I had no right to overturn the election. The presidency belongs to the American people and the American people alone. But one area where we haven't seen much courage is in our dealing with our national debt, especially when it comes to how we're going to pay for all that we owe in Social Security and Medicare. Everyone agrees that what we are doing is not sustainable.

There's bipartisan support for Social Security, Medicare. If anything, we need to shore those programs up. They're running out of money. But when President Biden brought up the subject at the State of the Union address this year, he managed to get Republicans and Democrats to agree that we shouldn't do anything about the problem. Some Republicans want Medicare and

Social Security a sunset. I'm not saying it's a majority. And he was proud of it. As we all apparently agree, Social Security, Medicare is also off the books now.

Well, not to this. We got you this week, though, we did get an example of real courage in addressing an aging population. As President Macron of France stood up to his parliament to implement pension reform in France, President Emmanuel Microns government faces two confidence votes as soon as today over his pension reform. Last week, Macron used a constitutional provision to push through the plan to boost the minimum retirement age from 60 to 264. That led to violent protests across government says a no confidence votes won't get a majority in parliament. Financial markets this week have called for more than a little bit of courage.

Courage to face the truth. Courage not to overreact. Courage to remain calm. And so we leave you this week with some further thoughts from John Mack, who led Morgan Stanley through the worst of it in the great financial crisis and what it took to lead his organization through that time. I knew if I cracked, they all cracked. So I had to put on a face. What they didn't know I was shut my office door and just try to pull myself together. I couldn't I couldn't show the stress of fear that we were under.

That does it for this episode of Wall Street Week. I'm David Westin. See you next week.

2023-03-26 00:06

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