2013 Financial Markets Conference
An interview with John Taylor, Mary and Robert Raymond Professor of Economics, Stanford University
Dennis Lockhart: I'm Dennis Lockhart, the president of the Federal Reserve Bank of Atlanta, and I'm here with Professor John Taylor, the Mary and Robert Raymond Professor of Economics at Stanford University. John, welcome to Stone Mountain, Georgia.
John Taylor: Great to be here. Thanks for inviting me.
Lockhart: You've written recently and extensively about resolution of too-big-to-fail banks. Could you outline some of your thinking and particularly your idea of a Chapter 14 in the bankruptcy code?
Taylor: Sure, one of the things I think is lacking in the resolution discussion now is just bankruptcy, if you like. We do think of most firms, when they get into trouble and when they fail, they go into bankruptcy whether it's American Airlines or Kmart, and they continue to function. My idea is you can do the same thing for financial firms, if it's done right. Now big financial firms deserve some special consideration, given that they are so large. That's the idea behind this Chapter 14. It's restricted to large banks, it puts in place some judges who are very experienced, it allows the primary regulator to file for bankruptcy, and the idea is to do this quickly over a weekend and by Monday morning you have a new firm up and running again.
Lockhart: Let's step back a little bit. Where do you think we stand as a country and the process of dealing with the too-big-to-fail problem?
Taylor: I don't think we're there yet. You can see in the data that there still seems to be subsidies as we measure going to the larger banks because of the fact that their creditors realize there's a chance that they will be bailed out so they charge a lower rate. You can sense how difficult it is to do the resolution now. You recognize what happened in the financial crisis as great pressure on top officials to go ahead with the bailout. The resolution process that's been set up in the Dodd-Frank Act is a place to begin. I just don't think it's gotten far enough in terms of the bankruptcy code because that provides clarity about how firms will be treated.
Lockhart: Our largest banks, they're highly complex and they operate in literally scores of countries. Each country has its own regulatory regime. How do you think through the speed and the complexity of resolving through a bankruptcy proceeding, a bank that really, truly is a global institution?
Taylor: All these issues on the international side are very important and very difficult, and I don't think we're there yet. That's one of the reasons why there're still lots of questions. There's a real question about what other countries do and I think one way to start is to maybe take a partner, if you like, naturally the U.K. Work out something between the U.K. and the U.S., and then have others join.
Lockhart: The Chapter 14 idea strikes me as dealing with a single firm, that's obvious. Can you speculate on how this would all work or how comfortable you would be with such a process if a number of financial institutions were in trouble at the same time?
Taylor: Well, it's much more difficult, that's what we want to prevent by having this kind of process in place, but there are interrelationships between these firms. To me, a real advantage of a resolution through bankruptcy like this is it reduces that interconnectedness and for that matter if you take one firm through this and it's able to open up on Monday morning, then you have eliminated at least a lot of the risk of contagion. Add one thing; the notion of a failed firm going through bankruptcy is not that unusual in the United States. What's unusual is how financial firms are somehow not doing that and so the idea that becomes an accepted way politically, it becomes I think to some extent easier for the top officials to take a credible stand to try and prevent these bailouts again.
Lockhart: Andrew Haldane from the Bank of England is associated with his now somewhat famous speech called the "The Dog and the Frisbee." He's arguing for simplification. He's arguing in some respects that rules have overpowered discretion and overpowered market discipline and the ability to have all of those factors influence the regulatory scene. You have been more associated, I believe, with believing in the efficacy of rules and the importance of putting down some very clear rules. Could you just elaborate on your philosophy, your views around that question?
Taylor: Sure, I think it's very important to think of rules as being simple rules, maybe just focus on leverage ratios rather than complicated risk weighting for capital ratios, for example. And I think this bankruptcy idea is also meant to be simple. We have the law, it's been applied in other cases, let's find a way to do it that way rather than to create a whole new complex entity with lots of discretion, which you don't know how it will actually play out. Simple rules seems to me is the message that Andy puts out, and I agree with that.
Lockhart: What would be your diagnostic of our current situation and the problems that it presents?
Taylor: I'm worried about the too big to fail, as we discussed a few minutes ago. I think more broadly about monetary policy, I think there are so many different things going on with the quantitative easing and the forward guidance and how that's all going to play out. I think it would be better for our economy if we found a way to get back to a more rules-based monetary policy, and I think that would go along with a more simple rules-based regulatory policy and perhaps as well with this bankruptcy idea.
Lockhart: So an open-ended question, what else do you think is important in this discussion of regulation, of too big to fail, and even monetary policy that you feel needs to get more airing?
Taylor: Well, I think the regulatory reform bill, the so-called Dodd-Frank Act, included a lot of things, a lot of complexities. And a lot of rules—as you very well know—still have to be written. And that's, I think, slowing the economy down, it's raising uncertainty, raising questions about lending at banks, especially smaller banks that don't know how to deal with all this. To me, that's another big question. Now that the act has been passed, what's the alternative? We have to go with what we have, but in some sense if we could roll some of that back, I think that would be better. And that goes to the broader view of concern I have with policy more generally as being quite interventionist, a lot more regulations. We need to have regulations, that's for sure, but they need to be simple, not complex. So many of them now are just all over the place. It's almost a nightmare of how you actually are going to make all these rules.
Lockhart: Well, Professor John Taylor of Stanford University, thank you so much for an excellent conversation and we'll call it a day. Thank you.