A Big Think Interview With Peter Wallison | Big Think

A Big Think Interview With Peter Wallison

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A conversation with the financial policy fellow at the American Enterprise Institute.

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Peter J. Wallison:

Peter J. Wallison, a codirector of AEI's program on financial policy studies, researches banking, insurance, and securities regulation. As general counsel of the U.S. Treasury Department, he had a significant role in the development of the Reagan administration's proposals for the deregulation of the financial services industry. He also served as White House counsel to President Ronald Reagan.

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TRANSCRIPT:

How can we discourage banks from taking excessive risks? (Scott Sumner of Money Illusion)

Peter Wallison: Other than through regulation, it's almost impossible to prevent banks from taking excessive risks. But there is one thing we could probably do that would help and that is to make sure that banks disclose more information to the market than they do today.

Right now, banks disclose a lot of information to their regulators. They disclose some information through their financial statements, but none of that gives creditors of banks enough information to understand whether the banks are really taking risks or not. So, we are relying in almost all circumstances on the regulators to prevent this risking and as it's turned out, I think it's fairly clear that the regulators are not very good at understanding the kinds of risks that the banks are taking. So, we have to rely on creditors and to rely on creditors, we should be giving them a lot more information.

But we will never be able to eliminate moral hazard from banking simply because the banks are backed by the government.

Should there be a minimum downpayment requirement on mortgatges? (Scott Sumner, Money Illusion)

Peter Wallison: I think that's a good idea. That used to be the case. We required minimum downpayments of 20%, then went to 10%, and then it went down to as low as no percent and that's one of the reasons why we have so many problems today.

A 20% downpayment would be a good way to start and that's the way it used to work. It turns out that the downpayment is the key to determining how sound a mortgage will be. The lowest downpayments result in the highest defaults, the highest downpayments are the ones that maintain solid prime mortgages better than any other system.

What happens if regulators are still unable to unwind non-banks? (Dan Indiviglio, The Atlantic Business Channel.)

Peter Wallison: You know, the different between a bailout and unwinding is a little hard to understand in some cases. If we're talking simply about the question whether an institution can be liquidated, and I think that's what most people mean by "unwinding." It's very hard to imagine that that can't be done by some organization, like the FDIC, or any other kind of organization.

Bailouts, however, are done not because an institution has failed, but because it's important to keep the institution going, and that has much more to do with the size and importance of the institution and what its effect will have on the rest of the market if it's allowed to fail.

I don't know exactly how we can say an institution can't be unwound, it can always be closed down. The question is whether we want it to be closed down, and in my view, very large commercial banks can create the kinds of, we'll call it a systemic breakdown, if they are not bailed out. Other kinds of financial institutions do not raise those questions for a variety of reasons, but non-bank financial – I’m sorry, bank financial institutions, that is, those that are commercial banks backed by the government could under some circumstances create serious systemic breakdowns and have to be bailed out. What we have to do, I think more than anything else, is through regulation and through the kinds of transparency that I talked about before, try to make sure that the market understands the risks that these institutions are taking so that they are deprived of the funds that they can take risks with because the market is well aware of how those funds are being used. If we don't do that, if we are relying entirely on the regulators to prevent these firms from taking excessive risks, well, I'm afraid we will have to engage in bailouts because we must keep some of these very large institutions alive under some circumstances.

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