PUBLISHED:March 26, 2009

Have we nationalized our banking system?

March 26, 2009 – Four days after Treasury Secretary Timothy Geithner announced a public-private partnership to remove toxic assets from bank balance sheets, a panel of economic scholars and notable financial minds convened in the Law School’s Star Commons to talk about the U.S. government’s response to the current economic crisis.

The panel, moderated by visiting professor of the practice and former Wachovia Bank executive Lawrence Baxter, covered an array of timely financial topics, from the role of the government as shareholder to regulating the shadow financial system.

Panelist Robert K. Steel T’73, chair of the Duke University Board of Trustees, director at Wells Fargo, and former CEO of Wachovia Corp., said that recent seismic changes in the banking world have to be taken into account when addressing the financial crisis.

“The goal and central function of banks has now been adjusted,” Steel said. “There are lots of non-bank financial institutions outside the well-developed regulatory supervisory framework of banks [that] are now doing lots of the same things as banks. … Now we have this blurring of activities.”

Bill Brown ’80, a visiting professor of the practice of law who has held leadership positions at Goldman Sachs & Co., AIG International, and Morgan Stanley, also talked about the “shadow banking system.”

“This is the part of the system that we’re actually trying to save right now,” Brown said. “The public-private partnership that was announced on Monday is intended to save it; the [Term Asset-Backed Securities Loan Facility] program is trying to save it. In fact, this system dwarfs the banking system.”

Steel said the current regulatory regime does not take into account the non-bank financial system, in part because it arose in response to a series of crises over the last 70 years, “but never with an overarching ambition.”

“To borrow a phrase that’s being commonly used, ‘You don’t want to waste a good crisis,’” Steel said. “Here the goal should be to basically back up and think about, ‘What’s the right regulatory structure?’”

Steel proposed a regulatory authority that would oversee the entire financial structure, with the ability to identify problems across the financial spectrum and regulate banks and other financial institutions. Geithner was expected to outline a similar proposal in his remarks to Congress on Thursday.

Steven Schwarcz, the Stanley A. Star Professor of Law & Business, said that regulation is made extremely difficult by complexity in financial markets rife with “unintended consequences and nonlinearity.”

Complexity in financial markets “is one of the most difficult problems of the 21st century,” Schwarcz said.

James Cox, the Brainerd Currie Professor of Law and an internationally recognized expert in corporate and securities law, discussed strategies the government could use to reinvigorate the flagging institutions now bolstered with taxpayer money, admitting that the current situation left few avenues for profitability.

Even selling off profitable divisions of failing institutions could be difficult, Cox said. “If it’s a stock deal… whoever’s buying it is now going to have a substantial government interest in their company,” he pointed out.

A cash purchase seems unrealistic at this point, as well, Cox said. “That means somebody has to have a lot of cash, which would be a different market than the one we’re looking at right now.”

Another option, Cox said, would be to have “one hell of a public offering.”

“The question then becomes, why would you and I want to buy it?” Cox said.

Craig Burnside, professor of economics at Duke University, agreed with Cox that the government representatives now sitting on the boards of financial institutions should not act as governmental emissaries, but should “maximize the value of the firm, pursuing profitable opportunities that are in the interest of the corporation and not in the interest of fringe political groups that capture the ear of Congress.”

Edward Greene, partner at Cleary Gottlieb and former investments general counsel at Citigroup, lamented political interference in the financial world since the government bailouts began. Greene targeted Congressional hearings in which executives were “castigated by a Congress that pretends it had nothing to contribute to and was in no way responsible for what went on.”

“I can’t emphasize enough that, as a consequence of the Congressional outrage… morale is basically devastated at most institutions,” Greene said.

Agreeing with the other panelists, Steel said that the government’s involvement in financial institutions should be limited to revitalizing those that are unhealthy before returning them to the public markets, and dismantling “in an orderly way” those that are irredeemable, but should not extend to complete government ownership, or nationalization. “The sole act of government ownership in an unhealthy institution doesn’t make it strong,” he said.

Sponsored by the Program in Public Law, “Have We Nationalized Our Banking System?” is available for viewing as a webcast.