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On November 6, 2008, at the National Press Club in Washington, DC., the �鶹������ý Foundation’s Next Social Contract Initiative hosted a panel of experts to discuss the roots of the crisis on Wall Street and the lessons to be learned going forward. Video of the event is available at right.

Andy Kessler—former President of Velocity Capital Management and author of several memoirs on life in the financial fast lane—provided an entertaining and informative opening presentation, after which a panel of experts offered diverse perspectives on the financial markets’ undoing and the potential path to recovery

On the panel were Marc Sumerlin, Managing Director and Co-Founder of The Lindsey Group and a former top economic advisor to President George W. Bush; Douglas Rediker, Co-Director of the Global Strategic Finance Initiative at �鶹������ý; and Phillip Longman, Schwartz Senior Fellow at �鶹������ý and Research Director of the Next Social Contract Initiative. Patrice Hill, Chief Economic Correspondent for the Washington Times, moderated the discussion.

Kessler mapped the history of financial markets, from Queen Elizabeth’s Royal Exchange, through the Buttonwood Agreement of 1792, and eventually into the postwar era. Kessler argued that Wall Street’s essential function was to provide capital to new industries and growing companies—especially, beginning in the 1960s, to the tech industry. His central claim is that the 40-year dance between Wall Street and technology is the primary cause of today’s meltdown.

According to Kessler, innovations like index funds and portfolio insurance reinvented finance by destroying the profitability of trading. Firms that had specialized in trading stocks and bonds morphed into giant hedge funds, and profits migrated to the “alphabet soup” of derivatives: most notoriously, Collateralized Debt Obligations (CDOs) and other mortgage-backed securities.

Wall Street erred, Kessler contended, because it “ate its own sausage.” Only the whizzes who engineered the complex derivatives knew how much they were supposedly worth, so top firms started leveraging “like crazy” and bought their own products rather than sell to customers. When the housing bubble undergirding the byzantine derivatives burst, the bottom fell out: short-term loans froze up, leveraging began to unwind, and some of the biggest names in the business disappeared virtually overnight.

So what’s next? Kessler believes that Wall Street can never go back to old-fashioned relationship banking. However, he does envision a return to the prudent, fundamental business of financial markets—to provide capital to “great and growing companies.” The panelists that followed Kessler broadly agreed with his analysis, and offered some unique insights and recommendations of their own.

Sumerlin emphasized a more sound monetary policy, criticizing the Fed’s “free money” negative interest rates after the stock market bubble and the September 11 attacks. He cast blame, not just on financial institutions, but on American homeowners and consumers who borrowed too much. Going forward, he tendered four recommendations for recovery: a broader focus for central banks that incorporates asset prices; simple leverage ratios to serve as a backstop; housing policy that shifts from leverage to equity; and a “devil’s advocate” contrarian in power. As a caveat, Sumerlin reminded the audience that bad regulation is worse than no regulation.

Doug Rediker, who spent 17 years as an investment banker in Europe, offered an internationalist perspective that considered the role of China and other creditor nations. Central bankers and managers of sovereign wealth funds hold an incredible amount of global liquidity, and need a place to put it. They were not looking for yield, Rediker argued, they were looking for “a place to go home to.” Credit bubbles are not just a macroeconomic phenomenon—someone actually has to spend that money. And in the globalized, 24-hour financial marketplace, capital never sleeps.

Transitioning from globe-trotting bankers to the world of It’s a Wonderful Life, Phillip Longman argued for a return to small-scale banking and made the case that “small is beautiful.” Wall Street collapsed because capital was not allocated smartly during the globalizing boom years. By contrast, community-level banking is rich in “informational capital,” shortening the distance between ultimate borrowers and lenders and cultivating a symbiotic deposit-loaning relationship. Three banks now control 30% of all deposits and commercial loans, Longman noted, and the future of finance must countervail against that trend. Specifically, he argued that small-scales must receive a proper share of the rescue package, and that a new transaction tax on asset-backed securities should fund a community investment trust. It sounds romantic, Longman admits, but today it is actually hard-headed to say that “small is beautiful.”

Audience questions following these comments touched on the gold standard, political pressures on Fannie Mae and Freddie Mac, potential conflicts of interest and criminality on Wall Street, and the stability of retail banking.

Participants

Featured Speakers
Andy Kessler
Founder and Former President of Velocity Capital Management
Author, Wall Street Meat: My Narrow Escape from the Stock Market Grinder
Author, Running Money: Hedge Fund Honchos, Monster Markets and My Hunt for the Big Score

Marc Sumerlin
Managing Director and Co-Founder, The Lindsey Group
Former Deputy Assistant to the President for Economic Policy and Deputy Director of the National Economic Council for President George W. Bush
Co-Author, What a President Should Know: An Insider’s View of How to Succeed in the Oval Office

Douglas Rediker
Co-Director, Global Strategic Finance Initiative, �鶹������ý Foundation
Former Senior Investment Banker and Private Equity Investor with Salomon Brothers, Merrill Lynch and Lehman Brothers

Phillip Longman
Schwartz Senior Fellow, �鶹������ý Foundation
Research Director, Next Social Contract Initiative
Author, The Next Progressive Era: A Blue Print for Broad Prosperity (2009)

Moderator
Patrice Hill
Chief Economic Correspondent
The Washington Times