Financial Issues (Panel Transcript)

• Pages: 241-279

241

CHAPTER X

FINANCIAL ISSUES (PANEL TRANSCRIPT)

Moderator

Dennis W. Carlton

University of Chicago, Chicago, IL

Panelists

Lawrence J. White

New York University, New York, NY

Thomas O. Barnett

Covington & Burling LLP, Washington, DC

MR. CARLTON: My name is Dennis Carlton. I‘m the moderator. I

am from the University of Chicago.

I am pleased to be the moderator of such a distinguished panel. We

have two panelists who are very well suited to talk about problems both

of the financial crisis and the interplay of the financial crisis with

antitrust.

We have Larry White, who is the Arthur Imperatore Professor of

Economics at NYU. In addition to being a highly regarded and highly

productive research scholar, Larry wears many hats, one of which is as a

former regulator. He sat on the Board of th e Federal Home Loan Bank

Board, and he also was one of my predecessors at the Department of

Justice, where he served as Chief Economist in the early 1980s.

The second panelist is a luminary in the antitrust world and

undoubtedly needs no introduction, so I will be short. He is currently the

chair of the antitrust practice at Covington & Burling. As everyone

undoubtedly knows, he is my former boss. He was the recent Assistant

Attorney General [of the Antitrust Division]. I can assure you it was a

delight to work under Tom. Not only did I learn a lot of law, but Tom

knows an incredible amount of economics. I learned he was a roommate

of one of my colleagues at the University of Chicago Business School.

I am going to start off with about 15 minutes or so of comments to

set the stage and then turn it over to Larry and Tom, each of whom will

speak for around 25 to 30 minutes.

During the Great Depression, from 1929–1933, real income fell by

30 percent, unemployment went from 3 percent to 25 percent, prices fell

by about 25 percent, and stocks went down by about 85 percent.

242 Competition as Public Policy

One of Milton Friedman‘s great contributions, together with Anna

Schwartz, was in studying t his period he noticed that the response of the

Federal Reserve made the Great Depression much worse; it was the

response of the economy to the initial shocks that were occurring that

actually made things pretty bad.

We are not in a Great Depression, but I wanted to follow the insight

of Friedman and Schwartz, which is to look at the r esponse to an initial

shock, a negative shock, and ask what can we learn from that? In

particular, we are in, or are coming out of, a financial crisis, and the

question is: how does our economy respond to the financial crisis?

My point is going to be a simple one. It is that, contrary to this

stream of criticism that we had too many markets, that markets didn‘t

work and we should get rid of them, I think just the opposite: we want to

have more markets working and we want to make them work better.

I am going to focus my remarks really on two points of law in

market creation, one of which has to do with bankruptcy law, and the

other having to do with the creation of organized exchanges.

Let me first turn to bankruptcy law. There is this notion—and it

came up a little yesterday—that when people hear that a company is

going bankrupt, they think that it‘s like getting blown up, that all its

assets are disappearing. Well, that‘s not necessarily what bankruptcy

means. The assets often stay in place; it‘s just their ownership that

changes.

Oftentimes when you read or listen t o commentators, they take the

first view of bankruptcy, ―You can‘t let a company go bankrupt because

that will destroy all its assets.‖ Sometimes that can occur, but in some of

the bankruptcies that we have been talking about and that have been in

the press, we are not really talking about assets being made completely

worthless.

If you focus on financial firms, they need to have their assets liquid,

they have to have access to those assets and they have to trade all the

time, every ten seconds or even faster. If you are a financial firm and

you are told, ―Hey, billions of dollars of your assets, don‘t worry, they‘re

secure, but you can‘t get them for a while; I‘ll tell you when you‘ll have

access to them‖—well, that could be the kiss of death.

In general, uncertainty about when a bankruptcy will be resolved, as

well as to the outcome of the bankruptcy, can have serious consequences

for all firms in the economy, whether a financial firm or not. By creating

this uncertainty, there is a huge gain to you in waiting before you do

anything else. So you wait because you are going to get more

information, and as you get more information, you‘ll have a b etter idea

Financia l Issues (Panel Tra nscript) 243

of what your future is going to look like; therefore, in financial terms, the

option value to waiting, to doing nothing, rises. From a macro point of

view, if everybody stops doing everything, or suspends many actions for

a while, then you have real trouble.

If you focus on financial firms, it is even worse. If I am a financial

firm, I want to trade constantly. If you tell me I don‘t have access to my

assets, then what am I supposed to do?

And then think of the following: suppose you are a financial fir m

and you hear that the investment bank where your accounts are may not

have access to its assets because they‘re tied up in some bankruptcy in

England. What do you say to yourself? You say: ―If my customers hear

that their assets that they‘ve put with my f irm may be tied up in some

bankruptcy proceeding in, say, London, they are going to try to take their

assets out.‖ So hedge funds, which have their funds held in investment

banks, are going to get nervous, and you‘re going to see a run on

investment banks as they try to pull their funds out.

That‘s kind of what we saw. That is what really spooked, in part, the

Fed. That‘s why you saw all of this rapid motion and rapid change to

make all these bank holding companies into banks and start guaranteeing

debt and the like.

So what is the solution? The solution is to make the Bankruptcy

Codes work much better and much faster. Maybe you want a special

term when financial firms are involved that explains how you can

rapidly, instantaneously, by the end of the day, resolve any issues

associated with bankruptcy that have to do with where your funds are or

who has access to them.

Although bankruptcy can impose costs on all types of firms, the cost

of delay for financial firms can be especially large. If we had been able

to make the Bankruptcy Code work much more quickly for them in times

of distress, we would have been able to eliminate some of these run-like

problems for investment banks.

Now, although the courts through the Bankruptcy Code are one way

to deal with this notion of bankruptcy, counter-party risk, and liquidity,

another way is the greater use of organized exchanges and

clearinghouses.

Let me just start out with an example. Suppose now I am no longer

an investment bank, I‘m a wheat farmer. So I‘m a wheat farmer and I

see my harvest is going to come in in two months. I sell my wheat to

someone who‘s a baker. So Joe here is a baker, he buys my wheat, we

set a price, and I‘m going to deliver it in two months to his factory. The

price is $1.00 a bushel.