Late last year, Robert Pozen, chairman of $195 billion MFS Investment Management in Boston and a senior lecturer at the Harvard Business School, authored Too Big to Save? How to Fix the Financial System . [Click here to download the foreword written by Robert J. Shiller, Yale University.] Pozen, who was also chairman of the SEC advisory committee on improving financial reporting during 2008, sat down with Julie Segal, staff writer at Institutional Investor magazine, to talk about his book and thoughts on the government’s continued role in the financial industry.
What has the reception to the book been so far?
Well, Tyler Cowen, who writes the blog ‘Marginal Revolution,’ wrote the review that I’ve always wanted someone to write: “This is the book you’ve been waiting for.” It’s for those of you who wanted to really know not only what happened in the financial crisis, but also what government interventions worked, which haven’t and proposals for going forward.
You offer some unique analysis on short selling that occurred during the crisis. Tell me about that.
I worked with a quant. We really ran numbers to see the effect of short selling on stock prices during that period. Of course, every CEO of a financial institution claimed that they were being short sold to zero. Some were on to something. Based on our analysis, John Mack turned out to be right that, yes, short sellers were driving Morgan Stanley’s stock down, but with Merrill it didn’t turn out to be right. Short sellers did drive Lehman Brothers down, but Fannie Mae they didn’t. We looked at this from an empirical standpoint.
I have a very balanced view of short selling. I just want to slow down the downward momentum it can have on stock prices. In an efficient market you want longs and shorts, but there was so much hysteria on short selling, and then you got the prohibition on the activity and that didn’t have the effects that regulators wanted it to and instead it had other negative effects.
Even with all the government intervention, loan volume was slow to pick up, worsening the recession. Why?
Everyone questioned why the banks weren’t lending. But there is a common misconception that banks are responsible for most lending. If you look at the statistics in the U.S. before the financial crisis, say in a normal year like 2006, then you realize that only 20 percent to 25 percent of credit that was extended by banks and the rest was by non-bank lenders who were heavily dependent on the securitization markets. In 2006 we were securitizing $1.2 trillion in loans and in 2009 we did about $50 billion. So the securitization process has broken down, despite some recent deals, and that’s why loan volume is down.
The market isn’t coming back until there is much more transparency in these structures, based on actual risk assumptions and with capital from the sponsor backing the security. Securities like collateralized debt obligations are difficult, if not impossible, to understand. The SEC could require a lot more disclosure, which they don’t. And most importantly, most of these securitization deals are registered under the 33 Act and then they deregister within the first year, because they say less than 300 people have the securities. But that is looking at the question as if the only investors involved are the ones who hold the securities of the trust. But my view is that the sponsoring bank has investors who care as well. So we have terrible disclosure. If there are problems in an off balance sheet trust, we don’t have good disclosure about what is happening. If we care about lending, we need to bring this back.
You say that the bailouts were poorly handled. Why?
First they bought preferred warrants in the banks. That gave American taxpayers all the downside and not enough on the upside once the recovery took hold. I also believe that Treasury offered bailouts to small banks, credit card issuers and insurance companies. These were made without telling people exactly why.
I think the bailout of CIT is ridiculous, for example. We have a theory of too big to fail, and we’ve somehow recapitalized 600 institutions. Are there 600 institutions that are too big to fail? It seems unlikely. I try to delineate in chapter 9 the two valid rationales for bailouts: One is you have to protect the payment system, but that probably involves a handful of money center banks. The second is if you have an institution like Fannie or Freddie where its failure would lead to massive failures throughout the system. Does CIT count as either of them? No. We bailed out American Express. It’s a credit card company. If American Express went bankrupt, would the whole financial system go? No, a new credit card company would emerge. We have no rationale and we’ve bailed out far too many firms. I point out in my book that there is now a trucking company that wants a bailout, and of course, we can’t do without trucking.
The outcry over executive pay has not waned since the start of the credit crisis. What should be done?
Well some limits have already backfired. Caps on executive bonuses for executives at bailed out firms led to large guaranteed salaries. That broke the link between pay and performance. Regulators should set principle-based guidelines on compensation packages and those could be overseen by the board of directors. I’m also a big believer that the private equity model of having “super-directors” with extensive experience, could help rein in pay as would the ‘say on pay’ votes, which have worked well in the U.K.
