WASHINGTON (MNI) – The following is the text of the remarks of
Federal Reserve Gov. Elizabeth Duke, prepared Tuesday for the Consumer
Bankers Association Annual Conference in Hollywood, Fla.:
Good morning. I am pleased to be here today to address the Consumer
Bankers Association’s Annual Conference. Many of you may know that I
spent most of my career as a banker. Some of you also know that I spent
two weeks a year for many years with the CBA Graduate School of Retail
Bank Management teaching bank management concepts to mid-career bankers
who specialized in providing financial services to consumers. One of the
best tools I ever found for teaching adults was a simulation exercise.
In the retail banking simulation developed for CBA, students compete by
making the decisions that comprise a retail strategy- choosing customer
segments, designing products and prices, and establishing a distribution
network. The computer model calculates market share using a series of
demand curves derived from actual consumer surveys and observed
behavior, then applies pricing decisions and standard cost tables to
construct profitability. All of this number crunching takes place in the
context of an assumed economic and regulatory environment.
Of course, the credibility of a simulation exercise comes from its
similarity to real world conditions that students have experienced. As I
thought about this speech, it occurred to me that if I had tried to
simulate an environment in which interest rates dropped from more than 5
percent to near zero in 16 months, unemployment went to 10 percent,
housing prices dropped nearly 30 percent, mortgage delinquencies hovered
around 10 percent, and credit card loss rates went over 10 percent,
nobody would have believed it. But that is exactly the environment that
lenders have experienced in the last two years, and it has been the
environment that I, and my fellow policymakers, have faced during my
entire time at the Federal Reserve. And I never got a chance to practice
first in a simulation.
Consumers were at the very center of the recent crisis. And
consumers were the focus of Federal Reserve actions as we fought the
crisis-lowering interest rates to stimulate economic activity, providing
liquidity to markets to maintain credit flows, and issuing regulations
to improve the quality of credit provided to consumers. The environment
you face today as retail bankers is very different from the one that
prevailed before the crisis. It was changed in some ways by the crisis
itself and in other ways by actions taken by the Federal Reserve and
other policymakers to fight the crisis. Ongoing policy actions designed
to reduce the frequency and intensity of any future crises will further
change the rules governing consumer banking. And as bankers you will
shift the competitive environment as you modify your business models to
adjust to regulatory changes and your recent loss experience.
In my remarks today, I will begin by discussing some of the key
elements of the crisis that led us to where we are today. Then I will
talk about new regulations governing consumer financial products and the
current financial condition of the consumer, with some thoughts about
the resulting implications for retail banking. I will conclude with some
suggestions for principles to guide consumer banking going forward.
Reflections on the Crisis
The recent crisis in our mortgage finance system and capital
markets was severe. It plunged our economy into a level of stress second
only to the Great Depression of the 1930s. The results were devastating
for investors, financial institutions, businesses, and consumers from
Wall Street to Main Street. As a first responder, the Fed used a wide
range of tools to fight the crisis in a direct and urgent manner,
including lowering interest rates; maintaining a steady flow of dollars
to meet demand abroad; providing liquidity to sound institutions to
support faltering financial markets; and providing emergency loans to
specific, troubled institutions whose failures would have had disastrous
consequences for the financial system and the broad economy. The
pervasiveness of the panic required that the Federal Reserve act
swiftly, responsibly, and effectively. If we had been unable or
unwilling to do so, I believe that today the economic and financial
situation would be much worse.1
Our actions have hardly come without scrutiny or criticism, of
course. While some hailed the forceful steps taken by the Federal
Reserve in the fall of 2008 to help prevent the apocalyptic scenario
that we all believed possible, a vocal contingent of critics questioned
the Federal Reserve’s decisions and the degree to which individual
financial institutions benefitted from our actions, especially the
so-called bailout for insurance company American International Group
(AIG).
To help you understand our actions, let me put you into the moment
when we decided to provide liquidity to AIG. The government had already
put Fannie Mae and Freddie Mac into conservatorship to preserve the
mortgage market. Lehman had just failed, and we were getting the initial
reports of the fallout, like reports of battlefield casualties, that
market after market was damaged or frozen. Panic was so heavy in the
markets that it was almost a physical presence. I kept having this image
in my head of the panic being like the monster called “the Blob” that I
saw years ago in an old movie. Like the Blob, panic attacked one
institution after another, and with each institution it ate, it grew
bigger and stronger. We had just watched it eat Lehman. We could not
stop it there because we are only authorized to lend against collateral,
and Lehman did not have enough collateral. Now it was focused on AIG.
Unlike the situation with Lehman Brothers, we were presented with an
action we could take, a loan we could make to avoid the collapse of AIG.
Our knowledge of the company was limited because we had never supervised
AIG, but the loan could be secured with collateral. Based on our
assessments of the collateral, we believed the risk of the loans to be
limited. And while the risk of making the loan was
(1 See Congressional Budget Office, “The Budgetary Impact and
Subsidy Costs of the Federal Reserve’s Actions During the Financial
Crisis,” May 2010,
http://www.cbo.gov/ftpdocs/115xx/doc11524/05-24-FederalReserve.pdf.
limited, the risk of not making the loan-of letting AIG, which was
significantly larger than Lehman, fail-was certain to be huge. And no
other entity-not a private company, not a consortium of private
companies acting together, not any other branch or agency of the
government-was in a position to do anything. The clock was ticking, and
default was imminent. There was no time to gather more information or
find another solution. So I ask you, what would you have done?)
It was in this context that the Federal Reserve, with the full
support of the Treasury, made a loan to AIG to prevent its failure. The
loan imposed tough terms, senior management was replaced, and
shareholders lost almost all of their investments.
If I had to cast that vote again, even knowing all that followed,
including the criticism that we have received, I wouldn’t change it. I
still believe that the consequences would have been far worse for all
businesses and consumers if we had let AIG fail. Despite the claims by
some that healthier Wall Street firms or even the small businesses and
consumers on Main Street did not benefit from assistance to AIG, I would
argue that no business or individual was immune to the effects of a
sequential collapse of key financial intermediaries.
As it was, we still had frozen credit markets so we turned our
attention to facilities designed to unfreeze those markets. While
actions like our lending to AIG have grabbed the biggest headlines,
other moves by the Federal Reserve, like those to ensure the functioning
of consumer credit markets, were equally important when it came to
supporting consumers and the economy in the midst of the financial
crisis. New issuance of asset-backed securities (ABS), which provided
funding for auto loans, credit cards, student loans, and other loans to
consumers and small businesses, had virtually ceased. Investors had lost
faith in the quality of the triple-A ratings on the securities, and the
complex system that funded the securities known as the “shadow banking
system” broke down. Without access to funding, credit for households and
small businesses would have become even less available and more costly.
The Federal Reserve designed the Term Asset-Backed Securities Loan
Facility, or TALF, to provide funds for the purchase of securities
backed by new consumer loans. In the end, nearly 3 million auto loans,
over 1 million student loans, about 850,000 small business loans, and
millions of credit card accounts were supported by TALF-eligible
securities. TALF worked. It served its intended purpose of unlocking
lending, the lifeblood of the U.S. economy. As pleased as I was to see
that TALF worked, I was even more pleased when it eventually became
unnecessary. ABS issuance remained stable in the months after TALF
ended.
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** Market News International Washington Bureau: 202-371-2121 **
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