The CARES Act, Inflation and Financial Regulation

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>> Jon Hartley: This is the capitalism and freedom in the 21st century podcast where we talk about economics, markets and public policy. I'm Jon Hartley, your host.

Today I'm joined by Andrew Olmem, who is a partner in Mayer Brown's Washington, DC office and a member of their public policy, regulatory and political law practice. As deputy director of the White House National Economic Council in the Trump administration, working under both Larry Kudlow and Gary Cohn.

Before that, he worked as chief counsel and deputy director of the Senate Banking Committee. Andrew is incredibly knowledgeable in all things regulatory and economic policy related and draws on years of experience in government. Welcome, Andrew.

>> Andrew Olmem: Hi John. Thanks for having me today.

>> Jon Hartley: So I want to start by your early career.

So you did your undergrad and law school at Washington Elite. You spent a lot of your early career in Washington, DC in various congressional offices. You spent a couple years working at the Richmond fed as an associate economist before joining the Senate banking staff. How did you first get interested in economics and economic policy?

 

>> Andrew Olmem: Well, I think I was that kid who was always interested in history. And so I kind of devoured history books as a kid, starting with somehow I got interested in, I think, the American Revolution as a young kid in the way that some kids fixated on certain things.

That's what I got hooked on. And then just kind of American history, and it just kind of spread from there. And I kind of read voraciously as a kid. And then my parents took us to Washington, DC on one of those classic family trips. And I just had a blast exploring, learning about Congress and the White House and what the president did and Supreme Court.

And so that kind of had a natural kind of evolution into understanding kind of how our government works. And then over time, I think that migrated in just how economic policy and helped explain how government policies are designed and which ones are successful, which ones are not. And this would have been the heyday of the Reagan years.

And so I naturally ended up reading national review, something I got introduced early. A lot of people in my generation on the Republican side watching William F Buckley on the firing line as a kid. And so by the time I got and got to college, I knew I wanted to do something along the lines of politics or economics.

I always had a little bit of a business interest, too, but those are kind of my main academic interests. And so I ended up working on the hill for a few years in college. I just had a great time with, and then went to noted the Richmond fed right out of undergrad, where I was an econ major and just had a great experience there and learned just a ton.

 

>> Jon Hartley: That's great, and you grew up in the midwest, is that right?

>> Andrew Olmem: Yep, I grew up in Minnesota, kind of northern Minnesota.

>> Jon Hartley: Got it. So was it, were you a bit countercultural, I guess, reading National Review growing up, but were you sort of one of the few, sort of, I guess, conservatives in your class or.

 

>> Andrew Olmem: It was a pretty democratic area? Yes, I guess I was a little bit, definitely the outlier. I had an uncle who was just a great influence on my reading and was very serious about what books I read. Not just necessarily conservative leaning, but just making sure I was reading really good stuff.

And so I think that also helped fuel it. And then, like I said, I had this trip out to DC that just kind of really. I think I was ten at the time, really kind of triggered an excitement for it. And so even though my leanings, I think, were more on the conservative side, kind of free market, which we can talk a little bit more.

I was just really interested in kind of government and understanding how the world works. So, yeah, I grew up in a place that was certainly very, very democratic, but I was always comfortable just being. Having my own views.

>> Jon Hartley: Fantastic, many very well known economic policy hands banks sometime on the Senate Banking committee.

I think a lot of people don't necessarily realize this, that a lot of people go on to serve on the Fed board or work in the NEC. Spend some of their early careers working on the Senate Banking committee. You worked within the Shelby office? Senator Richard Shelby's office, alongside many others who kind of went on to have very distinguished Senate policy careers, like Mark Calabria went on to lead the FHFA and many others.

I'm curious, what was your time like as a congressional staff or working on the Senate Banking Committee? Can you explain sort of what some of the key responsibilities of the Senate Banking Committee are?

>> Andrew Olmem: Yeah, I love working on the banking committee. It was just a great job for me.

The team we had there was just superb. And it was also a unique time to be there because I got there kind of right at the ending of, they call the kind of GSE wars about fights about what to do about the regulation of Freddie and Fannie. And then that quickly moved into the financial crisis of 2008 and then the Dodd Frank negotiations and debate about the Dodd Frank bill.

So it was probably the most active time in the committee since the new deal. And so we were right at the center of all that. Just kind of fortuitously. The banking committee is always an interesting place to work because it's the committee that's responsible for overseeing all the federal agencies related to financial services.

Not only banking agencies, but HUD, the SEC, and also certain parts of treasury, export controls, flood insurance. Interestingly enough, and actually even has a piece in transportation because it oversees transit programs. So there's a pretty broad jurisdiction. And I got to work on a lot of different issues and ended up staying seven and a half years there, which is pretty long tenure.

But I just, it was such an interesting place and we had such a good team.

>> Jon Hartley: And what years would that have been? The seven years.

>> Andrew Olmem: From 05' to 13.

>> Jon Hartley: Got it. So you're there during the global financial crisis-

>> Andrew Olmem: Yep.

>> Jon Hartley: And Dodd Frank, sort of the whole aftermath, financial regulatory response.

Wow, what a time to be there. And I guess, like, sort of looking back on it, any thoughts on sort of the legacy of Dodd Frank here now, like 12 years later, or a big sort of evolving thing?

>> Andrew Olmem: Yeah, I think the critiques' of Dodd Frank have largely proven to be right on mark, which was that it was, one, a big missed opportunity to do real reform of the financial system.

Two, is it resulting in another layer of bureaucracy and unnecessary costs on the financial system that isn't necessarily making the system safer. And that we have a kind of risk now of really institutionalizing too big to fail, and that has a real danger in skewing our markets over the longer term?

Certainly there are certain aspects of the financial system that certainly needed to be reformed post global financial crisis. The way capital was done was certainly really one of those areas. Derivatives reform. There are a lot of areas that I think there was bipartisan agreement that needed to be reformed.

 

>> Jon Hartley: So like Basel three capital regulation in some respect, I mean, maybe not ideal in terms of-

>> Andrew Olmem: We can talk about details of capital regulations, which has now recently gotten a little bit more complicated. But I think it was clear that the system was under capitalized going out into 2008.

And that there were some regulatory problems in the housing finance system that hadn't been addressed and needed to be. But then there was, again, pretty strong bipartisan support for a lot of those provisions. But I think the controversy around the CFPB and in particular some of the credential regular authorities.

And how institutions are regulated, still problems that we haven't really figured out how to get the right balance on.

>> Jon Hartley: Absolutely. I mean, it's fascinating to see how the CFPB, the Financial Protection Bureau. Elizabeth Warren's so called brainchild, has kind of evolved over time and been used in different ways for a whole number of things.

I can think of things like income share agreements are something that I think the Biden administration really doesn't like. And the CFPB has been suing a number of income share agreement providers. Yeah, it's very interesting how the legacy of Dodd Frank, and we'll get back into some of that later, banking regulation and reforms.

I wanna now sort of fast forward to you joining the White House. You joined the White House National Economic Council in February 2017, right at the beginning of the Trump administration. And for those, I guess, that aren't aware, the NEC was created in the early 1990s. But sort of grew out of a few other predecessors as sort of handling economic policy coordination within the White House.

Can you explain a little bit how the NEC works within the White House and how it's evolved with other economic policy bodies, like to the Treasury Department? And how did it function within the Trump administration in particular? Cuz I know sometimes these things can change from administration.

>> Andrew Olmem: Yeah, they changed a little bit.

But for the most part, the NEC has been pretty stable since it's created under the Clinton administration. And the purpose of the NEC is to serve as one, the coordinator of economic policy decision-making for the White House, right? Under Article 2, the president leads the executive branch. He's the one ultimately responsible for all decisions being made in the executive branch.

And there needs to be a process for determining which decisions need to go up. And have the president formally be decided upon, which ones other senior officials can provide guidance, knowing already where the president's positions are. So there's a lot of meetings to making sure that there's coordinating kind of the president's policies throughout the administration.

It also does a function in helping devise policy, in bringing the different officials together, relevant officials throughout the executive branch together, to determine what policies the administration should pursue. And that process usually requires a presidential sign off cuz usually the stuff that is in the White House are the kinda most important issues, right?

There's only so many hours and a lot of decisions we made, you have to make sure it's the important ones. So there's a lot of meetings about what direction policy should go, making sure the president's informed on decisions, briefing the president. I spent a lot of my time briefing the director of the National Economic Council.

And then also working with the other policy councils in the White House because there's some overlapping jurisdiction. The National Security Council is better known, serves very similar function for foreign policy. There's also the domestic policy council, who handles, again, this name signifies the traditional domestic policies. So you spend a lot of time, particularly when I was deputy, kinda coordinating with the other policy councils to make sure everybody knows what's going on and where we're going and the appropriate sign offs are being obtained.

So it's a very interesting place to do and just a fantastic place to do economic policy.

>> Jon Hartley: That is fascinating and also what a fascinating time to be at the NEC and in particular in early 2020, the COVID pandemic hit. And you were very involved in the US economic policy response to COVID-19, the CARES Act, some subsequent economic policy response as well.

Can you explain what your role was as deputy director? And also I wanna get into what you think some of the CARES Act's sort of biggest successes and failures were. But can you sort of explain, like, sort of take us into the room or some of the rooms that you were in in helping to set up and sort of get the CARES Act going?

And can you explain maybe some of the details of the CARES Act as well? There are a lot of pieces from stimulus checks, unemployment insurance expansion. There was obviously all this small business oriented paycheck protection program grants or forgivable loans. Can you explain how did that all come together?

And what was the thinking around that being the optimal policy response at the time?

>> Andrew Olmem: Well, there's a lot there, John, so let me unpack it first, is the deputy director of the NEC handles the day to day management of the NEC. The NEC is a pretty small organization, and so each of its staff members have a pretty significant amount of authority over their issues.

And the way we were structured, and I think similar for most White Houses. We had a special assistant to the president who handles tax policy, one who handed telecom, one who handled agriculture, one healthcare, financial services, infrastructure, transportation. You can see kinda the big sectors of the economy.

And the deputy's job is to make sure each of them understand what each of them is doing. And giving them direction on where the director and ultimately president want policy to move. And how they are supposed to help coordinate policy throughout the administration. Certainly, there's a lot of direction that comes from the White House.

But there's also a lot of information that comes in from the executive branch to inform the White House of what's happening and also looking for guidance. There's a constant stream of information, and the deputy director's real job there is to help manage that flow. And then also, again, as I mentioned earlier, help coordinate with the other policy councils on issues that have overlapping interest amongst the councils.

So that's generally the structure. The COVID presented a particularly unique and challenging policy area or policy response to put together, because it involved first and foremost a health crisis. And normally when you think about the most recent economic crises, they involve something within the financial sector. 2008, put it simply, you had a lot of bad mortgages that were basically throughout the financial system and had to be addressed in some way.

You can have an inflation scare, you can have a trade dispute, a recession, right? These are things that kinda the traditional economic problems or crises, generally, we have a playbook. And also are things that are largely handled within the financial, regulatory, economic policy realm. With COVID though, the front lines on addressing the core problem are outside, it's the public health officials.

And so for us, we knew that it was pretty clear early on there was going to be an economic impact. But it was also we were not the ones who would be on the front lines of addressing the root cause, right. Which is how do you figure out how to get vaccines, understand how to prevent transmission, those sorts of really important public health response.

What we had to do instead was think about what are the secondary effects and what areas of the economy are going to be impacted the most which workers are likely to be impacted the most. And think about what type of response would be needed to mitigate some of these adverse effects that were about to hit the economy because of the pandemic.

There was just a great team that I work with on a lot of these issues on the economic side certainly team at the White House, at Treasury, the Small Business Administration. Commerce Department all had certain areas, ideas and certain authorities that they could utilize to help respond to the crisis.

And then also I think the US Senate did a great job in helping come up with a means for Congress to quickly consider legislative response. And one thing that's really striking, and I think I'm quite proud of about the CARES Act, is that that piece of legislation was passed before really the data had even come out.

Showing how significant an impact the COVID was having on the economy. And as you know, if you look at the data, historical data, now for most economic series, there's a sharp drop in 2020 that really skews all data on the charts, right?

>> Jon Hartley: Absolutely.

>> Andrew Olmem: On the employment side.

 

>> Jon Hartley: Absolutely.

>> Andrew Olmem: How significant it was and the fact that we were able to be proactive is pretty remarkable. The, we often talk about an economic policy. I remember still in my econ class is the idea that you want policy to be looking ahead. And attempting to be providing support as it's needed and not passing legislation after the crisis has already occurred.

And you end up wasting a lot of money that way and not being effective. Unfortunately, that happens too much in any go on policy because it just takes too long to formulate and events move fast. But in this case, we were able to get it out early. And I think I take a lot of comfort in the fact that there are millions of people who really benefited and were able to get help.

That legislation helped bridge the real economic storm that we went through and kind of emerge the other side. And help the economy really emerge on the other side a lot more robust than it otherwise would have been.

>> Jon Hartley: Absolutely, it's fascinating just to think. I remember in March of 2020, so many service sector part time retail restaurant workers lost their jobs instantly.

And it's incredible just how high the unemployment rate went very quickly. And of course, it came back down very quickly as well. But so much happening in such a short span of time, it's really amazing how quickly a coordinated policy response was able to be put together. And I think that's maybe something that people don't quite appreciate as much.

So I know there's some stories, I think, of how, I guess, PPP came together, and I know that was in part that was using the small business administration. There were a lot of, I guess, on the top of coordination and getting things out the door. You had the CARES Act was passed in late March of 2020.

But then there were sort of a number of questions about how quickly could you actually get that economic relief out to people. And there were certain things like whether the stimulus checks could be paid out through direct deposit versus sent in the mail. And the direct deposit would be much faster in using, for example, people's banking information from their tax returns.

And obviously PPP took some period of time to get out through the banking system, which is how the small business administered those. I'm curious what you think about the implementation side of the CARES Act and where were you sitting amidst all of that?

>> Andrew Olmem: Yeah, so one thing I really learned about working in the White House, which is the White House does not do implementation.

That's what you leave the departments and agencies for. And there are times in US history where the White House has sought to manage particular programs, and usually it doesn't work out well because the personnel involved and expertise is nothing in house. Right, it's someplace else. So it's very hard to do.

So I think where we saw it is we had really good teams on SBA and Treasury who were very capable in getting these programs up and running. There's a lot of work, as you point out, there's a lot of technical difficulties in doing some of these programs so quickly.

Some worked faster than expected, others took more time. Some of that is just the nature of responding to a very unexpected crisis. And certainly as I look back, there are lots of areas where I probably have things changed and modified and things you would do differently. One doesn't have the time, and it's very easy to look back retrospectively and say, we would have done things differently.

But I think overall the team did a pretty good job of taking these programs and getting the legislation passed and then getting them up and running as you want. PPP, I think, was a good example, figuring out how to handle the increased and unemployment benefits with another complicated program to actually set up.

But ultimately these programs were, within a reasonable amount of time, were up and running.

>> Jon Hartley: That's fascinating. I do want to talk a little bit more about both, not only the successes, but also some of the failures, potential failures here, too. Or maybe how you think things may have been done differently, knowing what we know now and the whole experience that was had.

In particular, I want to talk a little bit about inflation as well, since it's in 2022 and 2023, very front and center issue. Now in late 2023, we're seeing inflation finally receding, but over the past few years, we've seen some of the highest inflation rates since the 1980s.

I'm curious, to what degree do you think that government stimulus, ranging from the CARES Act, the $400 a week of the pandemic unemployment insurance supplement on top of replace wages. That PPP to stimulus checks to and subsequent top ups, American rescue plan, the ARP stimulus that was continued throughout the Biden administration.

I'm curious, to what degree do you think that maybe government stimulus overdid it? And to what degree do you think that the inflation that we've been experiencing over the past few years, something to do with government policy? And there's others, there are some people that take the view that it's largely a supply chain issue and that government stimulus had very little to do with it.

So maybe it's not a monocausal answer and it's multiple things, but I'm curious what your view is on this.

>> Andrew Olmem: Yeah, so I would say, well, a couple observations. First, this just shows on how difficult it is to finally tune the US economy. When we think of an academic settings where you think about, well, if only we had policymakers were able to increase, reduce taxes by x percent and increase government spending by 4%.

That will get the economy to a perfectly adjusted equilibrium and we'll have full employment and low inflation. And this is something that policymakers have tools to do. I think this experience to me just reinforced the belief that it is very hard to do, that the economy is just too dynamic, healthy even under the best of situations, will involve some delays.

And here we are about as fast as could be expected, but certainly more time would have probably helped us improve the calibration of the programs. It's just the realities of the world that it's very hard to calibrate these programs correctly. Second is the coordination is also very challenging and it puts policymakers, I think, forces policymakers to make some really tough decisions.

And you can look at where the Fed was sitting and they saw, certainly saw this huge increase in government spending, deficit expanded pretty unprecedented levels. You have to go back to World War II to see these debt levels. So you had a lot of government debt going out, a lot of spending, but you also had the economy collapsing too, so you'd think rates would be going down.

But the response proved to be very successful, probably more successful than people expected at getting the economy up and running again. As you noted, economic growth jumped back very quickly the following quarter, and suddenly the economy starts to get back on track faster than expected. But you still have this large increase in government spending and debt issuance, which by itself is a very inflationary impact.

But the Fed at the same time has to figure out, to make the judgment call with an incredible amount of uncertainty about where the economy is, given that this pandemic is still going on. And so it's not surprising to me that through all of that, very simply, big increases in money supply, suddenly big increases in demand, right?

Whether you're a keysy or monetis, there are reasons to see that inflation coming, but it's also in real time, hard to react fast enough to know which to do. So it's not surprising that it would do that. Certainly, I think the Fed was too slow to respond, and that's probably the big reason why we got the inflation bout that we did.

I do think one of the lessons I learned both in 08 and in the 20, is really the value of inflation expectations and having anchored expectations by the American public. If you look back in 08, there was a lot of expectations or concerns that inflation was gonna surge in the same way.

But it turned out inflation expectations were so anchored that the inflation rate was a lot stickier and the us government had a lot more flexibility to respond without creating an inflation problem. Or at least having to respond to one at the same time than was expected. I think in 20 it was the same case, and that people had confidence that even after zero eight, inflation didn't surge.

And that meant the federal government could take a big response here the Fed could be more aggressive on lowering rates to respond without sparking an inflation problem. And that certainly helped policy. The fact that then we suddenly did see this bout of inflation, I think, shows to me that the potential for inflation was always there, and once those expectations got kind of unlocked, right?

That they can change pretty, a little bit faster than we expected, and that is made policymaking over the last couple of years very, very challenging, right? You have a large jump in inflation that the Fed now has to respond to, while you also have a large fiscal deficit.

These are in Congress really should be starting to think about how to get its finances under control at the same time, not an optimal situation. So it's a little bit of a long, little rambling answer on it. But certainly the Fed needed to get more, should have been more aggressive, and probably got a little lax because of the success in 2008 and up till then, 2020, and that no inflation had emerged.

 

>> Jon Hartley: Absolutely. And I think there's a number of former Fed governors like Randy Quarles, who were on the acts with the Fed board at the time, and even they would say now. And have said publicly that the Fed should have started raising rates earlier, as early as the autumn of 2021, when it became clear that the uptick in inflation was not just a story about used car prices going up due to supply chain supply constraints.

But you started to see rents and other items in the price basket really start to surge. And that was really the key moment when the Fed should have started to raise interest rates not six months later in the first quarter of 2023. I wanna now pivot to financial regulation, specifically banking regulation, I kinda wanna get back to that and talk a little bit more about the legacy of Dodd-Frank.

You spent a lot of time on Senate banking and have a lot of expertise in this, and I think also having a legal background, I think also just brings so much expertise to the realm of regulation, which is wonderful. So there was a lot of momentum, I feel like throughout the 2010s on the republican side, a lot of momentum in the repeal, Dodd-Frank or certain elements of Dodd-Frank.

While some, like capital rules for banks, banks were over levered in 2008, a lot of sort of bipartisan sort of agreement on that. These other parts that were like the Volcker rule, some of the implementation of the Dodd-Frank Act, CFPP. And there's also a lot of scrutiny about the impact on regulatory costs on smaller banks, there weren't any new de novo banks created for quite a few years, in part due to the regulatory constraints.

I'm curious, there's also some changes to 13-3 that some people didn't like, the lender of last resort lending that sort of put more power in the hands of Congress. Some people, I think even, On the left didn't really like that. So we have Trump then elected amidst this 2010s momentum to repeal certain elements of Dodd Frank.

Trump gets elected in 2016, a Republican House and Senate is also elected that year. And I'm curious, in that time period where there are two years of Republican White House and full congressional control, the biggest thing that came out of that in terms of financial regulatory reform or some form of deregulation was really just changing the CFI threshold to exempt some firms.

I'm curious if you could sort of maybe speak a little bit about what that push which was led by and then House financial services chair Debling. I'm curious, to me that it seems like.

>> Jon Hartley: Yes, of course and Senator Kraper on the bank. I'm curious, what happened to all that momentum and why did so little get done to peel back some elements of Dodd Frank, like Republicans have promised for so long in the 2010s after they actually got into power.

 

>> Andrew Olmem: Yeah, so, I mean, one word is the filibuster, right? In the Senate, you have to have 60 votes to move legislation. And when the Democrats passed Dodd Frank, they had the 60 votes and they passed it largely on a partisan basis that way Republicans during that time period didn't.

And therefore, there had to. So if anything, the expectation probably really was that nothing was gonna happen because there was no way Republicans and Democrats would get a deal together to get the 60 votes to move legislation. But I think we were able to get a bill through for a couple of reasons.

One is we focused on the area, one of the areas that needed the most attention and one that I think even supporters of Dodd Frank realized needed to be reformed, which was how regulations were tailored. These new enhanced prudential regulations were tailored based on size, so that you don't have a $2 trillion bank being regulated the same way as a $300 billion bank.

Certainly billions in dollars was a lot, but there's a big magnitude Between those two types of institutions and the types of activities that they engage in, where they conduct their activities. It's a very, there's a lot of differences there. And the danger that I think has been well recognized is that if you wanna have a diverse banking system where you have large banks, small banks, intermediate banks, banks with a lot of different business models, which I think is really important for an economy like the United States, as large it is and as dynamic it is.

We can't have a cookie cutter approach that banks, where they all kind of look alike, they have the same kind of products, same business models is gonna result in certain segments of the economy not getting the credit they need and also not as efficient management of risk. There's an element of having diversity in business models and risk management that provides some resiliency to the system, and that Dodd Frank, even the original Dodd Frank, recognized this problem, that there's some language in there, but it needed to be, the implementation needed to be improved.

And Congress had to clarify more what it wanted to see on this so that we didn't suddenly have the financial system completely barbelled, where you have, say, 6 really big financial institutions and then a whole bunch of really, really small institutions and nothing in between. It also, there's a competitive element is that these banks, from, say, 50 billion up to 700, 800 billion, provide a lot of competition for the system.

Certainly that means small banks can grow and become, that are successful, can grow and then compete with these banks. But they also, those banks also compete with the large G-SIBs and can potentially grow to challenge them. And so it really brings a really healthy competitive element to our system.

And I think members of both parties recognized that there wasn't sufficient tailoring to account for these differences in business models and banks. Again, there's common interest in making sure all these banks are well regulated, well capitalized and appropriately regulated, just trying to make sure that they're appropriately regulated based on the types of activities that they engaged in.

And as a result we were able to get a package together that it was 17 Democrats ended up voting for. So we had a really strong bipartisan coalition. I think it's a good lesson too, is that financial regulation, in my experience, usually the bipartisan legislation is one that turns out to be more durable.

If you look at Dodd Frank, the areas that were most controversial, a lot of them no longer exist because subsequent congresses came back and changed the law or they were declared unconstitutional by the courts. There were a lot of changes to Dodd Frank based on the approach it was passed.

And the 21 55 bill, I think, is endured pretty well because it had such a bipartisan approach. And it was also just simply common sense that we wanna make sure regulations appropriate based on the nature of the banking activities a bank is engaged in, as opposed to some kind of cookie cutter.

Here's a whole list of what every bank thinks that every bank needs to comply, regardless of the activities that it's actually engaged with, right? For a period of time banks had to prove that they were in compliance with the Volcker rule, even if they weren't engaged in any proprietary trading right it was, doesn't make any sense.

 

>> Jon Hartley: Absolutely.

>> Andrew Olmem: So I think it's a good lesson and again, our system, here's a bigger point, too, on this, is that our system is designed not to have kind of radical changes, particularly Congress to Congress. It's designed to have change over time based on successive legislative congresses with different majorities and that that brings a lot of stability to our system.

It makes sure that when things are passed, they've been usually pretty well vetted. It also means that there's a broad geographic support for legislation. I think overall that approach has really served the United States well. The filibuster is pretty much key to that continuing going forward. And I think really on the conservative side, I know there's always frustration about why didn't we achieve bigger successes, right?

And I fully understand that, but at core, it's, you have to get the legislative majorities to do that. And Democrats have been very successful over the last, again, 70 years of having several occasions where they were able to actually have the 60 votes needed to do some pretty big bills.

And it's been well beyond anybody's current lifetime since Republicans had those kind of majorities.

>> Jon Hartley: Absolutely, and I mean, it is fascinating, too, to think also some of the bipartisan legislation that's been passed, particularly more so on the spending side whether it's some appropriation bills or bipartisan infrastructure bill.

Just how many piece of legislation has actually drawn quite a few Republicans to get to 60 votes? This is under the Biden administration, of course, filibuster is changing a bit, too, in terms of what things need to filibuster and don't.

>> Andrew Olmem: What point just to know like this is where the filibuster right now is, the movement on the left to undo the filibuster and we may see that in our lifetime here term actually come to pass.

I think overall it will not be good for policy because it'll mean policy will shift a lot more from Congress to Congress. But from a republican perspective, there are things that wouldn't be doable with the filibuster. And so this is where I actually think folks on the left sometimes should think about what does it mean when they're not in power?

And the reverse is also true. So it's a more complicated issue than I think most people who have kind of debated that issue, assuming, have really thought. And I think banking regulation is a very good example if the filibuster goes, you will likely see Congress be much more active and prescriptive with passing legislation on how institutions should be regulated.

And there's probably pros and cons to that.

>> Jon Hartley: Absolutely. Just a little bit to regional banks and it's been several months since Silicon Valley Bank and Signature Bank were taken to receivership by the FDIC in March of 2023. First Republic bank was troubled as well, ended up being acquired by JP Morgan.

But it's now several months later and it seems like the regional bank apocalypse that many were predicting did not happen. And I'm curious, what is your diagnosis of this whole situation? There's obviously Silicon Valley Bank had a large fraction of uninsured deposits. There was also some very serious issues around maturity mismatch, significant amounts of interest rate risk that Silicon Valley Bank was taking, this is sort of classic finance 101 mistake.

The duration of your assets should equal the liabilities unless you wanna make some big bet on interest rates. And it seemed like they had a lot of duration risk, the fed was raising rates. But I'm curious, is your take that SVP and a couple others were just a couple of cases of gross mismanagement and incompetence?

Or do you buy into this that there is some bigger regulatory issue at play? And I think still there's some big questions that need to be addressed, which is somewhat along the lines of the lender of last resort role here, but also how should deposit insurance be reformed going forward?

I'm curious what your thoughts are.

>> Andrew Olmem: Lender of last resort after this, because I think, I'm happy to talk about 13 three, because I think there's some interesting stuff which you've mentioned, I wanna explain a little bit more. But on what happened with Silicon Valley Bank, if you read the Geo reports about it, it reads very much like a lot of bank failures.

Particularly if you go back to the SNL crisis where you had a rising interest rate environment and a lot of banks misread it or mismanaged it. So it's not surprising that we've had bank failures when the federal funds rate goes from zero to 5% in the course of a year.

What is a little surprising, reading it though, is that the supervisory process, it looks like they caught it, but was not forceful enough to get any one of the bank to address it and take actions. So it seems like it's pretty clearly a supervisory problem here, when you have a country of 5,000 banks, that happens.

And this is why I've always been a believer in having strong resolution mechanisms. Banks are gonna fail as part of our capitalistic system works. Sometimes bets don't pan out and you have losses and bank goes belly up. It's impossible to avoid a healthy financial system from time to time, a bank failing.

But what you need to have is really the capabilities to make sure that the failure of one institution doesn't kinda bring down the whole system. And that they can't hold the federal government hostage for a bailout because of the concerns about the wider impact on the economy. And I think what you saw in Silicon Valley Bank was that there are some pretty strong authorities the regulators have, and we've been doing bank failures for a long time in this country.

They've been a problem since almost day one. Going back to the early republic, I think since the Great Depression, we've gotten a lot better how to resolve banks without them, their failures spreading and having serial bank failures and bank runs. And I think what you saw here was the regulators using the authorities they had to make sure that these institutions were resolved.

There was some market discipline exercise. You saw unsecured creditors and shareholders take losses, and it for the most part, stabilized the banking system and prevented it spreading. Now there's issue about how unsecured creditors are treated, but that's a more technical issue we can talk about if you want.

But overall, my take is that the response there was exactly how Congress anticipated the agencies to respond, and I think we should look at that as kind of a good thing. Now, I think that the resolution of institutions is an area that always has to be constantly being examined, make sure that our regulatory system doesn't become outdated by changes in the marketplace, particularly for larger institutions.

And I think we've seen, and that was certainly one of the efforts of Dodd-Frank, where there was a lot of bipartisan support. Is thinking about how we resolve institutions while preserving market discipline and avoiding bailouts, but also making sure there's an orderly resolution. I think that's an area that I still think deserves more work.

But I was glad to see that in the case of Silicon Valley Bank and Signature, that the existing authorities work pretty well because after all, these were real traditional banks, almost all the assets were in the bank. So they're not like kinda large financial institutions that have significant assets outside of the bank.

Those are much more complicated or as large as you saw with the GSEs and have special government charter missions. And that gets a whole other complicated area as well. So it looks like, again, we know how to resolve these types of institutions, and they did appropriately.

>> Jon Hartley: It's a fascinating take on regional banks.

One last question, section 13(3), a very famous topic. Effectively, the legislation that enables lender of last resort powers on the part of the Fed. So I believe 13(3) the Federal Reserve Act, it's changed over time a bit. And I'm curious, I mean, we're in this world where it seems like there is this de facto too big to fail issue, where anytime there's a big financial institution that goes down.

Or even in this case with a regional bank like Silicon Valley Bank, that there are some sort of issues that potential for spread of contagion, that there needs to be some sort of a backstop. And there's all these issues, things like Bagehot's rule, which is, I think, lend generously in these sorts of times, but have some sort of a penalty rate.

I'm curious, what do you think about the evolution of 13(3) lender of last resort, too big to fail? Because I do think it is a somewhat recent phenomenon in the sense that I don't think there were as many big bank bailouts, historically speaking. There haven't been crises that we've seen at least since the Great Depression.

But I'm curious what you think that evolution, whether it's been a positive development, a negative development, and I know there's been some sort of reform proposals that have been debated for decades now. I'm curious what your take is on 13(3).

>> Andrew Olmem: A couple of observations, first is, you're right, 13(3) is a Great Depression era statute that was largely not used, was really not used since the Great Depression until 2008.

And there was used very aggressively to provide assistance to banks, but also to non-banks, and that's the authority that allows. And then it was used again during the pandemic, response to the pandemic. And then we saw lucid with Silicon Valley Bank. So we now have three episodes on where it's been used, and that's supposed to be the emergency authority for the Fed.

But you're right to say what's going on here? Are we seeing an evolution? Well, one is certainly 2008 and 2020 are the kinda cases where you would think if you're ever gonna use 13(3). I think the more recent case of Silicon Valley Bank is a more interesting case, and the question is better focused there.

And I think that the answer of what's really going on is that we don't have as active a discount window as we should. Remember, the fed was established to provide liquidity to the financial system when you had a banking panic or to help with seasonal needs, right? That goes all the way back to the founding.

Since the federal government controls the currency, they wanted to have that elastic currency to make sure that when banks had needs for money, they were able to get it. And they would pledge collateral to help them get over short-term liquidity crisis. For a variety of reasons, discount window has not worked as planned, and that means The Fed sometimes feels has become concerned.

And this is what you first saw in 2008, that there wasn't enough liquidity. Now, in 2008, it wasn't just banks who needed liquidity, it was a lot of non banks. So 13-3 seemed appropriate. There was some of that recently with Silicon Valley bank, but the real target were other banks.

And so it's appropriate question to say, why are we using 13-3 and not having a better discount window? And I think this is an area that needs a lot more thought and attention, I think, by the academic community and by policymakers to think of how we can make it work.

Right now, going to the discount window is viewed negatively. There's concerns about stigma by banks that use it both from a supervisory perspective and also kind of reputational by clients, other banks, public sentiment in general. And so there's a real reluctance to use in these types of crises.

So I think this is an area that, I think that there's more tension.

>> Jon Hartley: It's so fascinating that this idea that there's this sort of lender of last resort tool, this discount window there, that exists, but banks are too afraid to use it because it'll be perceived as some sort of act of desperation.

And that could make their troubles even worse, even though it's supposed to be a lifeline. And so instead, banks are opting for these secretly negotiated bailouts that get announced sort of at the 11th hour.

>> Andrew Olmem: And remember, disco window is not inherently like a bailout, right? You have good collateral, you're providing the government is not taking really any credit, ideally not taking any substantial credit risk.

The thing about 13-3 that really has to be recognized is that when 13-3 is used the way it has been, particularly in 20 and 08, is that's a form of credit policy. We're like Fed's moving away from monetary policy to allocating credit in the US economy. And that is the responsibility historically of Congress favoring which industry and institutions get public money.

That's something that we've decided would be determined through the democratic process. So it's been, Congress has extended that authority to the Fed for emergency uses. But as you read the language, it's very clear that this is a break the glass. We really don't want you to be using this because your job is not credit allocation.

And Fed shares, particularly since Bernanke, have all kind of recognized that and have been very careful to closely consult Congress on how these programs are established because they are moving outside of their traditional realm. And the real issue there is that for the Fed is that once the Fed starts picking winners and losers.

It's moving from a technocrat type agency to a very political one. And that can result in questions of legitimacy and politicization of the Fed that in its worst case, come back and punt it for the credibility on its monetary policy, right? So that's why I think one of the better reforms of Dodd Frank was you have to have the treasury secretary sign off on those loans.

That way you have someone who's directly accountable to the president, somebody who's elected by the entire country, at least have some accountability for how that money is spent. Because remember, when you're using 13-3, even though it's supposed to be on good collateral, not, you're still taking some credit risk.

And as we saw in 2008, there's some real risk of losses there. So it's very appropriate, in my view, to have that democratic accountability. That's a reasonable balance. It is hard for Congress to quickly allocate money in the way that the Fed can do through 13-3. So having that emergency authority there can be very useful.

But it's also the risks that come along with using that, particularly from a democratic perspective, being democratic principles is really important. Plus is kind of going to the issues you talk about we're talking about, which is it creates expectations of bailouts and creates moral hazard in the economy that's also there.

So it's use like a lot of big policy decisions certainly has, can have some benefits, but they don't come without real costs that have to be recognized.

>> Jon Hartley: Absolutely, and I know some folks have criticized that 13-3 change that at some level might impede the lender of last resort sort of function to act as quickly as it might need to in a banking crisis if it happens super quickly.

But again, I guess it's a trade off. How much accountability?

>> Andrew Olmem: Yeah, my experience. It's actually the reverse, which is the treasury secretary then can take the political accountability for the use of that money. And when Congress calls up, wants to understand what happened, it allows for somebody who's getting directly accountable to the president to come before the country and explain how the money is being used.

Again, as much as the economic profession really focuses a lot on the Fed, and there's a little bit of the cult of the Fed in a crisis it's actually not the Fed chair who's the center. It's the treasury secretary, right? That is the leader of the executive branch in responding to crises.

And that's the person who should be in terms of what we talked before, the center of executing the response of the federal government. That's the appropriate official who should be leading those leading efforts. Again, because this is public money that's on the line and you want to have democratically accountable officials responsible.

It also, I think, is a nice division of labor because it allows the Fed to still continue to focus on monetary policy, which we talked about earlier, really important to continue to get right. And it's very technical policy making there that Congress has been very clear about what the goals are and how the Fed's supposed to operate.

That continues to focus on getting monetary policy right while then supporting the treasury secretary as the secretary formulates the response of the administration.

>> Jon Hartley: Those are some excellent points truly.

>> Andrew Olmem: Division of labor turns out to be good not only in theory, in economics, but also in practice when responding to financial crises.

 

>> Jon Hartley: Absolutely, yes.

>> Andrew Olmem: Our system works, too now there's one last kind of point on that is then you have the FDIC, which largely has the resolution authorities. So I think one of the other reforms, I would say it's been good from 2008 was that rather than having the Fed try and manage restructuring entities.

Those entities now under the new title two will go to the FDIC, and that will be the federal government's resolution expert, right? And that means it will have, can make sure it has on staff the best experts in how to resolve complicated financial institutions all in one place.

It also, again, gets it away from the Fed and the treasury. Those are very intensive work that again, helps divide the labor up of how to respond. Treasury comes out, figures out how to respond, which who has to get money. The Fed makes your monetary policy going in the right direction, lender of last resort functions working, and then the FDIC is dealing with the institutions that have failed or near failing.

That's not a bad way to work it out, and particularly if we're going to have a financial system that has so many regulators, which I think is still a problem. But at least here we've taken one of the problems of our systems and turned it into a little bit of virtue.

 

>> Jon Hartley: Absolutely, now such a great point on all those fronts, divisional labor, clear objectives for various regulators. I couldn't agree more. Such an interesting conversation, Andrew. It's been a real honor to have you on here, talking about your experience and thoughts on all these really important matters across economic policy to banking regulation.

Thank you so much for joining us today.

>> Andrew Olmem: Thanks for having me.

>> Jon Hartley: Today our guest was Andrew Olmem, who's a partner in Mayer Brown's Washington, DC office and a member of their public policy, regulatory and political law practice. He previously served as deputy director of the White House National Economic Council.

This is the capitalism and freedom in the 21st century podcast where we talk about economics, markets and public policy. Thanks so much for joining us.