Shultz on the Economic Meltdown of 2008-09
Shultz on “Too Big to Fail”

PAUL SOLMAN: Now 89, Shultz is a distinguished fellow at Stanford's Hoover Institution, where, of late, he's been pondering the problem of banks deemed too big to fail. A recent quote, "If they're too big to fail, make them smaller," he said. We wanted to know more.

What's the basic problem, as you see it, with financial institutions at this point in time?

GEORGE SHULTZ: In the first place, if somebody, it's known they will be bailed out, well, they -- they do excessive risk, because they're doing it on the taxpayer's dollar. The whole system is badly damaged when bailouts occur. It takes all of the accountability out of the system. And the market system depends on accountability. So, we have to design a system so anybody in it can fail.

Read the complete transcript.

The current economic crisis must be viewed as a gigantic wake-up call. We have been living beyond our means for some years now, and the message is clear: We must change our ways. We are so blessed with human talent and resources that we can meet the challenges and succeed.

How did this crisis get started? The effort to identify the sources of the problem can easily lead us into staggering complexity, but the outline is simple. In the first place, the environment included a prolonged period of Fed-provided, exceptionally easy money. People and institutions behave more responsibly when they have some of their own equity at stake, some "skin in the game." The current financial crisis emerged after this principle became virtually inoperative. In an effort to make housing more affordable, financial wizards, with the implicit backing of the federal government, figured out how to give houses away: no down payment and few if any questions asked about ability to service loans.

People and institutions behave more responsibly when they have some of their own equity at stake, some "skin in the game."

When you give something away, demand rises rapidly, as do prices, so rapidly rising prices made the easy terms look reasonable and seemed to validate them. Meanwhile, financial intermediaries packaged these mortgages and traded in them, in all too many cases with very high (30 or more-to-1) leverage. Once again, there was little equity in these deals. (Read more at the Wall Street Journal.)

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