He spent a week living as a homeless man. That adventure was part of his campaign to defeat California’s entrenched governor.
He once helped develop a component designed to reduce vibrations in the James Webb Space Telescope.
But who would have imagined that last November, 42-year-old Neel Kashkari would be named president of the Federal Reserve Bank of Minneapolis? How did a nontraditional hire — he is not an economist — land the job?
Most of all, because of a very special experience. Kashkari managed the federal government’s $700 billion fund set up to bail out troubled financial institutions endangered in the 2008-09 financial crisis. In a MinnPost interview, he said it’s fair to conclude that he was chosen largely for his work in overseeing the bailouts.
Banks’ critics get top billing
Now, barely three months after he settled into his new job, Kashkari is serving up another surprise. The Minneapolis Fed is staging a high-profile, daylong gathering Monday at its headquarters in downtown Minneapolis. The event will feature appearances by two of the leading critics of large banks, economists Simon Johnson and Anat Admati. Nine more out-of-town experts with a wide array of views about the role of these banks are also on the agenda. The symposium is the first local event in a yearlong initiative unveiled by Kashkari in mid-February at the Brookings Institution in Washington. The effort will include speakers, panels, town halls and applied research designed to explore ways to lower the risk that a collapse of one or more large financial institutions could lead to an economic downturn as bad or worse than the recession the financial crisis did so much to intensify.
Kashkari plans to focus on easing that potential threat by (a) breaking up the big banks; (b) requiring them to issue far more capital than they do today; (or c) taxing leverage throughout the financial system to lower the risk that not just banks but also hedge funds, money market funds, private equity funds and other large pools of money could pose to the system. The bank intends to recommend a course of action by the end of the year.
Notably missing from the program on Monday is representation from Wells Fargo or U.S. Bancorp. Wells, the country’s fourth largest bank, has the second largest work force in downtown Minneapolis with 7,000 employees. U.S. Bancorp, the nation’s seventh largest bank, is the sixth largest employer downtown with 3,945 workers. However, at least one of the speakers has been supportive of the interests of the large banks.
Many outside critics of these banks agree that they should be trimmed down; they are so big and so connected with other financial institutions that the collapse of any one of them could spark global economic turmoil. Yet few within the industry or the regulatory community have gone as far as Kashkari in proposing to scrutinize the power of the big banks.
“I hoped he would take this issue and run with it, and he has,” says Art Rolnick, the longtime research director at the Minneapolis Fed who retired in 2010 after 40 years at the bank.
Building on earlier work
For years, researchers at the Minneapolis Fed have specialized in examining the stability of the financial system, particularly concerns about banks seen as “Too Big to Fail.” In 2004, Gary Stern, then the bank’s president, and researcher Ron Feldman wrote a book about those concerns. They worry that some banks have grown so large and so linked to other financial institutions that they can’t be allowed to fail; a failure could trigger a collapse that would promptly imperil the entire financial system. Before the bailouts of 2008-09, the markets believed the government would step in to rescue financial institutions in danger of collapsing. Today, they still award the big banks’ securities premium prices — in effect subsidies — based on the assumption, however unlikely, of new bailouts should another crisis occur.
Congress and bank regulators have been trying to guard against Too Big to Fail concerns by adopting new provisions such as the Dodd-Frank law, passed in the wake of the financial crisis. But Rolnick and other skeptics say the big banks invariably end up gaming the new laws and rules. Their lobbies are “always one step ahead” of the regulators, says Rolnick.
In fact, the large banks have emerged from the crisis notably larger. Assets at JP Morgan Chase, the largest U.S. bank, have grown 60 percent to $2.58 trillion — 14 percent of the size of the entire U.S. economy — since 2007. In 1983, Citibank, then America’s largest bank, accounted for only 3.3 percent of the economy, according to Simon Johnson. Assets of JP Morgan Chase and the next five largest U.S. banks combined are now $10 trillion — 56 percent of the economy.
Minneapolis Fed researchers found that from the fourth quarter of 2009 to the comparable period in 2015, the combined assets of the nation’s 20 largest bank holding companies rose 14.8 percent to $13.4 trillion from $11.7 trillion.
Lobbyists and researchers backing the big banks cite studies concluding that the costs of breaking them up would exceed the benefits from doing so. They also say regulations enacted since the financial crisis should be allowed to work as intended. John Boyd, a retired economist and researcher who worked at the Minneapolis Fed and taught banking at the University of Minnesota’s Carlson School for many years, doesn’t buy those arguments. “If anything, we’ve made it worse by allowing the large banks to get larger,” says Boyd. “We could have another big one. We’ve got banks out there that are too big to fail, with invidious side effects. We ought to put in size limits and enforce them.” The big banks could be given five years to downsize, he adds.
Raising capital requirements is one of the most popular proposals for limiting the power of large banks because it is seen as a relatively straightforward change as opposed to more complicated regulations. The banks’ capital to assets ratio, a measure of how much equity they hold as a share of assets, had fallen to 3 percent at the time of the financial crisis. Today, it is somewhat higher. Kashkari and others say it might be appropriate to raise it as high as 25 percent. The banks counter that this would greatly increase their costs of funding, which could in turn lower their lending capacity and reduce economic growth.
Kashkari concedes that the new tools regulators have available thanks to post-crisis legislation help, but says now is the time — rather than when another crisis arrives — to put stronger provisions into place. He told MinnPost he disagrees with the view of Donald Kohn, a former Fed vice chair, that new authority given to regulators to wind down large, troubled banks “probably will work.”
Asked whether he thought the power of the large banks’ lobbies is too great, Kashkari said “it’s a concern.”
Time coming for tougher curbs?
Since the Dodd-Frank law, much of the supervision of the large banks has shifted to Federal Reserve officials in Washington. The Fed has been running “stress tests” to monitor conditions at these banks. It has blocked management’s plans for dividends and buybacks at some of them. The Fed and several other regulatory authorities have also drawn up lists of financial institutions seen as too “systemically important” to fail. Large insurers have been included on some of these lists. This week, Met Life, the nation’s largest insurer, won a court ruling that will drop it from such a list.
Kashkari argues that stronger congressional legislation is needed to prevent institutions from being so large and connected that they are too big to fail. He thinks the climate for such legislation is improving. “I feel like now is the right time,” he said. (Democratic presidential candidate Bernie Sanders hailed the Minneapolis Fed’s initiative immediately after it was announced; specialists from several conservative think tanks have also welcomed elements of it).
Kashkari was asked in the interview how effective his proposals to cut down the size of the largest banks would be given that most of the world’s largest banks are based abroad. “We can’t control what other countries do with their financial systems,” he replied. “We should do what makes sense for the U.S. and require all banks that do business here to abide by our regulations.”
As for the banks’ view that breaking them up would make them less efficient, thereby weakening their global competitiveness and, more generally, that of the U.S., he said this: “The benefits of scale of large banks need to be weighed against the risks of that scale. If we can make our financial system more resilient, I believe that will benefit U.S. economic competitiveness globally. If other countries choose to take extreme risks with their banking systems, we can’t stop them.”
Kashkari added that the Federal Reserve System is moving away from a “Wizard of Oz” culture of ambiguous statements and toward more transparency. To that end, the Minneapolis bank is live-streaming its conference on Monday, opening it to the media and wrapping it up with an evening town hall.
Arena of economists
The choice of Kashkari marks a striking departure for the Minneapolis Fed, which serves a territory less densely populated than those of all of the Federal Reserve System’s other 11 regional banks. Economists have held the top job there for nearly half a century. All of the bank’s past five bank presidents since 1971 — Narayana Kocherlakota, Gary Stern, Gerald Corrigan, Mark Willes and Bruce MacLaury — had doctorates in economics. Kashkari earned undergraduate and graduate degrees in mechanical engineering from the University of Illinois at Champaign-Urbana.
Tapping Kashkari, who ran as a Republican candidate for governor of California in 2014, was also an unusual move for the overall Fed. The system traditionally stresses its distance from the political process in order to carry out monetary policies without interference from politicians. In its story about the Kashkari pick, The Wall Street Journal noted that the central bank has turned to only one other aspirant for a highly visible elected office in recent times. The exception was Richard Fisher, who ran unsuccessfully for a U.S. Senate seat in Texas as a Democrat, in the early 1990s. Fisher was president of the Federal Reserve Bank of Dallas from 2005 to 2015.
From telescope to TARP
Neel Kashkari, 42, grew up in northeastern Ohio. His parents immigrated from India in the 1960s. His father was a professor of electrical engineering, his mother a pathologist. He launched his career in 1997 as an aerospace engineer for TRW, a National Aeronautics and Space Administration contractor in southern California. That’s when he helped develop a component designed to reduce vibrations in the James Webb Space Telescope. He moved on to the University of Pennsylvania’s Wharton School, graduating with an MBA degree in 2002. Then it was back to California, to join Goldman Sachs in San Francisco. When Henry Paulson, the former head of Goldman, left to become Secretary of the Treasury in 2006, Kashkari talked Paulson into hiring him as an aide.
Soon, with the subprime housing crisis mounting scarily, Kashkari and another Paulson assistant drafted a bank recapitalization plan — “Break the Glass.” Paulson has described this plan as the intellectual forerunner of TARP — the Troubled Assets Relief Program shaped by the Treasury and other bank regulators to staunch the contagion that raced through the financial system in September of 2008. Kashkari managed the TARP bailouts, which together with other actions, steadied the banking system and the financial markets. Ultimately, the U.S. Treasury profited from the bailouts, recovering $442 billion after laying out $430 billion. But the financial crisis turned what initially looked like a garden variety recession into the deepest downturn since the Depression. Many millions of Americans lost their jobs and saw the value of their homes and stocks plunge. The sluggish recovery from this recession has taken years.
After leading the bailouts for seven months, Kashkari dropped out to live in a cabin in California’s Sierra Mountains. “It’s detox of a tough period,” he told Washington Post reporter Laura Blumenthal for her widely read story, “The $700 billion man.” Then he returned to the private sector to manage stocks for Pimco, the huge bond fund firm based in Newport Beach, California. In 2013, he left Pimco to map out a run for governor as a fiscal conservative with moderate social views. Kashkari beat a hard-right conservative to become the GOP candidate against Gov. Jerry Brown. He roamed the streets of Fresno for a week as a homeless person to buttress his argument that over-reregulation, high taxes, failing schools and misguided water policies led to record-high poverty rates in California. Brown defeated him by a three-to-two margin.
Kashkari tweets regularly. He is a rabid fan of the Cleveland Browns, so much so that he named his two Newfoundland dogs for players on the team.
Mapping a media blitz
Last year, after Kocherlakota decided to leave the Minneapolis Fed for a teaching and research job at the University of Rochester, the Minneapolis Fed hired Spencer Stuart, a leading executive search firm, to seek a new president. The bank’s search committee of six non-bank directors chose Kashkari from among 75 candidates. The Fed’s Board of Governors approved him 5-to-0.
After he started work, the bank’s staff quickly developed plans for the initiative to explore curbing the big banks’ power. Asked if he had proposed the idea as part of the process of landing the job, Kashkari replied, “No, I did not.” Rather, he said, the plan arose out of meetings with the bank’s staff after he began the new job. Staffers pointed him to the body of work done by the bank on the Too Big to Fail issue. It quickly became obvious that this expertise could be the basis for further research and events to better define these concerns and give them a larger audience, Kashkari said.
A few days before Kashkari disclosed the initiative, he met with representatives from the Weber Shandwick public relations firm to discuss media training, which the firm typically does for senior management at the Minneapolis Fed. Then, in a separate effort immediately after the Brookings meeting on February 16, Kashkari met with financial journalists from the Washington Post, the Wall Street Journal, the Financial Times, CNBC, Fox Business News, Bloomberg Radio and TV, National Public Radio and Reuters. Later in February, he appeared on the Charlie Rose show and the “PBS News Hour” and did an interview with the New York Times.
He has a lot to talk about, given his insights into the dark side of banking and finance when he managed the bailouts. It was by many accounts a challenge so unfathomably big, so awesomely complicated and so utterly unpopular that nobody else had ever done anything like it.
And it led Kashkari to sharply revise his view of how the financial system operates. He told MinnPost that the experience transformed him from a free-market ideologue into a pragmatist. “We saw firsthand the limits of free markets in 2009,” he said.