My Two Cents

Robert Rubin

Chris Farrell Oct 25, 2007

A small group of journalists met with Citigroup chairman and former Treasury Secretary Robert Rubin yesterday. Walter Mondale, former Vice-President and Ambassador to Japan, hosted the session. It’s impressive how much these men have accomplished in their lifetime. Rubin was in to give a speech for the law firm Dorsey & Whitney.

A couple of highlights from the conversation with Rubin:

He believes the Federal Reserve Board does face a risk when the central bank does cut its benchmark interest rate once again. The reason is the move could spark a plunge in the value of the dollar, which is already down sharply in the world currency markets.

The credit market turmoil ,and weakening economy is why the federal government should run a sound fiscal policy. It’s not clear that monetary policy will be highly effective in the current environment. If the federal government were running a surplus, fiscal policy could play a much bigger role underpinning economic activity..

For the first time since the early 1970s he’s seeing a large group of the really affluent interested in Democratic party policies.

In Greenspan’s book, the former central banking maestro is very bleak on the outlook for inflation in his forecast to 2030. Rubin isn’t concerned about inflation, however. He thinks the global supply of goods and services will keep downward pressure on inflation. The counterforce would be if there is a sharp decline in the value of the dollar or if America put up a series of protectionist barriers. .

Independent of short-term views, there are a lot of challenges facing the American economy and society. Health care. Education. Fiscal imbalances. Global warming. Displaced workers. Everyone of these issues is difficult. Is our political system up to making these difficult judgments? (I think he’s pretty skeptical that you can get the kind of bi-partisan compromse that needed to address each of them.)

He defended the controversial $80 billion “super-SIV” plan spearheaded by U.S. Treasury Secretary Henry Paulson and three giant banks, Citigroup, Bank of America, and JPMorgan Chase. (Here’s the basic idea: The $80 billion fund will buy highly complex and illiquid structured investment vehicles or Sivs. SIV sell short-term debt to buy mortgage securities, and profit from the spread between low interest rate commercial paper and higher interest rate mortgages. Problem is, with all the turmoil in the mortgage market, and uncertainty about the value of the mortgages, SIVs aren’t finding any buyers for their commercial paper. The fear is that SIVs will be forced to liquidate their holdings in a firesale, harming the global capital markets. The super-SIV is designed to prevent such a firesale and the prospect of another credit crunch.) Rubin said that there is about $300 billion in SIVs and about $200 billion is at risk. The remaining $100 billion is held by well capitalized banks, like Citigroup. He says the right analogy is that the SIV is to prevent a “run on the bank.”–although its really a run on the capital markets. It’s a way to avoid the problem of assets sold at panic prices.

Derivatives. He is truly worried about the derivative market. He believes that there has been an exponential increase in financial engineering that hasn’t been tested by adversity. He isn’t worried about hedge funds being over-leveraged, however.

Liquidity is psychological, not monetary. The past three years or so there was a systemic underestimation of risk. Markets have short memories.

Short-term, the biggest risk is the impact on American consumers from high world oil prices, soft housing market, tighter credit conditions. He thinks the economy will slow, but still skirt a recession. Still, can’t rule out the risk of a recession.

Long-term, the global economy going through a transformation of historic proportions. The emergence of China, India, and other emerging economies. It’s equivalent of the emergence of the U.S. economy, or maybe even as big as the rise of the Industrial Revolution, as former Treasury Secretary Larry Summers has suggested. Non-Japan Asia to become the center of the global economy over the next 25 years.

A risk of increased protectionism in this country and around the globe. Troubling, the rise of protectionism in the U.S. about China.

Globalization will continue to put wage and job pressure in the U.S.

Broad participation in growth is critical to growth. American people will support the policies if they benefit from it. Need to continue trade liberalization with a powerful domestic agenda.

The politics are difficult. People who support trade don’t support the domestic agenda. And people who support the domestc agenda don’t support trade.

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