(CNSNews.com) - John Allison, the former chairman and CEO of BB&T, the nation’s 10th largest bank, told
"What we need to do is get rid of the long-term program,” Allison said of Social Security in an “Online With
Allison said he believed Rep. Paul Ryan’s (R.-Wis.) proposal to allow workers to put part of their payroll tax in a personal retirement account that they would convert into an annuity when they reached retirement age was a good practical solution for Congress to pursue on Social Security, but that personally he would like to see people entirely liberated from the entitlement program, letting them plan and save for their retirement free of government compulsion.
"You know, if you look at what killed democracies in the end, it’s always lack of personal responsibility,” said Allison. “And it’s when 51 percent of the people find out they can vote a free lunch from 49 percent, and then 60 percent want a free lunch from 40 percent, and then 70 percent want a free lunch from 30 percent, and that’s the end of the party.
"All of this dependency on the federal government ends up attacking and almost punishing personal responsibility,” said Allison. “And
Allison became president of BB&T in 1987 and was elected chairman in 1989. He remained CEO through 2008. He is now distinguished professor of practice at the Wake Forest University Schools of Business.
You can read a transcript of
John, thanks for joining me.
John Allison: Glad to be here, thank you.
Jeffrey: Unemployment was at 9.6 percent in September. It has been above 9.5 percent since August of 2009. Real GDP grew at only 1.7 percent in the second quarter of this year. The real average earnings of American employees grew by only one half of one percent from ’09 to ’10.
Now, as of Friday, according to the Treasury Department, President Obama had borrowed since his inauguration $3 trillion, which is as much as the entire debt that the
Allison: Terry, that’s a great question. In my opinion, there’s no question of the answer and the answer is there’s something wrong with the government.
If you look at how we entered this financial crisis and the following great recession, significant government policy mistakes were made. We do not live in a free market in the
Fundamentally, government policy created a bubble in the residential real estate market that deflated as all bubbles do. The nature of that policy were severe errors by the Federal Reserve in over-inflating the monetary supply, trying to avoid a correction in the past, and then that bubble ended up in housing because the giant government-sponsored enterprises, Freddie Mac and Fannie Mae, which when they went broke owed $5 trillion dollars.
It is true that individual market participants, the so-called Wall Street firms, made some very serious mistakes and if I’d been in charge, I’d have let them fail, but those mistakes were secondary to the policy issues created by primarily the Federal Reserve and Freddie Mac and Fannie Mae.
Jeffrey: John, let’s talk about that housing bubble for a little bit. No doubt its central to the American dream that people, when they grow up, they want to get a job, they want to work hard, they want to save, they want to put together the money they need to put a down payment on a house, buy a house, build equity in the house as a way of building wealth in their life. I mean, this is central to the way Americans have viewed their lives, particularly in the 20th century, I think. What happened that caused that bubble? What is it that the government did that specifically that caused that problem in the housing market?
Allison: Well, you describe the American dream, and that’s so for the people that dreamed it that way. They got confused in the sense that they believed owning a house per se would change human behavior. It’s actually the other way around. The set of characteristic that enable people to own homes result in better behavior. So, just giving people houses per se does not change their behavior. So the government set about a program trying to--believing that if everybody had a house they would all act differently which, in fact, didn’t happen.
They started with the Community Reinvestment Act back in the 1970’s, which was oriented towards encouraging low-income home ownership. But the big decision that was made was actually made by Bill Clinton back in September of 1999, was to basically force Freddie Mac and Fannie Mae, these giant government-sponsored enterprises that would have never existed in a free market to have at least half their loan portfolios in affordable housing--i.e. sub-prime lending. And that was a huge risk because the legitimate affordable housing market—people that are kind of on the income bubble but are disciplined—is not that big. So, they were making home loans to people that didn’t have the discipline, didn’t have the down payment, didn’t have the income history to pay for their houses, and a lot of those loans ended up failing and it pushed a bubble through the whole U.S. economy, because if you push up the prices of the entry-level houses, then a person in an entry-level house sells his house for a profit, buys a bigger house and buys a bigger house and it pushes through the whole economy.
And here’s what people don’t get: When you waste resources—and it was over a trillion dollars, the too-much-housing bill, that’s a trillion dollars in capital that doesn’t go to a productive use.
In addition, you mentioned unemployment. What, we spent years teaching people how to build houses. Now, we don’t need for those people to be building houses, right? But that doesn’t mean they all of a sudden know how to become computer technicians, or even work in a manufacturing plant. And as we built these houses, we drove up wage rates for construction workers, and that drove up wage rates, interestingly enough, for manufacturing workers, and so the manufacturing jobs went to
Jeffrey: John, let me take you back—you talked about trying to make people change their habits or putting things backwards. If I understood you correctly, are you saying that, traditionally, in order to be able to buy a house in our free society, someone had to have developed certain habits and virtues—some fundamental things like getting up in the morning and going to work, and then not spending as much money as you earn, actually saving money, and accumulating the wealth you need to form a down payment, and having demonstrated the sort of habits in your life that would make you a good risk to someone that was willing to give you credit. Are you saying that people in government pursued a policy that thought that they could take people who hadn’t developed those virtues, and through the government policy of giving them a home develop those virtues in the person? Is that what you’re saying?
Allison: Absolutely. That is exactly what their belief was—and it was both Republicans and Democrats. They believed that owning a home itself would change human behavior, which is absolutely not true. But it really is, on a fundamental level, happiness has to be earned, and a house has to be earned. It’s not the house, it’s the earning of the house, that has the value in it, and they got cause and effect backwards.
Jeffrey: And, so, do you think they’ve learned their lesson that the government cannot create virtue in citizens by giving them a subsidy?
Allison: I don’t believe they’ve learned it at all and it’s tragic. Because, on the other hand, unfortunately, they do know they can get votes oftentimes by giving a subsidy. So you have a dual conflict and I saw this with Freddie Mac and Fannie Mae. I was on a committee, a financial services roundtable, for nine years trying to do something about Freddie Mac and Fannie Mae.
Jeffrey: You saw it coming?
Allison: You couldn’t help but see it coming. You ran the numbers, particularly the last several years, and it was mathematically certain Freddie and Fannie were going bankrupt.
Jeffrey: This was not a surprise.
Allison: We met with Congress. We met with Barney Frank and Chris Dodd and they absolutely wouldn’t see it. And the reason they wouldn’t see it was two-fold and it really relates to these two issues: One, they had a religious belief that affordable housing was a good thing; it was going to change the fundamental behavior of people and improve the quality of life. And, secondly, Freddie and Fannie were huge political contributors. They were the single biggest contributor to the Democratic Party and one of the biggest contributors to the Republican Party.
Jeffrey: Even though they were basically a government-subsidized enterprise?
Allison: Absolutely. They wouldn’t have existed. The government guaranteed their debt. Even before they got in trouble, they were leveraged about a thousand to one. They had a thousand dollars of debt for every dollar in equity, which had driven everybody else, by the way, out of the house-finance business.
Jeffrey: Now you said that Fannie and Freddie together had $5 trillion in debt?
Allison: They have $5 trillion in debt, and $2 trillion of that was related to subprime affordable housing.
Jeffrey: What does subprime affordable housing mean exactly?
Allison: Well, basically, it meant high risk--it meant loans that people generally had low incomes or the debt-to-income ratios were very high or the worst case, and this is where your biggest problems were, the people had okay incomes and the debt-to-income ratios were okay, but they had bad habits of not paying their debts. Because, you know, it’s wrong to think that all the subprime loans were just low-income people. There were a lot of middle-income people who had bad credit histories because they didn’t have self-discipline—just making money doesn’t mean you’ll spend it properly--and a lot of those people were able to buy bigger houses under this more relaxed--i.e. subprime lending-phenomenon.
Jeffrey: So, is it fair to say that the kind of person who is getting a subprime loan regardless of what their income was or the value of the house they were trying to buy, they were a person that if they brought their personal history, their economic history and so forth, to a bank in the free market, the banker would be reluctant to make that loan to the person because they’re quite frankly a bad risk?
Allison: Right. I would say the vast majority of the subprime loans would not have existed in a free market.
If you go back to the early 1970’s when the savings and loan industry dominated the house finance business, and they made loans and held them, the vast majority of these borrowers couldn’t have gotten a loan. First, those savings and loans generally required 20 percent down, and second they had a cap on the debt-to-income ratios. So, the savings and loans weren’t purely private but they were closer to being private enterprises and had to exercise much more discipline in terms of lending credit to homeowners.
Jeffrey: So the federal government, systematically and with forethought, pursued a policy that was designed to get banks in the private sector to loan money to people who are a bad risk in order to allow those people to buy houses?
Allison: Oh, absolutely.
Jeffrey: And that’s what led to the Fannie-Freddie problem?
Jeffrey: And that led to $5 trillion in debt being transferred essentially from the responsibility of Fannie and Freddie to the responsibility of the
Allison: Right. You now guarantee that 5 trillion dollars in debt. Congratulations.
Jeffrey: They’re still holding it but we’re responsible for making sure it’s made good?
Jeffrey: What’s going to happen there do you believe?
Allison: I don’t know what’s going to happen; I know what should happen. What should happen is that Freddie and Fannie should be--They should make an announcement, six months from now, Freddie and Fannie are out of business, they’re going to liquidate their portfolio, and we’re going to have a private market for home finance in
Jeffrey: Now, if you shut down—Fannie and Freddie, as I understand it, they took all these mortgages and they securitized them. They put them into bonds where you’d have multiple house mortgages in one financial instrument that was then sold. Can those things be unraveled or are they stuck together for eternity?
Allison: They’re stuck together, so Freddie and Fannie are going to have to pay out their debts based on how many of those mortgages pay, and the taxpayers or going to have to potentially have big losses, but those losses—every day they’re making it more risky because they’re making more losses. So, whatever your losses are, now’s the time to cut them off.
Jeffrey: Okay, so Fannie and Freddie have this combined $5 trillion in debt. There’s some percentage of that debt that’s wrapped up into these securitized mortgages that can’t be undone, that are bad, and the bottom line is the taxpayers are going to have to pay those off you think?
Allison: Oh, absolutely. Either way. And how bad that is really depends a lot on what happens with interest rates and real estate prices. You know, the taxpayers could suffer up to a trillion dollar losses. It may not go that high, but if the economy stays weak or if interest rates rise rapidly. Here’s an interesting thing to think about. Today, almost all home financing in
Jeffrey: Right. I’d like to get back to that in a second, but I just want to make sure I understand this question about liquidating Fannie and Freddie. So, what you think ought to be done is at the soonest possible moment we just shut these two enterprises down, liquidate all these mortgages and securities they have, and you think maybe that’s a trillion-dollar hit to the U.S. taxpayers if we do that?
Allison:Yup. And you could liquidate them by just letting them pan out. You don’t have to sell them or anything, you just liquidate them by letting them pan out. But what you want to avoid is: Are they making high-risk mortgages today? And the answer is, yes, or else there would be a private market that would be competing against them.
Jeffrey: Right, so that’s your second point. Let’s get to that second point in a second, John. But, so, obviously there’s going to be an election, a new Congress is coming in. Regardless of the partisan balance of that Congress, you think that Congress needs to get rid of Fannie and Freddie and take the hit next year because if we wait, it’s going to be a bigger hit to the taxpayer down the road?
Allison: Well, I think we need to get rid of Fannie and Freddie. I don’t know—Well, I think we take the hit as we actually liquidate these mortgages, because we don’t know what the hit will be.
Allison: What we need to do is stop them from making new mortgages and let a private market develop. One thing that people miss is that one of the few economic systems in the world that had no problems during this crisis was Canada, and one of the main reasons is house financing in Canada is provided by the banks, which meant they required 20 percent down and they didn’t make high risks because there’s no Fannie and Freddie to compete against in the Canadian marketplace.
Jeffrey: Okay, now, so let’s go to this, your second point, because I think this is a stunning point. You’re saying that essentially it’s the federal government that is making all the home mortgages in the
Allison: Through Freddie Mac and Fannie Mae, which are government agencies, they’re formally government agencies now. If Bank of America originates a mortgage, there’s a very high probability that mortgage will be sold to Freddie Mac, Fannie Mae, or, if it’s a higher risk borrow it’ll go to the FHA, which is another government agencies. I think something like 90 percent of home-mortgage financing in
Jeffrey: So, Bank of America, if they’re going to make a home mortgage, they’re not really thinking, "I’m going to loan this guy money to buy his house over 15 or 30 years and I’m going to hold the mortgage and he’s going to pay the money to me." They’re saying, "I’m going to set up this loan to this guy for this house that I can turn around tomorrow and give to Fannie or Freddie or the FHA."
Allison: Yeah. And Bank of America almost has no choice because they wouldn’t be willing to offer the interest rate and to take the risk that Fannie and Freddie are willing to do.
Jeffrey: So, they’re basically, the banks in this country or the mortgage-lending institutions in this country are essentially now fronts for the federal government when it comes to making home mortgages.
Allison: Well, "front" is a harsh word, I just think that that’s the way the market has evolved because government owns and controls the marketplace. You can’t compete again the federal government.
Jeffrey: So this is a perverse incentive for the banks?
Allison: It’s a perverse incentive for everybody. I mean, because you couldn’t--a homeowner, if you can get a mortgage from Freddie or Fannie for 5 percent, is not going to pay Bank of America 6 percent.
Allison: But if Bank of America were going to do it they would need to charge at least 6 percent. Here’s why: Freddie and Fannie cannot hedge the interest rate risk in a mortgage portfolio. You can’t hedge a 30-year mortgage. So, if interest rates stay low, they’ll be okay. But if interest rates rise, what happens? People refinance their houses less and they’re going to have whopping losses from rising interest rates.
Jeffrey: Right. Right.
Allison: And a private institution wouldn’t be willing to take that kind of risk. The taxpayers are taking huge risks on rising interest rates because there’s no way Freddie and Fannie can hedge 30-year mortgages.
Jeffrey: So the bottom line is you’re saying we really haven’t gotten through this housing crisis. We haven’t actually resolved this. We still have what you’re describing hanging over our head, this distortion of the market.
Allison: It’s hanging there, and then the whole effort to keep people from foreclosing is also keeping the market from clearing. The best thing that could happen with housing is let’s find the bottom of housing prices and then start from there. When people feel like housing prices are finally bottomed, they’ll start buying houses again. But you can’t get a market moving when people can’t figure out what the bottom is.
Jeffrey: So you say, let’s just go back to the market.
Jeffrey: Do you think that there is a group in Congress that shares your point of view and will be ready to move forward with this policy?
Allison: I think there’s a group in Congress but unfortunately I think they represent a pretty small minority.
Jeffrey: So you would not count on the leadership of either the Democratic or the Republican Party to move in this direction and try and get back to a free market in housing?
Allison: Well, there’s always hope. And I think that more people in Congress, particularly on the Republican side, are realizing how bad that Freddie and Fannie are. So, I don’t think it’s hopeless, but I’m not optimistic at the same time.
Jeffrey: Okay, John, we’ve talked about the debt problem insofar as it relates to houses, which people can relate to obviously in their personal life, but then there’s the larger—the overarching—debt problem of the
Allison: You know, that’s a very, very important question.
I think the first thing we have to realize is where we’re going and to face it objectively. If you run the numbers, on all those numbers that you just talked about, which I think are accurate, very accurate, in 20 or 25 years, the
It reminds me very much of that story I told you about Freddie Mac and Fannie Mae. We were running the numbers and Freddie Mac and Fannie Mae went bankrupt, and we got there. In 20 or 25 years, the
Now, countries don’t go bankrupt the way companies do. They don’t file bankruptcy. They usually hyper-inflate. They print a bunch of paper money, or they become Third World economies like
And the irony of that is it requires an interesting combination. It requires both discipline, but it also requires a focus on growing our economy. And it means a fundamental philosophical change from where we are today, from the idea of redistributing wealth to the idea of creating wealth. The
I’ll tell you one of the easiest ways to cut costs would be to cut the whole massive government bureaucracy and all the regulations that go with it. I know in my career, between 1971 and today, the amount of paper that it takes to make a loan has gone--you could make a loan with two sheets to whoever, two thousand sheets. I don’t know how many sheets of paper it takes to make a loan. And all that’s been added in the last 40 years. We could reduce bureaucratic overhead by hundreds of billions of dollars, maybe as much as a whole, if you look at the secondary effects, by a trillion dollars—and at the same time, the elimination of all that useless government red tape would spur economic growth and productivity.
Jeffrey: Okay, well John, that’s one side of the equation—getting government out of the way of individuals so they can go out and they can create wealth and build businesses and create jobs, and for good or bad, generate more revenue for the federal government.
Jeffrey: But on the other side, a lot of people and I believe accurately point out, that the driving engine of the debt problem in the United States, especially as we look forward, are the entitlement programs.
Jeffrey: And primarily Medicare and Social Security. Medicare makes up $38 billion of that 61.9--excuse me, $38 trillion--of that $61.9 trillion in unfunded liabilities. Growing the economy doesn’t solve the entitlement problem, does it?
Allison: Well, it obviously helps, but, no, it doesn’t solve the problem. And here’s what we need to do in regards to entitlements. Social Security, interestingly enough, is mathematically fixable. It won’t be much fun, but it’s mathematically fixable by phasing in a higher retirement age and, unfortunately, maybe raising the taxes a little bit on higher-income people. But what we need to do is get rid of the long-term program. And the way to do that, even though it may create some short-term funding problems, would be to offer people privatized programs for retirement and effectively offer people under a certain age the option to get out of Social Security.
And the reason that would be a double effect is you wouldn’t have these unfunded liabilities that you’re creating because you’re under-funding Social Security, but secondly, you would have a huge amount of capital created that could be used to make American workers more productive. If Social Security had actually been a private savings account and we had all that capital in the capital markets, we’d have much better equipment, we’d have much better technology, we’d have much better educational institutions, because there’s a double whammy with Social Security. There’s no real savings. We never saved the real money in Social Security, right. It’s a ponzi game that depends on the young people paying for the old people. And that means that there’s been no capital accumulation. So, you’re probably going to have to raise the age, raise the taxes, and offer young people an out so we start creating capital.
Jeffrey: John, Congressman Paul Ryan from Wisconsin, who is the ranking Republican on the Budget Committee, has actually offered legislation that would allow people to take a certain chunk of their payroll tax, which is for Social Security, and put it into mutual-fund-type investments over the course of their working lives. At the end of their working life, they’d be required to buy an annuity that would pay them the equivalent of a Social Security benefit and any surplus they had over and above that they could do whatever they wanted with. The actuary of Social Security has said that Ryan’s legislation would actually make the program solvent over the long run. Is that the sort of thing that you would like to see or would you like to see it even loosened up more?
Allison: I would certainly like to see what Ryan is proposing. Personally, I would actually do more. I’d be even more dramatic because I don’t really think that it’s the role of government to force savings on people. I think that’s an individual choice, an individual responsibility, and they get individual consequences, right. They may have to work longer if they choose not to save. There’s certainly an interesting issue about the high savings rate forced on 18-year-olds when they go to get their first job, and 23-year-olds when they’re trying to raise their children. So, I’m not sure Social Security is economically efficient, but I don’t think we’ll get rid of it. So, I would certainly take Ryan’s proposal over anything else I’ve seen, practically speaking, offered in Congress.
Jeffrey: It’s not ideal but in terms of practical—You know, the first Social Security check was paid to a lady named Ida Mae Fuller, who was from
Allison: I think it’s a terrible thing.
Jeffrey: And you think it’s a bad thing for the government to say to people, ‘you must save, whether it’s for Social Security or some other form. You think that people should have to make the choice on their own?
Allison: I do, and I think they would make better choices. Not everybody. But I think over time people would make better choices.
Jeffrey: Do you think the American people and the American culture has changed since 1940, since we started to create this welfare state where people are dependent in some ways on the federal government for their well-being?
Allison: I do, and I think it’s a huge threat. You know, if you look at what killed democracies in the end, it’s always lack of personal responsibility. And it’s when 51 percent of the people find out they can vote a free lunch from 49 percent, and then 60 percent want a free lunch from 40 percent, and then 70 percent want a free lunch from 30 percent, and that’s the end of the party. And all of this dependency on the federal government ends up attacking and almost punishing personal responsibility. And
Jeffrey: And it worked for most of our history, John. Last question that I can ask you: Social Security, according to the Treasury Department figures, only makes up about $7.7 trillion of that unfunded liability. So as you said, it’s mathematically fixable. So it’s a lot smaller than that $38 trillion we face in Medicare. How do we unwind this Medicare liability that we have?
Allison: The answer is to privatize medicine. Go back and to really subsidize really poor people. Now, thinking about the process of undoing that is a complicated task because we have people we’ve made obligations to. But what’s lacking in the medical system is discipline. There’s no price competition in medicine. And that’s the problem.
Whenever you destroy price competition you get massive waste of economic resources. If you look at Lasik surgery, which is not typically—you can’t get it paid for by insurance of any kind--the price has been in a freefall. In every arena—if you look at veterinary medicine, the quality-to-price ratio has been improving significantly--every time there’s competition. The lack of competition in the medical system is leading to huge economic waste. And we have a terrible incentive: The doctor, a, is scared he’s going to get sued, and the more he charges the more money he gets, and the patient really doesn’t think about the price because he’s got, quote, insurance, and particularly if he has Medicare, somebody else is determining the price. So the doctors have huge motivation to over-prescribe medicine and use the most advanced technologies that may or may not make any sense from a long-term health care perspective.
Jeffrey: So, John, just to close up, you think that either private charity or even government ought to take care of the truly poor and needy, but for the rest of us, we should have a free market in medicine too?
Allison: Absolutely. I think there is a very important role for private charity. I think that’s a very good thing. But I think private charities have a very different kind of discipline. It is the entitlement to medical care that’s dangerous. My right to medical care is my right to enslave a doctor or enslave somebody to pay that doctor to provide me that care. That is exactly the opposite of the American concept of rights where each of us has a moral right to what we produce, what we create. We don’t have a right to anybody else’s life.
I think there is an important role for charity, but that’s voluntary. And the fact that it’s not entitled means that you can put some discipline on it. So, if you’re going to get my charity, I may make some rules about how you have to behave, which is a fair tradeoff.
Jeffrey: John Allison, former chairman and CEO of BB&T, professor at Wake Forest University School of Business, thank you very much.
Allison: Yes, sir. Thank you. Have a great day.
Jeffrey: You too.