[forbesvid id="fvn/inidaily/ini-fullvideo-william-rhodes-banker-to-the-world-citi" showid="80"]Steve Forbes: Bill, great to have you with us. You've been involved until 2008 in virtually every major debt crisis around the world, from Turkey to Uruguay, Asia and everything else. You've got a great new book out where you recount your experiences. I don't know how you survived all those plane trips. I've always said that people who take a lot of plane trips, those miles should be convertible into a 401(k), which would put you on our rich list with all the travel you've done.
Bill Rhodes: I think that's a great idea.
Forbes: But tell us just briefly, before we get into the crises today, how you got involved in banking. It was quite a circuitous route, it seemed, on a freighter.
Rhodes: That's right. I took my freshman/sophomore years at Brown University and wanted to see Latin America. So I hired myself on first as a cabin boy and then the next year as an ordinary seaman and went down the east coast one year and the west coast the next year.
So I helped myself learn Spanish. Then it came time to look for a job. I had been playing lacrosse up at Brown and I busted up my knees. I thought I was going into naval training school at Newport, and suddenly I had two busted knees. And in those days the operation wasn't as easy as it is today. So they did the operation and they weren't interested in me.
So I have to go out and find a job. I heard they were hiring at Citi. George Moore, who was a great banker, was running the international division. He was hiring people who could speak Spanish to go to Latin America. So that's how I got the job. I never thought I was going to be a banker. I was brought up on the opposite side by my father, having come out of the Great Depression, and I thought I was going to get in the oil business or something, as he was.
Forbes: You also made note that the equivalent of human resources said, "Don't hire this kid."
Rhodes: Yeah. Because I was telling them stories about my trip. They said no. And then George Moore said, "I want to talk to him anyway." And what George said to me – after we spent a little time talking and he found out that I worked my way through Latin America for two summers at Brown – he said, "I don't care what they have to say. What we're looking for here is workers, not talkers. We've got too many talkers and you're hired." And that's how it started.
Forbes: Sounds like Washington today, about talkers. One of the things you've emphasized is a comprehensive approach when you have these crises – that it's not enough to focus on just the debt itself, you've got to make sure the borrower can get back on its feet. In terms of Europe, you've used the words and others have, austerity, austerity, austerity: Ain't ultimately going to work. Please explain for me.
Rhodes: Well, you've got to have a plan, first of all, that you can sell to your own population. Because if you don’t have the population of the country behind you, it's not going to work. Austerity is just one part of reform. They used to call it "adjustment," as you remember, in the 1980s and '90s. Now we're into the word "austerity." But if you don't have a pro-growth program in, it's not going to work. You have the revenue side there. And I think that that's one of the problems that we've seen in Greece, because they haven't been able to adjust the tax system, they haven't been able to start privatizing and all they've been doing is cutting.
They're in their third year of negative growth. And until you can get Greece, Ireland, Portugal – and Spain is just hanging in the balance here – into a pro-growth strategy, they're not going to be able to work their way out. That was the beauty of the Brady Plan because that allowed a path towards growth.
Forbes: Now describe briefly – some people may not remember those years when the Brady Bonds were invented. What, essentially, do they do? They take the debt and make it longer?
Rhodes: Yes, well what they did is they securitized it because it was basically bank debt.
Forbes: Right.
Rhodes: And when you securitize it, you can trade in the market and it makes it much more interesting.
Forbes: Gives you an instant barometer of how people feel.
Rhodes: Exactly. And you had options; you had an option to take a hit on interest, to take a hit on principal or even if you wanted to put new money in, you could do that. And it all added up together, backed by zero coupon bonds. Part of this was financed by the IMF, World Bank, there were U.S. Treasuries, zero coupon bonds, the Japanese Government, regional development banks like the Inter-American Development Bank. Basically, what it did is allowed the countries of Latin America – and subsequently those that had problems in eastern Europe and Africa and some in Asia, like the Philippines – to get back to growth.
Forbes: Now, part of making that happen is the word "leadership." Where in the world is leadership in Europe, where somebody steps up and says, "Hey, let's get realistic about this and restructure"? And, as you say, have a pro-growth strategy so the borrower can maybe pay you back.
Rhodes: Well, I think they've wasted 18 months because it was very apparent right after Papandreou became the prime minister [of Greece] at the end of 2009 that they had a major problem with the books. And they took until May – the EU and the IMF – to come up with a program. By then, the markets were becoming very concerned. And today the markets, as you know so well, operate in nanoseconds. It's not like it was in the early 1980s when we dealt with the Latin American debt crisis. You can't fool the markets. So the markets started to move against not only Greece, but other countries. And I kept warning the policy makers about contagion.
This is a word we learned in Latin America, relearned again in Asia in the financial crisis in 1997-'98, and the European policy makers didn't buy off on it.
Forbes: Sort of a domino theory.
Rhodes: Exactly. Pretty soon we had both Ireland and Portugal, with the attempt to try and ring-fence Spain. And a few weeks ago you saw the problems in Italy. So I think that finally forced the politicians, the heads of state in Europe, to get together and put together some program. But a lot of time was wasted. Paul Volcker taught me that early on in the debt crisis when he ran the Federal Reserve – that the clock is always running against you.
Forbes: You look at Greece, which is still all austerity – they talk about privatization, but it's one thing to say it and quite another to make it happen. Why don't they put in a flat tax, as their neighbors like Albania and Bulgaria have done, which makes tax collecting very easy?
Rhodes: Well, I think that's something that they definitely ought to look at, because the present system isn't working. People aren't paying taxes. And it's now been aggravated by three years of negative growth. So I think this is something they definitely ought to take a look at.
As far as privatization, they have to move on it, because otherwise this program that they had this big battle over a few weeks ago with the parliament in Athens won't work.
Forbes: Just one little story, I was in Greece a month ago and there was a conference. And they had the minister from Poland, which has done a very successful privatization in the last two years – 500 companies, including several billion-dollar ones.
Rhodes: Right.
Forbes: He was there. He outlined what they did, fascinating, and then he, in exasperation, said, "Why isn't anyone from the Greek Government here talking to us on how we did it?” What they can learn – making something like that work – gets to your point. Let me ask a broader question. First, on Britain: Yes, they're doing austerity, but they've also been, except for a little bit on the corporate side, raising taxes as well. Are they making sort of the same mistake? Too much austerity, not enough room for growth?
Rhodes: Well, they've got to get some growth. And as you know, they had minimal growth –
Forbes: Yeah. You need a microscope.
Rhodes: 0.02% this last quarter. And I think for that program to succeed, they've got to make some changes there because there's no doubt they've got to reduce the deficit.
Forbes: Right.
Rhodes: But at the same time that they reduce the deficit, they've got to make sure they get growth. So now the pressure is going to be on the Bank of England again to do a quantitative easing. And of course inflation is 4+% and the Bank of England doesn't want to do it. They've got to come up with some formula where they can reduce the deficit over time, but also get some growth.
Forbes: This leads to a broader question, and that is: Why are banks always buying government debt?
Rhodes: I think that's a good question. Because they basically think it's safe.
Forbes: They should read your book.
Rhodes: Exactly. One of the things, again, Paul Volker taught me, he said, "You know, Bill, the problem with bankers is they have a big crisis, they manage to get through it, and then within ten years, it's back on them." And of course what I always say is, “With investment bankers it's usually five years.”
I think part of that was one of the reasons, actually, that I wrote the book – so that you have the lessons learned the hard way, Latin America, Asia, and other areas. Turkey, all these other areas. And when we have these problems, we learn from them. The learning lesson is hard because Europeans didn't want to be compared with the Latin Americans or the Asians. And here in the United States, we're sitting with our own big problem.
Forbes: Do you think the Basel Accords have anything to do with it – in terms of, now that they try to rate your capital that government, it's always AAA or near AAA, so they did more than they would have if they weren't under those pressures?
Rhodes: Well, actually, I think it's even more than that, Steve, because the head of the Basel Committee will tell you that these are the minimal standards vis a vis capital. In other words, they're saying this is a base, and if your individual country wants to add onto that, they can do so. And I think we're going from a situation here where people felt the supervisors and regulators didn't utilize the laws on the books three years ago in the great recession, to now they want all of this new regulation and additional capital and we've got to be very careful we don't cut off lending.
So I think you've got to be reasonable. What you want is regulation, but smart regulation, not excess regulation. And that is properly implemented by the supervisor. That's what you need – not just stacks and stacks of regulation and increasing capital, capital, capital.
Forbes: So you wouldn't give high marks to Dodd-Frank?
Rhodes: Well, I think it's not even clear how it's going to be implemented. I think that's one of the questions today. We still don't know, a year later –
Forbes: What the rules are?
Rhodes: What the rules are and how they're going to be implemented. Because at the end of the day, once you agree on the rules, what really counts is the supervision. My friend Jacques de Larosière, who's headed a lot of these commissions in Europe and did such a great job running the International Monetary Fund during the Latin American debt crisis was always makes the point that at the end of the day, it's not the amount of regulation you have there, it's basically how the supervisor supervises. Because all the regulation in the world isn't going to do you any good if the supervisor doesn't supervise.
Forbes: Gets to management of banks. You've made the point that risk lies with the institution. Do you feel the banks, including your alma mater, have learned the lessons that you've got to have better risk management than they've had?
Rhodes: I certainly hope so, because that's really key. Many bankers like to blame the rating agencies and the regulators – and they all have their part in it, as well as the politicians. But at the end of the day, the responsibility is the individual institution, as you say, and to have a first-rate risk management system. Because that is the first line of defense. That has to be the key lesson that comes out of all of this.
Forbes: Looking at the world today, it seems one of the complications, which you didn't have in the early '90s and the '80s, is the rating agencies, credit default swaps, can trip up pretty quickly. What kind of fallout do you think is going to come from that or could come from that?
Rhodes: Well, I think we saw what happened with AIG, the pileup there. And that had been ignored by everybody – the company, regulators, everybody else. So now they want to put them on exchanges and one thing or another. But I think this is an area that, obviously, has to be watched very carefully. And people have to be careful on how they use these instruments.
Forbes: Let's say they brought you in, or your clone, to deal with this crisis in Europe. Do you have to bring in the rating agencies now, since they could trigger a default and start something that people don't know how it's going to end up?
Rhodes: Well, let me give you an example. When I was asked to lead, by the Uruguayan Government, the Uruguayan restructure, you remember –
Forbes: Argentina.
Rhodes: Exactly. Argentina infected Uruguay, which was doing just fine. And you had a liquidity crisis, which was going into a solvency crisis. So we came together and the recommendation was we'd do a bond exchange, and we knew that would cause an event, a default.
But the main thing was that if the Uruguayan Government carried out their reform program, the fund and other countries that wanted to help would be dispersing and we weren't able to get the bond exchanged.
So we were not concerned that initially these bonds were going to trade at a big discount, because we felt if the country did what it needed to do, just like I mentioned with Greece, that the rating agency would upgrade. And that's exactly what happened, because these bonds in less than a year were back to par.
Forbes: So in terms of looking at the banks, it seems that one reason why Europe's been behaving the way it has – which is almost like a mobster trying to collect a debt – is fear about what it does to bank capital. Are those fears justified?
Rhodes: Well I think first of all, as you well know, Steve, the banking system in Europe is more important to the total economy than here in the United States.
Forbes: Right.
Rhodes: Because we have such an active capital market. And I think one of the real problems and the doubts about the banks was the first round of stress tests. Now, for all the things that we may do wrong here, at least here in the United States we had it right in the sense that there were tough stress tests and the banks went out and raised capital.
Forbes: And Europe is more like Comedy Central?
Rhodes: Well, the first round was. They passed all the Irish banks – and of course within months the state had to step in and guarantee them, which is what got Ireland into the problem in the first place. And that's also true in Spain with the Cajas, the equivalents to our savings and loans, when we had the problem.
So I think it's fair to say that that not only did not help the situation, it exacerbated it. Now, since they announced that they were going ahead with the second set of stress tests and they changed the dates twice on that before they came out with the results –
Banks in Europe have raised a lot of capital. And I think after the Greek situation they will continue to raise capital, because compared to the American banks I think a number of the banks in Europe were obviously capital light. So I think that's the effect. Now, we'll have to see, but the banking system is important. One of the major points that people tend to forget is if the sovereign gets in trouble, the banking system will get in trouble. If the banking system's in trouble, like in Ireland, then the sovereign gets in trouble.
And so Greece got their banks into trouble and Ireland got dragged into it because of its banks. But I think they have to recapitalize the Greek banks. Because if you don't have a healthy banking system, how are you going to get to growth?
Forbes: Was one of the mistakes of Ireland – and I ask this because before the crisis on paper, their debt was highly reasonable, 25-35% of GDP. They had already started to do some austerity. They didn't wait like Greece. Was their mistake not having an international intervention with their banks and unilaterally guaranteeing everything?
Rhodes: Well, I think you're very correct about the Irish fiscal situation. It was in pretty good shape. I think the mistake was they really did not properly regulate and supervise their banking system. And then rather than decide how they were going to handle the situation in the sense of restructuring the banks, they just went in and guaranteed them.
That really is what caused Ireland to go under. They should have basically said, "Okay, we've got to restructure the banks." Example: Korea, 1997. There was a run on the Korean banks. The reserves had dropped below a billion dollars.
Kim Dae-Jung, who came from the left, was the president. He didn't like the IMF agreement. But he knew that he had to take action. And Korean women, I'll never forget this, were lined up around the block for blocks and blocks in front of the central bank, the Bank of Korea, melting their gold jewelry because they did not want to see their country go into default. So I was called on to restructure the banks. The first thing I did is get on an airplane, which I recount in the book, Banker To The World. And I went over and saw Kim Dae-Jung. And he was president elect. And I said, "I can't do anything unless I know that you will
Forbes: Five days before his inauguration.
Rhodes: Exactly. That you will do everything possible to see the implementation of this IMF agreement, and then you'll support me in the restructuring. And he said, "I give you my word." And that's what made the difference because then I got the Japanese banks, who were the biggest holders, 40 percent, the Europeans and the U.S. banks to agree. And we were able to put this, an agreement together in a month, which was at that point a record time. But I think it was a recognition that the banking system was the key to the whole policy of turning Korea around.
Forbes: Now, is there sort of a doctrine arising in the world that governments, no matter how small, are too big to fail?
Rhodes: Well, I used to kind of joke with Walter Wriston – because when you had the really bad crisis in 1982, they kidded about the deck chairs and the Titanic at the IMF World Bank meetings that were held in Toronto that year.
He was asked by our then secretary if he could come out with something reassuring. And he came out with this op-ed saying, “With all the assets countries have, over the long term, they won't fail.” Well, that was perceived the wrong way. And the joke became, well, countries don't fail, just the banks that lend to them. But I think that you can't beat good fiscal and monetary policy and good risk management. That, at the end of the day, gives you the type of pro-growth strategy that you have. Look where Korea went after that, and then in Brazil, Fernando Enrique Cardoso.
Forbes: Real plan.
Rhodes: Exactly. He was the minister of finance. He and I sat down, we worked out the restructuring, we did a Brady bond deal. Immediately, he announced the Real Plan, which finally after ten years, including a moratorium in Brazil, killed hyper inflation, stabilized the economy and Brazil hasn't stopped since. The same with Kemal Dervis in Turkey in 2001 when he put in that program, stabilized the economy after ten years of problems in Turkey. And look where the Turks have gone since.
Forbes: How do you avoid, looking back, moral hazard. Take a quick look back at 2008. Was it a mistake to save all the creditors of Bear Stearns, which led everyone to believe, hey, you can buy Lehman paper and that'll be good even if the stock goes down?
Rhodes: Well, it's difficult to say. What I guess people question is if you saved Bear Stearns, why didn't you save Lehman? And I think that at the end of the day, the markets are going to have the final word. And you can only do so much. And you still have this problem we're carrying around of Fannie Mae and Freddie Mac.
Forbes: Yeah.
Rhodes: That still hasn't been resolved. Here we have Dodd-Frank and nothing's been done about Fannie Mae and Freddie Mac.
Forbes: Mark to market accounting, you are not a fan of. You felt that worsened the crisis. Do you think that monster has finally been buried once and for all?
Rhodes: Well, it depends. You have the International Accounting Standards Board which sits in London, and basically they feel if a bank takes a piece of paper and holds to maturity, then it should be treated different than mark to market.
The whole idea of mark to market was tradable securities. Bonds are tradable securities, not loans that you make. And I think that was a big mistake and that exacerbated, I think, the problems of the banks. Because a bond house or a trading asset should be treated that way. But I think if you're making a loan to a company or to an individual, it should be really held to maturity. I think that did exacerbate it. And FASBE still hasn't come to grips with the International Accounting Standard. And Axel Weber – who by the way has decided that he wants to teach over University of Chicago because that's his mentality. He used to always say to me, and we used to give these speeches together, “How are you going to have international regulatory standards if you can't get international accounting standards? How are you going to be doing the ratios? You're going to have two columns on every balance sheet? Every public statement?”
Forbes: Obviously one of the key things to a country's health no matter what size is trade. What's happening to free trade in the world today? I know the answer, but –
Rhodes: Well, you've been a big supporter, and you know how I feel. But basically, I think we have done a miserable job here because I convinced Rob Portman when he was our trade representative in 2005 –
Forbes: Junior Senator from Ohio.
Rhodes: Exactly. And we signed in 2007, with the Koreans, an agreement. Here we are in 2011 and we still haven't been able to pass that through Congress. And our great ally in Asia – and we have a president who is a big supporter of the United States, Lee Myung-Bak – and the Korean people in general.
And we can't get that approved. So what has happened? The EU, with all of its problems, took the agreement that we had made with the Koreans – they basically have the same agreement. They passed it and they implemented it the first week of July. This is one of our largest trading partners. The Australians and Canadians are about to do the same. And so where are we going to be creating jobs? The president keeps saying trade is jobs, but they keep changing the rules of the game coming out of the administration on trade adjustment.
And the Republicans and Democrats in the administration, I've testified down there, have got to get together. But we also have Colombia and Panama, two great allies of ours. What an example that is to the rest of the world – that we can't get these trade agreements that we signed three, four years ago approved.
I think it's a real disaster. The latest bad chapter is, well, because everyone's tied up with our own debt problem here and deciding how they're going to meet this August 2nd or whatever the final date is, to move forward on getting a lifting of our deficit limit. They put this aside until afterwards. I mean, it sends a terrible signal. But it’s costing jobs. The administration, the White House, estimates that the trade agreement with Korea alone will create 70,000 jobs. The U.S. Chamber of Commerce estimates that if we don't do Korea, over time it'll cost up to 300,000 jobs because with these other – EU, Canada, Australia – we're going to lose all of this trade. This isn't even taking into account Colombia and Panama, just Korea.
Forbes: It's amazing. Bill, I hope they call you out of your semi-retirement and put you back to work. Great book, very readable: Banker to the World. Thank you for being with us.
Rhodes: And you do great things keeping capitalism alive, and I think finally the Greeks ought to look at your suggestion on a flat tax because they certainly have to do something on the taxation.
Forbes: Terrific, thank you, Bill.
Rhodes: Thank you.
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