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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?
Source: forbes.com
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