Center for Social Innovation

Published: November 17, 2009

Banking industry executives need to look broadly at changes needed to reform the American financial system, says the man responsible for helping prop it up over the past six months.

Herbert A. Allison Jr., the government's overseer of the Troubled Asset Relief Program (TARP) and an assistant secretary of the U.S. Treasury Department, in impassioned remarks before an audience at the Stanford Graduate School of Business Nov. 10, said the banking industry needs to step up and fix itself.

"They can’t just look at government regulation. They need to be responsible business leaders who acknowledge the need to change," he said. "And maybe they need to apologize to the American public for what happened."

What happened 18 months ago with the U.S. banking industry at its crux almost brought down the country's entire financial system. Overextended because of significant losses from their mortgage-backed securities and collateralized debt obligations when the housing market crashed, financial institutions stopped lending, slowing economic activity. It was left to the U.S. government to bail out key institutions and implement economic stimulus programs to keep the system afloat.

What Allison, MBA '71, oversees is the result of the Emergency Economic Stabilization Act passed by Congress on Oct. 3, 2008. It authorized the U.S. Treasury to spend up to $700 billion to purchase distressed assets and make capital injections into banks. The plan was dubbed the Troubled Asset Relief Program.

Under former U.S. Treasury Secretary Henry Paulson, nine of the largest banks were given $25 billion apiece, and the Treasury also used the bailout to steer funds to stronger banks so they could purchase weaker ones. The asset purchases were roundly criticized for not creating a system that would require banks to increase lending and unfreeze credit markets. In addition, $17.4 billion in emergency loans were made to General Motors and Chrysler.

Paulson's successor, Obama appointee Timothy Geithner, has proposed a plan to flood the financial system with as much as $2.5 trillion. Part of his plan was an attempt to get banks to sell their troubled assets to investors and to TARP.

Appointed to his post on June 19, 2009, Allison is playing a key part in coordinating the Treasury's policy on legislative and regulatory issues affecting financial stability. He told the Stanford audience that his focus now has changed from "helping the banks' stability and helping the financial system to helping small businesses and small banks so they can keep people in their homes."

He acknowledged TARP has been a "widely unpopular" program, especially after some of the banks that were bailed out refused to sell their loans, in part because doing so would force them to mark down the value of those loans and book big losses. Some of the same institutions also turned in strong quarterly financial performances. In June, the Treasury Department cleared the way for 10 big banks to start repaying the government billions of dollars of taxpayer aid.

While the program has been controversial, Allison termed it a success. "It succeeded in stabilizing the system." Without it, he said, "Every major bank would have become insolvent within days."

But he would like to see government get out of the business of coming to the rescue if another financial crisis occurs. And he predicted, under the present model where banks are scrambling for profit at the expense of their customers, there will be another.

Banks take too many risks and are focusing on "themselves and keeping their employees. They should focus on the welfare of their clients. That will take less risk and the companies would become more survivable entities," he said.

Asked about the general state of the economy, Allison was pessimistic. The economic crisis is "far from over," he said, predicting more delinquencies and foreclosures in the residential real estate market and a "looming crisis" in commercial property. Small businesses "face many challenges, especially in getting working capital," he said.

Prior to assuming his present post, Allison, 66, was named president and CEO of Fannie Mae in September 2008. He was chairman and CEO of pension fund TIAA-CREF from 2002-2008, where he oversaw a massive restructuring program. He started his career at Merrill Lynch after business school and a stint in the U.S. Navy including serving in Vietnam.

His appearance was sponsored by the student-run Public Management Initiative, a program that promotes discussion around a specific issue each academic year. This year’s topic is: "Debating Tomorrow: The Changing World of Business."

- Joyce Routson