Neel Kashkari was a key player in extracting the U.S. from the Great Recession.
Now he is worried that regulators -- fresh off legislation that eases regulations on regional and community banks -- are sowing the seeds of the next financial meltdown.
"The banking sector is far more concentrated today than it was before the last financial crisis," Kashkari tells TheStreet. Kashkari, a one-time capital raiser at Goldman Sachs (GS - Get Report) who rose to prominence as a member of Treasury during 2008, has been the president of the Minneapolis Federal Reserve since 2016. "In a sense, the nuclear reactors, as I call them, at the heart of our financial system are now bigger and more radioactive than they ever have been."
TheStreet (TST) talked with the outspoken Kashkari about new banking legislation, rising interest rates and the Federal Reserve's course of action and the outlook for the U.S. economy. What follows is an edited and condensed version of the interview.
TheStreet: Your thoughts on the rollback of regulations for banks?
Kashkari: We have known this was likely coming for a while. And while I agree that community banks do need some relief because they are not systemically risky for the country, the fact is that the biggest banks are still too big to fail. And this banking bill relaxes regulations on very large regional banks, they are major beneficieries, they don't need any help. They are doing fine, profits are up. I am not sure why they need all this help.
TheStreet: Are regulators sowing the seeds of the next Great Recession?
Kashkari: That is absolutely true. Human history is full of examples of financial crises, and we repeat the same mistakes we have made in the past because we forget the lessons. It has only been 10 years and we are already forgetting how devastating the last financial crisis was. We are already convincing ourselves that everything is fine again and we can relax some of the rules and we will be fine in the future. And the fact is that we are going to repeat these same mistakes again.
It's a question of when, not if.
TheStreet: Will there be a potential M&A boom in the banking sector following this latest regulatory decision?
Kashkari: It just reflects how flush with cash banks are. I think the FDIC reported this week that the banking sector made roughly $60 billion in net profits in the last quarter. They are doing great, they have a lot of cash, they are buying back their stock. So, now they are gobbling each other up.
The banking sector is far more concentrated today than it was before the last financial crisis. In a sense, the nuclear reactors, as I call them, at the heart of our financial system are now bigger and more radioactive than they ever have been.
TheStreet: That sounds pretty serious. Do you think investors understand where we could be headed again?
Kashkari: I think investors learned the lesson that they basically got bailed out in the last crisis. The only people who are hurt by this are taxpayers. The investors do great, management teams do fine, boards of directors do fine. But it all falls on the back of the taxpayers because when the next crisis hits, the government will once again say well if we let the banking system collapse and let shareholders and bondholders take their losses we will devastate Main Street and plunge us into another Great Recession or Great Depression. So, they will ride to the rescue.
That's ultimately why banks are not holding shareholders accountable.
TheStreet: Anything that can be done to prevent going back to Great Recession conditions?
Kashkari: You know, it's hard. I have been thinking about how you institutionalize the lessons from these crises so that future generations remember them. I think it has to be through our political process. It has to be through legislation and locking in these rules, and not letting the banks walk them back. I think both sides of the aisle basically agree that the biggest banks are too big to fail. This banking bill that just passed was marketed as community bank reform, it really did little for the community banks. It did a lot for the really large regional banks.
TheStreet: What's the status of your too big too fail research you did several months ago?
Kashkari: I have talked to folks on both sides of the aisle, nobody has been able to poke any holes in the analysis. The biggest banks need a lot more equity capital. Most members of Congress I talk to say yes, the biggest banks are still too big too fail. But, they also acknowledge this is not the political moment. The regulatory winds are blowing in a de-regulatory direction rather than more regulation.
We are doing everything we can do get the message out and hoping the stars will align so we can take action.
TheStreet: Are you worried about inflation? Rising inflation was a dominant theme within Corporate America this past earnings season.
Kashkari: We are paying very close attention. We are looking for signs. The latest inflation data says that now we are basically at 2%, that is the personal consumption expenditure measure. So, we are basically at our target. We have been under our target for the last six years, so we feel inflation is where it's supposed to be. The real question is why wages aren't growing more quickly and is there still slack in the job market.
We are not yet worried about inflation taking off, we are pretty happy where inflation is right now.
TheStreet: What's the risk of the Fed moving too fast to raise rates?
Kashkari: I think the risk is that we do it too fast unnecessarily and we shorten the economic recovery. One thing I look at is the shape of the yield curve. And the yield curve has been flattening quite a bit. The inverted yield curve is the single best predictor we have of recessions. To me, it's an indicator of the Fed overtightening.
So if we keep raising rates despite the fact the yield curve is flattening, if the long end of the curve does not move up, if inflation does not emerge and we just keep raising rates we could end the expansion by being too aggressive on monetary policy. So it is something I am worried about, and I pay close attention to.
TheStreet: Do you fall into the camp that thinks a recession is possible in 2019?
Kashkari: We all say we are data dependent at the Federal Reserve. If we are in fact not data dependent and we are just committed to raising rates and the data doesn't support it, then certainly that [recession] is possible. There are other risks as well. There could be trade outcomes if we were to go into a full-fledged trade war with China and other geopolitical risks. There are other risks out there, and some are very hard to predict.
But one thing we should understand is the risk of the Fed over doing it, and that's why we need to remain data dependent.
TheStreet: How is the Fed thinking about potential trade wars?
Kashkari: We pay a lot of attention because trade is an enormous part of the U.S. economy both with exports and as consumers of exports from around the world. If there were a full-fledged trade war then it would be inflationary for the U.S. and it would probably hurt U.S. economic growth quite a bit.
At the same time, I have watched the U.S. negotiate with China for the last 20 or 30 years -- we have all these negotiations -- and China does what it wants to do. The fact is that today, we do not have free and fair trade with China. I am sympathetic with the view we need to be more aggressive in pushing them to open their markets to U.S. exports but at the same time, we need to be careful to avoid these very bad outcomes where everybody loses.
TheStreet: What could the market impact be if we do get a trade war with China in the next 6-8 months?
Kashkari: It could be profound. A major correction could certainly be possible. Trade has been net positive for global economic growth, and if there was a full blown trade war between the U.S. and China U.S. economic growth would be hurt and Chinese economic growth would be hurt. Global growth would be hurt. And then there would be a shock to confidence and I think you would see equity markets responding to that shock to confidence.
It's clear we have to avoid that outcome. But, we also need to achieve a full and fair trade environment.