Simon Johnson is the former chief economist of the International Monetary Fund and in recent months has emerged as one of the most cogent critics of how the Obama administration is addressing the banking crisis. On Tuesday, Johnson, Joseph Stiglitz and Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, testified before Congress' Joint Economic Committee on the topic of the day: "Too Big to Fail or Too Big to Save? Examining the Systemic Threats of Large Financial Institutions."
On Wednesday, Salon caught up with professor Johnson for the second time this month, and this time, managed to successfully record the interview.
You have become famous for decrying the consolidation of power by a new financial oligarchy over the politics and economy of the United States. Since our last conversation I was intrigued to learn that this isn't necessarily a new obsession of yours. In the soon-to-be-published paper "From Ancien Regime to Capitalism: The Spread of the French Revolution as a Natural Experiment," which you co-authored with Daren Acemoglu, you argue that after the French Revolution, Napoleon's armies contributed to future economic growth by breaking up local church and aristocratic oligarchies.
Oh yes! So you know that I work on longer-term issues as well as shorter-term issues. You see, there are some recurring themes here. It's about power, and you have to see it all in that light.
Well, there was a lot of damage done the way he did it. And I don't think we currently are living under the "ancien regime." The structure of Western Germany, for example, when the French came in, was post-medieval, and they completely transformed it. I still think that we have basically a good system here today. It's just that a relatively few people got out of control. And they need to be reined in. I think that's doable.
In the Joint Economic Committee hearing on Tuesday, I thought the most the interesting stuff came from Thomas Hoenig, who had this amazing quote. I mean I was just shocked to hear him say it, to hear a Federal Reserve regional bank president say that any time you have banks that are too big to fail, you are going to have oligarchs. I thought it was brilliant. That's where I am! And I'm trying to persuade people I'm not a sensationalist, or an extremist.
In your own testimony, your basic message was pretty simple: It's time to break up the banks.
Yeah. I've been saying that for awhile, but the new piece is to use antitrust law to do it. Some good lawyers have thought about this now for us, and they are saying, certainly, changing the legislation to make this easier is the way to go. The lawyers themselves are divided on whether you can do this under the existing legal framework. But the historians are adamant that what we are saying is very much in the spirit of the original antitrust movement. What Teddy Roosevelt and his cohorts were worried about was excessive power -- political power for these oligarchs.
But you've pointed out that one of the key aspects of the triumph of finance over everything else in the last 40 years is not just the consolidation of political power, but conceptual power -- in other words, a majority of the country came to believe that what was good for Wall Street was good for everyone. How do you use antitrust to break up a belief system?
The breaking of the belief system is an outcome of the crash. The belief system is kind of a perpetuating mechanism but when the economic realities change, people stop believing the same things. I think one advantage of a society like the United States, a democracy, is that we can change our minds pretty quickly on some things, even some firmly held beliefs. I am not saying throw capitalism out with the bath water. I'm saying big finance has just become too powerful and it needs to be reined in. There are some relatively straightforward technocratic steps that can be taken that will move us in the right direction. But I'm not a starry-eyed idealist -- I don't think this is going to change massively overnight.
While researching bank deregulation this morning I found a paper by Philip Strahan from 2002 arguing that the removal of limits on interstate banking in the late '70s and early '80s "was followed by better performance of the real economy." We can quote literally thousands of papers written over the last 40 years arguing that deregulation was good for the economy. We now have a pretty dramatic counter-example, but it still raises the question of how quickly you can undo 40 years of a dominant economic orthodoxy?
Slowly. But I would also say that the Strahan-type result doesn't strike me as implausible. It's quite possible that things can be overregulated, so you deregulate them, and things operate better. But what I'm arguing is that then feeds into this political cycle where you make more money, and you plow that back into political action committees or whatever, and use that to tilt the playing field in your favor. So let's say that you have excessive regulation to start with, you bring that down to a sensible level, and then the guys making a ton of a money use that to undermine sensible regulation. That would be the kind of dynamic I would buy into.
Is there any way to get to a steady-state?
No. Come on. There's no nirvana. It's a struggle. It's always a struggle. There's got to be some kind of dialectic. I would just say the pendulum has swung too far. And you also have to worry about regulators being captured. And I don't think that just breaking up the banks eliminates the possibility of capture -- small guys can get together and capture their regulators too. But there's nothing quite as powerful as four guys walking into the room and saying, "Look, Tim, if you do this, the world will end." That's just a terrible thing for a treasury secretary to have to deal with.
While you were testifying before the Joint Economic Committee, Geithner appeared before Elizabeth Warren's Congressional Oversight Panel. I was struck by the fact that while Warren was pushing Geithner on whether liquidating and restructuring the banks were "on the table" for the Obama administration, the Republicans on the panel, John Sununu and Jeb Hensarling, were extremely suspicious of anything that even smacked of partial nationalization. Some people seem to be upset that in his first 100 days Obama hasn't already completely broken the power of Wall Street, but there are plenty of politicians in Washington who think he's already gone too far.
I do think "nationalization," the word, as a concept, is a red herring. I'm with Hoenig on this. What we need is a government-managed bankruptcy -- you can call it prepackaged bankruptcy, or you can call it conservatorship. The point is you don't throw banks into Chapter 11 because that is destructive. But you manage a bankruptcy process -- it's not nationalization, it's a government-run receivership. Technically what you do is appoint an official receiver who is either the government or is going to be an agent for the government, and that agent manages the split into a good bank and bad bank. You take the bad stuff off your balance sheet and you minimize your losses on that through some kind of Resolution Trust Corporation structure and the good bank you get back into business as soon as you can and you privatize it. I would advocate breaking it up into many competing private bits.
Hensarling appeared to be worrying that the Obama administration's strategy is a kind of backing into nationalization.
Well, I'm with him on that! That's exactly the point to make. We're stumbling into bad forms of nationalization. Joseph Stiglitz said this very well: The difference between ownership and control leads to big distortions. The government is going in with a massive amount of control, but either it's not going to have ownership or it's not going to exercise those ownership rights. My favorite line, which was in an Op-Ed we wrote for the Financial Times in January, was, "If you want to end up with the politics of Pakistan, the economy of Ukraine and the inflation rate of Zimbabwe, bank nationalization is the way to go." That's my feeling about nationalization. I want government-managed bankruptcy.
Does the government currently have the authority to put a multinational institution as large as Citigroup or a B of A into receivership?
Hoenig addressed that directly. He was asked that question. He's worked for the Fed for 30 years. He's managed a lot of bank winding downs and receiverships in his district, or he's been involved in them, and his answer to that question was yes. So, I'm no longer going to say take my word for it, I'm going to say call Mr. Hoenig. It was a striking statement. To my mind, he directly contradicted what Secretary Geithner said when he testified on the need for the resolution authority. The resolution authority would be helpful, it'll give you a better tool to use, but Hoenig definitely said it can be done, now, following the Continental Illinois model of a negotiated conservatorship. That was the most important thing said at the JEC hearing. Although I do support giving them the resolution authority.
What we have been arguing for consistently is recapitalization on the basis of a government takeover and government-managed process. So you wipe out the shareholders, and then, how much of a hit you put on the creditors depends on the political calculation. How much money can you raise, which creditors do you protect? Our priority is protect the payment system: You want to protect deposits and anything that is like a deposit. If you force people to take losses on the payments part of the system, then all hell is going to break loose. But if you protect that, then the rest of it is a calculation about how much do we want to guarantee creditors, and I think at this point, with the situation a little bit calmer than it was last fall, everyone agrees that creditors need to take some sort of hit in an organized fashion.
What do you think of the fact that these very same banks that are at the heart of this are now taking a hard line on what kind of hit they will take in the negotiations with the government on reducing the debt of Chrysler and General Motors?
The ironies just abound. Shooting yourself in the foot and then reloading and shooting yourself in the foot again.
Won't we run into the same problem when we try to get the bank creditors to deal?
Well, sure, the creditors will scream, if that's what you mean. Creditors always scream. And creditors will hold out, creditors always try to hold out. That's what the Hoenig vs. Geithner debate is about: What legal authority do you have to force them?
What do you think of the theory that a political calculation was made by the White House: They wanted to get their stimulus passed and the budget passed and push what is likely to be a pretty big political fight over the banks into the future so they could get those priorities taken care of.
I think it's an intelligent spin. The way the administration guys are now articulating it, and they said this to F.T.'s Krishna Guha on Monday: They're following a doctrine of "reversible error." Their idea is if you take the banks into bankruptcy you may regret it, so let's just see what happens. But our point is that any inaction on the banking system creates irreversible damage, so there's no free option here. If you delay you are inflicting other costs on the system including most particularly massive fiscal costs and the need for more fiscal stimulus, and an increase in the debt. As I said in the hearing yesterday I think the national debt is going to roughly double as a result of this fiasco. Which is huge. That's your taxes and my taxes.
I mean, I think the reversible error could be what they believe, I'm not saying they are lying about that, I'm just saying they are wrong about that. Are they waiting for it get to worse? I guess the view could be is they are waiting for it to get worse because then there will be political support for them to do really aggressive things, but I don't think that's going on, because when I talk to people on Capitol Hill -- which I do quite a lot -- they don't tell me that the administration is there preparing the ground for this, they say they are not coming to talk to us at all.
In your testimony before the JEC you said that as a professor of entrepreneurship at MIT you spend a lot of time interacting with entrepreneurs and venture capitalists who are "absolutely livid at the way large banks have been run." You noted that venture capitalists are betting their own money, and that's a better model than betting other people's money. I thought that was a little ironic, because during the dot-com boom, the venture capitalists did plenty of incredibly stupid things with their money too. It's not as if they are above reproach.
Let's be clear here. I am not trying to legislate away booms. And I am not trying to prevent crazy investments. I see a lot of crazy people around MIT who turn out to be brilliant and very successful and I never would have picked them. I like that. But those are equity investments, and the dot-com bubble to me is an excellent counterpoint to the housing meta-financial problem -- which was a debt-driven bubble. There's a big difference. If your equity value goes down a lot, it's painful and consumer spending may fall because of the wealth effect, but it is not a global cataclysm. The dot-com bust was a big bad bubble and it burst and it was messy and a lot of my students couldn't get jobs, and they went off and did something else.
I'm not saying venture capitalists putting their own money at risk is going to lead automatically to stability. But it does feed into innovation. I think if you look at canals, or railroads in the 19th century, or the advent of the automobile or any of the other sort of big breakthrough technologies, they often come with crazy investment booms, particularly in the United States. Anywhere that's a frontier of technology, often these breakthroughs come with a thousand firms being formed, massive amounts of money being pumped in, lots of of stupid things happening, people building two canals next to each other, or two railroads next to each other, and then there is a financial collapse, but you still get to keep the physical infrastructure. At the end of the dot-com thing we had a pretty good Internet.
What do we get out of the meta-financial crap? It's not so clear that we got useful things. Did our ATM fees come down? No.
Yesterday, Robert Reich graded the first 100 days of Obanomics. He gave the budget an A, the stimulus a B and the banking bailout an F for an overall grade of C+. What marks would you give?
I'd give the bailout an incomplete, which is allowed at MIT. Come back and finish it in the summer. Most of the other stuff I would give some sort of A. I know I am complaining a lot, it's true. But I give them an A+ on the G20 given the cards that they were dealt and I think they've made a lot of progress on other things. My worry is that the banking thing is the Achilles' heel, and that could damage the whole rest of the strategy. So it's like a report card where you are doing very well across the board, but there is this one subject that is really dragging you down. And that's very dangerous.