Simon Johnson writes that he’s seen a lot of bank crises during his years at the IMF, and eventually problems with the banking sector always roll downhill onto the rest of the economy. Unsurprisingly, the same thing has happened here:
But theres a deeper and more disturbing similarity: elite business interests financiers, in the case of the U.S. played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.
Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better in a buck stops somewhere else sort of way on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for safety and soundness were fast asleep at the wheel.
But these various policies lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sectors profits such as Brooksley Borns now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998 were ignored or swept aside.
Johnson’s solution is twofold: nationalize the bad banks and then carve them up into a bunch of small banks so they can never harm us again. I have my doubts. Not about nationalization, which I suspect is inevitable, but about the size of individual banks being at the root of our problem. As Johnson himself suggests, banks would have to get pretty damn small smaller than Lehman Brothers and Bear Stearns were before their failure could be tolerated, and I’m just not sure we live in a world where that’s practical.
After World War II we eventually rejected the Morgenthau plan to deindustrialize Germany, deciding (wisely, I think) that industrialization per se wasn’t the cause of the conflict. Likewise, I think crude bank size is a red herring for our current financial collapse. Small banks can become overleveraged just as easily as big ones, hedge funds pay higher salaries than Wall Street behemoths, the interconnectedness of the global financial sector is a bigger cause of systemic worries than size alone, and credit expansions spiral out of control largely due to lack of political will, not because Citigroup is large and clumsy. Those are the things we should be focused on.
Now, Johnson makes the fair point that the kind of systemic regulation I prefer is impossible to put in place because big banks have so much lobbying power that they can prevent it. But again, I don’t think it’s big banks that produce this kind of power, it’s a big banking industry. If we can somehow shrink the overall size and profitability of the industry, their lobbying power will shrink too. And if we limit their leverage, limit systemic credit expansion, and force more sunlight into Wall Street’s trading activity, there’s a pretty good chance we can do that.
It won’t be easy, of course. As Johnson says, the finance industry still has enormous sway in Washington and will fight tooth and nail to keep their toys from being taken away. But hell if we can’t do it now, of all times, then what chance do we have of permanently slashing the size of big banks either? Not much. So since it’s going to be a fight either way, why not attack the roots instead of the branches?
POSTSCRIPT: Just in case it’s not clear, Johnson’s article is terrific reading, well worth a few minutes of your time. I happen to disagree with his technical approach to reducing the size and power of the finance sector, but his description of the problem is top notch.
Plus, of course, he might be right and I might be wrong. So go read it.