What Next For The Global Crisis?

Slides for speech to World Bank conference (Lessons from East Asia and the Global Financial Crisis), Tuesday in Seoul (1pm local time), are attached.  This post summarizes my main points.

There are two views of the global financial crisis and – more importantly – of what comes next.  The first is shared by almost all officials and underpins government thinking in the United States, the remainder of the G7, Western Europe, and beyond.  The second is quite unofficial – no government official has yet been found anywhere near this position.  Yet versions of this unofficial view have a great deal of support and may even be gaining traction over time as events unfold.

The official view is that a rare and unfortunate accident occurred in the fall of 2008.  The heart of the world’s financial system, in and around the United States, suddenly became unstable.  Presumably this instability had a cause – and most official statements begin with “the crisis had many causes” – but this is less important than the need for immediate and overwhelming macroeconomic policy action.

The official strategy, for example as stated clearly by Larry Summers is to support the banking system with all the financial means at the disposal of the official sector.  This includes large amounts of cash, courtesy of Federal Reserve credits; repeated attempts to remove “bad assets” in some form or other, and – the apparent masterstroke – regulatory forbearance, as signaled through the recent stress tests.

But most important, it includes a massive fiscal stimulus implying, when all is said and done, that debt/GDP in the United States will roughly double (from 41% of GDP initially, up towards 80% of GDP). 

Not surprisingly, funneling unlimited and essentially unconditional resources into the financial sector has buoyed confidence in both that sector and at least temporarily helped shore up confidence in financial markets more broadly.

And now, in striking contrast to the dramatic action they call for on the macroeconomic/bailout front, the official consensus claims relatively small adjustments to our regulatory system will be enough to close the case – and presumably prevent further recurrence of problems on this scale.  If the exact causes and presumed redress are lost in mind-numbingly long list of adjustments, so much the better.

This is, after all, a crisis of experts – they deregulated, they ran risk management at major financial firms, they opined at board meetings – and now they have fixed it.

Maybe.

The second view, of course, is rather more skeptical regarding whether we are really out of crisis in any meaningful sense.  In this view, the underlying cause of the crisis is much simpler – the economic supersizing of finance in the United States and elsewhere, as manifest particularly in the rise of big banks to positions of extraordinary political and cultural power.

If the size, nature, and clout of finance is the problem, then the official view is nothing close to a solution.  At best, pumping resources into the financial sector delays the day of reckoning and likely increases its costs.  More likely, the Mother of All Bailouts is storing up serious problems for the near-term future.

 We’ll double our national debt (as a percent of GDP), and for what?  To further entrench a rent-seeking set of firms that the government determined are “too big to fail,” but will not now take any steps to break up or otherwise limit their size.

We need to disengage from a financial sector that has become unsustainably large (see slides before and after #19; the cross-country data should be handled with care). 

We can do this in various ways; there is no need to be dogmatic about any potential approach – if it works politically, do it.  But the various current proposals for dealing with this issue – both from the administration and the leading committees of Congress – would make essentially zero progress.

As moving in this direction does not seem imminent, the probable consequences or –  if you prefer – collateral damage looks horrible.  You can see it as higher taxes in the future, lower growth, a bigger drag on our innovative capacity, fewer startups, and less genuinely productive entrepreneurship.  Plenty of people will be hurt, and they are starting to figure this out – and to think harder about what needs to be done and by whom.

“Small enough to fail” may well prevail eventually – at least sensible ideas have won through in past US episodes – but it will take a while.  The official consensus always seems immutable, right up until the moment it changes completely and forever.

By Simon Johnson

76 responses to “What Next For The Global Crisis?

  1. I sure hope you are correct that sensible ideas may win through, but if the governments of the world have been captured by “the big banks… extraordinary political and cultural power” then it seems to me that change (where have I heard that word before?) won’t happen without truly massive failure.

    Perhaps, as “plenty of people will be hurt, and they are starting to figure this out” we will see voters realize that they must repeatedly vote out as many incumbents as possible, time after time, until the grip of those big banks is broken.

  2. One thing surprises me. We haven’t heard anything from the Silicon Valley crowd, the true innovators, the true creators of wealth. What do they think about the current crisis? What do they think about the “financial industry”?

    According to Simon, the hypertrophy of the financial sector is taking resources from them.

    Surely those Silicon Valley guys have clout, plenty of it (Google or Microsoft, for instance, are giants). Why don’t they fight the master-of-the-universe financiers with us? Have they been co-opted too?

  3. The situation reminds me very much of Churchill’s dictum: You can always count on the Americans to do the right thing – after they’ve tried everything else. Let’s hope that the colletaral damage doesn’t become too big in the meantime.

  4. EmilianoZ:
    > We haven’t heard anything from the Silicon Valley crowd, the true innovators, the true creators of wealth.

    Don’t overestimate the role of high technology in innovation. Innovative technology can sometimes be rather simple. And in general, technology is a help but better organization is necessary, too.

  5. The 2010 Congressional elections may tell the tale.

    Between now and then, I’m sure that the technocrats can keep the plates spinning (though state and local government insolvencies, the developing commercial real estate collapse and the bizarre behavior of financial services sector leadership may overwhelm those earnest Johnnies).

    I think I’ll go watch Lord of the Flies. When I was in the financial services sector (at an AIG predecessor) we had a not-so-delightful game called ‘playing Piggie’. You didn’t want to be piggie.

  6. In his role as economic advisor to President Obama and contributor to the administration’s Finance Reform Plan, Larry Summers has taken the path of least resistance. And for the next 8 years he may get away with it. He won’t need to worry what happens to the American economy after 2016. I have no doubt he’s sleeping better than the unemployed in Michigan, Indian, and Ohio. Sleeping better than the people whose houses have been or will soon be foreclosed on.
    I wonder, which industry will Larry Summers work for or receive income from after he leaves his appointment????

  7. TonyForesta

    We hope and pray Simon Johnson, – we hope and pray.

    Iranians had the courage to mass and demand a voice and recognition, and protest their dismay at the governments actions. Americans? Not so much. Americans allowed fascists and shatains in the bushgov, to commandeer control of the government, to pervert and betray the core principles of the Constitition, in virtual silence. Protesters in America are demonized and hippies, and freaks. Treehuggers, commnunists, socialists, anarchista, terrorista. It’s all about the oil, and the war profiteering that controls the oil.

    All the rank deception, and fantasy PONZI scheme financial products or assets, and all the kings men, cannot and willnot put America’s economy back together again. Ashes, ashes, all fall down.

    If American leadership fails to honor the rule of law and hold accountable anyone who breaks the law, and defend and advance the principle that no one is above or beyond the law, – and demand accountability from the bushgov, and the Obamagov – then how could any sane investor look to Amerika in confidence knowing Amerika is owned and controlled, “captured” by predators, swindlers, and thieves, wanton profiteers, mercinaries, – pirates.

    There is either law, and no one is above or beyond the law, and particularly the predator class is not above or beyond the reach of the law, – or there is no law. If there is no law, – there is no law for anyone biiiaaatches.

  8. EmilianoZ, one of your hosts is, in fact, a Silicon Valley entrepreneur; look up James Kwak’s bio. But I’m not sure the leaders of the financial industry believe that creating wealth is actually possible. My impression is that they are trying very hard to win a zero-sum game.

  9. Here’s my alternative world: Replace the bankers and their lawyers by a computer program run by the government.
    http://sep.stanford.edu/sep/jon/financialcrisis.html

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  11. Simon, your courage is an inspiration to us all! It has become apparent that the ‘New Normal’ will be yet another ‘shrinkage’ of the economy in the face of a growing global workforce.

    Yet the ‘name of the game’ is the same as it ever was…survival.

    Yet the investors are betting on ‘winners and losers’ in a game where the fate of our species hangs in the balance.

  12. There’s something systemic going on here. The growth of finance is a symptom, not a cause. Finance explodes when there are not enough profitable enterprises in the real economy to invest in.

    Germany has a minimal finance sector, and has been slammed as hard as anyone.

  13. You wrote:
    > You can see it as higher taxes in the future, lower
    > growth, a bigger drag on our innovative capacity,
    > fewer startups, and less genuinely productive
    > entrepreneurship.

    The problem is that none of this directly affects the billionaire bankers, or their political helpers.
    Million dollar bonuses are back already, using government bailout money.

    As Tony above said, the rule of law has broken down. That is what needs to be corrected first.

  14. While I’m inclined to believe your viewpoint, apparently Paul Krugman does not:

    http://krugman.blogs.nytimes.com/2009/06/18/too-big-to-fail-fail/

    In any case they both work toward the same end and perhaps it should be a mix of both as the ultimate solution.

    Unfortunately at the moment, really neither are happening to any appreciable level.

    Keep the fire under their feet regardless – and good work to the entire BaselineScenario. Thank you for your efforts. At least there has been some comfort that major and reputable players like yourselves have been actually speaking out here.

  15. Krugman revises this slightly in:

    http://krugman.blogs.nytimes.com/2009/06/19/a-bit-more-on-too-big-to-fail-and-related/

    It’s really important to distinguish between the two arguments associated with TBTF, however. One is moral hazard (the one Krugman responds to). I happen to fall into Krugman’s camp, in that fixing moral hazard may help but the other causes (irrationality, private debt, trade imbalance, poor regulation, and the ideology of the dominant economic paradigm) probably account for the lion’s share of the responsibility for this crisis.

    BUT Krugman really hasn’t answered SJ’s other argument (from the Atlantic article) – notably, the problem with big finance is that the rents it accumulates give it tremendous political influence, resulting in capture of the regulators and politicians. I suspect that Krugman might be amenable to such an argument; he seems to hop on board the anti-industry-concentration train here, for example:

    http://krugman.blogs.nytimes.com/2009/06/22/competition-redefined/

    But it’s also hard to lay the blame for this crisis SOLELY on big finance; much of the increase in debt from 40% to 80% that SJ talks about will be due to the _structural problems_ we accumulated over the course of the last 8 years, and indeed ever since 1981. Health care, social security, continuing dependence on oil, failure to save, excess consumer debt, china trade gap… It’s convenient to blame TBTF, but there are many culprits, and most of them tie back to a dominant economic ideology (which lays an undue emphasis on moral hazard).

    In some ways, the over-emphasis on TBTF represents a refusal by this dominant economic ideology to recognize all of the OTHER failures of the pure free market paradigm. (e.g. “If only we could get the free markets working better, they wouldn’t have failed!”)

    This is the flipside of Larry Summer’s position “If only we made those financial instruments a little more perfect, they would have added real value to the economy!”

    While TBTF is a contributing factor, the overemphasis on TBTF ignores the other disasters we’re reckoning with while being too easy on the Friedmanomicons who dominated the policy debates for the last 30 years.

  16. Ed Beaugard

    The problem is not the “too big to fail” size of banks and shadow banks, it’s the financial instruments they created that caused the trouble. Yes, Glass-Steagall(sp.?) should be restored, but Canada has only 2 or 3 big banks and they’re doing well compared to the rest of the world, so perhaps it’s not the size of institutions that’s the problem.

  17. I’m not sure if I can say much in response other than, “Amen!”

    I think you said it better than I probably ever could.

    Thanks!

  18. Charles R. Williams

    Why is the financial sector bloated? Tax policy necessitates elaborate schemes to avoid taxation and to maximize leverage. The solution is not regulation but a drastic simplification of the tax code, refocusing it from income to consumption and reducing the incentives to leverage – both corporate balance sheets and incentive compensation plans.

    Why is the financial sector politically powerful? BECAUSE it is regulated and the marginal utility of purchased political influence is high. More regulation is not the answer.

    The policy goals with respect to the financial sector should be to draw as much shadow banking activity as possible into the regulated commercial banking sector by assuring that commercial banks are not at a competitive disadvantage and to develop a receivership process capable of recapitalizing insolvent banks of any size.

    We should also recognize that there is no way to fully insulate the financial sector from erratic and damaging public policies – the Nixon-Carter stagflation, the Volker contraction, pushing incompetent S&Ls into commercial real estate, asset bubbles and the housing boom of the last 13 years.

  19. What a shame, to pollute good thinking with the superficiality inherent in a power point presentation.

    Ignored has been the 120 year corporate take-over of the systemic reins of power. The founding fathers were specific in requiring anyone wishing a corporate charter to achieve public good with that corporation. I rather suspect their lack of granting corporations political power was intentional.

    Said political power was subsequently granted them by the SCt in a bought decision (or so I suspect, given there is absolutely no justification in the constitution for political rights for corporations). Ballot box stuffing without the need to be caught stuffing ballot box because all one is doing is nullifying the intent of the electorate — at least when it is contrary to the intent of large corporations. Returning banking or any material aspect of Wall Street to “small enough to fail” is not likely, the optimism voiced by Simon Johnson notwithstanding.

  20. Max Hyperbole

    Re: EmilianoZ’s question about tech & Internet entrepreneurs…

    For better or worse, the Internet/tech sector encompasses what is probably the single largest concentration of anarcho-capitalists anywhere outside of the financial sector itself. Far from heeding the lesson of what happens when the core mechanisms of the liquidity system are uncoupled from the productive economy and redirected to the enrichment of liquidity providers themselves, the industry is now flirting with idea of adopting the same business strategy to help drive industry-wide migration to a new technical medium of exchange (as the old one, IPv4, will soon be fully exhausted).

  21. I was looking at Simon’s slides.

    1) On slide 6 it is said that large banks have the
    “Ability to extract rents directly from the state and force government to massive increase in public debt”.

    What are those rents? Could we have some concrete, explicit examples?

    2) Slide 19 shows that at its maximum (circa 2005) Finance/Insurance represented 8% of US GDP. That is a lot compared to agriculture (1% around the same time), but still, 8% seems rather modest.

    How can an industry that represents 8% of GDP force the US government to increase its debt/GDP from 41% to 80%?

    What industry has the largest share of US GDP?

  22. Government in the US, at least, believes that it has, so far, bought the way through the problems for the bankers using other people’s money. If what they have done is gut Main Street to enrich Wall Street, the old, old tale of the goose that laid the golden eggs may be an apt comparison.

  23. Purple said:
    “There’s something systemic going on here. The growth of finance is a symptom, not a cause. Finance explodes when there are not enough profitable enterprises in the real economy to invest in.”

    Purple Seymour Melman has written about the reason why US lost its edge…It’s been a long time coming..and given the demographics no recovery will be like one before (aging boomers and the new minority-majority)…

  24. similarly, the defence budget costs about the same as a financial system bailout, but that’s every year.

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  26. apachecadillac: “The 2010 Congressional elections may tell the tale.”

    Oh, great! Replace the tax-and-spend Dems with the reduce-taxes-and-spend Reps. Besides, the Reps love deregulation and corporate welfare. We need a grass roots throw the bums out movement, regardless of political party. Maybe there is a young Tibetan who is the reincarnation of Teddy Roosevelt.

  27. StatsGuy: “In some ways, the over-emphasis on TBTF represents a refusal by this dominant economic ideology to recognize all of the OTHER failures of the pure free market paradigm.”

    Would you please elaborate on some of these failures? I would be interested in hearing what you have to say. :)

    BTW, it may be a minor point, but I wonder if free markets tend to overvalue traded assets. In a short period of time, given a range of (rational) evaluations because of differing preferences, those who undervalue the assets in question tend to sell them, while those who overvalue them, and that tends to drive the price up, because those who now hold the assets value them more highly, on average. However, the new, higher price does not reflect the overall evaluation of the assets by the community as a whole. There is a tendency, in fact, for the price to rise to the maximum evaluation in the range.

    Also, is there not a too big to fail problem from a purely systemic point of view, moral hazard and politics aside? They system is too brittle. And does not market economics exacerbate the problem by its very efficiency? Fail safe measures are by their nature inefficient.

  28. Larry Summers wants to be Fed Chief, if you belive Bloomberg. Talk about rearranging the deck chairs on the Titanic. He already screwed Harvard, now he might get the whole banking system? Yikes.

  29. Charles R. Williams: “Why is the financial sector bloated? Tax policy necessitates elaborate schemes to avoid taxation and to maximize leverage. The solution is not regulation but a drastic simplification of the tax code,”

    Yes. Simple regulation is best, in practice. Cleverness is not a virtue.

    “refocusing it from income to consumption and reducing the incentives to leverage – both corporate balance sheets and incentive compensation plans.”

    Let’s not tax consumption, as we do not wish to discourage economic activity. As for reducing the incentive to leverage, let’s keep it simple: ban excessive leverage. Do not let people take excessive risk with other people’s money. That may not be best in theory, but let’s keep regulation simple. Do not just incentivize people to do the right thing, because they won’t, anyway.

  30. DesolationRow

    “Small enough to fail” may well prevail eventually

    It may…but by then the damage will have been irreversible. I rememember reading a study a long time ago that basically equated nation stagnation with an oversized financial sector…essentially arguing that financial engineering didn’t add long-term competitive advantage. This is probably what will happen to this country. We have a Congress that dares not challenge the big banks and a president who is primarily concerned with health-care reform…not banking reform. There will probably be a revolt at the ballot at some point…and the more educated the electorate is on this topic, the sooner it will happen. Keep up the good work.

  31. Simon van Norden

    I’ve been wondering how to understand the economic arguments for regulatory forebearance. As I understand it, proponents argue (explicitly?) that with time, banks and near-banks will be able to restore their reserve ratios without public assistance and thereby reduce costs to taxpayers. My problem is with understanding how the reserve ratios are restored.

    One approach is to attract new equity. But that raises two awkward questions. 1) Why would new equity take on the old bank’s debts instead of just setting up an entirely new bank in competition? or investing in the competitors of banks that have done badly? 2) Why will letting existing shareholders and management screen offers of equity infusion work better than having a government-run liquidator close banks and sell of their assets?

    The other approach seems to be to allow banks to replenish their equity capital through retained earnings. I think this has its own set of awkward questions. 1) What if the next downturn is unpleasantly soon? 2) How can banks with big capital gaps compete with banks that have smaller capital gaps? 3) Isn’t the the same as imposing a tax on capital to replenish bank reserves? Do we think that taxing capital is a good way to raise this revenue?

  32. Simon van Norden

    There is much food for thought in those slides. However, I also had problems with one or two references in the slides that were just too cryptic for me. Can anyone explain the meaning of

    “Overgrazing: “tragedy of the bankers’ commons””?

  33. I am not about to launch into a diatribe here, but let me just note this one thing:

    In the context of the FINANCIAL crisis, (version 1 of) TBTF lays the blame on moral hazard. Fix moral hazard, and the problem resolves. (as I noted above, I think the political-economic version 2 is more persuasive)

    In the context of the MEDICAL crisis, moral hazard is also cited as the main problem (by free market defenders) – if we get rid of moral hazard due to insurance, the problem will fix itself. (But as JK’s recent posts point out, that’s a hard case to make given the reality we’re observing.)

    In general, blaming moral hazard as the chief culprit in recent crises propagates a view of reality that seeks _more_ reliance on freer markets, and requires that markets be made even more “free”. This, I fear, is Larry Summer’s philosophical bent (markets aren’t the problem, just market failures).

    SJ’s defense of the focus on TBTF has increasingly shifted to how big finance has obstructed political change. In this, recent events have certainly confirmed some of his fears.

  34. Nice reminder.

  35. Eric Dewey, Portland, Oregon

    Well done, Simon – always a joy to read your analyses, even when they are as painful as this one.

  36. Simon van Norden

    On question #1, I think Simon is thinking of the near-doubling of government debt to pay for the bailout of the financial sector as a massive increase in public debt forced by the financial sector.

    I think he’s justifying this as a rent in the sense that TBTF banks earn above-normal profits by taking on riskier activities, knowning that they have free insurance from the govt to protect themselves from the downside (because they are TBTF.)

    On question #2, biggest industry depends purely on how you define industries. Is construction a separate industry? Retail trade? etc. How can an industry that’s only 8% of GDP force the government? Look at railroads in US history. Look at Standard Oil. Ask yourself why the government is intervening in the GM and Chrysler bailouts when they represent a much smaller fraction of the US economy (and their direct competitors are not receiving such aid.)

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  38. Yes, Silicon Valley has been co-opted. Microsoft is the rentier par excellence.

  39. Is there any doubt that Summers will be the next Federal Reserve Chairman?

  40. It’s not often that you read a .pdf file that ends with this line:

    …”And potentially destabilize the world”.

    Cheers!

  41. @StatsGuy

    Many thanks. :)

  42. In 1939, everybody wanted to fight WW1 all over again…

    Looks like Big O and his econ-Minions are hell-bent on re-living 2008. Because they didn’t get a chance to facilitate the last crisis, so they need to make sure they get a do-over? Geithner, Bernanke et.al. were around the last time, is this rehab, or Deregulators Anonymous?

  43. Walt French

    @ EmilianoZ — in understanding such huge issues as Mr. Johnson addresses, most of us fall back on comfortable paradigms.

    (See Kuhn’s “The Structure of Scientific Revolution” for examples of how even the most free-thinking of us reject new ideas, e.g., Einstein’s “God does not play dice with the Universe” rejection of Quantum Mechanics.)

    The dominant paradigm in SV is that regulation helps ossify businesses, often by firms’ self-interested lobbying to expand profit margins, driving out attention to the New and Innovative.

    DARPA’s support of the internet was itself an innovation, but today’s news has a story of squabbling between various cell providers and those who own the internet infrastructure, trying to get the FCC to favor their situations. That’s innovation?

    SV is (mostly) very cautious in keeping a low profile in Washington. The very reason you cite is the reason they won’t be helpful.

  44. For the defense budget we get an Army, Navy, Air Force, Marine Corp & Coast Guard. What do we get with the financial bailout?

  45. And Geithner & Bernanke will give the stupid banksters another blank check signed by we the taxpayers. Think the Bank of China will cash another one?

  46. sekou toure

    More please about the “nothing good can come of this” argument. What is the problem, according to them? Who articulates this concern? That people are trying to shut you up in this way is a very encouraging sign.

  47. I agree with much of your assessment, but it is too late for regulation or reorganization of the financial sector to save the day. The biggest problem, to me, is whether government will be able to succeed in the present wealth-maintenance strategy. The bank holding companies were highly levered. It is primarily their creditors, rather than the banks themselves, that are the great unfillable pit absorbing our tax dollars. In other words, the excess of liaibilities over assets is much bigger than the capital of the bank holding companies and this capital can be preserved only by making the creditors whole – a very misguided policy. The biggest fault with the current financial sector is their political clout to get such transfers from taxpayers, even though it risks sinking us all.

  48. Robert David Cohen

    Maybe I’ve missed something, but I have never seen you mention the UN General Assembly conference on the global economic crisis that opens tomorrow after months of preparation and controversy. Here’s the most inclusive global body — made up of 192 countries — trying to grapple with the crisis and propose reforms, and you ignore it. Leaving solutions in the hands of the US or the G8 or G20 much less the IMF would bring us band aids when radical reforms are needed. The media have ignored or written off tomorrow’s conference, following the lead of the rich countries, but the Stiglitz Commission’s recommendations to the conference are serious and deserve a hearing. Hopefully you will take the conference seriously.

  49. In the sense that the power of ideas matters, Wired magazine – the SV bible – has had a number of good articles about the crisis and about reforming finance to make it more transparent, break up monopolies etc. So has SEED magazine, which is based in NY but aimed at the science / tech crowd.

  50. Min–
    why do you assume from my observation that the Republicans have much of a chance of making a comeback in 2010? The Republican approach to governing has been utterly discredited. If the midterm elections confirm that, the inside the Beltway dynamic will shift markedly. Most of those people are still hedging their bets (the House insurrection over AIG bonuses almost upset the equilibrium but it wasn’t quite enough).
    Keep in mind, 2006 was, for the Congress, beginning of a shift. Have you heard from Frist, Foley or Delay since then? Those guys were at the heart of the Republican leadership. 2008 was another step in the process. 2010 needs to prove the concept as it were (drive a stake through Karl Rove’s approach, if you prefer).
    BTW, TR was a Republican, even if he was a Roosevelt.

  51. @apachecadillac: Sorry if I suggested that you were backing the Reps. The only assumption I made was that the incumbent Dems would not lose in the primaries — with perhaps a few exceptions. IOW, the midterm elections seemed like a vain hope.

    Yes, I know that TR was a Republican, but, as one of his family said, he was half Democrat, too. ;) As for the idea of Too Big to Fail doctrine, I think he would have said, Balderdash! Or something stronger. ;) I expect that he was a gold standard kind of guy, but his reincarnation would probably have learned from history.

  52. I haven’t read all of the comments, and, so I may repeat what someone else has said.

    I know that the governments around the world have taken action to limit the damage. What has been done so far may be seen as political hand wringing. First, because no one in their right mind wants the “commoners” to know just how bad it really is. But, when we grant almost unlimited political power to the financial (or any other) elite, this is what we get.

    I think that the most serious problem is global political destabilization. The economic issues are gradually becoming politics. And the real upheavals will be geopolitical. That part hasn’t really sunk in yet. But, in back rooms around the globe, a very nasty concoction is brewing. And no one can control this genie that is now out of the bottle.

    It could help us to eliminate the oligarchic interests that are the major destabilizing factor, but who is going to voluteer for Kamakazihood.

  53. Simon,

    I live in California and called U.S. Senator Feinstein’s office about the status of the ‘Financial Crisis Inquiry Commission’ (Senate Bill 386 recently signed into law), which establishes a 10 member commission in the legislative branch to examine the causes, domestic and global, of the current financial and economic crisis in the U.S.

    The committee members are to have national recognition and significant depth of experience in such fields as banking, regulation of markets, taxation, finance, economics, consumer protection, and housing.

    Senator Feinstein’s office stated that they hope to have the committee established soon – no specific date was given but was asked.

    Simon, I hope you are called upon to serve on this committee. You are very knowledgeable and articulate and well-respected. I did suggest your name to serve on the committee. Feinstein’s staffer, who works on the economic crisis for her office stated you certainly picked the best of the best. My response was the best of the best are needed to get our country out of the economic ditch and onward towards prosperity for all.

    I hope you are interested and called upon to serve on the commission. Please let all of us know your thoughts about this commission.

  54. I read that Canada and low level staffers will be attending the meeting. For some reason, it appears that these meetings are not taken seriously by the U.S. I believe Obama’s financial reform recommendations were established for that meeting.

  55. Simon,
    One additional question. In your opinion, when all is said and done with this economic mess, will the national debt be doubled? Will the banks be paying anything back to the taxpayers? If so, how long will it take to see the taxpayers made whole or am I a dreamer?

  56. Larry Summers will never be chairman of the federal reserve. Obama will have to reappoint Bernanke for all kinds of obvious reasons. Obama has almost said as much in his recent praise for Bernanke.
    And Bernanke probably does deserve credit for helping the U.S. and the world avoid a much worse outcome than we have had to date with this crisis. Paul Krugman certainly thinks so, although I’m unclear what Simon Johnson thinks about that subject.
    Unfortunately, Bernanke had only Hank Paulson and George W. Bush to work with during the worst days of the crisis. Paulson took care of his own first, last and always.
    As for what we have purchased by increasing our national debt from 40% to 80% of GDP, how about avoidance of a depression and much, much more pain for the little guy? The issue Johnson raises so intelligently, however, is what a further great increase of debt to GDP will buy.
    Finally, we’ll see whom Obama is beholden to after the healthcare reform debate is settled. If we get a public plan option, Obama can take on anybody–even the big banks. If we don’t, we’re in no better shape in economic terms than if GWB could have been re-elected for a third term.
    But even if Obama truly reforms healthcare, there is every sign he is beholden to the financial services industry. It might have started from the initial (and, much more importantly) subsequent support he received from the “rent seeker of all rent seekers,” Warren Buffett. It might be campaign contributions. But that the financial services sector has something over (or perhaps on?) Obama, of that there can no longer be much doubt. Why else would have Obama named a total failure (in his former role as the head of the Federal Reserve Bank of New York) like Tim Geithner his secretary of the treasury? To see the stock market go up by 700 points in one hour–as is did after word of Obama’s choice of Geithner leaked out in the media?

  57. I doubt it Joyce. I guess the next Chairman would be someone already inside the Federal Reserve. Possibly someone on the FOMC. Alan Blinder was rumored to replace Greenspan, but I guess (only guess) he got tired of the politics involved. Janet Yellen would be a great female choice.

  58. It seems you have begun reciting as a certainty what is really only a reasonable estimate — “We’ll double our national debt (as a percent of GDP).” Adding 40% of GDP to the national debt is a guess, is it not?

    Do you believe our ability to add debt beyond 80% of GDP would be constrained by market rejection, such that additional deficit spending, bailouts, and other stimulus would be clearly counter-productive in the form of immediately and disproportiontely higher interest rates?

    If not, what will prevent our debt level from following the path of Japan up beyond 150% of GDP, recovery?

  59. Simon van Norden

    BR;

    Reinhart and Rogoff (2008) look at a dozen or so recent banking crises in developed countries; they find that on average these countries saw their real govt. debt increase by 86% in the three years following the start of the crisis. By that metric, seeing the US debt/GDP ratio double seems “about right.” They also find that the recessions following such crises are more severe than usual, but typically last no more than 6Q.

    So if you think the “typical banking crisis” model tells us something about what to expect in the US, there is little reason to expect debts to keep rising and the recession to continue indefinitely. That’s a big if, but it is the most reasonable benchmark I’ve been able to find.

  60. RE: World Trade Organization (WTO) Financial Services Agreement.

    It is my understanding that this agreement forbid governments from limiting the size of banking, insurance and other financial services firm. Public Citizen Trade Watch on June 22, 2009 posted a memo to reporters regarding the Obama Administration working with the EU & Canada to block real reform. Here’s that memo:

    http://www.citizen.org/documents/UNSummitRelease062209.pdf

    Simon your name is mentioned in the memo regarding the “too big to fail” comment you have previously stated. However, the memo states that WTO rules explicitly forbid government from limiting the size of foreign financial services firms, even if such limits are equally applied to domestic firms.

    One key question, as stated in the memo, is whether the wealthy countries will force the final UN summit
    to repeat the glaring mistake of the G-20 summit declaration – a call for completion of the WTO’s Doha Round which includes further extreme financial service deregulation.

    I would appreciate hearing your thoughts on this agreement and the WTO’s roll in financial services deregulation and needed reform.

  61. Simon,
    Were the AIG counterparty bailouts necessary?

  62. Why should the taxpayers pay for gambling? Who benefitted from the AIG bailout?

  63. Thank you all for the interesting ideas.

    I can believe that established technological companies tend to behave like their financial counterparts.

    But surely young entrepreneurs looking for funds to start a new company must be livid that people with money prefer to invest in hedge funds or real estate rather than in something that can potentially create real sustainable growth.

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  65. Walt French

    But surely young entrepreneurs … must be livid that people with money prefer to invest in hedge funds…

    Actually, if you’re really a startup, you don’t have much time or energy to worry about problems over which you have almost zero control. Inventing the future (R) is hard.

  66. Eric, we already had the massive catastrophic failure — of the banks. The next will be when the banks fail again, and then the backstop, the US govt, fails.

  67. Tippy Golden

    What I take from Simon’s slide show that I really like is his reference to the “power of ideas” as a counter weight to the power of the oligarchy. I like the clarity of his analysis.

    The way out, if I understand it correctly, is to grow other sectors of the economy. The financial sector has shown itself to be “rent seeking” and produced castastrophic “innovation”. Reflating the financial bubble is not the right place for investment. Rather, the right investment is innovation that grows a real economy.

    I might add: With a “green economy” as central to the real economy.

  68. Max Hyperbole

    Ironic that you should mention real estate in this skeptical sense, because that is exactly the sort of market structure that some people hope to impose on one of the most fundamental (and nonsubstitutable) prerequisites for “new companies” to provide Internet content and services, innovative or otherwise. To date, IPv4 addresses have served as the Internet’s basic attachment-based medium of exchange, and to date they have been available to all comers based on neutrally administered, industry-defined eligibility criteria. Now that the finite reserves of IPv4 have been almost completely distributed to incumbent Internet service providers, doubts about whether or not those incumbents will embrace the successor IPv6 addressing format are suddenly on the rise (note: IPv6 has been the technology plan of record for 15+ years). Unfortunately, because IPv6 is not directly backward compatible with IPv4, if they do choose to forego IPv6 in favor of other private, non-standard, or IPv4-dependent technologies, then that will impose a durable if not permanent upper-limit on the size of the Internet’s “ground floor” — with current incumbent services providers occupying 100% of it. This would basically be equivalent to a virtual “enclosure act,” albeit an enclosure that would directly cause the loss/abandonment of potential “ground floor” space for future Internet growth equal in size to the entire Internet as it exists today multiplied by 2^96 — which is a very large number (appx. equal to the number of atoms in a cubic meter of water).

    Why would any commercial interest willingly accept, or perhaps even actively prefer a future where direct participation in the Internet is subject to extreme scarcity constraints when alternatives exist, especially when all of the other prerequisites for creating and delivering innovative new services (e.g., bandwidth, data processing capacity, data storage capacity, etc.) are getting cheaper at near-exponential rates year after year? For starters there is the incremental capital cost that incumbent Internet service providers would have to bear to integrate IPv6, a cost which provides them with no obvious/direct offsetting revenue. However, even if the excuse provided by this modest but immediate hurdle did not exist, it’s likely that the competitive/commercial advantages of artificial scarcity would induce at least in some an equivalent if not stronger and more enduring reluctance. Simply by doing nothing and allowing IPv4 addresses to be exhausted “organically” (i.e., through existing endogenous growth processes) with no clear successor Internet attachment mechanism, incumbent Internet operators would passively but decisively install themselves as the owners of all of the Internet’s “ground floor real estate.” In an industry where open competition continues to dramatically undermine producer pricing power, the prospect of inheriting the power to preempt or co-opt all future disruptive innovations (e.g., by permitting them only if/when they directly benefit the incumbent providing the essential bottleneck IPv4 input) might be difficult for even the most forward-looking companies to resist. But an even greater temptation is likely to emerge as a consequence of one of the unique features of the Internet’s basic liquidity mechanism, the “business ends” of which are represented by IP addresses. Unlike the contingent, self-limiting “means of payment” mechanisms that fuel the conventional economy (i.e., money in all of it’s various forms), the Internet’s underlying liquidity mechanism depends on a relatively durable, usage insensitive “means of attachment” function, which is embodied in every unique IP address. Although a non-circulating, attachment-based medium of exchange makes perfect sense in context — the Internet’s “real factors” being inherently nonrival (since online “exchanges” are conducted via a duplication process) — the resulting “virtual economy” of unbounded supply and demand factors has wrought havoc on the scarcity-dependent commercial strategies that prevail in the conventional economy. How convenient it might be, then — e.g., for investors driven by “conventional economy” models — if the Internet’s unique but to-date commercially intractable liquidity mechanism could finally be captured and transformed into a more pliant vehicle for online content producers, distributors, and other middlemen to individually assert their own incremental reserve pricing requirements on different aspects of Internet usage. As long as the Internet’s liquidity mechanism remains open and immune to capture by any particular commercial interest, that would be extremely difficult to achieve. Once it becomes fully enclosed, however, making new entry impossible except for those who secure permission from an incumbent, it becomes almost inevitable — as does the perverse direct monetization and de-coupling of this virtual liquidity mechanism from the productive, innovative elements of the “real” Internet economy.

    If this scenario sounds vaguely familiar, it is not a coincidence.

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  72. Most probably the second scenario is the closest one to reality, however scenario 1 is being implemented with the possible consequences you mention. UNLESS, a complete regulation of the Political and Financial System and its institutions take place within the next 3 years.

    Since the Regan era, the financial system has been left to be free. Complex financial structures and products, plenty of secrets that only true specialist could understand. Derivates were out of control. Hedge Funds are a massive ball of products, that invested in something, whit hallway nice statistics, managed by Mr. X who anybody know (or think are known), promising exceptional returns that where cap by lofty incentives. And as the financial markets where not enough, a group of selected rich and powerful people decided to go after the commodity market, manipulating their prices and destroy investors and consumers welfare.

    Financial markets, or better said, a group of “few”, took over the Governments and the economies. Yes a “few”, 7 banks and a restricted group of 20 families, control the US and most probably part of Europe. Their power have deep reach into the US and UK Government, and that is why scenario 1 is on it’s way, and personally do not expect a shift in policy, even as some parts on the Governing party will try to change them.

    I can spell many lines on it. We can read many questions that have not been answered, or may be answered as simple as it is, in order to comfort citizens of the world.

    For example:
    • Which was the first yellow light to the financial Crisis? BNP – Oct 07.
    • Who spread the buzz that lead to Bear and Stern collapse? Deutche Bank, who later on try to get B&S but was denied.
    • Why JPM got B&S ? Yes the answer was, that JPM was the only bank able to absorb the 3er most important Broker.
    • But was this true?. JPM put 2 BL$, and the Fed put 29BL$, JPM offered 2$/SH, and 5 days later 10$/sh. Was that a mistake ?
    • Who favored the run on Lehmann? JPM was in so bad shape (!!) that cut Lehman 17BL$ line of credit from one day to another.
    • How is that JPM bought Washington Mutual, for 1.9 BL$ . This is a long story, that we will still hear about due to the ongoing Legal cases.
    • For those that are interested, please learn how JPM was created, and how the FED was born ? You will get many astonishing answers.
    • Merrill ? Was B of A forces to absorb ML??, why? How can B of A purchase a company without an due diligence?? Yes no time to think, and the need to act. But billons of $ where spent in hidden agreements at ML.
    • Mr. Paulson, he came from Goldman Sacs, as many previous Treasurer. Is that a coincidence? Mr. Paulson distributed 700 BL$ without even putting clear rules. No wonder that he now opened a Bad Assets Fund. He intends to gain double, since he was shorting the big banks/brokers that failed (public information)
    • The Fed and Short selling on main financial institutions? Why those that where big and failed where not included in the No short list ??
    • Shorting Naked was not allowed But?……………………..
    • Even the trading rules for big institutions are less strict than for individual investors. Is this true? Or are more favorable for the Big Guys?
    • Hedge Funds ?? What are they doing ?? Who knows!!!!!
    • Mortgage re industrialization has been even worst. We can right 10 books on that.
    • AIG derivate contract with GS ? 12 BL$ from taxpayers to GS using AIG as a bridge !!!
    • Who is World Bank, FMI, etc……………………….??
    • ………………………

    Unless the financial System and Political structures and responsibilities are changed, we will find, in 20 to 30 years from today , a world of poverty and a reduced elite, that will image some Spielberg films.

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  74. I sure would like to see:
    1. a description of a successful future for the World and US economic health.
    2. a project plan/roadmap to get there
    3. a clear and quantified statement of each incoming financial problem (such as further mortgage impacts – when, how much).
    4. s how we should item 3 without losing our way.
    5. how we are to keep our government’s eye on the main game.

    Having read all these comments I see no fix, just incredibly clever comments about details of the debacle!

    Do we have a solution in mind or only criticisms?

  75. Sorry for the typo.
    item 4. should read:
    ‘how we should satisfactorily handle item 3 without losing our way’

  76. Max Hyperbole

    To notabanker’s challenge:

    The first problem to recognize is that there are no generally accepted definitions for concepts like “financial problem” and “world and US economic health.” For the vantage point of the average isabankertoday, “the problem” is likely to be strongly informed by concerns about “threatened” or “diminishing” incentives for “innovation” — esp. but not exclusively the kind of financial innovation that has garnered isabankertoday many many more multiples of the “average” notabanker’s annual income every year for the last couple of decades. For isabankertoday, a (the?) key component of the ideal project plan/roadmap would be preserving that earning potential, which requires restoring enough investor and counterparty confidence (plus a return to the usual passivity/indifference among great unwashed non-counterparty majority) so that deal-making can resume, and demands for oversight and comp caps again recede into the general background noise. Achieving this will be no small feat, and will probably involve a great deal of “strategic ambiguity.”*

    Any other kind of decision-maker — e.g., isaregulator, isanonlobbyistopinionleader, et al. — with the means and inclination to advance a different (perhaps even the opposite) agenda will almost certainly need to make extensive use of the same tool* to blunt some of the impact of the inevitable obstructionism and obfuscation coming from their opposite numbers during the long march to some new financial industry coordination/regulation arrangement.

    So while your apparent frustrations are completely understandable, the apparent absence of a clearly outlined “fix” in public discussions does not necessarily mean that it really is just clever comments all the way down… or at least I hope it doesn’t anyway. MH

    *c.f., http://en.wikipedia.org/wiki/Policy_of_deliberate_ambiguity