On PBS this evening (first airs at 9pm eastern; on the web from about 10pm), Bill Moyers, Rep. Marcy Kaptur, and I discuss where we stand – and what we’ve learned – a year after the US financial system almost collapsed.
There’s a detailed preview on Bill’s website – our conversation moved back-and-forth between people losing their homes in Ohio, how bank behavior brought us to this point, and where we go from here.
We also discussed the latest revelations that, at the height of the crisis earlier this year, Treasury Secretary Tim Geithner spoke primarily to a very small group of top bankers (at Citi, Goldman, and JP Morgan). Further implications are taken up in my Daily Beast column this morning.
Also today, coincidently, on NPR’s morning edition (about 21 minutes into the first hour; will be on-line around 9am), Alex Blumberg, Charles Calomiris, and I role play whether the administration’s reform proposals are “Jamie Dimon-proof”, meaning that Too Big To Fail will really be brought under control. I’m Jamie Dimon, Charles is Charles, and Alex is the President. It doesn’t go well for the taxpayer.
On behalf of the administration, Diana Farrell (Larry Summers’s deputy at the National Economic Council, NEC) responds by saying effectively: “big has its benefits”, and the best we can hope for is to regulate our massive banks. As I said in my NYT Economix column yesterday (reproduced after the jump here), I take the position of Louis Brandeis on this one: our biggest banks have simply become Too Big To Regulate.
The NPR story didn’t get into the tragic human dimensions of the crisis, but Rep. Kaptur was forceful on this point during the Moyers conversation. In part, this strengthens the case for a consumer protection agency focused on financial products - a point on which we agree with Ms. Farrell and her colleagues.
But, hopefully, senior staff at the NEC will have a chance to review the Moyers segment (it only takes 30 minutes or so) and reflect on whether big banks are really ever so beneficial when they make, facilitate, and now refuse to renegotiate loans that have ruined so many lives.
Big is Bad Again
At about this time after the near-collapse of its banking system, any democracy goes through a phase of soul-searching regarding its broader economic model. Around almost every water cooler in the U.S., people ask: Does the severity of our financial crisis reflect the disproportionate influence of a few incompetent investment bank executives, something about how dangerous our financial sector has become, or a deeper breakdown of capitalism?
The deeper breakdown view is, without doubt, gaining center stage – debated now in movies, TV, and radio shows. And of course this position is not just about the crisis; it builds on serious longer term concerns, particularly rising inequality, that are real and quite disturbing.
At least in general terms, opinion leaders begin to point the finger at big corporations, including both their stupidity and greed in economic terms and their ability to generate political cover through campaign contributions and simply stunning amounts of lobbying.
The US experienced a similar phase of reaction against “bigness” in the early 20th century, spurred both by the 1907 financial crisis (which led, among other things, to the creation of the Federal Reserve, at the time a radical new component of the US capitalist system) and also by the rise of industrial trusts – huge companies that began to form in the 1890s and which, by 1910, dominated the American commercial landscape.
In the 1912 Presidential campaign, there were three main views on how to handle mega-trusts: do nothing (President Taft), build up federal power to counterbalance and regulate concentrated industrial power (ex-President Theodore Roosevelt, running as the Bull Moose Progressive independent candidate), and break up big companies to reduce their power (Woodrow Wilson, advised by Louis Brandeis).
Brandeis’s views are the most relevant for our modern discussion. In 1985 Thomas McCraw won a Pulitzer Prize for Prophets of Regulation, in which he criticized Brandeis for not understanding basic economics when he argued that big business was too big to manage effectively and undermined the individualism that was essential to American democracy.
McCraw rightly pointed out that some big U.S. firms have been well run over the past century – in fact, many of the best jobs in this country continue to be with large employers (look at the pay packages and benefits around you). It’s also true that the undoubted power of major corporations has not prevented waves of productive technological change, mostly brought to us by start-up entrepreneurs.
But Brandeis was right on the politics of size and what that meant in turn for the US economy – and he is very much in tune with the cutting edge of modern economics. When large firms can (1) shape their regulatory environment, (2) take advantage of lax regulation to take on more risk than they can manage, and (3) “put” the downside losses onto the taxpayer, we should be very afraid.
This exact problem has repeatedly slapped us in the face over the past 12 months with almost every development in the financial sector, and it remains inherent in every “too big to fail” bank. Brandeis was exactly right on the dangers that could arise from the financial system – even though he could not foresee how the creation of the Federal Reserve would, when combined with weak regulation, lead to even worse outcomes.
But we should not suffer another failure of imagination or apply Brandeis to our modern circumstances too narrowly. The problems before us now are not limited to the financial sector. Just as Brandeis argued, beginning with a piece entitled “Our Financial Oligarchy” in Harper’s Weekly, November 1913, we have allowed other parts of our economy to become “too big to regulate”. Any company that can set its own rules and then behave in a reckless fashion is potentially very damaging to both prosperity and democracy.
Teddy Roosevelt thought you could regulate and control monopolies, and his idea that “big corporate” could be controlled by “big government” was taken forward with some success by FDR, the reforms of the 1930s, and the way our system operated for 30-40 years after World War II. But the complete breakdown of financial regulation under great political pressure in the 1980s and 1990s should serve as a wake-up call, both with regard to banking and much more broadly.
We need to go back to Brandeis who, with his extensive experience on the interface between politics and law, thought that breaking up big firms was essential: “We believe that no methods of regulation ever have been or can be devised to remove the menace inherent in private monopoly and overweening commercial power” (Urofsky, p.346).
If we can update and apply Brandeis to finance and more broadly, we still have a chance to save the positive features of our American model.
By Simon Johnson
The material after the jump is a slightly edited version of my NYT Economix column yesterday. Anyone seeking to republish that material in its entirety should seek permission of the NYT. However, the material before the jump can be distributed freely, subject only to providing an appropriate credit and a link back to BaselineScenario.