By Simon Johnson
Just over 100 years ago, as the nineteenth century drew to a close, big business in America was synonymous with productivity, quality, and success. “Economies of scale” meant that big railroads and big oil companies could move cargo and supply energy cheaper than their smaller competitors and, consequently, became even larger.
But there also proved to be a dark side to size and in the first decade of the 20th century mainstream opinion turned sharply against big business for three reasons.
First, the economic advantages of bigness were not as great as claimed. In many cases big firms did well because they used unfair tactics to crush their competition. John D. Rockefeller became the poster child for these problems.
Second, even well-run businesses became immensely powerful politically as they grew. J.P. Morgan was without doubt the greatest financier of his day. But when he put together Northern Securities – a vast railroad monopoly – he became a menace to public welfare, and more generally his grip on corporations throughout the land was, by 1910, widely considered excessive.
Third, there was a blatant attempt to use the political power of big banks to shape the financial playing field in ways that would help them (and their close allies) and hurt the remainder of the private sector – including farmers, small business, and everyone else. Senator Nelson Aldrich’s push to create a central bank after 1907 – to be underwritten by the government but controlled by big banks – ultimately backfired. The Federal Reserve, while far from perfect, was created with far more public control and greater safeguards than Wall Street had in mind.
The fact that Nelson Aldrich’s daughter was married to John D. Rockefeller’s son was not lost on anyone.
A hundred years later, we have come full circle – as the mainstream consensus again weighs what to do with today’s overly powerful banks.
There are differences, of course. We no longer fear individuals – it’s the organizations they run that can make us or break us.
And, strangely, it is not the power of big finance to control everything that has us worried – other than in some movies. Rather it’s the ability of major banks to generate the conditions that make major international financial crises possible – with the incentive to take risks that, when things go well, result in huge upside for bankers and, when things go badly, massive downside for the rest of us.
Even the supporters of our existing financial structure – men like Hank Paulson (in On The Brink), Larry Summers (in his 2000 Ely Lecture), and Jamie Dimon – concede that big crises occur every 5 years or so. What hit us in 2008-09 was not a “once per century” event. Rather it was the latest – and scariest – in a series of regular global crises that goes back to at least the 1970s.
At the heart of this pattern of behavior is a perception of invincibility among the folks who run our biggest banks – and following our most recent crisis they act more assured than ever that the government will provide a backstop.
At the same time, everyone agrees that such “too big to fail” arrangements cannot continue. Even the Federal Reserve, which has fallen on hard and embarrassing times since it was captured by Big Finance during the 1990s, now has its leading officials give speeches to this effect.
We like to think we live in a more professional and technocratic age than a century ago, so the central pretense of current reform efforts is that we can design a “resolution authority” of some kind that would allow the government to take big banks into a form of bankruptcy or liquidation.
But this notion of a resolution authority that can handle massive banks is a complete unicorn – a mythical beast with magical powers that does not really exist. A US resolution authority does nothing to help handle the failure of international banks – there is no cross-border resolution authority, nor will there be one anytime soon. If a Citi or a JP Morgan or a Goldman were to fail, our government would be in exactly the same awkward position as it was in during September-October 2008.
Big banks cannot be reined in through some clever tweaking of the rules. The issue before us is intensely political – just as it was in the first decade of the twentieth century. There is again a confrontation between concentrated financial power and our democracy. One side will win and the other side will lose.
The banks start with a definite edge. The public relations machines of today’s bankers may be even more effective than those of Morgan and Rockefeller – although the campaign contributions and control of the Senate exercised by those titans was immense.
But it is still early days – the Senate legislation expected this week or next will achieve nothing, except make the stakes clearer and motivations more transparent. If the banks win this round, as seems likely, they will become even larger – and more dangerous. At current scale, our megabanks bring no social benefits and great social risks.
Just as a hundred years ago, the consensus on big banks has to change. In this instance, either we break them up or they will soon break us all.
An edited version of this post appeared this morning on the NYT’s Economix; it is used here with permission. If you would like to reproduce in full, please contact the New York Times.
The Baseline Scenario 
Again, a trenchant criticism from one who, while
not exactly in power, has the ear of power . . . to
some extent.
I ask again: can we not decide on the outlines, in
theory, of a financial system which people can
be _for_. The banks know what they want: more of the
some. More derivatives, more “innovative financial
instruments”, etc. We criticize, but we don’t have
a construct of what we are _for_.
I am reading, slowly but reasonable carefully,
Stiglitz’s “Freefall”. Even early on, he has what
seem to me to be excellect suggestions of what
an efficient, regulated financial system in a
capitalist democracy _should_ be.
Maybe a discussion of Stiglitz’s book here might
produce some ideas worth pursuing? (NB I have
no idea whether Messrs Johnson and Kwak read
these comments. I do know that Mr Kwak has been kind
and responsive to me, when I had some technical
difficulties with the mechanism of ths blooging
software used here)
Best wishes to all,
Alan McConnell, in Silver Spring MD
I would place some of the complicity on the mainstream media (their corporate lapdog approach to covering politics and finance), especially at the local level. Of course, the counter argument is that with the advent of the internet, news and information choices are broader and more diverse in opinion and analysis. However, empirical evidence really points towards the notion that people tend to seek out sources of news and information that confirm or validates one’s already-held precepts.
President Obama could offer some teachable moment regarding financial reform but his views are more aligned with the traditional methods of reform – not the transformative, tour de force type of intellectual thinking – so I don’t see the financial reform proposals that are making their way around Capitol Hill to be anything more than the standard call to regulate. The ‘intellectual capture’ you were quoted as having said really sums up President Obama’s overall thinking on finance, reform, and capitalism (his version of trickle-down economics, though, appealing mostly to the arugula crowd).
Mr Johnson wrote:
“At current scale, our megabanks bring no social benefits and great social risks. ”
Hmm, I think someone else agrees.
Mr. Stiglitz wrote Tuesday, 9 February 2010, The Independent:
“The system, he says, is “corrupt”.
His sheer indignation at what he calls “the Great American Robbery” – that multi-trillion dollar bailout for the banks sanctioned by the Bush and Obama administrations – is as awesome as the sums involved, and as understandable.
He reminds us that the banks have effectively tried to keep “a gun to our heads”, that says that if we don’t keep them going on their terms then they will “kill the economy”.”
http://tinyurl.com/yeknaot
March 3 (Bloomberg)
“The Fed has an “innate conflict of interest” in trying to protect consumers while fulfilling its mission of safeguarding the rest of the financial system, billionaire George Soros said at a conference in New York today. “When Barney Frank called it a joke, I think he’s right,” Soros said.”
http://tinyurl.com/y994g6g
Have you noticed the tenth amendment attemps at nulification?
I am generally sympathetic to Simon Johnson’s aims but too often, he falls into the trap of the cyclical model asserted by the quasi-scientific, nee apologetics, of economic theory, that attempts to define social interaction as if transaction reflects some sort of discrete closed system that abides by external and “natural” mathematical principles and behavioral laws.
The only abiding principle of relevance is that human beings are inherently social and in their sociality, they seek to devise methods for organizing their behavior into predictable patterns of collaborative action. (The invention of money as a medium of value exchange is one example.) When the material interests of one group become irreconcilably divergent from another’s, there is war, fought using the means at hand.
The warring that has occurred throughout history is cyclical in name only, because the means of combat is never the same. Though our idea of war seems constant, replacing bows and arrows with nuclear bombs changes the historical facts on the ground, and so too, the mathematics of conflict.
Today’s corporations have become nations of people with substantively divergent interests, who have at their disposal the means to nuke their opponents’ ability to construct stable systems for organizing their interactions and transactions into useful and reasonably predictable patterns. By assuring a chaos of unpredictability, corporate nationals are able to prey upon the nation of the dazed and confused.
The changes required are systematic rather than reformist but the weapons wielded by those who embrace the status quo, are the material, psychological and sociological equivalent of a nuclear arsenal.
To begin with, it is necessary to cast off the false “science” of naturalistic Newtonian economics. We must begin with an aim.
I’m glad to see others recognizing how “resolution authority” is a scam. No matter how rigorous on paper any unwinding process ever was (and even if the enactors were miraculously sincere at the time of enactment; but we know today’s criminals are not, and the idea is just a fig leaf), in the heat of the crisis that would all go out the window.
Some disaster capitalist like Paulson would shout, “By Monday we won’t have an economy! STAMPEDE!”, and the rout would be on, just as in 2008.
We already have the Prompt Corrective Action Law. Out the window it went.
In that connection, I got a grim chuckle out of this today, from The Economist.
http://www.economist.com/opinion/displayStory.cfm?story_id=15603267&source=features_box_main
The German constitutional court ruled two decades ago that the Maastricht treaty was acceptable only if its no bail-out provisions were respected — so any bail-out would have to be disguised to avoid legal challenges.
Ho-hum. Another stupid law. Another stupid treaty. Another stupid constitution. So how will they get around it this time? Such a bland and world-weary tone.
What Mr. Hersch overlooks are powerful continuities in U.S. history. The reaction by Biddle et al to attempts to control the first national bank are echoed almost verbatim by the financial community during the Progressive era and, then, again, during attempts to reform both banking and securities in the 1930s. This is not cyclical, rather, it speaks to the ways in which financial elites invariably invoke the same kinds of spectres should the public (i.e. the state) seek to rein them in. Ideologically, there are appeals to ‘efficiency’ (the economies of scale hoax), that the economy will collapse if they (financial elites) are thwarted, and then someone shrieks about immanent socialism (in the 18th century it was Jacobinism).
I agree that the changes required are systemic rather than reformist in character, but considering systemic change obliges one to not ignore history.
Russ wrote:
“Ho-hum. Another stupid law. Another stupid treaty. Another stupid constitution. So how will they get around it this time? ”
Woody Allen wrote:
“More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other, to total extinction. Let us pray we have the wisdom to choose correctly.”
(1935 – ), My Speech to the Graduates
We just need a new law that all future bailouts will be paid for in Food Stamps. The public will generously concede that the bankers who cause the next crisis will not be left to starve.
Mr. Leonard, it sounds to me as though we are largely in agreement. Historical context is required. Economic theory as an apologetic, goes back to the early 1800’s and has been elaborated over time, into an ideological pretender to scientific truth. It is not surprising that the arguments put forth by the financial elites of the 1930s closely resemble those being put forth today by those same elites. This is no more than saying that the arguments put forth by the Catholic church of the Middle Ages resemble those put forth today. Our ideological constructs are repeatable, more or less, but historical circumstances do not repeat themselves. As the delta between ideology and circumstance increases, there comes a point at which the tension between our conception of how things work and how they actually work, becomes tectonic. So long as the ideological plates remain locked, we can reasonably predict that, on the Richter Scale of social dislocation, the severity of the quakes produced will increase at an increasing rate.
That systemic change is a change from a culture of greed. That could take a generation. Among this generation of leaders, greed and selfishness are the norm and social conscience has become a joke.
We once had a culture of fair dealing in which large wealth accumulation was viewed with suspicion. Now, we have rent-seeking celebrity executives whose wealth is viewed as an indication of worthiness instead of pursuit of craven self-interest.
Jackrabbit,
The moral compass that guides nations of people is ever-changing and largely circumstantial. During WWII, the killing of Nazis was on the whole, perceived as a moral act. In its day, the relative “success” of free market ideology (greed is good) in producing a prosperous American middle class, produced a meta-morality along the lines of Adam Smith’s “invisible hand”.
Sadly, the systemic changes needed today will not be driven, on the whole, by conscience, but rather by an emerging shared vision of a clear and present danger and consensus regarding theory and method for avoiding that danger.
In 1930’s Germany, the perception of a clear and present danger drove a process of systemic change that produced the Third Reich and a nation of people who were guided by the moral compass of their circumstance. The Nazi theory of social interaction and transaction was disconfirmed by the jury of practice, but the price paid in deliberation was astoundingly high.
Which brings us back to first causes — What is our aim?
We can’t live with them too big, we can’t live with them too innovative, we want them efficient, we love them leveraged, we want them global, and we want them safe from fall.
So what is a bank? does it really have an operable definition in capitalism?
Marc
Thanks for your thoughtful reply. There is certainly a danger that people’s discontent is manipulated.
The aim, I would think, is a populace that is politically aware, and demand a democratic process that works in their interest instead of for large corporate interests.
How to get there? PUBIC FUNDING OF ELECTIONS would be a good start.
Simon Johnson writes, “There is again a confrontation between concentrated financial power and our democracy. One side will win and the other side will lose.”
Save yourself the suspense. The returns are already in. “Our” democracy is “their” instrument. The market system regulates the government, and not the other way around.
And about that monopoly cum crisis issue. Capitalism has always required crises, and always will. Not a planned economy, you see. And a calumniated leftist long ago explained why monopoly was built into the genetic striving of capitalist development.
You academics pretend that the world is one of your seminars, where conjecture holds sway and brilliant ideas light up the finest egos while the hoi polloi await your guidance. And you have the gall to talk about bankers’ “perception of invincibility”! You might as well hold an astrology conference; at least they have funky hats.
I tend to think that a discontent with a clear and present danger, with no viable alternative, is doomed to just explode up the big alien into a zillion little aliens, with the same blood sucking purpose. The nature of blood sucking itself, parasitic and killing, should be part of the public discourse. Let’s not think that only banks present this danger to society. The medical industrial complex is the next great and long term danger. It is driven by the same greed, self interest, close mindedness, compromise of values, spread of disinformation, brinksmanship, etc, that characterize this debate. Perhaps the administrations real plan is what it has been accused of, to get some measure of control and then to impose its will to a greater and greater extent. If so, I applaud it. But to promote that we are somehow doomed to inferior care if we drive the cost of medical care down as a percentage of GDP is essentially the same fear based argument made by the megabanks. You need us, you can’t take care of yourselves.
The administration’s unwillingness to make any major players pay a price, in banking or in medicine, prevent any real reform. In both cases we will have reform. The question is whether we will name the problem, greed, apply it to more than just some scapegoats, own it for ourselves, and free ourselves of it. If not, crisis will breed revolutionary change, in both cases.
But to return to the first point, there must be an alternative to the current system, and smaller but equally greedy banks are not the answer. You don’t think smaller banks are greedy? then why did they go nuts over commercial real estate? We need a third way.