The case for keeping banks in something close to their current structure begins to take shape. It’s not about traditional claims that big banks are more efficient, or Lloyd Blankfein’s argument that this is the only way to encourage risk-taking, or even the House Financial Services Committee view that immediate resumption of credit flows is essential for preserving jobs.
Rather, the argument is: those opposed to banks and bankers are angry populists who, if unchecked, would do great damage. Bankers should therefore agree to some mild reforms and more socially acceptable behavior in the short-run; in return, the centrists who control economic policymaking will protect them against the building backlash. This is a version of Jamie Dimon’s line: “if you let them vilify us too much, the economic recovery will be greatly delayed.”
There are three problems with this argument: it is wrong, it won’t work, and it doesn’t move the reform process at all in the right direction.
The “center vs. the pitchforks” idea fundamentally misconstrues the current debate. This is not about angry left or right against the center. It’s about centrist technocrat (close to current big finance) vs. centrist technocrat (suspicious of big finance; economists, lawyers, nonfinancial business, and – most interestingly – current/former finance, other than the biggest of the big, particularly people with experience in emerging markets.)
Just as an example, a broad range of entirely centrist people (including in and around the IMF; former Treasury; you’d be amazed) are expressing support for the ideas in our Atlantic article. People on the left are, not surprisingly, also in line with this view; but we’re also hearing convergent thoughts from some on the right – many who emphasize improving the environment for entrepreneurship don’t see big finance as their friend. So far, the only person who called to complain works for an “oligarch.”
You might think the “anti-pitchfork” strategy might work, particularly as it has in the past (e.g., in the early Clinton years). The problem for this strategy now is not just the fragile state of banks – by itself this can be ignored for a long while through forbearance, behind a smokescreen of complicated schemes with confusing acronyms – but the ways in which the markets they created now operate.
Just as global financial liberalization created the potential for capital to move violently across countries and greatly facilitated speculative attacks on currencies, so financial deregulation within the United States has made it possible for capital markets to attack – or, in less colorful terms, go short or place massive negative bets on – the credit of big banks and, in the latest developments, the ability of the government to bailout/rescue banks.
The latest credit default spreads data for the largest banks show a speculative run underway. As the system stabilizes, it becomes more plausible that a single big bank will fail or be rescued in a way that involves large losses for creditors. This would like trigger further speculative attacks on other banks, much as the shorting of countries’ obligations spread from Thailand to Indonesia/Malaysia and then to Korea in fall 1997.
The government’s own policies are facilitating these attacks, because as the Fed and Treasury make progress towards easing credit conditions, this makes it easier and cheaper for large hedge funds and others to take large short positions. And keep in mind the underlying loss of confidence is self-fulfilling: as you lose confidence, you want to go short, and selling the credit causes further loss of confidence – and banks are forced out of business.
The government’s entirely reasonable and long overdue request for a resolution authority will set up runs on that authority. If the authority is not granted, the runs will be on the government’s low and failing ability to save banks – given that the trust of Congress has been lost and no more cash for bailouts is likely forthcoming (presumably until there are large further shock waves or until Goldman Sachs itself is on the line.)
The continuing pressure on banks has nothing to do with populism and everything to do with the internal contradictions of the house of cards they built. Now they will scramble to limit short selling or find other emergency measures that will protect their credit. Such partial fixes would do nothing to stop the underlying deterioration of their credit; think about how countries facing currency attacks throw up futile defenses, try to change the rules, and squander their reserves on the way down.
You can see where this is going, but do not cheer. The likely result will be misery for many and further financial chaos around the world.
The big issue is of course the financial sector reform process. Some of my colleagues expressed great satisfaction with the progress made by the G20. But progressing down a blind alley is not something to be pleased about. I have yet to hear a single responsible official in any industrial country state what is obvious to most technocrats who are not currently officials: anything too big to fail is too big to exist.
If the bankers were just stupid, as suggested by David Brooks, then regulatory fixes might make some sense. But we know that bankers are smart, so it is their organizations that became stupid. What is the economic and political power structure that made it possible for such stupid organizations to become so large relative to the economy? Answer this and you address what we need to do going forward.
At a high profile conference in the run-up to this crisis, someone destined to become a leading official in the Obama Administration responded to a sensible technocratic critique of the financial system’s incentive structure (from the IMF, no less) by calling it “Luddite”. By all accounts, this is the prevailing attitude in today’s White House.
But the right metaphor is not breaking productive machines, or peasants with pitchforks, or even the poor vs. the rich. It’s as if the organizations running the nuclear power industry had shown themselves to be stupid and profoundly dangerous. You might wish to abolish nuclear power, but that is not a realistic option; storming power plants makes no sense; and the industry has captured all regulators ever sent after them.
The technocratic options are simple, (1) assume a better regulator, of a kind that has never existed on this face of this earth, (2) make banks smaller, less powerful, and much more boring.
By Simon Johnson