A Trap Of Their Own Design

At this stage in the electoral cycle, Democrats should be running hard against big banks and their consequences.  Some roots of our current economic difficulties lie in the Clinton 1990s, but the real origins can be traced to the financial deregulation at the heart of the Reagan Revolution – and all the underlying problems became much worse in eight years of George W. Bush’s unique brand of excess and neglect.

The mismanagement of mammoth financial institutions over the past decade produced a crisis in September 2008 that required a substantial fiscal stimulus – among other bold government measures – simply to prevent the outbreak of a Second Great Depression.  That sensible fiscal response, plus the “automatic stabilizers” that worsen any budget (and help limit job losses) as the economy slows, will end up adding around 40 percentage points to our net national debt as a percent of GDP.  If you want to accuse the Obama administration of wantonly increasing the national debt – then let’s talk about the circumstances that required this fiscal policy.

The theme for the November midterms should be: Which part of the 8 million jobs lost [since December 2007] do you not understand?  The big banks must be reined in and forced to break themselves up, or we’ll head directly for another such crisis

Instead, the Democrats have fallen into a legislative and electoral trap that – amazingly – they built for themselves.

Top Democratic political strategists have become obsessed with the idea that they must pass legislation on financial reform, no matter how much that requires compromise (e.g., discarding the consumer protection desperately needed in this arena) – the thinking is that as they control the Presidency, House, and Senate (sort of), any other outcome will be judged a failure.

This is a mistake Teddy Roosevelt would not have made.  The point is not to pass laws, irrespective of content; the point is to win on substance – by convincing the mainstream middle that you are right.  When you’re up against the most powerful people in our society – the kings of finance – there is little chance that a direct legislative assault will work; they give too much to campaigns across the political spectrum and their control over the official mindset is still too strong.

Instead, the administration needs to come at such opponents in a different fashion.  Writing in today’s Financial Times, Krishna Guha proposes innovative anti-trust action against big banks with oppressive share of particular markets; this would not require legislation. 

Also in Tuesday’s FT, Peter Boone and I suggest combining regulatory action (raising capital requirements steeply) and a size cap on our biggest banks – which could become the centerpiece of legislation that fails in the Senate this spring, after a great struggle, and then becomes a rallying cry for November.  Bring the leading Senate Republicans out into the open and force them to articulate their views on “too big to fail”; you will surprised (and perhaps disappointed, depending on where you are coming from) to hear their views – they are happy for our biggest banks to continue to operate substantially as they did during the Bush years. 

Senator Shelby (ranking Republican on the Senate Banking Committee) shows no inclination to rein in our largest banks.  He is cooperating with Senator Dodd at this point – presumably just in order to further weaken the likely financial reform legislation.  The likelihood this will lead to meaningful reform is rapidly approaching zero.

Think of it this way.  If the Democrats lose badly in November – as seems likely, with their current weak and unconvincing narrative about the financial crisis and origins of our mass unemployment – then President Obama’s reelection campaign will be a long struggle to redefine the message, presumably towards finding something he has changed in a major way.  In that context, strong attempted action against the power of big banks would appeal to the left, center, and even part of the right.  Why wait for defeat in November before making this switch? 

Run hard now, against the big banks.  If they oppose the administration, this will make their power more blatant – and just strengthen the case for breaking them up.  And if the biggest banks stay quiet, so much the better – go for even more sensible reform to constrain reckless risk-taking in the financial sector.

When you are running against opponents with bottomless resources, great hubris, and a profoundly anti-democratic bent, get them to speak early and often in as public a manner as possible.  Dig up and publish everything there is to know about them.  Review and forward the details of how JP Morgan was humbled over Northern Securities and how John D. Rockefeller was finally brought to account.

FDR’s favorite president was Andrew Jackson.  The White House might like to read up on why – Jackson confronted, ran against, and ultimately defeated, the specter of concentrated financial power.  President Obama needs to do the same.

By Simon Johnson

39 thoughts on “A Trap Of Their Own Design

  1. A simple concept to get Democrats to rally around is a Derivatives Tax (aka Stamp Duty) that could raise 10x the amount targeted by the current lightweight bank tax. A derivatives tax may be passed on eventually but it hits hardest the proprietary trading desks which is where the big risks are. Anyway, whatever the technical pros and cons I would expect it to raise closer to $1 trillion than $100 billion over the same period. Now that is a sizeable dent in the forecast deficit worth fighting for. The Europeans (and UK) are all for it so why not bite the bullet? Another benefit is that in writing tax legislation you find out what needs regulating in the process as many of the issues are common.

  2. I am afraid you misunderstand the Obama Administration and Democrats generally. Clinton proved that success derives from talking populism and serving finance. You make these wonderful speeches and the boys on the Street go straight to the bank. Eight years later you are worth $100 million and make $5 million a year talking bs to business groups. On the other hand, you can oppose the banks. In that case you probably end up like Garfield.

    As for Andrew Jackson, his constituency was the rising businessmen who wanted a piece of the banking business. Teddy Roosevelt was a Morgan front in the battle between Morgan and Rockefeller which was ultimately settled by division of the spoils.

    There is no shortage of good ideas for dealing with this mess but Obama is not Martin Luther. We are unlikely to get real change without tar and feathers, but we certainly will not get it by reelecting these opportunistic center Democrats whose only virtue is they are not Republicans.

  3. Simon writes:

    the Democrats have fallen into a legislative and electoral trap that – amazingly – they built for themselves.

    It’s not amazing when you think of the Dems as the Washington Generals.

  4. Awesome freaking post. Simon Johnson you are like one of the coolest professors around. Instead of being the mundane, middle of the road professor who sits back and watches the bullets fly, you’ve rollin’ up your sleeves and shown you care about America and the world around you. I don’t always agree with you, but your damned for certain right about this and I respect you as a member of academia not being afraid to say it like it is, and speak out against wrongs. YOU ROCK DUDE, YOU ROCK!!!!!

  5. Amen brother. Wasn’t gonna happen, but Obama using those talking skills to lead the tar/feather parade sure would have been nice. He could have got anything he wanted..
    Instead he throws out the ‘give us back our money’, meanwhile his Treasury Sec. gets deeper and deeper in the sh.. Are you f..ing kidding me ‘O’-one hundred billion over ten years is ten per, math even the T-Bags understand.

  6. It’s been very depressing…

    If the debate on Capitol Hill and Congress turns out to be anything like what the current form of healthcare has turned into, you may want to Google elsewhere for a better standard of living.

    The American Medical Association (AMA) didn’t get on board with President Obama’s healthcare bill until the Administration conceded their leveraging powers first to Pharma, and then to the medical providers themselves. There is also and will continue to be a shortage of general practitioners b/c the more lucrative and prestige positions in medicine are awarded in Specialties (Orthopedics, Oncology, Cardio); not to blame meds for trying to pay back their huge student loans as they go into practice but from what I could recall, the government was rather lax during the late 1980s for repayment (Sallie Mae), allowing many to forego their debts, thus, another taxpaying bailout (as microscopic as that may seem in today’s climate).

    President Obama wants to hurry up and pass the healthcare bill, so he can move forward on jobs and the Economy (to save his and the Dems’ skinny azzes in November), by applying some of the strategies from President Clinton’s playbook. Obama’s senior economic advisor, Lawrence Summers seems to hold this notion that the economy will ultimately return to normal growth patterns of the 1990s, but just taking longer to do so—-slogging along until those “green sprouts” in the economy become more numerous. Are there any sane economists out there that think we can have a returning economy of the 1990s without the consequences of today’s markets? (How about removing the financial incentives, taking them out of the equation if the Administration expects to hold down costs and more bailouts of the future.)

    It’s really annoying to watch mainstream media turn these political elections into some sort of celebrity contest, and giving equal time and validity to unproven claims from both sides (FactCheck.org). The truth lies in between – just listen a few times to the rantings on talk radio to get their best line on politicians – “Heads On A Stick” campaign to hound them out of office.

  7. Jake Chase had it right when stating that Clinton success was built upon populism and service to the financial industry. The idea of the Democrats supporting any meaningful financial reform is a wishful thinking and perhaps a little naive. At the core, our system imparts the rights of the individual to the corporation save a very few, while the corporate right to “free speech” provides virtually unfettered financial support to our elected officials. The two party system is an illusion of choice and cannot represent the will of the people when the primary electoral funding mechanism is provided by the same industry they are tasked at regulating. People should remember that the financial industry should function solely as a service industry rather than the shell game it has become. In other words, financial reform is asking the two major political parities to bite the hand that feeds.

  8. “This is a mistake Teddy Roosevelt would not have made.”

    No kidding! Big times demand big people… and we now have the biggest collection of small people in our government that I can remember. Richard Nixon looks like a giant in comparison.

  9. he won’t for 2 reasons:

    1. 3/4 of his staff came from big finance.

    2. the democrats are afraid that if they press for financial reform, wall street will switch contributions to more heavily favor republicans and then democrats will lose elections. remember, the guy with the most money wins.

  10. Vincent Reinhart touched on the administrations’s political economy at a conference i attended last week. he put forward the idea that the administration has a hard “realist” view of what’s possible in washington and is actively pursuing a “theory of the second best” where multiple sub-optimal and occasionally contradictory policy prescriptions that are “possible” and politically expedient are preferable to the singular but politically expensive and unrealistic path of true reform. the thought then being that changes made now open up possibilities for revision and improvement in a second term, or beyond.

    that level of political calculus is quite removed from the “change we can believe in” that people signed up for but as a narrative for the first year, it fits the evidence about as well as anything i’ve heard anywhere else.

  11. I agree with most of this. But, do you really want to defend Andrew Jackson’s attack on the Bank of the United States? Emotionally satisfying, yes, but a truly disastrous policy that left the American banking system inadequate, and inadequately regulated, for a century, directly leading to numerous financial crises with no system in place for addressing them. Indeed, some reflection on the post-Jackson experience reveals that size alone is not the whole problem, or really even the core problem of the financial system. We had a very decentralized banking system in 1930, and it utterly failed. Much analysis today equates “systemic risk” with “too big too fail,” but that’s incredibly simplistic.

  12. An Empire dissolves from within and over several generations. Take the money away from how America defines itself and what is left?

    Simon, great article.

  13. Decentralized banking did fail utterly despite the fixes like the Federal Reserve, even after the Trust Company debacle was supposedly cured in the years after 1907. TR was as clueless about the Trust Company problem as current politicals were clueless about the current mish mash decentralized system that imploded. The academics wax poetic about regulatory failure when the financial types did what anyone in their position would do. Dominate those required to be diminated by buying them. Keep them in your pocket like so many nickels and dimes. End running regulation requires the use of complexity and cunning to achieve your goal of doing what you please to make money. Looking out for number one is now required religion in America. That is until it no longer pays to keep up the added effort to maintain the systems relied on. That is when the acquisitor age causes the labor rebellion to utilize the descriptive ideas of P.R. Sarkar.

    Things are so complex that survival forces simplicity. Sheer societal survival will force simplicity when complexity simply irretrievably breaks down.

    A great way to understand this is the study of military science. Why warrior groups can destroy trinitarian military principles. Why the US lost trinitarian goals in Viet Nam, Iraq, Afghanistan and similarly why the Empires collapsed.

    Will someone repeat Gibbon someday with the theme that software collapsed society?

  14. Obama also needs to use in a very Rooseveltian and Johnsonian (LBJ that is) manner the power of the IRS and the FBI to get the bankers’ cahones in his pocket. Then to squeeze real hard. Getting the “dirt” on individual bankers does wonders for reform legislation!

    History books are replete with examples of how successful this approach can be.

  15. Amen.

    SOMEONE sees through the Obama is jesus nonsense. Larry Summers and Rob Rubin are both mainstream wallstreet types, and they are running the obama administration on finance.

  16. “Instead, the Democrats have fallen into a legislative and electoral trap that – amazingly – they built for themselves.”

    This isn’t really amazing at all. National elections require money – lots of it – in order to succeed. In 2007 and early 2008, the finance industry had it to give, and Obama lined up at the trough. Per Opensecrets, they gave Obama $71mil, and McCain $61mil. Without that money, or with a substantial switch from Obama to McCain, the election results may have been swayed. After all, the same sector gave GWB $34mil in 2004, and Kerry $24mil.

  17. Well said. I look at it from an evolutionary/ecological standpoint. You have an environment with energy available (money for campaigns) and selection pressures (big money only if you meet certain criteria– psychologically, behaviorally, connections, etc.) Such an environment will select out of a wide distribution of politicians those best suited to continue to get energy from the environment. There is variation in the population that is successful too, so we have “Republican” and “Democrat” but it’s more like differences between breeds than different species. Those that are “fit” will gain political power and will enact policies that maintain or “reproduce” the circumstances of their success. Obama, and all the other current politicians, are those “fit” individuals. It is constitutionally outside his makeup to “do the right thing” because he and the other politicians (Dem or Repub) were selected because they lack that sense of understanding and concern for the consequences of their behavior. Those who did think differently just aren’t elected. Obama is not imprisoned in a power structure he can’t control nor is he just confused and making the wrong strategic decisions. He simply does exactly what his qualities of personality and beliefs and perspective make him do. If we want change, we need to elect people with very different beliefs and perspectives, but that just isn’t going to happen until the environment changes.

  18. Dear Mr. Johnson,

    Very nice post, but you’re still taking seriously TBTF which as I’ve tried to point out is a pseudo-problem. Even if the big banks are broken-up, whatever you exactly mean by that, that will do absolutely nothing to prevent a new financial crisis since you’re not dealing with the real cause of the crisis, derivatives.
    Unless of course by breaking-up the big banks you mean the restoration of Glass-Steagal, the banning of derivatives that almost and may still destroy us all, and bringing back the financial regulatory regime of the pre-1980 era, then perhaps there’s hope.
    But I strongly urge you to continue to point out that as Glen Hubbard said, “deficits don’t matter”. We must maintain effective aggregate demand at a minimum with a new stimulus and by indefinitely extending Federal UI and, if we can, “slay the zombie banks”.
    The more seriously you take the non-existent deficit problem, and other pseudo-problems like TBTF, the more it will rebound to your discredit when future historians search for the causes of the second Great Depression that, on balance, I believe is now a near certainty.

  19. Dear Mr. Johnson,

    Your diffidence in referring to the catastrophic and suicidal financial de-regulation that went on during the Clinton Administration is…interesting.
    As far as I’m concerned, Clinton is just as culpable as George Bush, Reagan and Carter. Why, do you ask?
    Well, let’s see:

    1) Clinton defeated the very brave effort by the head of the CFTC(I believe) to regulate derivatives.
    2) Clinton didn’t veto the repeal of Glass-Steagal,(I think it was the bill co-authored by Phil Graham).

    So if Clinton’s actions are any different from what Reagan, Carter, Bush I and Bush II did, I don’t see it, but then I’m just a high-school math teacher.

  20. Yes, I’ve been trying to point out the same thing. Maybe Mr. Johnson will listen to you.

  21. This is a response to Brett McDonnell. I did click the “Reply” under his post, but somehow it turned up not near it.

  22. The baseline scenario is C-O-R-R-U-P-T-I-O-N.

    Not Republican, not Democratic. Just Government.

    I understand more and more each day why my grandparent used to say, “Vote them all out”.

    And Obama is PWNED like the rest.

    D*mn shame too.

  23. I continue to be surprised by your Democratic leanings.

    Certainly, the Big Banks need to be reined in, broken up. Or, hang the bastards…..

    But, what of Fannie and Freddie? What do we do about them?

    And the Consumer Finance Protection Agency. What has happened to Elizabeth Warren?

    And what of the Community Re-investment Act, which caused the Big Banks to play “hot potato” with all the mortgages they were forced by gov’t to make, but wanted to refuse to hold? They knew the loans were going south, bad investment.

    We need to break up the banks, divide them by investment vs savings, simplify the “products” they offer.

    We need fewer rules, yet better ones.

    Rescind five old laws for every new one.

    As a former resident of The People’s Republic of Massachusetts, I’m rather proud of it tonight. 2000+ pages of backroom deals, mutually exclusive legislation and ever more incomprehensible bureaucracy was not what I ever envisioned as health care “reform.”

  24. The Dem Party took a hard-right turn during the Reagan administration, and have remained stuck in
    Blue Dog mode ever since. The one Dem president following Reagan/before Obama was Clinton, who was solidly corporatist/conservative. It was Clinton who took an ax to the New Deal policies that so greatly benefited the country as a whole following WWll; his welfare “reform” merely funneled public dollars out of “common good” programs, into the bank accounts of the very rich, and we are living with the trickle-down impact of those policies today.

    Time and time again, we’ve seen Dems embrace conservative ideology only to be rejected by voters, while comparative progressive politicians keep getting re-elected. But the Party leadership just doesn’t get it, and we see the efforts to push Obama well to the right, in opposition of the goals and hopes of those who voted for him.

  25. Is this an economics blog or the Daily Kos?

    What drivel: “Which part of the 8 million jobs lost [since December 2007] do you not understand? The big banks must be reined in and forced to break themselves up, or we’ll head directly for another such crisis”

    Are you actually suggesting the banks were responsible for 8MM job losses, or are you just trying to rally the populist masses? I would have expected a little more sophistication from this site.

  26. not to blame meds for trying to pay back their huge student loans as they go into practice but from what I could recall…

    There is a very simple solution for that. Until the end of the draft in 1973, male doctors were pretty much automatically for two years of military service. For example, my uncle spent a year as a battalion surgeon in Korea (a role now filled by physician assistants due to the Army’s doctor shortage). His roommate spent a year at the Navy research station at the South Pole (bet he wasn’t expecting that when he applied to medical school).

    Student loans suck and we’re in the middle of two shooting wars. So bring back the doctor draft and forgive student loans and all will be right in the forest. :o)

  27. Finally someone has hit-the-nail right on-the-head.


    Thank you, Professor Johnson.

    I’ll spread this word …

  28. I think what we’re going to see is that people no longer believe *anything* Obama says, and will be more likely to believe new R-Party candidates–including the 2012 Presidential candidate–when they spout their populist rhetoric, than they’ll believe the *very same* Obama Admin will do a sudden about face.

    It doesn’t look like people in MA bought the Obama line yesterday.

    I certainly could not come out here today and assert that they *should* have done so without looking like a fraud and an idiot.

  29. Red sez: Well, quidditas, I don’t know why you would suggest that you look like a fraud and an idiot….hmmm could be…but the “people of MA” did not have any concern for the “Obama line yesterday”. I would credit the women of MA who bought the pubic hair of the winning candidate. But what does it matter really?

  30. Strange that the party most likely to end the current “privatize the profits, socialize the losses” regime is the tea party.

    That’s where the Jacksonian heritage is now.

  31. Great post, particularly in light of what just happened in Mass. Financial reform should be aimed at dismantling TBTF banks by adopting soomething like Glass-Steagal; reforming Wall Street so once again it is a market and not a casino with artificial instruments with zero sum outcomes; prohibit investment banks from raising public equity (debt is fine; just don’t allow the lenders to avoid ongoing due dilligence by buying CDSs); rein in derivatives and never again allow such sizeable markets to operate so opaquely, etc.

    This should be the Democrat’s issue, if we can just pull them off the teat of finance. Go after finance with all the intensity the situation requires. They are the folks that stole the jobs, stripped our enterprises, looted pension funds and cash reserved for growth and R&D. Leave it to the Republicans to defend these folks. It will be a losing proposition for them.

    Dems should focus on jobs, jobs, jobs, including government-sponsored, temporary jobs focused on infrastructure repair and rebuildinig, if necessary. Hammer, hammer, hammer on the deficit–Dems didn’t create it, the GOP did by irresponsible tax cuts for the wealthy, a reckless war directed by chickenhawks and unrestrained spending between 2001 and 2009. Their reckless spending coupled with their abject failure to regulate an out of control financial sector led to the financial melt down of 2008-2009 that created these deficits. The deficit must be managed, but not on the backs of the 10% plus of this population that is unemployed and the small businesses that are closing their doors every day. Democratic policies didn’t create the deficit or add to it, except to the extent there was a stimulas package that was endorsed by economists, businesses and pols on from all sides of the political spectrum.

    This message must be repeated and repeated to respond to the outright lies spread by the other side. That can’t happen without cubic yards of money, organization and messengers. Money for TV and media. Volunteers to speak at any and every forum available, from colleges to community events, political gatherings to union halls. And we need organization to coordinate it all. The alternative is to return to the financial equivalent of the Ice Age with large money triumphant and economic inequality the law of the land.

    One more thing–and I know this will be unpopular with many–but scale back universal health care to two or three clear, inexpensive and cost reducing, if not revenue raising, mandates. The public is afraid of trillion dollar programs when the economy is such a mess and unemployment and the deficit are so high. Slap down the insurance companies and require them to cover everyone and everything, including pre-existing conditions; negotiate drug prices and, even better, prohibit drug advertising and limit marketing deductions; require insurance companies to put profit of more than 7% of revenues into a pool to be used to reimburse hospital costs for tending to the uninsured; and, obviously, limit insurance company deductions for compensation–immediate and deferred–as well as pensions for the highly compensated. (These latter restrictions should apply to all businesses.)

    Adopt policies to make economic inequality painful for its advocates and the beneficiaries.

    It can be done, but it won’t be done by this administration without a strong push, I’m afraid. All together now–PUSH.

    Jim Coffman

  32. How do you expect Democrats to run against the practices of big banks when you had a study, commissioned by Senator Schumer and Mayor Bloomberg ,http://www.fr.com/practice/McKinsey.pdf,
    Sustaining New York’s and the US’ Global Financial Services Leadership. In this study, released 1-22-2007, they both advocated fewer restrictions on the banks in “leveraging” and “derivatives.” Both politicians were worried about the loss of business to London where regulations and liability were less onerous. I have not seen one journalist or media person hold Senator Schumer responsible for the ideas expressed in this study. In fact Schumer had it on the front page of his senate website until November 2008 after the collapse of Lehman and the panic that ensued.

  33. Ed, the bill to repeal Glass-Steagall was passed with a veto-proof majority. Clinton had to sign it or get overridden.

  34. The derivatives tax is the sort of harmful and irrelevant idea that comes out of the left at time like this. It’s the Glass-Steagal Act of the 2000s and that’s not good. All it would do is prevent people hedging their risks while doing nothing to prevent overleveraging that is the real risk. Indeed it’s likely they’ll increase it.

    What destablised the system wasn’t speculation by Wall Street, but by Main Street. It was the fact that ordinary people took out loans that would get them huge returns if housing prices went up but would ruin them if it went down. Regulations didn’t restrain the worst actions, they spurred them. To propose a tax on speculation when all that would have been necessary to prevent the crisis is stop subsidising it is absurd. End the Fed, end bank guarantees, end all support for Wall Street then you need not tax anyone to recover.

  35. Why is enslaving people still acceptable? I’d rather have Doctors in debt that helping the government kill people.

  36. On your first observation, doesn’t this just reinforces the argument for a higher rate of tax than may at first be considered in order to make such speculation so much less profitable?

    In the UK and France, there were no subsidies on housing but prices bubbled hugely just the same. Interest payment deduction against income tax also was stopped years ago and in France even your primary residence attracts capital gains tax (plus value), albeit with a small annual allowance and there is additionally a stamp duty of 6% on purchase. So you are correct on the one hand (daft expectations of easy profits) but I think your solution doesn’t stand up fully.

  37. I think this author is correct that the big banks need to be broken up, but
    I think he doesn’t understand that the Dems are as much a part
    of the Bankster Oligarchy as the Repubs are. IMO the Dems are squandering
    their opportunity for change on purpose. They know they will be thrown
    to the dogs by their Bankster masters if they pass any serious legislation
    to reign them in. After all, it was under Clinton that the banking laws
    from the depression were eliminated.

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