By Simon Johnson
Geely Automotive has acquired Volvo from Ford. This is a risky bet that may or may pay off for the Chinese auto maker – after first requiring a great deal of investment.
Goldman Sachs’ private equity owns a significant stake in Geely, with the explicit goal of helping that company expand internationally. Remember what Goldman is – or rather what Goldman became when it was saved from collapse by being allowed to transform into a Bank Holding Company in September 2008 (which allowed access to the Federal Reserve’s discount window, among other advantages). Goldman’s funding is cheaper on all dimensions because it is perceived to be Too Big To Fail, i.e., supported by the US taxpayer; this allows Goldman to provide more support to Geely (and others).
Our Too Big To Fail banks stand today at the heart of global capital flows. People around the world – including from China – park their funds in the biggest US banks because everyone concerned believes these banks cannot fail; they were, after all, saved by the Bush administration and put completely – gently and unconditionally – back on their feet under President Obama. These same banks now spearhead lending to risky projects around the world.
What is the likely outcome?
We know that risk-management at the megabanks breaks down in the face of a boom (remember Chuck Prince of Citigroup in July 2007: “as long as the music is playing, you’ve got to get up and dance. We’re still dancing”). We know there is a growing boom in emerging markets – including through the overseas expansion of would-be multinationals from those countries. This is most notably true of state-backed firms from China, but there is also a more general pattern (think India, Brazil, Russia, and more).
The big global banks, US and European, are charging hard into this space – Citigroup is expanding fast in China and India (areas where they claim great expertise); and the CEO of HSBC has moved to Hong Kong. Many investment advisors are adamant that China will power global growth (never mind that it is less than 10 percent of the world economy), that renminbi appreciation is around the corner, and that the value of investments in or connected to that country can only go up.
There is a very good reason why, between the 1930s and the 1980s, large US commercial banks were severely constrained in their risk-taking activities. By the 1930s US policymakers had learned the very hard way that we do not want the banks that run our payments system (with the implicit or explicit backing of the government, depending on how you look at it) to be engaged also in high risk equity-type investments – this is really asking for trouble.
The problem is not that all such banking-based risky investments go bad. Far from it – we’ll first get an apparently great boom, which will suck in all kinds of financial institutions, our future Chuck Princes. As long as the market goes up, the executives and traders involved will do very well – lauded as geniuses and paid accordingly.
And if some of them fail, so what – failure is essential to a market economy. But here’s the key problem with having so much of our economy in the hands of financial firms that are Too Big To Fail. When the next emerging market crash comes, we’ll have to make the 2008-2009 decision all over again: should we rescue our big troubled financial institutions, or should we let them fail – and cause great damage to the economy?
In our assessment (13 Bankers: The Wall Street Takeover and The Next Financial Meltdown, out today), based on the details of financial deregulation over the past 30 years, the prevailing belief system of top bankers, and the big banks’ incentives to take risk, we are all heading for trouble. The “financial reform” legislation currently before Congress and still prevailing pro-banker attitudes at the top of the Obama administration are really not helpful. The country’s course was set by a fateful meeting at the White House last March; a resurrected, unreformed, and still crazy system – symbolized by 13 bankers – is in the driving seat now.
At best, this will be another very nasty boom-bust-bailout cycle. At worst, we are heading towards a situation in which our banks are so massive that when they fail, there is no way the government (or anyone else) can offset the damage that causes.
This time our government debt (held by the private sector) will roughly double – increasing by 40 percentage points of GDP – as a direct result of what the banks did. We’ve lost more than 8 million jobs since December 2008 – for what good reason? Next time could easily be worse.
You can disagree with our analysis – provide your own facts and figures, and we’ll have that debate here or elsewhere; the more public, the better from our perspective. And you should certainly want to improve on our policy prescriptions. We put forward some simple ideas that can be implemented and would help – our versions can also be communicated and argued widely: if banks are too big to fail, making them smaller is surely necessary (although likely not sufficient).
But don’t ignore the question. Don’t assume that this time Goldman and its ilk will avoid getting carried away – they are just doing their jobs, after all, and their job description says “make money”; system stability is someone else’s job.
And also don’t presume that, just because the big banks and their friends seem to hold all the cards, they will necessarily prevail in the future.
In all previous confrontations between elected authority and concentrated financial power in the United States, the democratic element has prevailed (see chapter 1 in 13 Bankers; also Monday’s WSJ, behind the paywall). This can happen again – but only if you stay engaged, argue this out with everyone you know (including your elected representatives), and help change the mainstream consensus on banking definitively and irrevocably.