The Ruinous Fiscal Impact Of Big Banks

By Simon Johnson

The newly standard line from big global banks has two components – as seen clearly, for example, in the statements of Jamie Dimon (JP Morgan Chase) and Bob Diamond (Barclays in the UK) at Davos last weekend.  First, if you regulate us, we’ll move to other countries.  And second, the public policy priority should not be banks, but rather the spending cuts needed to get budget deficits under control in the US, UK, and other industrialized countries.

This rhetoric is misleading at best.  At worst it represents a blatant attempt to effectively shakedown the public purse.

On Tuesday morning, in testimony to the Senate Budget Committee, I had an opportunity to confront this myth- making by the banks head-on and to suggest that the bankers’ logic is completely backwards.

Start with the bankers’ point about budget deficits and spending cuts.  Public deficits and debt relative to GDP have ballooned in the past three years for one simple reason – the big banks at the heart of our financial system blew themselves up.  On this point, the conclusions of the Financial Crisis Inquiry Commission, which appeared last week, are very clear and utterly compelling.

No one forced the banks to take on so much risk.  Top bankers lobbied long and hard for the rules that allowed them to behave recklessly.  And these same people effectively captured the hearts, minds and some would say pocket books of the regulators (in the sense that a well-regarded regulator can and often does go work for a bank afterwards). 

The mega-recession, which is starting to look more like a mini-depression in employment terms for the US (we lost 6 percent of employment and we are still down 5 percent from the pre-crisis peak), caused a big decline in tax revenues.  Falling taxes under such circumstances is known technically as part of the “automatic stabilizers” for the economy, meaning in this context that they help offset the contractionary effect of the financial shock – without the government having to take any discretionary action.

Whatever you think about the effectiveness of the additional fiscal stimulus packages provided to the economy in early 2008 (under President Bush) or starting in early 2009 (under President Obama), just remember that the impact of these on the deficit was small relative to the decline in tax revenues.

The total fiscal impact of this regulatory capture cycle, as reflected for example on the Congressional Budget Office baseline debt forecast – comparing what this was pre-crisis and what this is now – is about a 40 percentage point increase in net federal government debt held by the private sector.

As we discussed at length during the Senate hearing, it is therefore not possible to seriously discuss bringing the budget deficit under control in the foreseeable future without measuring and confronting the risks still posed by our financial system.

Neil Barofsky, the Special Inspector General for the Troubled Assets Relief Program put it well in his latest quarterly report, which appeared last week: “perhaps TARP’s most significant legacy, the moral hazard and potentially disastrous consequences associated with the continued existence of financial institutions that are ‘too big to fail.’”

But next up for the US economic outlook is not necessarily another ”too big to fail”  boom-bust-bailout cycle; we may well move on to “too big to save”, which is what Ireland is now experiencing.  When reckless banks get big enough, their self-destruction ruins the fiscal balance sheet of an entire country.

In this context, the idea that megabanks would move to other countries is simply ludicrous.  These behemoths need a public balance sheet to back them up, otherwise they will not be able to borrow anywhere near their current amounts.

Whatever you think of places like Grand Cayman, the Bahamas, or San Marino as off-shore financial centers, there is no way that a JP Morgan Chase or a Barclays could consider moving there.  The “national champions” of banking are actually very poorly-run casinos with completely messed-up incentives; they need a deep-pocketed and somewhat dumb sovereign to back them. 

The latest credit rating methodology from Standard and Poor’s says essentially just this – henceforth, it will evaluate banks not just on their “stand alone” creditworthiness, but also in terms of their ability to attract generous support from a creditworthy government in the event of a crisis.

New York-based banks might move to London, and vice versa.  But the Bank of England is far ahead of the Federal Reserve in its thinking about how to rein in banks – see, for example, the new paper by David Miles (member of the Monetary Policy Committee in the UK) on the need for much more equity financing in banks than specified in the Basel III agreement. 

Officials outside the US are increasingly beginning to understand the point being made by Anat Admati and her colleagues — bank capital is not expensive in any social sense (e.g., look at Switzerland, where the biggest banks are now required to have about double the Basel III levels of equity funding).  We need our financial system, particularly our largest banks, to be financed much more with equity than is currently the case.

The intellectual right in the United States understands all this and, broadly speaking, agrees.  Officials in other countries begin to see the light.  Unfortunately, officials in the United States and most of the political right (i.e., those who seek public office) – as well as much of the political left – still appears greatly in thrall to the big banks.

An edited version of this post appeared this morning on the NYT’s Economix blog; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.

50 responses to “The Ruinous Fiscal Impact Of Big Banks

  1. Simon, I agree with the thrust of your argument, but I think you misrepresent what Dimon and Diamond said in Davos. Dimon’s complaint was about excessive bank regulation and the effect on growth and jobs. Diamond mounted his now-familiar defence of the benefits of big banks. To my knowledge, neither has publicly threatened to move their institutions abroad — a threat that would be particularly ludicrous for JPM, and only slightly less so for Barclays. And I don’t think either banker is advocating austerity as an alternative to bank regulation.

    There is clearly a strong case for increasing bank capital requirements — one that the bankers resist. And it is also clear that financial crises are ruinous for the public finances. But you can make both these arguments quite forcefully without having to put words in the mouths of messrs Dimon and Diamond.

  2. Herbert Wetherby

    I always find it better to give a client a small sample a portfolio and let them decide if they want to invest in more down the road. Often a person will get paranoid about a portfolio and have a bad outcome or experience about what they expected of or from it. Usually it is their own fault for indulging to much of a seemingly good tasteing investment, but over time they come back and buy more, and then use it differently, or curse it off entirely, it is solely their choice. Much like a diamond in the ruff.

  3. “Dimon’s complaint was about excessive bank regulation and the effect on growth and jobs.”

    That would be a somewhat valid defense IF the primary businesses of the megabanks were 1) making loans to individuals and firms and 2) helping firms raise capital through new bond and equity issues. Unfortunately, that’s not the case. Their primary business, both in the years leading up to the crash and today, is trading in the secondary markets. This does not create growth or jobs, it creates asset bubbles and instability. You could eliminate it tomorrow (or rather, reduce it to the bare minimum needed to maintain liquid markets, a tiny fraction of what exists today) and the impact on long term employment and GDP growth would be nil.

  4. Thank you Simon-nice article, if not a little too academic-nice.
    We know it, they know it, hell, the enire world knows it: It’s not ‘enthrall’, it’s ‘Payolla’, plain and simple. Them using voice-over ‘reassure’ers’ via the mind-numb box just makes it worse.

  5. Great article, thanks Simon.

    This was just academic enough for me – very useful for sources and consise, to the point as always.

  6. One more point on the motives of banks, one which you lead up to when you mention banks being “too big to save”. After having drive government budgets into large deficits through their actions, banks now face a situation in which governments may have not choice but to live up to claims that they will never again bail out banks. Banks need fiscal austerity in order to be able to continue with morally hazardous behavior.

  7. “First, if you regulate us, we’ll move to other countries.”

    There is a very simple, elegant solution to this threat: Macroprudential Man!

    He’s probably just aping the common refrain “if you tax us too harshly, we’ll take our money elsewhere.” The threat is not that the Financials will cease to suck American money, but that they will spend it elsewhere.

  8. desi girl, lloyd b worshiper

    There are four ways that Academic scamsters like Johnson run their scam:

    Tactic 1: circular logic
    Simon Johnson: Look over there, Daron Acemoglu agrees with me. He is right.
    Doron Acemoglu: Look over there, Simon Johnson agrees with me. He is right

    Tactic 2: CDO squared logic, where there is no underlying truth
    Simon Johnson: Look over there, Admati says bank capital is too low. He is right.
    Admati: Look over there, Ooi, Ong and Li say bank capital should be 30%. I wrote a 54 page paper mostly relying on about 100 other papers that I used as references. I did a spectacular job but to understand what I am saying, you need to read those 100 other papers.
    Ooi, Ong and Li: REITs always maintain a 30% capital ratio. REITS are financial firms, they lend money, have retail branches, raise equity and debt, hedge client positions and also have ATMS!!. Yeah Baby, REITS and Banks in the same business. If you don’t believe me, look at the 100 references that make up 2 pages on my research document.

    Tactic 3: Lie
    Dimon and Diamond threaten to move to Grand Cayman, the Bahamas, or San Marino. Ha Ha!!
    Dude Johnson, come on, please provide any quote from any banker that they are against regulation. Please. Now, none of those dirty tactics such as taking out 5 words from a sentence. For Example, Dimon quoted that he is “not against regulation”, he is against “irrational regulation, such as the Volker rule”, can not be quoted as “Dimon says all regulation is irrational”.

    Tactic 4: Lie more
    Orderly bankruptcy for a financial firm is not possible. Huh? What? and Why not? the US put a man on the moon. They can’t unwind a financial instution? complete rubbish. and a defatist attitude. and as expected from someone who thinks that the average american is incapable of taking any major responsibility.

    Now, for about 4 million greedy americans, without whose active participation the financial crisis would not have happened, these are very desirable arguments. Johnson is convincing them they they were never at fault for borrowing beyond their means and they likey likey this great man.

  9. Are you a professional chump(ie getting paid to write this crap), or just an extremely clever teenager who has her “Ten Ways to Avoid and Therefore Win An Argument” book continually flipped?..

    Tell your hero Lloyd to take his ‘business’ to China-meanwhile we, come hell or high water, will reverse the Commodities and Futures Modernization Act, wtih which none of your/his so called ‘profits’ would be possible.

  10. Richard Hoogesteger

    Of course, much of the problem here is that the big banks give lots of money to politicians in this country. They give a lot to the Republicans and even more to the Democrats.

  11. CBS from the West

    IMO, it’s really too bad that the threat to leave is an unrealistic bluff. I think we’d be better off without them.

  12. @1 Kings: Thanks. Somebody had to say it, and you said it so well!

  13. Simon Johnson “The latest credit rating methodology from Standard and Poor’s says essentially just this – henceforth, it will evaluate banks not just on their “stand alone” creditworthiness, but also in terms of their ability to attract generous support from a creditworthy government in the event of a crisis.”

    And at the same time the banks can lend to “creditworthy” governments with zero capital requirements, thereby completing the most egregious (and I would also say communistic) “I scratch your back and you scratch mine” the world has ever seen.

  14. Bayard Waterbury

    Simon, great article. In my view, it has been two years, or so, since the government closed the “front door” on bailouts (Paulson’s TARP), but, to the TBTF’s or TBTS’s, Bernanke’s back door is not just open, but is like the infamous screen door to the submarine. He has quietly leaked trillions to these “banks” and succeeded in doing nothing for the broader economy in the process, but grandly succeeded in spiking their profitability. How long will we go without being honest about what has created what threatens to be a perminently two tier economy, with the biggest banks (fully globally connected) and biggest corporations (fully globally connected) failing to recognize or act in support of their own economies. Someone will have to go a long way to convince me that we are going to survive as a viable nation if this situation/trend continues unabated. I just don’t see how it can happen. The collapse of these banks would be horrible, but it might actually be fortuitous in the long run, certainly better than the kind of slow death that is being inflicted on us.

  15. Bayard Waterbury

    Actully, Richard, in the 2008 elections, the Democrats received about $65 million and the Republicans about $54 million. On a per seat basis, this is nearly identical contributions to both parties. This is emblematic of plutocracy. It is simply how they function, whether in the US or in Russia. Same situation, different continents.

  16. Bayard Waterbury

    So, Desi Girl, if you are such a Blankfein fan, why don’t you even know how to spell his name? Sadly, you don’t have enough brain cells to participate. Gladly you do, because there’s just not much humor in the responses without you!!!

  17. Simon Johnson “bank capital is not expensive in any social sense”

    NO! Bank capital in itself might not be too expensive in a social sense, but the way regulators currently require it to be had by the banks, favoring those perceived as less risky and discriminating against those perceived as risky, is most definitely socially expensive. The regulators threw social risk-sharing out of the window and now the perceived risky are subsidizing the perceived not-risky.

    Suppose the insurance company regulators decided that insuring those who are perceived to represent more health risks, and who already pay higher premiums because of it, is required to post higher capital than insuring those with less perceived health risk who already pay lower premiums. Mr. Johnson would you hold that is not expensive in any social sense?

  18. The Ted Danson character in Bored to Death says,”at first we enthrall and then we disappoint.” The banks have ruined our home equity, they shake down millions every month with credit card usury and they bribe our politicians silly with campaign contributions.

  19. Good piece Simon. So let them move offshore, their new homeland can bail them out next time.

  20. Herbert Wetherby

    DITTO!!

  21. Herbert Wetherby

    I think we’d be better off without them.

    And better off without their money?

  22. Herbert Wetherby

    And its about dang time too.

  23. Herbert Wetherby

    I personally would say the latter is not expensive at all. Fewer visits to the doctor and lower premiums are directly perportional. If an insurance company can prove a bad habit (cigarette smoking below freezing tempartures) or any bad habit for that matter, then they have a god given right to ask the participant for higher premuims, stemming from the bad habit. Confusion enters the picture surrounding the debates of bad habits, but that has been and is being handled in the form of the law. For those that do not like it, yes take a back seat and listen for a while, rather than ploting your next game or scheme.

  24. I am not referring to the insurance companies charging higher premiums when insuring the not so healthy…

    I am referring to forcing insurance companies to have more equity when insuring the not so healthy.

  25. From you Carla, that is a compliment indeed. Thanks.

  26. Actually the majority of finance industry campaign loot goes to the perceived winner and for obvious reasons.

    In a tossup the majority goes to Republicans. Anti-regulatory ideology you know.

  27. Right on the money.

  28. Herbert Wetherby

    I’ll throw it back to MY IQ test results which for you are not in.

  29. I had a long snarky reply all set for Desi Girl, but felt I was being rude…I am glad someone else had the guts to do it. Thanks!
    Sleep tight little Desi, and dream the dream of plutocratic rule…

  30. Actually it’s OUR TAX money. But hey, you knew that.

  31. Herbert Wetherby

    Well maybe I did, and maybe I didn’t.

    I am certain that I would be a fool to walk away from the responcibility of where our tax money should best be used. Or even created and harvisted for that matter. No I think I will just ride off into the great wide open future and be happy for what it is that I do have. And of course leave the pain behind.

  32. Don’t discourage the banks, Simon, they know what’s best for them, certainly not what’s best for us. Let them leave!! And then we should restrict their access to our money and our business, too. We can have good old-fashioned banks that give interest and make loans – like in North Dakota! Generic state banks, community banks and credit unions, these are what we need.

  33. Herbert Wetherby

    Shoot, if it were that easy, everyone would be on board. And Dorothy, you were the one that wanted to leave, and go back to KS. Remember?

  34. markets.aurelius

    @ desi girl, lloyd b worshiper

    Unlike the Chinese proverb re living in interesting times, one hopes for intellectual opponents incapable of formulating an argument … like you … and not that bright … like you.

    Here’s a re-cap of a post that addresses your last and deliberately misleading assessment of the “4 million greedy americans, without whose active participation the financial crisis would not have happened, these are very desirable arguments. Johnson is convincing them they they were never at fault for borrowing beyond their means and they likey likey this great man.”

    You, and apologists like you, ignore the massive fraud in the mortgage market aided and abetted by the banks and former investment banks, many of which bought mortgage-processors that ultimately smoothed the way for this fraud. The real argument is not about robo-signers: It’s about fraud committed on a world-historical level. Were you aware that the bank clerks typically represented the jobs of the folks they lined up to perpetrate the fraud as antiques dealers? Check out the FCIC report Simon cites above.

    By 2004, the FBI was testifying to Congress about the massive case of abuse of the financial system from the start of the process — the clerk filling out an app — thru to the securitization by the banks, who willfully ignored this fraud.

    Have a look … we’ll wait for you to catch up, Lucy:

    http://www.fbi.gov/congress/congress04/swecker100704.htm

    Here’s a bit of testimony from 2004!!!

    “Market Impact:

    “The potential impact of mortgage fraud on financial institutions and the stock market is clear. If fraudulent practices become systemic within the mortgage industry and mortgage fraud is allowed to become unrestrained, it will ultimately place financial institutions at risk and have adverse effects on the stock market. Investors may lose faith and require higher returns from mortgage backed securities. This may result in higher interest rates and fees paid by borrowers and limit the amount of investment funds available for mortgage loans.

    “Often times, mortgage loans are sold in secondary markets or are used by financial institutions as collateral for other investments. Repurchase agreements have been utilized by investors for protection against mortgage fraud. When loans sold in the secondary market default and have fraudulent or material misrepresentation, loans are repurchased by the lending financial institution based on a ‘repurchase agreement.’ As a result, these loans become a non performing asset. In extreme fraud cases, the mortgage backed security is worthless. Mortgage fraud losses adversely affect loan loss reserves, profits, liquidity levels and capitalization ratios, ultimately affecting the soundness of the financial institution.”

    GS’s mortgage servicing company was in the thick of it — we can see you love Lloyd — as were the servicing arms of all these banks. There’s all kinds of ‘splaining to do, Lucy (assuming that’s the “desi girl” in the moniker you use).

  35. “First, if you regulate us, we’ll move to other countries.”

    Our response to them should be two words: “Do it.”

    We wouldn’t be worse off if they did. Maybe somebody that actually knows how to run a boring, responsible, publicly beneficial bank would step in to fill their place. Maybe we’d all use credit unions instead. I somehow doubt we’d miss the entitled rich that destroyed our financial system.

    We all know in the end that they’re bluffing. They just say that in public for show. In the end, they won’t find anyone else remotely able (or willing) to dump truckloads of cash in the blackhole they call a balance sheet to support their gambling habits. It’s all just a dog and pony show for the public. They’ve already arranged how the story will go with key officials behind the scenes.

  36. You need a sign attached to every one of your posts:

    Do not feed the trolls.

    http://knowyourmeme.com/memes/trolling

  37. Gosh…this is as thorough as it gets Professor Johnson, Bravo! What a masterful, and wonderful job of psychologically decrypting these two satirical flaccid buffoons postulating mercurial detente.

    Perhaps Luxembourg or Liechtenstein would suit them better? Two countries with similar parallels – cities, and towns with no-name but a numbered post littering the virgin landscape, painting a panoply of digital nefarious conversation? Indeed, 21st Century “ghost countries” of the financial monger’s bohemian quasi kind?
    Funny, isn’t it…but those ghost have been holding the “Full Monty Purse” out from transparency for centuries, only to find their surreptitious in cyberspace a thing of the past…now in vogue?

    Quote from the “Warren Commission”…oops, I meant – yet the Federal Reserve neglected it’s (JMHO- Communistic?) mission “to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers”

    The Fed’s (FRB) job also has to do with maintaining unemployment…in which it has failed miserably.

    Thankyou Simon and James :-)

    God Bless You, Julian Assange !

  38. 3-D, I agree with every word. Keep talking!

  39. Thank you for the synopsis. Something that hadn’t crossed my mind is how, by relocating, the mega-banks would simply find themselves without the 2.3 trillion dollar government-guaranteed and taxpayer-funded bailout that pulled them from the ash-heap of history. Now, with these latest pronouncements, I’m reminded of George Steinbrenner’s ridiculous threats to leave NY city for a town that would appreciate his Yankees more, and show it with a larger portfolio of public subsidies. It was always an empty gesture given the obscene profit margin that’s a by-product of playing in the Big Apple. It was, nonetheless, a fiction he could draw on to get a strong reaction from the brain-dead and bribe-fed politicians. The keys to New York city’s financial coffers were always made available shortly thereafter.

    So it is for the mega-banks. They fill the air with similar threats and the pols scramble. We’ve been headed down this road for a long time and many “fringe” commentators have pointed it out. Where once they only drew sneers, there’s now a clear realization that they were right. We have socialism for the very wealthy and the rest of us can go to hell.

    Until the incestuous relations between Wall Street and Washington are ended, and that may never happen, we’ll be watching this movie over and over again, at least till the reel burns up.

  40. As to “we’ll move to other countries”, fine. Call the bluff.

    In fact, moving to other countries will cost them tremendously in investor confidence, for not trivial reason. They will fail … and most suspect this.

    Most business is local, and if they move elsewhere, there are lots of folk who will take their place.

    And most suspect this ….

  41. Here’s some ruinous fiscal impact of big banksthat Dr. Johnson didn’t get to: http://www.webofdebt.com/articles/egyptian_tinderbox.php

  42. @ 3-D

    How about “Basel, Switzerland”? After all, it’s all under the umbrella of the *”Bank of International Settlements (BIS)”*, “Basel (Accord) Committee on Banking Supervision (BCBS)”, and “Basel Capital Accord (BCA)”! Their lapdogs being the “International Monetary Fund (IMF)”, betrothed to the “World Bank {(WB= Warner Brother’s= Loonie Toons?)} (WB)”

    Remember this date: “The first BCA came into existence in 1988. Juxtapose that with financial timelines/wars, and presidential elections with various laws implemented throughout the world. Thus a pattern of developed “Negative-Patterns” in this “Dark-Room of Alchemist Patrimony” comes to life!

  43. Actually it was not the banks that moved so much to Basel as your regulatory machinery.

    If you for instance go to the meeting in April 2004 of SEC where they authorize brokerage houses and investment banks to leverage like crazy, it was specifically mention that it shoud be done in accordance to what the Basel Committee said.

  44. @ Per Kurowski

    Yes…and as you mentioned in a previous post that the Dodd-Frank (FinReg) Bill never once mentions “The Basel” in its 2500 pages?

    Ironically the SEC, and the U.S. Comptroller General have been declawed by the very Basel Accord via the Treasury, and FRB,…?

    PS. The Top was in, as we all can look back to 2005/06

  45. desi girl, lloyd b worshiper

    johnson lapdogs out in full force…as expected, after all that is where they come to feed.

    please go ahead and reverse the CFMA…i am eagerly waiting. Ha Ha!

  46. desi girl, lloyd b worshiper

    Markets, so you agree REIT = Bank?