Author: Simon Johnson

Does The US Have A Lot Of Government Debt?

By Simon Johnson

In the nation’s latest fiscal mood swing, the mainstream consensus has swung from “we must extend the Bush tax cuts” (in December 2010) towards “we must immediately cut the budget deficit.” The prevailing assumption, increasingly heard from both left and right, is that we already have far too much government debt – and any further significant increase will likely ruin us all.

This way of framing the debate is misleading – and very much at odds with US fiscal history. It masks the deeper and important issues here, which are much more about distribution, in particular how much are relatively wealthy Americans willing to transfer to relatively poor Americans?

To think about the current size of our debt, start at the beginning of the American Republic. (For a very short history of US government debt, listen to my conversation with NPR’s Guy Raz from this weekend; we cover more than 200 years in about 3 minutes; if you want more detail, look up the annual debt numbers for yourself at Treasury Direct). Continue reading “Does The US Have A Lot Of Government Debt?” →

Nominate Elizabeth Warren – Provide The Pecora Hearings We Need

By Simon Johnson

Ms. Warren is helping get the new Consumer Financial Protection Bureau (CFPB) off the ground and remains the leading contender to become its formal head (subject to Senate confirmation). She summarizes her substantive agenda this way,

We’re trying to make these markets transparent, which makes it easier for community banks to compete both with large financial institutions and with their nonbank competitors.”

She should now be nominated to the CFPB position. There will be strong Republican opposition and some Democrats who are close to the financial sector may be lukewarm. But a public hearing on her case represents our best opportunity to experience a modern version of the Pecora Hearings – the Senate Banking Committee hearings in the 1930s that laid bare the inner (and rotten) workings of the biggest financial firms (see Michael Perino’s book on Pecora for details).

These hearings would represent a major step forward towards forging a new consensus regarding how to really establish markets (as opposed to the crazy government subsidy schemes that predominate). In addition, the administration would win a big victory with Ms. Warren’s confirmation. Continue reading “Nominate Elizabeth Warren – Provide The Pecora Hearings We Need” →

The FDIC’s Resolution Problem

By Simon Johnson. Links to the articles mentioned below are available here: http://economix.blogs.nytimes.com/2011/04/28/the-problem-with-the-f-d-i-c-s-powers/

Under the Dodd-Frank financial reform legislation (Title II of that Act), the Federal Deposit Insurance Corporation (FDIC) is granted expanded powers to intervene and manage the closure of any failing bank or other financial institution. There are two strongly-held views of this legal authority: it substantially solves the problem of how to handle failing megabanks and therefore serves as an effective constraint on their future behavior; or it is largely irrelevant.

Both views are expressed by well-informed people at the top of regulatory structures on both sides of the Atlantic (at least in private conversations). Which is right? In terms of legal process, the resolution authority could make a difference. But as a matter of practical politics and actual business practices, it means very little for our biggest financial institutions. Continue reading “The FDIC’s Resolution Problem” →

Is S&P’s Deficit Warning On Target?

By Simon Johnson

On Monday Standard & Poor’s announced that its credit rating for the United States was “affirmed” at AAA (the highest level possible), but that it was revising the outlook for this rating to “negative” – in this context specifically meaning “that we could lower our long-term rating on the U.S. within two years” (p.5 of the report). This news temporarily roiled equity markets around the world, although the bond markets largely shrugged it off.

While S&P’s statement generated considerable media attention, the economics behind their thinking is highly questionable – although, given the random nature of American politics, even this intervention may still end up having a constructive impact on the thinking of both the right and the left.

It is commendable that S&P now wants to talk about the U.S. fiscal deficit – one wonders where they were, for example, during the debate about extending the Bush-era tax cuts at the end of last year. Continue reading “Is S&P’s Deficit Warning On Target?” →

“Fiscal Conservatives” Dodge $10 Trillion Debt

By Simon Johnson. This post comprises the opening paragraphs of my column today on Bloomberg; the rest is available here: http://www.bloomberg.com/news/2011-04-19/fiscal-conservatives-dodge-10-trillion-debt-simon-johnson.html

Washington is filled with self- congratulation this week, with Republicans claiming that they have opened serious discussion of the U.S. budget deficit and President Barack Obama’s proponents arguing that his counterblast last Wednesday will win the day.

The reality is that neither side has come to grips with the most basic of our harsh fiscal realities.

Start with the facts as provided by the nonpartisan Congressional Budget Office. Compare the CBO’s budget forecast for January 2008, before the outbreak of serious financial crisis in the fall of that year, with its latest version from January 2011. The relevant line is “debt held by the public at the end of the year,” meaning net federal government debt held by the private sector, which excludes government agency holdings of government debt.

In early 2008, the CBO projected that debt as a percent of gross domestic product would fall from 36.8 percent to 22.6 percent at the end of 2018. In contrast, the latest CBO forecast has debt soaring to 75.3 percent of GDP in 2018.

What caused this stunning reversal, which in dollar terms works out to a $10 trillion swing for end-year 2018 debt, from $5.1 trillion to $15.8 trillion?

To read the rest of this post, click here.

Could Goldman Sachs Fail?

By Simon Johnson. This link to MIT Sloan’s website provides a partial transcript and video covering the points made below.

If Goldman Sachs were to hit a hypothetical financial rock, would they be allowed to fail – to go bankrupt as did Lehman – or would they and their creditors be bailed out?

I asked this question on Sunday to four leading experts (Erik Berglof, Claudio Borio, Garry Schinasi, and Andrew Sheng) from various parts of the official sector at the Institute for New Economic Thinking (INET) Conference in Bretton Woods – and to a room full of people who are close to policy thinking both in the United States and in Europe. In both the public interactions (for which you can review video here) and private conversations later, my interpretation of what was said and not said was unambiguous: Goldman Sachs would be bailed out (again).

This is very bad news – although admittedly not at all surprising. Continue reading “Could Goldman Sachs Fail?” →

The Vickers Commission Report On Banking

By Simon Johnson

Will the Vickers Commission report on UK banking – with a preliminary report released today – have a major positive impact? Not likely in our assessment – see today’s Daily Telegraph.

The fight to reform the banking system in the US and more broadly is largely over – and the bankers won. A number of sensible ideas were put forward – including on creating a resolution authority, reducing the scale and scope of big banks, and significantly increasing capital requirements. As reviewed by Peter Boone and me in this morning’s Financial Times, all of these initiatives have essentially failed.

Big Banks Have A Powerful New Opponent

By Simon Johnson

As a lobby group, the largest U.S. banks have been dominant throughout the latest boom-bust-bailout cycle – capturing the hearts and minds of the Bush and Obama administrations, as well as the support of most elected representatives on Capitol Hill. Their reign, however, is finally being seriously challenged by another potentially powerful group – an alliance of retailers, big and small – now running TV ads (http://youtu.be/9IUt-lY-XgM, by Americans for Job Security), web content (http://www.youtube.com/watch?v=DiKoFzS_lXs, by American Family Voices), and this very effective powerful radio spot directly attacking “too big to fail” banks: http://www.savejobs.org/audio18.html.

The immediate issue is the so-called Durbin Amendment – a requirement in the Dodd-Frank financial reform legislation that would lower the interchange fees that banks collect when anyone buys anything with a debit card. Retailers pay the fees but these are then reflected in the prices faced by consumers.

The US has very high debit card “swipe” fees – 44 cents on average but up to 98 cents for some kinds of cards. These fees are per transaction – representing a significant percent of many purchases but posing a particular problem for smaller merchants. This is estimated to be around $16-17 billion in annual revenue.

Other countries, such as Australia and members of the European Union, have already taken action to reduce interchange fees – because the cost of such transactions is actually quite low (think about it: the “interchange fee” for checks, which also draw directly on bank deposits, is exactly zero). The United States severely lags behind comparable countries in terms of how consumers are treated by banks in this regard. Continue reading “Big Banks Have A Powerful New Opponent” →

Institute Of International Finance Wins Two Nobel Prizes

By Simon Johnson

In a surprise announcement early this morning, the 2011 Nobel Peace Prize and the Nobel Prize for Economics (strictly speaking: “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel”) were simultaneously awarded to the Institute of International Finance (IIF), “the world’s only global association of financial institutions”.

This is the first time the Economics Prize has been awarded to an organization – although the Peace Prize has been received by various institutions (including the Intergovernmental Panel on Climate Change, the International Atomic Energy Agency, and Lord Boyd Orr – in part for his work with the Food and Agriculture Organization).

In its citation for the economics prize, the Royal Swedish Academy of Sciences said the IIF won for its work on capital requirements for banks, which proved that requiring banks to fund themselves with positive equity – and therefore have any kind of buffer against insolvency – would limit credit, be very bad for economic growth, and generally make all consumers less happy. Based on this single remarkable paper, the IIF earned the prize for its: Continue reading “Institute Of International Finance Wins Two Nobel Prizes” →

The Myth Of The Resolution Authority

By Simon Johnson

Back when it really mattered – last spring, during the Dodd-Frank financial reform debate – Senator Ted Kaufman of Delaware emphasized repeatedly on the Senate floor that the proposed “resolution authority” was an illusion. His point was that extending the established Federal Deposit Insurance Corporation (FDIC) powers for “resolving” (jargon for “closing down”) financial institutions to include global megabanks simply could not work.

At the time, Senator Kaufman’s objections were dismissed by “experts” both from the official sector and from the private sector. Now these same people (or their close colleagues) are falling over themselves to argue resolution cannot work for the country’s giant bank holding companies. The implication, which these officials and bankers still cannot grasp, is that we need much higher capital requirements for systemically important financial institutions.

Writing in the March 29, 2011 edition of the National Journal, Michael Hirsch quotes a “senior Federal Reserve Board regulator” as saying: Continue reading “The Myth Of The Resolution Authority” →

What Is Spencer Bachus’s Game?

By Simon Johnson

Representative Spencer Bachus, Republican chair of the House Financial Services Committee, famously remarked in December,

“in Washington, the view is that the banks are to be regulated, and my view is that Washington and the regulators are there to serve the banks.”

With regard to the Consumer Financial Protection Bureau (CFPB), this apparently now implies that Mr. Bachus will use any means possible to change the topic away from substance – how banks treat their customers – to imagined procedural issues.

Specifically, Mr. Bachus is wrongly accusing Elizabeth Warren of misleading Congress with regard to the role of the CFPB in the negotiations over how to settle allegations that mortgage foreclosure practices have been abusive (see also this news coverage). Continue reading “What Is Spencer Bachus’s Game?” →

Dividend Lost

By Simon Johnson

Four types of people were directly affected by the Federal Reserve’s decision at the end of last week to allow major banks to increase their dividends and to buy back shares. Three of these groups – bankers, bank shareholders, and government officials – were somewhere between happy and delighted. The four group, US taxpayers, should be much more worried (see also this cautionary letter to the Financial Times by top finance academics).

The bankers’ reaction is obvious. They are officially released from the financial hospital ward that was set up for them in 2008. No matter that this was a very comfortable place with few conditions relative to any other bailout in recent US or world history – there were still restrictions on what banks could do and, naturally, bank executives chafed at these constraints.

In particular, banks were required to build up the equity in their business – insolvency is avoided, after all, while there is positive equity in a business. When shareholder equity is exhausted, creditors face losses. Continue reading “Dividend Lost” →

Who’s Afraid Of Elizabeth Warren?

By Simon Johnson

The next big political battle in Washington – after the budget debate is declared “over” – will likely feature the Consumer Financial Protection Bureau, in particular the fight to determine whether Elizabeth Warren can become as the agency’s first official head.

But will this fight feature a classic left vs. right set-piece confirmation showdown in the Senate? Or it will it be resolved with cloaks and daggers closer to the White House – with Treasury Secretary Tim Geithner managing to prevent Professor Warren’s nomination?

There is much to commend the left vs. right scenario. The Republicans, after all, want to argue that regulation is excessive in general and regulation of financial products is somewhere between unnecessary and dangerous for economic growth in particular. This theme came up during the Dodd-Frank legislative debate on financial reform last year but it was largely lost in the larger conversation.

Now Spencer Bachus, Republican chair of the House Financial Services Committee, has Elizabeth Warren firmly in his sights – with the mortgage settlement negotiations as the flashpoint. Continue reading “Who’s Afraid Of Elizabeth Warren?” →

Battle Of The Banking Policy Heavyweights

By Simon Johnson

Just when it seemed that the debate over banking was winding down – with overwhelming victories on almost all dimensions for the people who run the world’s largest cross-border financial institutions – two of the biggest name policy heavyweights have entered the arena. Both voices are typically listened to most carefully within official circles and yet their messages today are diametrically opposed.

Which one is right?

Speaking on the side of greater reform for the biggest banks, Mervyn King – governor of the Bank of England – gave a forceful interview to the British newspaper The Telegraph at the end of last week.

“Why do banks in general want to pay bonuses? It’s because they live in a ‘too big to fail’ world in which the state will bail them out on the downside.”

In Mr. King’s view, casino-type banking caused the crisis of 2007-08.

“Financial services don’t like the word ‘casino’, but instruments were created and traded only within the financial community. It was a zero sum game. No one knew which ones were winners when the crisis hit. Everyone became a suspect. Hence, no one would provide liquidity to any of those institutions.”

“We allowed a [banking] system to build up which contained the seeds of its own destruction.”

And “reform” efforts so far do not amount to much.

“We’ve not yet solved the ‘too big to fail’ or, as I prefer to call it, the ‘too important to fail’ problem. The concept of being too important to fail should have no place in a market economy.” Continue reading “Battle Of The Banking Policy Heavyweights” →

“A Healthy Financial System Cannot Be Built On The Expectation Of Bailouts”

By Simon Johnson. Testimony submitted to the Congressional Oversight Panel, “Hearing on the TARP’s Impact on Financial Stability,” Friday, March 4, 2011.

I. Summary

1) The financial crisis is not over, in the sense that its impact persists and even continues to spread. Employment remains more than 5 percent below its pre-crisis peak, millions of homeowners are still underwater on their mortgages, and the negative fiscal consequences – at national, state, and local level – remain profound.

2) To the extent that a full evaluation is possible today, the financial crisis produced a pattern of rapid economic decline and slow employment recovery quite unlike any post-war recession – it looks much more like a mini-depression of the kind the US economy used to experience in the 19^th century. In addition, the fiscal costs of the disaster in our banking system so far amount to roughly a 40 percentage point increase in net federal government debt held by the private sector, i.e., roughly a doubling of outstanding debt.

3) In this context, TARP played a significant role preventing the mini-depression from becoming a full-blown Great Depression, primarily by providing capital to financial institutions that were close to insolvency or otherwise under market pressure.

4) But part of the cost is to distort further incentives at the heart of Wall Street. Neil Barofsky, the Special Inspector General for the Troubled Assets Relief Program put it well in his latest quarterly report, which appeared in late January, emphasizing: “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.’” Continue reading ““A Healthy Financial System Cannot Be Built On The Expectation Of Bailouts”” →