Author: Simon Johnson

Will Ireland Default? Ask Belgium

By Simon Johnson

On the face of it, Ireland seems poised on the brink of default. Its debts are very large relative to the size of its economy, most of this money is owed to foreigners and – unless there is an unexpected growth miracle – the country will struggle to pay its debts in full for many years to come.

Yet all the indications are that, as part of the historic rescue package to be introduced this week by the European Union and the International Monetary Fund, Ireland will not default on or otherwise restructure its most substantial debts. Why not?

To be clear, Ireland owes a huge amount of money to the outside world. In the best scenario, Ireland’s government debt is likely to stabilize at more than 100 percent of gross national product (G. N. P.); in the worst scenario, with greater real estate losses and a deeper recession, this level could reach 150 percent. Continue reading “Will Ireland Default? Ask Belgium” →

Who Gains From The Eurozone Fiasco? China

By Simon Johnson

Ireland will get a package of support from the EU and the IMF. Will the money and the accompanying policy changes be enough to stabilize the situation in Ireland or more broadly around Europe? Does it prevent Ireland from restructuring its debt – or move the Irish (and other parts of the European periphery) further in that direction?

And who gains from the delay and mismanagement we continue to see at the highest European levels?

This is complicated economic chess within Ireland, across Europe, and at the international level. In my Bloomberg column this morning, I suggest we look several moves ahead, recognizing the underlying political dynamic:

There is a much more general or global phenomenon in which powerful people cooperate to build an economic model that provides growth based on a great deal of debt. When the crisis comes, those who control the state try to save their favorite oligarchs, but there aren’t enough resources to go around

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Here is the present problem: It’s not just the Irish elite that is under pressure and struggling to sort out who should be saved. It’s also the European bankers who funded them. Continue reading “Who Gains From The Eurozone Fiasco? China” →

Fixing The US Budget – Straightforward Or The Hardest Problem On Earth?

By Simon Johnson

The conventional wisdom is that we face a serious budget problem, ballooning debt and political deadlock that prevents any semblance of progress either in the short term or over the next 20 years. “The sky is falling — cut everyone’s wages, slash Social Security, buy gold!” summarizes the mood of this midterm moment.

But step back and look at American public finances from any angle — historical, comparative with other nations, from Mars — and the picture is very different. We have a simple economic problem — we need to fix our tax system, irrespective of how much revenue we want from it. And we continue to face the central American political problem of the last 200 years: how much inequality are we willing to accept as reasonable and fair? Continue reading “Fixing The US Budget – Straightforward Or The Hardest Problem On Earth?” →

The Debt Problems of the European Periphery

By Anders Åslund, Peter Boone and Simon Johnson

Last week’s renewed anxiety over bond market collapse in Europe’s periphery should come as no surprise. Greece’s EU/IMF program heaps more public debt onto a nation that is already insolvent, and Ireland is now on the same track. Despite massive fiscal cuts and several years of deep recession Greece and Ireland will accumulate 150% of GNP in debt by 2014. A new road is necessary: The burden of financial failure should be shared with the culprits and not only born by the victims.

The fundamental flaw in these programs is the morally dubious decision to bail out the bank creditors while foisting the burden of adjustment on taxpayers. Especially the Irish government has, for no good reason, nationalized the debts of its failing private banks, passing on the burden to its increasingly poor citizens. On the donor side, German and French taxpayers are angry at the thought of having to pay for the bonanza of Irish banks and their irresponsible creditors.

Such lopsided burden-sharing is rightly angering both donors and recipients. Rising public resentment is testing German and French willingness to promise more taxpayer funds. German Chancellor Angela Merkel’s hasty and ill thought out plan to demand private sector burden sharing, but only “after mid-2013”, marks a first response to these popular demands. We should expect more. Continue reading “The Debt Problems of the European Periphery” →

It’s Not About Ireland Anymore

By Simon Johnson

On the Project Syndicate website, Peter Boone and I argue, with regard to the European situation in this coming week:

The Germans, responding to the understandable public backlash against taxpayer-financed bailouts for banks and indebted countries, are sensibly calling for mechanisms to permit “wider burden sharing” – meaning losses for creditors. Yet their new proposals, which bizarrely imply that defaults can happen only after mid-2013, defy the basic economics of debt defaults.

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Given the vulnerability of so many eurozone countries, it appears that Merkel does not understand the immediate implications of her plan. The Germans and other Europeans insist that they will provide new official financing to insolvent countries, thus keeping current bondholders whole, while simultaneously creating a new regime after 2013 under which all this debt could be easily restructured. But, as European Central Bank President Jean-Claude Trichet likes to point out, market participants are good at thinking backwards: if they can see where a Ponzi-type scheme ends, everything unravels. Continue reading “It’s Not About Ireland Anymore” →

G20: Profound And Complete Disappointment For The US Treasury

By Simon Johnson

Early Friday I went through the G20 communique for the Wall Street Journal; a marked up copy is available on-line.

It is hard to imagine how the summit could have gone any worse for the US Treasury and the president. The spin machine is now working overtime – and you’ll see big efforts to get more positive stories over the coming week – but on all fronts the outcome is very bad.

There was no substantive progress on anything to do with exchange rates. The “indicative guidelines” to be agreed next year are just a way to kick the can down the road. The Chinese are digging in hard on their exchange rate; this is headed towards a mutually destructive trade war.
There was less disagreement at the summit regarding the “regulation” of global megabanks – but only because this had been gutted so effectively by the bankers’ lobby and officials who bought their specious arguments. There is nothing here that will prevent or limit the impact of another major worldwide financial crisis. Continue reading “G20: Profound And Complete Disappointment For The US Treasury” →

Vikram Pandit Has No Clothes

By Simon Johnson

Vikram Pandit heads Citigroup, one of the world’s largest and most powerful banks. Writing in the Financial Times Thursday morning, with regard to the higher capital standards proposed by the Basel III process, he claims

“There is a point beyond which more is not necessarily better. Hiking capital and liquidity requirements further could have significant negative impact on the banking system, on consumers and on the economy.”

Mr. Pandit is completely wrong. To understand this, look at the letter published in the Financial Times earlier this week by finance experts from top universities – the kind of people who trained Mr. Pandit and his generation of bank executives. Continue reading “Vikram Pandit Has No Clothes” →

Top Finance Experts To G20: The Basel III Process Is A Disaster

By Simon Johnson

The Group of 20 summit for heads of government this weekend will apparently “hail bank reform,” particularly as manifest in the Basel III process that has resulted in higher capital requirements for banks. According to leading authorities on the issue, however, the Basel process is closer to a disaster than a success.

Bank capital can be best thought of as the amount of financing of a bank’s operations (lending and investment) that is covered by equity and not by debt obligations. In other words, it describes how much of the assets of the bank are subject not to the “hard claim” of debt but rather to a residual or equity claim, which would not lead to distress or insolvency when the value of the asset goes down. For global megabanks, equity capital is thus a key element in preventing the failure of an individual institution (or a couple of banks) from bringing down the financial system.

The framing of the Basel “success,” according to officials, is that the big banks wanted to keep capital standards down — and this is definitely true — but that governments pushed for requirements that are as high as makes sense. The officials implicitly conceded the banks’ main intellectual point, that higher capital requirements would be contractionary for the economy. Continue reading “Top Finance Experts To G20: The Basel III Process Is A Disaster” →

The Elusive Quest For Gold

By Simon Johnson. As prepared for the NYT’s Room for Debate – for the context and the whole discussion, see this link.

In a world with so many instabilities, there is an understandable search for something that offers a stable value – preferably something that cannot be affected by the whim of government or the latest scheme of a central bank. Unfortunately, this search proves just as illusory as the pursuits of alchemists in pre-modern times; there is no magic to gold.

For international economic transactions, proposing any kind of return to the gold standard is equivalent to wanting more fixed exchange rates, i.e., moving away from market-determined rates and returning to the system, at least in part, to how it operated before 1971.

But it is hard to imagine how this would help with regard to the major currencies, which are again the subject of controversy today. The main issues in the US are high unemployment, an unstable financial system, and longer-term issues around the budget. How exactly would gold help on any dimension? Advocates of a modified gold standard argue that this would serve as a form of anchor to the system – but in the 1930s it proved to be an anchor tied around the neck of some countries, including the United States. Nobody needs the kind of “stability” associated with the Great Depression. Continue reading “The Elusive Quest For Gold” →

Making The Volcker Rule Work

By Simon Johnson. This is the text of a letter (about 2,000 words) submitted on Friday to the Financial Stability Oversight Council, in response to their request for comments on the Volcker Rule. The full letter is here and on regulations.gov. If you would like more background on the Volcker Rule and its political importance, please see this post and the links it provides.

Dear Members of the Financial Stability Oversight Council:

Thank you for the opportunity to submit these comments on the study regarding implementation of Section 619 of the Dodd-Frank Act, also known as the Merkley-Levin provisions on proprietary trading and conflicts of interest or as the Volcker Rule.

Summary

I would like to offer three main comments.

Mismanagement of risks that involved effectively betting the banks’ own capital was central to the financial crisis of 2008; this is why our largest banks failed or almost failed. The Merkley-Levin Volcker Rule, properly defined, would significantly reduce systemic financial risks looking forward. Congressman Bachus’s comment to contrary (as submitted to the FSOC, as part of the Public Input for this Study, dated November 3, 2010) is completely at odds with the facts.
Trades need to be scrutinized in a detailed and high frequency fashion. It is not enough to rely on relatively infrequent and “high level” inspections – or the established supervisory process. The comments provided to you in this regard by Senator Harkin (dated October 20, 2010) – and also by Senators Merkley and Levin (dated November 4, 2010) – are exactly on target.
The separation between banks and the funds they sponsor, in any fashion, needs to be complete. The argument offered by State Street and other “Custodian Banks” in their comment to you (dated October 27, 2010) is worrying and potentially dangerous, because it ignores the basic economics that leads to bank failure.

The remainder of this letter expands on these points. Continue reading “Making The Volcker Rule Work” →

Paul Ryan Is Not A Fiscal Conservative

By Simon Johnson

Writing in the Financial Times today, Paul Ryan – the incoming chair of the House Budget Committee – presents himself as a fiscal conservative, primarily focused on bringing the budget deficit and government debt under control. He is not.

Only in American could self-styled “fiscal conservatives” say that “America is eager for an adult conversation on the threat of debt,” but then decline to discuss the first order problem that has brought us here and threatens us going forward: Dangerous systemic risk brought on by the reckless behavior of big banks. No “fiscal conservatives” showed up for the legislative fight to rein in big banks – none, and now Spencer Bachus (presumptive incoming chair of House Financial Services) says that restrictions on big banks should be further lifted (quoted in the FT today, p.15).

We can reasonably draw only one conclusion: Paul Ryan and his colleagues are not real fiscal conservatives. This is further confirmed by the following: Continue reading “Paul Ryan Is Not A Fiscal Conservative” →

Will the Volcker Rule Survive The Midterm Elections?

By Simon Johnson

The Obama administration saved the deeply troubled megabanks in the United States in early 2009 with a bundle of rescue measures that, compared with similar financial crises elsewhere, stands out as extraordinarily generous – particularly to the bankers at the epicenter of the disaster.

The banks responded to this magnanimity with – by all accounts – extraordinarily generous support for the Republicans leading up to this week’s midterm elections. Why would they do this?

The answer is straightforward: The Republicans have promised generally not to tighten restrictions on the financial sector, which means specifically that they will seek to make the recent Dodd-Frank financial regulatory legislation less effective. Continue reading “Will the Volcker Rule Survive The Midterm Elections?” →

The White House Needs Elizabeth Warren, Now More Than Ever

By Simon Johnson

The White House today is under pressure, with insiders asking: After the strong showing of the Republicans in the midterm elections, should the president move to the right or to the left?

This is entirely the wrong way to think about the problem – the administration needs to get beyond its mental framework of early 2009, which led it sadly astray with regard to the financial sector. The President needs to find people and themes capable of cutting across the political spectrum; specifically he needs to promote strongly the ideas of Elizabeth Warren – what we need in financial services, above all else, is much more transparency.

The premise – and central mistake – of the Obama administration in 2009-10 can be summed up in what the president said to leading bankers on that fateful day, March 27, 2009: “My administration is the only thing between you and the pitchforks”. Continue reading “The White House Needs Elizabeth Warren, Now More Than Ever” →

Phony “Fiscal Conservatives” – In The Midterms And Beyond

By Simon Johnson

Should we take seriously people who, in the current US political debate, argue that they are “fiscal conservatives”? No.

These self-labeled conservatives are very far from even being willing to discuss the real issues – let alone make proposals that would have significant effects. As Peter Boone and I argue on Bloomberg this morning, US “fiscal hawks” are just pretending. Perhaps this will prove effective in the midterm elections, but then they will face the music – what exactly will they put on the table that will make any difference at all?

Unless and until you are ready to really reform the financial sector, you cannot be taken seriously in the fiscal space. It’s the big banks that blew up the economy, caused a devestating recession, and pushed up debt by 40 (forty) percentage points relative to GDP.

None of today’s “fiscal conservatives” showed up to work hard on constraining global megabanks over the past 18 months. They have repeatedly and explicitly earned the right not to be taken seriously.

Here’s the full Bloomberg link: http://www.bloomberg.com/news/2010-11-01/u-s-fiscal-hawks-turning-french-commentary-by-peter-boone-simon-johnson.html

Foreign Money, National Security, And The Midterm Elections

By Simon Johnson

Campaign contributions by non-citizens are a huge issue lurking behind the midterm elections; they will be even more important in 2012. Think about the economic dynamics:

Americans have a long-standing and well-founded aversion to foreign involvement in their politics, and it is well-established that this can happen in part through corporate “commercial” structures. Thomas Jefferson objected to Alexander Hamilton’s plan for a national bank in part because he feared this would become a stalking horse for the British in some form (see Chapter 2 of 13 Bankers for the context). Dubai Ports World was not allowed to invest in the United States – for reasons of perceived national security. You may or may not think that case was handled well, but we have the CFIUS process to vet foreign direct investment for good reason.
The Supreme Court has determined that corporations can make political contributions virtually without limit, apparently not understanding or not caring that (a) management has a fiduciary responsibility to shareholders, (b) globalization means more foreign shareholders on average (for privately held companies and funds, as well as publicly traded companies), and (c) at the margin, key strategic shareholders – the people who provide extra capital when the chips are down – increasingly tend to be foreign. Think about the role of Sovereign Wealth Funds in providing funds to our banking system in 2007-08, or the fact that Citigroup goes cap-in-hand to Saudi Arabia every decade or so.
During the Reagan years and again, even more, under the Second President Bush, the US ran a large current account deficit – reaching 6 percent of GDP before the 2008 crisis (and still around 3 percent of GDP). You may think this a technical detail that is largely irrelevant to the political process, but you would be wrong. We finance our current account deficit with capital inflows from abroad or, to put that more plainly: Foreigners buy and hold financial assets in the United States. Some of those assets are US government obligations but traditionally and increasingly non-US people have also acquired claims on corporate entities – including common or preferred stock. Continue reading “Foreign Money, National Security, And The Midterm Elections” →