Author: Simon Johnson

The G20’s China Bet

By Simon Johnson

The G20 communiqué, released after the Toronto summit on Sunday, made it quite clear that most industrialized countries now have budget deficit reduction fever (see this version, with line-by-line comments by me, Marc Chandler and Arvind Subramanian). The US resisted the pressure to cut government spending and/or raise taxes in a precipitate manner, but the sense of the meeting was clear – cut now to some extent and cut more tomorrow.

This makes some sense if you think that the global economy is in robust health and likely to grow at a rapid clip – say close to 5 percent per annum – for the foreseeable future. With high global growth, it will matter less that governments are cutting back and unemployment will come down regardless. Taking this into account, the IMF is actually predicting (as cited prominently by the G20) that budget “consolidation” actually raise growth over a five-year horizon.

There is no question that some weaker European countries, such as Greece, Portugal, and Ireland, had budget deficits that were out of control. Particularly if they are to pay back all their foreign borrowing – a controversial idea that remains the conventional wisdom – these countries need some austerity. But what about those larger countries, which remain creditworthy, such as Germany, France, the UK, and the US? If these economies all decide to reduce their budget deficits, what will drive global growth? Continue reading “The G20’s China Bet” →

What Is Goldman Sachs Thinking?

By Simon Johnson

The next financial boom seems likely to be centered on lending to emerging markets. Sam Finkelstein, head of emerging markets debt at Goldman Sachs Asset Management, summed up the prevailing market view – and no doubt talked up his own positions – with a prominent quote in Monday’s Financial Times (p.13, front of the Companies and Markets section):

“Debt-to-GDP ratios in the developed world are about double those in emerging markets and they’re growing. This makes emerging markets interesting because you’re pick up incremental spread [higher interest rates compared with developed world rates], and in return you’re actually taking less macroeconomic risk.”

This is a dangerous view for three reasons. Continue reading “What Is Goldman Sachs Thinking?” →

JP Morgan Responds To Financial Reform: The Poison Pill Strategy

By Simon Johnson

While the financial reform negotiation process grinds to its meaningless conclusion, the real action lies elsewhere – in Jamie Dimon’s executive suite.

Dimon, the head of JP Morgan Chase, is apparently seeking to (a) become more global, (b) move further into emerging markets, and (c) become more like Citigroup.

This is terrific corporate strategy – and very dangerous for the rest of us. Continue reading “JP Morgan Responds To Financial Reform: The Poison Pill Strategy” →

Tim Geithner and Larry Summers Need Paul Krugman To Replace Peter Orszag

By Simon Johnson. Tim Geithner and Larry Summers are talking a good game on fiscal policy to the G20. But they are struggling with to establish traction for their “spend now, consolidate later” message. Fortunately, there is an easy and obvious opportunity to establish credibility on this issue: Bring Paul Krugman into government.

Earlier this week, Peter Orszag resigned from his cabinet position as director of the Office of Management and Budget. The Washington Post put out one of the first lists of candidates who could replacement him. Senator Byron Dorgan would be a smart pick and some of the Post’s other suggestions could make sense.

But surely the front runner is Jason Furman. The working assumption is that Treasury Secretary Tim Geithner and National Economic Council director Larry Summers are in positions of influence for the long haul – and they have a track record of preferring team players over people who could bring competing perspectives to the table.

The Hamilton Project, housed at the Brookings Institution, was designed as a government-in-waiting by Robert Rubin. Then-Senator Obama attended its inaugural public meeting, with Peter Orszag as head of the project. Appointing Furman, successor to Orszag at Hamilton and currently a deputy to Larry Summers at the NEC, or another person from the same wing of the Clinton administration would continue in this tradition.

This is unfortunate, because the brilliant choice would be Paul Krugman – completely taking the wind out of the Republicans’ sails on fiscal deficits. Krugman has scolded them, in real-time and to great effect, consistently with regard to ruining the budget. And he has an important point – the Bush administration inherited a fairly sound fiscal position from the Clinton administration but squandered it thoroughly over 8 years. Continue reading “Tim Geithner and Larry Summers Need Paul Krugman To Replace Peter Orszag” →

“Chuck Prince” Is Going To Run This Bank (Into The Ground)

By Simon Johnson

“Breaking up big banks would actually increase system risk” is a refrain heard from top administration officials, ever more vocal after they helped kill the Brown-Kaufman amendment (that would have limited the size and leverage of our largest banks) on the floor of the Senate.

But while Mr. Geithner and his colleagues are still taking their victory laps and congratulating themselves on retaining “business as usual” after the biggest crash-and-bailout in world financial history, educated opinion starts to feel increasingly uncomfortable.

People who worry seriously about system risk break the problem down into several distinct buckets, including the nature of shocks and the way these are propagated across the system. In this typology, the “Chuck Prince problem” is in a class of its own. Continue reading ““Chuck Prince” Is Going To Run This Bank (Into The Ground)” →

Paul Krugman For OMB

By Simon Johnson

The president should nominate Paul Krugman to replace Peter Orszag as director of the Office of Management and Budget (OMB). (Orszag resignation details are here.)

We have previously reviewed Krugman’s outstanding qualifications for this (or any other top level) job (link to details). The main reason Krugman himself has been reluctant in the past relates to a potentially difficult Senate confirmation hearing – for example, if Krugman had been put forward to replace Ben Bernanke.

But for the OMB position, the dynamic of a hearing would be terrific for the president’s specific agenda and broader messages. Krugman, of course, is the leading advocate for continued (or increased) fiscal stimulus. This is exactly President Obama’s message to the G20 this weekend. Continue reading “Paul Krugman For OMB” →

Dead On Arrival: Financial Reform Fails

By Simon Johnson

The House-Senate reconciliation process is still underway and some details will still change. But the broad contours of “financial reform” are already completely clear; there are no last minute miracles at this level of politics. The new consumer protection agency for financial products is a good idea and worth supporting – assuming someone sensible is appointed by the president to run it. Yet, at the end of the day, essentially nothing in the entire legislation will reduce the potential for massive system risk as we head into the next credit cycle.

Go, for example, through the summary of “comprehensive financial regulatory reform bills” in President Obama’s letter to the G20 last week. Continue reading “Dead On Arrival: Financial Reform Fails” →

G-20 Rules; Time for Germany-Bashing

This guest post is by Arvind Subramanian, senior fellow at the Peterson Institute for International Economics.

Yesterday’s announcement by China to introduce greater exchange rate flexibility is unambiguously good news. Greater currency flexibility will help China with its domestic overheating problem. But China deserves a lot of credit for its act of responsible international citizenship, for making its contribution to global re-balancing. Two implications follow.

First, the G-20 deserves a lot of credit for the change in China’s policy. True, Secretary Geithner played his cards skillfully, balancing private chiding with public encouragement. It is also true that recent sabre-rattling by the US Congress to impose trade measures against Chinese exports may have played a role in persuading China. But it is the fact of the G-20 that allowed Secretary Geithner to convert the China currency issue from a bilateral US-China matter (on which little progress had been made for many years) to one in which a broader set of countries had a stake. The public pronouncements by Brazil and India earlier this year re-inforced this “multilateralization” of China’s currency undervaluation. This multilateralization had two positive effects. It forced China to take more seriously the international consequences of its currency policy. And it also made the politics of changing policy easier because China is seen not as caving to bilateral pressure but as responding to the wider international community. Regardless of what happens at the G-20 Summit in Toronto over this week-end, the G-20 can already count the change in China’s currency policy as its victory. Continue reading “G-20 Rules; Time for Germany-Bashing” →

Why “Living Wills” Fail

By Simon Johnson

A central idea in the financial reforms currently undergoing final negotiation in the United States – and also in similar initiatives in Europe – is that large banks must draw up “living wills” that should explain, in considerable detail, how they will be wound down in the event of future failure.

The concept is appealing in theory. No one knows their business better than the banks, the reasoning goes, so they should have responsibility for explaining how they can close down their various operations – or perhaps sell more valuable parts while limiting losses for unprofitable activities. This is often presented as “smart regulation”, with government regulators requiring private sector experts to do the difficult technical work.

Tuesday’s hearing of the House Energy and Commerce Committee shed considerable light on why living wills are highly unlikely to work in practice. The hearing was actually about the oil industry – and its government-mandated plans to deal with oil spills. The committee posted the spill response plans for the Gulf of Mexico of five companies – BP, Chevron, ConocoPhillips, Exxon Mobil, and Shell – which demonstrated striking, peculiar and disconcerting similarities. Continue reading “Why “Living Wills” Fail” →

After “Financial Reform”

By Simon Johnson

Informed opinion is sharply divided about how the next 12 months will play out for the global economy. Those focused on emerging markets are emphasizing accelerating growth, with some forecasts projecting a 5% increase in world output. Others, concerned about problems in Europe and the United States, remain more pessimistic, with growth projections closer to 4% – and some are even inclined to see a possible “double dip” recession.

This is an interesting debate, but it misses the bigger picture. In response to the crisis of 2007-2009, governments in most industrialized countries put in place some of the most generous bailouts ever seen for large financial institutions. Of course, it is not politically correct to call them bailouts – the preferred language of policymakers is “liquidity support” or “systemic protection.” But it amounts to essentially the same thing: when the chips were down, the most powerful governments in the world (on paper, at least) deferred again and again to the needs and wishes of people who had lent money to big banks.

[to read the rest of this article, on Project Syndicate, click here]

Don’t Forget The Kanjorski Amendment

By Simon Johnson

Substantive discussion in the House-Senate financial reform reconciliation conference is focusing on the Lincoln amendment, with some back-and-forth on the Volcker Rule (as manifest in the Merkley-Levin amendment). The FT reports today that Paul Volcker is no longer opposed to the Lincoln approach – now it has become clear that this is really just about (substantially) raising the capital that banks need to back derivatives trading. And the influential Tom Hoenig, of the Kansas City Fed, appears to be strongly in the Lincoln camp.

While our most experienced regulators weigh in, the lobbyists start to struggle. The mobilization of broader support against gutting the legislation also helps – the earlier Senate debate has raised sensitivity levels and there is a new concentration to the public scrutiny. The reconciliation process itself is much more open than would ordinarily be the case – a result of outside pressure.

But amidst all this excitement and potential moving parts, don’t forget about the Kanjorski amendment (not currently on the list of most prominent topics). Continue reading “Don’t Forget The Kanjorski Amendment” →

Decision Time: Has the President Abandoned Paul Volcker’s Ideas On Financial Reform?

By Simon Johnson

The official reconciliation process between Senate and House reform bills will get underway next week, but the behind-the-scenes maneuvering (and intense lobbying) is already well underway. The main remaining question is whether the final legislation will ultimately make the financial system at all safer than it was in the run up to the crisis of September 2008.

How do big banks repeatedly get themselves into so much trouble? Dangerous banking in today’s world involves banks trading securities and, in that context, taking positions – i.e., betting their own capital. For example, almost all the profits made by big banks in 2009 came from securities trading. When market conditions are favorable and traders get lucky, the people running these banks (and hopefully their shareholders) get tremendous upside. But when this same risk-taking behavior results in big losses, the major negative impact is felt in terms of a major recession, raising government debt, and sharply lower employment.

“Wall Street gets the upside, and society gets the downside” is an old saying that is now more relevant than ever. This asymmetry in incentives explains how smart people with concentrated financial power can cause so much damage – according to, for example, the Bank of England’s analysis. Continue reading “Decision Time: Has the President Abandoned Paul Volcker’s Ideas On Financial Reform?” →

Richard Fisher (Federal Reserve Bank Of Dallas): Larry Summers, The G20, And Financial Dementia

By Simon Johnson, co-author of 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown

Richard Fisher, president of the Dallas Fed, has long been a proponent of serious financial sector reform. As a former commercial banker, he sees quite clearly that the legislation now headed into “reconciliation” between House and Senate versions amounts to very little. He also knows that pounding away repeatedly on this theme is the best way to influence his colleagues within the Fed and across the policy community more broadly.

He is now taking his game to a new, higher level. Couched in the diplomatic language of senior officials, his speech on June 3 to the SW Graduate School of Banking was both a carefully calibrated assault on the administration’s general “softly, softly” approach to the big banks and a direct refutation of arguments put forward by Larry Summers in particular.

As the title of Mr. Fisher’s speech implies, if the legislation is not real financial reform (and it is not, according to him), then our current policy trajectory amounts to facilitating further rounds of financial dementia. Continue reading “Richard Fisher (Federal Reserve Bank Of Dallas): Larry Summers, The G20, And Financial Dementia” →

French Connection: The Eurozone Crisis Worsens Sharply

By Peter Boone and Simon Johnson

The big news is France. With sentiment worsening across Europe, France has lost its relative safe haven status – credit default swap spreads on French government debt were up sharply today.

The trigger – oddly enough – was Hungary’s announcement that its budget is worse than expected (blaming the previous government; this is starting to become the European pattern) and in the current fragile environment discussed yesterday, this relatively small piece of news spooked investors. But these developments only reinforced a trend that was already in place. Continue reading “French Connection: The Eurozone Crisis Worsens Sharply” →

The Maginot Line Illusion

By Peter Boone and Simon Johnson

Many commentators suggest Spain is now the euro zone’s Maginot line. The argument is clear: Spain, with GDP over $1.3 trillion (8^th largest in the world; 5^th largest in Europe) and its large outstanding bank and public debt, is simply too big to fail without causing irreparable harm to the euro zone financial system. If we dig in here, the reasoning goes, eurozone market upheavals can be stopped.

Just as Germany did in 1940, in past weeks global market forces circumvented this new Maginot line without serious resistance. The events that shook equity markets were not just in Spain; they were everywhere in the world. The cost of protecting against default on India’s largest private bank rose 79BP, or 44%, and the cost of protecting against major Korean banks’ default similarly rose 45%. Oil prices collapsed and emerging markets found their access to credit markets dried up. The interest rate for lending between banks in US dollars (LIBOR) shot up, and investors piled funds into their currently perceived “safe-havens” driving down the yields of German, French, and US bonds.

This pattern reflects the core problem facing world markets today. Investors have already begun to extrapolate from eurozone problems to understand that the world remains a highly dangerous place. The latent dangers include our overreliance on rapid Asian growth that might falter, the pressure for sharp fiscal tightening in nations with high deficits (other than in the world’s “safe havens”), and highly leveraged banks that continue to own toxic real estate, weak sovereign debt, and other assets. If world financial markets once again decide their risk appetite is again low, there are many unsustainable leveraged institutions and governments that are in for a tough ride. Continue reading “The Maginot Line Illusion” →