By Simon Johnson

Eighteen months ago, on October 24, 2008, Peter Boone, James Kwak and I published an opinion piece in the Guardian (UK), “Start by Saving the Eurozone“.  We argued that the recession would put a great deal of pressure on the eurozone, because of flaws in its design.

Our proposals for addressing these issues, and preventing a broader global crisis, included:

“2. Create a European Stability Fund with at least €2tn of credit lines guaranteed by all Eurozone member nations and potentially other European countries with large financial systems such as Switzerland, Sweden and the UK. This fund should provide alternative financing to member countries in case market rates on their government debt become too high. This will prevent a self-fulfilling cycle of rising interest rates. The fund should be large enough to have credibility; countries could access the fund automatically, but should then adopt a 5-year program for ensuring financial stability, subject to peer review within the Eurozone.” Continue reading “Our Eurozone Call In October 2008 And Banking Reform Today” →

By Simon Johnson, 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown

The bank lobbyists have the champagne out – the Brown-Kaufman amendment, which would have capped the size and leverage of our largest banks – was defeated in the Senate last night, 33-61.  Feeling ascendant, the big banks swarm forward to take on their next foe – the Kanjorski amendment (that would greatly strengthen the power of regulators to break up megabanks), which they plan to gut in the backrooms.

This is overconfidence – because the consensus against them is beginning to shift significantly.  Partly this is the result of great efforts by Senator Ted Kaufman, Senator Sherrod Brown, and their colleagues over recent months and weeks.  Partly this is due to all the people who came on board and pushed hard.

But, as in many such cases, it is also a question of luck – and timing. Continue reading “Falling Back On Waterloo” →

By Peter Boone and Simon Johnson

The Greek “rescue” package announced last weekend is dramatic, unprecedented, and far from enough to stabilize the eurozone. 

The Greek government and the European Union (EU) leadership, prodded by the International Monetary Fund (IMF), are finally becoming realistic about the dire economic situation in Greece.  They have abandoned previous rounds of optimistic forecasts and have now admitted to a profoundly worse situation.  This new program calls for a total of 11% of GDP in terms of “fiscal adjustments” (i.e., reduction in the budget deficit; now meaning government spending cuts mostly) in 2010, 4.3% in 2011, and 2% in 2012 and 2013.  The total debt to GDP ratio peaks at 149% in 2012-13 before starting a gentle glide path back down to sanity.

This new program is honest enough to show why it is unlikely to succeed.  Daniel Gros, an eminent economist on euro zone issues based in Brussels, has argued that for each 1% of GDP decline in Greek government spending, total demand in the country falls by 2.5% of GDP.  If the government reduces spending by 15% of GDP – the initial shock to demand could be well over 30% of GDP.  Obviously this simple rule does not work with such large numbers, but it illustrates that Greece is likely to experience a very sharp recession – and there is substantial uncertainty around how bad the economy will get.  The program announced last weekend assumes Greek GDP falls by 4% this year, then by another 2.6% in 2011, before recovering to positive growth in 2012 and beyond. 

Such figures seem extremely optimistic, particularly in face of the civil unrest now sweeping Greece and the deep hostility expressed towards Greece in some north European policy circles.  Continue reading “It’s Not About Greece Any More” →

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

After months of denial, the European policy elite finally begins to understand that something is seriously wrong in the eurozone.

But the prevailing definition of the problem is still too narrow – the consensus in France and, even more, in Germany is that “this is a Greek problem”.  Even the most negative still think that Portugal and Spain can easily escape serious damage.

This is a major misconception, as we pointed out last week – and as we have been emphasizing, to anyone who would listen, for more than a year. Continue reading “Expect Nothing” →

By Simon Johnson, co-author of 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown.  This post also appears on pbs.org/needtoknow – as part of that new TV program’s coverage of the week’s issues.

There is widespread agreement that the financial crisis which broke out in September 2008 was our most severe in over 50 years.  There is also a consensus that, whatever other factors may have been involved, the excessive risk-taking and general mismanagement of huge banks at the center of our economy played a significant role in what happened.  (Yes, of course the largest banks themselves deny any responsibility – including most recently using insulting language.)

The financial reform package now on the Senate floor puts surprisingly little constraint on the activities of our largest banks going forward – preferring instead to defer to regulators to tweak the rules down the road (despite the fact that this approach has gone badly over the past 20-30 years).

A growing number of senators insist we should do more to reduce the size and limit the leverage of megabanks (i.e., the amount that banks can borrow), arguing that this would constitute an important additional failsafe – on top of all other efforts to establish “more effective regulation”.

Senator Ted Kaufman (D, DE) has led the charge on this issue, pounding away for months – and giving another powerful speech on the floor of the Senate yesterday.

Yet, astonishingly, it seems increasingly likely there will be no real Senate debate on this issue. Continue reading “Fake Debate: The Senate Will Not Vote On Big Banks” →

 By Simon Johnson

On Friday, Senator Bob Corker (R, TN) took to the Senate floor to rebut critics of big banks.  His language was not entirely senatorial: “I hope we’ll all come to our senses”, while listing the reasons we need big banks.  And Senator Chris Dodd (D, CT) rose to agree that (in Corker’s words) reducing the size of our largest banks would be “cutting our nose off to spite our face” and that by taking on Wall Street, “we may be taking on the heartland.”

Unfortunately, all of their arguments in favor of our largest banks remaining at or near (or above) their current scale are completely at odds with the facts (e.g., as documented in our book, 13 Bankers).

The senators led with the idea that our nonfinancial sector needs huge, complex, global banks in order to remain competitive internationally.  But this is completely untrue – in fact, Senator Dodd conceded as much to Ezra Klein recently when he said that he had heard the arguments of 13 Bankers against big banks also from “CEOs” (presumably of nonfinancial companies). Continue reading “Why Do Senators Corker And Dodd Really Think We Need Big Banks?” →

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

Frank Luntz is the midst of making one of the great mistakes of modern American politics.  He seems to have completely missed the change in plot line on financial reform over the past few months – ever since Ted Kaufman waded into the fray, started to bring other key figures with him, and really moved mainstream thinking (as manifest, for example, in the Goldman Sachs hearing this week).

This is about the “arc of the fraud”.  The financial system committed fraud during the boom (liar loans and misrepresentation to customers of all kinds); fraud during the bailout (“if you ruffle our feathers, we will collapse”); and now fraud during the serious attempts at reform (e.g., the astroturf/fake grassroots nonsense.)

Luntz thinks this is about higher costs being passed on to consumers and wants to fight in November on “the Democrats are just about special interests”.  That would be terrific – for the Democrats – and Mr. Luntz should be encouraged in this endeavor. Continue reading “Frank Luntz Hasn’t Read 13 Bankers (And That’s A Good Thing)” →

By Peter Boone and Simon Johnson

When Mr. Trichet (head of the European Central Bank, ECB) and Mr.  Strauss-Kahn (head of the International Monetary Fund, IMF) rushed to Berlin this week to meet Prime Minister Angela Merkel and the German parliament, the moment was eerily reminiscent of September 2008 – when Hank Paulson stormed up to the US Congress, demanding for $700bn in relief for the largest US banks.  Remember the aftermath of that debacle: despite the Treasury argument that this would be enough, much more money was eventually needed, and Mr. Paulson left office a few months later under a cloud.

The problem this time is bigger.  It is not only about banks, it is about the essence of the eurozone, and the political survival of all the public figures responsible.  If Mr. Trichet and Mr. Strauss-Kahn were honest, they would admit to Ms. Merkel “we messed up – more than a decade ago, when we were governor of the Banque de France and French finance minister, respectively”.  These two founders of the European unity dream helped set rules for the eurozone which, by their nature, have caused small flaws to turn into great dangers. 

The underlying problem is the rule for printing money:  in the eurozone, any government can finance itself by issuing bonds directly (or indirectly) to commercial banks, and then having those banks “repo” them (i.e., borrow using these bonds as collateral) at the ECB in return for fresh euros.  The commercial banks make a profit because the ECB charges them very little for those loans, while the governments get the money – and can thus finance larger budget deficits.  The problem is that eventually that government has to pay back its debt or, more modestly, at least stabilize its public debt levels.  Continue reading “To Save The Eurozone: $1 trillion, European Central Bank Reform, And A New Head for the IMF” →