Author: Simon Johnson

Contradicting Secretary Geithner

By Simon Johnson

Speaking Thursday morning on the Today show, Treasury Secretary Tim Geithner insisted on two points:

1. If the bank rescue of 2008-09 had been handled in any other way – for example, being tougher on bankers – the costs to the real economy would have been substantially higher.

“again, what was the choice the president had to make? He had to decide whether he was gonna act to fix [the banking system] or stand back because it might be more popular not to have to do that kind of stuff, and that would have been calamitous for the American economy, much, much worse than what we went through already.”

2. The reform legislation currently before Congress would end all concerns regarding Too Big To Fail in the future.

“The president’s not gonna sign a bill that doesn’t have strong enough teeth.”

In 13 Bankers, we disagree strongly with point #1 (see this excerpt) and find point #2 so at odds with reality that it is scary. Friday morning, also on the Today Show, I have a brief opportunity to suggest a different narrative. Continue reading “Contradicting Secretary Geithner” →

Capital Requirements Are Not Enough

By Simon Johnson and James Kwak, authors of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (Pantheon, 2010).

The number of important people expressing serious concern about financial institutions that are too big or too complex to fail continues to increase. Since last fall, many leading central bankers including Mervyn King, Paul Volcker, Richard Fisher, and Thomas Hoenig have come out in favor of either breaking up large banks or constraining their activities in ways that reduce taxpayers’ exposure to potential failures. Senators Bernie Sanders and Ted Kaufman have also called for cutting large banks down to a size where they no longer pose a systemic threat to the financial system and the economy.

To its credit, the Obama administration recognizes the problem; according to Treasury Department officials, addressing “too big to fail” is one of the central pillars of financial reform, along with derivatives and consumer protection. However, the administration is placing its faith in technical regulatory fixes. And, as Andrew Ross Sorkin emphasizes in his recent Dealbook column, they see increased capital requirements as the principal weapon in their arsenal: “[Treasury Secretary Tim] Geithner insists that if there is one change that needs to be made to the banking system to protect it against another high-stakes bank run like the one that claimed the life of Lehman Brothers, increasing capital requirements is it.”

(Brief primer: Capital is money contributed by a bank’s owners–conceptually, their initial capital contributions plus reinvested profits–that does not have to be paid back. Therefore, it acts as a buffer to protect a financial institution from defaulting on its obligations as the value of its assets falls. The more capital, the less likely a bank is to fail. The more capital, however, the lower the institution’s leverage, and hence the lower its profits per dollar of capital invested–which is why banks always want lower capital requirements.)

Don’t get us wrong: we think that increased capital requirements are an important and valuable step toward ensuring a safer financial system. We just don’t think they are enough. Nor are they the central issue. Continue reading “Capital Requirements Are Not Enough” →

Lloyd Blankfein: Time Man Of The Year

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

In a surprise announcement earlier this morning, Time Magazine brought forward its annual “Man of the Year” award – and conferred this honor on Lloyd Blankfein, CEO of Goldman Sachs. April 1st apparently is at least 7 months earlier than anyone else has ever won this award, since it began in 1927.

As the award has previously been conferred on controversial figures (including Joseph Stalin in 1942 and Mrs. Simpson in 1936), Time also saw fit to issue a statement clarifying Mr. Blankfein’s merits,

“[Goldman is] very important. [They] help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle. [They] have a social purpose.”

A spokesperson for Goldman responded quickly,

“It was always clear to us that had [Lloyd not won], it would have been quite disruptive to the world’s financial markets. We would have had to spend money, other people would have had to replace transactions as well. Generally for us, volatility is good for our trading business, however it would not have been good for the financial markets as a whole, so it would not have been good for our business…We would not have been affected directly by our exposure to [him], but the world’s financial system would have been affected…there would have been no losses vis a vis our credit exposure.”

Now it seems the Nobel Peace Prize Committee feels pressed to follow suit. Their statement just released in Oslo begins, Continue reading “Lloyd Blankfein: Time Man Of The Year” →

“13 Bankers” In The Media

By Simon Johnson

I’ve already discussed the main points of 13 Bankers with more than a dozen interviewers across a wide range of formats; we’ll post links on the book’s site as they become available.

The Colbert Report and MSNBC aired interviews on Tuesday. Tom Keene talked to both James and me for his Bloomberg radio show – this ran about 40 minutes, so we covered a lot of ground (but I’m not sure if this is on the web). On WNYC I had an extended conversation with Mike Pesca. And here’s the Reuters coverage.

There are more discussions to come, including with Big Think (already taped) and on The Diane Rehm show tomorrow.

Paul Volcker: Do The Right Economic Thing

By Simon Johnson

A great deal of the popular anger directed at big banks is completely legitimate, as put nicely by John Cassidy at the end of his interview with Treasury Secretary Tim Geithner,

“The hardest part of his job, Geithner often says, is getting people to comprehend the inner logic of a financial-rescue operation, and the unpopular actions it entails. In fact, his problem may be not economic illiteracy but its opposite: Americans understand all too well what has happened. Financial crises have a way of revealing aspects of our economic system that otherwise remain obscured, such as the symbiotic relationship between Wall Street and Washington, the hidden subsidies that financial firms sometimes receive from the Fed and other government agencies, and the fact that the vast profits that firms like JPMorgan Chase and Goldman generate depend in part on an implicit guarantee from the taxpayer. When ordinary Americans are confronted with these realities, they get angry.”

Paul Volcker is also angry. Continue reading “Paul Volcker: Do The Right Economic Thing” →

Geely Buys Volvo: Goldman Gets The Upside, You Get The Downside

By Simon Johnson

Geely Automotive has acquired Volvo from Ford. This is a risky bet that may or may pay off for the Chinese auto maker – after first requiring a great deal of investment.

Goldman Sachs’ private equity owns a significant stake in Geely, with the explicit goal of helping that company expand internationally. Remember what Goldman is – or rather what Goldman became when it was saved from collapse by being allowed to transform into a Bank Holding Company in September 2008 (which allowed access to the Federal Reserve’s discount window, among other advantages). Goldman’s funding is cheaper on all dimensions because it is perceived to be Too Big To Fail, i.e., supported by the US taxpayer; this allows Goldman to provide more support to Geely (and others).

Our Too Big To Fail banks stand today at the heart of global capital flows. People around the world – including from China – park their funds in the biggest US banks because everyone concerned believes these banks cannot fail; they were, after all, saved by the Bush administration and put completely – gently and unconditionally – back on their feet under President Obama. These same banks now spearhead lending to risky projects around the world.

What is the likely outcome? Continue reading “Geely Buys Volvo: Goldman Gets The Upside, You Get The Downside” →

Volcker, Warren, and Kaufman: There Must Be New Law

By Simon Johnson, (13 Bankers, out tomorrow)

Some people at the top of the administration begin to understand that it makes both economic and political sense to impose binding constraints on our largest banks. But even the clearest thinking among them still has a problem – breaking up banks seems too much at odds with the way they saved these same banks in 2009. At best, this would be most awkward for the individuals involved on all sides.

“We’ll achieve the same general goal by imposing capital requirements that increase with the size of the bank” (not an exact quote) is the administration’s latest whispered idea, and in principle this has some appeal. If done properly, this could level the playing field – and therefore should be supported politically by small banks. By increasing the buffer against future losses, it would put in place greater protection for taxpayers against too big to fail (TBTF) institutions. And it would push TBTF firms to break up if they really have nothing better than cheap funding – based on implicit government subsidies – to support their continued existence.

But this “let’s do it with capital requirements” proposal is deeply flawed and completely unacceptable. From different perspectives, Paul Volcker, Elizabeth Warren, and Ted Kaufman all agree, we cannot rely on our existing regulations (and regulators). We need new law. Continue reading “Volcker, Warren, and Kaufman: There Must Be New Law” →

“13 Bankers”: National Public Radio Interview

By Simon Johnson

On Friday afternoon, NPR’s All Things Considered broadcast Robert Siegel’s interview with me on 13 Bankers (further down that link there is an excerpt from the very beginning of the book).

We talked, naturally enough, about how the ideas in 13 Bankers connect with the current policy debate – specifically the financial reform legislation now before the Senate. As anticipated when the book went to press in January, some sensible measures to protect consumers of financial products seem possible – yet this progress just emphasizes how and why we have not yet broken through on Too Big To Fail issues.

But there is a broader point here also. What happened in 2008-09 should not be allowed to happen again. The nature of power in and around the financial sector has become so great – and so distorted – that it harms the rest of us.

I don’t think a majority of Americans understand how much influence financial institutions have in Washington, DC. Banks used to answer to Washington. They were once held accountable for their actions. That is no longer is the case. Continue reading ““13 Bankers”: National Public Radio Interview” →

Who Will Tell The President? Paul Volcker

By Simon Johnson: link to NPR radio interview (and book excerpt) on how 13 Bankers got their hands on so much political and economic power – and why this spells serious danger for the rest of us.

Against all the odds, a glimmer of hope for real financial reform begins to shine through. It’s not that anything definite has happened – in fact most of the recent Senate details are not encouraging – but rather that the broader political calculus has shifted in the right direction.

Instead of seeing the big banks as inviolable, top people in Obama administration are beginning to see the advantage of taking them on – at least on the issue of consumer protection. Even Tim Geithner derided the banks recently as,

“those who told us all they were the masters of noble financial innovation and sophisticated risk management.”

In part this is window dressing. But in part it recognizes political opportunity – the big banks are unpopular because they remain completely unreformed and unrepentant. And in part it responds to a very real danger – Senator Dodd’s bill is so obviously weak on “too big to fail” issues that it will be hard to paint its opponents as friends of big banks.

Senator Richard Shelby knows this and is taking the offensive. The administration can convert an easy win into an own goal if it fails to toughen substantially Senator Dodd’s bill.

Fortunately, there is an easy way to address this issue. Continue reading “Who Will Tell The President? Paul Volcker” →

Hard Pressed, Senator Dodd Gives Ground

By Simon Johnson

Senator Chris Dodd has good political antennae. He knows that his financial reform bill will come under severe pressure because it has a weak heart – the provisions that deal with “too big to fail” are simply “too weak to make any sense.”

Stung by the hard-hitting critique of Senator Ted Kaufman earlier on Friday and unsure exactly where an increasingly combative White House is heading on the broader strategy vis-à-vis banks, Mr. Dodd took to the Senate floor yesterday afternoon – actually immediately after Senator Kaufman – in an attempt to sustain the momentum behind his approach to “reform”.

Note the prominent and rather defensive mention of Delaware, Senator Kaufman’s state, in what Senator Dodd said (the wording here is from the verbatim recording, not the official transcript):

“A business, as I say respectfully, in Connecticut or Delaware or Colorado, a homeowner in those states shouldn’t have to pay the price because a handful of financial institutions got too greedy, too risky, they were unwilling to examine what they were doing or did, recognizing that the federal government would bail them out if they made a bad choice, which they did.”

Perhaps it was this picture that did it: Continue reading “Hard Pressed, Senator Dodd Gives Ground” →

Senator: Which Part Of “Too Big To Fail” Do You Not Understand?

By Simon Johnson

When a company wants to fend off a hostile takeover, its board may seek to put in place so-called “poison pill” defenses – i.e., measures that will make the firm less desirable if purchased, but which ideally will not encumber its operations if it stays independent.

Large complex cross-border financial institutions run with exactly such a structure in place, but it has the effect of making it very expensive for the government to takeover or shut down such firms, i.e., to push them into any form of bankruptcy.

To understand this more clearly you can,

Look at the situation of Citigroup today, or
Read this new speech by Senator Ted Kaufman. Continue reading “Senator: Which Part Of “Too Big To Fail” Do You Not Understand?” →

The Canadian Banking Fallacy

By Peter Boone and Simon Johnson

As a serious financial reform debate heats up in the Senate, defenders of the new banking status quo in the United States today – more highly concentrated than before 2008, with six megabanks implicitly deemed “too big to fail” – often lead with the argument, “Canada has only five big banks and there was no crisis.” The implication is clear: We should embrace concentrated megabanks and even go further down the route; if the Canadians can do it safely, so can we.

It is true that during 2008 four of all Canada’s major banks managed to earn a profit, all five were profitable in 2009, and none required an explicit taxpayer bailout. In fact, there were no bank collapses in Canada even during the Great Depression, and in recent years there have only been two small bank failures in the entire country.

Advocates for a Canadian-type banking system argue this success is the outcome of industry structure and strong regulation. The CEOs of Canada’s five banks work literally within a few hundred meters of each other in downtown Toronto. This makes it easy to monitor banks. They also have smart-sounding requirements imposed by the government: if you take out a loan over 80% of a home’s value, then you must take out mortgage insurance. The banks were required to keep at least 7% tier one capital, and they had a leverage restriction so that total assets relative to equity (and capital) was limited.

But is it really true that such constraints necessarily make banks safer, even in Canada? Continue reading “The Canadian Banking Fallacy” →

Financial Reform: Will We Even Have A Debate?

By Simon Johnson

The New York Times reports that financial reform is the next top priority for Democrats. Barney Frank, fresh from meeting with the president, sends a promising signal,

“There are going to be death panels enacted by the Congress this year — but they’re death panels for large financial institutions that can’t make it,” he said. “We’re going to put them to death and we’re not going to do very much for their heirs. We will do the minimum that’s needed to keep this from spiraling into a broader problem.”

But there is another, much less positive interpretation regarding what is now developing in the Senate. The indications are that some version of the Dodd bill will be presented to Democrats and Republicans alike as a fait accompli – this is what we are going to do, so are you with us or against us in the final recorded vote? And, whatever you do – they say to the Democrats – don’t rock the boat with any strengthening amendments.

Chris Dodd, master of the parliamentary maneuver, and the White House seem to have in mind curtailing debate and moving directly to decision. Republicans, such as Judd Gregg and Bob Corker, may be getting on board with exactly this.

Prominent Democratic Senators have indicated they would like something different. But it’s not clear whether and how Senators Cantwell, Merkley, Levin, Brown, Feingold, Kaufman, and perhaps others will stop the Dodd juggernaut (or is it a handcart?)

This matters, because there is more than a small problem with the Dodd-White House strategy: the bill makes no sense. Continue reading “Financial Reform: Will We Even Have A Debate?” →

The Brown Amendment: Do the Volcker Rules Live?

The administration may be distancing itself from the Volcker Rules, but the same is not true of all Senators. (Why did President Obama go to the trouble of endorsing Mr. Volcker’s approach to limiting risk and size in the banking system, if his key implementers – led by Treasury Secretary Tim Geithner – were going to back down so quickly?)

Among a number of sensible amendments under development in the Senate, Senator Sherrod Brown (D., OH) proposes the following language: (update: text now attached)

“LIMIT ON LIABILITIES FOR BANK HOLDING COMPANIES AND FINANCIAL COMPANIES.—No bank holding company may possess non-deposit liabilities exceeding 3 percent of the annual gross domestic product of the United States.”

And a few paragraphs later, an essential point is made clear: this includes derivatives,

“OFF-BALANCE-SHEET LIABILITIES.—The computation of the limit established under subsection (a) shall take into account off-balance-sheet liabilities.”

And there is a strong provision for requiring prompt corrective action if any bank exceeds this hard size cap.

Naturally, the Federal Reserve is pushing back. Continue reading “The Brown Amendment: Do the Volcker Rules Live?” →

The Administration Starts to Fight On Banking, But For What?

By Simon Johnson

Speaking to the American Enterprise Institute, Treasury Secretary Tim Geithner had some good lines yesterday,

“The magnitude of the financial shock [in fall 2008] was in some ways greater than that which caused the Great Depression. The damage has been catastrophic, causing more damage to the livelihoods and economic security of Americans and, in particular, the middle class, than any financial crisis in three generations.”

Like Ben Bernanke, Mr. Geithner also finally grasps at least the broad contours of the doom loop,

“For three decades, the American financial system produced a significant financial crisis every three to five years. Each major financial shock forced policy actions mostly by the Fed to lower interest rates and to provide liquidity to contain the resulting damage. The apparent success of those actions in limiting the depth and duration of recessions led to greater confidence and greater risk taking. “

But then he falters. Continue reading “The Administration Starts to Fight On Banking, But For What?” →