Author: Simon Johnson

Peter Fox-Penner Replies

On October 24, we published a guest post, “Patchwork Fixes, Conflicting Motives, And Other Things To Avoid: Some Lessons From the Regulated Non-Financial Sectors,” by Peter Fox-Penner.  Below is his response to some of your more than 200 comments.

As a stuck-in-the-last-century guy, I’m remiss in not replying to the many comments to my guest post. As an I-O (industrial organization) economist, I learned a lot more than I contributed reading the many colloquies.  Here are just a few general observations stimulated by the discussion:

To start off, there seems to be agreement on the difficulty of measuring risk, either because there is no transparency and/or the instruments are so darn complex.  Incidentally, the best short piece I’ve ever read on the emerging science of systemic risk measurement is Andrew Lo’s Senate testimony; perhaps all of you have other good pieces.  The one thing I learned from Andrew’s piece is that we are a long way from knowing how to do it. Continue reading “Peter Fox-Penner Replies” →

Ackermann vs. Hoenig: Take It To The WTO

Josef Ackermann, chief executive of Deutsche Bank and chairman of the Institute of International Finance (an influential group, reflecting the interests of global finance in Washington) is opposed to breaking up big banks.  According to the FT, he said,

“The idea that we could run modern, sophisticated, prosperous economies with a population of mid-sized savings banks is totally misguided.”

This is clever rhetoric – aiming to portray proponents of reform as populists with no notion of how a modern economy operates.  But the problem is that some leading voices for breaking up banks come from people who are far from being populists, such as the UK authorities (in the news today) and the US’s Thomas Hoenig. Continue reading “Ackermann vs. Hoenig: Take It To The WTO” →

Britain To Break Up Biggest Banks

The WSJ reports (on-line): “The U.K.’s top treasury official Sunday said the government is starting a process to rebuild the country’s banking system, likely pressing major divestments from institutions and trying to attract new retail banks to the market.”  The British style is typically understated and policymakers always like to play down radical departures, but this is huge news. Continue reading “Britain To Break Up Biggest Banks” →

Baseline Scenario, October 30, 2009

Yesterday morning I testified to a Joint Economic Committee of Congress hearing (update: that link may be fragile; here’s the JEC general page).  The session discussed the latest GDP numbers, the impact of the fiscal stimulus earlier this year, and whether we need further fiscal expansion of any kind.

I argued that a global recovery is underway and in the rest of the world will likely be stronger than the current official or private consensus forecast, but growth remains fragile in the United States because of problems in our financial sector.  While our situation today is quite different in key regards from that of Japan in the 1990s, the Japanese experience strongly suggests that fiscal stimulus is not an effective substitute for confronting financial sector problems head on (e.g., lack of capital, distorted incentives, skewed power structure). 

We are well into the adjustment process needed to bring us back to living within our means. Although such a process always involves an initial fall in real incomes, growth can resume quickly as the real exchange depreciates.  The idea that we necessarily are in a “new  normal” scenario with lower productivity growth seems far fetched, but continuing failure to deal effectively with the “too big to fail” banking syndrome delays and distorts our adjustment process – it also makes us horribly vulnerable to further collapses.

The fiscal stimulus enacted in early 2009 had a major positive impact, particularly as it was coordinated with other industrial countries – this prevented the global recession from being even deeper (disclosure: I testified to the need for a major fiscal stimulus in October 2008).  But a further broad stimulus at this time is not warranted and the first-time homebuyers tax credit should be phased out.  We should extend unemployment insurance and focus our future efforts on improving the skills of people with less education, e.g., through strengthening community colleges. 

Like all industrialized countries, we also need to look ahead to “fiscal consolidation” in order to stabilize our debt-GDP levels (and pay for the rising cost of Medicare).  The large contingent government liabilities implied by the existence – and potential collapse – of big banks are a major risk to medium-term outcomes.

My written testimony (with some small updates indicated) is below (pdf version).  This is now our revised Baseline Scenario. Continue reading “Baseline Scenario, October 30, 2009” →

Does Ben Bernanke Have The Facts Right On Banking?

Ben Bernanke, chairman of the Federal Reserve, has stayed carefully on the sidelines while a major argument has broken out among and around senior policymaking circles: Should our biggest banks be broken up, or can they be safely re-regulated into permanently good behavior? (See the recent competing answers from WSJ, FT, and the New Republic).

But the issues are too pressing and the stakes are too high for key economic policymakers to remain silent or not have an opinion.  On Cape Cod last Friday, Mr. Bernanke appeared to lean towards the banking industry status quo, arguing that regulation would allow us to keep the benefits of large complex financial institutions. Continue reading “Does Ben Bernanke Have The Facts Right On Banking?” →

Naming Systemically Dangerous Firms

This guest post was submitted by David Moss, professor at Harvard Business School, author of When All Else Fails: Government As The Ultimate Risk Manager, and founder of the Tobin Project.

 As currently drafted, the Financial Stability Improvement Act of 2009 (released by the House Financial Services Committee on 10/27/09) contains several important elements for reducing systemic risk.  It aims (1) to identify systemically dangerous financial firms, (2) to apply heightened regulation to these firms, (3) to establish a stabilization system to prevent or quell panic during periods of systemic distress, and (4) to create a resolution mechanism that would wind down complex financial firms when necessary.  These could represent very important steps forward.

Unfortunately, these reforms may ultimately be undermined by one very significant weakness – the explicit requirement in the bill that the identification of systemically dangerous financial firms by federal regulators remain entirely secret, and never be revealed to the public.  This is the bill’s Achilles heel.  Continue reading “Naming Systemically Dangerous Firms” →

Patchwork Fixes, Conflicting Motives, And Other Things To Avoid: Some Lessons From the Regulated Non-Financial Sectors

This guest post was submitted by Peter Fox-Penner, a leading expert on regulation at The Brattle Group.  The views expressed here are those of the author alone.

Improving the regulation of the financial sector is a prime topic of conversation amongst financial economists, and appropriately so.  Most agree that massive failures of financial regulation were one, if not perhaps the largest, cause of the 2008 meltdown.     

When the conversation turns to the specifics of what needs to be regulated, how regulation should work, and what agencies should be involved, the range of views is tremendous.  There is agreement that some kind of prudent regulation is needed, as is investor and consumer protection, but that’s about it.  Fueled by billions of dollars of lobbying and purchased research, everyone has their own idea.  One super-regulator?  Council of regulators?  Control bankers compensation schemes?  Exchange-trade them?  The cacophony is deafening. 

As an industrial organization economist, I think this discussion would benefit greatly from a consensus on the role and goals of financial regulation.  Paul Joskow, a dean in the IO economics community, recently noted that:

Continue reading “Patchwork Fixes, Conflicting Motives, And Other Things To Avoid: Some Lessons From the Regulated Non-Financial Sectors” →

Dan Tarullo Gets New Talking Points

On Wednesday, Dan Tarullo, a governor of the Federal Reserve and distinguished law school professor, dismissed breaking up big banks as “more a provocative idea than a proposal” and instead put almost all his eggs in the “creation by Congress of a special resolution procedure for systemically important financial firms”.  He stressed: “We are hopeful that Congress will, in its legislative response to the crisis, include a resolution mechanism and an extension of regulation to all systemically important financial institutions” (full speech).

This put him strikingly at odds with Mervyn King, governor of the Bank of England, who said Tuesday night, quite bluntly,

 “There are those who claim that such proposals [involving breaking up the largest banks] are impractical. It is hard to see why. Existing prudential regulation makes distinctions between different types of banking activities when determining capital requirements. What does seem impractical, however, are the current arrangements. Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly. But that is where we now are.” Continue reading “Dan Tarullo Gets New Talking Points” →

Big Banks Fail

In the Wall Street Journal on Tuesday morning, Charles Calomiris, a leading banking expert, published an op ed entitled “In the World of Banks, Bigger can be Better.”  It begins,

“Legitimate concern about the risks to taxpayers and the economy posed by banks that are “too-big-to-fail” has prompted some observers, among them Simon Johnson, former chief economist of the International Monetary Fund, to favor draconian limits on financial institution size. This is misguided. There are sizable gains from retaining large, complex, global financial institutions—and other ways to credibly protect taxpayers from the cost of government bailouts.”

And the article goes on to make the detailed case for keeping intact our largest banks – in contrast to the recently expressed views of two former Federal Reserve chairs (Paul Volcker, Alan Greenspan) and – late Tuesday – the current governor of the Bank of England (Mervyn King), who are calling for these banks to be broken up in some fashion. Continue reading “Big Banks Fail” →

The Consensus On Big Banks Begins To Move

Just when our biggest banks thought they were out of the woods and into the money, the official consensus in their favor begins to crack. The Obama administration’s publicly stated view – from the highest level in the White House – remains that the banks cannot or should not be broken up.  Their argument is that the big banks can be regulated into permanently low risk behavior.

In contrast, in an interview reported in the NYT this morning, Paul Volcker argues that attempts to regulate these banks will fail:

“The only viable solution, in the Volcker view, is to break up the giants. JPMorgan Chase would have to give up the trading operations acquired from Bear Stearns. Bank of America and Merrill Lynch would go back to being separate companies. Goldman Sachs could no longer be a bank holding company.”

Volcker may not have the ear of the President (as the NYT points out), and Alan Greenspan – also arguing for bank breakup, but along different lines – might also be ignored.  But watch Mervyn King closely. Continue reading “The Consensus On Big Banks Begins To Move” →

Why Is The Chamber Of Commerce Defending Big Banks?

On Warren Olney’s radio show To The Point yesterday, I had a chance to talk with US Chamber of Commerce management directly regarding the issue posed here last week: Why would an organization representing 3 million small businesses come out in support of our largest banks?  My question was picked up and focused by the host.

Warren Olney (at the 36:35 mark): “Mr. Hirschmann, back to you.  Are you serving the interests of your own members, if you resist the idea of breaking up the big banks?”

David Hirschmann (leading the Chamber’s financial lobbying efforts): “I just don’t think the question is whether we need to break up the big banks.  The question is how do we ensure that the kinds of practices that they engaged in — and others outside the banking system — don’t happen any more.  Which is why we pointed to transparency in areas like derivatives and leverage.” [my transcription]

Mr. Hirschmann then goes on to talk about the consumer protection agency (he’s opposed).

The conflict between the Chamber’s principles and its actions becomes increasingly clear. Continue reading “Why Is The Chamber Of Commerce Defending Big Banks?” →

Who is Carlos Slim?

The US increasingly displays characteristics that we have seen many times in middle-income “emerging markets” – new dimensions of vast inequality, forms of financial instability that benefit the best connected, and consistently easy credit for the privileged.  But this raises the question: who exactly is going to dominate our economic and political landscape moving forward?

In most emerging markets, a major crisis means that some powerful people and their firms fall from grace.  After the Asian Financial Crisis (1997-98), some of the biggest Korean chaebol disappeared or broke up, numerous Thai bankers lost their top positions, and there was a discreet reshuffle among the Malaysian business elite.  Russian oligarchs rise and fall with the price of oil; the process in Ukraine is similar, although somewhat murkier.

With every sharp turn of the cycle, new people rise to the front – taking advantage of low asset prices and the fact that most people struggle to borrow on reasonable terms.  In Mexico, after the crisis of 1994-95, Carlos Slim consolidated his position in telecoms and used this as a launching pad to become one of the world’s richest people.

Three sets of players look positioned to do the same in the US today, mostly based on the amazing set of “carry trades” available if you have access to large amounts of cheap short-term funding (e.g., along the yield curve, from dollars into other currencies, and – arguably – into equity in some parts of the world). Continue reading “Who is Carlos Slim?” →

The Chamber of Commerce Has It Backwards

The US Chamber of Commerce is opposing the administration’s proposed Consumer Financial Protection Agency, on the grounds that it would hurt small business.  Their argument is that this agency will extend the dead hand of government into every small business.

For the Chamber of Commerce, government is the enemy of small business and should always and everywhere be fought to a standstill.  Chamber Senior Vice President (and former Fred Thompson campaign manager) Tom Collamore sees this as “advocacy on behalf of small businesses, job creators, and entrepreneurs” (quoted in the WSJ link above), and the Chamber has launched the “American Free Enterprise” campaign.

Somewhere, the Chamber’s senior leadership missed the plot.  What brought on the greatest financial crisis since the 1930s?  What has hurt, directly and indirectly, small business of all kinds to an unprecedented degree over the past 12 months?  What is killing small and medium-sized banks at a rate not seen in nearly 80 years?

It’s the behavior of the financial sector, particularly big banks and their close allies – by consistently mistreating consumers.  And the letter and spirit of the regulatory regime let them get away with it. Continue reading “The Chamber of Commerce Has It Backwards” →

Diana Farrell And The White House Theory Of Bank Size

On Friday morning, Diana Farrell – a senior White House official – made a significant statement on NPR’s Morning Edition, with regard to whether our largest banks are too big and should be broken up.

 “Ms. DIANA FARRELL (Deputy Assistant for Economy Policy): We understand Simon Johnson’s views on this, and I guess the response is the following….  

 “Ms. FARRELL: We have created them [our biggest banks], and we’re sort of past that point, and I think that in some sense, the genie’s out of the bottle and what we need to do is to manage them and to oversee them, as opposed to hark back to a time that we’re unlikely to ever come back to or want to come back to.” (full transcript)

Ms. Farrell is Larry Summers’s deputy on the National Economic Council and the former director of McKinsey Global Institute, and she has a strong background on banking issues – based on extensive professional experience with global financial institutions.

Her statement contains three remarkable points. Continue reading “Diana Farrell And The White House Theory Of Bank Size” →

Tonight On Bill Moyers Journal, This Morning On NPR, And Louis Brandeis

On PBS this evening (first airs at 9pm eastern; on the web from about 10pm), Bill Moyers, Rep. Marcy Kaptur, and I discuss where we stand – and what we’ve learned – a year after the US financial system almost collapsed.

There’s a detailed preview on Bill’s website – our conversation moved back-and-forth between people losing their homes in Ohio, how bank behavior brought us to this point, and where we go from here. 

We also discussed the latest revelations that, at the height of the crisis earlier this year, Treasury Secretary Tim Geithner spoke primarily to a very small group of top bankers (at Citi, Goldman, and JP Morgan).  Further implications are taken up in my Daily Beast column this morning.

Also today, coincidently, on NPR’s morning edition (about 21 minutes into the first hour; will be on-line around 9am), Alex Blumberg, Charles Calomiris, and I role play whether the administration’s reform proposals are “Jamie Dimon-proof”, meaning that Too Big To Fail will really be brought under control.  I’m Jamie Dimon, Charles is Charles, and Alex is the President.  It doesn’t go well for the taxpayer.

On behalf of the administration, Diana Farrell (Larry Summers’s deputy at the National Economic Council, NEC) responds by saying effectively: “big has its benefits”, and the best we can hope for is to regulate our massive banks.  As I said in my NYT Economix column yesterday (reproduced after the jump here), I take the position of Louis Brandeis on this one: our biggest banks have simply become Too Big To Regulate.

The NPR story didn’t get into the tragic human dimensions of the crisis, but Rep. Kaptur was forceful on this point during the Moyers conversation.  In part, this strengthens the case for a consumer protection agency focused on financial products – a point on which we agree with Ms. Farrell and her colleagues. 

But, hopefully, senior staff at the NEC will have a chance to review the Moyers segment (it only takes 30 minutes or so) and reflect on whether big banks are really ever so beneficial when they make, facilitate, and now refuse to renegotiate loans that have ruined so many lives. 

Continue reading “Tonight On Bill Moyers Journal, This Morning On NPR, And Louis Brandeis” →