Author: Simon Johnson

Protect Consumers, Raise Capital, And Jam The Revolving Wall St-Washington Door

Ben Bernanke has a great opportunity to lead the reform of our financial system.  His standing in Washington and on Wall Street is at an all-time high, as a result of his bailout/rescue efforts.  He is about to be reappointed with acclaim for a second term as chairman of the Federal Reserve’s Board of Governors.  And he has a lot to answer for.

Look, for example, at his speech of May 17, 2007, which discusses some of the problems in the subprime market and contains the memorable line: “Importantly, we see no serious broader spillover to banks or thift institutions from problems in the subprime market; the troubled lenders, for the most part, have not been institutions with federally insured deposits” (full speech; marks in the margin are from an anonymous and careful correspondent.) Continue reading “Protect Consumers, Raise Capital, And Jam The Revolving Wall St-Washington Door” →

Why Didn’t The Major Bank CEOs Show Up On Monday?

Speaking on Wall Street at noon Monday, President Obama laid blame for the crisis and recession of 2008-09 squarely at the feet of the financial sector.  The diagnosis was sound but the rest of his speech was disappointing – the administration’s draft regulatory reforms look lame, banks are fully mobilized against the only proposal with any teeth (a consumer protection agency for financial products), and the President’s call to “please don’t do it again” surely fell on deaf ears.

In fact, were any of the most relevant ears even listening?  The real news from Monday was not the substance of the speech or the stony silence of the financial elite in the audience, but rather that not a single chief executive officer (CEO) of a major bank was in attendance. Continue reading “Why Didn’t The Major Bank CEOs Show Up On Monday?” →

Obama And Brandeis

President Obama’s speech yesterday was disappointing.  As a diagnosis of the problems that let us into financial crisis, it was his clearest and best effort so far.  He didn’t say it was a rare accident for which no one is to blame; rather he placed the blame squarely on the structure, incentives, and actions of Wall Street.

But then he said: our regulatory reforms will fix that.  This is hard to believe.  And even the President seems to have his doubts, because he added a plea that – in the meantime – the financial sector should behave better.

The audience was comprised of our financial elite, but the Wall Street Journal reports “not one CEO from a top U.S. bank was in attendance” (p.A4).  How’s that for demonstrating respect, gratitude, and a willingness to behave better? Continue reading “Obama And Brandeis” →

Where Are We Again? (Pre-G20 Pittsburgh summit)

This revision to our Baseline Scenario is required reading for my Global Entrepreneurship Lab (GLAB) class at MIT this week.  For those classes, please also look at these updated slides.

Financial markets have stabilized – people believe that the US and West European governments will not allow big financial institutions to fail.  We have effectively nationalized any banking system losses, but we’ll let bank executives enjoy the full benefits of the upside.  How much shareholders participate remains to be seen; there will be no effective reining in of insider compensation (my version; Joe Nocera’s view).  Small and medium-sized banks, however, will continue to fail as problems in commercial real estate continue to mount.

The economic recovery, in the short-term, may be surprisingly strong in terms of headline numbers; this is a standard feature of emerging markets after a crisis (e.g., Russia from 1998 or Argentina after 2002).  Official short-term forecasts are probably now too low, as the IMF and other organizations make the case for continued fiscal stimulus and very loose monetary policy. Continue reading “Where Are We Again? (Pre-G20 Pittsburgh summit)” →

Economic Donkeys

Early in the First World War, British generals decided to attack German trenches with an initial light bombardment, followed by infantry walking in close order across No Man’s Land.  The result was tens of thousands killed in a series of military disasters, but the generals reacted with only small adjustments to their approach and essentially persisted in repeating the same mistakes for years.  “The English soldiers fight like lions,” one German general remarked. “True.  But don’t we know that they are lions led by donkeys?” was the reply.

Today, a year after global financial collapse and the ensuing tragedy for millions, our economic leaders are lining us up to suffer again (and again) through the same horrible experiences. Continue reading “Economic Donkeys” →

Lessons Learned and Soon Forgotten

One year after the collapse of Lehman, the controversial “rescue” of AIG, and the ensuing collapse of world financial markets there are two questions: what have we learned, and what good will it do us?

The second question is essential, because we have learned so much about the functioning of our financial system – and the three main lessons are all rather scary.

First, our financial system has become dangerous on a massive scale.  We knew that the banks were playing games, e.g., with their so-called off-balance sheet activities, but we previously had no idea that these huge corporations were so badly run or so close to potential collapse.

Continue reading “Lessons Learned and Soon Forgotten” →

The Crisis Next Time: Role Of The Fed

The Federal Reserve is taking a victory lap (e.g., Ben Bernanke at Brookings, next Tuesday morning; no weblink yet available), and the emerging consensus is that its leadership has done a great job over the past 12 months.  But we should also take this opportunity to reflect on the longer run role of the Fed, both in the past decade or two and since its founding. 

Over on The New Republic website (and in the lastest hard copy), Peter Boone and I suggest that in the absence of effective financial regulation – i.e., both during the 1920s and again since 1990 – the Fed has operated in a manner that encourages the formation of sequential bubbles.  This destabilization of our financial system is not a minor matter; the damage caused – human, financial, social – is already enormous. 

And we are very far from being done. 

Don’t take my word for it. Lou Jiwei, the chairman of China’s sovereign wealth fund said recently, “It will not be too bad this year. Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that. So we can’t lose.”

By Simon Johnson

G20 Summit, IMF Meeting: What To Expect?

As we wade through a long line of international economic meetings – G20 ministers of finance last week, G20 heads of government in Pittsburgh coming up, IMF-World Bank governors meeting in Istanbul early October (and all the associated “deputies” meetings, where the real work goes on) – it seems fair to ask: where is regulatory reform of our financial system heading?

Long documents have been produced and official websites have become more organized.  Statements of principle have been made.  And the melodrama of rival reform proposals has reared its head: continental Europeans for controlling pay vs. the US for raising capital vs. the UK not really wanting to do anything.  But what does all of this add up to, and what should we expect from the forthcoming summit sequence?

Nothing meaningful. Continue reading “G20 Summit, IMF Meeting: What To Expect?” →

Good Finance Gone Bad

As the Lehman anniversary approaches, defenders of the financial sector struggle into position – partly in response to your comments (also here).  They offer three main points:

  1. We need finance to make the economy work.
  2. Financial innovation delivers value, although it’s not perfect (but what is?)
  3. Don’t kill the goose that laid the golden egg.

Point #1 is correct, but this does not necessarily mean we need finance as currently organized.  The financial sector worked fine in the past, with regard to supporting innovation and sustaining growth.  Show me the evidence that changes in our financial structure over the past 30 years have helped anyone outside the financial sector. Continue reading “Good Finance Gone Bad” →

What Is Finance, Really?

At one level and in most economics textbooks, this is an easy question with a rather encouraging answer.  The financial sector connects savers and borrowers – providing “intermediation services”.  You want to save for retirement and would obviously like your savings to earn a respectable rate of return.  I have a business idea but not enough money to make it happen by myself.  So you put your money in the bank and the bank makes me a loan.  Or I issue securities – stocks and bonds – which you or your pension fund can buy. 

In this view, finance is win-win for everyone involved.  And financial flows of some kind are essential to any modern economy – at least since 1800, finance has played an important role in US economic development.

Unfortunately, two hundred years of experience with real world finance reveal that it also has at least three serious pathologies – features that can go seriously wrong and derail an economy. Continue reading “What Is Finance, Really?” →

The Nature of Modern Finance

Is modern finance more like electricity or junk food?  This is, of course, the big question of the day.

If most of finance as currently organized is a form of electricity, then we obviously cannot run our globalized economy without it.  We may worry about adverse consequences and potential network disruptions from operating this technology, but this is the cost of living in the modern world.

On the other hand, there is growing evidence that the vast majority of what happens in and around modern financial markets is much more like junk food – little nutritional value, bad for your health, and a hard habit to kick. Continue reading “The Nature of Modern Finance” →

More On The Two-Track Economy — From The WSJ And Others

The notion of a two-track economy seems to be taking hold.  We kicked the concept around pretty well last week — your 130 comments (as of this morning) helped clarify a great deal of what we know, don’t know, and need to worry about.  The two-track concept overlaps with, and builds on, long-standing issues of inequality in the U.S., but it’s also different.  Within existing income classes, some people find themselves in relatively good shape and others are completely hammered.

New dimensions of differentiation are also taking hold within occupations and within industries – the WSJ this morning has nice illustrations.  The contours of this differentiation begin to shape our recovery or, if you prefer, who recovers and who does not – it’s hard to say how this will play out in conventional aggregate statistics, but these are likely to become increasingly misleading.

For now, I would highlight three points about the two-track future for banks – partly because this matters politically, and partly of the way it impacts the rest of the process. Continue reading “More On The Two-Track Economy — From The WSJ And Others” →

Firefighter Arson And Our Macroeconomic Policymakers

Firefighter arson is a serious problem.  The U.S. Fire Administration, part of Homeland Security, concluded in 2003, “A very small percentage of otherwise trustworthy firefighters cause the very flames they are dispatched to put out” (p.1). Illustrative and shocking anecdotes are on pp. 9-15 of that report, as well as here and here.

Macroeconomic policy making now has a similar issue to confront. Continue reading “Firefighter Arson And Our Macroeconomic Policymakers” →

Chat Today About Bernanke Nomination For Reappointment (1pm Eastern)

The Washington Post is hosting an on-line chat about Ben Bernanke and his likely reappointment as chairman of the Federal Reserve Board of Governors (today, 1pm eastern: use this link to chat).  News story on President Obama’s announcement of Bernanke’s renomination this morning, with video of press conference, is here.

You can submit questions in advance or live during the chat, which will probably run until about 2pm.

By Simon Johnson

Update: here’s the transcript of the chat; a lot of very good questions.

Which Bernanke? Whose Bubble?

Ben Bernanke will be nominated for a second term as chairman of the Federal Reserve.  But which Bernanke are we getting?  There are at least three.

  1. The Bernanke who led the charge to rescue the US (and world’s) financial system after the Lehman-AIG collapse.  If you accept that the choice from late September was “Collapse or Rescue,” this Bernanke did a great job.
  2. The Bernanke who argued for keeping interest rates low as the housing bubble developed.  This Bernanke was part of the Greenspan Illusion – the Fed should ignore bubbles and “just clean up afterwards.”  Is that still Bernanke’s view?  Surely, he has learned from that experience.
  3. Then there is Bernanke-the-reformer.  Given #1 and #2 above, shouldn’t he be pushing hard for tough re-regulation of the financial system – particularly those dodgy parts where markets meet banking?  But is there any sign of such an agenda, even with regard to recently trampled consumers – let alone “too big to fail” financial institutions?

Most likely, we’re in for another bubble. Continue reading “Which Bernanke? Whose Bubble?” →