Author: Simon Johnson

A Dangerous Idea In The Deficit-Reduction Supercommittee

By Simon Johnson

Can tax cuts “pay for themselves” – inducing so much additional economic growth that government revenue actually increases, rather than decreases? The evidence clearly says no.

Nevertheless, a version of this idea, under the guise of “dynamic scoring,” has apparently surfaced in the supercommittee charged with deficit reduction – the joint congressional committee with 12 members. Dynamic scoring sounds technical or perhaps even scientific, but here the argument means simply that any pro-growth effect of tax cuts should be stressed when assessing potential policy changes (e.g., reforming the tax code). For anyone seriously concerned with fiscal responsibility, this is a dangerous notion. Continue reading “A Dangerous Idea In The Deficit-Reduction Supercommittee” →

Too Big To Fail Under Dodd-Frank

By Simon Johnson. This post comprises the first three paragraphs of my latest Bloomberg column; you can read the full column there.

Here we go again. Major shocks potentially threaten the solvency of some of the world’s largest financial institutions. Concerns grow over the ability of European leaders to shore up their banks, which are reeling from a sovereign-debt crisis. In the U.S., the shares of some large banks are trading at less than book value, while creditor confidence crumbles.

Private conversations among economists, regulators and fund managers turn naturally to so-called resolution powers — the expanded ability to take over and wind down private financial companies granted to federal regulators by the Dodd-Frank financial reform law. The proponents of these powers, including Tim Geithner and Henry Paulson, the current and former U.S. Treasury secretaries, argue that the absence of such authority in the fall of 2008 contributed to the financial panic. According to this line of thought, if only the Federal Deposit Insurance Corp. had the power to manage the orderly liquidation of big banks and nonbank financial companies, the government could have decided which creditors to protect and on what basis. This would have helped restore confidence, it is argued.

Instead, the government was forced to rely on the bankruptcy process, as in the case of Lehman Brothers Holdings Inc., or complete bailouts for all creditors, as in the case of American International Group. The FDIC already has limited resolution authority, which functioned well over many years for small and medium-sized banks.

To read the rest of this column, please click on this link to Bloomberg: http://www.bloomberg.com/news/2011-10-10/too-big-to-fail-not-fixed-despite-dodd-frank-commentary-by-simon-johnson.html

The 4 Trillion Euro Fantasy

By Peter Boone and Simon Johnson

Some officials and former officials are taking the view that a large fund of financial support for troubled eurozone nations could be decisive in stabilizing the situation. The headline numbers discussed are up to 2-4 trillion euros – a large amount of money, given that German GDP is only 2.5 trillion euros and the entire eurozone GDP is around 9 trillion euros.

There are some practical difficulties, including the fact that the European Financial Stability Fund (EFSF) as currently designed has only around 240 billion euros available (although this falls if more countries lose their AAA status in the euro area) and the International Monetary Fund – the only ready money at the global level – would be more than stretched to go “all in” at 300 billion euros. Never mind, say the optimists – we’ll get some “equity” from the EFSF and then “leverage up” by borrowing from the European Central Bank.

Such a scheme, if it could get political approval, would buy time – in the sense that it would hold down interest rates on Italian government debt relative to their current trajectory. But leaving aside the question of whether the ECB – and the Germans – would ever agree to provide this kind of leverage and ignoring legitimate concerns about the potential impact on inflationary expectations of such measures, could a, for example, 4 trillion euro package really stabilize the situation? Continue reading “The 4 Trillion Euro Fantasy” →

What Would It Take To Save Europe?

By Simon Johnson

Last weekend official Washington was gripped by euphoria, at least briefly, as people attending the IMF annual meetings began to talk about how much money it would take to stabilize the situation in Europe. At least one eminence grise suggested that 1.5 trillion euros should do the trick, while others were more inclined to err on the side of caution – 4 trillion euros was the highest estimate I heard.

This is a lot of money: Germany’s annual Gross Domestic Product (GDP) is only about 2.5 trillion euros, and the combined GDP of the entire eurozone is about 9.5 trillion euros. The idea is that providing a massive package of financial support would “awe” the markets “into submission” – meaning that people would stop selling their holdings of Italian or Spanish debt and thus stop pushing up interest rates. Ideally, investors would also give Greece and Portugal some time to find their way to back to growth.

But this is the wrong way to think about the problem. The issue is not money in the form of external financial support – provided by the IMF or other countries to parts of the European Union. The real questions are: will Italy get complete and unfettered access to the European Central Bank, and when will we know this? Continue reading “What Would It Take To Save Europe?” →

Anti-American Bankers

By Simon Johnson. An edited version of this short post appeared today on the NYT.com’s Room for Debate: “Are Global Banking Rules Anti-American?”

Jamie Dimon claims that the new rules on bank capital “anti-American” because they somehow discriminate against American banks and American bankers. This framing of the issues is misleading at best.

The term “bank capital” is often poorly explained in the debate on this issue. It is just a synonym for equity – meaning the amount of a bank’s activities that are financed with shareholder equity, rather than debt. The advantage of equity is that it is “loss absorbing,” meaning that it takes losses and must be wiped out in full before any losses fall on creditors.

More capital means that a bank is safer, both from the perspective of shareholders and for creditors. Bankruptcy has become less likely. Continue reading “Anti-American Bankers” →

Will The IMF Save The World?

By Simon Johnson

The finance ministers and central bank governors of the world gathered this weekend in Washington for the annual meeting of countries that are shareholders in the International Monetary Fund. As financial turmoil continues unabated around the world and with the IMF’s newly lowered growth forecasts to concentrate the mind, perhaps this is a good time for the Fund – or someone – to save the world.

There are three problems with this way of thinking. The world does not really need saving, at least in a short-term macroeconomic sense. If the problems do escalate, the IMF does not have enough money to make a difference. And the big dangers are primarily European — the European Union and key eurozone members have to work out some difficult political issues and their delays are hurting the global economy. But, as this weekend’s discussions illustrate, there is very little that anyone can do to push them in the right direction. Continue reading “Will The IMF Save The World?” →

What Next For Greece And For Europe?

By Peter Boone and Simon Johnson

Uncertainty about potential loan losses in Europe continues to roil markets around the world. For many investors, taxpayers, and ordinary citizens there is no clarity on the exact current situation – let alone a stable view about what could happen next. What should any friends of Europe — the US, G20, IMF, perhaps even China — strongly suggest that they do?

A good start would involve being honest on four points. There is nothing pleasant about the truth in such crisis situations, but continued denial increasingly becomes dangerous to all involved.

Greece is on the front burner. Currently on offer is a debt swap for private sector lenders that, once it goes through, will effectively guarantee 33 cents for every 1 euro in bonds that they currently hold. The downside protection here is attractive to banks – made possible by the fact they will now get hard collateral in the restructured deal (meaning that Greece buys the bonds of safe EU countries, like Germany, and holds these where creditors could get at them).

The first brutal truth is that this is a default by Greece and all attempts to deny this or use another word just muddy the waters. Continue reading “What Next For Greece And For Europe?” →

You Get What You Pay For

By Simon Johnson

Standard & Poor’s downgrade of United States government debt last month has been much debated, but not enough attention has been devoted to the fact, reported last week by Bloomberg News, that it continues to rate securities based on subprime mortgages as AAA.

In short, S.&P. is suggesting that these mortgages are more creditworthy than the United States government – a striking proposition. Leave aside for a moment that S.&P. made a big mistake in its analysis of the federal budget (as explained by James Kwak recently in this blog). Just focus on all the things that can go wrong with subprime mortgages – housing prices can fall, people can lose jobs, the economy may fall into recession and so on.

Now weigh those risks against the possibility that the United States government will default. As we learned this summer, that is not a zero-probability event – but it would take either an act of Congress, in the sense of passing legislation, or a determination by members of Congress that they could not act. S.&P. finds this more likely to happen than some subprime mortgages going bad. Continue reading “You Get What You Pay For” →

Three Questions For The Financial Stability Oversight Council

By Simon Johnson

The Dodd-Frank financial reform legislation of 2010 created a Financial Stability Oversight Council (FSOC), with the task of taking an integrated view of risks in and around the U.S. financial sector. The FSOC is comprised of all leading regulators and other responsible officials, chaired by the Treasury Secretary. So far, it has done little – fitting with the predominant official view being that in the post-crisis recovery phase, financial risks in the U.S. were generally receding rather than building up.

But this summer has established three important and related issues on which FSOC needs rule quickly. These are: impending bank mergers that could create two more “too big to fail” banks; whether to force the break-up of Bank of America; and how to rethink capital requirements for large systemically important banks, particularly as the continuing European sovereign debt problems undermine the credibility of the international Basel Committee approach to bank capital. Continue reading “Three Questions For The Financial Stability Oversight Council” →

Is This A Second Great Depression – Or Could It Become Something Worse?

By Simon Johnson

With the US and European economies having slowed markedly according to the latest data, and with global growth continuing to disappoint, a reasonable question increasingly arises: Are we in another Great Depression?

The easy answer is “no” – the main features of the Great Depression have not yet manifest themselves and still seem unlikely. But it is increasingly likely that we will find ourselves in the midst of something nearly as traumatic, a long slump of the kind seen with some regularity in the nineteenth century, particularly if presidential election-year politics continue to head in dangerous direction.

The Great Depression had three main characteristics, seen in the United States and most other countries that were severely affected. None of these have been part of our collective experience since 2007. Continue reading “Is This A Second Great Depression – Or Could It Become Something Worse?” →

Should We Expect Another Round Of Bailouts?

By Simon Johnson

In the wake of recent equity market declines, the clamor for bailouts of various kinds grows ever louder around the world. Influential voices call for “leadership” from the US and Western Europe, and for policymakers in those countries to “get ahead of the curve”. This is all code for a simple and familiar plea: Do something that will protect investors, particularly creditors who have lent a lot of money to banks and countries that now appear to be in serious difficulty.

But providing another round of unconditional creditor bailouts in this situation would be a mistake. What we need is a combination of transparent losses where bad loans were made, combined with a ring fencing approach that protects sound governments and firms. There is no sign yet that policymakers are willing to make that distinction clear.

The situation around the world is undeniably bad. As Peter Boone and I argued in a Peterson Institute policy paper released a couple of weeks ago, Europe is most definitely “On the Brink” of a serious economic crisis that could involve widespread defaults or significant inflation or both. At the same time, Bank of America shares this week fell to their lowest in 2 years; with other large banks under pressure, there is a legitimate fear of rerunning the parts of the financial crisis of 2008-09. Continue reading “Should We Expect Another Round Of Bailouts?” →

Would A Balanced Budget Amendment Make Sense?

By Simon Johnson

Some House and Senate Republicans have worked hard to ensure that a “balanced budget” constitutional amendment be included in the mix of policies under consideration to address longer-run fiscal issues in the United States. Such an amendment is presented as way to keep spending and deficits under control, by requiring that federal spending not exceed revenues.

But there are three main problems with this potential approach as it is currently articulated.

The first issue, which has been forcefully identified by Bruce Bartlett, is that there is no way to make this amendment work in practice. The language currently proposed would, as part of the “balance”, limit federal government spending to 18 percent of Gross Domestic Product (GDP), subject only to a potential override by a 2/3 majority in both houses of Congress. On the table, in effect, is a balanced budget amendment with a spending cap. Continue reading “Would A Balanced Budget Amendment Make Sense?” →

Who Is In Worse Shape – the United States or Europe?

By Simon Johnson

If economic performance is in part a beauty pageant, as John Maynard Keynes suggested, both the U.S. and Europe seem to be competing hard this summer for last place. If anything, based on the latest flow of news coverage, Europe might seem to be experiencing something of a resurgence – last week the eurozone agreed on a big deal involving mutual support and limiting the fallout from Greece’s debt problems. In contrast, the U.S. this week seems to be completely mired in a political stalemate that becomes more complex and confused at every turn.

But rhetoric masks the reality on both sides of the Atlantic. The eurozone still faces an immediate crisis – the can was kicked down the road last week, but not far. The United States, on the other hand, is in much better shape over the next decade than you might think listening to politicians of any stripe. The American problems loom in the decades that follow 2021 – the good news is that there is still plenty of time to sort these out; the bad news is that almost no one is currently talking about the real issues.

In a policy paper released by the Peterson Institute for International Economics last Thursday, Peter Boone and I went through the details on the eurozone crisis, including how this common currency area got itself into such deep trouble – and what exactly are the likely scenarios now (you can also see the discussion and contrasting views at the launch here). Continue reading “Who Is In Worse Shape – the United States or Europe?” →

Could Tax Reform Help Make the Financial System Safer?

By Simon Johnson. My written testimony to the joint hearing of the House Ways and Means Committee with the Senate Finance Committee is here.

In the deafening cacophony of Washington-based voices on the debt ceiling, it is easy to miss a potentially more significant development. There is growing bipartisan interest in tax reform, including changing the corporate tax system to make it more sensible – and a bulwark against financial sector instability.

The House Ways and Means Committee and Senate Finance Committee held a joint hearing last week – apparently the first time these two committees have met in this fashion to discuss tax in over 70 years. The theme of the hearing might sound a little dry, “Tax Reform and the Tax Treatment of Debt and Equity,” but in fact it was well-designed to carve out some space for future agreement across the political spectrum.

The basic premise of the hearing was the question: Did the tax code contribute to the severity of the financial crisis in 2008-09? At one level the answer is simple: Yes, because the tax deductibility of interest payments encourages families to take out bigger mortgages and companies to borrow more relative to their equity capital (as dividend payments to stock owners are not tax deductible). But where within the tax code should we focus attention, if the goal is preventing similar crises in the future? Continue reading “Could Tax Reform Help Make the Financial System Safer?” →

Should We Blame Bank Examiners For Slow Job Growth?

By Simon Johnson. My written testimony to House Financial Services, Subcommittee on Financial Institutions and Consumer Credit is here.

With unemployment back up to 9.2 percent, in the numbers that came out last week, the hunt is on for an explanation of why job creation has been so slow since the financial crisis of 2008. Some House Republicans think they have found a specific culprit: bank examiners.

In the view of Representative Bill Posey (R.) and a number of his colleagues on the House Financial Services Committee, bank examiners are clamping down on otherwise perfectly healthy banks – and forcing them to inappropriately classify some loans as “nonaccrual” (meaning less likely to be paid back). Mr. Posey has therefore introduced a bill that would direct examiners to regard all loans as accrual, as long as payments are still being made – and a hearing was held last Friday to discuss the merits of the matter.

I testified at the hearing and was not supportive of Mr. Posey’s legislation. On the subsequent panel of witnesses, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) testified – as the relevant regulators – and they were even more forcefully against the proposal. Continue reading “Should We Blame Bank Examiners For Slow Job Growth?” →