Simon Johnson: Wall Street's Stranglehold on Our Democracy Must Be Broken
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Zach Carter: Your push to break up the largest banks into smaller banks that can actually fail without wreaking havoc on the economy has been very well-received by progressives. But historically, the IMF and the Federal Reserve are not exactly hotbeds of progressive thought. How did you and Paul Volcker become the vanguard of the economic left?Simon Johnson: The ideas that we're advancing both in Baseline Scenario and in the book should appeal to people on the right, the center and the left. There's an article by Arnold Kling that we wrote about on Baseline Scenario. He's a libertarian, which I am not, but he's come around to our way of thinking about the banks. If you think about it from the right, our financial system is just monstrously unfair. It's not in any way a market economy to have these banks who are so big that the government can't let them fail. They have funding advantages over other banks, and those advantages only encourage them to get bigger. That's just not reasonable. The left—which coincides more with my own views than the right—is very uncomfortable with the power structure that is inherent in that imbalance. And the center--which I would also say characterizes my own views, I'm a center-left person—the center is very concerned about the effects of giant banks on efficiency and the interworkings of the economy. You can see the spectrum of appeal from the blurbs on our book. ZC: Sen. Jim Bunning, R-Kentucky, is a fan.
SJ: I thought we just had to include Jim Bunning, because what else would these people agree on? You can't list five other words in the entire English language that Bunning and Alan Grayson would agree on outside of financial reform.
ZC: But doesn't the broad appeal of your argument run counter to the basic idea? Your point is that Wall Street has taken over the economic ideology in
We are in the fight, at least, and we have some people on our side, but it is very, very lopsided. Did you see Chris Dodd told Don Imus that he's reading 13 Bankers? I was quite amazed by that. So we're at the table, but it's going to be an uphill battle for some time.
ZC: You've been making this argument for more than a year now, that there's no way to fix our financial system without breaking up the big banks. But watching the debate over financial reform, Congress really hasn't seriously considered the idea. Is this something we can hope to enact with this reform bill, or are you geared up for a longer fight?
SJ: It's a longer fight. There is a slim chance—maybe it's five percent, maybe it's ten percent—that in this legislative cycle, the White House will change its position. And I think after they got a pretty good final outcome on health care, all things considered, a re-energized President Obama saying, "Anybody who opposes us is on the side of the too-big-to-fail banks, and here's how we're going to make them smaller" would have a tremendous effect. That's a very powerful message, and that's what we're telling the White House.
The political side of the White House, I think, finds that very appealing. The economic side of the White House, of course, is in a very different place, which is why the odds are about 90 percent against us. But that's just in this legislative cycle, and this is not a one-cycle debate. It took 10 years for Theodore Roosevelt and the people who came after him to change the consensus around big business in the
Not that Chris Dodd will suddenly change his mind and we'll see a sudden legislative shift, but that we'll have a good chance of moving the entire mainstream thinking on this—including mainstream left and mainstream right—away from support for this oligopoly. People currently think, 'Oh my gosh, we cannot allow a monopoly on an industrial product." After a hundred years, that's a mainstream view. But what people don't get is that massive banks are incredibly dangerous, too.
I would point to J.P. Morgan Chase CEO Jamie Dimon's letter to his shareholders this week as an indication of what we're up against. He says they should be allowed to get as big as they want, and that's how the free market works. Well no, Jamie, that's not a free market. That is the result of unfair competition and an implicit government subsidy.
ZC: He also completely ignores all of the egregious things his bank did over the past decade, particularly the $30 billion subprime operation. But it does seem like there has already been some positive ideological movement. When you were pushing this idea a year ago, a lot of people viewed it as crazy. That doesn't seem to be true any more. Lots of people still disagree with you, but your views have become an acceptable part of the dialogue.
SJ: I think that's true. But you also saw the Volcker rule in January, which turns out, I admit, to be rather tepid. Nevertheless, seeing the president say, "If these guys want to have a fight, let's have a fight," was very important. And to see Treasury willing to take on the financial lobby, even the Chamber of Commerce, is noteworthy, although it's only been over consumer protection. Treasury official Neal Wolin gave a pretty good speech recently where he said, "Look, you're spending $1.5 million a day on lobbying and employing four or five lobbyists per member of Congress. This is totally unacceptable, and you're not even representing the interests of all your members."
ZC: And Wolin is a former lobbyist for the financial industry.
SJ: Yes! If you gave me the opportunity, I would hire some of those people, too. In the
ZC: The first SEC Chairman was Joe Kennedy, and he wasn't exactly a shining example of business integrity.
SJ: It takes one to know one, right?ZC: Let's talk about the revolving door, though. A lot of people from Wall Street leave to work in
SJ: Well yes, the revolving door is obviously out of control, and I didn't mean to say you should exclusively employ poachers, that doesn't go well. What you need is a very strong set of incentives and guidelines, and you need people at the top of the regulatory chain who truly believe that the bad aspects of the financial sector need to be curtailed. We haven't had that for a very long time. You saw just last week, a guy left Barney Frank's staff to become a financial lobbyist. Not to pick on that one guy, but it's a perfect illustration of how the whole culture between Wall Street and Washington is just totally out of whack.You probably need to come in with some overly draconian initial restrictions, like banning anyone from revolving through the door for a period of five years. Once the cultural perceptions about Wall Street change, you can maybe relax those rules a bit. But right now it's just so massively out of control, it really does need strong action.
ZC: I want to ask you some smaller-bore economic questions. At a certain point, there was a lot of public debate on executive compensation, which has subsequently disappeared from the reform push. What role did executive compensation play in the crisis, and do people have a right to be angry about it?
SJ: Yes, people have a right to be angry about it. I think it's a symptom of a deeper problem. I don't think you can just fix executive pay by itself, because people will find other ways to compensate themselves that get those restrictions. But a lot of pay that rewards short-term performance is undoubtedly a reflection of the dangerous incentives in our financial system.There was a very nice write-up in the Washington Post going through how people are being paid, and the executives of big banks, most notably John Stumpf, head of Wells Fargo, are getting just huge cash payouts. And those payouts are absolutely not in line with what the administration asked them to do.
I think this shows two important things. First, when you ask bankers nicely to do something, they just don't do it. Second, when Wells Fargo was pressed on why Stumpf was getting paid so much, his spokesperson said, "Well, we had a really good year in 2009." I'd say that, actually, no, you didn't have a good year, you were saved like all of the other big banks by the government. That is not a good year from a social point of view, it's not a good year if you're trying to run a bank well, and paying this much cash is completely inappropriate. It reflects how deep we are in this mess. We haven't gotten out of it.
ZC: So would you say that too-big-to-fail and excessive Wall Street pay are connected?
SJ: Yes, I would say they are two sides of the same coin. But I would caution that if you fix too-big-to-fail, I wouldn't have a problem with the compensation. Then I think it's an issue for shareholders and corporate governance that the company's owners can either take on or ignore.
If some hedge fund, for example, makes a lot of money and pays its guys a lot of money, I don't really have a problem with that, so long as they aren't creating systemic risk. I'm an entrepreneurship professor at M.I.T, I like people who take risks. What I don't like is people who play with house money, which in this case is the taxpayers' money.
ZC: Your background is with the IMF. Drawing on that experience—do financial crises of the size and scope of what we've just experienced take place without widespread fraud?
SJ: It's a good question. You never know how much fraud there is unless big banks actually collapse. You can see this around Lehman. We knew Lehman was a sharp operator, we knew Lehman was really skating along the edge in many ways, but we didn't know they were engaged in outright fraud. And in fact, even after the revelations about their Repo 105 plan to hide assets from investors, we still don't know if that behavior can be proved fraudulent in a court of law.
They certainly bent the rules massively. They certainly misrepresented things to their investors and to the market. Whether they can be held accountable for that is another question, unfortunately.
But you never really find out about fraud until the company collapses, because after that, nobody wants to do business with them anymore, and nobody wants to cover for them. Nobody thinks, "If I get tough on Lehman, they won't give me any more good trades," because Lehman is gone.This is what protects the big guys right now, the J.P. Morgans, even Citigroup, which most people on Wall Street really dislike and regard as very poorly run. Even Citi is immune from some level of criticism because there are hedge fund people and people on Wall Street who are very knowledgeable and want to do business with those companies going forward. As long as a company stays in business, the public will never know what was fraudulent and what was not.
ZC: So what's the difference between an Enron-style scandal where people go to jail and what we just lived through?
SJ: I think there are a lot of parallels. With Enron, we never found out about anything until the firm collapsed. After that, there were prosecutions. So we should wait and see how things play out. But the rules that apply to the financial sector are very loosey-goosey, and much more open to interpretation and exploitation than the rules that apply to other companies. Enron was sort of a weird hybrid that committed many financial infractions, but they weren't a bank, and they didn't have the kind of protection that you get from being a bank and being regarded as central to the credit system.
ZC: But they were involved in the derivatives market, and they did engage in accounting hijinks.
SJ: Right, although by today's standards, of course, they were small-scale and primitive.
ZC: But shouldn't that scandal have sounded an alarm somewhere? Shouldn't there have been some broader federal response after Enron?
SJ: Well, the big alarm bell was the failure of the Long-Term Capital Management hedge fund in 1998. And the extraordinary thing, which we point out in 13 Bankers, is that Brooksley Born actually rang the alarm bell before the Long-Term Capital Management crisis, and she was ignored, marginalized and attacked for it.
I think Enron was actually misconstrued, because people dismissed it, saying it was just fraud, they just failed to disclose important things to shareholders. And we did get the Sarbanes-Oxley Act out of it, and I don't think that was a bad idea. But the response did not cut to what now appears to be the heart of the problem.
ZC: You've done a very good job emphasizing the conflict between big banks and the broader economy. But there are also conflicts between the managers of companies and the shareholders who own them. How do you align those incentives to prevent executives from looting their own firms, as thousands did during the savings and loan crisis?
SJ: That's a very tough problem and it gets to the heart of our modern economy. The central problems in the economy today are these agency problems, the phenomenon in which the people who run companies are controlled only very indirectly by shareholders or anyone else. And in big, complex enterprises, its easy to hide a lot of stuff. Remember even small banks are relatively large and complex compared to other businesses.
The savings and loan crisis was very much about regulatory failure, and about regulators being encouraged to look the other way by the executive branch and by Congress. At the end of the day, though, I would emphasize that the savings and loan crisis resulted in more than 750 people going to jail and more than 2,000 institutions going out of business—all without bringing down the global economy.
You cannot expect for there to be zero fraud in a country like the
ZC:In a recent column in the New York TimesPaul Krugman argued that breaking up the big banks won't solve all of our problems, that the bank crash of the 1930s was mostly small banks, and the government made a mistake when it allowed them all to fail. Do you have a response to that?
SJ: The 1930s obviously taught us a very important lesson, particularly the need for deposit insurance. I would not want us to have small banks fail in the context where you had removed federal deposit insurance, but that's not going to happen. That's never going to happen. That aspect of a retail panic run is something people have to take away from the '30s experience.
Now, when you've prevented that, you've introduced a distortion into the system, because people now have protected sources of money, so they won't pay much attention to how the institution is governed. That means you have to have substantive regulations.
I'm not suggesting that we forbid or outlaw crises. That's impossible. But ask yourself this question. If Citigroup had failed in 2008—this is a little funny because of course they did fail, and we saved them—but in 2008, they had a total balance sheet of about $2.5 trillion. That's 17 percent or 18 percent of the
That's question number one. Question number two is, are the incentives for the banks now to become bigger or smaller? Jamie Dimon's letter to his shareholders is very clear on this. He thinks if you do well, you should be allowed to get as big as you want. That is incredibly dangerous.
Actually, Jamie Dimon may be the most dangerous person in
Every business eventually falls into the hands of somebody who doesn't know what they are doing. That is particularly true in finance, and it is particularly true at big financial institutions. So I think it's safe to say Jamie Dimon is the most dangerous man in
ZC: There is a very strong culture of hero worship in finance, not just on Wall Street but in the Federal Reserve. People view the Fed Chairman as this great golden god who descends from the clouds to speak to the monetary multitudes.
SJ: Yes, he's like the adventure hero in some King Kong movie.
ZC: At least with Alan Greenspan, and the way his reputation has changed so dramatically in the last three years, is it safe to say that this idolization is a bad thing?
SJ: This is sort of a secondary point to our main theme, but Federal Reserve reforms are very important. There should be term limits on the Fed Chairman and the Fed Governors, and you should change the Sunshine Act to the extent that it applies to the Fed. The Sunshine law says that if you have more than three Fed Governors meeting at any time, it has to be subject to public notification.
Over the past few years, Ben Bernanke, Donald Kohn, and Kevin Warsh were the inner core, and everyone else was basically ignored, and to be honest, not that important. That's a mistake. It feeds into this whole policymaker-as-hero idea which is very dangerous in a democracy.
ZC: You've mentioned Citigroup a few times. What should Robert Rubin do with all of his money?
SJ: Robert Rubin is the most interesting person and the most important character for the country to understand in this crisis. What he thought, when he thought it, why he pursued these deregulatory policies when he was at the Treasury during the 1990s, what he was doing or dreaming about when he was supposedly in charge of governance at Citi. The way he viewed the world, and the way Greenspan viewed the world, is largely responsible for what just happened. How that has changed, if at all, is very important.
ZC: I'm not a fan of his policies at Treasury, but whatever you think of them, he was one of the few people who stayed on at Citi for the entire mess.
SJ: And a figure who has slipped below the radar. But here's what he should do with his money. My kids love Colonial Williamsburg. And I think Rubin needs to take page from John D. Rockefeller here and go out and restore some historic banking place and create a living museum where people can go around and learn about and wear the clothes of people from this crazy era. I'm being a little facetious here with
ZC: But this lesson about financial crashes seems to get unlearned every few years. One of the more obnoxious things Jamie Dimon said before the Financial Crisis Inquiry Commission was that remark about how financial crises happen every five to seven years, and we should stop being surprised by it and stop trying to prevent or contain it. But why does it keep happening? Why can't people remember that markets often get out of control and crash?
SJ: Oh that's hooey; they remember. The problem is that they have incentives to do it again. The Chuck Prince quote that we all make fun of--"While the music is playing you've got to get up and dance"--is actually 100 percent correct. It totally encapsulates what is wrong with Wall Street now and what was wrong with Wall Street before. Remember, he said that in July 2007 just as the wheels were starting to come off the bus. The insanity couldn't continue forever, but everybody was getting rich by pretending it could.