Arnold Kling  

Simon Johnson on Money and Power

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He writes


Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.

But there's a deeper and more disturbing similarity: elite business interests--financiers, in the case of the U.S.--played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

Read the whole thing. Johnson is one of the two great bloggers at baseline scenario. He has other, lesser credentials, including a stint as chief economist of the International Monetary Fund.

The one complaint that I would make is that Johnson focuses on examples of deregulation that enabled the financial sector to grow. I do not think those are as important as the risk-based capital regulations themselves, which took a complacent view of AAA-rated assets. I think it is important to recognize that regulation per se was as much a part of the problem as part of the solution. Having said that, Johnson's main prescription is to reduce the power of big banks, which I think is quite right.

Read the whole thing. Did I say that already? Fine, read it twice.

UPDATE: Megan McArdle has more. She writes,


One of the similarities between the last decade and the 1920s that has not been much remarked on in the popular press is the absolute flood of foreign capital that hit Wall Street.

Read her whole post, also.


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COMMENTS (7 to date)
fundamentalist writes:

Johnson: “But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common…they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector’s profits…were ignored or swept aside. “

They had something else in common—cheap money provided by the Fed. Can Mr. Johnson not see that had the Fed not reduced interest rates none of the egregious acts he deplores would have been possible? Higher interest rates would have squashed them before they got started. The whole point of having market rates is to reduce speculation through higher rates. In a free market, interest rates act as a governor on an engine: interest rates rise to keep investment in line with savings. Artificially low rates that the Fed is so fond of break the governor and allow the engine to increase rpm until it flies apart.

This is such simple common sense that I’m astounded that an IMF economist refuses to accept it. Even Washington Irving understood the principle in 1819 when he wrote his Crayon Papers about John Law and the Mississippi Bubble. Had Congress and regulatory agencies implemented the policy changes that might have forestalled the crisis, where does Mr. Johnson think all of the money created by the Fed would have gone? It has to go somewhere; it doesn’t evaporate into thin air. Had it not gone into the mortgage industry, it would have gone somewhere else, possibly overseas to emerging markets, possibly to bonds or commodities or back into the stock market, but it would have gone somewhere and created the same problems but in different industries.

Besides, the whole raison d’etre of the Fed from its creation has been to provide as much cheap money as possible. Small banks can’t get by with small reserves; they must maintain larger ones to meet their customers’ needs. The Fed was intended to allow greater expansion of credit through lower reserves by making the entire nation essentially one bank.

Johnson: “Instead, the American financial industry gained political power by amassing a kind of cultural capital—a belief system.”

I think campaign contributions were a bigger factor.

Johnson: “Many other factors contributed, including excessive borrowing by households and lax lending standards out on the fringes of the financial world.”

Again, where would the money come from for households, or anyone to borrow if the Fed didn’t create it and make it flow like water?

Johnson: “In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts… The second scenario begins more bleakly…It goes like this: the global economy continues to deteriorate … A dramatic worsening of the global environment forces the U.S. economy, already staggering, down onto both knees.”

The more likely scenario is that the US will default on its debt by resorting to monetary inflation which causes price inflation. They will inflate the money supply until the dollar is worth less than half its current value, or until voters scream, and thereby reduce the real federal debt by half.

Mark T writes:

Seems oversimplified and overstated to me. Just a bunch of generalizations that have been served up dozens of times a month over the past year. A lot of bloggers would be better served if they posted less frequently.

JP writes:

Yes, knowledgeable people need to fight the incipient "it was deregulation, stupid" folklore. The problem wasn't deregulation. The problem was mis-regulation combined with misuse and non-use of the regulatory tools that continue to be available.

The Snob writes:

Speaking about the public-private toxic waste program with a friend last night, I said, "I don't know who's going to make out like a bandit in this deal but I know the taxpayer is getting screwed."

IMHO, any institution bailed out because it's "too big to fail" needs to be broken up.

fundamentalist writes:

The Snob, I agree completely. If we can't get rid of the "too big to fail" nonsense, then maybe we should pass a law that limits the size of companies so that none become "too big to fail." That would be the logical conclusion of a stupid notion.

M. Simon writes:

Wall Street has not only been flooded by foreign exchange. It is also totally dependent on hot money.

Catherine Austin Fitts has amply documented the importance of narco dollars to the American economy. She calls it Narco Dollars for Dummies.

Which is not to say the narco dollars have been all bad. The rise of Silicon Valley was mainly the result of narco dollars funding all kinds of start ups (some one needs to do the real history of Silicon Valley - i.e. follow the money). A high risk/high reward business. Just the kind of business deal that a big time drug cartel "owner" would understand.

I have some thoughts and links here:

Banks Still Getting Illegal Cash

Victoria writes:

I really enjoyed reading the article, Simon Johnson drew very good parallels and didn't over-complicate things with minutia. But I'm not sure about the first alternative in his conclusion - the Japanese scenario.

The thing is, Japan was WEALTHY, it had huge reserves, so it propped up all those zombie banks and zombie companies, but it could sort of afford it. The price for this desire to avoid the pain was, of course, no gain... for well over a decade.

But US is simply not in that nice position, it simply doesn't have the money (and even the money/support from China is dwindling and is likely to disappear) to prop up all that dead weight.

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