In the keynote speech for The Political Economy of Financial Regulation conference at George Washington University, Simon Johnson, professor of entrepreneurship at the Sloan School at MIT, called once again for a “more focused debate” on the issues raised by the handling of the financial crisis by the administration and the financial regulators.
Although the pamphlet for the event referred to the aftermath of the 2008 crisis, the host of the conference, Arthur Wilmarth, executive director of the George Washington University Center for Law, Economics & Finance, stated clearly in his introduction of Johnson that the crisis is a continuing one marked by undercapitalized banks and he looked to Johnson “to provide a better understanding of the financial and political challenges we face.”
Johnson did not disappoint. He began by recounting a vignette from the 90th birthday party of Milton Friedman, where Federal Reserve Chairman Ben Bernanke, then a governor of the Federal Reserve Board, addressed Friedman and his longtime fellow historian of the Federal Reserve, Anna Schwartz, and apologized on behalf of the Fed for causing the Great Depression: “We did it, the Depression, but we won’t do it again.”
The question now for Johnson is how long it will take the Fed as an institution to apologize to America for the failure of the Fed’s monetary and regulatory policies both during the 2007 run-up to the 2008 episode and in the years since. He declared that the issue of this year, which coincides with the 100th anniversary of the establishment of the Fed, is, “Can we push for a meaningful shift in Fed policy?” Such a change would have to come from central bankers who, Johnson quipped, “are always very confident about their thinking until 20 minutes before they completely change their minds.”
Preparing his audience for some “good-natured whining,” Johnson asked what the Fed is responsible for in terms of its mandates for price stability and full employment and for the regulation of banks. He charged that with the advent of the Dodd-Frank Act, the Fed has become more powerful as “custodian of the thinking, beliefs, doctrine and ideology of the financial system.”
There is something of a consensus that blame should be placed on former Fed Chairman Alan Greenspan, who propagated the idea that nothing can be done about assets bubbles, which Johnson called “a completely mistaken belief [that] you won’t hear again for a very long time.”
The biggest shortcoming now, according to Johnson, “where leadership is needed from the Fed, and we’re not getting it,” concerns policy regarding the “too big to fail” financial institutions.
He expressed astonishment that the head of the Criminal Division of the Department of Justice, Lanny Breuer, had defended the decision not to prosecute banks and bankers on the grounds that to do so would jeopardize financial stability, a decision supposedly arrived at after consultation with “experts.” Paraphrasing a letter to the Department of Justice from Sens. Sherrod Brown, D-Ohio, and Chuck Grassley, R-Iowa, Johnson wondered aloud who these experts were.
Johnson referred to an effort by Brown to amend Dodd-Frank to raise the issue of breaking up the largest banks that was defeated by a vote of 33-61, an idea Johnson predicted would continue to be brought up and would surely elicit pushback from the banking industry. Johnson noted that the banking industry is led by former Treasury Secretary Robert Rubin, who now leads the Hamilton Project at the Brookings Institution and who insists that “banks are not the problem.” Rubin was paid $100 million to join Citigroup’s executive suite after he left the Treasury.
Johnson concluded by raising three fundamental questions:
1. Are there economies of scale in banking?
Johnson pointed to the growth of the six largest banks, from 15 percent of gross domestic product in 1990 to 60 percent. He found that Goldman Sachs had grown to $1.1 trillion at the time that it essentially failed in 2008, approximately four times its $250 billion size during its best years.
Johnson declared, “Many people have looked for these economies, but they have nothing,” and he cited the finding of Andrew Haldane, executive director for Financial Stability at the Bank of England, that after adjusting for subsidies, there are no economies of scale beyond, perhaps, the level of $100 billion. Johnson lamented that he has been unable to engage JPMorgan CEO Jamie Dimon or the New York Clearinghouse on this issue.
To dramatize this point, Johnson invited the representative of the Clearinghouse, a sponsor of the conference, to speak to the issue, and the gentleman in the audience declined to respond.
2. Are there subsidies in banking?
Johnson charged that, again, on this issue, the industry refuses to engage, nor has the Fed, which Johnson sarcastically observed “is supposed to have the smartest, deepest thinking experts.”
Johnson asserted that the implicit assumption that the authorities will once again find a way to rescue the too big to fail banks persists, although no one knows exactly what form it will take. Now the Federal Reserve Bank of New York warns that, with diminished authority, it may have to come into the act later.
The industry, led by the Financial Services Roundtable, is resisting calls for the Government Accountability Office to investigate the extent of the too big to fail subsidy. Johnson also ridiculed measures like cross border resolution, which he confidently predicts will never be implemented; resolution authority, which he called “a black box”; and living wills as providing no answers to questions regarding how creditors would be treated upon the failure of the largest banks, which, Johnson insists, “don’t have enough capital and never will, if left to their own devices.”
He demanded that the industry answer these charges, as documented in the book “The Bankers’ New Clothes,” co-authored by two of the speakers at the conference, Anat Admati of Stanford and Martin Hellwig of the University of Bonn.
3. Who cares?
Referring to the claim by the Treasury that it makes money when it bails out the banking system, Johnson pointed to the loss of jobs and homes due to the financial crisis and the ongoing risk of the excessive leverage in the system, as documented in a study by the Federal Reserve Bank of Dallas, as reasons why public policy needs to address the issues of bank subsidies and bailouts.
He joined the authors in urging that the debate over bank capital standards be raised to another level in the neighborhood of 40 percent, even as bankers quibble over the nominal levels that would be required under Basel III.
Finally, Johnson proclaimed that now is the time to discuss the policy issues he and the authors have raised rather than to wait, perhaps many decades, for a successor to Bernanke to apologize again on behalf of the Fed.
On the Feb. 10 Washington Post editorial page, a column by George Will titled “A Badly Needed Breakup” joined the debate, perhaps at the behest of Sen. David Vitter, R-La., camp. Will concluded the column by exhorting readers: “Aux barricades!”
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