00:00:03
[Music]
00:00:17
We're speaking today with Simon Johnson,
00:00:19
who's a professor at MIT and also a
00:00:21
former chief economist at the
00:00:23
International Monetary Fund and the
00:00:25
author of 13 bankers, The Wall Street
00:00:28
Takeover and the Next Financial
00:00:29
Meltdown. Welcome.
00:00:31
Thanks for having me. In your book,
00:00:33
which was written before the recent
00:00:34
financial legislation was passed, you
00:00:37
have a sentence in there that's
00:00:38
predictive and it says, "It's likely our
00:00:40
government will use this legislative
00:00:42
cycle to declare victory over the
00:00:44
financial crisis without addressing its
00:00:46
most fundamental cause." Is is that
00:00:48
what's happened in your view?
00:00:49
I'm I'm afraid so. Yes. The book was
00:00:51
finished in January of this year. The
00:00:52
legislation obviously was debated most
00:00:54
intensely in the Senate in March and
00:00:56
April and it passed in the summer. There
00:00:59
were some steps in the right direction.
00:01:01
This is the DoddFrank financial reform
00:01:03
uh act and some steps that that I
00:01:05
definitely support, but it's not enough.
00:01:07
It doesn't really address the
00:01:08
fundamental causes. I think the
00:01:09
financial system, if anything, is
00:01:11
becoming more dangerous than it was even
00:01:13
before 2008.
00:01:15
Could you tell us what were the the
00:01:17
positive points in the bill, just a
00:01:19
brief summary of your views and what
00:01:22
what the big gaps were? Well, the big
00:01:24
positive was obviously consumer
00:01:26
protection and the fact the president
00:01:28
has now put Elizabeth Warren in charge
00:01:30
of figuring out how to implement and how
00:01:31
to build an agency as mandated by by the
00:01:35
statute that that's that's terrific.
00:01:36
That's exactly what we needed. But in
00:01:38
terms of system risk, in terms of making
00:01:41
the biggest banks less risky, in terms
00:01:43
of reducing the kinds of
00:01:44
interconnections that almost brought
00:01:47
down the world's financial system at the
00:01:49
end of 2008 and early 2009, the
00:01:52
legislation makes very little progress,
00:01:54
if any, in the right direction there.
00:01:56
Of course, proponents would say that it
00:01:58
it did make progress and that um it has
00:02:02
ended the worries about too big to fail.
00:02:04
You obviously disagree. Can you tell us
00:02:07
specifically why you disagree?
00:02:10
The heart of the argument
00:02:13
on behalf of the DoddFrank legislation
00:02:15
with regard to too big to fail is that
00:02:17
there is now a resolution authority and
00:02:20
a resolution mechanism so that the FDIC
00:02:23
on behalf of the government can take
00:02:24
over shut down manage the failure of any
00:02:28
kind of financial institution.
00:02:29
Previously they could do it for
00:02:30
depository institutions in well
00:02:32
institutions banks with insured FDIC
00:02:35
insured deposits. Now in principle they
00:02:37
can do it for everyone but they can't
00:02:40
because our largest banks are global
00:02:42
banks and there is no crossber bank
00:02:46
resolution failure mechanism nor is the
00:02:50
G20 taking up the issue of how to
00:02:51
construct one nor do any of our major
00:02:54
trading partners want to have such a
00:02:56
mechanism. So if Croup hypothetically
00:03:00
were to fail, Cityroup operates in in
00:03:04
more than 100 countries, how would you
00:03:06
manage that? What would the FDI do?
00:03:08
What's the mechanism for the failure for
00:03:11
losses to be faced by creditors? And the
00:03:13
answer is if you if you take this up
00:03:15
directly face to face off the record
00:03:17
with senior administration officials,
00:03:19
they'll concede the point. They'll say,
00:03:20
"Well, actually, we we would do um we
00:03:24
would we would support the institution.
00:03:26
we'd have to um we'd have to do a
00:03:27
conservatorship.
00:03:30
Conservatorship is a bailout.
00:03:31
Conservatorship is protecting the
00:03:32
creditors. That's not a resolution
00:03:34
mechanism. And the creditors know this.
00:03:36
So the big banks, the global banks, the
00:03:38
ones at the heart of the previous
00:03:40
crisis, are invulnerable from the in the
00:03:43
sense that their creditors cannot face
00:03:45
losses. So without a global mechanism
00:03:48
really the United States, however
00:03:50
well-intentioned, would be unable to
00:03:52
protect against banks that are too big
00:03:55
to fail because they could crash the
00:03:56
system ultimately. And so does that mean
00:04:00
that bankers today are back again to
00:04:02
being confident that they can take on
00:04:04
what I think you call in your book many
00:04:06
times uh excessive risk um and uh that
00:04:11
the public will will take care of any
00:04:14
downside and they'll be able to skim off
00:04:15
the upside which is what the perception
00:04:18
is that happened last time.
00:04:20
Yes, that's exactly where they are. Of
00:04:21
course, there's a cycle and right after
00:04:23
a major financial crisis you're going to
00:04:25
be somewhat careful. That's
00:04:26
understandable and that's why you don't
00:04:27
see back-to-back global financial
00:04:29
crisis, not year in year out. But over
00:04:32
time, as we go through this cycle, we're
00:04:34
going to have the same sort of
00:04:35
risk-taking. Jaime Diamond says you have
00:04:37
financial crisis every 3 to seven years.
00:04:38
Hank Pollson says it's four to eight
00:04:40
years. Larry Summers says uh four to
00:04:43
nine years. Doesn't matter. These big
00:04:44
guys agree and they're right that you'd
00:04:46
do it again because the system of
00:04:47
incentives and the structure of these
00:04:49
organizations is essentially unchanged.
00:04:52
So then the question starts to be what
00:04:54
what could what else might be done about
00:04:56
that? And um you quote Alan Greenspan of
00:05:00
all people in your book saying that uh
00:05:02
if they're too big to fail then they're
00:05:04
too big. And uh he goes on to say in his
00:05:08
prescription and this was just about a
00:05:10
year ago so not all that long ago. Break
00:05:12
them up. In 1911 we broke up standard
00:05:14
oil. So what happened? The individual
00:05:16
parts became more valuable than the
00:05:18
whole. Maybe that's what we need. Um,
00:05:20
and I know that this is what you
00:05:22
advocate in your book to some degree.
00:05:24
Break them up in the sense of reduce
00:05:25
their size. So, could you talk about how
00:05:28
that would work? I know you talk about
00:05:30
size limits and you have some ideas and
00:05:33
mechanisms on what that would look like.
00:05:35
Yeah, absolutely. This is the heart of
00:05:37
the matter. And in addition to Alan
00:05:39
Greenspan, I'm now citing Gene Farmer,
00:05:41
the the the father of modern finance,
00:05:43
the person really behind the idea of
00:05:45
efficient markets in finance, who said
00:05:46
on CNBC recently after we finished the
00:05:48
book, he said, "Too big to fail is an
00:05:51
abomination. It's not a market. It's a
00:05:54
government subsidy scheme and it should
00:05:55
be ended." And the best way to end it is
00:05:57
to update and apply the Regal Neil Act
00:05:58
of 1994. Regal Neil sets a size cap on
00:06:01
our largest banks as a share of retail
00:06:04
deposits. No bank can have more than 10%
00:06:06
of total retail deposits. The idea that
00:06:09
was proposed as an amendment to
00:06:11
DoddFrank by Senators Brown, Sheriff
00:06:13
Brown and Senator Ted Calfman was that
00:06:17
there be a hard size cap in terms of the
00:06:19
size of bank relative to the US economy.
00:06:22
You can relative to GDP.
00:06:24
Exactly.
00:06:25
Relative to GDP so that nobody can no
00:06:27
individual bank can become big relative
00:06:29
to your economy. Now we can discuss
00:06:30
where that limit should be drawn. I
00:06:32
would definitely be in favor of a much
00:06:33
lower limit.
00:06:35
Um, we can put a dollar number on it if
00:06:37
you like, but that basic idea of a hard
00:06:39
size cap beyond which you cannot go,
00:06:42
I think is is what you need in in the
00:06:44
American situation.
00:06:45
I think in your book when you were
00:06:46
talking about what that level should be,
00:06:48
you said something that would be akin to
00:06:51
where banks were in size in the mid 90s
00:06:53
or so. So, we're not talking about we're
00:06:55
not talking about draconian reductions.
00:06:58
Absolutely. So Goldman Sachs um in the
00:07:01
late 1990s was about a $200 billion
00:07:03
bank. Let's call it $250 billion in
00:07:05
today's money. Before the crisis in
00:07:08
2008, their balance sheet peaked at 1.1
00:07:11
trillion. Now what did the US economy as
00:07:15
a whole, what did the financial system
00:07:17
even gain from that big increase in size
00:07:19
of Goldman Sachs? Nothing. No one can
00:07:21
point to any economies of scale or scope
00:07:23
or other benefits from increasing size
00:07:26
above actually above about $50 billion
00:07:29
in total assets. So there were lots of
00:07:32
benefits for sure private benefits for
00:07:33
Goldman Sachs. The CEO gets more
00:07:36
compensation definitely CEO by the way
00:07:38
in this period of rapid growth was Hank
00:07:40
Pollson who later became secretary of
00:07:41
the treasury. But if you go back, if you
00:07:44
we you've asked or forced Goldman Sachs
00:07:46
and banks like that to go back down to
00:07:47
the days where there are 200 billion or
00:07:49
maybe we even end up with a hundred
00:07:50
billion as as the hard cap. Um what's
00:07:52
the damage? What do you lose from that
00:07:54
in terms of either the functioning of
00:07:56
the American economy or the functioning
00:07:57
of the global financial system? And the
00:07:59
answer from all the experts I've talked
00:08:01
to, both academic and and practical
00:08:03
people really in the business, the
00:08:04
answer is you wouldn't lose anything.
00:08:06
You don't remove system risk completely.
00:08:08
Of course, there is no magic bullet.
00:08:10
these measures we're proposing are
00:08:12
surely not sufficient to reduce
00:08:16
financial system risk. We're just
00:08:18
arguing that they're necessary and and
00:08:19
also that they haven't been taken. The
00:08:21
other interesting stat in the book, I
00:08:23
think I've seen this elsewhere also, was
00:08:25
I think it's the percentage of corporate
00:08:28
profits that the financial industry
00:08:30
represents, and um I might have this a
00:08:32
little off, but I think this is roughly
00:08:34
right that up through maybe the
00:08:36
beginning or middle of the 80s or maybe
00:08:37
even a little bit later, um the most the
00:08:40
financial system ever took up in total
00:08:42
corporate profits in the US was about
00:08:44
15% or so. By uh just prior to the
00:08:48
crash, it was up to 41%. In other words,
00:08:50
the financial services industry was
00:08:53
earning 41% of all profits in the US.
00:08:56
Um, that was that that's something that
00:08:59
we never even got close to in the past
00:09:02
that suggests that that maybe something
00:09:03
was out of whack. Why didn't anybody see
00:09:04
that? Well, I know some people did, but
00:09:07
what and where are we now? And how long
00:09:09
do you think it it might take before we
00:09:11
get back up to that? According to your
00:09:13
view, what's likely to happen?
00:09:14
Well, we're heading back into similar
00:09:16
territory. the financial sector profits
00:09:17
are are strong and I I think they're
00:09:19
going to uh really do well partly
00:09:21
because there's fewer of them. There's
00:09:22
less competition, there's more market
00:09:23
power in this area. But you're
00:09:25
absolutely right, it's a it's a wakeup
00:09:26
call because those are not real profits.
00:09:28
Those are not riskadjusted profits.
00:09:29
Those are not profits if you go back and
00:09:31
state them against the losses that were
00:09:33
incurred because a lot of those losses
00:09:34
were transferred to the taxpayer.
00:09:38
Larry Summers says that 40% financial
00:09:41
sector profits at 40% of total corporate
00:09:43
profits is a warning sign and we should
00:09:45
have taken it as such. And he's
00:09:47
absolutely right. When you show those
00:09:48
numbers to the CEOs of non-financial
00:09:49
companies, they're staggered actually
00:09:51
and quite shocked and and so they should
00:09:54
be, but they won't do anything about it.
00:09:56
They won't even participate in criticism
00:09:58
of the financial sector. they've
00:10:00
actually closed ranks protecting the
00:10:01
biggest banks and that's very dangerous
00:10:03
for them individually for their
00:10:04
companies and for all the people who who
00:10:06
work for them because this is the big
00:10:08
risk facing the United States going
00:10:09
forward.
00:10:10
The other thing that's that's
00:10:11
interesting uh and and you talk about a
00:10:14
number of different problems with too
00:10:15
big to fail such as um taxpayers end up
00:10:19
on the hook for all the money. But also
00:10:22
this idea that because it the backup the
00:10:25
backs stop the the implicit guarantee
00:10:27
the moral hazard is is is basically
00:10:29
there but only for the very largest
00:10:31
banks that the next tier down say large
00:10:33
regionals and so forth. They're actually
00:10:35
put at an unfair disadvantage
00:10:37
competitively because they don't have
00:10:38
that subsidy and therefore they you know
00:10:42
they can't operate in the same way and
00:10:44
you know it's not a level playing field
00:10:45
and yet we don't see too much opposition
00:10:48
from them either. You just talked about
00:10:49
the corporate sector in general. What's
00:10:50
going on here?
00:10:51
That's a very interesting question and
00:10:53
you should pose it to the bankers
00:10:55
themselves. I I don't think I can speak
00:10:57
on their behalf, but I but I think we I
00:10:58
I would certainly agree and underline
00:11:00
there is a big divergence in interest
00:11:02
between the massive the mega banks, the
00:11:04
mega global banks that have this
00:11:06
implicit government guarantee now and
00:11:07
therefore a lower cost of funding and
00:11:09
the banks they compete against in many
00:11:11
markets, including the mid-size banks
00:11:12
and and the community banks. It's not
00:11:14
fair. It's it's it's a government
00:11:16
subsidy scheme that's not fair. not
00:11:18
transparent and very dangerous. But the
00:11:21
US corporate leadership unfortunately
00:11:25
feels they should stick together in
00:11:26
situations like this. The Chamber of
00:11:28
Commerce uh has certainly spoken out uh
00:11:31
consistently on behalf of the big banks
00:11:33
and and saying claiming to speak on
00:11:35
behalf of small business. It has opposed
00:11:38
um almost all of the sensible provisions
00:11:40
of the DoddFrank Financial Reform Act. I
00:11:42
I find this extraordinary and and
00:11:44
disconcerting and I spend a lot of time
00:11:46
I'm a professor of entrepreneurship at
00:11:47
MIT among other things. I talk to a lot
00:11:49
of business people. I work with
00:11:50
entrepreneurs in the US and around the
00:11:51
world. I spent a lot of time with them
00:11:52
on on these issues and I think over time
00:11:55
that their their view will change. But
00:11:56
it is unfortunate and and it definitely
00:11:58
affected the political process in this
00:12:00
goound that the business sector the
00:12:02
non-financial business sector didn't get
00:12:04
it. They don't understand how much they
00:12:06
and their families and their people have
00:12:08
been damaged by the irresponsible,
00:12:11
reckless, unnecessary behavior of the
00:12:13
big banks.
00:12:14
Given that um that you don't think that
00:12:17
that the latest round of financial
00:12:19
reform has has done the trick, um let me
00:12:24
just turn to something else that you say
00:12:25
in your book. We face the prospect of a
00:12:27
1920 style roller coaster. um meaning
00:12:32
the economic cycle will be more volatile
00:12:34
I believe. And then and then you say uh
00:12:36
this is a recipe not for stagnation but
00:12:38
for a metaboom in which we will receive
00:12:41
warnings including painful recessions
00:12:42
but consistently ignore them. And one
00:12:45
last thing in the the 1920s opened with
00:12:47
an 18-month re uh recession, an eerie
00:12:50
parallel to the 2007209 experience. It
00:12:53
ended with the great crash of 1929. So,
00:12:56
not that we want to be talking about
00:12:57
depression necessarily, but I think you
00:12:59
want to talk about volatility and and
00:13:01
certainly recession such as we have now.
00:13:04
Or maybe you do want to talk about the
00:13:06
I want to emphasize that too big to fail
00:13:07
is not the worst of our problems. I
00:13:09
actually had this conversation with with
00:13:10
a leading banker, a gentleman with a
00:13:13
great deal of international experience
00:13:14
recently and he said, well, look, too
00:13:16
big to fail is part of the scenery. Now,
00:13:17
you just got to deal with it. Now, I
00:13:19
agree on a tactical level that is
00:13:21
actually correct. I don't think there is
00:13:22
anything on the table or or waiting in
00:13:26
in the wings that will make any
00:13:27
difference to the rising power and the
00:13:29
dangers posed by these big banks. But
00:13:31
too big to fail is not the worst of our
00:13:33
potential problems. Be too big to save.
00:13:36
Think about Ireland.
00:13:37
Too big to bail.
00:13:38
Absolutely. Ireland allowed its three
00:13:41
largest banks to build up total assets
00:13:44
two times the size of the Irish economy
00:13:46
and then they failed.
00:13:48
The Irish government issued a guarantee
00:13:51
that at least as we speak today
00:13:54
covers all the liabilities of those
00:13:56
banks. They turned a financial banking
00:13:58
sector problem into a fiscal issue and
00:14:01
in my view and this is something we
00:14:03
write about on our website and we go
00:14:05
through the analysis. In my view and and
00:14:07
I certainly disagree quite strongly with
00:14:09
the views coming out of the official
00:14:11
sector but I would point that the market
00:14:12
point out the market is moving in in my
00:14:14
direction on this issue. My my point is
00:14:16
that um Ireland can't afford the
00:14:19
bailouts they've taken on. It's not
00:14:20
fiscally sustainable.
00:14:23
So, it's kicking the can down the road.
00:14:25
Well, it's trying to kick the can down
00:14:27
the road.
00:14:27
Trying to kick the can,
00:14:28
but it's not moving. The can's too big.
00:14:30
Mhm.
00:14:30
Right. You're going to break your foot.
00:14:32
You're looking at a fiscal disaster.
00:14:33
You're looking at a sovereign debt
00:14:35
issue.
00:14:37
And I and I think we must take this
00:14:39
seriously for the United States.
00:14:42
When will will that actually hit the
00:14:45
wall though? Because I say kick the can
00:14:46
down the road in the sense that that
00:14:49
there there's no there's no panic.
00:14:50
There's no strong reaction. There was a
00:14:52
strong reaction and then certain steps
00:14:53
were taken. Uh, and maybe we can talk
00:14:55
about that because I know also in in
00:14:58
that blog piece, um, you talked about
00:15:01
perhaps one way out for Europe is, uh,
00:15:04
to issue some form of Brady bonds, which
00:15:07
were used to help bail out Latin
00:15:09
America, which I think essentially just
00:15:11
spread the debt out over a long period.
00:15:12
Is that right? Is that is that was that
00:15:14
the main mechanism that allowed them to
00:15:16
work? And and you're recommending those
00:15:18
uh to be used in Europe as well? Well,
00:15:20
what what helped Latin America at the
00:15:23
end at the end of the very difficult and
00:15:25
and and essentially lost decade of the
00:15:26
1980s was that they restructured their
00:15:28
debt. They were allowed to extend their
00:15:30
payments reducing the debt burden
00:15:32
reducing the cash and there was a let's
00:15:35
say regulatory compromise reached
00:15:37
including the Brady bonds that allowed
00:15:38
the banks not to mark down their debt so
00:15:41
much. So this is how they squared the
00:15:42
circle of not wanting to recognize the
00:15:44
losses among the lenders and letting the
00:15:46
borrowers
00:15:48
get somewhat off the hook. So it's a
00:15:49
forgiveness of debt a little bit without
00:15:51
it being recognized. So it's sort of
00:15:53
accounting.
00:15:53
It's how you forgive the debt in a in in
00:15:55
a situation where you don't want to look
00:15:57
like you're forgiving the debt. So
00:15:59
something like that um for Ireland and
00:16:01
and maybe for other Europe Euro zone
00:16:03
countries I think should definitely be
00:16:05
considered seriously. It is unfortunate
00:16:08
that the official sector never wants to
00:16:10
consider such options until it's too
00:16:11
late until they have to scramble until
00:16:13
they have to do things in a manic rush
00:16:15
over a weekend. I think now is the time
00:16:17
to prepare for that kind of sovereign
00:16:19
debt restructuring. And as we look
00:16:20
forward, I would emphasize that while
00:16:23
the moral hazard in and around the big
00:16:25
banks is absolutely huge and will be a
00:16:30
major problem that we face resolving
00:16:32
that looking at the implications moral
00:16:34
hazard around lending to governments,
00:16:35
governments that are regarded as safe
00:16:38
will also be an issue.
00:16:39
Can we just define moral hazard for
00:16:41
folks that are watching so we can be
00:16:43
they can be clear about what it Oh,
00:16:44
moral hazard is very simply that when I
00:16:47
give you insurance, you're going to be a
00:16:48
little bit less careful. And if you go
00:16:50
back to the, it's interesting, you go
00:16:51
back to the foundation of the Federal
00:16:52
Reserve, 1913, quite late for the
00:16:55
formation of a modern central bank
00:16:57
compared to other countries comparable
00:16:58
to the United States. There was a big
00:17:00
debate about this issue because the
00:17:01
bankers said, "We want protection. We
00:17:03
the financial markets have gone too big,
00:17:05
too complex. We can't support
00:17:07
ourselves." This is what they learned in
00:17:08
the crisis of 1907. We need the
00:17:09
government to be involved. In fact, the
00:17:11
government had put in a big amount of
00:17:13
cash in 1907 to save some of the private
00:17:15
banks. And the debate was, okay, you the
00:17:18
bankers want support. That's fine.
00:17:19
Nobody wants a global or or even
00:17:21
national financial collapse, but there
00:17:24
has to be a quid proquo. We need some
00:17:26
oversight. We need some regulation or
00:17:28
what we now call regulation supervision.
00:17:31
So, that's the essence of the moral
00:17:32
hazard problem. But unfortunately, it's
00:17:35
hasn't worked. It worked. It didn't work
00:17:37
by the way in the 1920s either. That's
00:17:39
why you got a runaway boom. That's you
00:17:40
know the banks went crazy in terms of
00:17:42
taking risk and keeping risk on their
00:17:43
own balance sheet. That's why we got the
00:17:45
reforms of the 1930s and those worked
00:17:46
for about 50 years and then they were
00:17:48
systematically carefully with a great
00:17:50
deal of forethought dismantled. Well,
00:17:53
that's what why we got the crisis of
00:17:54
2008. We did not though go out and
00:17:58
rebuild the modern equivalent
00:18:00
of those constraints that were put up in
00:18:02
the 1930s. The DoddFrank bill doesn't do
00:18:05
that. And therefore, we still have the
00:18:07
same problem that we had prior to 2008
00:18:10
and in the 1920s.
00:18:12
So that's the that's the um the metaboom
00:18:16
cycle that you're talking about.
00:18:18
Yes, that that's my
00:18:19
as a parallel.
00:18:20
That's that's my baseline scenario. We
00:18:22
call our website baseline scenario,
00:18:23
meaning we have a baseline view. We move
00:18:25
it from time to time, but as we speak
00:18:27
today, that is my baseline view. And
00:18:28
since we touched on Europe, could you
00:18:30
give your view of the Bessel 3 Accords
00:18:33
as which is the European uh the latest
00:18:36
European financial legislation or
00:18:38
reforms and uh maybe draw some parallels
00:18:40
between that and what was done in the
00:18:42
US?
00:18:42
Well, the Basel 3 is is a is a global
00:18:44
agreement. There's 27 countries on the
00:18:46
Basel committee and they agree on a lot
00:18:49
of things around bank regulation with
00:18:51
first and foremost issue being bank
00:18:53
capital. And the problem at Barcel 3 is
00:18:56
that while the US does want somewhat
00:18:58
higher required capital in banks, the
00:19:01
Europeans don't and actually the
00:19:03
Japanese don't. Um and as a result, we
00:19:06
end up with a compromise which is what
00:19:09
people often call least common
00:19:10
denominator and which in in common
00:19:12
English you could say not enough. So the
00:19:15
capital required at the end of the day
00:19:17
when you make all the adjustments by
00:19:18
Basel 3 will be about 10% tier one
00:19:20
capital. That's roughly what the US
00:19:24
banks have had for the past two decades.
00:19:27
So there's no change in required capital
00:19:30
relative to what US pinging practice has
00:19:32
been.
00:19:33
But it will help Europe in some way
00:19:35
presumably
00:19:36
if they follow the rules. Unfortunately,
00:19:38
they have a track record of providing
00:19:40
many exemptions and exceptions to their
00:19:43
most privileged banks.
