A very important article by an expert, discussing the necessary next step to solve the financial crisis

Here is some sound advice from an experienced professional.  I strongly recommend reading this in full;   “High Noon: Geithner v. the American Oligarchs“, Simon Johnson, The Baseline Scenario, 8 February 2009.

Johnson was chief economist of the IMF, now a professor at the MIT Sloan School of Management and senior fellow at the Peterson Institute for International Economics.

Excerpt

There comes a time in every economic crisis or, more specifically, in every struggle to recover from a crisis, when someone steps up to the podium to promise the policies that – they say – will deliver you back to growth. The person has political support, a strong track record, and every incentive to enter the history books. But one nagging question remains.

Can this person, your new economic strategist, really break with the vested elites that got you into this much trouble?  The form of these vested interests, of course, varies substantially across situations, but they are always still strong, despite the downward spiral which they did so much to bring about.  And fully escaping the grip of crisis really means breaking their power.

Not only is this a standard way of thinking about crisis resolution in many developing and post-communist countries, it also turns out to be a good guide to thinking about the US today. We have a powerful banking industry that has mismanaged its way into deep trouble. Yet these banks obtained an initial bailout – the Troubled Asset Relief Program, or TARP – on generous terms, and have consistently failed to use the opportunity provided by this government support to turn their operations around.

… The elites who run the US banking industry have had a great run of economic good fortune. They used this wealth to further strengthen their political power, both through donations to politicians of almost all stripes and more broadly through taking positions of formal and informal influence throughout the executive and legislative branches.

Our unsustainable debt-fuelled boom, in other words, produced both the conditions for a major global financial disaster, and a political strengthening of the people who benefited most from the risk-taking and associated compensation packages that made this disaster possible.  Ending the financial crisis is relatively straightforward – a forced recapitalization and change of ownership/management in the banking system – although this will not immediately lead to an economic recovery (more on that here).

But seen in deeper political terms, decisive action to restructure large banks is almost impossible.  Such action would require overcoming perhaps the single strongest interest group in the United States today.

How can you do it?  The answer must be by splitting this powerful interest group into competing factions, and taking them on one by one. 

Can this be done?  Definitely, yes.  In particular, bank recapitalization – if implemented right – can use private equity interests against the powerful large bank insiders. Then you need to force the new private equity owners of banks to break them up so they are no longer too big to fail.  And then there is always more to do to contain the power of a lobby that is boosted by any boom and which, the more it succeeds, the more likely it is to ruin us all.

Afterword

Please share your comments by posting below.  Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

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For more information from the FM site

To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp interest these days:

Some of the posts about  solutions to the financial crisis:

  1. A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
  2. Slow steps to nationalizing the US financial sector, 7 April 2008 — How this will change our society.
  3. A solution to our financial crisis, 25 September 2008
  4. The last opportunity for effective action before disaster strikes, 3 October 2008 — How to stabilize the financial system.
  5. Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
  6. Dr. Bush, stabilize the economy – stat!, 7 October 2008
  7. The new President will need new solutions for the economic crisis, 9 October 2008
  8. A brief note about our financial system: Intermediation, disintermediation, and soon re-intermediation, 16 October 2008
  9. New recommendations to solve our financial crisis (and I admit that I was wrong), 23 October 2008
  10. A look ahead to the end of this financial crisis, 30 October 2008
  11. Everything you need to know about government stimulus programs (read this – it’s about your money), 30 January 2009

25 thoughts on “A very important article by an expert, discussing the necessary next step to solve the financial crisis”

  1. This is like the moment after Titanic struck the iceberg and many people on board wanted to carry on and continue the party – not realizing that the ship slowly, but surely has begun to sink. I think there is a strong temptation to just carry on and perhaps think that minor repairs will fix the problem in the financial system – while the real problem at the same time only gets worse.

    As a matter of fact I feel that Simon Johnson might underestimate the REAL challenge: As showed by the rise in oil and food just before the financial meltdown it was like the whole world was heading towards some sort of a roof. Even if the financial crisis never occurred we would in a matter of years be in grave crisis, because there is simply not enough oil left and because our way of living is causing to much environmental damage. Once the crisis is over (whether in five or ten years from now) we will be reminded again that there is simply limits to growth. At least as we are living right now.

    I mention it because economic growth has been THE religion of the Western world for the last hundred years. We have nothing else to put in its place and the discount department stores are the true churches in our society. What will we do if this religion simply can’t deliver anymore? Will we keep moving around like the mindless zombies in the department store “Dawn of the Dead”?

  2. Divide and conquer. Great idea. It needs two things: somebody willing to take on the job, and a strong Executive to support that person, and muster public support for them.
    Despair is a sin, as Jerry Pournelle likes to remind us, but I don’t see anybody who will actually do these things. I hope I am wrong.

  3. I don’t know about Geithner. If the man even wanted to take on banking political power, I don’t see evidence that he’s got the political horse-sense. That speech was a such a fiasco, he’s permanently damaged — which is bad. If he’d just added that ‘the details will be revealed on ‘XXX’ date’ it would have spared 100 pounds on the Dow right there. Right now, we’ll sit and watch the US economy further collapse as we give Geithner another chance.

    Anyway, going after bank’s political influence in Washington requires an Obama-decision, and who knows whether this kind of idea will reach him. Being surrounded by so many bankers might trap him into a ‘reality warp’ of prioritizing the banks over the nation.

  4. That speech reminded me sickeningly of the words given to Lt Norman Dike in BAND OF BROTHERS when
    he was asked for his plan of operation by his men. Argle-bargle is a nice way of classifying it.

  5. Fabius, thanks a lot for posting Simon Johnson’s views. Johnson displays some now-rare American political courage here.
    What Dr. Krugman refers to as ‘Gothamgroup’ in a banking analogy, isn’t a local US Oligarchy. It is, in fact, a global oligarchy, and this oilgarchy isn’t limited to the banking sector, either. A Gothamgroup can have branch networks, receivables and liabilities from Peru to South Korea; hold significant equity in large corporations around the world; and be significantly integrated into ownership of
    US weapons manufacturers, oil companies,etc.
    Considering the populist ‘buy American’ clause in the stimulus, I’m happy to note that the United States Steel Corporation was founded in 1901 by JPMorgan, among others and was the largest ever business enterprise at the time :-)

  6. FM note: This comment was 1400 words. This is over the 250 word limit in the comment policy, which is clearly stated at the end of every post. It can be read in full here.
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    In this interview, Dr. Simon Johnson, with reference to Geithner, says that he has “no objection to the poacher turning game keeper”.

    Suppose the Treasury refuses to pay out the $200 billion as the bills mature, and asks the Fed to reduce the electronic credit balance in the Treasury Supplementary Financing Account. What this means is that the US taxpayer will be off the hook for this liability. Holders of the maturing Treasury bills will have to be paid not from the Government’s coffers, but from the Fed, or the banks; whoever benefited from the resulting extra credit will have to bear that repayment.

    In any case, through the February 2009 Geithner plan, I expect that the US will soon have a few large banks recapitalized and freed of bad debts; the deleveraging process can then come to a conclusion. That will be the beginning of a recovery in the real economy. I suspect that a lot of capital will flow to sectors like Telecom, Power, Highway Construction,Public Transportation, etc in emerging markets, with a view to utilize the zero interest rate regime in the US and stimulus programs there. But this flow will be constrained and limited by the pace of execution there. It’s much more than likely that large private equity flows will happen to the nanotechnology and biotechnology sectors in the US thereafter. …

  7. “They used this wealth to further strengthen their political power, both through donations to politicians of almost all stripes and more broadly through taking positions of formal and informal influence throughout the executive and legislative branches.”

    Precisely. Hence the need to get that money out of politics, and to break the revolving door with strong and lengthy barriers to crossing from one side to the other. Which someone posted here awhile ago. Nothing will change till we fix this, period.

  8. How can you do it? The answer must be by splitting this powerful interest group into competing factions, and taking them on one by one.

    This sounds nice, but I remained convinced that inventing a perpetual motion machine would be a better – and more feasible as well as more probable – solution.

  9. The esteemed gentleman ignores the ongoing role of government in creating incentive for financial institutions to make bad loans. Under President Obama, government pressure for bad banking is only growing. His brave words are like the captain ordering a bailing out of the Titanic’s hull with teaspoons. Bankers (like everyone else) follow incentives laid out by government policy. Change that policy.

  10. Yes and no? How’s that for fence sitting? This crisis will probably allow the government to realign the balance of power more favorably towards regulating the private sector and the nebulous ‘masters of the universe’ (I hope Tom Wolfe and Dolfe Lundgren are getting in on this action) if it hasn’t already, but unlikely that they will be able to break such a powerful lobby.

    The divide and conquer solution is well thought out, and could be very successful. There are two problems though. The first is that the Fed has seen a lot of bankers in its ranks–people like Paulson and Neel Kashkari (the first interim head of the Office of Financial Stability)–and the remaining bankers are not only unlikely to take on big banking as an institution, but are probably very hesitant to vigorously oppose friends and former colleagues.

    The second troubled assumption is that our government acts as one coherent entity. It can but usually doesn’t. The reality is that different personalities in congress and the cabinet will have different views and different connections to various lobbies. Bureaucrats can and have obstructed administration policy. Geithner might be able to formulate a strong regulatory framework that puts the government back in control of banking and the bailout money, but other people who have the president’s ear will probably force him to compromise. It would be nice to think that the government can take a divide and conquer approach to the banking interests, but it very well might be true that the banking lobby has a better chance of implementing that strategy.

    That being said, with a popular outcry and well liked president behind him, Geithner is wielding more power than people seem to give him credit for. He may very well be able to put down opposition from the banks while moving forward.

  11. Do a little research on Geithner (former head of NY Federal Reserve) and you’ll see he is not the man to take on the guys who put him there. His first public appearance was considered a flop (and caused a stock market sell-off) because he did not offer a STRONG ENOUGH plan to relieve the banks of their bad debt. He is surely going to do that, in time, but first has to sidle past Congress’ new sense of public opposition, and find a way not to include public ownership or supervision of the banks in the details.

    I was surprised that there was hardly anything to Johnson’s article beyond the few paragraphs quoted by FM. I think he’s engaging in wishful thinking, or else ironically stating the obvious, that no-one’s going to take on the Wall Street goliaths.

  12. I hope you don’t mind, FB, but I thought this link was funny/creepy and related to the topic here: “The banks’ reverse takeover of Britain“, Fraser Nelson, The Spectator, 15 February 2009 — Excerpt:

    As we wait for the next nationalisation – probably Lloyds Banking Group – a horrible thought occurs. Something has gone badly wrong. It is as if there has been a silent coup d’état – instead of the taxpayers owning the banks, the banks now seem to own the taxpayers. They have been given access to the present and future earnings of the British public, which will plug their mind-blowing losses.

    In my News of the World column today, I look at how Britain became a bankocracy – the government being so dependent on banking profits that it had a clear incentive not to ask too many questions about how this money was being generated. This isn’t venal, I don’t think it was some mafia-style racket. The money was there, the government just took it. Bankers were almost deified, invited to do various reviews (NHS, skills, etc) and feted like the masters of the universe. Meanwhile the gulf between what they had and what they owed grew massively – until it swallowed up an entire government, as it is now in the process of doing.

    The bank nationalisations are not like the postwar nationalisation or coal, railways, the NHS etc. These indusrtries were (relatively) small and manageable. What’s happening with RBS, B&B, Northern Rock and, soon, Lloyds is what the bankers call a reverse takeover. The scale is mindblowing. RBS’s £2 trillion of liabilities dwarfs not only the government reserves but the entire UK economy. Brown hasn’t so much nationalised the banks, he has bank-ised the nation. It really does change how we see government, and transforms the nature of the machine David Cameron will pretty soon be in charge of. It is, as John Redwood says, a massive bank with a small struggling government attached to it.

    This is a bit of hyperbole, though the numbers look about right to me. The banks hit the iceberg, and now we’re hooking a toe line back onto the Titanic.

  13. Cathryn: you hit the nail on the head! (“a massive bank with a small struggling government attached to it.”)

    Everything that’s happened so far has had the effect of making the large banks larger and more entrenched. Geithner will continue that trend.

    I’m surprised that FM quoted this article in the first place, since it’s recommending some kind of partial nationalization — a step usually considered anathema among conservatives.
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    Fabius Maximus replies: First, the articles on this site have long stated that nationalization was the only possible outcome for many or even most of the US money-center banks.

    Second: Is the FM site is a hotbed of conservatism?

    (a) Look at the articles 2008 Presidential Campaign, with all those critical posts about McCain (wasn’t he the Republican candidate?). And the posts about Gov Palin (Alaska – R) were even more critical.

    (b) Articles about America – How can we reform it?. Section 4, about politics. Some of these articles don’t your theory. Like “R.I.P., G.O.P. – a well-deserved end” (7 November 2008).

    (c) Articles about the Iraq & Afghanistan Wars. There are 94 of them, every one hostile to these wars.

    (d) Articles about the Bush Administration’s efforts to build support for a strike at Iran: 20 of them, and they look quite critical of this Bush program.

    (e) Articles about the financial crisis, all 78 of them. Some of these seem quite critical of the Bush Administration.
    * “Slowly a few voices are raised about the pending theft of taxpayer money“, 20 September 2008
    * “The Paulson Plan will buy assets cheap, just as all good cons offer easy money to the marks“, 30 September 2008
    * “A reminder – the TARP program is just theft“, 24 November 2008

    (f) Plus the 23 articles reposted on the FM site from that good leftist Tom Engelhardt (see here).

  14. Nationalisation of banks will just shift the assets to bankers with closer ties to the administration in power. Fascist socialism works a bit differently than Marxist socialism.
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    Fabius Maximus replies: Perhaps so, but it is too late — there is no longer an alternative to nationalization.

  15. The Banks takeover of the taxpayer. Good luck to the Banks owning my town’s taxpayers – increasingly toxic taxpayers , ie unable to pay tax. (Unemployed or cash flow problems.) Lets hope the Banks pay the welfare cheques Also I wonder if the Insurance industry is going down the spout next.
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    Fabius Maximus replies: Deflation results in falling asset prices, which will destroy most firms in the financial sector if it continues long enough. Let’s hope it is stopped long before that point, either by the economy’s natural operation or government action.

  16. FM:” — there is no longer an alternative to nationalization.”

    Yeah, well these days even Greenspan has come out in favor of nationalization, so it’s becoming inevitable in that weird Washington group-think way.

    Greenspan:”You would have to be very careful about imposing any loss on senior creditors of any bank taken under government control because it could impact the senior debt of all other banks… This is a credit crisis and it is essential to preserve an anchor for the financing of the system. That anchor is the senior debt.”

    This looks like the next battle line. Over who exactly has to experience pain with this. Stockholders, obviously have to go down. Does nationalization make all the bank obligations good, or just some, or what? ‘Senior creditors’ Grenspan says should not experience ‘any loss’ at all. So nationalization is a subsidy to these guys if Greenspan has his way because they have government guarantee.

    This says to me there are some others who will have to take a loss — that is the non-senior creditors. Note, he didn’t say all creditors, he said ‘senior creditors.’
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    Fabius Maximus replies: Agreed. The battleground we be about the losses to be “shared” by holders of bank preferred shares and junior debt. And, more important, do we get “pseudo-nationalization” like AIG, or the full monty?

    My guess: it no longer matters, as the storm has moved from the financial sector to the real economy. In six months the government might fully nationalize most of the money center banks, and the story will be on page 3 of the NY Times. Massive unemployment around the world, with riots in the weaker states (emerging nations, esp eastern Europe; the PIGS: Portugal, Italy, Greece, Spain).

  17. Here is the beginning and the conclusion of a blog post by one Alex Jurshevski of “Recovery Partners.” Despite starting from a very different place (“We act as a source of liquidity for holders of non-core and impaired assets, by offering to acquire individual loans and/or portfolios of distressed and off-strategy financial assets”), Jurshevski hammers at some of the same points discussed at length by this site’s host.

    The Politics of Denial meet the Economics of Hypocrisy

    “At every turn this Administration, similar to the last, is making decisions believing that somehow everything will turn out alright in the end – that the massive deficits will be financed overseas, that we in the West are not vulnerable to further financial disruption, that missteps now could never produce social dislocation, not to mention risk heightening geopolitical stress and the probability of conflict.

    “… it is highly questionable, due to the speed of the unfolding crisis and competition for limited investment funds, that the US can play at this for much longer before foreign sources of capital dry up and they are forced to decide whether to bite the bullet and to then implement a set of appropriate policies, or to take their chances and let inflation rip.”

    Jurshevski ends with a quote Das Kapital:

    “Owners of capital will stimulate the working class to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and State will have to take the road which will eventually lead to communism.”

  18. If indeed it is true that there is ‘no alternative to nationalisation’ then the Federal Reserve system has to go too since you cannot have a nationalised banking system dependent upon private sector monetary control.

    Geithner is the ex-head of the New York Fed, hardly someone to take on the powers that sit behind (all of his and our) throne. The only hope for genuine reformation is, unfortunately, collapse. A tax revolt would do it nicely!

    The sort of nationalisation that we are about to get is a more consolidated takeover. The Fed will remain albeit probably now a Big Dog in a new international system centred at the BIS in Switzerland or somesuch.

    Mussolini’s ‘union of state and corporate power’ will soon have evolved such that the difference between nationalisation and privatisation has become irrelevant. What matters is control of the money which in our system means charging interest to governments who borrow it from you. That is what needs to be dismantled, but it looks like the opposite is occurring.
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    Fabius Maximus replies: The Fed is not a private entity in any meaningful sense. It’s key powers are all delegated from Congress, and can be changed at its whim. Its board of directors is appointed by the President and confirmed by the Senate, as with all other high offices.

  19. FM wrote: “The Fed is not a private entity in any meaningful sense. It’s key powers are all delegated from Congress, and can be changed at its whim.”

    Technically correct. But the day a ‘whim’ of Congress can dismantle the Fed is the day America is a far different country! In practice…

    And I believe it is incorrect to state that it is ‘not private in any meaningful sense’ because it is private in the MOST meaningful sense: there is no oversight whatsoever; decisions are taken in secrecy. What more ‘privacy’ could they have? Because much of their operations are secret, there is no telling how much insider information is used by major interests. This is a deliberately conceived ‘black hole’ at the heart of the US financial system. Whether or not nefarious things happen – and of course they do – they should not be so easily permitted as the current structure clearly does.

    A good article by Michael Hudson overviewing ‘rentier’ economy weaknesses and also dealing with the ‘oligarchy’ issue. His conclusion cuts into the current (highly confused and confusing) nationalisation/socialism/capitalism debate rather nicely. Conclusion:

    “Today it is easier to see that the Western economies cannot go on the way they have been. They have reached the point where the debts exceed the ability to pay. Instead of recognizing this fact and scaling debts back into line with the ability to pay, the Obama-Geithner plan is to bail out the big banks and hedge funds, keeping the volume of debt in place and indeed, growing once again through the “magic of compound interest.” The result can only be an increasingly extractive economy, until households, real estate and industrial companies, states and cities, and the national government itself is driven into debt peonage.

    “he alternative is a century and a half old, and emerged out of the ideals of the classical economic doctrines of Adam Smith, David Ricardo, John Stuart Mill, and the last great classical economist, Marx. Their common denominator was to view rent and interest as extractive, not productive. Classical political economy and its successor Progressive Era socialism sought to nationalize the land (or at least to fully tax its rent as the fiscal base). Governments were to create their own credit, not leave this function to wealthy elites via a bank monopoly on credit creation. So today’s neoliberalism paints a false picture of what the classical economists envisioned as free markets. They were markets free of economic rent and interest (and taxes to support an aristocracy or oligarchy). Socialism was to free economies from these overhead charges. Today’s Obama-Geithner rescue plan is just the reverse.”

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    Fabius Maximus replies: The first part about the Fed is arrant nonsense. First, the workings of the Dept of Defense are also secret. Is it also a “private” entity? Second, Erasmus grossly mis-states the degree of secrecy in which the Fed works. For example, the minutes of Fed meetings are released to the public. What other government agencies do so?

    Also, this is both absurd and off-topic. More like this will be deleted.

  20. Here is my contribution…dag into Johnson & Moyers…Don´t Bailout, Don´t Nationalize, Don’t ‘Good’/’Bad Bank’ !!…but Intervene, Capitalize, and Re-Privatize. You Americans now, MUST Confront Against the Oligarchs…

    [ Intervene, Capitalize, and Re-Privatize !!]…this is the way. Nationalization can work only in some particular cases -as it did in Chile- cos’ the banking oligarchy was relatively new, after a leftist regime eroded it for years.

    Not the case for the US…I presume.

  21. I’ll give Obama credit for this much. Not sure about the specifics, but the cramdown proposal, at last, sends a message that the government is looking to do something for the actual homeowners — rather than trying to squeeze every last drop of blood out of them to save the banks.

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