Of course banks resist reform, MIT professor says

SF Public Press
 — Jul 20 2010 - 6:31pm

Q&A with Simon Johnson, the MIT professor of economics and former chief economist of the International Monetary Fund.

As the financial crisis drags on, Congress and the Obama administration are taking up regulatory reform of the banks at the center of the crisis. Johnson, author of "13 Bankers: The Wall Street Takeover and the Next Financial Meltdown," shared his views May 13 before the World Affairs Council.

Question: This year we have already seen the failure of 68 banks, twice the failure rate of last year. In fairness, should the government be bailing out these medium and small banks, and are we perpetuating the problem of “too big to fail” by allowing smaller banks to fail?

Answer: Well, we are certainly perpetuating the problem of too big to fail; that is for sure. And it's very unfortunate, and we should address that. However, I wouldn't favor saving small- and medium-sized banks. They are failing because they made bad business decisions. And it's appropriate for business to fail when they make mistakes. The problem is that the biggest banks don't fail, can't fail, will not be allowed to fail. That's where the problem lies.

Q: We see a revolving door between banking institutions and government. Do you think that is problematic, and, if so, how can it be addressed?

A: The revolving door is definitely, definitively a problem. I think what we need is tighter safeguards in the form of more restriction on government employees. You certainly should not be allowed to work on a bill, or a set of regulations, and then turn around in a week or a month and go to work for people who are trying to game that regulation, or play game with regulators more broadly. You need some code of conduct, or whatever you want to call it, within the administration.

Q: Do you believe that banks foresaw the economic crisis, and if so did they sleep easy knowing that in a worstcase scenario the government would be obliged to bail them out?

A: That's a very good question. It’s hard to know. I think they felt at various points that they had some privileges and some advantage. And this encouraged them to take risks. They also made some mistakes prior to September 2008. The interesting point and the important point is not what they felt prior to 2008, but how they feel now, because now they have proved to themselves and to everyone else that theyare indeed too big to fail. They know this for sure, and the financial markets know this. They can now borrow more cheaply than their smaller competitors. So now going forward, this is front and center of our problems.

Q: In your book, you advocate for a major financial overhaul of the system. Is there still the political will in the country to move in that direction?

A: I think President Obama missed a very important opportunity to make big changes in the financial system when he first came into office. It would have been difficult. But there is no question that he and his advisers decided to pass on that and just focus on putting the existing system back on its feet. Now there is some political will for change. The administration has woken up to the fact that this system is very dangerous and they are pushing for reform. But now the banks are strong again. Now the banks are making money. The banks spend, according to the administration’s own estimates, $1.4 million a day on lobbying. And of course they are resisting, with all their energy, attempts to reform them. 

Q: You speak in your book about a new American oligarchy. Do you feel these large investment banks are antithetical to a democratic system?

A: I think when you have very large concentrated economic power you tend to get concentrated political power. Concentrated political power is absolutely not consistent with democracy. We have seen this multiple times in American history. There was a big showdown between President Jackson and the biggest bank in the country in the 1830s. Teddy Roosevelt had a big showdown with the leading industrial magnates and financiers, including J.P. Morgan, in the early 1900s, and FDR had a big bust-up, successful in the end, with the major banks in the 1930s. So we have seen exactly this confrontation before in American history and it is very clear what has to happen. The democratic side either prevails or we will go down a route that takes us away from democracy and takes us away from good outcomes for most of the people in the country.

A version of this article was published in the summer 2010 pilot edition of the San Francisco Public Press newspaper. Read select stories online, or buy a copy.