Break the Financial Oligarchy
The Atlantic, May 2009
Edited by Andy Ross
The International Monetary Fund specializes in telling its clients what they
don't want to hear. The real problem is almost invariably the politics of
countries in crisis. Typically, these countries are in crisis because their
powerful elites overreached in good times and took too many risks.
The US economic and financial crisis is reminiscent of recent crises in
emerging markets: South Korea (1997), Malaysia (1998), Russia and Argentina
(time and again). In each of those cases, global investors, afraid that the
country or its financial sector wouldn't be able to pay off mountainous debt,
suddenly stopped lending.
Financiers played a central role in creating the current crisis, making
ever-larger gambles, with the implicit backing of the government, until the
inevitable collapse. They are now using their influence to prevent the reforms
that are needed. For the past 25 years or so, the financial industry has boomed,
becoming ever more powerful.
In a primitive political system, power is transmitted through violence. In a
less primitive system, power is transmitted via money. The US financial
industry gained political power by feeding the belief that what was good
for Wall Street was good for the country.
One channel of influence was the flow of individuals between Wall Street and
Washington. At the IMF, I was struck by the easy access of leading financiers to
the highest U.S. government officials, and the interweaving of the two career
tracks. A whole generation of policy makers has been mesmerized by Wall Street.
From the confluence of campaign finance, personal connections, and ideology
there flowed an astonishing river of deregulatory
policies. The mood that accompanied these measures in Washington seemed to be
that finance unleashed would continue to propel the economy to greater heights.
Many other factors contributed to the financial crisis that exploded last year,
including excessive borrowing by households and lax lending standards out on the
fringes of the financial world. But each time a loan was sold, packaged,
securitized, and resold, banks took their transaction fees, and the hedge funds
buying those securities reaped ever-larger fees as their holdings grew.
In the summer of 2007, the boom had produced so much debt that rising
delinquencies in subprime mortgages caused a stumble. Ever since, the financial
sector and the federal government have been behaving as one would expect. But financial elites have
continued to assume that their favored position is safe.
In a financial panic, the government must respond with both speed and
overwhelming force. The root problem is uncertainty. The longer the response
takes, the longer the uncertainty will cripple the economy. Yet the principal characteristics of the
government’s response to the financial crisis have been delay, lack of
transparency, and an unwillingness to upset the financial sector.
Throughout the crisis, the government has taken extreme care not to upset the
interests of the financial institutions, or to question the basic outlines of
the system that got us here. This approach is inadequate to change
the behavior of a financial sector accustomed to doing business on its own
The challenges the United States faces are familiar territory to the people at
the IMF. If you hid the name of the country and just showed them the numbers,
the IMF would say: nationalize troubled banks and break them up as necessary.
The IMF would advise scaling up the standard Federal Deposit Insurance
Corporation process. An FDIC intervention would allow the government to wipe out
bank shareholders, replace failed management, clean up the balance sheets, and
then sell the banks back to the private sector. According to IMF numbers, the
cleanup of the banking system would probably cost close to $1.5 trillion (or 10
percent of GDP) in the long term.
The IMF would also advise the government to break the power of the financial
oligarchy. Big banks should be sold in medium-size pieces. The efficiency costs
of a more fragmented banking system are real. But so are the costs when a bank
that is "too big to fail" fails.
The United States could stumble along for years without doing what it needs to
do. No one at the IMF can force it to make a clean break with the past.
Simon Johnson was
Economic Counselor and Director of the Research Department at the IMF in 2007 and 2008,
on leave from the Sloan School of Management at MIT.
AR I agree — a clean break is needed
but is not yet assured.