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THE POLITICAL ECONOMY OF THE BANKING CRISIS.
Simon Johnson's piece in the upcoming Atlantic is one of those must-ready things bloggers occasionally go on about. But it's not a fun must-read. It's more of a depressing must-read. Sort of like watching Hotel Rwanda.
The central thesis is that America's financial crisis is as much a problem of political power as of economics. Ridding the banks of toxic assets without ridding the political system of the bank's influence will prove, in the long-run, insufficient. What's so depressing about Johnson's article is that his insights come because he's examining America in much the same way he'd examine a banana republic. As a former IMF troubleshooter, he's used to assessing the financial problems of small economies and delivering unwelcome news. In most cases that news is uniquely unwelcome to the elites who birthed the problem and must now be displaced. "The biggest obstacle to recovery," he says, "is almost invariably the politics of countries in crisis." Different countries, of course, protect their elites in different ways. And the American system has developed a process of power transmission that is particularly subtle, and will likely prove particularly difficult to undermine:
In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption—envelopes stuffed with $100 bills—is probably a sideshow today, Jack Abramoff notwithstanding.
Instead, the American financial industry gained political power by amassing a kind of cultural capital—a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors the way, for example, the tobacco companies or military contractors might have to. Instead, it benefited from the fact that Washington insiders already believed that large financial institutions and free-flowing capital markets were crucial to America’s position in the world.
We let the financial sector have free rein of our political system because we believed they deserved it. To paraphrase Calvin Coolidge, the prevailing sentiment held that what's good for investment banks was good for America. And in some ways, the current crisis has only emphasized that belief: What's been bad for investment banks has, after all, been very bad for America.
The implicit mission of the Treasury Department has been to restore the financial sector, not replace it. Christina Romer explained that "private firms that are kind of doing us a favor...coming into this market to help us buy these toxic assets off banks' balance sheets," and Geithner spoke of the "financial expertise" needed to price the assets that the financial system originally mispriced. We're angry at the financial sector, but it's not clear that our government has actually lost faith in it. On Friday, in fact, Obama held a summit with 15 of the nation's top bankers where Bank of America CEO Ken Lewis explained that "at some point you have to stop focusing on the past, and focus on the present." Robert Kelly, CEO of Bank of New York Mellon, agreed. "Our interests are very much aligned with the administration's," he said.
What makes this crisis different, Johnson argues in his article, is not that the economic fundamentals are different, but that the political fundamentals are. Smaller economies needed the IMF. By the time they came to Johnson, they were in a position where they had no choice but to make difficult decisions and upend their existing political economies. The U.S., by contrast, "is the world’s most powerful nation, rich beyond measure, and blessed with the exorbitant privilege of paying its foreign debts in its own currency, which it can print. As a result, it could very well stumble along for years—as Japan did during its lost decade—never summoning the courage to do what it needs to do, and never really recovering." No one can make us do anything.
Depressing stuff. But don't take my word for it. Some banks are too big to fail and some articles are too good to blog. Read the whole thing.
COMMENTS (15)
Atlantic has the history of such articles. Path breaking nature of this article reminds me another article by another Atlantic luminary - James Fallows - in another era; when I wrote the first impressions and analysis of Iraq war when the insurgency was at its peak. That article shook up American political establishment.
I am expecting that Simon's this article will do the same thing.
Is there way we can force 'each and every' member of Congress to read this article? Any public official worth her or his salt needs to read it, digest it, mull over it and start working on what is said there.
And this means Messers Geithner, Summers and Christina Romer have some serious home work cut of for themselves. If these individuals have any iota of 'intellectual honesty' (and many of them work in Universities); then there is simply no way for them to avoid answering / responding what Simon is saying here.
Posted by: Umesh Patil | March 30, 2009 12:42 PM
Correction -
'....Path breaking nature of this article reminds me another article by another Atlantic luminary - James Fallows - in another era; when he wrote the first impressions and analysis of Iraq war when the insurgency was at its peak.
Posted by: Umesh Patil | March 30, 2009 12:44 PM
Umesh Patil: If these individuals have any iota of 'intellectual honesty'
LOL! Does the fox have any 'intellectual honesty' with respect to the ethics of raiding the hen house?
Better that everyone except those clowns read this article, and threaten a revolution if they don't get rid of this corruption.
and many of them work in Universities
Ah, unsullied bastions of intellectual honesty (especially in the economics departments).
Posted by: alex | March 30, 2009 1:00 PM
And that will be pretty much the death of any Democratic resurgence.
Thanks obama! So glad I supported you in the primaries! At least I know Clinton would be doing these same damned things. Should have gone with the philanderer. That does usually seem to work out best for us anyway.
Posted by: soullite | March 30, 2009 1:04 PM
It's a good article, but there's a lot to object to in it. A couple of things:
1. Johnson compares the government responses in IMF rescues to the US response in the current crisis, and, finding them similar, projects a similar trajectory in both cases. But there's very little discussion of how the underlying mechanics of each crisis are similar, other than noting lots of debt and deregulation were involved. That might seem picky, but we're already comparing apples and oranges here, so without a direct comparison of how the crises evolved, it's pretty hard to conclude that Malaysia and the United States should proceed identically, with "overwhelming force."
2. I don't buy his claim that the latest crisis has increased financial industry influence in Washington. No, it's increased visible financial influence in Washington, but it's still better than it was a few years ago, when regulations were being struck down left and right and the good folk in Washington were hardly batting an eye. In any case, the crisis is such that a certain amount of political cooperation with the finance industry is necessary, but it's a bit of stretch to read this as collusion. It's like saying that because a hostage is doing what an armed robber has asked him to do, he's complicit in the robbery.
3. I think Johnson also vastly oversimplifies the possible conclusions to the crisis. He totally ignores the possibility of incremental or cautious reform, instead suggesting reform will only happen if we edge towards a depression. But what really throws me is that he seems to think risking a second Great Depression is the better scenario, because it allows us to truly reform the banking system. Sorry Simon, but I'll take the near-indefinite continuation of financial "confusion" and "torpor," taxing on this country though it may be, over a 25% GDP drop and the unheard-of suffering that will inflict on Americans and people around the world.
Posted by: WHS | March 30, 2009 1:34 PM
What bothers me about Johnson's argument is that it presumes it was the right thing for the IMF to propose sweeping structural reforms in Latin/South American countries as a condition of receiving aid. I don't think it was, for the simple reason that China has corrupt banks, and India is not a stranger to corruption and inefficiency, yet they were untouched by the crisis, *not* because they were any more moral or any more willing to crack down on their elites, but because they had a financial architecture which did not leave them vulnerable to hot money flows in the way that Thailand and Indonesia and Brazil (and later Argentina)were.
previous comment I left on Yglesias's blog, linking to a good Krugman & WSJ article.
http://yglesias.thinkprogress.org/archives/2009/03/simon_johnson_is_making_sense.php#comment-1212274
Posted by: roublen | March 30, 2009 1:38 PM
And we have yet another example of how substantive reform is almost impossible without institutional reform - whether it be in the Senate or the campaign finance system. Right now neither party can get away with alienating the financial industry, because if they do the other party will pour tens of millions into the other party.
Posted by: arbitrista | March 30, 2009 1:48 PM
I don't save many articles from the web. But I saved Simon Johnson's so I could savor it sometime in the future when his 5-alarm signal was wrongly ignored and the whole block (not just a house or two) burned down, and everyone is saying hoocodanode.
Ya, Obama's financial team seems to have the blinders on. What really bothers me is that he doesn't have a 'shadow group' of naysayers like Johnson, Krugman, Stiglitz and (many) others invited to meet both privately with him to give unvarnished opinions, and to meet with his financial team for some real debate. I thought Obama promised reality and pragmatic openness.
Not once that I can recall have any of the financial team addressed with substantative arguments those who oppose bailouts and protection for banks. Major team-Obama failure!
Regarding the IMF: Smaller economies needed the IMF. By the time they came to Johnson, they were in a position where they had no choice but to make difficult decisions and upend their existing political economies.
The asian countries really didn't like the IMF remedies they were forced into when they had foreign capital being withdrawn very quickly. They resented it enough that they resolved to build their own foreign currency reserves and invest them in US treasuries, arguably allowing the US to overborrow at low rates and set off our own overconsumption and debt-resorting ways.
I don't mind political mistakes. As Obama says, they are going to happen. But with US debt pushing the frontiers of credibility, we can't just say (later) we made a mistake. Version 2.0 of this recession/depression might well be actually catastrophic, as Johnson hints at.
The stakes for the younger parts of our citizenry couldn't be higher (while death eases the burden at some point for the olders.)
The US could well end up as a second tier actor in this ongoing revolution of global wealth redistribution.
Posted by: JimPortlandOR | March 30, 2009 1:49 PM
I don't save many articles from the web. But I saved Simon Johnson's so I could savor it sometime in the future when his 5-alarm signal was wrongly ignored and the whole block (not just a house or two) burned down, and everyone is saying hoocodanode.
Ya, Obama's financial team seems to have the blinders on. What really bothers me is that he doesn't have a 'shadow group' of naysayers like Johnson, Krugman, Stiglitz and (many) others invited to meet both privately with him to give unvarnished opinions, and to meet with his financial team for some real debate. I thought Obama promised reality and pragmatic openness.
Not once that I can recall have any of the financial team addressed with substantative arguments those who oppose bailouts and protection for banks. Major team-Obama failure!
Regarding the IMF: Smaller economies needed the IMF. By the time they came to Johnson, they were in a position where they had no choice but to make difficult decisions and upend their existing political economies.
The asian countries really didn't like the IMF remedies they were forced into when they had foreign capital being withdrawn very quickly. They resented it enough that they resolved to build their own foreign currency reserves and invest them in US treasuries, arguably allowing the US to overborrow at low rates and set off our own overconsumption and debt-resorting ways.
I don't mind political mistakes. As Obama says, they are going to happen. But with US debt pushing the frontiers of credibility, we can't just say (later) we made a mistake. Version 2.0 of this recession/depression might well be actually catastrophic, as Johnson hints at.
The stakes for the younger parts of our citizenry couldn't be higher (while death eases the burden at some point for the olders.)
The US could well end up as a second tier actor in this ongoing revolution of global wealth redistribution.
Posted by: JimPortlandOR | March 30, 2009 1:49 PM
WHS: I don't buy his claim that the latest crisis has increased financial industry influence in Washington. No, it's increased visible financial influence in Washington, but it's still better than it was a few years ago
Once the house is on fire, you don't need a strict disciplinarian to figure out that you shouldn't let children play with matches.
When you say "better", how much better? They're getting incredible sweetheart deals. And I don't think his point is that they now have more influence, but that they've long had too much influence.
Posted by: alex | March 30, 2009 1:55 PM
Yes, the IMF is the valiant crusader against oligarchies and corporate interests! No one could possibly ever be upset with them for going in and wiping out social safety nets and privitizing everything from social security systems to water. Who could ever object to something like that?! The only time there are ever riots is agains the corrupt oligarchs, never against the IMF reforms.
While there is some good stuff in there, it really is a load of self-serving !#@$!#@. Compare Europe, with its strong social safety net and relatively stable response to the global downturn, with places the IMF has burned to the ground.
Posted by: Dan | March 30, 2009 2:20 PM
Alex,
Johnson explicitly says that their "political strength" has increased since the meltdown. I absolutely agree that the finance industry had too influence much previously, but to use your analogy, he seems to think that because we haven't let the children burn to death in the fire, we're not teaching them enough of a lesson.
Clearly some of the lines connecting Wall Street and Washington are still open - and that has probably resulted in some lighter-handed policies than we'd like, although we're not yet in a position to know for certain - but it's hard to imagine how wrecking the economy and becoming an absolute national pariah has improved Wall Street's ability to sway government policy.
Posted by: WHS | March 30, 2009 2:22 PM
It does my nerdy heart good to see an economist explaining that the problem is ideology.
Posted by: cate | March 30, 2009 2:23 PM
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Sarah
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Posted by: Sarah | April 8, 2009 3:25 AM
I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.
Sarah
http://www.craigslisttool.info
Posted by: Sarah | April 8, 2009 3:28 AM