Question: Why did you focus your book on a 2009 meeting at the White House?
I was the chief economist at the International Monetary Fund through August of 2008 and when the crisis broke really intensely in September, James Kwak and I set up a blog, Baseline Scenario, where we follow the crisis, we wrote about what was happening, we made policy proposals. We did the kind of thing that I had done at the IMF, but in a completely open source, private sector way for free over the web. And as we wrote and as we were engaged in this analysis we were quite horrified by how well the banks were being treated and the bankers were being treated despite the fact that they had messed up so massively. And it really came together for us in this meeting of 13 bankers at the White House in March of 2009. We felt that that meeting represented a lot of what had gone wrong with policy towards banks and more broadly, in this country and we wrote the book really to try and urge people in Washington and more broadly to reconsider and to change that policy.
This was a key moment, obviously. The Obama Administration had come in. They'd made some initial announcements about how they would deal with the financial sector, but nothing had really come together very clearly. Nothing was really believed in very much by the markets. They pulled these bankers into the White House and they had, at that point, the government, the administration, had the upper hand. They have, remember, the resources. They’re the only people with the resources to save the day in that kind of financial crisis. They can dictate the terms, completely.
Now, you can argue that perhaps you shouldn’t be too heavy-handed in this situation, but they erred completely on the other side. They said, “You will get to keep your banks, complete, as they currently exist,” and everything about your belief system and your incentive system—I mean, everything that got us into trouble remember, everything that caused this massive financial crisis—will remained undisturbed, at least for the time being. That’s extraordinary. That is, I think actually, almost unprecedented in the history of financial crises. For a government to save the day so decisively without conditions, without changing anything about the problems and the structures that have created the crisis. It didn’t make sense then, it doesn’t make sense now, and has created many problems that we have to deal with going forward. Question: Why did the government act in that way? Simon Johnson:
What they say is "We were scared of what would happen if we acted otherwise." What we point out in the book in chapter two is these very same people, these highly experienced, very well-qualified policy makers in the U.S. had, in the 1990’s, advised other countries who got into crisis to do something quite different. They were always on the side of saying, “No, as you seize the moment to turn around the economy and to prevent the crisis from getting worse, you must deal with some of the underlying structural problems. If you don’t then all your efforts of recovery will fail or all short-term benefits will prove illusory. You will have more difficulty again.” It’s a very hard message to deliver, but they delivered it repeatedly to other countries. They just couldn’t apply it to the United States. Question: Why is the deregulation of banks responsible for what we’re dealing with now?
: Well, it is all about the deregulations, some which started, I would say, in the 1970’s, but the Reagan revolution was really a big push for this. Reagan, himself, did not make that much progress, partly because the Congress was in democratic hands. The big move, though, came in the 1990’s when the Democrats had the White House and the spirit of Congress, both in its more Democratic and it’s more Republican phases, was very pro-finance.
So, there are many moments you can point to, particularly around the failure to regulate over-the-counter derivatives, which was a key decision made in 1998 and 1999 and 2000 there was some legislation. That really tipped the whole thing over. But, this process and this change has been building up for a considerable period of time and that of course is one of the things that makes it hard to address quickly and to really deal with fast, because we’re dealing with a problem that’s built up over 30 years.
Between the 1930’s and the mid-1980’s the banks were fairly well controlled. There were tight regulations. Glass-Steagall Act actually had some teeth and some bite, so commercial banks could not go too much into investment banking, more speculative activities and the same was true with the reverse as well. That was a good 50 years; it broke down from mid-1980’s. We need to go back to that post-World War II period when banks were really held accountable. Question: Can we ramp up existing legislation or do we need to start from scratch?
Well, there is, of course, reform legislation on the table. We think that could have gone in a much better direction. We think what is likely to happen will be largely meaningless in terms of making the system less risky and addressing the too big to fail problem, the fact that these banks are just out of control. So, it will take legislation. This legislation almost certainly will not do it; we’re just going to have to do it again. Question: How much regulation do you think is likely?
: Well, I think we will see some better protection for consumers and that’s a good thing and we support that, but in terms of constraining the size, limiting the activities of these massive banks that are seen by the markets as too big to fail and as a result, have this huge, unfair competitive advantage. They can borrow, by some estimates, 75, 80 basis points, that’s 0.7, 0.8 of a percentage point, cheaper than other banks can borrow—that’s a huge difference in today’s market. We think there will be nothing at all or make a difference to that perceived (and probably true) implicit government guarantee in backing those banks. Question: What was really behind the crisis?
: I think at the heart of this problem is a set of people, not a huge set of people-- and this is not anti-finance, this is not anti-Wall Street. I’m a professor of entrepreneurship. I like people who take risk and who put their own money and persuade other people to invest money in genuine risk-taking productivity-enhancing technology-transforming projects. But, there's this core of people who have become very, very powerful who can do enormous damage to the rest of society and honestly, they really don’t care. They’ve made a lot of money in the 2000’s, for example. Some of them have written their memoirs. Many of them just disappear with their hundreds of millions of dollars and they leave it to the rest of us to clean it up. That’s not acceptable. That’s not fair. That’s not reasonable. That’s not how we should organize our society going forward. Question: Are other countries experiencing similar problems?
Other countries have many of the same problems. I think we should look to American history for the solutions. I think we should look at what Teddy Roosevelt did. He took on JP Morgan and he won. We should look at what FDR did. He turned the economy around without kowtowing to the bankers. We should look at what Andrew Jackson did. Andrew Jackson, very controversial figure of course. He said the second bank of the United States in the 1830’s was too powerful and it should be reined in. At lot of people thought that Jackson was out of control and exaggerating until the second bank of the United States started to fight back and it showed its power and it bribed a lot of people and it restricted credit in an attempt to stop Jackson. And that, of course, is what turned public opinion against them. People said, “Oh, my goodness. Andrew Jackson is right.” That’s why his picture’s on the $20 bill. Question: Does anyone in particular deserve blame for the financial crisis?
: It’s not a conspiracy. It’s not an individual financial firm, for example. It’s a system. It’s a system of beliefs and a system of incentives that caused a lot of trouble before and it now remains in place and I would say it’s an ideology. I live in Washington. I interact with them every day. I argue this out. We have the blog where this goes on all the time and the book is just really meant to reinforce and push these points further. But, these people—these very, very powerful people believe that finance is good; unregulated finance is better and huge financial firms essentially unfettered in what they do around the world are the best.
This is wrong. This is incorrect. I’m not a radical of left or right. I’m a centrist. I’m an IMF technocrat if you like. I’m a professor and we bring a lot of people with us on this point. We have a lot of blurbs in the book from people across the political spectrum. The structure we have right now is wrong, it is dangerous, it must be stopped. Question: Is there any value in large banks being as big as they are?
: There is no value to the banks of their current size. There is no evidence, and we go through this in the book and we’ve debated this with all the leading people on the other side. There is no evidence that banks over $100 billion in scale confer benefits on society. Now, we’re looking at banks that are $2 trillion, $2.5 trillion, which is the case of Citigroup before the crisis. Of course, there's bigger bonuses for the guys who work there and the guys who run it, but all society is getting is this big, downside risk, these massive crises. Push them back to a couple hundred billion dollars. That’s our point. And then you get plenty of benefits from the scale and less danger. Question: Was the financial meltdown the result of a conspiracy?
: No, there's no conspiracy. Conspiracies, honestly, would be relatively easy to root out and expose and fight against. This is not a conspiracy. This is a system of beliefs. This is the way people think. This is what they have come to convince themselves of because Wall Street did so well, because they made so much money, became very prestigious and a lot of people drank the Kool-Aid, if you like. The belief is this is the way it’s got to be and that’s what we’re fighting against. This book is a counter on the ideological, on the belief system and we have the evidence, we have the facts, we have a lot of people on our side. Question: Have Washington’s actions so far made another meltdown more or less likely? Simon Johnson
: Oh, they made it more likely. I mean, that’s the point of keeping the bankers in place and keeping their entire incentives in place. Look, they weren't even embarrassed by what happened. Okay, maybe there were 20 minutes that it was a little bit awkward, but that’s it and these people, I can assure you, have no remorse. And, as far as they're concerned, it was a great trade. They made a lot of money. That’s what they care about, the bottom line. They did well out of this. Make no mistake, they’ll do it again. Question: How will the next financial crisis occur?
Secretary [Tim] Geithner says this crisis, this kind, only occur every 40 years. Hank Paulson, former Secretary of Treasury says they're every four to six years. Jamie Dimon, the head of JP Morgan Chase, says every five to seven years. So, this is a key issue. Our view is that the structure of the financial system has changed over the past 30 years so that these kind of crises now become more likely and we think that the most obvious source of danger now is in emerging markets.
People are convinced that China, for example, can only go up. Any investment there will make easy money they tell you. There is a lot of savings coming from middle-income countries that come into US and European banks and then come out again to those emerging markets, much like they did in the 1970’s. A sort of a movement of capital around the world through our banks. It’s all based on debt and it will be based, if people buy into this idea of the new boom in emerging markets, it will be based on unsustainable build up of debt in those places, probably around the private sector in their companies. And this will lead us into deep trouble, not just in those countries, but also for our banks that are pushing the debt and selling the debt. So, here we go again. Question: How soon will this happen?
: That’s hard to say. The timing of the cycle we’ve seen recently which suggests it’s a three to four to five year cycle we’re in. But honestly, if it’s 10 years or 12 years and at the end of it there's a cataclysmic collapse of the kind we just saw in 2008/2009, then that is something we should also be acting to prevent. You cannot do this every 10 years without really horrible consequences for a lot of people in society. Question: What keeps you up at night?
: I worry about the financial system and worry that people are going to forget. Attention is hard to sustain, particularly these days. You get a lot of focused attention, that’s an advantage of the Internet, and people grab onto issues and I think people have been very worried about these massive banks. But it will pass. Other things come up. The baseball season is just starting, always a great distraction. Many other issues will come to the fore and people will forget. And of course that is exactly what these masters of the universe and the fascists are counting on. As long as they can keep their positions and hold onto what they have, the public anger and the frustration will drift away and they can go back to doing what they were doing before.
And that is really very dangerous. That is dangerous toward democracy, frankly. That’s what Thomas Jefferson said, correctly, at the beginning of the Republic. He said, “Fear the emergence of a financial aristocracy,” and we’ve had a few episodes, we’ve had some fights with them along the way. And Andrew Jackson won, Teddy Roosevelt won, FDR won. Now we have to do it again, but we have to do a modern version, right? The world is more complex, attention is more fleeting, politics are different, campaign contributions are massive. The Supreme Court says they can give as much money as they want. This is going to be quite a fight. Question: Are you an optimist or a pessimist?
: I’m an immigrant. I’ve been here 25 years. I became an American citizen. I thought about it long and hard and I studied for the test and I did well on the test, the citizenship test... and I believe in this American project. I think it has survived for 200 years for a reason. I think it’s a Republic that was well designed and while some of its structures and some of the initial language might seem anachronistic, it is actually a framework within which you can deal with big problems that come up and one of the biggest problems is because we’re very innovative people, because we’re very dynamic, we build new things fast and we allow new people to come to the fore, we also allow massive wealth to develop and a great deal of capture. At the end of the 19th century, the so-called gilded age, there was enormous income inequality in the United States. There were huge monopolies and Teddy Roosevelt said it was out of control. He decided to take JP Morgan’s railroad monopolies called Northern Securities to the Supreme Court. J.P. Morgan came to see him at the White House and he said, “If we’ve done anything wrong, send your men to see my men and we’ll fix it up.” And Roosevelt said, “No. We’re going to go to the Supreme Court. We’re going to see this through,” and he won five to four and from that came the anti-trust movement and from that came the breakup of Standard Oil and all the other massive companies.
The consensus, the view we have—big is beautiful, big is high quality, big is great—does not apply to the financial sector. We need a new Teddy Roosevelt. We need political leadership that can take that message, build an alliance, seize the moment and put us all on a path to a better century.
Recorded on March 31, 2010