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The Government Saves the Banks—Without Conditions

Question: Why did you focus your book on a 2009 meeting at the\r\n White House? 

Simon Johnson: I was the chief \r\neconomist at the International Monetary Fund through August of 2008 and \r\nwhen the crisis broke really intensely in September, James Kwak and I \r\nset up a blog, Baseline Scenario, where we follow the crisis, we wrote \r\nabout what was happening, we made policy proposals. We did the kind of \r\nthing that I had done at the IMF, but in a completely open source, \r\nprivate sector way for free over the web. And as we wrote and as we were\r\n engaged in this analysis we were quite horrified by how well the banks \r\nwere being treated and the bankers were being treated despite the fact \r\nthat they had messed up so massively. And it really came together for us\r\n in this meeting of 13 bankers at the White House in March of 2009. We \r\nfelt that that meeting represented a lot of what had gone wrong with \r\npolicy towards banks and more broadly, in this country and we wrote the \r\nbook really to try and urge people in Washington and more broadly to \r\nreconsider and to change that policy. 

This was a key moment, \r\nobviously. The Obama Administration had come in. They'd made some \r\ninitial announcements about how they would deal with the financial \r\nsector, but nothing had really come together very clearly. Nothing was \r\nreally believed in very much by the markets. They pulled these bankers \r\ninto the White House and they had, at that point, the government, the \r\nadministration, had the upper hand. They have, remember, the resources. \r\nThey’re the only people with the resources to save the day in that kind \r\nof financial crisis. They can dictate the terms, completely. 

Now,\r\n you can argue that perhaps you shouldn’t be too heavy-handed in this \r\nsituation, but they erred completely on the other side. They said, “You \r\nwill get to keep your banks, complete, as they currently exist,” and \r\neverything about your belief system and your incentive system—I mean, \r\neverything that got us into trouble remember, everything that caused \r\nthis massive financial crisis—will remained undisturbed, at least for \r\nthe time being. That’s extraordinary. That is, I think actually, almost \r\nunprecedented in the history of financial crises. For a government to \r\nsave the day so decisively without conditions, without changing anything\r\n about the problems and the structures that have created the crisis. It \r\ndidn’t make sense then, it doesn’t make sense now, and has created many \r\nproblems that we have to deal with going forward. 

Question:\r\n Why did the government act in that way? 

Simon Johnson:\r\n What they say is "We were scared of what would happen if we acted \r\notherwise." What we point out in the book in chapter two is these very \r\nsame people, these highly experienced, very well-qualified policy makers\r\n in the U.S. had, in the 1990’s, advised other countries who got into \r\ncrisis to do something quite different. They were always on the side of \r\nsaying, “No, as you seize the moment to turn around the economy and to \r\nprevent the crisis from getting worse, you must deal with some of the \r\nunderlying structural problems. If you don’t then all your efforts of \r\nrecovery will fail or all short-term benefits will prove illusory. You \r\nwill have more difficulty again.” It’s a very hard message to deliver, \r\nbut they delivered it repeatedly to other countries. They just couldn’t \r\napply it to the United States. 

Question: Why is the \r\nderegulation of banks responsible for what we’re dealing with now? 

Simon\r\n Johnson: Well, it is all about the deregulations, some which \r\nstarted, I would say, in the 1970’s, but the Reagan revolution was \r\nreally a big push for this. Reagan, himself, did not make that much \r\nprogress, partly because the Congress was in democratic hands. The big \r\nmove, though, came in the 1990’s when the Democrats had the White House \r\nand the spirit of Congress, both in its more Democratic and it’s more \r\nRepublican phases, was very pro-finance. 

So, there are many \r\nmoments you can point to, particularly around the failure to regulate \r\nover-the-counter derivatives, which was a key decision made in 1998 and \r\n1999 and 2000 there was some legislation. That really tipped the whole \r\nthing over. But, this process and this change has been building up for a\r\n considerable period of time and that of course is one of the things \r\nthat makes it hard to address quickly and to really deal with fast, \r\nbecause we’re dealing with a problem that’s built up over 30 years. 

Between\r\n the 1930’s and the mid-1980’s the banks were fairly well controlled. \r\nThere were tight regulations. Glass-Steagall Act actually had some teeth\r\n and some bite, so commercial banks could not go too much into \r\ninvestment banking, more speculative activities and the same was true \r\nwith the reverse as well. That was a good 50 years; it broke down from \r\nmid-1980’s. We need to go back to that post-World War II period when \r\nbanks were really held accountable. 

Question: Can we \r\nramp up existing legislation or do we need to start from scratch? 

Simon\r\n Johnson: Well, there is, of course, reform legislation on the \r\ntable. We think that could have gone in a much better direction. We \r\nthink what is likely to happen will be largely meaningless in terms of \r\nmaking the system less risky and addressing the too big to fail problem,\r\n the fact that these banks are just out of control. So, it will take \r\nlegislation. This legislation almost certainly will not do it; we’re \r\njust going to have to do it again. 

Question: How much \r\nregulation do you think is likely? 

Simon Johnson: \r\nWell, I think we will see some better protection for consumers and \r\nthat’s a good thing and we support that, but in terms of constraining \r\nthe size, limiting the activities of these massive banks that are seen \r\nby the markets as too big to fail and as a result, have this huge, \r\nunfair competitive advantage. They can borrow, by some estimates, 75, 80\r\n basis points, that’s 0.7, 0.8 of a percentage point, cheaper than other\r\n banks can borrow—that’s a huge difference in today’s market. We think \r\nthere will be nothing at all or make a difference to that perceived (and\r\n probably true) implicit government guarantee in backing those banks. 

Recorded on March 31, 2010

At a White House gathering in early 2009, the administration bailed out the banking system without addressing the problems on Wall Street that caused the financial meltdown.

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