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Simon Johnson is a Professor of Entrepreneurship at MIT Sloan School of Management. He is a co-founder of the economic blog, and the former Chief Economist at the International[…]

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.

Question: Why did you focus your book on a 2009 meeting at thern White House? 

Simon Johnson: I was the chief rneconomist at the International Monetary Fund through August of 2008 and rnwhen the crisis broke really intensely in September, James Kwak and I rnset up a blog, Baseline Scenario, where we follow the crisis, we wrote rnabout what was happening, we made policy proposals. We did the kind of rnthing that I had done at the IMF, but in a completely open source, rnprivate sector way for free over the web. And as we wrote and as we werern engaged in this analysis we were quite horrified by how well the banks rnwere being treated and the bankers were being treated despite the fact rnthat they had messed up so massively. And it really came together for usrn in this meeting of 13 bankers at the White House in March of 2009. We rnfelt that that meeting represented a lot of what had gone wrong with rnpolicy towards banks and more broadly, in this country and we wrote the rnbook really to try and urge people in Washington and more broadly to rnreconsider and to change that policy. 

This was a key moment, rnobviously. The Obama Administration had come in. They'd made some rninitial announcements about how they would deal with the financial rnsector, but nothing had really come together very clearly. Nothing was rnreally believed in very much by the markets. They pulled these bankers rninto the White House and they had, at that point, the government, the rnadministration, had the upper hand. They have, remember, the resources. rnThey’re the only people with the resources to save the day in that kind rnof financial crisis. They can dictate the terms, completely. 

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

Question:rn Why did the government act in that way? 

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

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

Simonrn Johnson: Well, it is all about the deregulations, some which rnstarted, I would say, in the 1970’s, but the Reagan revolution was rnreally a big push for this. Reagan, himself, did not make that much rnprogress, partly because the Congress was in democratic hands. The big rnmove, though, came in the 1990’s when the Democrats had the White House rnand the spirit of Congress, both in its more Democratic and it’s more rnRepublican phases, was very pro-finance. 

So, there are many rnmoments you can point to, particularly around the failure to regulate rnover-the-counter derivatives, which was a key decision made in 1998 and rn1999 and 2000 there was some legislation. That really tipped the whole rnthing over. But, this process and this change has been building up for arn considerable period of time and that of course is one of the things rnthat makes it hard to address quickly and to really deal with fast, rnbecause we’re dealing with a problem that’s built up over 30 years. 

Betweenrn the 1930’s and the mid-1980’s the banks were fairly well controlled. rnThere were tight regulations. Glass-Steagall Act actually had some teethrn and some bite, so commercial banks could not go too much into rninvestment banking, more speculative activities and the same was true rnwith the reverse as well. That was a good 50 years; it broke down from rnmid-1980’s. We need to go back to that post-World War II period when rnbanks were really held accountable. 

Question: Can we rnramp up existing legislation or do we need to start from scratch? 

Simonrn Johnson: Well, there is, of course, reform legislation on the rntable. We think that could have gone in a much better direction. We rnthink what is likely to happen will be largely meaningless in terms of rnmaking the system less risky and addressing the too big to fail problem,rn the fact that these banks are just out of control. So, it will take rnlegislation. This legislation almost certainly will not do it; we’re rnjust going to have to do it again. 

Question: How much rnregulation do you think is likely? 

Simon Johnson: rnWell, I think we will see some better protection for consumers and rnthat’s a good thing and we support that, but in terms of constraining rnthe size, limiting the activities of these massive banks that are seen rnby the markets as too big to fail and as a result, have this huge, rnunfair competitive advantage. They can borrow, by some estimates, 75, 80rn basis points, that’s 0.7, 0.8 of a percentage point, cheaper than otherrn banks can borrow—that’s a huge difference in today’s market. We think rnthere will be nothing at all or make a difference to that perceived (andrn probably true) implicit government guarantee in backing those banks. 
Recorded on March 31, 2010