By Neville Bennett
Simon Johnson, who was the chief economist of the IMF, says that the finance industry has captured the US government: a state of affairs which usually describes emerging markets where an oligarchy takes big risks, confident that the government will bail them out.
I think this is an interesting topic as my previous article about oligarchy led to an animated discussion, and some very profound insights and contributions by readers.
What Johnson is saying is that the US is an oligarchy/plutocracy which I earlier defined as 'not merely the rule of the rich, but rule for and by the rich. The rich influence government in such a way as to protect and expand their influence, often at the expense of others'.
We know that the US banks have spent at least $340 million in the last year in lobbying against further regulation.
It has been money well spent as the banks remain pretty free to do as they please, while enjoying a 'too big to fail' status, meaning they can take huge risks and if these do not pay off, the taxpayer will assume the liability. They privatise profit and socialise debt.
I write about US banks, but there are similarities in the moral hazard aspect which involves British banks too, as well as kiwi finance and insurance companies.
Simon Johnson says that the recovery will fail unless we break the financial oligarchy that is blocking essential financial reform. We are running out of time to avert a recession.
This is pretty strong stuff. You do not often get a Professor at an elite university advocating that we 'break the financial oligarchy'.
I doubt he is a disciple of Lenin. I think he is a pragmatist rather than an ideologue. He is also pretty convincing and is well known for a solid book 13 Bankers.
Niall Ferguson sums up the nub of Johnson’s case: 13 Bankers describes the rise of concentrated financial power and the threat it poses to our economic well-being.
Over the past three decades, a handful of banks became spectacularly large and profitable and used their power and prestige to reshape the political landscape. By the late 1990s, the conventional wisdom in Washington was that what was good for Wall Street was good for America.
This ideology of finance produced the excessive risk-taking of the past decade, creating an enormous bubble and ultimately leading to a devastating financial crisis and recession.
More remarkable, the responses of both the Bush and Obama administrations to the crisis–bailing out the megabanks on generous terms, without securing any meaningful reform–demonstrate the lasting political power of Wall Street. The largest banks have become more powerful and more emphatically 'too big to fail', with no incentive to change their behavior in the future. This only sets the stage for another financial crisis, another government bailout, and another increase in our national debt.
The alternative is to confront the power of Wall Street head on, which means breaking up the big banks and imposing hard limits on bank size so they can’t reassemble themselves.
I first encountered Johnson’s thought in a very procative article in The Atlantic where Johnson said that while at IMF he got used to the depressingly similar syndrome where countries queued for loans because international banks had refused them. Each needed to make changes which encouraged exports and cut recessions.
But in every case powerful elites over-reached.
In these countries a tightly-knit oligarchy expected their political connections to absorb their problems. Oligarchs got favourable contracts, tax-breaks and access to foreign capital even though this situation had a whiff of corruption.
The US is now in a situation like South Korea in 1998, Russia and Argentina (time and again).
In these cases foreign investors suddenly assume the country will not be able to pay off is debt, so the affected country finds its credit disappears and it suffers a severe economic contraction. The similarity runs deeper: elite business interests make ever larger gambles with implicit government backing until the inevitable collapse. The elite uses its influence to prevent the reforms necessary to keep the economy out of its nosedive. People blame the regulators for being asleep at the wheel.
In the US financiers had a ball in inventing new profitable practices like securitisation, credit default swaps, and the like from 1973-1985. The financial sector earned 16% of profits, in the 1990’s; it doubled to 30% and in the last decade it was 40% of all profits.
This great wealth gave bankers enormous political weight: the US was the most advanced oligarchy in the world, able to get its way with bribes, lobbying and campaign contributions.
But its real power came from a belief system; the idea that large financial institutions and capital markets were crucial to the US’s position in the world. This was helped by the flow of top people from New York to Washington. Some thought service in Goldman Sachs was a kind of public service.
The banks also convinced the US elite and academia that markets were perfect and self-correcting.
We know Greenspan’s view, but Bernanke also said in 2006 that banks had made great strides in measuring and managing risk. As it happened the US government has spent $180 billion to cover losses deemed impossible by the huge insurer AIG alone.
Washington obligingly passed a river of deregulatory policy:
- free movement of capital across borders.
- repeal of regulation separating investment and commercial banking
- congressional ban on regulating credit default-swaps.
- increased leverage permitted
- an international agreement to allow banks to measure their own riskiness.
Banks were not alone in causing the crisis, but they and the hedge funds were big beneficiaries of the twin housing and stock market bubbles: profiting from a huge number of transactions founded on a small base of assets. [Readers might recall an article I did at the time saying assets were leveraged 40 times].
Despite these insane practices which eventually brought the sector to its knees, vast bonuses were paid out. The CEO of Merril Lynch confessed he had over-invested in sub-prime and walked off with $162 million. In 2008 Wall Street paid out $18 billion in bonuses, while the government had to provide $243 bn in urgent assistance.
Johnson details many dirty deals and concludes that there cannot be a recovery until the banks are healthy.
And, he thinks they must be broken up to become healthy.
The Atlantic article remains an important piece of analysis (I have the space merely to introduce it). Readers who wish to go further, and look at Johnson’s current concerns will find his website interesting.
* Neville Bennett was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR.