Economix Blog: Simon Johnson: No One Is Above the Law, Even Megabanks

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The American ideal of equal and impartial justice under law has repeatedly been undermined by attempts to concentrate power. Our political system has many advantages, but it also provides motive and opportunity for resourceful people to become so strong they can elude the legal constraints that bind others.

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The most obvious example is the oil and railroad trusts at the end of the 19th century. A version of the same process is happening again today, but what has become concentrated is not a vital energy source or the nation’s transport arteries but rather something much more abstract – financial sector risk.

In early 2009, Treasury Secretary Timothy F. Geithner reportedly said to President Obama and senior members of the new administration, with regard to the financial system (as described by Ron Suskind on Page 202 of “Confidence Men”:

The confidence in the system is so fragile still. The trust is gone. One poor earnings report, a disclosure of a fraud, or a loss of faith in the dealings between one large bank and another — a withdrawal of funds or refusal to clear trades — and it could result in a run, just like Lehman.

Three years later, the megabanks are even bigger, as is the risk they concentrate (see my recent testimony to the financial institutions subcommittee of the Senate Banking Committee for details). Curiously, their precariousness, as much as their power, is shielding these behemoths from the enforcement of financial fraud laws.

Thankfully, this lawlessness – and it is that – nettles some regulators and prosecutors. The New York State attorney general, Eric Schneiderman, is mobilizing the resources for a long-overdue investigation of Wall Street practices that, I hope, will gather momentum.

But the Obama administration continues to dither, arguing behind the scenes that the financial system is still too weak. This inertia – a government at rest tends to stay at rest – has led to public protest and deeply shaken trust in the financial system.

In an important article in The Huffington Post this week, Jeff Connaughton (former chief of staff to Senator Ted Kaufman, Democrat of Delaware) asserts that the Department of Justice failed to concentrate the resources that might have built successful cases:

As The New York Times and New Yorker have reported, the department’s leadership never organized or supported strike-force teams of bank regulators, F.B.I. agents and federal prosecutors for each of the potential primary defendants and ignored past lessons about how to crack financial fraud.

We may never know exactly why the administration failed to organize effectively along these lines, but Mr. Geithner’s influence is likely to have played a role. For his part, President Obama, the few times he was asked, explained that past unethical Wall Street actions were “not illegal.”

Mr. Geithner may dispute details in “Confidence Men” (which was also quoted by Mr. Connaughton in his piece), but worry about system stability is part of the Treasury secretary’s job. Despite a lack of any supporting evidence, Mr. Geithner sees megabanks as essential to the functioning of the economy – and he gambled on bailing them out as a way to restart the economy.

So it would have been entirely logical for him to fear disclosures that would damage their business models and legal viability.

Whenever someone or a group of people is above the law, equality before the law is ended. This is how the megabanks, and the way they are treated, threaten to undermine democracy.

For your holiday reading, pick an example of power and accomplishment gone awry in American history. I suggest the bizarre tale in the new book “American Emperor: Aaron Burr’s Challenge to Jefferson’s America,” by David Stewart, or the classic account of the confrontation between President Andrew Jackson and the Second Bank of the United States in “The Age of Jackson,” by Arthur Schlesinger; or Teddy Roosevelt’s confrontation with the railroad trusts, described in Edmund Morris’s “Theodore Rex.”

Or, if you prefer something more modern, try Richard Reeves’s ultimately sad “President Nixon: Alone in the White House.”

The lesson of these books is that throughout American history, the ultimate constraint is not so much the courtroom but the polling place. And here the classic American feedback mechanism appears to be damaged.

President Obama’s campaigns have taken a great deal of money from Wall Street and, as Mr. Suskind’s book vividly illustrates, have proved consistently reluctant to take on this powerful vested interest. This is why Mr. Geithner is still Treasury secretary.

In “The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities,” Mancur Olson identified the rise of special interests as a problem for all societies – a form of sclerosis sets in. This is a perfect idea for those on the political right; they can cite Friedrich Hayek’s The Road to Serfdom,” no less, on the idea that powerful people seize the state and its ideology to insulate themselves from competition.

Unfortunately, Mitt Romney and Newt Gingrich – the current front-runners for the Republican nomination – are also presumed to have taken or to be seeking a great deal of money from Wall Street. (See this coverage of President Obama and Mr. Romney, and of Mr. Gingrich.)

Ron Paul has expressed concern about big banks. But his only policy recommendation is not to bail them out in the future – that is, just let them fail.

Unfortunately, this philosophy fails to appreciate the true nature of the big banks’ power and the damage they can cause.

Too-big-to-fail banks benefit from an unfair, nontransparent and dangerous subsidy scheme. This isn’t a market mechanism; it’s a government-backed distortion of historic proportions. And it should be eliminated.

Jon Huntsman, the only candidate with a credible plan to break up big banks, is currently polling 13 percent in New Hampshire (although Nate Silver sees hope).

Presidential elections matter, because the winner appoints those who protect – or promise to protect – the public interest. As Mr. Connaughton reminds us:

Repeat financial fraudsters don’t pay relatively paltry — and therefore painless — penalties because of statutory caps on such penalties. Rather, regulatory officials, appointed by Obama, negotiated these comparatively trifling fines.

We could replace these officials with people who are less sympathetic to the banks. But this sympathy comes from fear – the fear of what could happen if a big bank fails. New officials would soon share the old fears.

Our biggest banks pose a real threat; if you hold them accountable for their past actions, they will collapse. The only credible way to counter to this threat – and the only reasonable way to protect our democracy – is to break them up.

Article source: http://feeds.nytimes.com/click.phdo?i=cfb43f22456d32a5cc77e8c1250d61cf