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Today’s Economist: Simon Johnson: Twelve Angry Central Bankers

February 21, 2013 by Leave a Comment

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Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

This does not happen very often: the 12 presidents of Federal Reserve Banks have spoken with great clarity and in public on a financial reform issue: the need to change the rules for money-market funds. They are explicitly taking on the biggest banks and their allies, including some recalcitrant officials.

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While this will be a long haul – and these central bankers need a lot of external support – we are starting to see some progress toward building a new, more skeptical understanding of how the financial system works.

As far as I have been able to determine, the comment letter submitted on Feb. 12 by the Federal Reserve Bank of Boston – on behalf of all the regional Fed banks – was literally the first time these 12 organizations have spoken with one public voice without involving the Fed’s Board of Governors.

The Federal Reserve System – 100 years old this year – has a curious legal structure. The system comprises a very powerful Board of Governors and the 12 regional banks, with each of the latter nominally owned by member banks in its region. (Before the 1930s, the Washington-based board was less important, and the New York Fed was arguably the most powerful element of the system; see Liaquat Ahamed’s brilliant Pulitzer Prize-winning history of that period, “Lords of Finance: The Bankers Who Broke the World.”)

Ben Bernanke, as chairman of the Board of Governors, sits on the Financial Stability Oversight Council, a new body created by the Dodd-Frank financial-reform legislation to watch for systemic risks. This council has called for comments regarding a proposal for the reform of money-market funds, and Mr. Bernanke can hardly comment on his own ideas.

But the regional Feds are separate legal entities, and they are allowed to comment, so we get some unusual insight into sensible official thinking.

The problem is straightforward. Money-market funds operate in some ways like banks – their liabilities are regarded by investors to be just like bank deposits when times are good. But when times are scary – as when Lehman Brothers failed in September 2008 – there can be rapid and destabilizing runs by investors out of the funds. What we saw in fall 2008 had the potential to become even more damaging than the bank runs that characterized moments of panic before the introduction of deposit insurance.

The industry proposes to deal with this by allowing temporary restrictions on withdrawals when the pressure is on. This is a terrible idea that will just encourage people to run sooner and faster.

Of course, what the industry really wants is an implicit government guarantee – downside insurance for funds, preferably without any insurance premium or effective regulation, which is the current status quo. In fall 2008, these funds got an explicit guarantee, and they know that similar support would be available in the future — unless a way is found to make this part of the system less prone to collapse and contagion.

In principle, the Securities and Exchange Commission is in charge of changing money-market fund rules. Unfortunately, the financial-sector lobby has fought this issue to a deadlock at the highest levels of the S.E.C. Fortunately, post-Dodd-Frank, the Financial Stability Oversight Council has the ability to push for stronger standards, which it can either use directly or by bringing enough pressure to move the S.E.C. forward.

On this issue, the 12 regional Fed presidents have their priorities exactly right. There are some nuances on the details, but the most important idea is to float the net asset value for money-market funds, i.e., eliminate the illusion that these investment products necessarily have a stable value. The value of your equity mutual funds goes up and down every day, in a way that you can measure and understand. The same is true for money-market funds, but this reality is currently masked from investors.

We need more transparency and honesty around the nature of these investment products. This is good for consumers and absolutely essential for system stability. The Systemic Risk Council, led by Sheila Bair, the former chairwoman of the Federal Deposit Insurance Corporation, has also been pushing in this direction (I’m a member of this council).

You might also want equity buffers at money-market funds, and the Fed presidents bring this up as a possibility. It is encouraging to see these individuals push for higher equity (less debt relative to total assets); I favor much higher equity throughout the financial system. But I doubt the levels of equity under discussion will be enough to make a significant difference.

(In addition, the New York Fed is indicating, at least at the technical level, a preference for a minimum balance at risk. In this approach, an investor pulling money out of a fund would have some fraction set aside, perhaps five cents on the dollar, that would be in first-loss position for a period of 30 days or more – with the goal of discouraging runs. I see no sign that this idea is getting traction either among officials or more broadly.)

A generation ago, many banks viewed money-market funds with suspicion and even hostility, as they were competing for part of the same investor base. Now, however, the big bank-holding companies like money-market funds. Some banks manage money-market funds, and almost all of them rely on them for short-term cheap funding.

But this funding is cheap in part because of the implicit government guarantees provided to money-market funds. This encourages banks to rely on unstable funding, and we should be pushing in the other direction – toward longer-term, more stable sources of funding.

Expressing these concerns is not populism; the Fed is perhaps the least populist organization in the country. This is sensible economics with a clear and powerful rallying cry: Float the net asset value.

Article source: http://economix.blogs.nytimes.com/2013/02/21/twelve-angry-central-bankers/?partner=rss&emc=rss

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Today’s Economist: Simon Johnson: The Debt Ceiling and Playing With Fire

January 24, 2013 by Leave a Comment

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Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

Congressional Republicans are again threatening not to increase the ceiling on the amount of federal government debt that can be issued. On Wednesday, they agreed to postpone this particular piece of the fiscal confrontation, but only until May. The decision to turn the debt ceiling into a confrontation is a big mistake for the Republicans and extending the indecision is likely to prolong the agony of uncertainty and have damaging economic consequences for the country.

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I made these points at a hearing on Tuesday of the House Ways and Means Committee, but unfortunately the Republican majority seems determined to persevere with its destabilizing strategy. (The hearing can be viewed on C-Span’s Web site; see the playlist on the right.)

In most countries, decisions about government spending and revenue bring with them an implied, even automatic decision about how much debt to issue. Spending minus revenue in a year gives you the annual deficit (a flow), while government debt is a stock of obligations outstanding.

Think of it as a bathtub. Spending is water coming in from the tap, and revenue is water leaving through the drain. If there is more spending relative to revenue, there is more water in the bathtub – and the amount of water is the debt.

In the United States, for odd historical reasons, Congress makes two separate decisions, one on the flow (spending and revenue) and the other on the stock (the allowed limit on the debt, known as the debt ceiling).

But once you have decided on the rate of flow into and out of the bathtub, the stock at any given moment is a given. So what happens if Congress suddenly decides that there should be a cap on the water in the bathtub, without altering the flow in or out?

To complicate matters, keep in mind that some of these fiscal flows have already been committed, for example, in terms of interest payments due on existing debt, salaries for active military personnel and Social Security payments. You cannot suddenly grab more revenue out of thin air.

The main problem is that no one knows what would happen if the federal debt were to hit its legal ceiling.

Would the government be forced to default on some obligations to bondholders? Would there be some other form of default — for example, in terms of nonpayment for goods and services already contracted? Or would there just be complete chaos in our fiscal affairs, a throwback to the mid-1780s, before the Constitutional Convention in Philadelphia and before Alexander Hamilton took the public debt firmly in hand?

In the past, the potential for confusion around binding debt-ceiling limits was well understood. The debt ceiling was therefore raised without too much fuss, and the party in opposition would typically object in principle but not put up a real fight. Plenty of other ways are available for Congress to affect revenue and spending (the flow) without throwing everything into disarray by insisting on a stock of debt that is inconsistent with previous commitments.

This changed in summer 2011 when some Republicans decided to dig in behind the idea that they could force the federal government to default if they did not get what they wanted. For some, this was about forcing big spending reductions. For others, federal government default was actually the goal; see this commentary from July 22, 2011, by Ron Paul, a Tea Party favorite who was a member of Congress at the time. (His son, Senator Rand Paul of Kentucky, is currently opposed to increasing the debt ceiling, even on a temporary basis as agreed this week.)

In summer 2011, I warned about the effects of this confrontation over the debt ceiling, contending that it would create a great deal of uncertainty and slow the economic recovery. I particularly stressed the damage that would be done to the private sector — exactly contrary to what the House Republicans asserted they wanted. I also testified to this effect before the Ways and Means Committee on July 26, 2011, although I cannot say my arguments had any impact on Republican thinking.

Recent research by Scott Baker and Nicholas Bloom of Stanford and Steven Davis of the University of Chicago looks carefully at what has generated uncertainty about policy over the last 25 years or so. Their Web site is a must-read, as is the latest version of their paper on the topic (updated Jan. 1). This chart from their paper was a main point in my five minutes of opening verbal testimony.

This index is composed of four series of data, weighted so that 50 percent is from news articles containing the terms uncertain or uncertainty and economic or economy and policy relevant terms, and 16.63 percent each from the number of tax laws expiring in coming years, a composite of ranges for quarterly forecasts of federal, state and local government expenditures, and a one-year consumer price index from the Federal Reserve Bank of Philadelphia.Scott Baker, Nicholas Bloom and Steven Davis This index is composed of four series of data, weighted so that 50 percent is from news articles containing the terms uncertain or uncertainty and economic or economy and policy relevant terms, and 16.63 percent each from the number of tax laws expiring in coming years, a composite of ranges for quarterly forecasts of federal, state and local government expenditures, and a one-year consumer price index from the Federal Reserve Bank of Philadelphia.

They find that while the financial crisis of 2008 and its aftermath greatly elevated policy uncertainty in general, the debt-ceiling confrontation in summer 2011 produced the highest level of uncertainty since 1985, when their analysis begins.

Uncertainty about policy creates doubts in the minds of people about what is going to happen to the economy. The natural response in the face of heightened uncertainty is to delay making decisions — people do not go on vacation or buy a car, and business owners and companies do not hire people unless they absolutely need them.

Slap everyone in the face with such concerns after a big financial crisis and you get a slower economic recovery and fewer jobs.

Most economists would say there is no chance that the United States would ever default; this would be an act of collective insanity far in excess of anything ever seen in this country or anywhere in the world. But what really matters is not the view of analysts and commentators. The real issue is whether decision makers throughout the economy think that default or some other disruptive event could occur.

The evidence from Professors Baker, Bloom and Davis is clear. The debt-ceiling fight in summer 2011 made people more uncertain about what was to come.

This is consistent with the fact that August 2011 was a very weak month for job creation. According to the Government Accountability Office, this political confrontation also pushed up the cost of borrowing for the government. And uncertainty of this kind increases risk premiums around the world, because investors want to be compensated for higher risks. This put more pressure on European sovereign debt at an inopportune moment, pushing up yields across the troubled euro zone (including, but not limited to Greece).

In the hearing this week, the Republican line was that the debt ceiling offered a “forcing moment.” This is plainly a threat; otherwise there is no sense in which it is “forcing.” What is the threat? No one knows; even the three Republican witnesses could not agree on what would happen if the debt ceiling were breached.

The threat lies between some form of default and some other form of unprecedented disruption to public finances. Expect uncertainty — perhaps at the level of August 2011, perhaps even higher.

This is an irresponsible way to run fiscal policy. As Representative Sander Levin of Michigan, the senior Democrat on the Ways and Means Committee, put it: “House Republicans continue to play with economic fire. They are playing political games and that undermines certainty.”

The Republicans should take the debt ceiling off the table.

Article source: http://economix.blogs.nytimes.com/2013/01/24/the-debt-ceiling-and-playing-with-fire/?partner=rss&emc=rss

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Today’s Economist: Simon Johnson: The S.E.C. at a Turning Point

December 27, 2012 by Leave a Comment

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Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

The job of head of enforcement at the Securities and Exchange Commission is now open. The Obama administration should press for the appointment of Neil Barofsky, former special inspector general for the Troubled Asset Relief Program, to this position. Unfortunately, the administration has given no indication it will do so, leaving the impression that it is likely to be business as usual for the next four years, with regulators who are less than tough on the industry.

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Perspectives from expert contributors.

(I have also endorsed Mr. Barofsky as a chairman of the S.E.C.; clearly, I want him at the commission one way or another.)

The departing director of the division of enforcement at the S.E.C. is Robert Khuzami, a former general counsel for the Americas at Deutsche Bank, a job he held from 2004 through early 2009. Although Mr. Khuzami was once a distinguished prosecutor, his appointment to the S.E.C. turned out to be a mistake because Deutsche Bank was so deeply involved in the securitization morass that led to the financial crisis of 2008.

(For more details, I recommend this Web page, with information collated by UniteHere, a trade union. You should also read this assessment by Yves Smith on her nakedcapitalism blog.)

Mr. Khuzami has vigorously defended his record and insisted it would have been “unwise” to press Wall Street firms and their executives for admissions of guilt. Whether the S.E.C. failed to prosecute the executives who made the key decisions because it had no case or because of Mr. Khuzami’s views, we may never know.

In addition, concerns continue to grow regarding the extent of mismanagement and illegal activity at Deutsche Bank during Mr. Khuzami’s time there; Mr. Khuzami has recused himself from the latest S.E.C. investigations.

According to Jordan Thomas, a lawyer representing one of the whistleblowers from Deutsche Bank, as quoted in the Financial Times,

During the financial crisis, many financial institutions faced an existential threat and the evidence suggests that Deutsche Bank crossed the line by substantially inflating the value of its credit derivatives portfolio – the largest risk area in its trading book.

This is precisely the kind of complex case that requires a skilled prosecutor with detailed knowledge of how the industry works. At the same time, it cannot be someone who has worked for a major financial institution either directly or as its outside counsel. The potential for a perceived conflict of interest is too great.

In the past, we would have looked to the United States Attorney’s Office for the Southern District of New York for the right kind of talent. But in the last few years this office has focused much more on insider-trading cases, with much of its evidence collected through wiretaps. The human capital that is capable of directly prosecuting and winning complicated securities fraud cases is much depleted.

Fortunately, Mr. Barofsky is at hand and is an excellent choice for head of enforcement at the S.E.C. (though surely not the only one so qualified). A career prosecutor who worked for the United States Attorney’s Office in a previous era (through 2008), Mr. Barofsky successfully pursued mortgage fraud cases and complex securities fraud and accounting fraud cases, including against the most senior executives of the former commodities giant Refco. He also worked on drug-trafficking cases, going up against some of the most dangerous criminals in the world.

In the fall of 2008, Mr. Barofsky, a Democrat, was nominated by the Bush administration to become the independent lawyer inside the Treasury Department (special inspector general, in Washington parlance) responsible for supervising the implementation of the divisive Troubled Asset Relief Program, or TARP. He was confirmed with bipartisan support and continued to enjoy such support until he stepped down in early 2011.

At TARP, Mr. Barofsky investigated and studied carefully almost every corner of the financial system, with the goal of preventing fraud and abuse in the use of taxpayer money. He prosecuted people who broke the rules and who were trying to steal from the government (and from you).

Remarkably, Mr. Barofsky had to contend with initial resistance from the Treasury team led by the secretary, Henry M. Paulson Jr. The extent and sophistication of resistance to Mr. Barofsky’s sensible compliance recommendations increased dramatically once Timothy F. Geithner was confirmed as Treasury secretary.

The Treasury philosophy was that all of its financial stability policies were intended to “foam the runway” for banks – making it easier for them to earn their way out of the crisis. The Obama administration’s much-hyped mortgage-modification program, for example, was designed and implemented in ways that were always going to be harmful to many homeowners, a point that Mr. Barofsky and his team made before, during and after this became painfully evident to the rest of us.

Mr. Barofsky understands the details and knows how to build an office that combines effectiveness and integrity with its own investigative capability. His reports will long stand out as beacons of clarity. (The TARP special inspector general reports are on the Web; the Barofsky reports are from February 2009 through January 2011.)

Another advantage to Mr. Barofsky’s appointment is that we would not have to fear that he would later rotate into a senior position on Wall Street. As he made abundantly clear in “Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street,” Mr. Barofsky has burned all those bridges already.

We need an honest and experienced prosecutor to oversee enforcement at the S.E.C. This person must be beyond reproach and able to tackle wrongdoers, no matter how powerful their political connections or how complicated their cover story.

Fortunately, we have Mr. Barofsky. It is no time for business as usual at the S.E.C.; it sorely needs an effective head of enforcement.

Article source: http://economix.blogs.nytimes.com/2012/12/27/the-s-e-c-at-a-turning-point/?partner=rss&emc=rss

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Today’s Economist: Simon Johnson: The Importance of Elizabeth Warren

November 8, 2012 by Leave a Comment

Elizabeth Warren greeting supporters in Boston after her Senate victory on Tuesday.Gretchen Ertl/Reuters Elizabeth Warren greeting supporters in Boston after her Senate victory on Tuesday.DESCRIPTION

Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

One of the most important results on Tuesday was the election of Elizabeth Warren as United States senator from Massachusetts. Her victory matters not only because it helps the Democrats keep control of the Senate but also because Ms. Warren has a track record of speaking truth to authority on financial issues – both to officials in Washington and to powerful people on Wall Street.

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During the campaign, Ms. Warren’s opponent and his allies made repeated attempts to portray her as antibusiness. In the most bizarre episode, Karl Rove’s Crossroads GPS ran an ad that contended that she favored bailing out large Wall Street banks. All of this was misdirection and disinformation.

Ms. Warren has long stood for transparency and accountability. She has insisted that consumers need protection relative to financial products – when the customer cannot understand what is really on offer, this encourages bad behavior by some companies. If this behavior spreads sufficiently, the entire market can become contaminated – damaging the entire macroeconomy, exactly as we have seen in the last decade.

Honest bankers should welcome transparency in all its forms. And the Consumer Financial Protection Bureau, which Ms. Warren helped to establish, has made major steps in this direction.

Ms. Warren has strong support from the progressive wing of the Democratic Party, and her resistance to sharp practices by big banks resonates across the political spectrum. (Disclosure: James Kwak and I wrote positively about Ms. Warren and her approach in “13 Bankers.”)

She has also established an impressive track record for effective oversight in Washington. As the chairwoman of the Congressional Oversight Panel for the Troubled Asset Relief Program, she drew bipartisan praise (until, of course, she decided to run for public office).

How much can a new senator accomplish? Within hours of her victory, some commentators from the financial sector suggested that no freshman senator could achieve much.

This is wishful thinking on their part. A newly elected senator can have a great deal of impact if she is well informed on relevant details, plugged into the policy community and focused on a few key issues. It also helps if such a senator can bring effective outside pressure to bear – and Ms. Warren is a most effective communicator, including on television. She has an unusual ability to cut through technical details and to explain the issues in a way that everyone can relate to.

Ms. Warren is a natural ally for Senators Sherrod Brown of Ohio, Jeff Merkley of Oregon, Carl Levin of Michigan, Jack Reed of Rhode Island and other sensible voices on financial sector issues (including some on the Republican side who have begun to speak out). My expectation is that Ms. Warren will work effectively across the aisle on financial sector issues without compromising her principles – and this could really be productive in the Senate context.

Hopefully, Ms. Warren will get a seat on the Senate Banking Committee, where at least one Democratic slot is open.

President Obama should now listen to her advice. Senator Warren should have been appointed head of the Consumer Financial Protection Bureau in 2010 – but was opposed by Treasury Secretary Timothy Geithner. Unfortunately, the president was unwilling to override Treasury.

If President Obama wants to have impact with his second term, he needs to stand up to the too-big-to-fail banks on Wall Street.

The consensus among policy makers has shifted since 2010, becoming much more concerned about the dangers posed by global megabanks. That has been clear in recent speeches by the Federal Reserve governor Daniel Tarullo; Richard Fisher, president of the Federal Reserve Bank of Dallas; and Andrew Haldane of the Bank of England (all of whom I have covered in this space – including last week).

At the same time, we should expect a renewed effort against all recent attempts at financial sector reform – a point made by American Banker, a trade publication, immediately after the re-election of President Obama.

Scandals of various kinds will be thrown into this mix. The full extent of money laundering at HSBC is only now becoming apparent. Complicity of various institutions in rigging Libor should also become clearer in coming months. No doubt there will be big unexpected trading losses somewhere in the global banking community. The European macroeconomic and financial situation continues to spiral out of control.

Senator Warren is well placed, not just to play a role in strengthening Congressional oversight but also in terms of helping her colleagues think through what we really need to make our financial system more stable.

We need a new approach to regulation more generally – and not just for banking. We should aim to simplify and to make matters more transparent, exactly along Senator Warren’s general lines.

We should confront excessive market power, irrespective of the form that it takes.

We need a new trust-busting moment. And this requires elected officials willing and able to stand up to concentrated and powerful corporate interests. Empower the consumer – and figure out how this can get you elected.

Agree with the people of Massachusetts, and give Elizabeth Warren every opportunity.

Article source: http://economix.blogs.nytimes.com/2012/11/08/the-importance-of-elizabeth-warren/?partner=rss&emc=rss

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Economix Blog: Simon Johnson: Who Built That?

September 6, 2012 by Leave a Comment

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Simon Johnson is Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and former chief economist at the International Monetary Fund. His books include “13 Bankers.”

Perhaps the biggest issue of this presidential election is the relationship between government and private business. President Obama recently offended some people by appearing to imply that private entrepreneurs did not build their companies without the help of others (although there is some debate about what he was really saying).

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Perspectives from expert contributors.

Mitt Romney’s choice of Paul D. Ryan as vice presidential running mate is widely interpreted as signaling the further rise of the Tea Party movement within the Republican Party – with the implication that the private sector may soon be pushing back even more against the role of government.

For most of the last 200 years, national economic prosperity has been about creating and sustaining a symbiotic relationship between government and private business, including entrepreneurs who build businesses from scratch. This symbiosis was long a great strength of the United States, something it got right while other nations failed to do so, in various ways.

Is the partnership between government and business now really on the rocks? What would be the implications for longer-run economic growth of any such traumatic divorce?

To think about these issues, I suggest starting with “Why Nations Fail” by Daron Acemoglu and James Robinson, a sweeping treatise on political power and economic history. (I have worked with the authors on related issues, but I wasn’t involved in writing the book. I am using their material as a reference point throughout my new course this fall at the Massachusetts Institute of Technology, “Global Controversies.”)

Income per capita in 1750 was relatively similar around the world. There were some pockets of prosperity – imperial capitals and trading cities – but most people lived at roughly the same level of income (and lived about the same length of time). That changed dramatically in the hundred years after 1800; some countries charged ahead in terms of industrialization and broader economic development, while others lagged. (Lant Pritchett memorably labeled this phenomenon “Divergence, Big Time.”)

Since 1900, while average income levels have risen almost everywhere, there has been surprisingly little convergence in income per capita. Countries that were relatively rich in 1900 are, for the most part, relatively rich today. Most countries that were poor in 1900 have failed to catch up with the highest income levels today – with some notable exceptions in East Asia and for some countries with a great deal of oil.

In the Acemoglu-Robinson view, it was all about having a favorable head start – based on strong and fair rules of the game:

Countries such as Great Britain and the United States became rich because their citizens overthrew the elites who controlled power and created a society where political rights were much more broadly distributed, where the government was accountable and responsive to citizens, and where the great mass of people could take advantage of economic opportunities.

These were excellent conditions for innovation and private-sector investment. People who were not born wealthy were able to educate themselves and create their own enterprises. But the government also played a very helpful role, with investments in clean water and public health, developing public education and supporting the creation of transportation and communication networks.

Equality before the law also became an essential component of successful societies – for example, much more present in the United States than in Mexico.

At least in the 19th century, government cooperated closely with private business in the United States. In much of the world, this relationship has never worked well – and conditions for growth are consequently undermined. “Why Nations Fail” explores in great detail exactly when and why politicians choke business, how economic oligarchs capture and abuse political power and what happens when militaries become too powerful. It is sobering reading.

“Why Nations Fail” has been very successful, in part because the history appeals to people on both the right and the left of the political spectrum. To those on the right, economic development requires strong property rights. To those on the left, constraints on the power of elites are essential. Both views garner a great deal of support from the Acemoglu-Robinson view of how the United States, Western Europe and a few other places did so well.

The United States avoided the problems on which the book focuses, but nevertheless it now faces a major struggle regarding the nature of its society — and its future.

The 20th century brought a new and expanded role for government, putting into effect regulations that constrained what private business could do (starting with antitrust laws and food purity rules), providing various forms of social insurance (including old-age pensions) and increasing marginal tax rates (particularly on income). The modern federal government also operates a global military presence on a scale unimaginable to any American before 1941.

Unlike the populations of some countries, the American people have never reached a consensus over what was achieved and what was given up in the 1930s. In the United States, the rising role of the state produced a long-term backlash, culminating most recently in the form of a tax revolt (from the 1960s), a move to the right in the Republican Party (beginning with Ronald Reagan and running through Newt Gingrich directly to Mr. Ryan) and a deep-seated conviction that tax rates and government spending must be reduced (“starve the beast”).

The discussion of Mr. Ryan and his budget ideas is likely to become central to the election over the next two months – and this is entirely appropriate.

A powerful coalition has risen against the state. It sees modern government as abusive and as standing in the way of economic recovery and growth. There is a strong urge to undo the reforms of the 1930s and roll back government at all levels. The economist Arthur Laffer spoke for many others when he said, “Government spending doesn’t create jobs, it destroys jobs.”

In truth, we all built the modern American economy. This certainly includes individuals taking responsibility for themselves, becoming more educated and working hard to develop their own companies. But the government also played a constructive role.

Can our political system reach a reasonable agreement on how to divide the benefits and share the costs? In “White House Burning,” James Kwak and I proposed one way to do this – phasing in a fiscal adjustment based on the principle that revenue should return to where it was before the Bush tax cuts. Mr. Ryan is proposing a very different vision: phasing out the nonmilitary part of federal government.

In my assessment last month, I found that anything close to Mr. Ryan’s version would be too extreme.

Mr. Ryan wants to strengthen the private sector and get government out of the way. In my reading of Professors Acemoglu and Robinson, Mr. Ryan’s fiscal intentions would destroy the positive role of government in modern America — throwing the baby out with the bath water. This would not be good for continued private-sector development, on which we all depend.

Article source: http://economix.blogs.nytimes.com/2012/09/06/who-built-that/?partner=rss&emc=rss

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Today’s Economist: Simon Johnson: The End of the Euro Is Not About Austerity

June 21, 2012 by Leave a Comment

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Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

Most current policy discussion concerning the euro area is about austerity. Some people, particularly in German government circles, are pushing for tighter fiscal policies in troubled countries (i.e., higher taxes and lower government spending). Others, including in the new French government, are more inclined to push for a more expansive fiscal policy where possible and to resist fiscal contraction elsewhere.

Today’s Economist

Perspectives from expert contributors.

The recently concluded Group of 20 summit meeting is being interpreted as shifting the balance away from the “austerity now” group, at least to some extent. But both sides of this debate are missing the important issue. As a result, the euro area continues its slide toward deeper crisis and likely eventual disruptive breakup.

The underlying problem in the euro area is the exchange rate system itself – the fact that these European countries locked themselves into an initial exchange rate, i.e., the relative price of their currencies, and promised never to change that exchange rate. This amounted to a very big bet that their economies would converge in productivity – that the Greeks (and others in what we now call the “periphery”) would, in effect, become more like the Germans.

Alternatively, if the economies did not converge, the implicit presumption was that people would move; Greek workers would go to Germany and converge to German productivity levels by working in factories and offices there.

It’s hard to say which version of convergence was less realistic.

In fact, the opposite happened. The gap between German and Greek (and other peripheral country) productivity increased, rather than decreased, over the last decade. Germany, as a result, developed a large surplus on its current account – meaning that it exports more than it imports.

The other countries, including Greece, Spain, Portugal and Ireland, had large current account deficits; they were buying more from the world than they were selling. These deficits were financed by capital inflows (including some from Germany but also through and from other countries).

In theory, these capital inflows could have helped peripheral Europe invest, become more productive and “catch up” with Germany. In practice, the capital inflows, in the form of borrowing, created the pathologies that now roil European markets.

In Greece, successive governments overspent – financed by borrowing — as they sought to stay popular and win elections. Whether the new government installed on Wednesday after last weekend’s elections will make any progress is not clear.

Greece has already adopted a considerable degree of fiscal austerity. Now it needs to find its way to growth. Cutting the budget further won’t do that. “Structural reform” – a favorite phrase of the Group of 20 crowd – takes a very long time to be effective, particularly to the extent that it involves firing people in the short run. Throwing more “infrastructure” loans from Europe into the mix – for example, through the European Investment Bank – is unlikely to make much difference. Additional loans of this kind are likely to end up being wasted or stolen as more and more well-connected people prepare for the moment when the euro is replaced in Greece by some form of drachma.

In Spain and Ireland, capital inflows – through borrowing by prominent banks – pumped up the housing market. The bursting of that bubble has shrunk their real economies and brought down all the banks that gambled on loans to real estate developers and construction companies. Their problems have little to do with fiscal policy.

As conventionally measured, both Ireland and Spain had responsible fiscal policies during the boom, but they were building up big contingent liabilities, in the form of irresponsible banking practices.

When the banks blew up in Ireland, this created a fiscal calamity for the government, mostly because of lost tax revenue. It remains to be seen if Ireland can now find its way back to growth.

Spain still needs to recapitalize its banks – putting more equity in to replace what has been wiped out by losses — and, most important, it must also find a renewed path to private-sector growth. Investors are rightly doubtful that the current policies are pointed in this direction.

In Portugal and Italy, the problem is a longstanding lack of growth. As financial markets become skeptical of European sovereign debt, these countries need to show that they can begin to grow steadily – and bring down their debt relative to gross domestic product (something that has not happened for the last decade or so).

Fiscal austerity will not help, but fiscal expansion is also unlikely to do much – although presumably it could increase headline numbers for a quarter or two. The private sector needs to grow, preferably through exporting and through competing more effectively against imports.

Peripheral Europe could, in principle, experience an “internal devaluation,” in which nominal wages and prices fall and those countries become hyper-competitive relative to Germany and other trading partners. As a matter of practical economic outcomes, it is hard to imagine anything less likely.

Some politicians still hint they could produce the rabbit of “full European integration” from the proverbial magic hat. What does this imply about quasi-permanent transfers from Germany to Greece (and others)? Who pays to clean up the banks? What happens to all the government debt already outstanding? And does this mean that all Europe would now adopt German-style fiscal policy?

These schemes are moving even beyond the far-fetched notions that brought us the euro. “Europe only integrates in the face of crisis” is the last slogan of the euro  enthusiasts. Perhaps, but crises have a tendency to get out of control – particularly when they produce political backlash.

Most likely, the European Central Bank will provide some big additional “liquidity” loans to bring down government bond yields as we head into the summer. We should worry about how long any such feel-good policies last. Historically, August is a good month for a big European crisis.

As these difficult times approach, some people will admonish governments to stand up to markets. But when you are relying on capital markets to finance a large part of your continuing budget deficit and your debt rollover, this is empty bravado.

European governments should never have put their heads so far into the lion’s mouth with regard to public-sector borrowing. But the politicians, and many others, convinced themselves that they were all going to become more like Germany.

Peripheral Europe will never be like Germany. It’s time to face the implications of that fact.

Article source: http://economix.blogs.nytimes.com/2012/06/21/the-end-of-the-euro-is-not-about-austerity/?partner=rss&emc=rss

Filed Under: Global Business Tagged With: , ,

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

December 22, 2011 by Leave a Comment

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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.

Today’s Economist

Perspectives from expert contributors.

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

Filed Under: Economy News Tagged With: , ,

Economix Blog: Simon Johnson: A Question for Newt Gingrich

December 9, 2011 by Leave a Comment

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

Newt Gingrich has surged in recent polls and now has a chance to establish himself as the front-runner in the Republican presidential primaries. But as Mr. Gingrich ascends, he will need to answer a difficult question: What is his policy for Wall Street’s too-big-to-fail banks?

Today’s Economist

Perspectives from expert contributors.

This a pertinent issue for all American voters in 2012 – both for the primaries and for the general election. It speaks directly to who wins and who loses in American society and why).

It is also a question that Mr. Gingrich is likely to be asked during the Republican debate on Monday, perhaps in the context of Europe’s financial problems (the planned topics for the debate between Mr. Gingrich and Jon Huntsman are national security and foreign policy).

Mr. Gingrich’s career path creates a number of potential vulnerabilities around this issue.

No doubt Mr. Gingrich will seek to deflect the issue – as he did on Oct. 11, during a previous debate, when in response to a Wall Street-related question he said, “If you want to put people in jail, you ought to start with Barney Frank and Chris Dodd.”

This was a crowd-pleasing one-liner – Representative Frank and former Senator Dodd have their names attached to the financial reform legislation of 2011, and bashing that bill is standard Republican rhetoric.

But Mr. Gingrich will find it difficult to avoid the substance of this issue for much longer for a simple reason: Mr. Huntsman has figured out that breaking up megabanks is both sensible economics and good Republican primary politics.

Mr. Gingrich claims to be the true conservative, but the awkward – for him – truth is that on all issues related to the financial sector, Mr. Huntsman has the conservative high ground. He understands that “too big to fail” is not a market, it’s a government subsidy program, and that these subsidies are large, hidden, unfair and incredibly dangerous.

As I explained last week, Mr. Huntsman is drawing on deep thinking around these issues by some of the most serious intellectuals on the right of the American political spectrum. He is also tapping into the deep and articulate resentment in the American nonfinancial sector; people who run the businesses that generate most of the jobs in the United States fully understand that the current structure of Wall Street does not serve us well.

So it will be hard for Mr. Gingrich to respond adequately on substance. As Mr. Huntsman told Bloomberg News, speaking of other presidential candidates more broadly:

They want to be able to point out the deficiencies in front of some crowds, but they want to take money from the banking sector. They’re not going to get contributions from the banking sector if they’re specific about how they want to remedy the situation.

Mr. Gingrich was reported to be in New York this week, seeking to raise a lot of money quickly. It seems reasonable to presume that much of the available quick money is close to the heart of Wall Street.

Mr. Gingrich will also have to address the issue of whose money he took while speaker of the House in the mid- to late 1990s. This was a period in which big banks were pushing hard for the repeal of Glass-Steagall – the last remaining restrictions on what they could do and, effectively, on their scale.

Mr. Gingrich may argue that it was the Clinton administration that argued forcefully for full financial-sector deregulation, and there is some evidence that is so. But there was also a bipartisan consensus around the issue and, as far as I can ascertain, Mr. Gingrich was a central part of that.

There was an intense debate on details during Mr. Gingrich’s tenure, and a great many campaign contributions entered the fray. I have not yet seen a detailed analysis of what Mr. Gingrich received and what he oversaw – and from whom. Presumably such information will be forthcoming as his candidacy advances.

Mr. Gingrich could, of course, now turn his back on megabanks – and brand them a dangerous form of European lemon socialism (socialized losses; private gains). He did say something vaguely along these lines in 2010.

But this is not the time for vagueness or generalities. Mr. Huntsman has a specific, detailed financial overhaul program that offers the most plausible way forward for forcing the big banks to become substantially smaller and also safer. I’ve discussed this approach with leading experts, both on the right and on the left, and my assessment is that these are the most ambitious and most sensible proposals we have seen from any politician.

Mr. Gingrich has no such plan – at least not on his Web site or elsewhere in the public domain.

So, Mr. Gingrich, do you agree that too-big-to-fail banks should be broken up, as Mr. Huntsman has proposed? What are your detailed, specific proposals for how to do this? Will you endorse Mr. Huntsman’s plan?

Article source: http://feeds.nytimes.com/click.phdo?i=e1791dca4db0d465f5c2ec6b1500547c

Filed Under: Business News Tagged With: , ,

Economix Blog: Simon Johnson:Is Europe on the Verge of a Depression, or a Great Inflation?

November 10, 2011 by Leave a Comment

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

The news from Europe, particularly from within the euro zone, seems all bad.

Today’s Economist

Perspectives from expert contributors.

Interest rates on Italian government debt continue to rise. Attempts to put together a “rescue package” at the pan-European level repeatedly fall behind events. And the lack of leadership from Germany and France is palpable – where is the vision or the clarity of thought we would have had from Charles de Gaulle or Konrad Adenauer?

In addition, the pessimists argue, because the troubled countries are locked into the euro, no good options are available. Gentle or even dramatic depreciation of the exchange rate for Greece or Portugal or Italy is not in the cards. As a result, it is hard to lower real wages so as to restore competitiveness and boost trade. This means that the debt burdens for these countries are likely to seem insurmountable for a long time. Hence default and global financial chaos seem likely.

According to the September 2011 edition of the Fiscal Monitor of the International Monetary Fund, 44.4 percent of Italian general government debt is held by nonresidents, i.e., presumably foreigners (see Statistical Table 9), on Page 72). The equivalent number for Greece is 57.4 percent, while for Portugal it is 60.5 percent.

And if you want to get really negative and think the problems could spread from Italy to France, keep in mind that 62.5 percent of French government debt is held by nonresidents. If Europe has a serious meltdown of sovereign debt values, there is no way that the problems will be confined just to that continent.

All of this is a serious possibility – and the lack of understanding at top European levels is deeply worrisome. No one has listened to the warnings of the last three years. Almost all the time since the collapse of Lehman Brothers has been wasted, in the sense that nothing was done to put government finances on a more sustainable footing.

But perhaps the pendulum of sentiment has swung too far, for one simple and perhaps not very comfortable reason.

There is no way to have just a little debt restructuring for Italy. If Italian debt involves serious credit risk – an end to the view that government debt has “no credit risk” and is a “risk-free asset,” with zero probability of default – then all sovereign debt in Europe will need to be repriced downward.

Will Germany will remain a safe haven? Even that is far from clear. According to the I.M.F., gross government debt in Germany will be 82.6 percent of gross domestic product at the end of this year (Statistical Table 7 of the Fiscal Monitor, on Page 70; the net government debt number for 2011, in Statistical Table 8, on Page 71,is 57.2 percent). Reports of German fiscal prudence have been greatly exaggerated.

German policy makers and the German public will not do well in the event of a major sovereign-credit disaster. Credit would tighten across the board. German exports would plummet. The famed German social safety net would come under great pressure.

There is an alternative to a decade of difficult austerity. The Germans could agree to allow the European Central Bank to provide “liquidity” support across the board to the troubled governments.

Many things are wrong with this policy – and it is exactly the kind of moral hazard-reinforcing measure that brought us to the current overindebted moment. None of us should be happy that Europe – and the world – has reached this point.

Among others, the bankers who bet big on moral hazard – i.e., massive government-backed bailouts – are about to win again. Perhaps the Europeans will be tougher on executives, boards and shareholders than the Obama administration was in early 2009, but most likely all the truly rich and powerful will do very well.

But if the German choice is global calamity or, effectively, the printing of money, which will they choose?

The European Central Bank has established a great deal of credibility with regard to keeping inflation at or close to 2 percent. It could probably offer a great deal of additional support – through creating money – without immediately causing inflation. And if the bank is providing a complete backstop to Italian government debt, the panic phase would be over.

None of this is a lasting solution, of course. Europe needs a proper fiscal center – much as the United States needed in 1787 and got under Alexander Hamilton’s policies from 1789. When he became Treasury secretary, the United States was in default and the credit system was almost completely broken. Some centralized tax revenue and control over fiscal deficits are needed.

Silvio Berlusconi stood in the way of all this. Other European leaders would not trust him to tighten Italian fiscal policy. But if he is really gone from power – and we should believe that only when we see it – there is now time and space for Italy to stabilize and, with the right help, find its way back to growth.

Of course, if the European Central Bank provides unconditional financial support to Italian, or other, politicians who refuse to bring their deficits under control, we are heading for another Great Inflation.

Article source: http://feeds.nytimes.com/click.phdo?i=1dcc306e0bb135f227b0bc0d8654efbf

Filed Under: Economy News Tagged With: , ,

Economix Blog: Simon Johnson: Mr. Hoenig Goes to Washington

October 27, 2011 by Leave a Comment

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

Thomas Hoenig, recently retired as president of the Federal Reserve Bank of Kansas City and nominated as vice chairman of the Federal Deposit Insurance Corporation, looks askance at too big to fail banks.Jin Lee/Bloomberg NewsThomas Hoenig, recently retired as president of the Federal Reserve Bank of Kansas City and nominated as vice chairman of the Federal Deposit Insurance Corporation, looks askance at “too big to fail” banks.

To fix a broken financial system and to oversee its proper functioning in the future you need experts. Finance is complex, and the people in charge need to know what they are doing. One common problem, manifest in the United States today, is that many leading experts still believe in some version of business as usual.

Today’s Economist

Perspectives from expert contributors.

At the height of the Great Depression, Marriner S. Eccles was summoned to Washington from Utah, where he was a regional banker. He helped remodel the Federal Reserve through the Banking Act of 1935 and then became its first independent chairman; the Fed board had previously been headed by the Treasury secretary.

Mr. Eccles was not a fan of big Wall Street firms and their speculative stock market operations; rather, he understood and identified with smaller banks that lent to real businesses. Mr. Eccles was the right kind of expert for the moment. Who has the expertise to play this kind of role in our immediate future?

Thomas Hoenig, the former president of the Federal Reserve Bank of Kansas City, has long been a strong voice for financial sector reform along sensible lines. Within the official sector, he has spoken loudest and clearest on the most important defining issue: “Too big to fail” is simply too big. And last week he took a major step toward a more prominent role, when he was nominated by President Obama to be vice chairman of the Federal Deposit Insurance Corporation.

The F.D.I.C. is not as powerful as the Fed, but in our current financial arrangements, it does play a critical role. The Dodd-Frank legislation has its weaknesses, but it gives the F.D.I.C. two important powers.

First, with regard to big banks, the F.D.I.C. can help force the creation of credible “living wills” — explaining how the bank can be wound down if necessary. If such wills are not plausible then, in principle, the F.D.I.C. could force simplification or divestiture of some activities. Second, the F.D.I.C. is now in charge of “resolution” for mega-banks, i.e., actually closing them down and apportioning losses in the event of failure.

One important concern is whether the F.D.I.C. has enough clarity of thought and — most critically — enough political support to take the pre-emptive actions needed to make our biggest banks smaller and safer. (For more specific suggestions – and some disagreement – on what exactly is required to strengthen financial stability, you can watch two speeches made on Oct. 21 at a George Washington University law school symposium: Sheila Bair, the former F.D.I.C. chairwoman, spoke first and I spoke immediately after; my remarks start around the 49-minute mark.)

The F.D.I.C. senior team is already strong, with a great deal of experience handling the problems of small and midsize banks. The current acting chairman, Martin J. Gruenberg, was vice chairman under Ms. Bair. These are not people who are easily intimidated by big banks. And Mr. Gruenberg is highly regarded on Capitol Hill, where he worked for the Senate Banking Committee for nearly two decades. (Disclosure: I’m on the F.D.I.C.’s Systemic Resolution Advisory Committee, which meets in public; I’m not involved in any personnel or policy decisions.)

I have been a strong supporter of Mr. Hoenig in recent years, endorsing his views and arguing in the past that he should be named Treasury secretary.

In the current mix of Washington-based policy makers, Mr. Hoenig would be a great addition. He spoke out early and often against “too big to fail” banks. In early 2009, his paper “Too Big Has Failed” became an instant classic. It is worth reading again because it contains a number of forward-looking statements that remain important. Perhaps the most relevant for his F.D.I.C. role:

Some are now claiming that public authorities do not have the expertise and capacity to take over and run a “too big to fail” institution. They contend that such takeovers would destroy a firm’s inherent value, give talented employees a reason to leave, cause further financial panic and require many years for the restructuring process. We should ask, though, why would anyone assume we are better off leaving an institution under the control of failing managers, dealing with the large volume of “toxic” assets they created and coping with a raft of politically imposed controls that would be placed on their operations?

This sounds very much like the basis for a sensible strategy of thinking about Bank of America, which is in serious trouble — and where the F.D.I.C. should consider a more proactive intervention.

The European debt situation is also threatening to spiral out of control, with potentially serious consequences for our financial sector. If you have not yet reviewed the details of Bill Marsh’s graphic from The New York Times on Oct. 23, I strongly recommend it — but you’ll need a big computer screen or the ability to print out on a very large piece of paper. (The picture is literally big, 18 by 21 inches; there is also a nice interactive version that lets you look at various scenarios.)

We do not know how these or other shocks will hit our financial system. Nor do we know exactly who will fall into what kind of trouble.

We need experts at the helm with sensible judgment and the right priorities – and with a good understanding of what kind of financial system we really need. We also need policy makers who have strong support from across the political spectrum, including on Capitol Hill.

Mr. Hoenig is exactly the right person for the moment.

Article source: http://feeds.nytimes.com/click.phdo?i=59cd483ba56bdf86c999aec672db3db4

Filed Under: Economy News Tagged With: , ,
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