The Ideas of Simon Johnson

As a sage and star of the ongoing economic crisis, Simon Johnson has risen in stature impossibly fast. His rising stock spiked with the recent publication of a piece in the Atlantic, describing his view of America as a nation captured by a financial oligarchy, and he has now taken his place alongside other popular perpetual hand-wringers like Paul Krugman and Nouriel Roubini. Only more so. Right now, Johnson is everywhere. Roughly one out of every four posts in my RSS feeder contains his name.

This is understandable. His basic thesis -- that the nation was captured under the spell of its financial elite in a process which led directly to this crisis -- is at this point rather banal. Clearly, financial interests led political leaders toward deregulation, clearly they worked to prevent oversight or regulatory authority from raining on their bubble-inflating parade, and clearly the ethos of the financial world infected the country as a whole, convincing us all we could make easy money quickly and risklessly.

Where Johnson's ideas become more interesting and troublesome is when he argues that the financial oligarchy that got us into this mess is now working to make sure we don't get out of it -- that our brilliant new president, Mr. Yes We Can himself, is under Wall Street's thumb. In a new piece at the American Prospect, Tim Fernholz lays out the basics:

His argument, in a nutshell, is that the last 25 years have seen deregulatory policies driven by the banking interests, leading to an over-large financial sector that has captured the political process. Financiers promoted free-market ideals, served in government, and funneled millions into the political process. Now, the risky behavior of major financial institutions, combined with the public policy they promoted, has created a major crisis. But the bankers' political power hasn't waned, and they are preventing the government from acting aggressively to start recovery.

Johnson and other economists across the ideological spectrum have fashioned a rough consensus that the government needs to take insolvent banks into receivership and use anti-trust tactics to break them apart, producing a financial sector that is small, simple and heavily regulated. But Johnson doesn't believe this will happen unless the financial crisis becomes even more severe; otherwise, the political incentives standing in the way will be insurmountable even if the price paid by the economy is, in the long-term, devastating.

This is a compelling story, but I simply don't think it holds together. Fernholz himself acknowledges as much in a blog post today discussing Barney Frank's decision to go slow on legislation that would give the administration authority to take large and complicated financial institutions into receivership:

[T]his decision should make it clear that main obstacle to more agressive action in the financial sector is congress, through an aversion to appropriating the up-front costs of that action and trepidation towards authorizing a broad government intervention in the market. While many critics direct their concerns about a complacent response to the financial crisis at the Obama administration, more time needs to be spent building a viable coalition in congress to support the kinds of tools and resources needed to take decisive action.

On the other hand, it is clear that the administration is concerned about the risks, and possible unintended consequences, of a recievership process. While time is of the essence in creating an effective recovery, these issues are complex and due consideration needs to take place in structuring a response...

But Johnson doesn't seem to be on the same page:

The election cycle is clearly in favor of immediate action, and -- increasingly -- so are public opinion and the tone of Congressional discussions. Be decisive now with banks while you can. To avoid fiscal costs you can make creditors take a hit if needed, but it is essential to guarantee the functioning of the payments system -- i.e., no defaults on cash-like obligations of banks.

Congress isn't anxious to move forward. An actual debate on a receivership bill would be contentious and damaging, and might well involve the insertion of policy provisions that would make the whole thing too unwieldy to do any good. It would also require the appropriate of hundreds of billions of dollars for the banks, to make creditors whole enough to avoid financial panic; fiscal costs cannot be avoided. Money for banks obviously isn't a popular priority these days. And if a bank takeover spooked depositors, who then began pulling money out of the bank, the administration might have to come back to Congress for even more money.

And that's just the part of the trouble. Legal challenges would be likely, to either the receivership law or to a specific episode of nationalization. Even if nothing bad happened, markets might get jittery. And in the end, no one has any idea what might be necessary to handle the nationalization of a firm like Citigroup, in terms of personnel, finances, or time.

Johnson is right that the power of financial interests warped policy in recent decades, leading directly to this crisis. I just don't think it's correct to extend that argument to say that the Obama administration is primarily constrained by the will of the financial oligarchy.

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/contributors/Ryan-Avent