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Speaker: Simon Johnson, Ronald A. Kurtz (1954) Professor of Entrepreneurship, Sloan School of Management, Massachusetts Institute of Technology
Professor Johnson's lecture can be viewed online.
In an entertaining and informative talk rich in anecdotes, Professor Simon Johnson of MIT presented his view of the problematic relationship between "Wall Street and Washington." Johnson began his talk with an appeal to the audience to phone their Senators, as well as the Senate Majority Leader and the White House, to express their support for an amendment – introduced by Senators Brown (D-OH) and Kaufman (D-DE) – that imposes a size cap on the country's largest banks. His aim in the remainder of the talk, Johnson explained, was to convince the audience that it was worth their while to make these calls to their representatives.
Johnson sketched the content of his recent book, co-authored with James Kwak and entitled "Thirteen Bankers: The Wall Street Takeover and the Next Financial Meltdown," which covers the back story to the current crisis and develops specific policy proposals to avoid similar occurrences in the future. According to Johnson, the current crisis – the worst since World War II – shows that the financial sector has become dangerous to the economy as a whole. Some, including Secretary of the Treasury Timothy Geithner, have suggested that the current financial crisis is the equivalent of a "forty-year flood" – an event that could be prevented, but only by measures that would impose a disproportionate burden during the other 39 years. Johnson suggested, by contrast, that the current crisis is the result of political choices that have, over the last decades, "weakened the levees" that were meant to prevent precisely the catastrophic consequences to the financial equivalent of a flood that we are currently witnessing.
This weakening of the levees, in turn, is the result of the financial industry's enormous political clout. Johnson pointed to one recent event as an example: When, in the spring of 2010, Goldman Sachs was investigated by the SEC, Goldman Sachs essentially threatened the economic and political system, with its CEO claiming that the SEC's investigation would have "horrible effects" on the economy as a whole. Johnson argued that this is merely one symptom of a more general malaise: The United States is currently reliving one of the historically quite regular moments of confrontation between our political representatives on the one hand and the representation of concentrated economic power on the other.
Johnson highlighted that, until recently, he was convinced that institutional problems of the sort the United States are currently confronting would only occur in other countries. A well-known hypothesis in economic theory posits that any regulated industry will over time capture its regulators; and this is indeed what has happened in the US in the wake of the increasing regulation of the financial sector in the 1970s. But sometimes the capture is not limited to particular regulatory agencies; instead, an industry essentially co-opts the entire government. This "state capture" – regulatory capture on a grand scale and with correspondingly catastrophic consequences – has normally been attributed only to other countries, like Russia in the 1990s. But, according to Johnson, the current crisis suggests that the concept of "state capture" may also be applicable to the United States. It is thus not just a financial and economic crisis, but a political crisis as well. (Crucially, and in reference to the general topic of the lecture series on "institutional corruption," Johnson emphasized that the real problem is a system of incentives and beliefs that has disastrous effects even if nobody inside the system has personally acted unethically).
Johnson briefly outlined the historical background to the economy's current predicament. The US had a regulated financial system from the 1930s onwards. Regulation started to break down in the 1970s, and has become weaker and weaker since. The continuing trend away from regulation is not, Johnson emphasized, an indication that the political system is unable to overcome the challenges industry power poses to proper regulation. (Similar challenges have been met in the past). But overcoming them will be difficult.
Moving to the present, Johnson focused on the "too-big-to-fail" rule, and argued that merely capping banks at their current size (as has been proposed by several politicians) is evidently inadequate, given that these banks, at their current size, are already too big to fail. Nor is there any evidence that banks of this size have great social value: At least at this stage, there are no convincing studies that show economies of scale for financial institutions above $100 billion. Nor doesit make sense to say that governments ought not to interfere, and let the size of banks be determined by the market alone, given that the market is already acting on the assumption of government support for banks too big to fail. Johnson estimated that this assumption of implicit government support gives the banks at issue an advantage of 70 to 80 basis points when they borrow money. The six banks that are so big that they are seen, by the market, as having implicit government support are, Johnson concluded, dangerous to the US economy, and ought to be restrained.
He pointed to another historical analogue to bring home both the challenge the US faces, and the possibility of overcoming it. In 1902, when President Theodore Roosevelt took on Northern Securities, a big railroad trust run by J.P. Morgan, Morgan came to the White House. He told Roosevelt that, if there was a problem, then "send your men to my men" and the matter would be resolved. Roosevelt, however, refused; and by pushing through anti-trust laws he set what became the commonly recognized standard for an acceptable concentration of economic power. Our political challenge today – and, Johnson said, the purpose of his most recent book, and of his appeal to the audience to phone their Senators – is to set such standards for our current situation, standards that govern the role and size of the financial industry.
Daniel Viehoff, Faculty Fellow in Ethics 2009-10