Thursday, July 22, 2010

13 Bankers

I read Simon Johnson and James Kwak's 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, which is a very good, albeit repetitive (in the sense that they repeat certain points over and over), overview of the 2008 economic crash, focusing on the problem of having a small number of financial institutions that are "too big to fail."  It is not a fun read, particularly since the recently passed financial reform addresses the problem only at the margins.  It is well-footnoted and also clearly written, with succinct definitions of very complicated topics (like synthetic collateralized debt obligations, which I am not sure I yet fully understand--in fact, another theme is that Wall Street viewed complexity as a virtue, so that if you are not an insider, you should accept everything at face value).  It is highly critical of the way in which the crisis was handled--Johnson, a professor at MIT's Sloan School, takes particular aim at Democrats who talk about reform and then buckle under.

A core issue the book examines is the fact that in recent years large financial institutions have developed extremely complex products that are too often intended to obscure their dubious origin.  The interests of the customer are ignored.  This is not particularly new, but the sheer size and scope of these institutions is much greater than in the past.  Thus, moral hazard is a severe problem, because these institutions feel emboldened by the idea that the government will bail them out.  Indeed, the bailout (and likely the financial reform as well) has only made the problem worse: "we can see now that the largest, most powerful banks came out of the crisis even larger and more powerful."  In 2009, an executive from Goldman Sachs argued that "The injunction of Jesus to love others as ourselves is a recognition of self-interest...We have to tolerate the inequality as a way to achieve greater prosperity and opportunity for all."  In other words, being too big to fail was good for everyone.

But what to do?  Their argument is to ensure that no institution becomes that big in the first place.  Breaking them up and creating caps are the central policy prescriptions.  Left intact, they will take on even more risk than in the past, create new products that elude regulations (and regulators who care little about enforcement anyway, sometimes refusing to do anything, or whose budgets rely on those same financial institutions--the current reform only asks regulators to make some new rules in the future) and thereby inevitably create a future crisis.  You can close a barn door, or at least partially close it, but there are always new barn doors.  It is, as the authors say, the "doom loop."


Tambopaxi 10:06 AM  

Agree with you, Greg. The "financial reforms" that the WH is trumpeting are marginal at best (as is the health reform program).

I think that we are indeed headed back into the doom loop, thanks to the resistance of the Republicans and the complicity of the obsequious, acquiescent Dems...

What a mess..

leftside 1:33 PM  

The idea that the size of financial institutions is at the root of the problem is wishful thinking (at best) by boosters of a capitalist system that only knows how to create bigger and bigger companies. The policy prescription of splitting up companies when they get too big is an example of the worst kind of liberal approach (arbitrary, reactive and like putting a band-aid on a festering wound).

But short of a socialist revolution ;), I actually think the Financial Reform Bill did some good things. It explictly gives the State the power to liquidate institutions in an orderly, planned way. This will put some real fear into companies. Also, taxing very large firms provides an important way to pay for any future problems, so the public is not put with the Bill. Of course, there will not be any funds for the havoc (or put nicely, the externalities) that future economic crisises put on the people of the world (which the poor always suffer disproportionately from).

But the point that any serious analyst has to admit is that even if we did resolve the "too big to fail" problem, the regular, devastating crises of capitalism will continue to find new ways to express themselves. For boom and bust is at the very heart of the system. Everything must be done to obscure this central issue.

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