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.”
Of all the arguments put forward by big banks and their allies in recent years against financial reform, the line that surfaced last week was arguably the most strange. Wall Street has been reformed, according to this view: There was a great battle, and we (the big banks) lost. There is, consequently, nothing more to do.
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The dangers to the global economy posed by very large banks are more clearly understood by a handful of people in policy-making circles. On the other hand, many influential people in Washington refuse even to discuss how to measure the extent to which undercapitalized megabanks contribute to the risk of serious crisis, as well as the true cost of such crises.
Megabanks’ lobbyists and other representatives certainly remain hard at work. At a House Financial Services Committee hearing last week, they continued to push back against the Volcker Rule. The charge, as so often in the last five years, was led by the Securities Industry and Financial
Markets Association, known as Sifma, which represents many companies in the securities industry,
but which always seems to have the interests of the biggest closest to heart.
The chairman of Sifma is Jim Rosenthal, chief operating officer of Morgan Stanley;
the vice chairman is John Rogers, executive vice president at Goldman Sachs, and so on.
The president and chief executive of Sifma is Kenneth E. Bentsen Jr., who previously served in the House of Representatives and was a member of the House Financial Services Committee. While in Congress, Mr. Bentsen was a Democrat, but at the hearing last week he seemed more closely in tune with the Republicans.
Mr. Bentsen and most Republicans asserted that the Volcker Rule did not involve sufficient consideration of the potential costs, despite a comment period and rule-making process that over three and a half years involved close to 20,000 letters from and more than 100 meetings with the industry. The implication from Republican members of Congress was that the rule should be scrapped or substantially scaled back.
For much of the hearing, the Republican majority projected onto a screen the total value of our national debt (using the total value of federal government debt outstanding).
I made the point that the recent increase in government spending (and decline in revenue) is almost entirely because of the way the financial sector imploded and damaged the rest of the private sector in 2007-8. In January 2008, the Congressional Budget Office projected that total government debt in private hands – the best measure of what the government owes – would fall to $5.1 trillion by 2018 (23 percent of gross domestic product). As of January 2010, the C.B.O. projected that over the next eight years debt would rise to $13.7 trillion (over 65 percent of G.D.P.), a difference of $8.6 trillion.
Of the change in the C.B.O. baseline, 57 percent is because of decreased tax revenues resulting from the financial crisis and recession; 17 percent to increases in discretionary spending, some of it the stimulus package necessitated by the financial crisis (and because the “automatic stabilizers” in the United States are relatively weak); and another 14 percent to increased interest payments on the debt – because the United States now has more debt.
I was disappointed, although not entirely surprised, that no one on the Republican side wanted to talk about how these enormous fiscal costs were the result of excessive risk-taking by what were then very large financial institutions and what have now become very large banks.
Spencer Bachus, Republican of Alabama and chairman emeritus of the committee, did assure me that proprietary trading – the kind of concentrated risk-taking that is the focus of the Volcker Rule – had nothing to do with the deep nature of the crisis and the very difficult subsequent recovery.
Unfortunately, he did not appear inclined to discuss the details of what went wrong in 2007-8 at Citigroup, Merrill Lynch, Morgan Stanley, Lehman Brothers, Bear Stearns or Goldman Sachs – or what the more recent London Whale experience at JPMorgan Chase should teach us about the continuing risks of allowing insured banks to gamble in complex derivatives that management does not fully understand.
Sifma and others at the hearing warned of dire consequences from the Volcker Rule, but they could point to nothing of macroeconomic consequence by way of concrete impact. (There was some unintentional impact on community banks from the rule as proposed in December, but this was addressed by further changes last week – and the hearing made it plain that there is bipartisan agreement on avoiding any such difficulties. For more details on the issues, see my written testimony.)
This is a big year for financial reform discussions. The Federal Reserve needs to propose and adopt further important rules, including those governing how big banks finance themselves. The Government Accountability Office must issue a report that details the subsidies currently received by too-big-to-fail banks. And another midterm election can affect the general tenor of the debate and who controls the legislative agenda.
But make no mistake about it. Washington or Main Street did not win any big battles against the largest and most powerful financial companies. The early skirmishes are over, and the lines are now more clearly drawn.
As Dennis Kelleher of the pro-reform group Better Markets put it,
Wall Street went to war against Washington and financial reform; it has had many significant victories and, yes, some defeats; but, most importantly, Wall Street’s war continues unabated with no end in sight. Wall Street’s too-big-to-fail banks simply have too much money at stake, literally hundreds of billions if not trillions of dollars, to stop fighting.
Anyone who thinks financial reform is over should read Mr. Kelleher’s full article.
The big conflict lies ahead, and it will be long and drawn out. As memories of the last crisis recede, will regulators continue to carry out financial reforms in a sensible manner or, as in so many instances in the past, will they relax and let the big banks return to their most dangerous ways?