BM Research

Its fair to say that Simon Johnson is a fan of Joseph Sitlgitz, with name checks and quotes in this book. Its possibly no surprise then that in a book which looks at the financial crisis in the US comes to many similar conclusions to Freefall, certainly in principle if not detail.

Yet this book is different. Firstly it is primarily a discussion of political economy rather than economics. The main proposition it discusses is not the mechanics of how the crisis occurred – though it does an extremely good job of that – but rather how the banking industry used its political leverage to create an environment where it could not be subject to proper oversight. Not so much a case of regulatory capture, but rather of system capture.

Chapter 4 in particular describes this process. Some of it is the usual corrupt mechanisms – for example, the banking industry is the largest corporate source of political funds. And the lobbyists get an dishonourable mention too. The reader cannot but have a mixture of amazement & incredulity to learnt that Citigroup still spends large sums on lobbyists even after the government has bailed it out and keeps significant ownership. But the largest single factor seems to have been the creation of a new group think within government – what is good for Goldman Sachs is good for the USA (though it seems the idea that this still applies to General Motors is still around too.)

Part of this is based on a revolving door – do you really need to have worked for Goldman Sachs to become Treasury Secretary? No, but it does seem that way at times. And this works all the way down the government system. And, of course, once you have finished with your government service there’s a nice job in finance for you. Even Tony Blair is on a retainer from an investment bank. But this leads us to the crux of the problem. Finance is now perceived to have grown so complicated that only someone from inside the business can be seen as able to get to grips with it. And this leads to the insiders perspective dominating, a perspective that banks can do no wrong, their preservation is the most important thing and regulatory freedom to do as they wish is what matters.

It would seem that only a fool could deny that the events of the last 3 years punch a gaping hole in that thesis, yet we are almost back to business as before. The Dodd-Frank Bill has pretty much left most serious changes to future negotiation, which the banks continue to fight hard against. There has been a suggestion that if the regulators don’t understand the banking system then we need to change the regulators. But this misses the point – the big banks have become unregulatable. For example, a proposal to disclose all forex trades (common practice in equity & bond markets) is being contested by participants. Yet how can you regulate something you have no visibility into? And the hotter areas of derivatives and credit default swaps are still to come. Ongoing calls for better disclosure have almost become cliched, yet the light this brings can help avoid us revisiting the dark places we are just escaping from. It needs to be the default option, with exceptions carefully justified – not the other way round.

The final chapter focuses on the too big to fail issues. Interestingly the authors propose a limit on banks of gross assets not exceeeding 4% of GDP. Not unreasonable you may think – only six US banks exceed that limit and perhaps it might even be achievable. But here’s some other countries and their large banks:

And each of those countries has at least one other bank of comparable size. I’m sure comparable figures exist for most countries around the world. Basically by the authors’ measure the global banking system outside the USA is too big to fail. Yep, all of it. I’ll warrant there is not a country in the world without a bank with gross assets larger than 4% of GDP. Which raises the question – why isn’t that a problem? There are two answers to that. One is that it is actually a potential problem. Reinhart & Rogoff chart the ongoing instabilities in the world’s financial system and reckon that no country has graduated from having financial crises. The second is that this crisis was born in the USA. Many European institutions suffered (especially those in countries with their own property bubble,) but many of those with operations in the US benefitted from their bailout measures. For example, Societe Generale was the biggest bank beneficiary in the AIG bailout.

So where does this leave us? The book is very good at outlining what happened, and to some extent why. It also touches how it took the Great Depression of the 1930s to create the actions required to solve the problems of the early 1900s. It’s almost to easy to say that history will repeat itself, but it does seem that it make take another financial problem for something realistic to be done.