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The Huffington Post asked me to write a quasi-review of the new Simon Johnson and James Kwak book, 13 Bankers. I also am allowed to cross-post it with a lag, so here it is (the original source is here, with HP comments, since it is me thre is no point in indenting the whole thing):
How much political power do the big banks have? I'd like to air a skeptical note and ask whether they're really running the show.
To most people these days - whether on the left or the right - such a question smacks of insanity or deliberate stupidity. It barely seems worth addressing.
Have we not observed hundreds of billions in bailouts, up to three decades of lax regulation, massive and unjust CEO bonuses, and now the near-immediate return of record bank profitability? Are not many of the Republicans serving up knee-jerk opposition to virtually any kind of meaningful financial reform, perhaps because they receive campaign contributions from banks? On the surface, banks seem to be a nearly invulnerable interest group in American politics.
Yet this last week's SEC civil lawsuit against Goldman Sachs, which caused a thirteen percent decline in the company's stock in one day, should serve a cautionary note. Of all the big banks, Goldman is supposed to be the strongest and most politically connected. It remains to be seen how the charges will proceed, but at the very least it is odd that the Masters of the Universe would have let it come to this at all.
The context for this question is the "public choice" analysis in Simon Johnson's and James Kwak's enlightening new bestseller 13 Bankers. Johnson and Kwak make a major step forward in describing our recent financial crisis as a fundamental problem in political economy, namely by pointing their fingers at an unholy alliance between banks and the U.S. government. Much as I admire their analysis and exposition, I see the problem a bit differently than they do. Whereas they see banks as the puppet master and our government as the fool, I wonder whether it is not more accurate to think of the government as running the show.
Perhaps the strongest piece of evidence for the financial sector dominance of U.S. political economy is the recent bailouts. Yet it's instructive to ask which other groups have received bailouts in the last fifteen years. The list would include Mexico and the numerous countries which have borrowed from the largely U.S.-created International Monetary Fund, such as Indonesia. They are hardly dominant forces of influence in Washington. It was China who made out like a bandit from the bailout of the mortgage agencies, and the validation of their debt issues, but again the Chinese are not in charge.
There's a different way to think about the bailouts, namely that the U.S. government stands at the center of a giant nexus of money raising, most of all to finance the U.S. government budget deficit and keep the whole show up and running. The perception at least is that our country requires the dollar as a reserve currency, requires New York City as a major banking center with major banks, and requires fully credible governmental guarantees behind every Treasury auction and requires liquid financial markets more generally. Furthermore the international trade presence of the United States (supposedly) requires the federal government to strongly ally with major commercial interests, just as our government sides with Hollywood in trade and intellectual property disputes. To abandon banks is to send a broader message that we are in commercial and political decline and disarray, and that is hardly an acceptable way to proceed, at least not according to the standards of the real Washington consensus.
In other words, it's our government deciding to assemble a cooperative ruling coalition - which includes banks -- at the heart of its fiscal core. It's our government deciding who belongs to this coalition and who does not, mostly for reasons of political expediency and also a perception - correct or not -- of what is best for the welfare of American voters. If we don't in this year "get tough" with banking regulation, it's because our government itself doesn't want to, not because of some stubborn recalcitrant Republicans.
Ask yourself the simple question: who has both the guns and the money, including the ability to print new money at zero cost? It's Washington, not the private banks.
If we look back at the broader stretch of American history, banks are by no means a dominant interest group. They arouse massive suspicion in the Jacksonian era, they are left to rot in the 1930s, they are forbid branching rights for many decades, and they end up as a decentralized sector for most of the postwar era. It's not clear why the fundamental equation of power should suddenly have changed so dramatically in recent times and perhaps it hasn't.
This analysis bears on one of the main policy recommendations of Johnson and Kwak, namely to break up the big banks so they cannot soil Washington with such powerful lobbying and privileges. I believe this recommendation will not achieve its stated ends and that Washington would find another way to assemble privileged financial institutions - no matter what their exact form -- within its ruling coalition. Breaking up the large banks would be striking at symptoms rather than at root causes, namely the ongoing growth of political power and the reliance of that power upon an ongoing inflow of capital.
If you do wish to break or limit the power of the major banks, running a balanced budget is probably the most important step we could take. It would mean that our government no longer needs to worry so much about financing its activities. Of course such an outcome is distant these days, mostly because American voters love both high government spending and relatively low taxes.
I commend Johnson and Kwak for their excellent work, but I also conclude that the problems of banking reform are harder than we usually like to think.
Posted by Tyler Cowen on April 20, 2010 at 05:23 AM in Books, Economics, Political Science | Permalink
Not to mention that banks can't seize the government based on banking rules about government balance sheets.
Maybe I'll dust off my conspiracy theory that maybe some folks helped precipitate the bank failures, not due to petty loyalties of Paulsen or whatever, but because the government needed cheap money and inflation.
Cue the investigations. People don't seem to understand relationships. I figure the government likes the banking relationship, but just needed the upper hand for a while.
Posted by: Andrew at Apr 20, 2010 7:41:20 AM
We could privatize the banks. Take away their ability to print money. Is that too radical.
Posted by: josh at Apr 20, 2010 8:00:19 AM
I think you have to separate political power from economic power, and also differentiate by time.
During a banking crisis, even of their own making, banks have more economic power because their failure can cause catastrophic damage to the rest of the economy. They do not have political power at that time, witness legislative willingness to fiddle with compensation and send in Ken Feinberg, pay czar.
During the good times, that's when they have the political power--power of political contributions -- politicians can be seen being associated with the the wealthy class, everyone likes, and listens to, successful businesses, and even the stock market will rise, or interest rates will rise, based on the wink or raised eyebrow of a commentating international banker on MSNBC or guest editorial in the WSJ.
But, the economic power is not our own--these banks lend to foreign businesses, put US taxpayers at risk for foreign enterprise, raise money from foreign sovereign wealth funds, and so on.
So, whose power is it anyway? What does power mean if you are hostage to someone's failure.
I say: stop the practice of having large banks purchase failing institutions with government subsidies...if you are going to subsidize anyway, subsidize the small to grow bigger. That's one policy.
Second, recognize that when investment banks were owned by their partners, they engaged in syndications (joint ventures) to underwrite. Require that banks carry less risk if projects are over a certain size, and require syndication in that context so risk is distributed ala a market mechanism that disburses, rather than concentrates, risk.
Third, limit US government risk protection mechanisms to transactions that are in the US and not to foreign lenders and require that the foreign transactions be segregated if not limited, while permitting foreign transactions to be syndicated or joint ventured with foreign banks which have their governments protecting part of the transaction.
Posted by: Bill at Apr 20, 2010 8:08:08 AM
Was it really that long ago when politicians were arguing that American banks needed to grow to compete in international markets with the growing power of large international banks?
Posted by: DanC at Apr 20, 2010 8:37:16 AM
Tyler, to answer your question, you need a much broader historical perspective that you provide in your review. I'm not planning to read SJ's book because I read his earlier posts in his blog and I figured out his many biases and his deliberate attempt to ignore history (remember that SJ is well-known because of his research on economic history). An alternative approach to answer your question is to ask about the political power of the military. In constitutional democracies, the military is a usuful tool to government --not totally controlled by government and often in tense relation with government, but its design and performance largely conditioned by government decisions. And so does the banking system, regardless of how big some banks are. In sum, an analysis of the recent banking crisis in which elected and appointed politicians are not main characters makes nonsense.
Posted by: E. Barandiaran at Apr 20, 2010 8:38:47 AM
Hey, nice post. Could one vastly oversimplify the argument by saying that the "US Government brand" is that it will maintain security and normal commerce for its citizens and all the world? So it needs to bail out anyone and everyone to maintain its rep?
On the flip side, one could say that Goldman asked the government to bust them for something little, so the government could maintain its rep while Goldman gets the public off its back after weathering the storm. An overt deal like that is a little too conspiracy-y for me to believe. But it may be true that the political constraints allow, and even make convenient, a token charge, while they tend against stronger action. But stronger action may yet come and prove that wrong.
Posted by: Dave at Apr 20, 2010 8:39:49 AM
DanC, it wasn't politicians who were saying that US regulation would hamper the growth of international banks, it was BANKERS who were saying this, including Hank Paulsen. Remember when everyone was goin' to London?
Posted by: Bill at Apr 20, 2010 8:41:45 AM
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