Simon Johnson: Obama’s plan to be judged by a Goldman breakup

At the broad level, there was much to applaud in yesterday’s announcement from the White House regarding potential new constraints on the scale and scope of our largest banks.

After more than a year of tough argument, Paul Volcker has finally persuaded top aides to President Barack Obama that the unconditional bailouts of 2008-2009 planted the seeds for another major economic crisis. Unfortunately, in their scramble to announce this major policy shift ahead of Wall Street’s bonus season, the administration didn’t line up all relevant details.

In particular, the White House background briefing yesterday morning — while somewhat ambiguous — gave listeners the strong impression that these new proposals would freeze the size of our largest banks “as is.” This makes no sense. Why would anyone regard 20 years of reckless expansion, a massive global crisis, and the most-generous bailout in recorded history as the recipe for creating right-sized banks?

There is no evidence, for example, that the increase in bank size since the mid-1990s has brought anything other than huge social costs in terms of direct financial rescues, the fiscal stimulus needed to prevent another Great Depression, and millions of lost jobs.

The administration has most evidently not done a great deal of other preparatory work. How will off-balance-sheet activities be treated? Should some hedge funds also be regarded as too big to fail? And why would merely controlling proprietary trading be enough to de-risk out-of-control behemoths, such as Citigroup?

Still, we should treat the next few weeks as the public- comment phase for potentially serious principles and an opportunity to press for workable details.

Pushing Back

The big banks, naturally, are already hard at work pushing in the other direction. This is actually good and exactly what we need. The banks have hidden behind their lobbyists and disinformation managers for too long. The administration has decided to take the fight to them, face-to-face, with the full backing of a president at last willing to press for change. The goal should be to flush both the big bankers and their Republican — and Democratic — backers into the open.

There are sensible people on both sides of the political aisle on this issue. But there is also Senator Richard Shelby of Alabama, the ranking minority member of the Senate banking committee, who has been arguing that the morass of massive financial institutions can be handled through minor modifications of our bankruptcy code.

Not Like Canada

This is as nonsensical, and as unconnected to reality, as the view — also current among some pro-banking constituencies – – that the U.S. can just become more like Canada, in the mythical sense of having four big banks that are well regulated. Please, just spend some time with people who know the facts and review in detail the breakdown of risk management at Canada’s greatest financial institutions.

President Obama finally has economic logic and solid history on his side. If he comes out clear and strong on this issue in his State of the Union address on Jan. 27 and in all the ensuing congressional discussions, he will flush out into the open the self-serving greed and frank stupidity that underpins the idea that bigger finance is good, unregulated big finance is better, and today’s mammoth unfettered global banks are best.

This could turn out to be a huge policy change with important and positive ramifications around the world. But it is not for the faint of heart or weak of mind.

Taking Side

The serious debate with big finance is just beginning; it will get very nasty, hundreds of millions of dollars will be spent, and everyone, in the end, must take a side.

What we need is for sensible legislation to come to the floor of the Senate and for all senators to go on the record, in detail.

A public debate of historic proportions — the kind that shaped this republic — will set up the Democrats for the midterm elections. If you would like to run on a pro-too-big-to- fail platform, go ahead.

As we drill down into the details of ideas for breaking the economic and political power of oversized banks, we need this litmus test against which serious suggestions should be judged: Does a proposal, at the end of the day, imply that Goldman Sachs should break itself up into at least four or five independent pieces, with the biggest being no more than 1 percent of gross domestic product, or roughly $150 billion?

If the answer is yes, we are making progress in moving our financial system back toward where it was in the early 1990s, when it worked fine (and Goldman was a world-class investment bank) and was much less threatening to the global economy. If the answer is no, we are merely repainting — ever so gently — the deckchairs on the Titanic.

Article here.

This entry was posted in Market Commentary. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s