Economist Simon Johnson talks banks, bailouts and bankruptcy

    According to Simon Johnson, failure is good, at least in the financial banking sector. The former chief economist of the International Monetary Fund talked to about 700 Northwestern students, faculty and guests at the Kellogg Distinguished Lecture Series Thursday night in the Coon Auditorium of Kellogg’s Jacobs Center.

    Johnson addressed the matter of “too big to fail” banks in America and their parts in instigating future financial crises. Dubbed by Northwestern Economics Professor Mark Witte as the “Simon Cowell” of Economics, Johnson is the professor of entrepreneurship at MIT Sloan School of Management and co-authored Thirteen Bankers: The Wall Street Takeover and the Next Financial Meltdown.

    In light of the recently passed financial reform legislature, Johnson joked, “Perhaps we can end this lecture and all go home now that our problems have been solved.”

    He argued that America is only at the very beginning of dealing with its financial problems.

    “Eighteen months after the worst financial crisis since World War II have come and gone before this legislature has appeared on the table – and it still doesn’t solve the problem of ‘too big to fail’ banks,” Johnson said, commenting on the vast time lag between the financial crisis in 2008 and government action.

    He explained that the tentativeness we see in the U.S. government in regulating the financial system is because of the change in ideology of banking from the 1930s to the 1970s and the subsequent excitement on Wall Street.

    To Johnson, the postwar banking system before the 1970s was “boring” because of the tight regulations; bankers operated under the unofficial 3-6-3 rule, in which bankers would give 3% interest on depositors’ accounts, lend money at 6% interest and be off playing golf by 3 p.m. Their only form of business and source of profit was from lending money at a higher rate than what they pay to their depositors.

    Johnson posited that there was much deregulation in the financial system in the 1970s, so banks were able to provide much more financial services, such as insurance and brokerage. With a growing fascination on Wall Street, aspiring bankers funneled the ideology that “financing was good, unregulated financing was better and big private banks were the best.”

    “And that is a dangerous view,” Johnson said, as the misconceived notion of deregulation reaping social benefits resulted in a privatized financial system that was more vulnerable to the regular inevitable storms of instability.

    Johnson switched up the lecture by posing the question, “Who here thinks that Goldman Sachs would be allowed to fail if they declare bankruptcy?”

    He argued that the six remaining American large banks are now termed “too big to fail,” because the federal government will bail them out to avoid disastrous economic consequences.

    This safety net has made the banking sector more reckless. Johnson likened the “too big to fail” government policy to a lifetime exemption of speeding tickets.

    “Sooner or later, all of us are going to be very tempted to speed because we are free from actually experiencing the negative consequences,” he said.

    In fact, the six banks left now have assets that account for 64% of the GDP in the U.S. These winning banks tripled their assets from the financial boom, bust and bailout since the 1930s. Jamie Dimon, the head of JP Morgan Chase, said that 2009 was perhaps “their finest year yet.”

    So, who are the losers in this reverse Robin Hood game of economics? The American taxpayers, Johnson said. He calculated that there was a 40% increase in government debt as a direct result of bail out, meaning a direct increase in income taxes.

    Johnson concluded that the only way to stop these banks from taking reckless risks was to change up their incentive structure and make their banks small enough to be allowed to fail. As the newly approved financial reform legislature did not address this point, it is likely that the banking system will continue along its vicious cycle of taking risks and having taxpayers compensate for them.

    “The banks get the private benefits while others experience the downsides,” Johnson said. “Unfortunately, this is economics at work.”


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