|13 Bankers: The Wall Street Takeover and the Next Financial Meltdown|
by Simon Johnson and James Kwak
Simon Johnson and James Kwak's "13 Bankers: The Wall Street Takeover and the Next Financial Meltdown" attempts to sum up what the pair have been arguing for several years now in their popular blog, The Baseline Scenario, and (mostly Johnson) on nearly every media channel available, from NPR to the Atlantic magazine to various cable outlets. The argument is a continuation of an idea Johnson, a former chief economist at the IMF now teaching at MIT, tossed out in 2009 in a controversial article in the Atlantic, where he argued that the big banks, like financial oligarchies of the emerging markets, had seized control of the government and captured the regulatory system. That theory, pounded home daily, led them initially to urge a nationalization of the big troubled banks rather than a bailout. And when that was obviously not going to occur, they swung to either breaking up the banks or putting a hard cap on size.
This question of bank size, the so-called too-big-to-fail problem, is a serious one that, as they say in this book, has not been adequately addressed in any of the reform bills inching their way through Congress. Instead of the kind of structural transformation urged by Johnson and Kwak, by others on the left like Columbia's Joseph Stiglitz and (in a weaker form) by former Federal Reserve Chairman Paul Volcker (now backed by the administration) with his proposed ban on proprietary trading, the reform legislation focuses on tighter regulation and capital requirements. The argument for breaking up the banks has merit because size is clearly an ongoing problem, invites moral hazard and does create a hidden public subsidy for the largest institutions. Indeed, there are subsidiary issues that force anyone that's serious about the situation to wrestle with TBTF: the polarization of incomes, the sheer size of finance relative to the rest of the economy, the Janus-like powers of innovation and even -- Johnson and Kwak's favorite issue -- the monetary power of finance in Washington, that is, the capture problem.
That said, this book is disappointing. Johnson and Kwak are avid bloggers and commentators, but the hope was that when they tackled a book they would leave the kind of imprecise language, loose historical references and polemical thrust of the blog behind. They haven't. In fact, for anyone who has regularly read The Baseline Scenario, which is lively and often interesting (particularly when Johnson opines on international finance), there's precious little here that's new. It's a pity, because the TBTF problem really cries out for a serious examination into both sides of the argument -- and an acknowledgment of just how little empirical knowledge we have about the consequences of staying in place or launching ourselves upon a structural transformation.
You get little of that here. Or, rather, what you get is the case for breaking up the big banks, backed by a farrago of academic studies (some suspiciously dated), newspaper and magazine clippings and quotes from like-minded souls, arrayed against what's almost a parody of the counterargument. Indeed, the most common rhetorical tactic of this book is to read history backwards from 2008, declare everyone and anything that can be linked to the great credit bubble to be, ipso facto, deluded or corrupt and then raise the necessity for sweeping changes. It is the kind of self-referential attack that suggests that anyone who questions the premises of the breakup argument is suffering from a sort of diseased consciousness spread by an all-powerful "Wall Street." There are no grays here (or very few: every once in a while they slip and offer up a caveat, sometimes in footnotes); this is a Manichaean struggle that, if it weren't for the obvious sophistication of the pair, would verge on the paranoid. Indeed, the most obvious sign of their inability to see anything more nuanced than fashionable black is their conjuring up and ritual destruction of false idols -- what they call ideologies -- on the other side: the "ideology of innovation," the "ideology of homeownership," the "ideology of finance."
The first sign of what is to come appears in the first chapter, when they attempt to wrap their argument in the democratic truths of Thomas Jefferson. Anyone who has ever written about banking knows the old chestnut that American banking history is split between Hamilton and Jefferson, with Hamilton favoring markets, order and central banking and Jefferson embracing entrepreneurs, freedom and the absence of a potentially oppressive central bank. The fact is, to take that split seriously is to be seduced by a cliché that any clear-eyed historical sense quickly unravels. Hamilton did favor a central bank; but he also called for regulation: he might well have been a New Dealer. Jefferson believed in the free capitalism of small farmers; and he also famously called for -- as the Tea Partiers remind us daily -- this yeomanry to create a new revolution whenever they saw fit. Jefferson, not Hamilton, believed in Adam Smith's invisible hand. Andrew Jackson in the 1840s used Jeffersonian arguments to destroy the Second Bank, enhance executive power and spread the wealth to his friends. He diffused banking and encouraged the creation of bank currencies, an anarchic system that eventually required reform. And Jeffersonian sentiments clung to many attempts to resist regulation up to this day. It's a little odd to see Johnson and Kwak take on the Jeffersonian view of banking when they're concerned about the likelihood of another financial crisis and declare belief in free markets to be a dangerous falsehood.
Still, most of that is ancient history. More disturbing is their chapter 4, "Greed is Good: The Takeover," where they attempt to explain how Americans fell for the siren song of Wall Street. Several things are very clear to just about everyone: Wall Street (which Johnson and Kwak use interchangeably with finance or financial services) has grown very large relative to the real economy; that growth began in the '70s with the first deregulatory moves; the big profits on Wall Street gave it an outsized influence in Washington and played a key role in the expanding role of money in politics; and "Wall Street" developed, as it has a number of times before, a particular allure, notably for high-achieving students at elite universities. None of this is new, particularly if you know any financial history, though there's no doubt that the Washington-Wall Street shuttle accelerated as both places swelled in size. Wall Street has long placed its minions at Treasury; the fact that Robert Rubin became Clinton's Treasury chief was hardly precedent setting. And to argue that Rubin represented a break with the past because he was trained in arbitrage and wasn't an investment banker (suddenly, investment bankers are good guys?) and that Henry Paulson, who spent decades as a banker but who ran a big trading firm, is another example of that sinister trend is to engage in evidential slipperiness of the most blatant kind. Besides, have Johnson and Kwak ever heard of Bernard Baruch and Joseph Kennedy? Johnson and Kwak love to beat up on Rubin, but it's Rubin the cliché, not the historical personage. Rubin was wrong on derivatives and made too much money at Citigroup and didn't mind the store; but you can't airily dismiss the fiscal discipline and strong economy of the '90s by saying that everything came apart in 2008.
What Johnson and Kwak bring to the game is the rhetorical gambit to call every kind of behavior and semibelief they don't like an "ideology." This suggests several things. Ideologies are created; there's an element of human agency here, making Wall Street a sort of superhuman entity, like Hobbes' Leviathan. Ideologies are rigid, corrupting, imprisoning -- often to poor souls who don't realize it. It's one thing to argue, as they do, that complex
financial vehicles to sell relatively simple products like home mortgages may suggest that someone's being taken. It's another to insist that the desire for a home, a piece of property that you may someday own and one that in rising markets at least appeared to be a solid investment, is an example of ideological capture. Certainly, there's nothing wrong with renting. Homeownership was undoubtedly hyped as the American dream by Fannie Mae and Freddie Mac and by politicians all the way back to the New Deal, but to call it an ideology, a sort of mass mania, is just one step short of saying the great mass of homeowners don't have a clue about what they're doing and shouldn't have the right to pursue, within the law, their perceived self-interest. That's an oddly un-Jeffersonian sentiment.
The same applies to their ideology of finance, which diverted so many elite students from amazing careers in cancer research or organic farming and sucked them into the greed and orgiastic wonderland of Wall Street. You can say that perhaps finance is too large, its practitioners too well compensated; you can worry that we spend too much time accumulating goodies, not attending to our cultural lives, or chasing the godless dollar; or that we have too many traders and not enough engineers. The suggestion, however, that Johnson and Kwak, a former McKinsey consultant and current Yale Law School student, have a broader and more profound understanding of human ends and have decided that the many thousands who flocked to Wall Street after the '80s were victimized by a false consciousness is remarkably self-righteous and chillingly moralistic.
There is also apparently no evidence that they can't turn to their ends. Thus, they argue, Tom Wolfe's "Bonfire of the Vanities," Oliver Stone's "Wall Street" and Michael Lewis' "Liar's Poker" (see below) were not absorbed by impressionable would-be cancer researchers as attacks on Wall Street practices, but rather as inducements to a glittering false world. Savonarola lives!
Their third ideology is innovation. They make the unremarkable observation that a lot of financial innovation, from securitization to credit default swaps, went very wrong. They are correct, and the voices rejecting regulation of derivatives, like Alan Greenspan, Rubin and Larry Summers, were very wrong too.
Johnson and Kwak go further, however, insisting that nearly everyone (they are prone to sweeping statements) was captured by the notion that all financial innovation is good -- everybody, that is, except those who publicly worried about it. "The recent orgy of financial innovation turned out badly because financial innovation is not like technological innovation," they write. Actually, there are all kinds of technological innovations that went awry, from cigarettes to nuclear weapons to the Corvair, and so it is with financial innovation. The only innovation they explicitly approve of is the debit card (which puts them at odds with Volcker, who voted for the ATM machine).
This blanket condemnation of innovation is disturbing in a number of ways. There's no nuance, no complexity. The notion that any innovation can be used for good purposes and bad demands a kind of realistic ambiguity (and regulatory apparatus) to live in all but the most primitive of societies. If it's partially bad to Johnson and Kwak, it's irremediably bad, eternally bad. Their discussion of innovation reveals just how sweeping an experiment they would perpetrate on the economy. You can say with some justification that a large part of Wall Street is speculative in nature and doesn't add to the social good -- but not all, and drawing that line requires sophistication and rigor. Despite Michael Milken's legal woes, junk bonds did finance some companies ignored by Wall Street; some became sizable entities, employing thousands. Most academic studies suggest that private equity provided a source of
financing that generated efficiency and growth. And securitization did produce liquidity that drove new company creation and employment. The most obvious sign of how much this economy has grown habituated to securitization is what occurred when the machinery shut down. The populace howled.
None of these innovations is close to perfect, and all require some form of regulatory oversight. But it's tricky to turn the clock back, particularly in a world rushing forward so eagerly. Or at least we don't really have a clue as to what will occur if we want to try to
return to an economy with smaller, more restrained, simpler banks that lack the liquidity creation we, and every other advanced economy, have grown accustomed to. At the end of "13 Bankers," the pair roll out their ideas about reducing the size of the six largest banks (they go from the 13 bailout bankers of the title to the big six banks at the end, which is slightly confusing) to no more than 4% of GDP -- 2% for firms with riskier assets like the old investment banks. There are considerable complexities beneath the surface -- of execution and of consequence, of economics and of politics -- that they never explore, including the derivation of the numbers themselves. In fact, even the true economic consequences of a bloated financial sector remain anecdotal in nature; macroeconomics hasn't really tackled the problem.
But most of all they themselves remain captured by their original notion: that a Wall Street oligarchy controls not only Washington but the minds of millions of Americans. Once you envision such a dark and unredeemable threat, destruction is the only answer. We must slay the dragon or pay again and again and again. And if you don't believe in dragons, well, that means that you're the problem.
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