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The Coming Meta-Boom and Meta-Bust -- One Economist's View

Simon Johnson, a former chief economist for the International Monetary Fund and author of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, says the recently passed Dodd-Frank Financial Reform Act does little to prevent the biggest financial risk of our time -- banks that are becoming "too big to save," either because potential losses could overwhelm government resources, or the public will refuse to sanction another large bailout. Either way, the world economy could crash. But preceding any crash, watch for a worldwide "meta-boom." Following a recent talk Johnson gave at Wharton, he discussed this and several other issues with Knowledge@Wharton, including how shrinking big banks could ward off financial meltdowns, Ireland's solvency-threatening debt burden and the implications of Basel III.

Knowledge@Wharton: The other interesting stat in the book, I think I've seen this elsewhere also, is the percentage of corporate profits that the financial industry represents. I might be off a little, but I think this is roughly right: that up through the beginning or middle of the 1980s, or maybe even a little bit later, the most the financial system ever took up in total corporate profits in the U.S. was about 15%. But just prior to the crash, it was up to 41%. In other words, the financial services industry was earning 41% of all profits in the U.S. That's something that we never even got close to in the past. It suggests that maybe something was out of whack. Why didn't anybody see that? Well, I know some people did. Where are we now and how long do you think it might take before we get back up to that, according to your view of what's likely to happen?

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Knowledge@Wharton: The other thing that's interesting -- and you talk about a number of different problems with "too big to fail", such as taxpayers ending up on the hook for all the money -- is this idea that because of the backup, the backstop, the implicit guarantee, the moral hazard is basically there, but only for the very largest banks. The next tier down, say large regionals and so forth, are actually put at an unfair disadvantage competitively because they don't have that subsidy, and therefore they can't operate in the same way. So it's not a level playing field. And yet we don't see too much opposition from them either. You just talked about the corporate sector in general, what's going on here?

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. But "too big to fail" is not the worst of our potential problems. That would be Too Big to Save. Think about Ireland.
Knowledge@Wharton: Too Big To Bail.
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Knowledge@Wharton: Can you define moral hazard for those people who aren't clear what it means?

Johnson: Moral hazard is very simply that when I give you insurance, you're going to be a little bit less careful.
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But in essence, I think Eve is right. The essence is, if the media doesn't get it, if the smartest journalists whom you respect and read every day who write on the front page of major newspapers and on leading analytical serious websites run by those papers, if they don't get it, if they don't understand what the financial sector is doing, why and how, then that definitely contributes to the problem.

With reference to :

http://www.nakedcapitalism.com

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Knowledge@Wharton: And talking about concentration, after this crash, it turns out that -- I don't know if that was 13 banks that you were referring to in 13 Bankers -- some of the bigger banks, in an effort to salvage the system, took over competitors. And so now there are really six large banks. Could you talk about them, just how much they control and some of the points you make about them in your book?

Johnson: Sure, well the six banks are, I think, the heart of the problem. Those six banks control, have assets -- the size of the banks and balance sheet -- of roughly 63%, maybe 65% of GDP right now. Before the crisis, they were 57% or 58% of GDP. And if you go back to the early to mid 1990s, that same group of banks and the other banks that they gobbled up along the way, that same group was 16% of GDP. So they have become much larger relative to the economy. There's a very important point, that the U.S. is not a country based on big banks. We don't have a big banking tradition relative to other countries. We don't have a tradition of bank concentration or of concentration relative to the size of the economy.

There are no benefits that anyone can point to from a broader economic point of view of this increase in bank size. So at the very least, we should roll the banks back to where they were before this merger movement, before many of the barriers on their activities were taken off. And we should also consider very seriously putting other controls and restrictions on the ability of those banks that are essential to our credit system, essential to our payment system, to take huge amounts of risk should be severely curtailed.

( to be continued)

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Labels: Knowledge at Wharton