By Simon Johnson
In early February I suggested there was a showdown underway between the U.S. Treasury and the country’s largest banks. Treasury (with the Fed and other regulators) is responsible for the safety and soundness of the financial system, the banks are mostly looking out for their own executives, and the tension between these goals is - by now - quite evident.
As we’ve been arguing since the beginning of the year, saving the banking system - at reasonable cost to the taxpayer - implies standing up to the bankers. You can do this in various ways, through recapitalization if you are willing to commit more taxpayer money or pre-packaged bankruptcy if you want to try it with less, but any sensible way forward involves Treasury being tough on the biggest banks.
The Administration seems to prefer ”forbearance”, meaning you just ignore the problem, hope the economy recovers anyway, and wait for time or global economic events to wash away banking insolvency concerns. But this strategy is increasingly being undermined by the banks themselves - their actions threaten financial system stability, will likely force even greater costs on the taxpayer, and demonstrate fundamentally anti-competitive practices that inflict massive financial damage on ordinary citizens.
As the NYT reported yesterday, the Federal Reserve - on behalf of all bank supervisors - recently requested banks in no uncertain terms (1) not to reveal stress test results, (2) not to give other indications of their financial health, and (3) most of all, not to announce capital raising plans immediately. The point, of course, is to manage the flow of information so that plans can be made to help the weaker banks at the same time that the market realizes exactly who needs what kind of help.
Amazingly, the biggest banks are defying the federal authorities on this point, insisting on signaling their soundness and - in the case of Goldman Sachs - rushing to raise capital. In the case of Goldman, the explicit intention is to pay back TARP funds and to escape all government-imposed limitations on compensation. This would obviously be good for Goldman and the people who run it. Anything that strengthens their advantage over competitors and increases market share will presumably raise their profits and compensation, making it easier to attract even more good people. (See my discussion with Terry Gross yesterday for more on these dynamics.)
Such developments would worsen the business prospects of other large banks and potentially threaten their financial situation. The government’s forbearance strategy is fragile unless big banks do as the supervisors tell them. But Goldman and other major players apparently think they have so much political power - and this may be more about connections on Capitol Hill than links with the Administration - that they can ignore the supervisors.
Treasury can try to refuse repayment of TARP funds, but Goldman would hardly have made its move unless repayment (particularly after announcing the intention) is essentially a done deal. Supervisors can send more assertive emails, but these are hardly likely to have any effect. The President himself can call on leading bankers to behave better, but didn’t he just do that (and isn’t that what Valerie Jarrett is working hard on)?
My practical friends in the Administration like to emphasize that “we are where we are” and that we need to understand the limitations of the policy tools in hand and the realities of our political constraints. I completely agree.
The Department of Justice’s Antitrust Division should be called in to investigate the increasing market share of major banks (remember that Bear Stearns and Lehman are gone), the anti-competitive practices of some market leaders (there’s more than one predatory way to force your rivals into bankruptcy and to move closer to monopoly power), and the broader increase in economic and political power of the biggest financial services players over the past 20 years and the last 6 months - this is potentially damaging to all consumers and, obviously, to all taxpayers.
Think of the costs arising from the market power of major banks - and it is financial market power that makes them “too big to fail”; the FDIC has no trouble handling the failure and liquidation of small banks. We started this crisis with privately held government debt at around 40% of GDP. My baseline view is that we will end up closer to 80% of GDP. This means higher taxes for all of us, and this is absolutely not a “left vs. center” or “left vs. right” issue. This is left, right, and center against those parts of the center who insist that we should go back to having the same organizations, essentially unchanged compensation schemes (and all they imply about “Wall Street owns the upside and taxpayers own the downside”), and even more concentrated market power in our financial system.
Probably we need to modernize our thinking about the exact nature of threats arising from financial trusts. Perhaps we need, at some point, new legislation that reflects this thinking. But we can make a great deal of progress, here and right now, with appropriate enforcement of our existing antitrust laws.
The pushback, of course, will be: you can’t do this in the middle of a recession - it will slow the recovery. Honestly, as my colleague Mike Mussa emphasized last week, banking is more likely to follow than lead the recovery; in fact, this is the exact logic that underpins the Administration’s forbearance strategy.
The goal of this antitrust action is to prevent some big banks from further destabilizing the system, hence reducing a serious downside risk. It’s also to limit the taxpayer costs arising from this crisis; for all major bank rescues, the cost is not just the bailout, it’s also the higher fiscal deficit, increased debt, taxes down the road and - given today’s predicament - the very real inflation risks arising from even more monetary expansion. The overarching goal, of course, is to (re)build a more sustainable, sound, and - in all senses - competitive financial system.