Strategies for Banking Reform: The Snowball Effect

By Simon Johnson

I was on a Capitol Hill panel yesterday morning, organized by the National Community Reinvestment Coalition, with Jim Carr and Mike Lux; Nancy Cleeland was the moderator. We had a wide-ranging discussion about the origins of our current economic crisis (the banks, their regulators, their lack of regulation), progress to date with financial sector reform (not much), and what should be the legislative agenda (a long list, ranging from protecting individuals to better safeguarding the system; if you can get any sensible measure past the lobbies, take it).

I was particularly struck by one point made by Mike Lux. Sometimes it seems the administration talks in terms of having limited political capital and of needing to decide where to spend it – perhaps, for example, it has all been stored up to address health care. Mike’s model is somewhat different – once you defeat one powerful industrial lobby, it becomes easier to defeat others; success can snowball. Drawing on the experience of FDR, in particular, Mike stressed that early success (e.g., initial recovery measures that were opposed by industry) laid the political foundations and generated the kind of public support necessary for further achievement (e.g., the introduction of social security).

What does that mean in today’s context?

It means that the banking reform agenda is likely to run for a long while. Sensible measures may not at first succeed and, let’s be honest, the prospects for the fall legislation do not currently look encouraging – various parts of the financial lobby are flexing their muscle already. But that is not necessarily the end of the conversation.

In particular, if banks make further mistakes – even if not on the recent scale – this will shift opinion towards reform. Jamie Dimon, for example, has another brilliant statement on why banking, or at least JP Morgan Chase, should be allowed to go back to “business as usual”. But his reasoning rests largely on the idea that JP Morgan has a culture that can manage risk, forever.

From all accounts, Dimon’s personality and demeanor are a critical determinant of the firm’s culture in general and the fact that it (partly) sat out the housing craze. Everything we know about the evolution of firms is that while some aspects of culture survive growth and a rise to predominance (and JP Morgan is now #1, in case you’re keeping score), generally attitudes change as top people change. And any rise to power brings with it potential sclerosis of various kinds – just ask Citigroup or Bank of America.

So major banks will run into some variety of trouble, probably sooner rather than later – remember there is a potential global credit boom underway (check your local oil prices for details). If enough transparency, accountability, and public discussion is preparing and waiting for that moment, attitudes towards permissible banking behavior can change quickly.

And this administration will at some point, hopefully, prevail against some powerful industrial group or other. If they can just get some political momentum vs. recalcitrant lobbies going, such success can be brought over into the financial sphere.

The wave of “reforms” this fall will likely not solve anything. But this is not the end of attempts to better regulate the functioning of finance and to make sure it can never again run us into a crisis that results in doubling the national debt. What we are looking at now is just the beginning of a 5 or 10 year struggle for real change in the structure of economic and political power around finance in the United States.

Comments

[James Quinn:]

Eliminate the Federal Reserve and let the insolvent banks go bankrupt.

theburningplatform.com...

Jun 12 10:45 AM

[infp:]

Why should we have any hope for financial industry reform? Both the conservative Bush Administration and the 'liberal' Obama Administration agreed to bailout Wall Street at the expense of US taxpayers. I see virtually no difference between the last two administrations on this issue. It appears to me that Wall Street owns both parties. So where exactly do you expect political reform to come from?

Jun 12 11:07 AM

[Leftfield:]

I am glad to see a perspective that seems plausible and gives me hope. Unlike the "don't worry be happy" media and government. But it must come from voters awakening. They will find, like Rip Van Winkle, a world changed, where "USA is #1" is mostly as valid as it would be if said of Detroit.
Continually throwing out incumbents is the way to bring on the changes this article considers possible.

Jun 12 03:30 PM

[User 422955:]

While I hope you are correct, I have my doubts. Obama's strategy, from the outset, has been to make peace with conservatives, at least those in his own party. In the financial crisis, largely the work of big banks, hedge funds, brokerages, etc., he took two bankers (Geithner and Summers) and told them to fix things. In health care, where the power of both health insurance and large pharmaceutical companies increases costs, he has invited both to join in "fixing" things. His approach seems to be, 'Find out who created the problem and tell them to fix it.'

Jun 12 07:20 PM

[Lin:]

RE

There's no doubt that the insurance companies , pharmacetical companies greed caused the healthcare crisis in America . Add to the list the " medical device makers " , $30 for IV tubing , PLEEASE !

Jun 12 08:26 PM

[John Lounsbury:]

Accounting rules changes are allowing the banks to "recognize" income in 2009 that is nothing more than money manufactured out of accounting tricks. "Mark-to-market" has become "mark-to-fantasy". This will all come home to roost as the over-valued fantasy must eventually be marked back to reality, as "assets" move closer to and reach maturity.

Thus, banks are manufacturing income in 2009 that will result in reduced income in future years. Under current compensation plans, management will reap huge performance bonuses for this chicanery in 2009 and the economy will suffer with an underperforming financial sector for years to come.

See the other Baseline post by James Kwak today for discussion of this compensation issue (or should I say compensation scam?).

Excellent article, Simon.

Jun 13 01:39 PM

[Jeff Nielson:]

There are no "reforms" taking place. All that is occurring is that there will be a FURTHER consolidation of power in the hands of the PRIVATE bankers of the Federal Reserve.

Beyond that, nothing more is currently "on the table" other than window-dressing, designed to create the ILLUSION of reform

Jun 13 02:23 PM

[Graham and ...:]

Dear Jeff:

You hit the nail on the head. Again.


On Jun 13 02:23 PM Jeff Nielson wrote:

> There are no "reforms" taking place. All that is occurring is that
> there will be a FURTHER consolidation of power in the hands of the
> PRIVATE bankers of the Federal Reserve.
>
> Beyond that, nothing more is currently "on the table" other than
> window-dressing, designed to create the ILLUSION of reform

Jun 13 03:02 PM

[dcb:]

Your article makes the assumption that Mr. Oama actually wants reform. I feel the evidence is overwhelming that the opposite is in fact the case. Start reporting it like it is Mr. Johson instead of the way you would like it to be, or the way the Obama administration says it is. If you and the rest of the American press started to do so this country would be much better off. If rational voices started saying what we all know to be true instead of attempting to play nice maybe we'd get somewhere.

Jun 14 02:43 PM