Simon Johnson Blasts Takeover of US Economy by Financial Oligarchs

Simon Johnson, the former chief economist at the IMF and a professor at MIT’s Sloan School of Management makes a bold contention in the May 2009 Atlantic Magazine: the US economy has been hijacked by a bunch of financial oligarchs. Until this oligarchy is broken up, a true recovery in the United States is impossible.

From his time at the IMF, he says the United States, despite its wealth, power, and sophistication, is behaving remarkably like many of the developing countries and banana-republics that the IMF have had to help in the past. Namely, they are protecting the interests of a rich set of powerful individuals at the expense of the general public. He writes:

"But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better—in a “buck stops somewhere else” sort of way—on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for “safety and soundness” were fast asleep at the wheel.

But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector’s profits—such as Brooksley Born’s now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998—were ignored or swept aside."

This indeed troubling but not exactly surprising. No one can doubt that Wall Street lives by its own rules when Merrill Lynch rushes out billions in bonuses depsite the bank being insolent, or AIG paying hundreds of millions of bonuses to the very individuals that caused the company to collapse. The web of connections between Wall Street and Washington is thick. Former Treasury Secretary Paulson was the CEO of Goldman Sachs, current Treasury Secretary Tim Giethner worked at Goldman Sachs, much of the Fed and Treasury are a revolving door between these two cities. So, of course the prevailing attitude is going to be to keep the schmucks in power, because they are our schmucks.

Johnson, like many economists believes that nationalizing the banks offers the best hope for solving the crisis.

"The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary."

He believes the banks are insolvent and are trying to obfuscate that fact. They may change the accounting rules - mark to market - or report a couple of quarters of good earnings but the bottom-line is "they don’t want to recognize the full extent of their losses, because that would likely expose them as insolvent." So what we have are a bunch of zombie banks struggling to hang on and dragging the economy down with it.

He concludes by spelling out two paths:

1. The current course of equity infusions at advantageous terms to the banks. This, he believes will result in a Japan-style recover- ie - no real recovery as the financial system remains crippled and unablel to lend. But it keeps the Wall Streeters in power and keeps them rich.

2. Nationalization and reform. Nationalize the banks, clean them up, privatize them. At the same time, put limits on financial compensation to discourage risk taking, and more importantly, break up financial institutions so they can never again become too big to fail. There may be some upfront economic pain from this but longer-term it will help to reform the economy and set the stage for future growth.