The Takeaway

The Next Financial Meltdown?


Despite having co-authored a book forecasting the next financial meltdown, Simon Johnson is optimistic about the future.

“You’re here because you’re worried,” he said to the standing-room only crowd at NPR West in Culver City. “If I were addressing only three people in this room, I wouldn’t be optimistic.”

Johnson, a professor of entrepreneurship at MIT, Baseline Scenario blogger and co-author of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, explained what led to the financial crisis and how we can avoid the next one.

The 40-year flood

Talking about the next financial crisis, Johnson acknowledged, can seem a little extreme. “I get this reaction quite a bit,” he said. “‘Are you exaggerating?'” While people across the political spectrum agree that the crisis was the worst in several decades, they disagree about the odds of another one, considering the events that led to September 2008 an example of “random bad luck.” Treasury Secretary Timothy Geithner, Johnson noted, described the event as “a 40-year flood.” If we worry too much about preventing the next such flood and regulate too much, Geithner’s logic would suggest, we will regret it for the next 39 years.

Simon Johnson and Zócalo guestBut, as Johnson noted, the structure of our economy and financial system has changed over the past few decades to become more dangerous, and anger over it isn’t only pitchfork populism. “I call it legitimate, sensible anger,” he said.

Wall Street wing

The transformation of the financial system began in the 1970s, Johnson said, with deregulation. “I’m actually in favor of some forms of deregulation. I must admit I like cheap air travel,” he joked. But financial deregulation “did kind of sneak up on us.” In the 1980s, Ronald Reagan pushed for more deregulation. The Democratic-led Congress at the time slowed the process. But “the real move toward complete deregulation in this country came during the Clinton administration.” What Johnson said could be called the “Wall Street wing” of the Democratic Party rose, symbolized particularly by Robert Rubin’s ascendance to Treasury Secretary, and his close relationship to then-Federal Reserve Chairman Alan Greenspan, a Republican. Megabanks went from holding assets that were 17% of GDP in the mid-1990s to holding assets around 63% of GDP today.

“It’s not just about money as in campaign contributions or corruption,” Johnson said. “It’s about money as an idea. You in Los Angeles probably get this more than other audiences.” Johnson cited the movie “Wall Street,” noting that bankers saw it as a how-to manual rather than a cautionary tale. The 1980s were marked, he said, by hard-charging, risk-taking bankers who nonetheless look “like a small time operation by today’s standards.”  What Michael Lewis, author of Liar’s Poker, a semi-autobiographical tale of being a bond salesman on Wall Street, warned about became a part of the general culture. “People in Washington became completely convinced that finance was good, unregulated finance was better, and completely unfettered finance was best.”

No speeding tickets for life?

Simon Johnson guests at the event receptionThat ideology is still with us today, Johnson said. Rubin didn’t disappear after his tenure under Clinton – he became a board member at Citigroup, one of the troublesome “megabanks” that Johnson identifies. And Rubin is still headlining think-tank events in DC, even getting co-billing with Vice President Joe Biden. Banks still take, and are in ways encouraged to take, big risks, Johnson said. Goldman Sachs, for instance, became a bank holding company after the financial crisis because it was deemed “too big to fail.” Its assets fluctuated around $800 billion at the time, large but still smaller than other megabanks that clocked in at $2 trillion or so. The new designation meant Goldman Sachs could borrow at a lower rate from the Federal Reserve. “We’ve allowed a lot of wacky things in this country over the last 200 years,” Johnson said. “But we have been careful about certain things. People who make such explicitly risky investments – we have not allowed them to have unfettered access to Federal Reserve borrowing.” These allowances mean we shouldn’t expect the behavior of megabanks to change, Johnson said, just as a person given a lifetime exemption from speeding tickets couldn’t be expected to avoid speeding. “You’d be cautious, you might have seen a big traffic accident recently,” he said. “But sooner or later you’ll be in a hurry.”

And because the banks were already deemed “too big to fail” – and because the country saw what happened when Lehman Brothers collapsed – Johnson said, the chances are quite slim that big banks would be allowed to fail today. “They know it, and they act accordingly.”

Faith-based economic policy

Most of the proposed fixes, Johnson said, are necessary but not sufficient. Secretary Geithner, for instance, proposes a resolution authority that would manage bank failures. But megabanks are too complex, and operate in too many countries, to be managed under such authority. “You can have a faith-based economic policy if you want,” Johnson said. “You can say, ‘we believe it will help.’”

A better idea, Johnson argued, is to make bigger banks smaller, though it’s not a solution in itself. Though American banks may seem small compared to their European counterparts – the Royal Bank of Scotland had assets totaling 1.5 times the UK economy when it failed – they’re still too big. “There is no evidence,” Johnson said, “of the benefit to society of having banks larger than $100 billion in total assets,” or even $30 billion. Their size gives them huge political influence, and isolates them from social responsibility. Their current low rates for borrowing, Johnson argued in Q&A, is not the market at work, but an “extremely dangerous” government subsidy.

Guests read Simon Johnson's 13 Bankers at Zocalo's receptionAnd these piecemeal measures are still more than we’ve accomplished so far, Johnson noted. Megabanks received an unconditional bailout: The eponymous 13 bankers were heads of financial institutions invited to the White House and saved from losing their salaries, jobs, bonuses, staffs, “their empires, their view of the world,” Johnson said. “There wasn’t even any embarrassment.” Criminal prosecutions didn’t happen, in part because of the complexity of the system and the ability to deflect blame. (Johnson did note, jokingly, that the last banker to be executed in the Anglo-American world was offed in 1836.) Some argued it was necessary to protect the bankers to avoid panic and a second Great Depression – but Johnson refuted the idea. Today, bankers are still lobbying aggressively for hands-off policies. And the U.S. has doubled its debt-to-GDP ratio, according to Johnson’s calculations, since the crisis. “We didn’t turn ourselves into Greece, it’s true, but we moved ourselves into that area of danger.”

Big isn’t beautiful

Fixing the financial system will require a broad shift in thinking, Johnson said, much like what happened when Theodore Roosevelt set out to break industrial railroad trusts in 1902. At the time, monopolies weren’t considered bad, and “the Senate was called the millionaires’ club for a reason,” Johnson said. “Big was beautiful in America.” But by 1912, after Roosevelt sued Northern Securities, everyone agreed that monopolies needed breaking up. It didn’t even go so badly for the monopolies: When Standard Oil was split into 35-odd pieces, shareholders still made money, and John Rockefeller “rehabilitated himself with charitable gifts. It was a very American way of solving his problem.”

Today, we need a similar shift in thinking. “There’s a long tradition…of confrontation between overly powerful corporate interests and democracy,” Johnson said. “Every time this has happened so far in the last 200 years, democracy has prevailed. So now we have to do it again.”

Watch the video here.
See more photos here.
Buy the book here.
Read an excerpt of the book here.
Read Johnson’s In The Green Room Q&A here.

*Photos by Aaron Salcido.