Rewriting The Rules Of The Financial System

The government — and taxpayers — rescued some of the nation's biggest companies in the heat of the financial crisis to prevent the economy from collapsing. The Obama administration says it has a plan to prevent a "Too Big To Fail" bailout from happening again, but there are some surprising points of view about whether that plan could work.

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President Obama's administration and Congress are rewriting the rules of the U.S. financial system. The plan tries to grapple with big questions, like what to do about institutions - say, AIG and others - so big or so complex that if they fail, it could derail the entire economy. Alex Blumberg is on NPR's Planet Money team, and he's taking a look at how the Obama plan approaches this problem.

ALEX BLUMBERG: To answer this question, I consulted two experts: Simon Johnson, a former chief economist at the International Monetary Fund and currently at MIT's Sloan School of Management, and Charles Calomiris, an expert on banking and financial history from the Columbia University Business School. They come from different ends of the political spectrum. Johnson supported Obama. Calomiris worked for McCain. But they agree on a lot. Here's Charles Calomiris, followed by Simon Johnson.

Professor CHARLES CALOMIRIS (Banking and Financial History Expert, Columbia University Business School): The thing that probably is bothering Simon as much as it's bothering me the most is the idea that big firms that failed didn't have adverse consequences. Capitalism has to have consequences for losers.

Professor SIMON JOHNSON (Economist, MIT Sloan School of Management): The last banker who we know who was executed for bank failure is Henry Fauntleroy in the 1820s. I'm not proposing to bring back capital punishment, but I think Charles had it right. The losers must lose.

BLUMBERG: Okay. So here is what's strange. Charles Calomiris, the Republican former McCain advisor, he likes the Obama plan, says it addresses this problem. He gives it a B. Simon Johnson, the Democrat and Obama supporter, gives it an F. So why the discrepancy? Well, they disagree on one essential question about the plan, a question Simon Johnson phrases like this…

Prof. JOHNSON: Is it Jamie Dimon-proof?

BLUMBERG: Jamie Dimon is the chairman and CEO of J.P. Morgan Chase, one of the largest financial firms in the world, and I should be clear here. Simon Johnson is using Jamie Dimon here as a symbol of all the heads of all the largest banks and financial institutions in the world: Citigroup, Bank of America, Goldman Sachs, AIG, all these huge, global, interconnected firms that, when they get into trouble, their CEOs can go to the government saying if you don't bail us out, the economy will collapse.

Prof. JOHNSON: It's a bizarre kind of blackmail, right? It's a very sophisticated sort of oligarchy that we've created where they - the power comes from not saying we'll have you all assassinated, but saying, well guys, if you want the second Great Depression, go ahead, make us all fail. That's fine, but it's your call.

BLUMBERG: One more thing to point out. Simon Johnson isn't saying this threat is not real. It's pretty clear that Fed Chair Ben Bernanke, Treasury Secretary Henry Paulson and President Bush all truly believed that the world economy would collapse if they didn't step in to prop up large institutions like Citigroup and AIG.

But to Johnson and Calomiris, the fact that it's true makes this threat even more important to deal with. And Charles Calomiris believes that the Obama plan is starting to deal with it, because, he says, the plan sets up something called a resolution authority, a kind of bankruptcy for really big companies. Some branch of government can step in when there's trouble, reorganize the failing firm quickly, and get it up and running again. Unlike what we faced with AIG or Lehman, there's a process in place.

An added benefit: Under the Obama plan, the management gets fired and the people who own the firm, the shareholders, lose money. The losers lose. Simon Johnson says the Jamie Dimon problem is way bigger than simple rules. To prove his case, he sets up a little in-studio drama right there, using me and Charles Calomiris as props. He imagines a scenario sometime in the future. Calomiris' plan, which is similar to the Obama plan, has been put in place and there's a new financial crisis at hand. Simon Johnson is playing the Jamie Dimon role. His bank is in trouble, it's about to fail and fall under the resolution authority we put in place back in 2010, long ago, and then he comes to see me: the president.

Prof. JOHNSON: Now I say to all of these systems that were built were build in a bygone era. The realities of today's financial system, it's global, it's interconnected, 2.5 billion people will be plunged immediately into poverty when these accounts are shut down. There is no way that that was envisioned by the Calomiris legislation.

BLUMBERG: At this point in our fictitious future scenario, Charles Calomiris - who, remember, is playing himself - can no longer contain himself and writes himself into the drama.

Prof. CALOMIRIS: And then, of course, you call me…

(Soundbite of laughter)

Prof. CALOMIRIS: …so I can give you some good advice, because you need it desperately, which is, let's look at this factual, counterfactual and see whether there's any possibility that he's right. Well, let's see, hold on. The bank continues to operate with a different manager. The stockholders in this bank lose some money. Since those are the only differences, exactly why is that going to cause a systemic crisis?

Prof. JOHNSON: You know, and then I page you, and I say, you know, Charles may be right. But, you know, me and everybody else on Wall Street says that this is going to melt down.

BLUMBERG: Now if you're wondering how the actual Jamie Dimon would solve the Jamie Dimon problem, we did reach his spokesperson for a comment. He comes down on the Obama-Calomiris side of this debate, supports the Obama plan, in fact. He says that big firms like his are fine as long as the government is there to ensure that if they need to, they can fail in an orderly way.

This week, the Associated Press reported something that Simon Johnson says supports his argument. They reviewed Secretary Treasury Tim Geithner's phone and appointment calendar over a period of seven months after the crisis last fall, and three people showed up a lot, more even than key leaders in Congress. Who was the secretary talking to? Lloyd Blankfein, CEO of Goldman Sachs, Vikram Pandit, CEO of CitiGroup, and you guessed it, Jamie Dimon. And to Johnson, this is the point. Bigness leads to power. Power leads to access. And when there's a crisis, the people with access have influence.

So what you have to do is get rid of that power, make sure that no individual institution is allowed to get big enough to take down the whole system. That way, this future scenario we just rehearsed would have a much different outcome.

Prof. JOHNSON: It'd be much better when we're having this conversation, this structure, if Charles could turn around and say, what are you talking about? Jamie Dimon used to be 10 percent of U.S. bank assets. Remember, we downsized them. He's only 1 percent now. He's tiny.

Ms. DIANA FARRELL (Deputy Assistant for Economy Policy): We understand Simon Johnson's views on this, and I guess the response is the following.

BLUMBERG: Diana Farrell is President Obama's deputy assistant for economic policy. She says that within the administration, as they were developing their plan for the financial system, they had many arguments, like the one between Simon Johnson and Charles Calomiris. The problem with Johnson's approach, they decided, is that bigness also has its benefits. Sure, the economy used to be simpler and financial institutions weren't so big and dangerous, but GDP was smaller then, too, and people were poorer. We can discuss a time before we created huge, complicated institutions like CitiGroup and AIG all we want, says Farrell. But…

Ms. FARRELL: We have created them, and we're sort of past that point, and I think that in some sense, the genie's out of the bottle and what we need to do is to manage them and to oversee them, as opposed to hark back to a time that we're unlikely to ever come back to or want to come back to.

BLUMBERG: In the end, what we should do about the genie comes down to how you think about it. Farrell's view and the view of economists like Calomiris from Columbia is that the genie does lots of good things for us and that we can learn to restrain it.

For Johnson, the good things that the genie does are outweighed by the bad things and we should be thinking hard about how to get it back in that bottle before it wreaks havoc once again.

For NPR News and Planet Money, I'm Alex Blumberg.

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