A Fix For Banks Too Big To Fail: Cut 'Em Down To Size

Branch of Chase bank in New York City

A branch of Chase bank in New York City. JPMorgan Chase reported $11.7 billion in earnings in 2009, more than double its revenue from 2008. Chris McGrath/Getty Images hide caption

itoggle caption Chris McGrath/Getty Images
'13 Bankers' cover
13 Bankers: The Wall Street Takeover and the Next Financial Meltdown
By Simon Johnson and James Kwak
Hardcover, 320 pages
Pantheon Books
List price: $26.95

Read An Excerpt

As Congress considers new financial regulations, Simon Johnson has some advice that will surely not be taken. But Johnson's advice does possess at least one virtue — you can sum it up in just a few words: If they're too big to fail, make them smaller.

Johnson and James Kwak are the co-authors of a new book, called 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown. The book opens on March 27, 2009, in the White House, where President Obama is meeting with the CEOs of some of the largest financial institutions in America. All 13 of these institutions played a role in the financial crisis. Looking back one year later, Johnson says that six of these banks — "The usual suspects; they're the megabanks" — are not just too big to fail; they're too big for the good of the American market.

The six: JPMorgan Chase, Citigroup, Goldman Sachs, Morgan Stanley, Wells Fargo and Bank of America. The danger they pose, Johnson says, is that they're all so huge that if they fall into danger, the government will be forced to bail them out.

"You're going to have a conversation like this with either the Treasury secretary or with the president: Somebody is going to say, 'Let them just fail, just like we did with Lehman,' " Johnson tells NPR's Robert Siegel. "And someone else is going to say, 'Wait a minute. When Lehman went bankrupt that was an enormous disaster. That triggered a global financial panic. We can't do that. We must therefore save them, provide a bailout.' "

But even beyond the government's binding relationship with these enormous institutions, Johnson says that there's simply no virtue in letting a bank grow so huge.

"There is simply no evidence," he says, "for banks over $100 billion in size." Citigroup, Johnson says, was at $2.5 trillion dollars in assets when it ran into trouble in 2008.

"These banks do not benefit society at an additional size but they obviously create big risks for society."

To make the banks smaller, Johnson says the government just needs to "modify and update legislation that already applies to this issue."

"The 1994 Riegle-Neil Act says that no bank can have more than 10 percent of total retail deposits in the country. That's exactly the right kind of idea," Johnson says. "The problem is, since 1994 most of the action in terms of the bank growth has not been in retail deposits; its been in so called wholesale financing. So you want to cap size of banks in terms of their total liabilities and their total assets."

Simon Johnson i i

Simon Johnson is a professor at the MIT Sloan School of Management. He and James Kwak blog about economics at The Baseline Scenario. Anthony Placet hide caption

itoggle caption Anthony Placet
Simon Johnson

Simon Johnson is a professor at the MIT Sloan School of Management. He and James Kwak blog about economics at The Baseline Scenario.

Anthony Placet

Johnson and Kwak, who also blog about economics at The Baseline Scenario, suggest a cap of 4 percent of the gross domestic product. And that's not even the extreme end of this argument.

"There are some Senate amendments that are pushing towards 3 percent of GDP, and if a bank wants to take on more risk it would have to be substantially smaller. So a Goldman Sachs type of operation would probably be capped around 2 percent of GDP," Johnson says. "These are still big banks. They can operate globally; they can work just fine for the real economy. They will not, of course, generate as much [in] bonuses for the guys who lead them."

The argument that tough capital requirements — that's keeping more money in the bank to protect against risky investments — would solve the problem doesn't float for Johnson. He says that with high enough requirements, that kind of proposal might work. But he's pessimistic that such requirements could be enacted.

He's similarly skeptical of the notion that Washington's actions following the crisis have made another meltdown less likely.

"What we're talking about here is a system of incentives and beliefs in and around Wall Street that leads into big trouble both for the firms involved and for the country. And those incentives and those beliefs have not changed," Johnson says. "The 13 bankers who were brought into the White House last March were basically saved completely. Their bonuses, their people, their staff and their pensions even their boards of directors who'd supervised the most colossal financial collapse you've ever seen, they all stayed in place."

Excerpt: '13 Bankers'

'13 Bankers' Cover
13 Bankers: The Wall Street Takeover and the Next Financial Meltdown
By Simon Johnson and James Kwak
Hardcover, 320 pages
Pantheon Books
List price: $26.95

Introduction

13 Bankers

My administration is the only thing between you and the pitchforks.
— Barack Obama, March 27, 2009

Friday, March 27, 2009, was a lovely day in Washington, D.C. — but not for the global economy. The U.S. stock market had fallen 40 percent in just seven months, while the U.S. economy had lost 4.1 million jobs. Total world output was shrinking for the first time since World War II.

Despite three government bailouts, Citigroup stock was trading below $3 per share, about 95 percent down from its peak; stock in Bank of America, which had received two bailouts, had lost 85 percent of its value. The public was furious at the recent news that American International Group, which had been rescued by commitments of up to $180 billion in taxpayer money, was paying $165 million in bonuses to executives and traders at the division that had nearly caused the company to collapse the previous September. The Obama administration's proposals to stop the bleeding, initially panned in February, were still receiving a lukewarm response in the press and the markets. Prominent economists were calling for certain major banks to be taken over by the government and restructured. Wall Street's way of life was under threat.

That Friday in March, thirteen bankers — the CEOs of thirteen of the country's largest financial institutions — gathered at the White House to meet with President Barack Obama. "Help me help you," the president urged the group. Meeting with reporters later, they toed the party line. White House press secretary Robert Gibbs summarized the president's message: "Everybody has to pitch in. We're all in this together." "I'm of the feeling that we're all in this together," echoed Vikram Pandit, CEO of Citigroup. Wells Fargo CEO John Stumpf repeated the mantra: "The basic message is, we're all in this together."

What did that mean, "we're all in this together"? It was clear that the thirteen bankers needed the government. Only massive government intervention, in the form of direct investments of taxpayer money, government guarantees for multiple markets, practically unlimited emergency lending by the Federal Reserve, and historically low interest rates, had prevented their banks from following Bear Stearns, Lehman Brothers, Merrill Lynch, Washington Mutual, and Wachovia into bankruptcy or acquisition in extremis. But why did the government need the bankers?

Any modern economy needs a financial system, not only to process payments, but also to transform savings in one part of the economy into productive investment in another part of the economy. However, the Obama administration had decided, like the George W. Bush and Bill Clinton administrations before it, that it needed this financial system — a system dominated by the thirteen bankers who came to the White House in March. Their banks used huge balance sheets to place bets in brand-new financial markets, stirring together complex derivatives with exotic mortgages in a toxic brew that ultimately poisoned the global economy. In the process, they grew so large that their potential failure threatened the stability of the entire system, giving them a unique degree of leverage over the government. Despite the central role of these banks in causing the financial crisis and the recession, Barack Obama and his advisers decided that these were the banks the country's economic prosperity depended on. And so they dug in to defend Wall Street against the popular anger that was sweeping the country — the "pitchforks" that Obama referred to in the March 27 meeting.

To his credit, Obama was trying to take advantage of the Wall Street crisis to wring concessions from the bankers — notably, he wanted them to scale back the bonuses that enraged the public and to support his administration's plan to overhaul regulation of the financial system. But as the spring and summer wore on, it became increasingly clear that he had failed to win their cooperation. As the megabanks, led by JPMorgan Chase and Goldman Sachs, reported record or near-record profits (and matching bonus pools), the industry rolled out its heavy artillery to fight the relatively moderate reforms proposed by the administration, taking particular aim at the measures intended to protect unwary consumers from being blown up by expensive and risky mortgages, credit cards, and bank accounts. In September, when Obama gave a major speech at Federal Hall in New York asking Wall Street to support significant reforms, not a single CEO of a major bank bothered to show up. If Wall Street was going to change, Obama would have to use (political) force.

Why did this happen? Why did even the near-collapse of the financial system, and its desperate rescue by two reluctant administrations, fail to give the government any real leverage over the major banks?

By March 2009, the Wall Street banks were not just any interest group. Over the past thirty years, they had become one of the wealthiest industries in the history of the American economy, and one of the most powerful political forces in Washington. Financial sector money poured into the campaign war chests of congressional representatives. Investment bankers and their allies assumed top positions in the White House and the Treasury Department. Most important, as banking became more complicated, more prestigious, and more lucrative, the ideology of Wall Street — that unfettered innovation and unregulated financial markets were good for America and the world — became the consensus position in Washington on both sides of the political aisle. Campaign contributions and the revolving door between the private sector and government service gave Wall Street banks influence in Washington, but their ultimate victory lay in shifting the conventional wisdom in their favor, to the point where their lobbyists' talking points seemed self-evident to congressmen and administration officials. Of course, when cracks appeared in the consensus, such as in the aftermath of the financial crisis, the banks could still roll out their conventional weaponry — campaign money and lobbyists; but because of their ideological power, many of their battles were won in advance.

The political influence of Wall Street helped create the laissez-faire environment in which the big banks became bigger and riskier, until by 2008 the threat of their failure could hold the rest of the economy hostage. That political influence also meant that when the government did rescue the financial system, it did so on terms that were favorable to the banks. What "we're all in this together" really meant was that the major banks were already entrenched at the heart of the political system, and the government had decided it needed the banks at least as much as the banks needed the government. So long as the political establishment remained captive to the idea that America needs big, sophisticated, risk-seeking, highly profitable banks, they had the upper hand in any negotiation. Politicians may come and go, but Goldman Sachs remains.

The Wall Street banks are the new American oligarchy — a group that gains political power because of its economic power, and then uses that political power for its own benefit. Runaway profits and bonuses in the financial sector were transmuted into political power through campaign contributions and the attraction of the revolving door. But those profits and bonuses also bolstered the credibility and influence of Wall Street; in an era of free market capitalism triumphant, an industry that was making so much money had to be good, and people who were making so much money had to know what they were talking about. Money and ideology were mutually reinforcing.

This is not the first time that a powerful economic elite has risen to political prominence. In the late nineteenth century, the giant industrial trusts — many of them financed by banker and industrialist J. P. Morgan — dominated the U.S. economy with the support of their allies in Washington, until President Theodore Roosevelt first used the antitrust laws to break them up. Even earlier, at the dawn of the republic, Thomas Jefferson warned against the political threat posed by the Bank of the United States.

In the United States, we like to think that oligarchies are a problem that other countries have. The term came into prominence with the consolidation of wealth and power by a handful of Russian businessmen in the mid-1990s; it applies equally well to other emerging market countries where well-connected business leaders trade cash and political support for favors from the government. But the fact that our American oligarchy operates not by bribery or blackmail, but by the soft power of access and ideology, makes it no less powerful. We may have the most advanced political system in the world, but we also have its most advanced oligarchy.

From 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson and James Kwak. Copyright 2010 by Simon Johnson and James Kwak. Reprinted by permission of Pantheon Books, a division of Knopf Doubleday. All Rights Reserved.

Books Featured In This Story

13 Bankers

The Wall Street Takeover and the Next Financial Meltdown

by James Kwak and Simon Johnson

Hardcover, 316 pages | purchase

Purchase Featured Book

Title
13 Bankers
Subtitle
The Wall Street Takeover and the Next Financial Meltdown
Author
James Kwak and Simon Johnson

Your purchase helps support NPR Programming. How?

Comments

 

Please keep your community civil. All comments must follow the NPR.org Community rules and Terms of Use. NPR reserves the right to use the comments we receive, in whole or in part, and to use the commenter's name and location, in any medium. See also the Terms of Use, Privacy Policy and Community FAQ.