Saturday, March 28, 2009

Must-Read Article on the Economic Crisis

So much has been written about the economic crisis, and the reader is inevitably left slightly bleary, the same way one feels hearing a number of voices speaking around an issue without anyone ever directly addressing it.

Simon Johnson, whose article, The Quiet Coup, appears in the May issue of The Atlantic, offers that rarest of rarities: a clear perspective and the ability to clearly express it. He's uniquely suited to the task; having served as former chief economist of the International Monetary Fund, Johnson has been called upon time and again to help untangle economic crises. He says they inevitably arise from the same dynamic:
"Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise."
It's not about derivatives, Greenspan's ultra-low interest rates, deregulation, or our debt to China, per se, though all those things were certainly factors. Johnson, who's seen this sort of thing play out a jillion times, notes that while the factors may change, the underlying dynamic is always the same. And we've fallen into it:
"[E]lite 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"
This crisis pattern had previously been seen only in emerging markets, but Johnson sees America's economy has having come to resemble, in some important ways, that of a banana republic, with overwhelming economic and political power concentrated in the hands of oligarchs. He traces the progression via the increasing domination of America's economy by the financial sector:
"From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent...The great wealth that the financial sector created and concentrated gave bankers enormous political weight—a weight not seen in the U.S. since the era of J.P. Morgan (the man). In that period, the banking panic of 1907 could be stopped only by coordination among private-sector bankers: no government entity was able to offer an effective response. But that first age of banking oligarchs came to an end with the passage of significant banking regulation in response to the Great Depression; the reemergence of an American financial oligarchy is quite recent."
It comes down to a new mindset:
"Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country."
We've all come to buy into that notion (and Bush's attempt to privatize social security was a bald attempt to even more tightly cement that linkage), but it hasn't always been so.

The appointment of two successive Goldman Sachs CEOs as treasury secretaries signaled a tightly entrenched channel of influence - personal connections that "were multiplied many times over at the lower levels of the past three presidential administrations, strengthening the ties between Washington and Wall Street."
"Throughout my time at the IMF, I was struck by the easy access of leading financiers to the highest U.S. government officials, and the interweaving of the two career tracks. I vividly remember a meeting in early 2008—attended by top policy makers from a handful of rich countries—at which the chair casually proclaimed, to the room’s general approval, that the best preparation for becoming a central-bank governor was to work first as an investment banker."
I doubt there's been a tighter and more elegant summary of our predicament than this:
"[M]ajor commercial and investment banks—and the hedge funds that ran alongside them—were the big beneficiaries of the twin housing and equity-market bubbles of this decade, their profits fed by an ever-increasing volume of transactions founded on a relatively small base of actual physical assets. Each time a loan was sold, packaged, securitized, and resold, banks took their transaction fees, and the hedge funds buying those securities reaped ever-larger fees as their holdings grew. Because everyone was getting richer, and the health of the national economy depended so heavily on growth in real estate and finance, no one in Washington had any incentive to question what was going on."
Finally, Johnson, whose specialty is, after all, the resolution of economic crises in banana republics, weighs in on how our current crisis is being handled. In true Banana Republic style, we are coddling the oligarchs rather than facing up to the harsh realities of digging out. 
Some of these [corporate bailout] deals may have been reasonable responses to the immediate situation. But it was never clear (and still isn’t) what combination of interests was being served, and how. Treasury and the Fed did not act according to any publicly articulated principles, but just worked out a transaction and claimed it was the best that could be done under the circumstances. This was late-night, backroom dealing, pure and simple.
It's a lengthy article, but well-written and jargon-free, so I hope you'll read through to the end, where Johnson rolls up his sleeves and offers his thoughts for how to fix things. The really good stuff is toward the very end.

Oh, and Simon Johnson (who is now at MIT) has a blog.

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