Is Simon Johnson Right? A note on finance and innovation

Posted by: Michael Mandel on March 31

In the latest issue of the Atlantic, Simon Johnson, former chief economist of the IMF, writes an article entitled The Quiet Coup. His premise: The financiers have taken over the U.S., and need to be cut down to size.

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.

His solution: Nationalization, and breaking the banks into smaller pieces.

The government needs to inspect the balance sheets and identify the banks that cannot survive a severe recession. These banks should face a choice: write down your assets to their true value and raise private capital within 30 days, or be taken over by the government.

Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical—since we’ll want to sell the banks quickly—they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.

and then he ends with a depressing note

The conventional wisdom among the elite is still that the current slump “cannot be as bad as the Great Depression.” This view is wrong. What we face now could, in fact, be worse than the Great Depression—because the world is now so much more interconnected and because the banking sector is now so big. We face a synchronized downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government finances. If our leadership wakes up to the potential consequences, we may yet see dramatic action on the banking system and a breaking of the old elite. Let us hope it is not then too late.

For anyone who has read down to the bottom here. You know, I understand what Johnson is saying, but I just can’t bring myself to believe it. He draws the analogy between the U.S. and the emerging economies that the IMF used to shepard, but I think that analogy is a false one.

The role of the U.S. in the global economy should be that of the risk-taking innovator—very different than that of a small emerging country. The problem is not that the U.S. took chances, but that it took the wrong ones. The route out of this mess is more innovation and risk-taking, not less.

(and folks, if you think my posts are conflicted these days…well, you are right. But I’m getting somewhere, I think).

TrackBack URL for this entry:

Reader Comments


March 31, 2009 09:25 AM

I think Johnson is right that the kinds of bets the banks prefer to make do us no good, and he is right that they have government in their wallet to a large degree. It also true that we're still pointed in the wrong direction for growth.
Just because equities have stopped their free fall for the moment doesn't mean they or the economy will take off a like a rocket, either.

We definitely need a banking sector that believes its roles is to invest in research and production rather than playing ever-larger games of poker. However, big games of poker are the most profitable endeavor for banks in a world with cheap money and lots of players. It's part of the natural consolidation effect and clearing effect of capitalism. Johnson's approach is the natural liberal foil to the let-em-fail approach.

Those are pretty much the competing philosophies. The first is to stay out and let market actors evolve naturally: don't touch, no matter how tempted you are! The second is to visualize where you want the market to go and try to legislatively take short cuts. Which approach you favor (liberal vs. conservative) is usually a result of your faith in other people's ability to plan the economy and how heavily you weigh empathy against fairness. You can see that pretty clearly in the allegiance of the respondents here.

If you don't trust or like people, you're naturally on the right. If you're full of empathy and you just want someone to "find a way to make it work", you're naturally on the left. If you like people, but don't think they should try to run other people's lives because they'll just make things worse, you're Milton Friedman. :) I can't find an approach consistently better than compassionate conservatism, but I can't help but keep looking, because people keep "forgetting" the "compassionate" part.


March 31, 2009 03:56 PM

SJ's 1st paragraph : Johnson is right.
SJ's 2nd and 3rd paragraph : Johnson's proposal should be supplemented in order to become a sustainable solution (possibly). He's talking about exercising "brute force" to break up power. And then what? Could someone not belonging to the "finance elite" and to the finance gurus' club describe the day after? A sociologist or a philosopher may be? Haven't heard from them lately. Do we still consider them useless?
SJ's 4rth paragraph : Johnson is right.
Following SJ's quotes.
MM's 1st paragraph : Hard to accept that the US bears so many similarities to the political and financial situation in emerging countries, isn't it?
MM's 2nd paragraph : Mike is absolutely right. This is why it is so crucial to preserve the credibility of the US's financial system. Risk-taking needs lots of capital and the rest of the world will invest eagerly if convinced that innovation in the real economy is now taking place. The US has done it before, it can do it again.
MM's 3rd paragraph : there is nothing to be embarrassed about being openminded even if some conflict occurs once in a while.
P.S. I truly enjoyed CompEng's analysis


March 31, 2009 05:56 PM


why do you make a simple thing like an attack on usury complex? The nature of lending money is such that the level of debt is guaranteed to rise faster in the economic system than the level of money because interest must by paid (my personal internal analogy is holes and elections for money and debt, but that's really geeky). With fractional reserve banking, you can also create money... but not as fast. So our monetary system defies the laws of thermodynamics. The rest feels obvious, but I'll walk through it a bit.

The fun cool side effect of this is that, on average, debt can't be paid back without reducing the level of money in the economy. Too bad for the lender (and the economy). If the effect of this is compartmentalized and contained, then defaults destroy debt and bring it in line with the amount of money in the world. But if bankers make good loans, they ultimately do make money from others, although it's diluted by the effect of fractional reserve banking.

It is fair to analogize banking as a game wherein you try to increase your size in order to allow you to print more money while sticking someone else with the debt. Manipulating credit and bankruptcy laws through lobbying is part of the game. When lots of large banks lend to each other, the game of poker merely has gotten higher stakes: you could theoretically have huge piles of debt (and money, but in fundamentally smaller piles) that have no real relation to anything. Thus my general distaste for banking, despite the valuable service it provides.

When this happens, the debt must be at least partially written off to save the monetary system. I don't care who organizes it, the market or government, but it must be done.

James Mason

March 31, 2009 08:21 PM

One thing that will be absolutely essential is that in future the argument that something is just too big to be allowed to fail should never be used again. This means no sector, especially the financial sector, should have firms which are allowed to expand to such an extent that their failure threatens the wider economy. Naturally, this means the current large entities have to be broken up and sold off and never be permitted to re-form.


March 31, 2009 11:59 PM

In that piece, Johnson starts off by trying to establish his credentials by comparing how oligarchs didn't want to give up power in emerging market financial crises to the current situation. His evidence of current-day oligarchy is scant and unconvincing, some Goldman Sachs ties and academic connections, so he finally resorts to damning an ideology of free markets. His examples of deregulation causing problems are useless when he bemoans the repeal of Glass-Steagall, even though the companies that were enabled by that change were the ones who survived this crisis. It's funny how he criticizes the SEC for not doing anything yet magically believes that some other regulator or regulation would have done something useful. Combined with some populist bonus-baiting and criticism of current policies, he claims, like power-hungry bureaucrats everywhere, that the only solution is to turn power over to them at lightning speed, so they can "fix" the problems. Does The Quiet Coup refer to the oligarchs or his plan? When he blames the banks for not lending us out of this mess, he seems to believe there's no such thing as a real economy. What does it matter if consumers want to buy the goods that such lending would help create more of, what matters is that money is lent out! Unfortunately, any time there is a financial crisis, there are govt bureaucrats willing to step up with such idiotic "fixes." His euphemistic solution for the real problem, "cleaning up balance sheets," will somehow come up with a solution for allocating losses between the various investors and bondholders that the market has been loath to do so far, because we all know how much politicians like making such unpopular decisions! ;)

I actually agree with him that the FDIC bankruptcy process is the best solution, I just don't want whatever changes he seems to want to get the govt more involved than it normally would be in the FDIC process. As for caps in corporation size, I'd be fine with that; in fact, I think it'd actually be much more efficient. I'd just rather that investors realized and demanded that rather than it happening by govt decree. As I've said before, I think the internet will lead to the natural destruction of all these behemoths anyway, so I don't see the value in legislating what is going to happen anyway. As for CEO wage controls, even he seems to back away from that dumb suggestion with a vague call for other equivalent forms of taxation and regulation. He finally ends with a crazy analogy between the US and Russia- if he cannot see how that is a real oligarchy and the US is nowhere close, he's clearly deluded- and a loony suggestion that the Great Depression might recur, obviously to give momentum to his preferred solution of a blitzkrieg of nationalization. His piece is better read as an exemplar of a govt bureaucrat demanding wide and sweeping powers based on shoddy analysis, rather than a worthwhile analysis of the current crisis. As for Mike's point that we need more innovation, not less, that's besides the point and not talked about by Johnson. His piece and the crisis today is about how to pay for the mistakes of the past, not about what to do in the future. Yes, regulation will weigh down innovation but the next big thing is technical innovation, which has been dormant for so long that they're not really talking about regulating it anyway.


April 1, 2009 01:49 PM

There's an interview with Simon Johnson on the topic that I haven't finished listening to at:

The title is "Are the Banks Running America?"


April 3, 2009 12:51 AM

Simon Johnson is right all around. For far too long, our polical system has fostered the growth of oligarchies, notjust in the financial markets, but in health care, energy, and other areas. We tend to forget the simpler life and our society places too much emphasis on wealth as a virtue, and tends to forget that great wealth and the unethical pursuit of it is destructive to the better parts of human life. Our system is particularly destructive becsuse it acts to promote an elite which Simon rightly identifies as an oligarchy.

I don't know how things will ultimately turn out, and I do believe in regulated free market capitalism. But, there is something essentially wrong in a system where the leader of a corporation is making 400 times what a worker is making. We are going to be looking ultimately at a modern day French Revolution, especially when our politicians are consistantly up for sale to the highest bidder.

Why do we subsidize drug companies on both the back end (research) and front end (pricing)? We have NIH (a highly revered research facility to develop answers to disease treatment, and then allow our drug companies to sell their products on foreign markets at a fraction of what our citizens pay for them. We do much to support the rest of the world's health care and ignore the needs of our own citizens. This is a major reason why many of our industries can't compete in world markets.

I hope that we give the Treasury the resolution authority it has requested so that we can break up the large financial businesses into smaller banks and services. Then we can really get back on track.


April 3, 2009 03:51 AM

Excellent article.

Why Americam management failed and resulted into great economic recession.? Mr. Obama can solve the problem.

The modern (Western) management concepts of vision, leadership, motivation, excellence in work, achieving goals, giving work meaning, decision making and planning, are all well discussed and implemented but failed miserably.
The greed is a more fundamental and better explanation than the principles of economics and the impact of government policy on economic decisions. Misses the point that most people and businesses are motivated to improve their condition and that this force is always at work. Why did greed suddenly cause this meltdown? What allowed it to get out of control. There is one major difference. While Western management thought too often deals with problems at material, external and peripheral levels, our PM tackles the issues from the grass roots level of human thinking. Once the basic thinking of man is improved, it will automatically enhance the quality of his actions and their results. If businessmen wanted to rape and pillage, I mean maximize profit, you wouldn’t have to force them to loan money. Their profit motive gives them an incentive to “serve” the community. If certain communities aren’t being served that signals the presence of other forces dissuading businessmen from selling their product or service. Implicit in this argument is the belief that customers have a right to demand the services and goods provided by businesses. Of course, this idea underlies arguments for universal health care and whatever other service or good deemed to be too valuable to trust to the market.
The management philosophy emanating from the West is based on the lure of materialism and on a perennial thirst for profit, irrespective of the quality of the means adopted to achieve that goal. This phenomenon has its source in the abundant wealth of the West and so 'management by materialism' has caught the fancy of all the countries the world over, India being no exception to this trend. My country, India, has been in the forefront in importing these ideas mainly because of its centuries old indoctrination by colonial rulers, which has inculcated in us a feeling that anything Western is good and anything Indian, is inferior. Gita does not prohibit seeking money, power, comforts, health. It advocates active pursuit of one's goals without getting attached to the process and the results.
The result is that, while huge funds have been invested in building temples of modem management education, no perceptible changes are visible in the improvement of the general quality of life - although the standards of living of a few has gone up. The same old struggles in almost all sectors of the economy, criminalization of institutions, social violence, exploitation and other vices are seen deep in the body politic.
The source of the problem
The reasons for this sorry state of affairs are not far to seek. The Western idea of management centers on making the worker (and the manager) more efficient and more productive. Companies offer workers more to work more, produce more, sell more and to stick to the organization without looking for alternatives. The sole aim of extracting better and more work from the worker is to improve the bottom-line of the enterprise. The worker has become a hirable commodity, which can be used, replaced and discarded at will.
Thus, workers have been reduced to the state of a mercantile product. In such a state, it should come as no surprise to us that workers start using strikes ( gheraos) sit-ins, (dharnas) go-slows, work-to-rule etc. to get maximum benefit for themselves from the organizations. Society-at-large is damaged. Thus we reach a situation in which management and workers become separate and contradictory entities with conflicting interests. There is no common goal or understanding. This, predictably, leads to suspicion, friction, disillusion and mistrust, with managers and workers at cross purposes. The absence of human values and erosion of human touch in the organizational structure has resulted in a crisis of confidence.
Western management philosophy may have created prosperity – for some people some of the time at least - but it has failed in the aim of ensuring betterment of individual life and social welfare. It has remained by and large a soulless edifice and an oasis of plenty for a few in the midst of poor quality of life for many.
Hence, there is an urgent need to re-examine prevailing management disciplines - their objectives, scope and content. Management should be redefined to underline the development of the worker as a person, as a human being, and not as a mere wage-earner. With this changed perspective, management can become an instrument in the process of social, and indeed national, development.
Now let us re-examine some of the modern management concepts in the light of the Bhagavad-Gita which is a primer of management-by-values.

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

BW Mall - Sponsored Links

Buy a link now!