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Is Big Finance Too Big To Save? Joint Economic Committee Hearing Tomorrow

Congress is back this week and various committees are positioning themselves to have influence over the broader financial sector reform process that continues to take shape.

First out of the block is the Joint Economic Committee, with a hearing tomorrow morning on the central issue of the moment: "Too Big To Fail or Too Big To Save? Examining the Systemic Threats of Large Financial Institutions."

It's always hard to tell how the interpersonal dynamics of any hearing will play out, but this looks to be a broad strategic discussion of the big picture. The fundamental principles of our financial system are on the table and there is a pretty straightforward, but also incredibly difficult question before us: How do we prevent this system from repeatedly damaging the US and global economy?

The panelists are, from left to right (which is also initial speaking order): Joseph Stiglitz, me, and Thomas Hoenig.

Stiglitz, of course, is a prominent critic of the Obama administration's handling of the banking system (and more). His most famous recent contribution to the debate was an article in Vanity Fair (reviewed here) in which he blames free market ideology - if you free it, we will all do well - for the boom and megacrash. The Columbia University professor represents the left of the spectrum and received a Nobel Prize for thinking about the economics of information, how markets really work, and many other ideas that policy should have heeded more over the years (homepage; Wikipedia bio). He is also a font of great quotes and quite capable of producing verbal fireworks.

Hoenig, on the other hand, is much more low key. He's the president of the Federal Reserve Bank of Kansas City (bio, speeches), but shot to national fame - and became a prominent feature of discussions on the Internet - with a brilliant speech in early March (reviewed here) in which he called, from a free market perspective (!), for temporary bank nationalization. Or perhaps he sees - correctly, in my view - the administration's approach as a form of de facto state control, with all the complications and distortions that this is likely to produce, and is arguing that nationalization and then re-privatization for some of the largest banks is the only way to bring the market back in.

I'm in the center seat and - just like on any airplane ride - have to decide if I talk more to the person by the window or on the aisle. I'm invited to play the role as the centrist which, given my views on the issue (be tough on bankers; bring in the Department of Justice's Antitrust Division; reinforce the criminal penalties for executive bad behavior) tells you something about where this debate is heading.

But one of my main points is that this debate is not really about left vs. right in any meaningful sense. Sure, the word "nationalization" is a hot button for polarization, but I don't think anyone wants the government to run the banking system - in fact, I expect to agree fully with what I think Hoenig will say, i.e., the Obama administration is running the banks right now, this is bad and needs to stop. The question to my mind is: What politically feasible exit strategy makes most sense, in terms of protecting taxpayers and facilitating an economic recovery?

I see the current debate - and tomorrow's hearing - as much more "left-center-right deeply suspicious of big finance" vs. "centrist supporters of big finance" (in Treasury and, it seems, the White House). The latter group will not be at the table on Tuesday but their ideas and approach constitute the backdrop for the whole conversation.

Are there workable and preferable alternatives to the administration's "financial rescue" policies?

By Simon Johnson  |  April 20, 2009; 6:01 AM ET
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Next: Treasury Sec. Geithner Testifies Today on Banking Industry


Years ago (old man talk, tune out) my father owned a mid size Mfg. company. He needed to purchase a costly new flat bed truck for hauling. He, his VP,his Managers all got together to discuss which truck would be best. It was a long meeting with many opinions. Wait my father said we all have opinions but what about the opinion the driver of the truck might have? The driver with all his practical years of experience came in and gave his humble yet very knowledgable opinion. #1 truck pick, the drivers.
(forgive my spelling, my secretary was so much better then I,er Me.) Moral to this true story. TO GET GRASS ROOTS ANSWERS TO GRASS ROOTS PROBLEMS GO TO GRASS ROOTS CITIZENS. (over there,the one's with tea bags.)

Posted by: eaglehawkaroundsince1937 | April 20, 2009 8:13 AM | Report abuse

They will be hearing, but will they be listening?

Posted by: _Nemo_ | April 20, 2009 9:52 AM | Report abuse

I don't know if banks these days are too big to fail - and living in America in 2009, we aren't allowed to find out.

Last fall, a former banker, Henry Paulson, in his capacity as Treasury Secretary, decided that ALL banks needed capitalization, regardless of performance.

Billions and billions of dollars went straight to Wall Street - to companies that did not have to account for these funds. And in the peculiar thinking that lives on Wall Street, it was deemed essential by some to use these funds for bonuses. Billions in bonuses.

Paulson's TARP covered the healthy as well as the sick - the reasoning being that funding just the sick banks would make them even less viable.

But the healthy banks are issuing reports and press releases trumpeting their health to the world. So the separation deepens. No one wants to remain on deck at the Titanic when Goldman beckons....

How long will we prop up the dead?

And now the politicians get involved in America's "free market."

I hope tomorrow that the legislators take the concept of "a hearing" literally. But I don't have high hopes this will happen. Most politicians involved in hearings of this nature seem eager to pontificate and bluster and talk for long periods of time in the hopes of getting a great sound bite. Not much listening seems to happen at these events.

Whatever nuggets of genius are revealed, I think it should be well understood that companies of this size must be regulated in ways that protect the public without killing the business.

Frankly, after failure of this magnitude, wondering if institutions are "too big to fail" seems almost irrelevant. Failure isn't just an option - it's our current reality. Here's to hoping that the best and brightest can develop solutions to prevent such catastrophe in the future.

Posted by: anne3 | April 20, 2009 10:44 AM | Report abuse

"Big finance" is a bunch of greedhead crooks, every last one of them. As far as I'm concerned, they should all be in jail.

I have cut up all my credit cards, and as soon as I can figure a place to put my money that doesn't involve, banks or the stock market, I'm going move it.

Posted by: nicekid | April 20, 2009 10:54 AM | Report abuse

Broad areas of agreement among experts from every part of the political spectrum suggest to me that the onus is upon the Administration to demonstrate why they are ALL wrong. Our tentative and slow approach to policy for the banking sector is, once again, in grave danger of being overtaken by events. If so, we may have to take over the banks in any case. If that is thrust upon us by events, it will be far more costly to taxpayers than if we take a more realistic and direct approach to downsizing our banks now. We've already seen the mushrooming of social costs as a result of under-regulated private risk-taking behavior. At the moment, banking cannot be left to the bankers, the mega-money-center "bankers" I mean.

Posted by: e-veblen | April 20, 2009 10:57 AM | Report abuse

The Constitution provides for discharge of unsupportable debt in bankruptcy (11 USC) and the Congress has provided for receivership of insolvent depository entities and credit unions (enabling acts for the FDIC and NCUA).

Any of these existing statutory regimes provides for nationalization of insolvent "banks". The conversion of investment banks into commercial banks, in order to receive TARP funds, should make FDIC receivership available as a remedy for stress test failures? This seems like a good avenue for rapid resolution of problems ... particularly if the FDIC is willing to piece-meal auction assets to smaller purchasing entities.

Posted by: angry_liberal | April 20, 2009 11:23 AM | Report abuse

One should mention that Stiglitz really got his Nobel for his views on the need for state regulation in the 1990s and for being right on Russia. His first book on globalization is a scathing--and accurate--attack on Summers' role in Russia and particularly its privatization.

The right-wing like Limbaugh are mocking Obama for simply being a prisoner of his teleprompters. He would, I think, be much better advised to be perceived, and correctly, as listening to a range of economic advisers, except simply to Summers (or his front man, Geithner).

With the gutting of mark-to-marketing and the end of Sarbanes-Oxney, Obama is for Summers' de-regulation, and Geither's statement on not needing another bailout means he is planning a Russian-like fraudulent privatization to bail out both the banks and the investment funds.

I wonder if Obama knows all this. I would be happier if I knew he were consulting the critics and hearing their proposals and their criticisms and making his own judgments. If it goes bad, he is going to fall very, very rapidly.

Posted by: jhough1 | April 20, 2009 11:26 AM | Report abuse

Here's a question I'd like to see posed to the witnesses at this hearing.

We're seeing a smattering of "green shoots" that suggest the rate of our economy's decline is slowing. The Administration has been talking up some not-as-bad-as-predicted indicators in consumer spending, housing, new orders for capital equipment, and equities markets while, at the same time warning that we're not out of the woods yet.

Q: Independently of how each of you may feel about any or all of these indicators, does the possibility that things are nearing a firming up on the economy, change your view on banking policy? After all, there is some probability of our muddling through isn't there?

Posted by: e-veblen | April 20, 2009 11:38 AM | Report abuse

I think the biggest issue in prevention of these type of problems is the culture change needed. The size of these financial institutions makes it nearly impossible to dictate significant oversight. If you look historically at the number of depressions/recessions the US has had that was caused by bank failure, it is a testimate to banks that they have managed to keep the government out of their business to a large degree. The boom/bust cycle is a extremely profitable because those who run companies make lots of money on the way up and are shielded from personal loss on the way down.

It would be preferred in the short term to split the banks apart and get them back in private hands as quickly as possible. By limiting their size it will also help to limit their influence.

Posted by: Trescml | April 20, 2009 12:11 PM | Report abuse

I think the biggest issue in prevention of these type of problems is the culture change needed. The size of these financial institutions makes it nearly impossible to dictate significant oversight. If you look historically at the number of depressions/recessions the US has had that was caused by bank failure, it says a lot about the influence of banks that they have managed to keep the government out of their business to a large degree. The boom/bust cycle is a extremely profitable because those who run companies make lots of money on the way up and are shielded from personal loss on the way down.

It would be preferred in the short term to split the banks apart and get them back in private hands as quickly as possible. By limiting their size it will also help to limit their influence.

Posted by: Trescml | April 20, 2009 12:12 PM | Report abuse

Dont't save Big Finance, it's too rotten. Take over the banks, rebuild and re-regulate, then sell them back to the private sector, the Swedish solution. Kick Wall Street's a$$, hard, so they never pull these reckless stunts again.

Posted by: hairguy01 | April 20, 2009 12:37 PM | Report abuse

Apparently the only way to save AIG, Wall Street, & big banks is to break US taxpayers.

They made trillions, broke the world economy, gave our representatives millions to stop public debate into derivatives, gave themselves bonuses, our representatives continue auto pay raises, gave them millions more, & they give our tax $ right back to the representatives who ivbest it in defense contractors & start wars based on lies so they make millions?

This isn't rocket science, it's democracy, representation 101, how to break an empire. If Iraq doesn't catch on they'll be as broke as we are. Does anyone in America really believe our representatives became millionaires running their business the sae way they've run US trillions into debt?

If the America people who just had their little english tea party aren't bright enough to catch on, let me spell it out.


Posted by: greyghost1 | April 20, 2009 12:56 PM | Report abuse

Big Finance should be gutted with bayonets; their leaders arrested; and their prpoerty expropriated by the state. Their families should be tossed out into the streets where they can starve to death. Unfortunately this is a country that rewards monumental failures with important positions and even decorations and medals.

Posted by: garrafa10 | April 20, 2009 12:58 PM | Report abuse

Some individuals in the finance sector committed crimes. Prosecute them.

Posted by: deepthroat21 | April 20, 2009 1:04 PM | Report abuse

On the topic, I am a centrist. I believe that today we have financial institutions that are both too big to fail and too big to save. I favor relying as much as possible on market forces to save those in jeopardy, while at the same time completely reforming the regulatory environment in which they function.

Conceptually, reform should include broad oversight to identify systemic risk, extension of FDIC-type regulatory powers over non-bank financial institutions, registration and orderly trading of synthetic securities, wholesale reform and regulation of the securities rating system, the requirement for financial institutions to clearly identify all liability, including off-balance-sheet exposure, the requirement for underwriters to retain a portion of their underwritings and call an after-market, regulation of overall leverage within individual financial institutions, regulation of executive compensation for publicly traded companies. What have I missed?

The point is to re-establish a financial system in the US that is sound and reliable. This itself will shortstop corruption going forward. It will tend to invigorate credit markets and bring institutions not excessively compromised by legacy assets to life more quickly. The world will again refer to the US for credit and capital, and trade will begin to flow once more.

It may be that some institutions must be nationalized (in the sense of seizing assets some Friday evening and eliminating shareholder equity). This must be temporary. Additionally, (IMHO) nationalization stands very little chance of achieving anything useful unless two things happen first:
1. regulatory reform must be in place, and
2. credit markets must be operating including particularly markets for legacy assets.

To attempt nationalization before there is a market for legacy assets, would be to risk doing more harm than good. Banks, strictly speaking, have done very little that is illegal. They were clever enough or powerful enough (or both) to have had the laws changed in advance. At present nationalization will occur due to insolvency caused by downward valuation of legacy assets. Once a government policy of seizure is revealed no market will form for those assets, uncertainty will spread, credit market will slow and the question of 'fair compensation for property taken' will be thrown before the courts. (Either that or the taxpayer will quickly agree to pay a premium for seized assets just to expedite the process and avoid collapse of the economy. A BBC commentator opined that if we were to pursue Paul Krugman's plan to seize 'zombie banks', the DOW would drop to 3000.)

I do not oppose but I do not favor an anti-trust action simply because it is too blunt an instrument, it is unpredictable, and it takes decades to resolve.

Posted by: BillBradbrooke | April 20, 2009 1:22 PM | Report abuse

Screw big finance. Look at what they've gotten us into.

Posted by: adrienne_najjar | April 20, 2009 1:42 PM | Report abuse

Does anyone else seem to feel like there has been (at least with regards to the bank bailouts) a continuation of the previous administrations' "Trust us, we know what's best better than you" mentality? What's up with the hush-hush on the stress tests...or the back-door recap of the big banks via AIG...or especially the mark-to-model FASB change (doesn't this pretty much work against Geithner's PPIP)? When I voted for change, I voted for an administration I thought would be open, transparent and looking out for the average American's best interest. What I've gotten is an adminstration that has replaced Cheney with Sumners and Halliburton with the big banks. And as for TARP, again, it was meant to buy toxic assets but then the previous/new (can't tell them apart sometimes) adminstration decided that they didn't want to do that anymore and so changed the rules. Am I way off base here? Is there something in the water of the White House that turns people into shells of their former selves? So just so I don't sound like I'm only whining, here's my proposal: let's get a new TARP, allow each bank to offload the worst of their assets (this could get expensive...but look at how the Fed's balance sheet has balooned) at face value and then hold these assets in escrow if you will. Other banks or hedge funds or whomever can bid on these assets and the bank that originally owed them can choose to sell them (if they sell, they take a loss)...or they can "ride out the storm" and buy them back when they want. However, they will have to buy them back at some point in the future. Seems to me this way, we replace junk with cash on the banks' balance sheet temporarily with the understanding that they will have to account for this junk at some point...when they and the economy are both healthier...and the prices of the assets have rebounded somewhat so the losses wouldn't be as steep. Point is, it's the banks that got themselves into this...and the govt should help them out...but we're just giving them a free ride here. So disappointed...and I work for a big bank.

Posted by: DesolationRow | April 20, 2009 3:20 PM | Report abuse

What would I say if I were invited to testify before Carolyn Maloney’s Committee tomorrow morning on the question of whether banks are too big to fail.

1. Of course, no bank is too big to fail.

2. Some would say that there are quite a number of institutions categorized as too big to fail that have already failed. Thus, our problem is how best to mitigate the adverse consequences and we need to have an informed public debate about the competing approaches that goes beyond outrage over bonus compensation schemes.

2. It would clarify our situation greatly, and it would activate market forces to find solutions, if it were not a foregone conclusion that too big too fail institutions will be saved by government.

3. With respect to the banks and the entire credit system, including securitization and trading in derivatives, the key question is not whether or not some institutions are too big to fail but rather: What is the most efficient, cost-effective and equitable approach to ensuring that credit is available on reasonable terms to support economic recovery and the fiscal stimulus programs?

4. I would want to point out that in thinking about this problem we seem to suffer from definitional confusion, because what we mean by banks includes, on the one hand, utility banks that take deposits, process transactions and make loans and, on the other hand, financial services conglomerates that may or may not include utility banking together with host of other activities from securities to insurance.

5. Behind the idea of too big too fail lies a valid concern about the risk to an international system of money transactions in which utility banks are but a small downstream node. Thus systemic risks affect the availability of credit in the domestic economy down to the level of consumers, but they also point outward to matters of foreign affairs and national security. Historically, systemic risks of the magnitude we are facing today have been associated with political upheaval and war. These concerns need to be brought into the discussion about the banking system.

Posted by: rfreudthroneofdebtcom | April 20, 2009 9:34 PM | Report abuse

Will the committies please recognize that our country's integrity which is represented by it's currency, depends upon their right responses to the problems for which they are charged to solve. And with that, can they please recognize that the country and indeed the world, believes their should be a clear and proper investigation of the possible conflicts of interest that were acted upon in the fall, to deny Lehman a 6 billion dollar loan, and bank holding status (or keep it held up in red tape) yet pass at this point 185billion dollars to AIG instead of taking it into receivership? If our country lets these kinds of things go unquestioned, it may destroy our currency literally, and figuratively.

Posted by: agrotera | April 20, 2009 10:39 PM | Report abuse

Mr. Johnson,
Why were Bear Sterns and Lehman Brothers allowed to fail while Goldman Sachs and Morgan Stanley were protected?? Can you please explain what would have happened if both or either one were allowed to file chap 11...probably someone has already explained this and so if you direct me to an URl, I would appreciate it. I am interested in the details....examples> all their clients (how many)would go belly up, all counter parties (how many) would go belly up, how would the event impact the financial system of other countries, etc.

Posted by: chillie | April 21, 2009 9:54 AM | Report abuse

The Summers Geithner fix is nothing less than a hail mary to save the whole globalization-corporatization joy ride, which was premised on the idea that a country (ours) which manufactures nothing but financial slight of hand, junk food, apocalyptic weapons and witless entertainment can nevertheless keep buying whatever the world can make by harnessing limitless coolie labor. Since 1980, the US economy has been based upon the credit card, which makes a very imperfect substitute for the living wage, but only in the long run which has now arrived. Nonetheless, lenders of the world bought into this fantasy and are now holding paper which can never be repaid except in Papiermarks. For a while, Suits can pretend that asset values haven't really cratered; those behind the curtain continue in power, drawing huge salaries, sounding reasonable and responsible, pooh poohing any need for change, but what they cannot seem to manufacture is a volume of transactions necessary to support a world in which most people must work in order to live. Business will not recover until asset values are allowed to fall. Unpayable debts can be liquidated only in bankruptcy. Not even the Treasury and the Fed can print money fast enough to save the lenders this time.

Posted by: jakeichase | April 21, 2009 10:30 AM | Report abuse

at the very minimum we must separate brokerage from banks. it amazes me to hear one bank downgrade another and see it actually has an affect on the stock of the 'other'.
Morgan stanley sells califonia bonds..then another division of same sells insurance against default, using the inside story on the bonds..then same creates a market in the CDS on the bonds.
Isn't this obvious to all as gross conflict of interest??
and the push back will be...oh, we have to be huge and diversified to compete internationally...BS.

TOO BIG to FAIL...TOO big to exist!!
simple slogan, sound bit might work to move this along...tail is wagging the dog and even controlling the conversation all too often.

also, off books has to go..clearly there is no such thing as off all comes back to haunt sooner then later. FED and USG is doing the same thing to deal with this...more of the same..moving picture so its hard to follow the bouncing ball..until short view media finds another lost child to focus on...or pirates perhaps, or...
and NO cds for something one does not own...plainly gambling and creating the illusion of some 'product' when nothing new is being produced...only winners and loosers in a zero sum game with brokerage fees in the middle. amazingly obvious.
so, why cannot the obvious be dealt with first and simply to get the ball rolling??

Posted by: mmdonner | April 21, 2009 1:56 PM | Report abuse

We continue to focus on the financial industries, who create shadow profits (or losses) through sophisticated manipulation processes. If this country is to survive, we will have to focus on true value added processes, such as high tech manufacturing, education and infrastructure clean up. The old model, which grew out of the post cold ward vacuum of world powers, did not serve us well. It will take a lot of discipline and power grapping, to build a better system.

Posted by: wkast | April 21, 2009 11:38 PM | Report abuse

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